H.R. 1624 requires the Federal Deposit Insurance Corporation (FDIC), the Board of Governors of the Federal Reserve System (Fed), and the Office of the Comptroller of the Currency (OCC) to treat certain investment grade municipal securities as level 2B High Quality Liquid Assets (HQLA), in order to allow these securities to be counted towards certain institution’s liquidity coverage ratio (LCR).
Liquidity is a term that can apply to assets, markets, or firms. An asset is liquid if it is easily bought and sold (i.e., converted into cash). Markets are generally considered to be liquid if there are many ready buyers and sellers. Banks hold liquid assets to reliably meet cash flow needs, which may be variable and unpredictable. When banks hold more liquid assets, they hold fewer loans, which are generally illiquid. Additionally, the Federal Reserve is authorized to set bank reserve requirements which require banks to hold a certain percentage of its liabilities in cash based upon the entity’s transactions.
In response to acute liquidity shortages during the 2008 financial crisis, the Basel Committee on Banking Supervision (Basel Committee), of which the United States is a member, agreed to modify internationally negotiated bank regulatory standards known as the Basel Accords, to increase certain financial institution’s liquidity requirements. On September 3, 2014, the OCC, the Fed, and the FDIC issued a final rule that implements the Liquidity Coverage Ratio (LCR) rule consistent with the Basel Committee’s standards. The final rule is designed to strengthen the liquidity risk management of banks, savings associations, and bank holding companies.
The LCR rule aims to require banks to hold enough High Quality Liquid Assets (HQLA) to match net cash outflows for 30 days during a hypothetical scenario of market stress where creditors are withdrawing funds. An asset can qualify as a HQLA if it has low risk, has a high likelihood of remaining liquid during a crisis, is actively traded in secondary markets, is not subject to excessive price volatility, can be easily valued, and is accepted by the Federal Reserve as collateral for loans. The final rule establishes three levels of qualifying liquid assets (level 1, level 2A, and level 2B), with level 1 being the most liquid and level 2B being least liquid.
The final rule excludes municipal securities from HQLA treatment. However, the Fed issued a new rule in April 2016 to classify non-revenue municipal bonds as level 2B HQLAs but neither the OCC nor the FDIC followed the Fed’s lead. This has created a bifurcated regulatory system as some national banks are subject to the OCC’s rule, which would still exclude municipal securities from favorable liquidity treatment. H.R. 1624 requires these regulators to amend the LCR rule in a unified way by reclassifying investment grade municipal securities as level 2B HQLAs.
H.R. 1624 is similar to H.R. 2209, which passed the House on February 1, 2016, by voice vote. H.R. 2209 reclassified municipal bonds as level 2A HQLAs. Under the current LCR, level 2A assets are treated at a 15% discount and level 2B assets are treated at a 50% discount, compared to cash which has no discount. In June 2017, the Treasury Department issued a report that recommends certain municipal securities be reclassified as level 2B HQLAs. During Committee consideration of H.R. 1624, an amendment was adopted by voice vote to adjust the treatment of municipal obligations from 2A to 2B, reflecting the Treasury recommendations.