Demystifying the New Liquidity Requirements

Transcription

1 Your State Association Presents Demystifying the New Liquidity Requirements Program Materials Use this document to follow along with the live webinar presentation. Please test your system before the broadcast. Be sure to print enough copies for all listeners. Friday, February 27, 2015 Presenters: Colette Wagner & Philip Stalcup Technical Support (for faster service please submit inquiries via or online): (Registration & Tech Support): - Phone- (877) FOR ADDITIONAL ASSISTANCE PLEASE REFER TO OUR FAQs

2 Demystifying the New Liquidity Requirements Course Agenda: Liquidity Risk Management BCBS ( Basel ) Liquidity Framework Overview New Terminology Explained Liquidity Coverage Ratio (LCR) High Quality Liquid Assets (HQLA) Net Stable Funding Ratio (NSFR) Applicability of New Regulatory Guidance for Liquidity Liquidity Governance Concepts Liquidity Contingency Funding Plans Liquidity Monitoring and Stress Testing Liquidity Buffers Tips for What You Can Do Next 2 1

3 Liquidity Basel Guidance, 2008: Liquidity is the ability of a bank to fund increases in assets and meet obligations as they come due, without incurring unacceptable losses Interagency Guidance, 2010 Liquidity is a financial institution s capacity to meet its cash and collateral obligations at a reasonable cost. Maintaining an adequate level of liquidity depends on the institution s ability to efficiently meet both expected and unexpected cash flows and collateral needs without adversely affecting either daily operations or the financial condition of the institution. 3 In the 2007 crisis, many financial institutions did not: Have an adequate framework to account for liquidity risks posed by individual products and business lines business incentives were not aligned with overall risk iktl tolerance Consider the amount of liquidity they might need to satisfy contingent obligations as they viewed funding of these obligations to be highly unlikely View severe and prolonged liquidity disruptions as plausible, and did not conduct stress tests that considered the possibility of market wide strain or the severity or duration of the disruptions. Contingency funding plans (CFPs) were not always appropriately linked to stress test results and sometimes failed to take account of the potential closure of some funding sources. 4 2

4 Liquidity Risk Management Basel 2008 Liquidity risk management is important for every financial institution, because a liquidity shortfall at a single institution can have system-wide repercussions. Financial market developments in the past decade have increased the complexity of liquidity risk and its management. Interagency Guidance 2010 Liquidity risk is the risk that an institution s financial condition or overall safety and soundness is adversely affected by an inability (or perceived inability) to meet its obligations. Changes in economic conditions or exposure to credit, market, operation, legal, and reputation risks also can affect an institution s liquidity risk profile and should be considered in the assessment of liquidity and asset/liability management. Because of the critical importance to the viability of the institution, liquidity risk management should be fully integrated into the institution s risk management processes. 5 Basel Committee on Banking Supervision Liquidity Framework Overview 6 3

5 BCBS updated guidance for liquidity risk management after the 2007 liquidity crisis, realizing that previous guidance (2000) was not sufficient. Built on 17 principles for managing and supervising liquidity risk 7 Principles for Sound Liquidity Risk Management (Basel) Principle 1 (Fundamental principle): A bank is responsible for the sound management of liquidity risk. A bank should establish a robust liquidity idit risk management framework that t ensures it maintains sufficient liquidity, including a cushion of unencumbered, high quality liquid assets, to withstand a range of stress events, including those involving the loss or impairment of both unsecured and secured funding sources. Supervisors should assess the adequacy of both a bank's liquidity risk management framework and its liquidity position and should take prompt action if a bank is deficient in either area in order to protect depositors and to limit potential damage to the financial system. Remaining Principles Principles 2-4 Principles 5 12 Principle 13 Principles Governance of Liquidity Risk Management Measurement and Management of Liquidity Risk Public Disclosure Role of Supervisors 8 4

6 Principles 2, 3, & 4: Governance 2. Articulate risk tolerance 3. Develop strategy, policy and procedures and monitor continuously 4. Assess liquidity costs and benefits for all activities and lines of business Liquidity risk tolerance, which should define the level of liquidity risk that the bank is willing to assume, should be set considering business objectives, strategic direction and overall risk appetite. The tolerance should ensure that the firm manages its liquidity strongly in normal times in such a way that it is able to withstand t a prolonged period of stress. There are a variety of ways in which a bank can express its risk tolerance. For example, a bank may quantify its liquidity risk tolerance in terms of the level of unmitigated funding liquidity risk the bank decides to take under normal and stressed business conditions. 9 Principles 5-12: Measurement and Management of Liquidity Risk 5. Sound measurement and monitoring framework Future cash flows Sources of contingent demand and triggers 6. Monitor and control risk within and across legal entities, considering limitations on transferability 7. Diversified funding sources Maintain market relationships and presence Test funding sources 8. Intraday liquidity positions under normal and stress conditions 9. Manage collateral positions (encumbered vs. unencumbered assets) 10. Conduct regular stress tests that inform contingency plans 11. Establish formal contingency funding plan (CFP) 12. Maintain a cushion of unencumbered, high quality liquid assets 10 5

7 Interagency Policy Statement on Funding and Liquidity Risk Management (March 2010) Note consistency of focus between Basel and Interagency Guidance 11 Additionally, note consistency of focus with Supervisory Approach

8 Liquidity Guidance Basel guidance is similar to Interagency Guidance You are already implementing While some of the newly implemented requirements are complex, they don t apply to community and mid-tier banks. 13 LCR, HQLA, and NSFR Explained 14 7

9 Includes some tools that may be useful 15 Liquidity Coverage Ratio An adequate stock of unencumbered high-quality liquid assets (HQLA) that can be converted easily into cash immediately in private markets with minimal deterioration of asset values to meet liquidity needs for a 30 calendar day liquidity stress scenario. Stock of HQLA s Total net cash outflows over next 30 calendar days 100% 16 8

10 HQLA HQLA includes three categories of assets with decreasing levels of quality, subject to haircuts and inclusion limits. The HQLA Stock can be calculated as follows: Asset Level Examples of Included Assets Haircut Level 1 Highest quality/most liquid assets Level 2A Relatively stable and significant sources of liquidity Level 2B Lesser degree of liquidity and more volatility FRB balances Foreign withdrawable resources U.S. government securities Certain sovereign and multinational organization securities Certain claims on/guaranteed by a U.S. GSE, sovereign entity or multilateral development bank Certain covered bonds Certain corporate debt securities Certain publically traded stocks Corporate securities Lower-rated corporate bonds Mortgage backed securities HQLA Stock must not include more than 40% of Level 2 (2A+2B) Assets. HQLA Stock must not include more than 15% of Level 2B Assets. None 15% 50% 17 Phase-In by US Regulators Faster than Basel Minimum LCR Requirements Basel 60% 70% 80% 90% 100% US Interagency 80% 90% 100% 100% 100% Threshold will be a minimum requirement in normal times. During a period of stress, banks would be expected to use their pool of liquid assets, thereby temporarily falling below the minimum requirement. 18 9

11 Reporting Requirements for Large Banks are Onerous Frequency of Calculation Jan 1 June 30 July 1 Dec 31 Jan 1 June 30 July 1 Dec 31 Full LCR Monthly Daily Daily Daily Modified LCR n/a n/a Monthly Monthly. Community Banks n/a n/a n/a n/a 19 Applicability is Limited Full LCR Modified LCR >$250 billion in assets Between $50 billion >$10 billion in foreign and $250 billion in exposures assets >$10 billion asset Does NOT apply to subsidiary of above subsidiaries of above Not Required <$50 billion in assets 20 10

12 Applicability The final rule focuses on large, internationally active banking organizations with $250 billion or more in total consolidated assets or $10 billion or more in total on-balance sheet foreign exposure because of their complexity, funding profiles, and potential risk to the financial system. The Board is separately adopting a modified minimum liquidity coverage ratio requirement for most financial institutions that have more than $50 billion in total consolidated assets but that are not internationally active. The agencies do not intend to apply the final rule to community banks. However, the concepts are still useful and could be considered as part of the overall liquidity monitoring and reporting process. 21 Tools to help visualize concepts: Do I have good short-term term coverage

13 Tools to help visualize concepts: How much of a buffer do I need? 23 NSFR Another Basel-proposed liquidity monitoring ratio the NSFR has not been agreed and adopted to date Net Stable Funding Ratio is designed to improve incentives for using more stable forms of funding. The NSFR is intended to limit overreliance on shortterm wholesale funding, to encourage better assessment of funding risks across all on- and off-balance sheet items, and to promote funding stability. The BCBS is in the process of reviewing the NSFR that was included in the Basel III Liquidity Framework when it was first published in The agencies anticipate a separate rulemaking regarding the NSFR once the BCBS adopts a final international version of the NSFR. Available stable funding Required amount of stable funding 100% 24 12

14 Beyond Ratios Liquidity Governance Concepts 25 Governance Roles and Responsibilities Board should: Set liquidity risk tolerance and communicate effectively Establish liquidity management strategy Stay informed about the risk profile Establish requirements for management to monitor, measure, and control liquidity risk. Assess CFP Approve policies annually Senior Management should Establish supporting processes and procedures to implement policy. Enforce compliance with policy Monitor and report liquidity position throughout the business

15 Governance Risk tolerance well-articulated Pro-forma cash flows identify cash flow mismatches or gaps Encumbered assets are segregated, at least on paper Metrics are used to identify unstable liabilities Funding is diversified Contingent liabilities are quantified and well-understood Assumptions are reasonable 27 Governance Stress Test Reporting Stress cash flow projections should: Cover at least one year Accurately reflect Stress scenarios Assumptions about sources and uses of funds For each stress scenario, should identify discrete and cumulative funding mismatches or gaps over the stressed time horizon. Contingent liquidity risk = peak cumulative net outflow difference over stress period 28 14

16 Stress Test Reporting Documentation for each scenario: Assumptions used Peak cumulative net outflow difference over a stress period that exceeds the minimum liquidity cushion Action plan to address instances where the peak cumulative net outflow exceeds the minimum liquidity cushion 29 Measurement and Monitoring Systems Liquidity Risk Reports Cash flow projections Critical assumptions Cash flow gaps Dashboard Asset and funding concentrations Key early warning risk indicators Available contingent funding Collateral usage 30 15

17 Reporting Dashboards For More Effective Communication Example for Illustrative Purposes 31 Liquidity Monitoring and Stress Testing 32 16

18 Measurement and Monitoring Systems Operational Cash Flow Forecasting 1+ year Projections 30+ day Gaps Assumptions Document, including their development Identify key assumptions (those that strongly impact results. Liquidity Models should be subject to sound Model Risk Management Principles 33 Measurement and Monitoring Systems Assumptions are inherently inaccurate, so develop a sense of the reliability of your estimates: Perform sensitivity tests to see the impact of assumption errors Isolate key assumptions Use operational daily cash flow projections Run multiple scenarios changing a single assumption (e.g., ±20%)

19 Measurement and Monitoring Systems Peak Cumulative Net Outflow Assumption Error Risk = Difference Over 30-day Backtest Period 35 Measurement and Monitoring Systems Back-Test to Understand Forecast Error Risk Determine key drivers of differences between actual and forecast over a given period. Forecast setup? Forecast assumptions? Methodology Use prior period operational daily cash flow projections Compare actual daily net cash inflow/outflow to projections 36 18

20 Measurement and Monitoring Systems Peak Cumulative Net Cash Forecast Error Risk = Outflow Difference Over 30-day Backtest Period 37 Measurement and Monitoring Systems Use the results of Assumption Sensitivity Analysis and Back-Testing to determine the amount of liquidity cushion needed

21 Liquidity Buffers 39 Liquidity Buffer Reg YY Enhanced Prudential Standards requires BHC s with total consolidated assets of $50 billion or more to: Establish and maintain robust liquidity management practices Perform internal stress tests for determining liquidity adequacy Maintain a buffer of highly liquid assets sufficient to cover net cash outflows based on a 30 day stress test cycle under various scenarios. Project Cash Flows Stress Tests Determine Liquidity Buffer 40 20

22 Liquidity Buffer Reg YY Guidance for liquidity risk management is generally consistent with Basel guidance and the 2010 Interagency Guidance. Pro forma cash flow projections and stress testing are already expected at most larger community and mid-tier financial institutions. While the minimum (30 day stress) buffer requirements do not apply to these institutions, the conceptual approach may offer value in developing a contingency funding plan Project Cash Flows Stress Tests Develop Contingency Funding Plan 41 Liquidity Contingency Funding Planning Contingent Liquidity Risks Reduced borrowing capacity Increased collateral haircuts Off-balance sheet exposure Depreciated assets become harder to sell Asset quality affects cash flows Interest Rate Risk Bad publicity and rumors 42 21

23 Liquidity Contingency Funding Planning Establish clear lines of responsibility and escalation procedures Identify liquidity stress event triggers Multiple liquidity events At least one where subject to PCA Consider the short-, intermediate-, and long-term liquidity profile Articulate assumptions about sources and uses of funds in a liquidity event Articulate plans under various and increasing levels of liquidity stress 43 Liquidity Contingency Funding Planning Projection and evaluation of expected cash flows under increasing stress scenarios: Quantitative, not just judgments Assumptions should be reasonable for each source and use of cash based on uniqueness: Insured vs. uninsured deposits Public vs. retail deposits Borrowing lines by provider reflecting collateral and collateral haircuts Renewing vs. new loans 44 22

24 Liquidity Contingency Funding Planning What about Interest Rate Risk? Are assumptions affected by a rapid long-term increase in interest rates? Increase in non-maturity deposit decay rates? Increase in time deposit early withdrawals? Decrease in loan prepayment speeds? Decrease in investment prepayment speeds? 45 What Should You Do Next? 46 23

25 Management of Funding and Liquidity Risk Liquidity as a Strategy Liquidity Cushion Diversification of Funding Sources Risk Measurement and Monitoring Systems Contingency Planning Stress Testing 47 Liquidity as a Strategy Balance sheet structure for liquid asset quality Strategic planning to diversify funding sources Liquidity risk measurement and monitoring system 48 24

26 Balance Sheet Structuring 49 How Much On-Balance Sheet Liquidity? Other considerations Cash-flow volatility Uninsured deposit concentrations Deteriorating asset quality Predictability of cash flow mismatches Credit rating with the FHLB 50 25

27 How Much On-Balance Sheet Liquidity? Sized to stress tests and maximum liquidity outflow over survival period, supported by: Stress tests Forecast error Risk profile Risk tolerance 51 Diversification of Funding Sources 52 26

28 Diversification of Funding Sources Considerations Limited number of borrowing sources Concentration of credit line availability Deteriorating asset quality Predictability of cash flow mismatches Credit rating with the FHLB 53 Actions for more robust liquidity risk management Assess systems and tools used to monitor and measure liquidity Assess whether your monitoring and reporting are sufficient for assessing liquidity position. Check your contingency funding plan (CFP) to make sure it can cope with the outcomes from your stress tests. Check your assumptions will you be able to execute your contingency plans in the face of a crisis? Make your liquidity risk management process dynamic to reflect the changing environment and financial position of the company Assess impact of liquidity idit actions on profitability Set correct incentives to align liquidity strategy with business objectives Think broadly in liquidity stress testing could a low probability/high impact situation sink the ship? 54 27

29 Questions 55 28