By Emily Stephenson and Douwe Miedema
WASHINGTON (Reuters) - U.S. regulators on Wednesday issued rules for banks to hold enough easy-to-sell assets to keep them afloat during a crunch, after many were caught short of cash during the 2007-09 financial crisis.
The rules, adopted by the three main bank regulators, are a new building block in a global effort to make big banks such as JPMorgan Chase (JPM.N) and Citigroup (C.N) sturdier and head off a future meltdown of the financial system.
"Liquidity squeezes were the agents of contagion in the financial crisis," Federal Reserve Governor Daniel Tarullo said. "The (new rule) makes such squeezes less likely by limiting large banks from taking on excessive liquidity risk."
The Federal Reserve said big U.S. banks would need to hold a total of about $2.5 trillion in highly liquid assets by 2017, and that they would have a shortfall of about $100 billion if that threshold applied today.
The regulators also proposed rules determining how much money - or margin - swaps buyers and sellers must set aside when they do trades outside central clearing houses, which makes them more risky than cleared derivatives trades.
The liquidity rules, which were first proposed in October 2013, will force banks to hold enough liquid assets such as cash, treasury bonds and other securities to fund themselves over a 30-day period during a crisis.
In the wake of the last crisis, regulators have told banks to rely less on borrowed money, and to raise more shareholder equity. But they had yet to address problems with everyday cash needs that came to light during the crisis.
The final rule provided some relief from the proposed version, allowing smaller banks to make their liquidity calculations on a monthly basis rather than every day.
It also exempted companies regulated by the Fed that are deemed to be of systemic financial importance but that are not banks - such as insurer Prudential Financial Inc (PRU.N).
Banks with more than $250 billion in assets will still have to tabulate their daily liquidity needs.
The Fed's estimate of the current shortfall is half of what it foresaw in its proposed rule. Bank of New York Mellon (BK.N), PNC Financial Services (PNC.N) and U.S. Bancorp (USB.N) are examples of banks that currently do not meet the ratio, according to a note by KBW research analysts.
"Banks have started to narrow the gap," said David Wright, a regulation expert at consultancy firm Deloitte. "Some were waiting to find out exactly how the buffer would be defined ... but now ... banks will be able to go ahead and close the final $100 billion gap."
Fed staff said they want to work on a plan to eventually include the most liquid municipal bonds in the asset buffer, although for now they will not count, something that has frustrated local government officials, who have argued banks will buy fewer of their bonds, and taxpayers will shoulder more costs for projects such as new roads.
U.S. cities and states criticized the regulators' tightening of the rules on Wednesday, saying it would raise their borrowing costs and hamper vital infrastructure projects.
Tarullo, the Fed's top official on financial regulation, said more rules were forthcoming. He said the Fed would write separate liquidity rules for foreign banks that are exempted from the rule that was finalized on Wednesday.
Liquidity standards for the handful of non-banks overseen by the Fed would be issued by order, he said.
Separately, the Fed is working on rules to rein in banks that heavily rely on short-term funding tools, and it will also need to implement forthcoming global requirements that would force banks to calculate their liquidity needs over a full year, the so-called net stable funding ratio.
The Fed also reproposed margin requirements for swap trades conducted outside clearing houses, which function as middlemen by taking on the risk that trading partners cannot deliver on their promises to make them less risky.
Swaps, a form of derivatives, mushroomed during the pre-crisis boom when they were only lightly regulated. Now, they must be routed through clearing houses, but some are so complex that they still won't be cleared, and the new rules set out how much money trading partners need to set aside.
Trading counterparties must post enough buffers to give themselves 10 days to unwind any deal going awry, the rules say. For cleared swaps, that period is one to five days.
That makes cleared swaps far cheaper to use, and market parties have said that the margin rules could have a direct impact on how popular these swaps are with clients.
The reproposal largely followed a global agreement released in 2013, and superseded an initial Fed proposal from 2011. The new U.S. proposal was somewhat stricter in its definition of large financial end users, agency staff said.
The three agencies adopting both sets of rules are the Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation.
(Reporting by Emily Stephenson and Douwe Miedema; Editing by Karey Van Hall, Bill Trott and Paul Simao)