Liquidity rules hinge on economy - FSA

LONDON (Reuters) - The top financial watchdog said on Thursday it was on track for introducing tough new liquidity rules for banks from the fourth quarter, but said full implementation would depend on the economic climate.

The Financial Services Authority (FSA) said the timing of the second phase of the proposals -- which will determine the size of banks' liquidity buffers -- has been cast into doubt by the worst recession in living memory.

"Even though we've said we aim to have this (the second phase) in Q1 2010, if we are still in recession, we will not be bringing in the quantitative element," an FSA spokeswoman told Reuters, noting that an industry consultation had yet to end.

"We will not be introducing anything that will make the current climate worse."

After a freeze on credit spawned a global recession and brought banks around the world to their knees and crawling to the taxpayer for cash, Britain has led Europe with proposals to address liquidity, the forgotten child of regulation.

Banks have said the "quantitative" phase, under which they will have to amass huge investments in safe securities such as gilts to help soften the impact of future crises, would be hard to achieve by the original target of the first quarter of 2010.

But they have been betting on a relaxation of the timetable for the proposals, which are expected to slice billions of pounds off the industry's annual profits -- and which were designed to force the sector to be self-sufficient in a crisis.

HAUNTED MEN

Bankers beavering away in risk and compliance departments, dubbed "the men with the haunted look in their eyes" at a recent industry conference, have hoped the FSA would delay implementing plans by as much as one year.

"The biggest impact is the need to build up the buffer of liquid assets and, practically speaking, it may take time for institutions to re-adjust themselves to do that," notes one veteran banker.

"But we're operating on the basis that it won't be the first quarter (of 2010). The expectation is that it will be pushed out by some period of time -- potentially, to the following year."

The FSA, which oversees UK financial stability and banking alongside the Bank of England and finance ministry, is keen to avoid piling demands onto a fragile banking sector, but equally wants to try and make amends.

For it admits that along with international peers, it failed to spot banks' increasing reliance on wholesale interbank funding, funding from abroad, off-balance sheet vehicles and long-term contractual assets financed by short-term debt.

GLOBAL HARMONY

But banks have also warned against unilateral plans, that analysts expect will force banks to amass up to an estimated 250 billion pounds in gilts, they say potentially deepening the recession, threatening Britain's competitiveness and damaging lending further.

The FSA stressed it was keen for global agreement. "We are still pushing for a global liquidity standard," the spokeswoman said.

Any delay in fully implementing liquidity proposals will not only allow the rest of Europe to catch up with similar requirements. The Conservative Party is expected to win a general election due by next June, and it has vowed it will strip the FSA of its supervisory powers.

The FSA's proposals are just part of Britain's response to the near-collapse of the financial system last October.

Measures are also underway at European Union and global levels to address a dangerous gap exposed by the financial crisis -- that many markets and banks operate internationally, while regulation tends to be national.

(Additional reporting by Huw Jones; editing by Elaine Hardcastle)