FRANKFURT (MNI) – The Basel Committee’s proposal on liquidity
addresses key shortcomings but may have a negative impact on the banking
sector, financial markets and the real economy, European Central Bank
Executive Board member Jose Manuel Gonzalez-Paramo said on Wednesday.

The proposals must therefore be revisited, Gonzalez-Paramo said in
a speech for delivery to a financial conference here.

“Clearly the proposed liquidity standards address the major
shortcomings identified by the financial crisis in the area of liquidity
risk by requiring banks to increase their holdings of liquid assets and
to reduce their reliance on short-term volatile funding sources,”
Gonzalez-Paramo said.

In addition, enhancing the liquidity risk management of banks may
improve market confidence and thereby reduce the volatility in money and
capital markets, he said.

“Still, the calibration of the proposed liquidity standards needs
to be revisited to take into account the comments received during the
public consultation and their impact on the banking sector, financial
markets and the overall economy,” cautioned Gonzalez-Paramo.

Critics of the proposal had warned that it is not in line with the
severe stress scenario that is assumed, that it could result in an even
denser concentration of risks and higher cost for assets that are not
included.

“Furthermore, the design of the longer-term standard was
questioned, as it was argued that a higher level of mismatch between
assets and liabilities is necessary for banks to fulfill their
intermediation role in the economy,” Gonzalez-Paramo said.

Any change-over to a new liquidity regime needs “an appropriate
phase-in period that will allow banks to adjust their balance sheets
without an undue impact on their operations or an increase in their
reliance on central bank funding,” he argued.

Another priority for regulatory reform is the role of rating
agencies, Gonzalez-Paramo said.

“The use of credit rating in legislation, regulations, and other
supervisory policies is so widespread that I would agree with the
Financial Stability Forum which has questioned whether it is not these
policies that unintentionally give credit ratings an official seal of
approval and discourage investors from performing their own due
diligence,” he said.

“This should certainly be one of the main concerns of regulatory
authorities in the immediate future,” Gonzalez-Paramo asserted.

The crisis has taught central banks “valuable lessons in their own
risk management and have made steps in solidifying their defenses, while
remaining faithful to their objectives of ensuring price stability while
also safeguarding financial stability.”

While central banks do not face liquidity risks, they are not
immune to solvency risks, and since they take on more risks during
crises “the management of the central bank’s risk exposures is even more
important in a crisis and requires, at least then, a very carefully
designed risk management framework,” he said.

In a worst case scenario, “a recapitalization of the central bank
by the government becomes ultimately necessary, it could jeopardise the
independence of the monetary authority,” Gonzalez-Paramo warned.

–Frankfurt bureau; +49-69-720142; frankfurt@marketnews.com

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