Transcript Slide 1

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Liquidity Risk Standards and Measurement
(& Liquidity Measures taken during & after the crisis)
23rd BSCEE Conference
Ohrid, 16 June2010
Jean-Philippe Svoronos
Senior Financial Sector Specialist
Financial Stability Institute
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Outline
 Financial crisis and emergency measures
 Lessons learned
 International framework for liquidity risk measurement,
standards and monitoring (Dec 2009 consultative paper)
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FX and maturity mismatches: Optimistic assumptions
 “Mitigating” factors:
• Access to short-term FX funding through subsidiaries of foreign banking
groups (E and C Europe), branches in the US (W Europe)
• Use of FX market rather than US funding markets
• “Diversification”: access funding markets in Asia for USD funding
 Liquidity/credit risk assumptions:
• Structured bonds (securitization assumed to be liquid because highly rated
• Some private label MBSs (in USD) considered fully liquid and made part of
banks’ liquidity/treasury reserves
 Underestimation/”hidden” liquidity risks
• Increasing complexity of products & lack of transparency
• “Shadow” banking system and use of OBS vehicles (SIVs)
• Secured funding always available provided you have good quality collateral.
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Triggers and transmission: the US subprime crisis
 Strains in funding markets started in mid-2007: growing unease about the exposure
of US FIs to US subprime mortgages and related securitizations
 Contagion spreads to European banks (large buyers of structured products and
large borrowers of USD)
 Factors increasing uncertainty and contagion:
• complexity of products and off-balance sheet leverage (SIVs)
• “deleveraging” and fire sales
• increasing reliance on short-term funding and secured funding
 Consequences:
• Liquidity dries up
• Shortening of interbank lending tenors
• Closures of markets for lengthy periods (e.g. “private label” MBSs, CP, etc…)
 Several episodes destroy market confidence over time: Sept-Dec 2007, March
2008 and Sept 2008 to March 2009.
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Private sector responses to liquidity pressures
 Uncertainty led to:
• Tightening of counterparty limits: less lending, shorter lending & more
expensive
• Hoarding and flight to quality (growth of bank deposits with the ECB,
fall in yields on US notes and Treasuries)
 “Fire sales” of seized collateral (SIVs) increase falls in asset prices
 Illiquid, fall in asset prices and one-sided markets meant:
• Hard and sometimes impossible to price in a reliable way
• Lack of visibility: unknown losses, size of hit to P&L unknown
 US dollar shortages increased in Europe after failure of Lehman and
MMMF “breaking the buck”.
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Central Banks’ emergency measures
 “Pre-Lehman” measures:
• Extraordinary market operations (outside of regular schedule, longer terms
and/or larger than usual amounts. Some 17 ECB operations between 9
August & 20 December 2007)
• 12 Dec. 2007 (FED):
• Introduction of a Term Auction Facility (TAF): gives depository institutions
(including foreign bank branches & subsidiaries) access to term funds via
auctions against a wider range of collateral
• Complementary USD term auctions by ECB and SNB funded by USD
swap lines with Federal Reserve (put in place the same day)
• Other measures (extending range of eligible collateral):
• FED for primary dealers:
• Term Securities Lending Facilities (TSLF) lending UST for 28 days
against high quality MBSs
• Primary Dealer Credit Facility (PDCF) overnight loans against
investment grade debt securities
• Bank of England (April 2008): Special Liquidity Scheme: asset swaps
(high quality illiquid assets versus UK Treasury bills)
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Governments and Central Banks’ emergency measures
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“Post-Lehman” measures to address acute USD global shortage, impact on local currency
liquidity and seizing up of unsecured funding markets
Unprecedented range of measures to support financial institutions:
• Increase in deposit insurance to prevent bank runs
• Government guarantees on banks’ liabilities (prevent run on wholesale funding)
• Asset purchase or guarantee schemes to protect financial institutions from extreme
losses
• Recapitalizations with public funds
Measures to address FX currency shortages
• In some countries (Brazil, Korea, Mexico), wider use of FX reserves to help banks and
corporates
• Expansion of USD swap lines in number (2 to 14), size (unlimited for 4 central banks)
and reach (1 to 5 continents)
• Policy responses within euro and Swiss franc markets
• Swap lines between SNB, ECB, National Bank of Poland and Magyar Nemzeti
Bank
• Swap line between ECB and Nat. Bank of Denmark
• Repos between ECB and Hungarian and Polish central banks.
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Lessons learned
 Markets:
• Even interbank markets and secured funding can freeze up
• Some key assumptions were misguided
• Interaction of market liquidity, credit risk, and funding liquidity under stress
misunderstood, under-appreciated
 Current shifts in banks’ liquidity risk management
• Improved monitoring, analysis, stress testing of tenor and FX mismatches
• Centralization of collateral management, contingent liabilities and access to
central bank facilities
• More stringent counterparty limits
• Efforts to develop retail deposit bases and/or longer-term (more stable)
funding
 Supervision
• Banks’ liquidity risk management needs improving
• Regulation & supervision of liquidity is just as crucial as capital adequacy
• Cross-border supervisory cooperation is essential for supervising liquidity at
large international banks.
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Objectives and components of liquidity supervision
 Ensure the bank maintains sufficient liquidity
• cushion of unencumbered, high quality liquid assets
• withstand loss of both secured and unsecured funding sources
 Key components of framework
• Standards
• Liquidity Coverage Ratio (LCR) – 30 days horizon
• Net Stable Funding Ratio (NSFR) – 1 year horizon
• Monitoring tools
• Contractual maturity mismatch
• Concentration of funding
• Available unencumbered assets
• Market-related monitoring tools.
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LCR – definition
Stock of high quality liquid assets
≥ 100%
Net cash outflows over a 30-day time period
 Supervisory scenario (idiosyncratic and market-wide)
• 3-notch downgrade (triggers)
• partial loss of retail deposits
• loss of unsecured wholesale and secured, short-term
funding (except for ‘liquid’ assets per this standard)
• increased collateral calls and/or haircuts
• draws on committed lines, non-contractual obligations
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LCR – liquid assets (narrow & wider definitions)
 Narrow definition
• Cash and central bank reserves that can be drawn in time of stress
• Marketable securities issued / guaranteed by sovereigns, central
banks, other PSEs, IMF, MDBs if:
• 0% risk weight under Basel II SA
• deep repo markets, and not issued by banks, other financial institutions
• Government or central bank debt issued in domestic currency where
the risk is taken, or by home country
 Wider definition
• Level 1: assets eligible for narrow definition (at least 50% of the stock)
• Level 2: haircut of 20% (AA- corporate & covered bonds)
• Level 3: haircut of 40% (A- corporate or covered bonds)
 BCBS decision to use broader definition pending on QIS results.
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LCR – net cash outflows (denominator)
 Net cash outflows = cumulative expected cash outflows minus cumulative
expected cash inflows in a given time bucket under specified stress
scenario
 Most ‘factors’ harmonized but some subject to national discretion
 No double-counting with assets included in numerator
 All cash outflows and inflows based on assumptions
 Example for retail demand funding
• Stable … ≥ 7.5% runoff
• covered by deposit insurance
• denominated in local currency
• transactional account (e.g. salary deposited) or other established
relationship
• Less stable … ≥ 15% runoff - all other
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NSFR – definition
Available amount of stable funding (i.e. sources)
> 100%
Required amount of stable funding (i.e.
uses)
 Uses with maturity > 1 year should be funded by sources
that are expected to be available for a period > 1 year
 Supervisory scenario = mild idiosyncratic (longer-term
focus)
• decline in profitability and/or solvency
• downgrade in credit rating
• reputational event
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NSFR – available stable funding (sources)
Components of ASF
ASF Factor
Tier 1 & 2 capital
100%
Other pref shares with effective maturity ≥ 1 year
100%
Other liabilities (e.g. secured and unsecured, including term
deposits) with effective maturity ≥ 1 year
100%
‘Stable’1 retail and SME non-maturity deposits and term deposits
with residual maturity ≤ 1 year
85%
‘Less stable’1 retail and SME non-maturity deposits and terms
deposits with residual maturity ≤ 1 year
70%
Unsecured wholesale funding, non-maturity and term deposits from
non-financial corporates with residual maturity ≤ 1 year
50%
All other liabilities and equity not included above
0%
1. As defined for the LCR
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NSFR – required stable funding (uses)
Summary composition of asset categories
i) Cash
RSF Factor
0%
ii) Securities with effective residual maturity < 1 year
iii) Non-renewable loans to financials with residual maturity < 1 year
Unencumbered marketable debt issued or guaranteed by
sovereigns, central banks, BIS, IMF, MDBs eligible for 0% risk
weight and with residual maturity > 1 year
5%
Unencumbered corporate bonds (or covered bonds) rated ≥ AA with
residual maturity ≥ 1 year AND traded in deep, active market
20%
i) Gold
50%
ii) Unencumbered listed equities and unencumbered corporate
bonds (or covered bonds) rated ≥ A- with residual maturity ≥ 1 year
AND traded in deep, active market
iii) Loans to non-financial corporates with residual maturity < 1 year
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NSFR – required stable funding (uses) – cont’d
Summary composition of asset categories
RSF Factor
Loans to retail clients with residual maturity < 1 year
85%
All other assets
100%
Off-balance sheet categories
RSF Factor
Undrawn amount of conditionally revocable and irrevocable credit
and liquidity facilities provided to retail clients, corporates, financials,
sovereigns, etc
10%
Other contingent funding obligations, including:
- unconditionally revocable uncommitted credit and liquidity facilities
national
discretion
- guarantees
- letters of credit
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Monitoring tools – firm-based
 Contractual maturity mismatch
• Provides insight into the extent to which the bank relies on ‘maturity
transformation’ contractually
• Standardization enables comparison, identification of outliers
• Contractual cash and security inflows and outflows in specified time buckets:
overnight; 7- and 14-day; 1-, 2-, 3- and 6-month; 1-, 3- and 5-year; beyond 5
years
• Asset flows per latest / liability flows per earliest possible date
 Concentration of funding: identify wholesale funding sources whose
significance could result in liquidity problems if funding is withdrawn
 Unencumbered assets: collateral for funding in secondary markets and for
central bank facilities
• monitor amount, type and location
• also consider haircut and currency
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Monitoring tools – market-related
 Market-wide information
• absolute level of, and trend in, major markets (e.g. equity
indices, debt markets, FX markets)
 Financial sector market information
• equity/debt markets for financial sector broadly
 Bank-specific information
• equity prices, CDS spreads, price/yield of debentures in the
secondary market – for individual banks
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Application issues
 Scope of application
• at least on a consolidated basis
• potentially also on sub-consolidated (legal entity) basis (ring-fencing?)
 Currencies
• at least aggregated across transferable and convertible currencies
• potentially also by ‘significant’ currency
 Frequency of calculation and reporting
• at least monthly, as often as daily in stressed conditions
• maximum two-week lag
• standards to be met ‘continuously’
 Public disclosure
• value and level of the metrics, drivers behind the metrics
• size and composition of the components
• frequency? not specified in consultative document …
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