Chairman Cox Letter to Basel Committee in Support of New Guidance on Liquidity Management
FOR IMMEDIATE RELEASE
BS&Co. Net Capital ($ billion)
Liquidity Pool ($ billion)
|10-Mar||18.1 (15.1 adjusted for customer protection rule)|
|11-Mar||11.5 (15.8 adjusted for customer protection rule)|
Holding Company Capital Ratio
The data above show that Bear Stearns' registered broker-dealers were comfortably in compliance with the SEC's net capital requirements, and in addition that Bear Stearns' capital exceeded relevant supervisory standards at the holding company level. Specifically, throughout the week of March 10 until the closing of the JP Morgan Chase transaction on Sunday March 16, Bear Stearns had a capital ratio of well in excess of the 10% level used by the Federal Reserve Board in its "well-capitalized" standard.
The data above also reflect the fact that the holding company had a pool of high quality, highly liquid assets of over $18 billion as of the morning of March 11. This was consistent with what the SEC had seen over the preceding weeks, during which SEC staff - both on-site and at headquarters - monitored the capital and liquidity positions of all the CSEs, in the case of Bear Stearns on a daily basis.
In accordance with customary industry practice, Bear Stearns relied day-to-day on its ability to obtain short-term financing through borrowing on a secured basis. Beginning late Monday, March 10, and increasingly through the week, rumors spread about liquidity problems at Bear Stearns, which eroded investor confidence in the firm. Notwithstanding that Bear Stearns continued to have high quality collateral to provide as security for borrowings, market counterparties became less willing to enter into collateralized funding arrangements with Bear Stearns. This resulted in a crisis of confidence late in the week. In particular, counterparties to Bear Stearns were unwilling to make secured funding available to Bear Stearns on customary terms.
This unwillingness to fund on a secured basis placed enormous stress on the liquidity of the firm. On Tuesday, March 11, the holding company liquidity pool declined from $18.1 billion to $11.5 billion. This improved on Wednesday, March 12, when Bear Stearns' liquidity pool increased by $900 million to a total of $12.4 billion. On Thursday, March 13, however, Bear Stearns' liquidity pool fell sharply, and continued to fall on Friday. The market rumors about Bear Stearns liquidity problems became self-fulfilling. On Sunday, March 16, Bear Stearns entered into the transaction with JP Morgan Chase. These events illustrate just how critical not just capital, but liquidity is to the viability of financial firms and how the evaporation of market confidence can lead to liquidity being impaired.
I also want to provide the Working Group with the following contextual information to provide a better understanding of how the SEC has incorporated the Basel standards into our supervision of large broker-dealers.
Under the SEC rules, a broker-dealer's holding company and its affiliates (known as consolidated supervised entities, or CSEs) may elect to be subject to group-wide SEC supervision. In electing to operate under this program, the holding company must, among other things, compute on a monthly basis its group-wide capital in accordance with the Basel standards. Further, the holding company must provide the Commission on a periodic basis with extensive information regarding its capital and risk exposures, including market and credit risk exposures, as well as an analysis of the holding company's liquidity risk.
With respect to computing capital at the holding company level, CSEs are expected to maintain an overall Basel capital ratio at the consolidated holding company level of not less than the Federal Reserve Bank's 10% "well-capitalized" standard for bank holding companies. CSEs provide monthly Basel capital computations to the SEC. The CSE rules also provide that an "early warning" notice must be filed with the SEC in the event that certain minimum thresholds, including the 10% capital ratio, are breached or are likely to be breached.
In addition to capital, liquidity and liquidity risk management are of critical importance to broker-dealer holding companies. Due to the importance of liquidity to the firms, CSEs have adopted funding procedures designed to ensure that the holding company has sufficient stand-alone liquidity and sufficient financial resources to meet its expected cash outflows in a stressed liquidity environment where access to unsecured funding is not available for a period of at least one year.
In evaluating the liquidity risk management processes at a CSE, the SEC staff considers not only capital but also the assets supported by the capital. Applying such a "liquidity standard" alongside a capital standard is critical to the effective supervision of a CSE. To assess the adequacy of liquid assets, the SEC staff takes a scenario-based approach. The CSEs have developed a set of scenarios for use internally in assessing liquidity. A key assumption underlying the scenario analysis is that during a liquidity stress event, the holding company would not receive additional unsecured funding but would need to retire maturing unsecured obligations.
Further, firms generally assume that during a liquidity crisis, assets would not be sold to generate cash. Another premise of this liquidity planning is that any assets held in a regulated entity are unavailable for use outside of the entity to deal with weakness elsewhere in the holding company structure, based on the assumption that during the stress event, including a tightening of market liquidity, regulators in the US and relevant foreign jurisdictions would not permit a withdrawal of capital. There are also considerations as to the degree a firm relies on overnight and other short-term funding versus long-term funding.
I hope this information will be of use to the Working Group as it revises its liquidity guidance for banks. I would be pleased to provide additional information or otherwise contribute to the examination of banks' liquidity management that the Working Group is undertaking.
|cc:||Michel Prada, Chairman, Technical Committee of the International Organization of Securities Commissions (IOSCO)|
|Tokio Morita, Chairman, IOSCO Standing Committee Three|
|Mario Draghi, Chairman, Financial Stability Forum|
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