WASHINGTON — A proposed House bill to treat investment grade and actively traded municipal securities as high quality liquid assets received support from members of a House Financial Services Committee panel as well as banking experts during a hearing on Wednesday.
The subcommittee on financial institutions and consumer credit discussed seven bills, including one Rep. Luke Messer, R-Ind., introduced on May 1 to treat certain munis as HQLA under a bank liquidity rule banking regulators adopted last September.
The rule requires banks with at least $250 billion of total assets or consolidated on-balance sheet foreign exposures of at least $10 billion to have a high enough liquidity coverage ratio — the amount of HQLA to total net cash outflows — to deal with periods of financial stress. Assets are considered HQLA if they can easily be converted into cash with no loss of value during a period of liquidity stress.
But the Federal Reserve Board, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corp. adopted the rule, which banks would have to comply with by Jan. 1, 2017, without including munis as HQLA because of concerns they are not liquid or easily marketable.
Following industry complaints and requests for reconsideration, the Fed proposed amendments to the rule in May that would allow a limited number of munis to be treated as HQLA as long as they are, at minimum, uninsured investment grade general obligations bonds. The bonds would be considered Level 2B, the same as corporate bonds that are liquid and readily marketable, but could only make up 5% of a bank’s HQLA.
Messer’s bill would be more generous to munis. It would treat munis that are investment grade and actively traded in the secondary market as Level 2A assets, the same level as some sovereign debt and debt of U.S. government entities like Fannie Mae and Freddie Mac. The bill would apply to all bank regulators and allow for munis to account for up to 40% of a bank’s HQLA.
Industry groups have supported Messer’s bill saying the Fed’s unilateral proposal is a welcome attempt, but ultimately too narrow to be effective. The FDIC and OCC regulate the majority of the larger institutions, so their failure to also consider amendments means the Fed proposal would not go far in changing market practices.
Paul Kupiec, a resident scholar with American Enterprise Institute, and Oliver Ireland, a partner at the law firm of Morrison & Foerster, both told subcommittee members at the hearing that Messer’s bill is a necessary addition to the liquidity rule discussion.
Kupiec said the bill is “appropriate and consistent with the public interest” and added that any rule that limits an institution’s ability to hold muni bonds cannot be a good thing for states and municipalities. He also recommended the bill be expanded to include munis that already meet Level 2B requirements.
The rule is like a “self-fulfilling prophecy,” said Ireland, who added that the demand generated by the designation of HQLA may create liquidity and result in a lower yield on the assets and lower-cost funding to the issuing entities.
“In order to assure an efficient market for municipal obligations, it is important that those obligations receive the appropriate classification in the rules,” Ireland said.
Reps. Carolyn Maloney, D-N.Y., Ruben Hinojosa, D-Tex., and Gregory Meeks, D-N.Y., all said they were concerned that, without a broader inclusion of munis in the LCR requirements like Messer’s bill would provide, municipalities in their districts would suffer from higher borrowing costs.
The third panelist in the hearing, Americans for Financial Reform policy director Marcus Stanley, diverged from the majority. He said that while AFR shares concerns that munis may be treated unfairly under the rule, especially when compared to accepted corporate bonds with similar characteristics, Messer’s bill goes too far and risks micromanaging regulators.
Any changes should be done through regulatory action and not legislation, Stanley said.
The subcommittee does not have a scheduled to vote on Messer’s bill, but a committee spokesperson said information on one will be forthcoming.
