Another new pillar of Basel III is the requirement that financial companies hold a “liquidity buffer” to guard against unforeseen events (stress). The buffer is essentially made up of two components, represented by a Liquidity Coverage Ratio (LCR) and a Net Stable Funding Ratio (NSFR):
- The LCR mandates that a financial institution hold enough high-quality/low-risk assets (e.g., cash, government bonds) to cover projected net cash outflows under conditions of acute stress over a 30-day period. Acute stress conditions can be defined by significant losses of deposits, loss of access to secured and unsecured funding sources, calls on credit and liquidity facilities, etc.
- The NSFR requirement aims at a similar goal but over a one-year period, mandating that at least 100 percent of assets be funded through stable sources, with both assets and funding sources weighted according to stability, tenor, and overall risk profiles.
- Would an individual affiliate need to hold a liquidity buffer if it were independent? (Regulators in many countries are expected to apply the Basel III standards to local affiliates.)
- If a separate buffer is needed, how do associated costs compare with what might be allocated from a central treasury?
- Are loans to affiliates priced on an arm’s length basis, i.e., treating them as stand-alone entities?
- Is the treasury operation treated as a profit or cost center?
- Are there (or will there be) any inbound charges for liquidity buffers held by an overseas affiliate?
- What is the institution’s schedule for adopting the new standards, and what methods/systems will be available to gauge their impact?
Precise translation of the Basel III guidelines on liquidity (and for that matter capital ratios) to specific rules will be the responsibility of national banking regulators in each country over the coming months and years. Some variation in country approaches is to be expected, though the 2008 financial crisis will likely force a greater degree of uniformity than was the case for the Basel II standards. National banking authorities are already signaling possible flexibility in the definition of high-quality assets for the LCR, for example. Financial institution tax departments would be well-advised to follow these regulatory developments closely in all countries in which they operate, as well as to familiarize themselves with liquidity management tools which might be useful in implementing any needed changes to transfer pricing policies.
Source: Ceteris' Transfer Pricing Times, Volume IX, Issue 10