7c leonard matz some thoughts on liquidity scenarios
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Some Thoughts on LiquidityScenarios
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LIQUIDITY RISK STRESS SCENARIO
Events triggered by no changeat all (public misinformation or
market perception)
Eventstriggered by
changes in
customerbehaviour
Eventstriggered by
changes in
businessstrategy
Eventstriggered by
changes in
other financialrisks
Events triggered bychanges in macro or
economic factors
Source: Jaqui Outram
Liquidity Risk Measurement Is VERY ScenarioSpecific
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1. Credit risk 415 adverse economic conditions and unexpected events
2. Credit risk 415 range or economic conditions likely to occur over a business cycle
3. Credit risk 434 economic or industry downturns
4. Credit risk 434 market-risk events
5. Credit risk 434 liquidity conditions
6. Credit risk 435- mild recession scenarios, (e.g., two consecutive quarters of zero growth)
7. Credit risk 436 changes in the banks rating
8. Credit risk in equities 527(j) hypothetical or historical scenarios that reflect worst case losses
9. Operations Risk 665 bank specific business environment
10.Operations Risk 665 scenario analysis defined in 675 to be statistical loss analysis
11.Interest Rate Risk 826 (6) upward and downward rate shocks
Eleven Scenarios Mentioned in the Basel II
Document
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1. Principal 1: ability to withstand stressful events in the marketplace as part of day-to-day management.
2. Principal 6: internal (bank-specific) what if scenarios {alsorequired by Basel II for operations risk}.
3. Principal 6: external (market related) what if scenarios {alsorequired by Basel II for credit risk}.
Three More in Sound Practices for Managing
Liquidity in Banking Organizations, February2002
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Market experience in the form of Systemic
Crises A Wide Variety of scenarios haveoccurred over time
1987199019911992
1994199519971998
19992000200120022007
U.S. stock market crashCollapse of U.S. high yield (junk) bond marketOil price surgeERM (European Exchange Rate Mechanism) crisis
U.S. bond market crashMexican CrisisAsian crisisRussian default, Ruble collapse. LTCM
Gold pricesTMT (telecommunications, media & technology ) sector collapseSeptember 11 payments system disruptionArgentine crisisU.S. sub-prime mortgage collapse
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Risk equals the product of
probability and severity.
PROBABILITY
SEVERIT
Y
HIGH
MEDIUM
LOW
($)
LOW MEDIUM HIGH
Normal
Painful
Catastrophic
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Scenario Selection and Application
1. Use at least three: normal, bank specific and
systemic.2. Define three characteristics for each: business
and market characteristics, duration and stress
level.
3. Use at least three stress levels for all non-normal scenarios.
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Stress Testing Should Reflect Both Internaland External Scenarios
Capital markets disruptions
Systemic shocks Payment system disruptions
Prolonged global recession
External
Credit lossesOperational lossesProblem merger or acquisition
Internal
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What is Marketable?
A 2005 survey of large U.S. andCanadian banks found that only 4
out of 17 reported that they variedthe projected quantity of liquid assetsto fit the scenario.
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No current funding problem, but an elevated level of risk
Some funding problems
Serious funding problems
Serious funding problems
Some funding problems
No current funding problem, but an elevated level of riskSystemic Crisis
scenario
Bank specific
crisis scenario
Ordinary course ofbusiness scenario
Stress
Level 3
????????????Stress
Level 2
Same quantity /
higher cost
Same quantity /
higher costUnimpairedUp 100Stress
Level 1
Until we run out of
collateralNoneSeverely impairedAs per budgetStressLevel 3
DiminishedNoneSeverely impairedAs per budgetStress
Level 2
UnimpairedDiminishedMildly impairedAs per budgetStress
Level 1
UnimpairedUnimpairedUnimpairedAs per budgetNo stress
Access to New
Secured
Borrowings
Access to New
Unsecured
Borrowings
Counter Party
Confidence
Liability
Rates
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No current funding problem, but an elevated level of risk
Some funding problems
Serious funding problems
Serious funding problems
Some funding problems
No current funding problem, but an elevated level of riskSystemic Crisis
scenario
Bank specific
crisis scenario
Ordinary course ofbusiness scenario
Stress
Level 3
????????????Stress
Level 2
As per budgetAs per budgetAs per budgetUp 100Stress
Level 1
Severely impairedNo growthSignificant increaseAs per budgetStress
Level 3
Severely impairedLittle growthSlight increaseAs per budgetStress
Level 2
Mildly impairedAs per budgetAs per budgetAs per budgetStress
Level 1
As per budgetAs per budgetAs per budgetAs per budgetNo stress
Changes in Credit
Quality
Other Changes in
Loan Volume
Draws Under
Commitments
Asset
Rates
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Perception Risk
The Southdown Building Society suffered abnormalwithdrawals of 35 million during three eventful days in
August 1991, owing to unfounded rumors of links with the
failed Bank of Credit and Commerce International, whichled to a pre-tax loss of 9.8m in 1991. The members of
Southdown were consulted and, at a Special General
Meeting in March 1992, voted in favor of a merger with the
Leeds Permanent.
FURTHER GLOOM IN THE BUILDING SOCIETIES' CHALLENGING NEW WORLD,Magazine: Management Accounting, January, 1994, vol. 72 Issue 1, p28, 4p, 6