Desirable and undesirable side effects of the FSA's new liquidity rules

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So, the FSA has become, "the first major regulator to introduce tighter liquidity requirements" for banks. The new requirements won't actually be applied until, "economic recovery is assured," but "qualitative rules" on weekly liquidity reporting will be imposed from December. Repercussions will therefore be visible soon. Expect to see -

An army of liquidity professionals

"This will create a whole new subspecies- the liquidity expert," predicts Harvey Knight, a regulatory consultant at Withers LLP and former lead authorisation and approvals lawyer at the FSA.

Where will this liquidity expert sit? He's likely to straddle risk and compliance, says Knight. If there's also a rush to install liquidity reporting software and update existing systems, he could be joined by business analysts, software developers and project managers.

Even more emphasis on government bond desks

Under the new rules, banks will ultimately be required to triple their holdings of gilts. As we mentioned in August, government bond desks are already hotter than they've been before. This will make them hotter still.

A temporary fillip for ABS and corporate bond desks

As banks seek to increase their holdings of government bonds, they're expected to sell existing holdings of ABS and corporate bonds. In the short term, this could be good news for ABS and high yield traders. Longer term, it may not be such a fortunate thing, however.

Lower bonuses all round

Plugging the 620bn 'liquidity gap' between the liquid assets the FSA wants them to have and the liquid assets they currently have, is expected to reduce banks' profitability by 9.2bn a year compared to 2007. Knight says this will certainly result in lower bonuses. Simon Maughan, an analyst at MF Global, says it will reduce banks' ROE by 1-2%.

Possible further job cuts

Combined with increased capital requirements, the new liquidity rules are likely to kick the prop trading profession into an even deeper hole than it's already in. Combined with reduced profitability, this could have a negative impact on headcount. However, Maughan argues that most banks have already chopped everyone they can think of.

A shift away from London

The FSA is being tough with its new rules. It is the first regulator to introduce such requirements. And it intends to apply them not only to banks headquartered in the UK, but to branches of foreign financial institutions which are based here (unless the regulator in their own country is as fierce).

"The FSA is trying to be a prime mover and wants to shame home country regulatory regimes into being equally strict," says Knight. "But if the FSA's requirements are too strict, banks can simply move elsewhere in Europe and passport back into London under rules implemented in France or Germany."

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