The Financial Services Authority (FSA) has announced a far-reaching overhaul of the liquidity requirements expected of financial institutions in the future with its Strengthening Liquidity Standards (PS09/16) document (see HERE for more). The new rules are intended to enhance firms' liquidity risk management practices in light of lessons learnt during the credit crisis. Simon Hills, executive director, prudential capital & risk, British Bankers' Association (BBA), gives the industry response

Importantly, the FSA has said that it intends to introduce its new liquidity rules even if an international consensus in liquidity regulation cannot be reached. While it is clear that no one would like to see a repeat of the Northern Rock experience, it is equally clear that the solution cannot be one that involves choking off Britain's economic recovery or giving up our status as a world-leading centre for international finance, with stricter rules in force here than elsewhere. But these are the very consequences we could face if the FSA were to allow its new liquidity rules to constrain bank lending (by requiring them to hold more higher quality government bonds) or to put UK banks at a competitive disadvantage with requirements that are out of step with those in other financial centres around the world.

The FSA's new rules will restrict banks' ability to diversify their assets, requiring banks instead to hold large amounts of government bonds. While these bonds are highly liquid, it goes without saying that any money a bank is required to hold in a 'liquidity buffer' is then unavailable for lending - and the return on such bonds is as low as it gets. Considered across all of the banks to which the new requirements will apply, this will add up to a considerable reduction in the amount of money banks could lend, both to individuals and to businesses across the UK. In an economy that is struggling to pull itself out of a long and deep recession this could be disastrous.

The new rules include wide-ranging requirements for the identification, measurement and monitoring of risk, alongside control measures, risk reporting and contingency planning to strengthen a firm's ability to withstand shocks. Financial institutions across the UK will need to introduce new technology systems and procedures. They will have to create daily, weekly and monthly reporting systems to get data from a wide variety of sources - all of which will add up to considerable additional costs for many firms. Inevitably, the transition to the new regime will also have a significant impact on banks' business models. To make its proposals work the FSA must now be prepared to take a flexible approach to implementation that is sensitive to the significant changes that banks must now make.

The FSA have listened to industry concerns by delaying the calibration of the liquidity buffer until economic recovery has taken place. To this end the FSA will also undertake a full cost/benefit analysis by the end of Q1 2010, examining the interplay between increased capital and liquidity requirements and their impact on banks' continuing ability to lend. By the middle of next year, the FSA aims to provide Individual Liquidity Guidance (ILG) to the large UK financial institutions on how much liquidity to hold, with others (for instance UK branches of overseas banks) following on behind. This guidance will also set a flight path over four years on how to reach the required quantum of liquidity.

The Bank of England has also been helpful, with its recent announcement that all UK banks, including the very smallest, will now have access to reserves accounts and other sterling monetary framework facilities. This should enable smaller banks to more easily meet the FSA's quantitative liquidity requirements, when they are introduced.

Among all of the G20 nations, the UK's FSA has gone further than any other national regulator in creating a far-reaching liquidity scheme of this nature. The regulator takes pride in this fact, and argues that the scheme will bring about "substantial long-term benefits to the competitiveness of the UK financial services sector". The FSA argues that London's competitive position depends on the perception of the financial soundness of the firms that operate in the UK. And that higher levels of financial soundness can provide a sustainable long-term competitive advantage. However, I believe that if the UK acts alone now the short-term damage to our competitive position could render any long-term benefits a pipe dream. Experience shows that in a truly globalised economy business is very quick to relocate if conditions in one country become less competitive. We must not allow Britain's financial services industry to be put out on a limb.

What is most needed in dealing with these issues is international consensus, to ensure that no country is unfairly advantaged - or disadvantaged. This message has been made repeatedly at global meetings of the G20, with assurances that major nations will work together to find solutions. The FSA itself says it recognises that it may be some time before there is global agreement on specific proposals. We must now strive to ensure that there is global agreement: by going it alone we would only harm the attractiveness of the UK as a place to do business. The consequences of this would be felt not just by our financial services industry, but throughout the British economy in the form of lost jobs, tax receipts and export earnings.

• For the latest FST feature on the new liquidity requirements facing the industry please click HERE

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