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NSFR is an Unreliable Guide to Banks’ Liquidity Situation and Could Restrict Credit Availability

By Bill Nelson and Francisco Covas

TCH research note finds NSFR may have substantial economic costs and doubtful benefits


Sean Oblack

Washington, DC  – July 5, 2016 – In a new research note, The Net Stable Funding Ratio: Neither Necessary nor Harmless, The Clearing House finds the Net Stable Funding Ratio (NSFR) has no clear, defining objective and its benefits are in doubt while its economic costs may be substantial.  The research note explains that absent a defining objective for the NSFR, the basis for its calibration is unclear. It also finds that, although U.S. banks are likely to be able to comply with the NSFR in today’s economic environment without major adjustments, as the Federal Reserve’s balance sheet and interest rate normalize over time, compliance is likely to restrict credit. 

“The calibration of the NSFR appears to be based simply on the subjective judgment and negotiations of the BCBS rather than on a well-specified conceptual basis,” The Clearing House writes in its research note.  “With substantial costs and doubtful benefits, a natural question is whether the NSFR is still needed. That question is especially pertinent because the regulation is likely to become increasingly impactful over time, reducing credit availability and economic growth.”

The NSFR was meant to complement another Basel Committee liquidity rule, the Liquidity Coverage Ratio (LCR).  The LCR was designed to ensure that a bank has enough liquidity to sustain a severe 30-day stress episode, while the NSFR, at least as initially defined, was supposed to ensure that a bank has enough liquidity to sustain a less severe but longer one-year stress episode. However, the Basel Committee, and now the Federal Reserve in its proposed rule, dropped the concept of a stress scenario for the NSFR.  Without this conceptual framework, the U.S. proposal made arbitrary and unworkable weighting decisions, which has made the two regulations inconsistent and made the NSFR an unreliable guide for a bank’s liquidity position. As an example, the note finds it could be possible that a bank is assumed to be able to take a liquidity providing action over the LCR’s 30 day episode of severe stress, but unable to take the same action over the NSFR’s one year horizon of less severe stress.  In an additional example, the research note demonstrates how a bank could pass the NSFR and be at risk of default.

The research note concludes that problems with the design and calibration will lead to many unintended consequences that are likely to result in substantial economic costs.   The research note provides empirical analysis suggesting that the NSFR could drive down loan growth substantially for several years, and restrict credit to households and small businesses. 

About The Clearing House.  The Clearing House is a banking association and payments company that is owned by the largest commercial banks and dates back to 1853.  The Clearing House Payments Company L.L.C. owns and operates core payments system infrastructure in the United States and is currently working to modernize that infrastructure by building a new, ubiquitous, real-time payment system.  The Payments Company is the only private-sector ACH and wire operator in the United States, clearing and settling nearly $2 trillion in U.S. dollar payments each day, representing half of all commercial ACH and wire volume.  Its affiliate, The Clearing House Association L.L.C., is a nonpartisan organization that engages in research, analysis, advocacy and litigation focused on financial regulation that supports a safe, sound and competitive banking system. 

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