Danmarks Nationalbank would strongly recommend permitting countries with a shortage of extremely high quality liquid assets to allow more covered bonds in LCRs if they are excluded from Level 1, it told the EBA in a consultation response released today (Friday).

The European Banking Authority held a consultation on derogations for currencies with constraints on the availability of liquid assets under Article 419(5) of the Capital Requirements Regulation from 22 October to 22 December, discussing measures that can be taken by banks in countries such as Denmark where there are insufficient extremely high quality liquid (or Level 1) assets (mainly government bonds) to meet their needs in liquidity buffers.

Danmarks Nationalbank

The derogations have come to the fore following the EBA’s recommendation on 20 December that covered bonds be excluded from Level 1 in the Liquidity Coverage Ratio (LCR) when the European Commission makes the final decision by the end of June.

The Danish authorities and banks had argued strongly that covered bonds should be eligible for Level 1 and in its consultation response the Danish central bank reiterates this view, as well as highlighting that their favoured scenario remains a possibility.

“First of all, we would like to point out that the results of the EBA’s empirical analysis across asset classes confirm that some covered bonds achieve the same average ranking as government bonds,” it said. “We agree with this analysis and see no reason to discriminate against such covered bonds based on other criteria.”

“If this finding is taken into account when the Commission decide on the final definition of the LCR in June 2014, Denmark would no longer be classified as a country with insufficient liquid assets.”

Danmarks Nationalbank points out that the two derogations already proposed have drawbacks for Denmark with regard to the conduct of monetary policy and its currency peg towards the euro.

“The use of derogation A with foreign denominated assets in the buffer is not seen as an appropriate option, since it introduces currency risk,” it said. “The use of derogation B – credit lines from the central bank – is not seen as a viable solution either, since Denmark maintains a fixed-exchange rate policy vis-à-vis the euro area.”

The central bank instead proposed a new derogation that would better accommodate the country’s needs.

“If Danish covered bonds are not classified as extremely liquid in the Commission’s delegated act, and if the Commission furthermore introduce a cap on the amount of assets of high liquidity and credit quality in the liquidity buffer, we would strongly recommend the introduction of the third derogation in the BCBS (Basel Committee on Banking Supervision) to allow additional use of assets of high liquidity and credit quality (e.g. certain covered bonds) in the liquidity buffer,” it said.

“This third derogation could allow banks to hold a more diversified liquidity buffer than mainly government bonds and central bank reserves. Furthermore the use of the derogation could assist in breaking the link between governments and banks.”

The consultation response can be found here.