The Basel Committee on Banking Supervision has drawn up the first ever global set of liquidity rules to try and prevent a repeat of the funding crises that engulfed many Western banks during the financial crisis.

One of these rules known as the liquidity coverage ratio (LCR) requires banks to hold a pool of top quality liquid assets such as cash and top rated government debt that could meet all their net outflows over 30 days at a time of acute stress in the market.

Banks in Singapore, Hong Kong and Australia, which have low levels of domestic sovereign debt, say they will find it harder to get their hands on enough of these assets to meet the rules given their relative scarcity.

Both the Singapore and Hong Kong governments tend to have budget surpluses so only issue a limited amount of bonds and bills each year. Australia's government, while currently running a deficit, was in surplus for most of the 10 years preceding the financial crisis, meaning its public debt pool is also relatively shallow.

Now banks in these countries are warning that this scarcity of public debt could trigger competition between them for these assets, making the market less, rather than more liquid.

"The adverse competition dynamics arising from the rules could become a threat to the overall banking industry," said Frederick Shen, Vice President of Market Risk Management at Singapore's OCBC Bank Shen warns that banks could try and undercut one another to attract more deposits acceptable under the new rules while rejecting assets that don't make the grade.

"This will have a negative impact on banks' bottom line, distort market deposit rates and create deposits which are more volatile and sensitive rate, thus resulting in a self-defeating vicious cycle for the industry," he said.

The Basel Committee did allow a degree of extra leeway for regulators in countries with a shallow pool of government debt in its release of the Basel III rules at the end of 2010.

This gives national authorities the ability to set up a central bank liquidity facility to help institutions meet the rules.

Regulators may also be able to widen the pool of assets classed as "highly liquid" to include top rated sovereign bonds of another country such as U.S.

Treasuries and more corporate debt and covered bonds paper issued by banks that are backed by a pool of loans, usually mortgages, that remain on a bank's balance sheet Stefan Walter, the Basel Committee's Secretary General says the rules are designed to improve the way banks' manage their funding rather than forcing the holding of sovereign bonds per se.

"We're trying to change behaviour, for example the excessive reliance on short-term wholesale funding, as opposed to necessarily inducing the holding of government debt," he told Reuters.

NOT ENOUGH LIQUIDITY TO GO ROUND

However, industry experts warn at present the rules are still too rigid to address the fact that assets considered liquid in the West just aren't as readily available in many countries in Asia and Australia.

"Liquidity is a big challenge as in many countries like Asia there isn't enough of the type specified by the Basel Committee to go round," said Simon Topping, a former director of banking regulation at the Hong Kong Monetary Authority and now a partner at KPMG.

That's not to say banks in these economies are more likely to face a liquidity crisis than those in the West. Banks in Singapore and Hong Kong have loan to deposit ratios well below 80 percent compared to many banks in Europe who have rates well over 100 percent.

But the problem is that their liquidity management programmes involve holding a wider range of assets than is allowed under the new rules.

"What requires further consideration is the form this liquidity must take," said Elbert Pattijn, chief risk officer at Singapore's DBS Bank "One of the unintended consequences as we had highlighted to our regulator and the Basel Committee is that many banks in many Asian countries will be forced to take undue FX risk by putting U.S Treasury, Bunds or JGBs into their liquidity portfolio," he added.

Banks might also have to cut lending in order to keep more cash in their liquidity pool.

"The new result is an increase in banks' funding cost, which could either translate into higher borrowing costs for customers or reduced lending capacity if banks cannot pass on the additional costs," Shen added.

AUSTRALIA SETS STRICT RULES

At the end of February, Australia's regulator ruled that despite the Basel Committee's concessions, no assets aside from cash, domestic government securities and central bank reserves can be counted for meeting the Basel Committee's classification of "highly liquid."

While this may change before the liquidity coverage ratio's 2015 deadline, it means that at present the country's banks fall far short of coming close to meeting the new rules.

Matthew Johnson, fixed income strategist at UBS in Sydney, estimates the country's banks hold around $65 billion $66 billion in assets that meet the Basel rules as they presently stand.

To become fully compliant, they will need to hold around $350 billion, which is greater than the country's public debt market.

This means the country's top four lenders National Australia Bank, Commonwealth Bank of Australia, Westpac Banking Corp and Australia and New Zealand Banking Group could be scrapping for all they can get.

"If Australian banks were to go after the remaining float of the paper, it may impair market liquidity, and therefore undermine the regulator's purpose," said Johnson.

For now, the alternative for Australian banks will be to tap a liquidity facility provided by the central bank, although that will come with a fee.

RULES NOT DESIGNED FOR ASIAN BANKS

Regulators in Singapore and Hong Kong are yet to announce how they will implement the new liquidity rules, although both are expected to make announcements later this year.

The HKMA has said it is discussing with local banks how to meet any liquidity shortfall under the new guidelines.

The Monetary Authority of Singapore announced in July 2010 that it would begin issuing new short term bills in the second quarter of this year, which will help to boost the stock of liquid assets.

The Basel Committee has included a review clause in the new rules to address any "unintended consequences" and said it may make further revisions ahead of the 2015 deadline if closer analysis deems it necessary.

However, it is unlikely that there will be any major changes to the rules for these countries given the Basel Committee's determination to make them a global standard.

"We're in an environment where everyone's competing against one another on a global basis and it is hard to predict from where the next shock could come from.

Thus all countries need to raise minimum standards to protect their banking systems against potential domestic or cross border shocks," the committee's Walter said.

Even if there are more tweaks to the rules, analysts say the wider problem lay in the fact they are tailored to solve the problems faced by Western banks operating in Western markets.

"Everything in Asia is very different and yet we're adopting all of this regulation which is driven by the problems which happened in sub-prime and CDOs (collateralised debt obligations)," said Daniel.