Two members of the Senate Banking Committee have reintroduced a bipartisan bill that would encourage large banks to hold more municipal bonds by requiring that the bonds be treated as high-quality liquid assets.

Mike Rounds
Sen. Mike Rounds, R-S.D. introduced a bill to require bank regulators to treat certain municipal bonds as high-quality liquid assets. Bloomberg News

The bill, S. 828, introduced by Sens. Mike Rounds, R-S.D., and Mark Warner, D-Va., on Wednesday, is the same measure they offered last September, and similar to legislation that has been pending in the House since March.

The measure in the Senate, which has nine co-sponsors including Senate Minority Leader Chuck Schumer, D-N.Y., would require bank regulators to treat investment grade, liquid and readily marketable municipal securities as level 2B high-quality liquid assets (HQLA), the lowest level of HQLA, which also includes corporate debt and publicly traded common stock. That would mean these munis could account for up to 15% of a large bank’s total HQLA.

The Municipal Finance Support Act of 2017 (H. R. 1624), which was introduced in the House on March 20 by Reps. Luke Messer, R-Ind., and Carolyn Maloney, D-N.Y., would go even further and treat municipal bonds that are investment grade, liquid, and readily marketable as level 2A HQLA, which is the middle level of HQLA and includes the debt of U.S. government-sponsored enterprises such as Fannie Mae and Freddie Mac and foreign sovereign debt. That would mean these munis could account for up to 40% of a large bank’s HQLA.

Messer’s bill is identical to the one he introduced in the last Congress that was approved by the House in February 2016.

These bills have all been filed in response to a rule adopted by bank regulators in 2014 to create a standardized minimum liquidity requirement for large banks to ensure they can easily and immediately convert assets to cash during a period of liquidity stress. Under the rule, banks with at least $250 billion of total assets or consolidated on-balance sheet foreign exposures of at least $10 billion must hold HQLA in an amount equal to or greater than its projected cash outflows minus its estimated cash inflows during a 30-day stress period. The ratio of HQLAs to projected net cash outflows is the liquidity coverage ratio.

Bank regulators did not include municipal securities as HQLA under the rule because they felt munis were not liquid enough.

Dealers and issuers protested, claiming that this would discourage banks from holding munis, increase borrowing costs for state and local governments and lead to higher volatility in the muni market.

In April of 2016, the Federal Reserve Board amended its rule to allow a certain amount of investment grade general obligation bonds backed by the full faith and credit of a state or locality to be counted as level 2B HQLA if they meet the same liquidity criteria that apply to corporate debt. Only 15% of an institution’s total HQLA can be level 2B assets. However the Fed said an institution can only hold up to 5% of its total HQLA as these munis.

Muni market participants said the revised rule was still too restrictive and also noted that it only applies to bank holding companies and certain savings and loan holding companies. It does not apply to national banks regulated by the Office of the Comptroller or state-chartered banks regulated by the Federal Deposit Insurance Corp. since these regulators have not changed their rules.

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