Yellen Promises To Reconsider Exempting Munis From HQLA

WASHINGTON — Federal Reserve chairwoman Janet Yellen promised a Senator that she would look into concerns that banking regulators' proposed liquidity rules would hurt the municipal market.

Yellen made the remark in response to a question from Sen. Kay Hagan, D-N.C. during a hearing held on Tuesday by the Senate Banking Committee. Hagan said she is concerned that the proposal by bank regulators to exclude municipal securities as high quality liquid assets for certain banks "could restrict the ability of state and local governments to raise the capital they need to finance [projects] for schools and hospitals and roads, airports, and … other infrastructure systems."

"What is the justification for excluding these municipal securities when other types of debt, including foreign sovereign debt, are covered?" Hagan asked, adding, "It seems like a strange outcome to me for the debt of some foreign countries to be treated more favorably than the AAA-rated debt of states like North Carolina."

Yellen said the rationale for excluding munis is that their liquidity "is substantially lower than any of the assets that are included on that list" of HQLA.

Hagan asked her to consider the muni exclusion's impact. Yellen said, "We will look at those comments."

Banks, broker-dealer groups, issuers and others have all adamantly urged that munis be excluded from the proposed rules, which are designed to create a standardized minimum liquidity requirement for large and systemically important banks and other financial institutions. The proposed rules would require these institutions to maintain a minimum liquidity coverage ratio, defined as the ratio of HQLA to total net cash outflows over a 30-day period of stress.

But the firms, groups, issuers, and even Fitch Ratings have all warned that excluding munis as HQLA will cause banks to make fewer investments in munis, decrease demand and liquidity for munis, while increasing borrowing costs.

The Securities Industry and Financial Markets Association on June 30 tried to address the banking regulators' specific questions and concerns about the liquidity of munis. SIFMA told them that while the proposed rules are intended to implement the Basel III liquidity coverage ratio, the muni exclusion would be "contrary to the Basel Committee on Banking Supervision's suggested treatment of marketable debt issued by 'public sector entities,' including state and local governments."

The regulators asked how much time it would take to liquidate a $30 billion to $50 billion muni portfolio with minimal market impact. SIFMA said it is reasonable to expect that a $30 billion could be liquidated over 21 business days. The regulators also asked about the relationship to muni credit quality and liquidity. SIFMA said investment-grade munis generally satisfy the proposed HQLA criteria and provide greater liquidity than other munis. SIFMA also said that while some individuals may buy and hold munis, other retail investors, banks, funds, and insurance companies do not.