REPARIS A REGIONAL PROGRAM The Use of IFRS for Prudential and Regulatory Purposes Liquidity Risk Management THE ROAD TO EUROPE: PROGRAM OF ACCOUNTING REFORM AND INSTITUTIONAL STRENGTHENING (REPARIS)
! Background Global financial crisis Liquidity drying up Banks in difficulty Central banks injected liquidity Liquidity a key issue in the crisis! Regulatory response Some regulators developed a fundamentally new liquidity regime Basel Committee issued new principles for sound liquidity management Basel III proposals for liquidity issued to be implemented in 2015 but observation period will start in 2011 for LCR 2
! Some key aspects of a new regulatory regime (FSA) Systems and controls requirements Governing body and senior management oversight Measurement and management of liquidity risk, management of collateral Business lines, legal entities and currencies Stress testing Contingency plan! Regulator s own stress testing specific criteria Buffer as defined by regulator! Reporting 3
! Basel III approach Short term: Liquidity coverage ratio (LCR) Short term resiliency Aim is for banks to have sufficient high quality liquid resources to survive acute stress of one month Sufficient liquid assets to survive until day 30 (minimum) of proposed stress scenario Appropriate actions by management and supervisors to resolve the issues by day 30 4
Long term: Net Stable Funding Ratio (NSFR) Longer term resiliency Incentives for banks to fund activities with more stable sources of funding Over a 1 year horizon Complement the LCR! Phased implementation LCR observation from 2011 and implementation from 2015 NSFR observation from 2012 and implementation from 2018 5
! Metrics to monitor liquidity risk profiles Contractual maturity mismatch Concentration of funding by counterparty, product, currency Available unencumbered assets by amount, type, location, currency Market based tools such as equity prices, debt markets, CDS spreads, etc. 6
! LCR Definition of the metric Stock of high quality liquid assets/net cash outflows over a 30-day time period 100% Net cumulative cash outflows for the scenario are to be calculated for 30 calendar days into the future The stock of liquid assets should at least equal the estimated next cash outflows Banks are expected to meet this requirement continuously 7
! LCR: Stress scenario (examples) Loss of unsecured wholesale funding capacity 3 notch-downgrade in the institution s public credit rating Loss of secured, short term financing transactions for all but high quality liquid assets Run-off of a proportion of retail deposits Increases in market volatilities that requires larger collateral haircuts Some jurisdictions may require on top: closure of FX markets which means that the banks would have to maintain buffer in forex too 8
! LCR: Highly liquid assets Fundamental characteristics Low credit and market risk o Less risky assets o High credit standing of the issuer o Low duration, low volatility, low inflation risk o Denominated in currency with low foreign exchange rate risk Ease and certainty of valuation o e.g. easy to value with publicly available inputs Low correlation with risky assets Listed on developed and recognised exchange market 9
! Market-related characteristics Active and sizable market Presence of committed market makers Quotes available easily Low market concentration Diverse group of buyers and sellers 10
! LCR: Liquid asset stock High quality liquid asset should be liquid in markets during a time of stress: Level 1: 60% of total stock Cash Central bank reserves Marketable securities with specific criteria such as o Claims guaranteed by sovereigns, central banks o Deep repo markets o Securities are not issued by banks or other financial services entities Domestic sovereign debt for non 0% risk weighted countries issued in foreign currency that matches the currency of the bank s operations 11
! Level 2: Liquid assets 40% of total stock Government assets qualifying for 20% risk weighting under Basel II s standardised approach for credit risk, with 15% haircut Non-financial corporate and covered bonds not issued by the bank itself, AA and above with 15% haircut With the following conditions o Not issued by a bank, investment or insurance firm o Proven as a reliable source of liquidity in the markets (repo and sale even during stressed market conditions 12
! Net cash outflows (I) = Cumulative expected cash outflows (II) Cumulative expected cash inflows (III) I : Net cumulative liquidity mismatch position under stress scenario II: Calculated by multiplying outstanding balances of various categories or types of liabilities by assumed percentages that are expected to roll-off, take into account various off-balance sheet commitments III: Multiplying amounts receivable by a percentage of expected inflow under stress scenario 13
! Liquidity coverage ratio: retail deposit run-offs Stable deposits: % run-off factor (assumed by scenario) at least 5% Less stable deposits: at least 10% There are criteria prescribed for stable and less stable deposits! Wholesale run-off (assumed scenario) includes: Small business 5-10% Non-financial customers: 75% Other legal entity such as SPVs:100% 14
! LCR: Cash inflows As in the case of outflows, banks will have to make assumptions for inflows e.g. Retail inflows 100% from fully performing loans Lines of credit: 0% assume no credit facilities as other banks may not be in a position to hnour credit lines Other cash inflows e.g planned contractual receivables from derivatives: 0% 15
! NSFR= Available amount of stable funding/required amount of stable funding >100% Banks are expected to meet this requirement on a continuous basis Account for off-balance sheet exposures Assumptions when performing calculations of reliable source of funds should be under conditions of extended stress 16
! Proposed stress scenario Potential downgrade in a debt, counterparty credit Siginficant decline in profitability or solvency arising from: Market risk Credit risk Operational risk! No reliance on central bank as a source of funding! Material event that impact on credit quality of institution Sufficient liquidity for survival of up to 1 year 17
! NSFR (over 1 year time horizon) Available stable funding = capital + preferred stock + liabilities + portion of stable non-maturity deposits A factor should be applied to available stable funding Ranges from 100% to 0% eg 100% to Tier 1 and Tier 2 Capital, 50% to unsecured wholesale funding 18
! Required stable funding There are factors applicable to various types of assets Required stable funding = Sum of value of assets held and funded by institution x specific required stable funding (RSF) factor + Amount of OBS x Associated RSF factor OBS: Off balance sheet 19
! RSF factors Ranges from 0% to 100% Cash, money market instruments: 0% Outstanding loans to financial entities with effective maturities of less than 1 year 0% Marketable securities 5% AA or higher 0% risk weight under Basel II standardised approach Gold 50% Loans to retail clients with residual maturity of less than 1 year 85% Other assets 100% 20
! Off balance sheet categories and RSF factors 10% of undrawn portion for some categories Variable % depending on national supervisors for other categories 21
! Can be challenging to apply! The rules are prescriptive! In Basel 3, rather long monitoring period which could include some reporting/disclosures! Some jurisdictions have started before others! Not sure how other jurisdictions would apply these rules or indeed other Basel III rules! Level playing field is a major issue for large international banks! As for other areas planning and preparatory work is key! Staying on the sideline is not an option! Prioritising is very important 22