* Basel Committee to discuss liquidity on Sunday
* Regulators set to relax timing on liquidity ratio-source
* Threat of credit crunch prompts rethink
* Banks would have had 1.8 trillion euro funding shortfall
By Steve Slater and Huw Jones
LONDON, Jan 4 (Reuters) - Europe’s credit-starved economies look set to be the main beneficiaries of plans to relax new rules and give lenders more time to build up their cash buffers.
The Basel Committee of global regulators will on Sunday give banks longer to comply with stricter new rules on the amount of liquid assets they hold, a regulatory source said on Thursday. Further tweaks could also be seen.
Banks have been fighting hard to delay implementation and alter parts of the liquidity coverage ratio (LCR) rules - governing the level of easily tradeable assets such as government bonds they need to hold to ensure their stability if markets freeze up.
Some top regulators have also warned the original rules, due to come into force by 2015, will cut lending just when they are trying to encourage the flow of money to help kick-start economic recovery.
“The banks have made quite marked progress in addressing the issue of liquidity since the crisis. Basel now seems to be worried about the danger of a knock-on impact on the wider economy,” said Chris Wheeler, analyst at Mediobanca in London.
“Banks are still deleveraging ... so they (regulators) seem keen to provide a little bit of leeway, on the basis that progress has been made, and they don’t need to force it,” Wheeler added.
A senior executive at a top European bank last year told Reuters the LCR needed to be eased significantly as it was too prescriptive and could spark another huge wave of deleveraging, or banks cutting their loan books.
The liquidity rules will run alongside tougher capital rules - covering the amount banks have to hold to absorb losses - which have already forced banks such as Royal Bank of Scotland , Lloyds, Citi, BNP Paribas and Societe Generale to aggressively shrink their balance sheets.
That has been achieved largely by shedding capital-markets assets, including derivatives on toxic sub-prime mortgages, or overseas loans, but a second wave of deleveraging was likely to land closer to home and hit domestic lending, the top bank executive warned.
The Basel Committee, made up of supervisors from nearly 30 countries, will discuss the liquidity issue at a meeting on Sunday. Regulators have for some time been expected to approve easing some parts, although they remain keen to be seen to be taking a hard line on banks.
The aim is to better protect taxpayers from having to bail out banks and avoid a repeat of the 2007-09 financial crisis. A liquidity rule could have prevented the short-term funding freeze that brought down lenders like Britain’s Northern Rock.
Investors, too, are keen to see banks meet new rules early. That will help Basel relax the rules on timing, analysts said, as banks are aware they could be punished by investors if they lag behind rivals in meeting new standards.
Most regulatory focus has been on strengthening capital and higher capital rules being phased in from this month are due to be fully implemented by 2019.
Yet the LCR is another key plank of Basel III, aiming to ensure banks have a stable funding structure and hold enough easy-to-sell assets to survive a 30-day credit squeeze in times of stress.
The implications are huge.
If the LCR had been in force at the end of 2011, the world’s biggest banks would have needed 1.8 trillion euros more liquidity, or about 3 percent of their assets, the Basel Committee has estimated.
Most of the shortfall is in Europe, where banks would have needed about 1.2 trillion euros, or 3.7 percent of their assets, Europe’s banking regulator estimated. Banks in France and Spain are among those most at risk of falling short, some analysts said.
In addition to wanting more time, banks say more assets should be eligible and deemed highly liquid, possibly including mortgage-backed securities.
“A phasing in of the LCR would enable banks to better finance growth as the economy recovers, rather than stashing assets away in government bonds,” said Simon Hills, director at the British Bankers’ Association.
“And including retail mortgage-backed securities in the LCR buffer would stimulate the securitisation market, enabling banks to shift good-quality mortgages off their balance sheet (and) freeing up capacity for the new loans to SMEs (or small and medium-sized firms) that they want to make,” Hills added.
Banks that have a shortfall need to scale back their lending or business activities that are most vulnerable to a short-term liquidity shock, or lengthen the term of their funding beyond 30 days, or opt to hold more liquid assets.
Yet the measures themselves are not risk free.
Industry sources say potential unintended consequences of the rules include an even greater emphasis on holding government bonds, which the euro zone crisis has shown carry their own risks; banks chasing a limited pool of retail deposits; and a possibility that more disclosure on liquid assets creates scope that short-term changes will panic investors.
Banks do not typically release LCR data. The Basel Committee’s last assessment said at the end of 2011 the average ratio across the 102 biggest global banks was 91 percent and across the next 107 banks 98 percent - short of the required 100 percent.
Some 38 percent of the banks in the sample would have had a ratio of below 75 percent, signaling they would need to take significant action.