2017 Seminar for Senior Bank Supervisors from Emerging Economies. Implementation of Basel III Liquidity Requirements in Emerging Markets
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1 2017 Seminar for Senior Bank Supervisors from Emerging Economies Implementation of Basel III Liquidity Requirements in Emerging Markets Christopher Wilson Monetary and Capital Markets Department International Monetary Fund October 31, 2017
2 Outline 1. Overview of BIII liquidity framework 2. Implementation challenges for EMDEs 3. Policy recommendations 2
3 1. Overview of BIII Liquidity framework 3
4 BIII introduced the first global liquidity framework Basel III Sound Principles LCR NSFR Monitoring Tools 4
5 Taken together, it is a comprehensive framework for liquidity A full balance-sheet metric, one year time horizon, contractual maturity mismatch 30 day time horizon, builds liquid buffers under stressed conditions NSFR LCR Sound Principles Monitoring Tools Complete suite of risk management governance, strategies, policies, processes risk appetite etc. Five monitoring tools to breakdown the LCR calculation and drivers of liquidity 5
6 LCR has a number of benefits to calculate short-term liquidity requirements Forward looking Forward looking estimates Calibrated using behavioral data Stressed assumptions Market-wide & idiosyncratic Applied to assets and liabilities Rigorous eligibility for HQLA Strict tests for inclusion Limits on composition Bespoke treatment of liabilities Differentiates run-off rates Breaks down the liability structure 6
7 Experience from adopting countries suggest that business models are adjusting Banks are moving toward lower more resilient funding structures business models to risk business models Less reliance on market-based funding Less reliance on short-term market financing Bank s holding greater amounts of better quality liquids Greater focus on transfer pricing e.g. internalizing cost of liquidity Overall, risk management improved As a result, banks business models are more resilient to short- term liquidity and funding shocks 7
8 Benefits of implementing LCR for EMDEs include. Accurate, forward looking and risk sensitive measure of liquidity in a stress Incentivizes resilience to short term liquidity shocks via management of the liability structure and HQLA Discourages a reliance on short term, unstable sources of funding e.g. wholesale, St repo Encourages banks to improve management of liabilities 8
9 2. Implementation challenges for emerging economies 9
10 While the LCR offers benefits, implementation is challenging Availability of HQLA Capital markets often not sufficiently deep and liquid Scarcity of assets Calibration of stressed outflows Liability structure not easily segmented Dearth of data on behavior of liabilities in a stress 10
11 Implementation challenges more acute for EMDEs Less developed capital markets Less availability of assets to qualify as HQLA Challenges in meeting strict definitions and criteria in LCR framework uniqueness Diversity Dollarization, pegged exchange rate regimes, role of central bank, role of required reserves etc. 11
12 Implementation and policy challenges in EMDEs so far include Bank-Sovereign Nexus May further entrench negative feedback loop Fixed or Pegged Exchange Rate Impact on reserves Potential pressure on peg in a stress Dollarization How does the central bank guarantee supply of FX? 12
13 3. Policy Recommendations 13
14 The priority for Emerging economies should be the implementation of robust standards of risk management Severe stress scenarios Liquidity risk tolerance Adequate liquidity cushion Allocate costs, benefits and risks Contingency funding plan Identify & measure full range of liquidity risks Intraday liquidity risk and collateral Liquidity Sound Principles, BCBS 2008 Market discipline 14
15 Adopt or adapt... Primary goal is to aim for strengthened liquidity risk management LCR has a number of benefits compared with traditional coverage ratios Convergence with LCR framework over times is sensible Local circumstances of economy and banking system need to be accounted for 15
16 Following principles help implementation for emerging economies: Reduce variance over time Modify initially with a view to reducing over time QIS absolutely essential Informs calibration, repeat throughout policy development Closely transpose LCR framework into local rules Future-proof framework as markets and banks develop Strong industry engagement necessary Understand impact, frictions Develop supervisory capacity Integrate LCR monitoring into offsite, regular onsite inspections 16
17 Making an assessment of whether a transition to Basel III liquidity makes sense where to start? Step 1: Assess the pre-conditions for the applicability of the LCR Can be made by looking at the money market conditions and the liquidity of government securities. Does a repo market exist for government securities? Is the market for government securities liquid (look at bid-ask spread, volumes, price volatility, etc). Does the market exhibit different liquidity at different maturities? Are there other liquid markets? Step 2: Consider evaluating assumptions for the LCR Particularly in the cases of crisis countries, with somewhat unstable banking systems, the appropriateness of the assumptions used for the LCR could be usefully reviewed in light of the current country s experience. Step 3: Assess the current level of the banks short term liquidity position Can be made by looking at a number of ratios. Liquid Assets to Total Assets is a commonly used but not fully appropriate measure as it does not provide information about the adequacy of a given stock of liquid assets. More in line with the rationale of the LCR is the ratio of Liquid Assets to Short Term Funding (where deposits should not or should only partially be included). Loans to Deposits ratio can also provide some useful insight with high values calling for more in depth analysis. Step 4: Assess the banks structural liquidity position and the possible impact of the NSFR Requires an evaluation of banks maturity mismatch. The banks reliance on short term wholesale funding should be investigated. The ratio of such funding to total liabilities (excluding equity) should also be determined. At aggregate level, a large external debt can be a signal of potential vulnerability. A proxy impact of the NSFR can be assessed at bank level if adequate data is disclosed using methodology proposed by IMF WP/14/106 17
18 Stylized BIII Liquidity Implementation Plan BIII Strategic Road Map Q1 Q2 Q3 Q4 H1 H2 Basel III Liquidity Issue LCR draft rules for consultation Establish a dedicated team of specialists Perform initial stock-take QIS 1 Issue QIS results with specific guidance to industry Assess QIS 2, perform calibration and issue final regulations Commence work on NSFR Enhancement of Supervisory Framework Integrate the ILAAP review with the onsite supervision activities to produce a more risk-based approach Integrate LCR monitoring tools into offsite supervision Ensure LCR monitoring tools feed into the risk-rating of banks and onsite resource planning
19 Integrate LCR monitoring tools into offsite supervision Market Monitoring Contractual maturity mismatch Significant currencies Available unencumbered Assets Concentration of Funding 19
20 If not implementing LCR now? LCR: good benchmark for own requirements Definition of liquid assets robust enough? Penalize Short-term wholesale funding? Reward stable source of funding (e.g., retail deposits)? Cover all possible cash outflows (e.g., off-b/s items)? 20
21 Implementation of the NSFR should be undertaken after the LCR has been fully embedded. Sequence LCR first Many of the definitions of assets and liabilities used in NSFR derive from the LCR Definitions A sensible approach is to ensure banks are using these definitions consistently and in line with the intent of the regulations before moving into the NSFR Calibration essential Calibration of haircuts (ASF and RSF) need to be informed by extensive quantitative analysis of impact on bank liquidity and management of assets and liabilities 21
22 Summary BIII liquidity reforms Comprehensive regulatory framework for liquidity Significantly strengthen resilience of banks to liquidity shocks, disruptions to funding markets Changed banks approach to liquidity risk management, internalized the cost of liquidity Policy recommendations for emerging economies Implement risk management standards as a priority, based on BCBS s Liquidity Sound Principles Adapt or adopt LCR on a time horizon that makes sense to suit local conditions Integrate LCR monitoring into offsite supervision Once LCR implemented, consider NSFR 22
23 Thanks & Happy Halloween!! 23
24 Key resources Liquidity Risk: management and supervisory challenges, BCBS, February, 2008 Liquidity Stress Testing: a survey of theory, empirics and current industry and supervisory practices, BCBS, October 2013 Comptroller s Handbook: Liquidity, OCC, June 2012 Principles for Sound Liquidity Risk Management and Supervision, BCBS, 2008 Managing Liquidity Risk, Swift, June
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