New Minimum Liquidity
Standards Under Basel III
David Hawkins
UST/OTA
April 2011
Why Now?
• Due to liquidity problems during the recent
crisis, even for banks with adequate capital.
• Basel developed in 2008 and published
“Sound Liquidity Risk Management and
Supervision.”
• These are meant to complement them.
Basel III calls for Two Minimum
Standards
• The standards are considered to achieve two
separate but complementary objectives.
– First is to promote short-term liquidity resilience of a
bank’s liquidity risk profile by ensuring that it has
sufficient high-quality liquid assets to survive a
significant stress scenario last for one month. This is
measured by the Liquidity Coverage Ratio (LCR).
– Second objective is to promote resilience over a
longer time horizon by creating additional incentives
for banks to fund their activities with more stable
sources of funding on an ongoing basis. This is
measured by the Net Stable Funding Ratio (NSFR).
Transitional Arrangements
• Banks will be expected to comply with
minimum LCR requirements by January 1,
2015, and the NSFR by January 1, 2018.
• Should be implemented consistently by all
regulators throughout the world.
• Supervisors can hold individual banks to more
stringent standards, and there is discretion in
applying them within a country for the
system.
Liquidity Coverage Ratio (LCR)
• Objective is to ensure that a bank maintains an
adequate level of unencumbered, high quality
liquid assets that can be converted into cash to
meet its liquidity needs for a 30 day calendar day
time horizon under a significantly severe liquidity
stress scenario specified by supervisors. At a
minimum, the stock of liquid assets would allow a
bank to survive for 30 days, by which time it is
assumed that appropriate corrective actions can
be taken by management and/or regulators,
and/or the bank can be resolved in an orderly
way.
Definition of the LCR Standard
Stock of High Quality Liquid Assets
Total Net Cash Outflows Over the Next 30 days
• Must be greater than or equal to 100%
• Must be met continuously
• Timing of cash inflows and outflows may lead to mismatches and
liquidity problems within the 30 day time period, so the bank and
supervisors are expected to be aware of any potential mismatches
within this period
Shocks for the Standard
•
Scenario for this standard entails a combined idiosyncratic and market-wide shock
that would result in:
– The run-off of a proportion of retail deposits.
– A partial loss of unsecured wholesale funding activity.
– A partial loss of secured, short-term financing with certain collateral and
counterparties.
– Additional contractual outflows that would arise from a downgrade in the
bank’s public credit rating by up to and including three notches, including
collateral positing requirements.
– Increases in market volatilities that impact the quality of collateral or potential
future exposure of derivative positions and thus require larger collateral
haircuts or additional collateral, or lead to other liquidity needs.
– Unscheduled draws on committed but unused credit and liquidity facilities
that the bank has provided to its clients.
– The potential need for the bank to buy back debt or honor non-contractual
obligations in the interest of mitigating reputational risk.
Stress Test, cont.
• This scenario should be viewed as a minimum
supervisory requirement for banks.
• Banks are expected to conduct their own stress
tests to assess the level of liquidity they should
hold beyond this minimum, using their own
scenarios that could cause difficulties for their
specific business activities.
• These should incorporate longer time horizons
that the one mandated by the standard, and
should share the results with bank regulators.
LCR Has 2 Components
• Value of the stock of high-quality liquid assets
in stressed conditions.
• Total net cash outflows, calculated according
to the scenario parameters (to be discussed
next).
Stock of High Quality Liquid Assets
• To be considered in this category, they must
be unemcumbered over a 30 days period
under the prescribed stress scenario.
• They must also be liquid in markets during a
time of stress and, ideally, be central bank
eligible.
Characteristics of High-Quality Liquid
Assets
• Fundamental Characteristics
– Low credit and market risk.
– Ease and certainty of valuation.
– Low correlation with risky assets.
– Listed on a developed and recognized exchange market.
• Market-related Characteristics
– Active and sizable market.
– Presence of committed market makers.
– Low market concentration.
– Flight to quality.
General Test for Inclusion
• The liquidity generating capacity of the asset
should be assumed to remain intact even in
periods of severe idiosyncratic and market
stress.
• Should ideally be eligible at central banks for
intraday liquidity needs and overnight liquidity
facilities; however, this is not a requirement.
Operational Requirements
• All assets in the stock must be managed as part of that pool and are
subject to operational requirements, including,
– Must be unencumbered – means not pledged (either explicitly
or implicitly) to secure, collateralize, or credit enhance any
transaction.
– However, assets received in reverse repurchase agreements and
securities financing transactions that are held at the bank, have
not been rehypothecated, and are legally and contractually
available for the bank’s use can be considered as part of the
stock.
– Also, assets which qualify for the stock of high-quality liquid
assets that have been pledged but not used for facilities at the
NBM or a public sector entity may be included.
Operational Requirements, cont.
– Stock should not be comingled with or used as
hedges on trading positions, be designated as
collateral or be designated as credit
enhancements in structure transactions or be
designated to cover operational costs (such as
rents and salaries), and should be managed with
the clear and sole intent for use as a source of
contingent funds.
– Can hedge the price risks associated with
ownership of the stocks and still include.
Operational Requirements, cont.
– Stock should be under the control of the specific function or functions charged
with managing the liquidity risk of the bank, usually the treasurer.
– Should periodically monetise a proportion of the assets through repo or
outright sale to test its access to the market.
– LCR does not cover intraday liquidity needs that begin and end on the same
day.
– While the LCR is expected to be met and reported in a single currency, banks
will be expected to meet their liquidity needs in each currency and maintain
high-quality liquid assets consistent with their liquidity needs by currency.
Should be reported to the bank management and the NBM on a periodic
basis.
– Bank should take into account that in stressed conditions, the ability to swap
currencies and access the relevant FX markets may be more difficult.
– If an asset becomes ineligible while being considered as a high-quality liquid
asset, it may be kept in the group for an additional 30 days to allow the bank
to replace it or to adjust its stock.
Definition of High-Quality Liquid Asset
• Should comprise assets with the
characteristics outlined above.
• There are two categories of high-quality liquid
assets, Level 1, which can be included without
limit, and Level 2, which can only comprise up
to 40% of the stock.
Level 1 Assets
•
•
•
Cash
Central bank reserves, to the extent that they can be drawn down in times of
stress
Marketable securities representing claims on or claims guaranteed by sovereigns,
central banks, non-central government public sector enterprises, BIS, IMF, EC, or
multilateral development banks, provided they meet the following:
– Are assigned a 0% risk weight under Basel II Standardized Approach
– Are traded in large, deep and active repo or cash markets characterized by a low level of
concentration
– Proven record as a reliable source of liquidity in the markets (repo or sale) even during
stressed market conditions, and
– Are not an obligation of a financial institution or any of its affiliated entities.
•
•
Non-0% risk weighted sovereigns, sovereign or central bank debt securities issued
in domestic currencies by the sovereign or central bank in which the liquidity risk is
being taken or in the bank’s home country
Non-0% risk weighted sovereigns, domestic sovereign or central bank debt
securities issued in foreign currencies, to the extent that holding of such debt
matches the currency needs of the bank’s operations in that jurisdiction.
Level 2 Assets
• Can be included up to a maximum of 40% of
the overall stock after haircuts have been
applied.
• Minimum 15% haircut is applied to the market
value of each Level 2 assets held in the stock.
Level 2 Assets, cont.
• Level 2 Assets are limited to the following:
– Marketable securities representing claims on or claims
guaranteed by sovereigns, central banks, non-central
government private sector enterprises or multilateral
development banks that meet the following:
• Assigned a 20% risk weight under Basel II standardized approach
for credit risk
• Traded in large, deep and active repo or cash markets
characterized by a low level of concentration
• Proven record as a reliable source of liquidity in the markets (repo
or sale) even during stressed market conditions (i.e. maximum
decline of price or increase in haircut over a 30 day period during a
relevant period of significant liquidity stress not exceeding 10%)
• Not an obligation of a financial institution or any of its affiliated
entities.
Level 2 Assets, cont.
• Corporate bonds and covered bonds, which are bonds issued and owned
by a bank and are subject by law to special public supervision designed to
protect bond holders, if they follow the following conditions:
– Not issued by a financial institution or any of its affiliated entities (in the case
of corporate bonds)
– Not issued by the bank itself or any of its affiliated entities (in the case of
covered bonds)
– Assets must have a credit rating from a recognized external credit assessment
institution (ECAI) of at least AA- or do not have a credit assessment by a
recognized ECAI are internally rated as having a probability of default (PD)
corresponding to a credit rating of at least AA– Traded in large, deep and active repo or cash markets characterized by a low
level of concentration
– Proven record as a reliable source of liquidity in the markets (repo or sale)
even during stressed market conditions, e.g. maximum decline in price or
increase in haircut over a 30 day period during a relevant period of significant
liquidity stress not exceeding 10%.
Testing of Additional Criteria
• Basel is in the process of testing additional
qualitative and quantitative criteria for
eligibility in Level 2 assets. The additional
criteria are not meant to exclude assets that
qualify for Level 2, but to address assets that
are not liquid, as well as to provide measures
in addition to credit ratings to evaluate
eligibility and not to place so much reliance on
external credit ratings. These will be provided
in the future.
Special Treatment for Jurisdictions
with Insufficient Liquid Assets
• For jurisdictions with an insufficient supply of
assets, there are options provided for which
we shall not go into at this time.
Total Net Cash Outflows
• The denominator in the LCR.
• Total Net Cash Outflows - defined as the total expected cash outflows
minus total expected cash inflows in the specified stress scenario for the
subsequent 30 calendar days.
• Total expected cash outflows are calculated by multiplying the
outstanding balances of various categories or types of liabilities and offbalance sheet commitments by the rates at which they are expected to
run-of or be drawn down.
• Total expected cash inflows are calculated by multiplying the outstanding
balances of various categories of contractual receivables by the rates at
which they are expected to flow in under the scenario up to an aggregate
cap of 75% of total expected cash outflows.
Total Net Cash Outflows = total expected cash outflows – total expected
cash inflows (up to a maximum 75% of total expected cash outflows)
Cash Outflows
• Retail Deposits
– Term Deposits >30 days with penalty (0%)
– Stable (Demand and Term) <30 days (5%)
– Less Stable (Demand and Term) <30 days (10%)
Cash Outflows, cont.
• Unsecured Wholesale Funding
– Portion of Corporate Deposits with Operational
Relationships covered by Deposit Insurance (0%)
– Stable small business customers (5%)
– Less Stable small business customers (10%)
– Deposits needed for operational purposes of legal
entities (25%)
– Non financial corporates, sovereigns, central
banks and PSEs (75%)
– Other legal entity customers (100%)
Cash Outflows, cont.
• Secured Funding
– Transactions backed by L1 Assets with any
counterparty (0%)
– Transactions backed by L2 Assets with an
counterparty (15%)
– Transactions backed by assets not qualifying as
highly liquid with domestic sovereigns, domestic
central banks or domestic public sector entities as
counterparty (25%)
– All other secured funding transactions (100%)
Cash Outflows, cont.
• Other items, such as undrawn commitments,
liabilities related to derivative transactions,
asset backed securities, covered bonds.
• Presence of deposit insurance alone is not
considered sufficient to consider a deposit
“stable.”
• NBM should consider how FX deposits should
be considered (i.e. the runoff rates).
Cash Inflows
• The bank should only include contractual inflows
from outstanding exposures that are fully
performing and for which the bank has no reason
to expect a default in the next 30 days.
• The bank and regulator should ensure that the
bank is not highly dependent on cash inflows
from one counterparty or a limited number of
wholesale counterparties.
• There is a maximum cap of 75% of total expected
cash outflows as calculated in the standard.
Cash Inflows, cont.
• A bank should assume that maturing reverse
repurchase or securities borrowing agreements
secured by Level 1 assets will not be rolled over
and will not give rise to any cash inflows.
• There are some exceptions.
• No lines of credit or other contingent funding
facilities that he bank holds at other institutions
for its own purposes are assumed to be able to
be drawn. Such facilities receive a weighting of
0%.
Cash Inflows, cont.
• For all other types of transactions, either
secured or unsecured, the inflow rate will be
determined by the counterparty.
Summary of Weights for Cash Inflows
• 0%
– Deposits held at centralized institutions of a network
of co op banks.
– Operational Deposits held at other financial
institutions.
– Credit or liquidity facilities.
– Reverse repos and securities borrowing with L1 assets
as collateral.
• 15%
– Reverse repos and securities borrowing with L2 assets
as collateral.
Summary of Weights for Cash Inflows,
cont.
• 50%
– Amounts receivable from retail counterparties.
– Amounts receivable from non-financial wholesale
counterparties (transactions not otherwise listed).
• 100%
– Reverse repos and securities borrowing with all other
assets as collateral.
– Amounts receivable from financial institutions from
transactions not otherwise listed.
– Net derivative receivables.
Net Stable Funding Ratio
= Available Amount of Stable Funding
Required Amount of Stable Funding
Must be greater than 100%.
•
•
•
•
This will not be required until January 1, 2018.
In short, it ensures that long-term assets are funded at
least with some stable liabilities in terms or their liquidity
risk profiles.
Encourages banks to develop more longer-term funding.
Looked at on a one-year horizon.
Definitions
• Stable funding – the portion of those types and amounts of equity
and liability financing expected to be reliable sources of funds over
a one-year horizon under conditions of extended stress.
• Available Stable Funding – defined as the total amount of a bank’s
–
–
–
–
Capital;
Preferred stock with maturity of equal to or greater than one year;
Liabilities with effective maturities of one-year or more;
That portion of non-maturity deposits and/or term deposits with
maturities of less than one year that would be expected to stay with
the institution for an extended period in an idiosyncratic stress event;
and,
– The portion of wholesale funding with maturities of less than a year
that is expected to stay with the institution for an extended period in
an idiosyncratic stress event.
– Includes stable and less stable retail and SME deposits.
Components of Available Stable
Funding and Associated ASF Factors
ASF Factor
Components of ASF Category
100%
•The total amount of capital, including
both Tier 1 and Tier 2 as defined in
existing global capital standards issued by
the Basel Committee.
•The total amount of any preferred stock
not included in Tier 2 that has an effective
remaining maturity of one year or greater
taking into account any explicit or
embedded options that would reduce the
expected maturity to less than one year.
•The total amount of secured and
unsecured borrowing and liabilities with
effective remaining maturities of one year
or more.
ASF, cont.
90%
•Stable demand deposits with no
maturity and/or term deposits with
residual maturities of one year or greater
(retail customers and SMEs)
80%
“Less stable” demand deposits and/or
term deposits with residual maturities of
less than one year (retail customers and
SMEs)
50%
Unsecured wholesale funding, nonmaturity deposits and/or term deposits
with a residual maturity less than one
year (non-financial corporates,
sovereigns, central banks, MDBs, and
PSEs.
0%
All other liabilities
Definition of RSF for Assets and OBS
Exposures
• The amount of stable funding required by supervisors is to
be measured using supervisory assumptions on the broad
characteristics of the liquidity risk profiles of an institution’s
assets, off-balance sheet exposures and other selected
activities.
• The required amount of stable funding is calculated as the
sum of the value of assets held and funded by the
institution, multiplied by a specific required stable funding
factor (RSF) factor assigned to each particular asset type,
added to the amount of OBS activity (or potential liquidity
exposure) multiplied by its associated RSF factor.
• Encumbered assets are not considered to be available for
funding, unless there is a less than one year remaining on
the encumbrance period.
Required Stable Funding
Components of RSF
RSF Factor
Cash and unencumbered assets with a maturity of less than
one year
0%
Claims on sovereigns, central banks, MDBs with risk-weight
under Basel II
5%
Corporate or covered bonds rated AA- or better; claims on
sovereigns, central banks, MDBs with 20% RW under Basel II
standardized approach
20%
Gold, equities, and other corporate and covered bonds (A+ to
A-) with maturities over 1 year; other loans to non-financial
corporate clients, sovereigns, centrals banks, PSEs with
maturity less than one year
50%
Residential Mortgages
65%
Other retail and SME loans with maturities less than one year
85%
All other Assets
100%
Conditionally revocable and irrevocable credit and liquidity
facilities to any client.
5% of the currently undrawn portion.
Other Contingent Liabilities, including revocable obligations,
L/Cs, guarantees, other trade finance instruments, and noncontractual obligations.
National supervisors to specify RSF factors based on national
circumstances
Monitoring Tools
• These additional metrics help a supervisor
monitor liquidity risk at a bank.
– Contractual maturity mismatch
– Concentration of Funding
– Available unencumbered assets
– LCR by significant currency
– Market-related monitoring tools
Contractual Maturity Mismatch
• Identifies the gaps between the contractual inflows and outflows of
liquidity during time bands.
• At a minimum, should collect data on all categories outlined in the
LCR. Some additional data such as NPLs should be reported
separately, as well as capital.
• These indicate how much a bank would potentially need to raise in
each of these time bands if all outflows occurred at the earliest
possible date. Banks should be expected to identify how to cover
gaps.
• Supervisors will determine specific template.
• Instruments with no maturity should be reported separately.
• Assumptions
– No roll over of liabilities is expected to take place.
– Other assumptions as well.
Concentration of Funding
• This metric is meant to identify those sources
of wholesale funding that are of such
significance that withdrawal of this funding
could trigger liquidity problems.
• Funding liabilities sourced from each significant community/Bank’s
Balance Sheet Total
• Funding liabilities sourced from each significant product or
instrument/Bank’s Balance Sheet Total
• List of asset and liability amounts by significant currency
• For first two, should look at absolute percentage and percentage change
Concentration of Funding, cont.
• Significant Counterparty – defined as a single
counterparty or group of connected or affiliated
counterparties, accounting in aggregate for more than
1% of the bank’s total balance sheet.
• Significant Instrument/product – defined as a single
instrument/product or group of similar
instruments/products that in aggregate amount to
more than 1% of the bank’s total balance sheet.
• Significant currencies – defined as those aggregate
liabilities denominated in that currency amount to 5%
or more of the bank’s total liabilities.
Available Unencumbered Assets
• Defined as available unencumbered assets
that are marketable as collateral in secondary
markets and/or eligible for central bank
facilities.
• Bank’s should repot that amount of these on a
periodic basis.
LCR by Significant Currency
• FX LCR = Stock of high quality liquid assets in each
significant currency/Total net Cash Outflows over a 30-day
time period in each significant currency.
• Should be net of any FX hedges.
• Should mirror those high quality liquid assets definition.
• Currency is considered “significant” if the aggregate
liabilities denominated in that currency amount to 5% or
more of the bank’s total liabilities.
• No defined threshold.
• Meant to allow the bank and supervisor to see potential
currency mismatch issues that could arise in times of stress.
Market Related Monitoring Tools
• High frequency market data with little or no time lag
can be used as earl warning indicators in monitoring
potential liquidity difficulties at banks.
• Supervisors can use:
– Market-wide information
• Equity prices, debt markets, FX markets, commodities markets
– Information on the financial sector
• Such as equity and debt market information for the financial
sector broadly
– Bank Specific Information
• Such as equity prices of a bank, money-market trading prices,
spreads, price/yield of various lengths of funding
Reporting, Standards, etc.
• Differences in home/host liquidity
requirements, when consolidated, liquidity
parameters should be applied are those in the
home jurisdiction to all legal entities being
consolidated, except for treatment of
retail/SME deposits should follow host
country requirements.
Timeframes
• QIS should be conducted using data from year-end
2010 and mid-year 2011 using components for both
the LCR and NSFR.
• Reporting to NBM throughout the observation period,
expected to start on January 1, 2012 for the two
standards, including overall percentages and
information on the components.
• Basel Committee is prepared to make revisions if
necessary – LCR by mid-2013 and NSFR by mid-2016.
• The LCR will be introduced on January 1, 2015 and the
NSFR on January 1, 2018.