Email of the day
Comment of the Day

June 03 2013

Commentary by Eoin Treacy

Email of the day

on capital requirements
“Over the last couple of weeks, you mentioned that pension funds that were required to hold risk-free assets, are being required to hold US treasuries and UK gilts. I assume you are referring to pension funds in USA & UK. I have not seen any references to this requirement on pension funds. Could you please give me some references/links to where this requirement is being imposed and by whom. Thanks in advance”

Eoin Treacy's view Thank you for this question which may be of interest to other subscribers. I believe I discussed this issue in the big picture long-term audio on Friday May 24 th and here is a section from Comment of the Day on February 20th :

Regulatory changes in the UK centring on what pension and insurance companies can class as Tier 1 capital have forced them to hold Gilts regardless of whether they think it is a good idea or not. The Fed's actions to bring more types of investors into the fold of the Treasury market can be viewed in the same light. The Liquidity ratio introduced via Basel III requires that a bank hold “ sufficient high-quality liquid assets to cover its total net cash outflows over 30 days“. Regardless of the rationale, this ensures they hold more government bonds than might have otherwise been the case.

Here is a link to a paper from the IMF dated February 2012 focusing on the impact for GDP growth of tighter capital adequacy rules for the banking system

Here is a link to Wikipedia section on the EU's Solvency II proposal which may come into effect at the beginning of 2014.

The perception of risk is generally most acute following a traumatic event. It is therefore likely that the regulatory response to the credit crisis is likely to err on being stricter than needed. Since capital requirements and capital adequacy rules are so contentious there is likely to be considerable disagreement over the optimal level at which they should be set and the implementation of the rules might yet be delayed.

From the perspective of governments who have increased the supply of bonds by orders of magnitude, regulations that expand the market for their offerings have obvious appeal.

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