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Federal Reserve sets tough cash requirements for big banks

The Federal Reserve moved on Wednesday (Sep 3) to require top banks to hold more super-safe assets to reduce the possibility of a liquidity squeeze like that which devastated the industry in 2008.

WASHINGTON: The Federal Reserve moved on Wednesday (Sep 3) to require top banks to hold more super-safe assets to reduce the possibility of a liquidity squeeze like that which devastated the industry in 2008.

Under new capital rules, the largest US banks will have to keep a higher level of very liquid assets to be able to withstand a crisis situation like that of six years ago, when the government was forced to prop up cash-squeezed major banks and let hundreds of smaller institutions collapse.

But the new rule could have an impact on bank earnings, because they will have a smaller portion of their assets available for more lucrative lending and investment activities.

The stringent minimum liquidity coverage ratio will be applied to banks with US$250 billion or more in assets, with a lower ratio set for those with more than US$50 billion in assets. It is based on an international standard set by the Basel Committee on Banking Supervision.

"As the financial crisis demonstrated, most of our largest and most systemically important financial institutions used excessive amounts of short-term wholesale funds and did not hold a sufficient amount of high-quality liquid assets to independently withstand the stressed market environment," Fed Chair Janet Yellen said.

Fed Governor Daniel Tarullo, who oversees banking regulation, said that behind the contagion that spread through the US financial system in the crisis was a liquidity squeeze - when nervous banks pull back from lending in the interbank market, drying up access to short-term funds needed by other institutions to balance their books.

Tarullo said the new rules make such squeezes less likely because it limits the size of the liquidity risk a large bank can take.

The new ratio will be partially enforced starting January 1, 2015, and fully by January 2017, giving the banks time to increase their level of liquid assets without forcing them to rapidly pull back on lending.

The toughest ratio will apply to the 15 largest US banks, and another 17 will come under a less stringent ratio. In all, the rules would force the banks to set aside US$2.5 trillion as "high quality liquid assets."

The Fed said about 70 percent of the banks could already meet all the requirements of the new rule, while the rest will have to make adjustments in their assets to do so.

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