Acting Comptroller of the Currency Discusses Potential Short-Term Liquidity Rule at Law School Event

Troutman Pepper

On January 18, at an event hosted by Columbia University Law School, Acting Comptroller of the Currency Michael J. Hsu discussed liquidity risk at banks and described potential “targeted regulatory enhancements” that would require midsize and large banks to have sufficient liquidity to cover “ultra-short-term” stress outflows over a five-day period. The rationale for the enhancements stem from last year’s large bank failures and are intended to ensure that updated liquidity and risk management practices are implemented and sustained across midsize and large banks.

According to Comptroller Hsu, such a new requirement would help de-stigmatize the Federal Reserve’s emergency “discount window,” which he sees as underutilized by banks as such borrowing could be perceived as a sign of weakness, while maintaining existing longer-term liquidity regulations, which require large banks to hold liquid assets sufficient to meet stressed liquidity outflows over a 30-day period.

The enhanced requirement would be effectuated by having the denominator of the rule consider the potential speed and severity of uninsured deposit outflows and the numerator consider the liquidity value of pre-positioned discount window collateral, in addition to reserves. “Adopting a separate liquidity requirement for ultra-short-term outflows could provide a safe space for appropriate discount window usage, while maintaining a credible stance against bailouts in longer-term stress scenarios.”

Comptroller Hsu sees the need for new or enhanced guardrails on liquidity risk becoming even greater as the speed of transactions continues to quicken. “As we transition towards a faster payments system and possibly tokenization of real-world assets and liabilities, banks may need to further enhance their liquidity risk management capabilities to keep up.” According to Comptroller Hsu, faster payments can lead to faster fraud and limited ability to remediate erroneous transactions, which necessitates enhanced liquidity risk management, third-party risk management, and fraud and compliance risk management.

In conclusion, Comptroller Hsu advised “[b]anks and regulators should start working now on building the right brakes for a more real-time financial system” and vowed to work with interagency peers, banks, academics, and other stakeholders on this task.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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