Transcript UPDATE ON INITIATIVE

Liquidity Management – Where Next?
13th April 2010
Martyn Hoccom
RBS
Overview
• 1. Markets
• 2. Regulatory Developments
• 3. Funds Transfer Pricing
Slide 2
1. Markets
Has the storm passed? – recent evidence from prices..
Bank CDS Prices
• The impacts of the crisis were
stark.
• Prices are reducing from in-crisis
highs..
• .. but have not (yet) returned to
pre-crisis levels.
Source: Bank of England, Financial Stability Report, Dec 09
(b) Excludes Co-operative Financial Services.
Bid-ask spreads on selected assets
Major UK banks’ Libor spreads
Source: Bank of England, Speeches: The Debt Hangover, Haldane, Andrew.
Source: Bank of England, Financial Stability Report, Dec 09
Slide 3
And from volumes / volatilities.
Global Issuance of Corporate Bonds and Loans
• As prices spiked, volumes fell..
• .. volatilities were huge..
Source: Bank of England, Financial Stability Report, Dec 09
Global Issuance of Structured Financial Assets
VIX Index
70
60
50
VIX
40
30
20
10
0
Dec-03
Source: Bank of England, Financial Stability Report, Dec 09
Dec-04
Source: Bloomberg
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Slide 4
Remaining challenges: macro / political environment
$/£
• Public sector bailouts have left
government finances around the
world weaker..
• .. and in some countries,
forthcoming elections add another
element of uncertainty.
1.7
1.65
1.6
$/£
• .. central bank balance sheets are
historically large..
1.75
1.55
1.5
1.45
1.4
1.35
Jun-09
Aug-09
Source: Bloomberg
Oct-09
Dec-09
Feb-10
Central banks’ balance sheets as a percentage of GDP
Government Debt as a % of GDP
140%
120%
108%
100%
80%
80%
75%
69%
60%
60%
40%
40%
20%
0%
Greece
France
Portugal
Source: CIA, The World Factbook, 2009
UK
Spain
US
Source: Bank of England, Financial Stability Report, Dec 09
Slide 5
Refinancing / funding challenges
• The banking sector has a lot of
debt to refinance, in particular as
public sector schemes close…
Major UK banks’ maturing funding: selected wholesale
liabilities
• .. at the same time as building up
liquid asset buffers.
• There is also a desire to refinance
from more stable sources.
Source: Bank of England, Financial Stability Report, Jun 09
Major UK Banks’ Customer Funding Gap
Aggregate Data from FSA Liquidity Risk Profile
Source: Bank of England, Financial Stability Report, Jun 09
Slide 6
2. Regulation
Regulatory Avalanche
• FSA - Policy Statement 09/16 Strengthening Liquidity Standards, October 2009
• Basel Committee on Banking Supervision – Principles for Sound Liquidity Risk
Management and Supervision, September 2008
• CEBS – Guidelines on Liquidity Buffers & Survival Periods, December 2009
• CEBS – Guidelines on Stress Testing, December 2009
• Basel Committee on Banking Supervision – International Framework for Liquidity
Risk Measurement, Standards and Monitoring, December 2009
• European Commission – CR04, March 2010
• CEBS - CP36: Guidelines on Liquidity Cost Benefit Allocation, March 2010
• FRB – SR 10-6: Interagency Policy Statement on funding and Liquidity Risk
Management, March 2010
And structural change proposals that could impact on environment, eg:
• Obama proposals; limits on size and / or functions
• Macro-prudential policy / instruments
• Recovery and resolution plans – Living wills
Slide 7
FSA Individual Liquidity Adequacy Assessment
• FSA’s new regime for liquidity risk management
• Purpose is to ensure that Banks and financial institutions have sufficient
liquid assets to survive periods of stress
• In periods of stress, banks experience outflows of funds which are
driven by the nature of the funds (wholesale / retail) and behaviours..
• .. and can lead to an extremely short survival period
• In order to cover the outflows banks must hold liquid assets
• Liquid assets include eligible assets - central bank balances and
government bonds
• ILAA: self- and supervisory- assessment
• Result of the ILAA: Individual Liquidity Guidance
• ‘Back stop’ regime for 2010 – 2 week and 3 month limits
Slide 8
FSA Backstop Limits
1. Two-Week Wholesale Mismatch
Slide 9
FSA Backstop Limits
2. Three-Month Liquid Asset Ratio
Slide 10
Behaviourlisation
“All history is bunk” - Henry Ford
• Status of behaviourlisation vs. forward looking judgement in stress
models
• Differentiate experience in crisis vs. normal market conditions
• Nature of liquidity stress
Slide 11
Basel
Definition
Liquidity
Coverage
Ratio
Stock of high quality liquid assets
Net Stable
Funding
Ratio
Available amount of stable funding
Issues
≥100%

Buffers are likely to be much
larger than in the past

Basel definition can not easily be
estimated from published annual
accounts data

The weightings applied to
different asset and liability
categories may require more
empirical evidence
Net cash outflows over a 30 day time
horizon
≥100%
Required amount of stable funding
• European Commission aim to agree for draft EU law in 2010 in line with
BSCS timetable
• FSA will ensure consistency of UK regime with final EU regulations
Slide 12
The Liquidity Coverage Ratio (LCR)
The LCR aims to ensure that a bank maintains an adequate level of
unencumbered, high quality assets which are sufficient to cover outflows
in a 30 day period of acute short-term stress scenario defined by the
regulators and which entails:
•a significant downgrade of the institution’s public credit rating;
•a partial loss of deposits
•a loss of unsecured wholesale funding
•a significant increase in secured funding haircuts
•increases in derivative collateral calls
•substantial calls on contractual and non-contractual off-balance sheet exposures,
including committed credit and liquidity facilities
Slide 13
The LCR has two components
1. Numerator: The Liquidity Buffer
Whether the narrow or broad definition is used assets must
include only those unencumbered assets which meet the criteria
of being easily and immediately converted into cash at little or no
loss of value. They must therefore have the following
fundamental characteristics:
•Low Credit and Market Risk
•Ease and Certainty of valuation
•Low correlation with risky assets
•Listed on an exchange
•Active and sizable market
•Presence of committed market makers
•Low market concentration
•Evidence that assets have been used in flight to quality
Slide 14
LCR Denominator
2. Denominator: Cash outflows
The Committee has been quite prescriptive in converting contractual flows
into behaviour flows for the purpose of the calculation:
1.
2.
3.
4.
Unsecured deposits
Secured funding
Drawdown of unutilised committed credit and liquidity
100% of liquidity needs associated with downgrade triggers in respect of
additional collateral needs for up to and including a 3 notch downgrade
A percentage (to be agreed by local regulators) of the increased liquidity
needs related to changes in market valuation of derivative contracts. Where
the collateral is non core an additional 20% of the value of the collateral
should be held due to the potential price volatility of the underlying securities.
100% of liquidity exposure to abcp, conduits, SIVs, and other such financing
facilities
100% of maturing funding of asset backed securities maturing in the 30 day
period
Slide 15
The Net Stable Funding Ratio (NSFR)
The NSFR aims to increase the amount of medium and long term funding to
support illiquid assets
Objectives include:
• reduce level of reliance on short-term funding
• ensure that investment banking inventories, off-balance sheet exposures,
securitisation pipelines funded with at least a minimum of stable liabilities
• limit over-reliance on wholesale funding
• encourage better assessment of liquidity risk across on and off balance sheet
items
• counterbalance possible “cliff edge” effects of using 1m period in the LCR
Slide 16
RBS Net Stable Funding Ratio
• Published in RBS annual report and accounts 2009
• HSBC has published industry wide indicator in research paper
Slide 17
NSFR Unintended Impacts?!
Macro
 Less maturity transformation – more term funding => credit creation?
Micro
 0% factors for secured borrowing => reduces market?
 Corporate bonds funded in CP more favourably traded => increases market?
Slide 18
3. Funds Transfer Pricing
Organisational Structure
Board / GALCO
Market access
Function
Divisions
Retail
Capital
Markets
Wealth
Liquidity FTP Centre
Wholesale
Corporate
Clearing
Clearing
Money
Markets
Markets
Execution
Etc.
Risk Control:
• Limits
• Mismatch Gaps
• Liquidity Cover
Slide 19
Balance Sheet Liquidity Breakdown
Liquidity Behavioural Assumptions
• Need to map products to maturities
• Basis for mapping to be determined
Slide 20
Liquidity Cost Benefit Allocation
“1.The liquidity cost benefit allocation mechanism is an important part of the
whole liquidity management framework. As such, the mechanism should be
consistent with the framework of governance, risk tolerance and decisionmaking process.
2.The liquidity cost benefit allocation mechanism should have a proper
governance structure supporting it.
3.The output from the allocation mechanism should be actively and properly
used and appropriate to the business profiles of the institution.
4.The scope of application of internal prices should be sufficiently
comprehensive to cover all significant parts of assets, liabilities and offbalance sheet items regarding liquidity.
5.The internal prices should be determined by robust methodologies, taking
into account the various factors involved in liquidity risk.”
CEBS Principles
Slide 21