One reasons for this is because the LCR scenario is one specific set of liquidity parameters, representing a stress motivated in large part by the experience of the Global Financial Crisis. In normal times, this set of parameters ensures that banks hold sufficient liquidity to weather a range of potential severe stresses. [33] But those same static parameters mean that when a real stress hits – which may look quite different to the stress embodied in the LCR – the LCR can move in counter-intuitive ways, and changes in the LCR are not straightforwardly related to changes in banks’ liquidity position. [34] And ultimately, the LCR is not the only liquidity metric. That’s why when banks face liquidity stress, the PRA considers a much broader range of liquidity information in determining its regulatory response. So a given level of LCR can be consistent with quite different levels of liquidity resilience depending on the nature of a stress – and if the LCR metric is constraining banks’ ability to appropriately draw on their liquid assets, we should consider ways to address that problem. Policy implications The question of how to prudently manage liquid assets in a given stress is no doubt a difficult one, and there are fundamental reasons why banks may be cautious. But the evidence suggests that the way the prudential framework itself is working may be inhibiting banks in appropriately using their liquidity when facing stress.
Concluding remarks Let me conclude, starting with a quote from the monetary economist and economic historian Charles Goodhart who back in 2008 used a metaphor that describes well the conundrum we face with liquidity buffers that are not used:[35] “The weary traveller who arrives at the railway station late at night, and, to his delight, sees a taxi there who could take him to his distant destination. He hails the taxi, but the taxi driver replies that he cannot take him, since local bylaws require that there must always be one taxi standing ready at the station.” In the context of impediments to liquid asset usability, the issues go beyond local bylaws: low internal risk appetites to let regulatory ratios fall hardwired in banks’ behaviours, market stigma amplified by stringent spot disclosures of volatile ratios, uncertainty about the eventual size of the shock. At the same time the benefits of liquidity regulation are also clear. Banks entered the Covid-19 crisis with strong liquidity – providers of funding to banks did not express any doubt on this front. To understand better the issues and to encourage debate for potential solutions the Bank and the PRA published a Discussion Paper on 31 March this year. [36] I look forward to your engagement. Many thanks to Marzio Bassanin and Artur Kotlicki for help in preparing this speech.