Federal Reserve Approves Restrictive Rule on High Quality Liquid Assets

Thursday, April 7, 2016

On April 1, 2016, the Federal Reserve Board announced that it will adopt a final rule that would classify a very limited number of investment-grade, liquid, and readily marketable municipal securities as high quality liquid assets (HQLA). The Federal Reserve’s action follows its May 2015 to amend the 2014 Liquidity Coverage Ratio rule, which classifies foreign sovereign debt securities as HQLA while excluding investment-grade municipal securities in any of the acceptable investment categories for banks to meet new liquidity standards.

While GFOA appreciates the Federal Reserve’s efforts to enable some municipal securities to be classified as HQLA, the rule is very restrictive in its approach – allowing investment-grade, liquid, and readily marketable general obligation bonds to be classified as HQLA, but not revenue bonds, for instance. The rule is made more restrictive because it is only being adopted by the Federal Reserve, which has jurisdiction over two of the nine bank holding companies with more than $250 billion in assets affected by the 2014 Liquidity Coverage Ratio Rule. This means that the other seven banks affected by the 2014 rule, which are larger purchasers of muni securities and fall under the jurisdiction of the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of Currency (OCC), will still not be permitted to classify any municipal securities they are holding as HQLA.

Not classifying municipal securities as HQLA would increase borrowing costs for state and local governments to finance public infrastructure projects. This is because banks would likely demand higher interest rates on yields on the purchase of municipal bonds during times of national economic stress, or even forgo the purchase of municipal securities. The resulting cost impacts for state and local governments could be significant, with bank holdings of municipal securities and loans having increased by 86% since 2009.

To address GFOA’s concerns with the 2014 rule, the Federal Liaison Center worked with GFOA’s state and local association partners and a dedicated group of bipartisan House members to secure House approval of HR 2209 on February 1. HR 2209 would require all federal regulators – Federal Reserve, the FDIC and OCC – to classify all investment-grade, liquid, and readily marketable municipal securities as HQLA. The bill would apply to all nine bank holding companies affected by the 2014 rule.

GFOA is working with members of the Senate Banking Committee to introduce legislation like the House-passed HR 2209, and needs your help in reaching out to members of the committee, encouraging them to help us. If your Senate representative sits on the committee, please send them a letter requesting their supporting in introducing this important legislation. A list of members of the committee is available here, and a draft letter outlining the need for this legislation is available here.