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FSA rules aim to strengthen banks’ liquidity

The FSA is to force UK banks to invest heavily in government bonds from October 2009 to reduce lenders’ vulnerability to market conditions.

The regulator is proposing new rules that would require firms to have a higher amount and quality of liquid asset stocks, including a greater proportion held as government debt.

In its consultation paper on liquidity standards released last week, the FSA proposes an overhaul for banks, building societies and investment firms.

If implemented, banks would be forced to limit lending during favourable economic conditions to avoid “unsustainable expansion”.

Firms would need enhanced liquidity risk management capabilities, including greater use of stress testing and improved contingency funding plans.

They would also have to be less reliant on short-term wholesale funding and there will be greater incentives for firms to attract a higher proportion of retail deposits.

The proposed rules are based on recently agreed international liquidity standards, in particular, the Basel committee on banking supervision’s principles for sound liquidity risk management and supervision.

FSA director of wholesale and prudential policy Paul Sharma says: “We have put forward a set of proposals that we believe will greatly improve firms’ ability to deal with liquidity risks and thereby increase the overall stability of the UK financial markets.”

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