GROUND-BREAKING new liquidity standards from the UK Financial Services Authority (FSA) could force British banks and investment companies to increase their holdings of cash and government bonds by £110 billion (€119.6 billion) and cut their reliance on short-term funding by 20 per cent in the first year alone.

If the FSA ramps up the requirements in subsequent years, as is likely, banks might have to increase their holdings of easily saleable assets by a total of £370 billion or significantly cut their reliance on short-term funding.

Yesterday’s announcement puts the UK at the forefront of international efforts to prevent a repeat of bank collapses, such as Lehman Brothers and Northern Rock.

The Group of 20 countries have pledged tighter liquidity rules, and Australia recently put forward a first draft of its plans, but the UK is the first to adopt formal requirements. UK companies will have to begin detailed reporting on liquidity in the first half of next year. “We thought it was very important to put in place a strong regime in time for the end of the recession,” said Paul Sharma, FSA director of prudential policy.

The FSA’s move may also press other countries to act more quickly because it plans to force British branches of overseas banks to comply with UK requirements unless their home state regulator has adopted similar rules and shares information with the FSA.

The FSA bowed to industry concerns about getting too far ahead of the rest of the world, saying it would not implement the rules until it was sure the recession was over.

“Pragmatism rules the day in bank regulation. Regulators are loath to force through dramatic change until economic recovery is assured,” said Huw van Steenis, analyst at Morgan Stanley

Unlike capital requirements, liquidity buffers are a prescribed share of the easily saleable assets an institution would need to survive catastrophes, such as an inability to refinance short-term debt and a run on deposits.

The FSA’s new rules draw on lessons learnt last year, when many institutions found themselves unable to sell assets previously considered liquid. Now, only cash and high-quality government bonds will count toward the requirements. The 210 affected financial institutions hold about £300 billion in eligible assets. – (Copyright The Financial Times Limited 2009)