Basel III and liquidity

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Probably the most scary period of the GFC (to date) was after Lehmann Brothers collapsed and the GFC became a global liquidity crisis. To try and avert future liquidity crises regulators have been working hard to ensure that financial institutions will in future hold higher levels of liquid assets. Not quite back to the days of SRDs and LGSs (statutory reserve deposits and liquid and government securities requirements for those too young to remember) but among the requirements is that banks hold a level of liquid assets sufficient to cover 30 days required liquidity. Assets allowed under the regulations include cash, central bank deposits and government securies among other assets (see the article here from Risk magazine for a good description). The liquidity requirements are supposed to come into full force in 2015. The requirements are already creating some difficulties for countries like Australia where government bonds don’t exist in sufficient quantity. But a question I have is what happens when a Euro country defaults (which is quite likely to be before 2015)? It looks to me that the whole system at that point becomes a bit shaky. I’d appreciate comments on this one, as I hope others have more expertise and can enlighten me, but I am very worried that BASEL III is built partly on the liquidity and solvency of governments – in some cases pretty sandy foundations.

2 Responses to "Basel III and liquidity"
  1. Hmm, 
    Interesting stuff there. Who’s to say that having assets you can sell faster will give you a company that’s good for the economy anyway?
    It’s my understanding that the real problem that led to the GFC was that banks were giving out irrational loans because of the numbers that supported it rather than it actually making any practical sense to do so.
    Economics worked great when demand was simple (demand was governed by what people wanted or needed, supply was governed by what had been produced) 
    Now, though, things are a lot more complicated.
    The whole reason supply and demand worked was that it was a more or less direct representation of what we needed and how easy it was to get it. Now, though, with investment, and loans being bought and sold like commodities, stocks going up and down in value based on whether they’re going (or will be going) up or down in value. I’d like to think that capitalism is the best way for society to work, but I’m not quite sure where it’s going. 
    Oh, and as for Government bailouts and subsidies – that just completely ignores the natural ecosystem of an economy. Justifying that’s like trying to tell Charles Darwin why it’s okay to keep inferior species alive. It messes up progress when you protect something that’s flawed. And it messes up supply and demand when people base what they want on supply and demand itself.

    Glad I got that out of my system.

  2. Ollie,
     
    Poor lending practices were certainly the initial factor that lead to the liquidity crisis. However, financial institutions’ low level of reserve funds exacerbated the problem. Since there are many different forms of shocks that can affect liquidity, it makes sense to treat the poor lending practices and the level of reserve funds separately.
    The obligatory car analogy is that improving cars’ safety features in response to an accident is a good idea even if the cause of an accident was poor driving, because accidents can be caused by factors other than poor driving.

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