The use of letters of credit (L/Cs) to back US variable-rate municipal bonds is in doubt under a Federal Reserve proposal to exclude such debt from a list of easily sold assets.

Since the 2008 financial crisis, banks have flocked to buy municipal bonds, which routinely have the additional security of an L/C which in turn serves to reduce the price of such debt.

Federal Reserve proposal

In late October, the Federal Reserve proposed that some banks should be required to hold enough assets that would be easy to sell during a 30-day credit crunch.

The requirements aim to satisfy global regulations to make the financial system less vulnerable to periods of volatility such as occurred during the global financial crisis.

L/Cs excluded

While the Federal Reserve's proposal categorises treasury bonds, some sovereign debt and publicly traded investment-grade corporate securities as easily sold assets, it excludes state and local debt.

The proposal also excludes L/Cs that banks extend to variable-rate municipal bonds for additional security.

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