a briefing on the liquidity coverage ratio and its effect ... · • interagency policy statement...
TRANSCRIPT
©
2013
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A Briefing on the Liquidity Coverage Ratio and
Its Effect on Banks and Their Customers
February 13, 2013
Presented By Dwight Smith
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Introduction • History • Liquidity Framework • Revised LCR
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History – Basel
• 1992: A Framework for Measuring and Managing Liquidity • “Measuring and managing liquidity are among the most vital activities of
commercial banks. By assuring a bank’s ability to meet its liabilities as they come due, liquidity management can reduce the probability of an irreversible adverse situation developing. Even in cases where a crisis develops because of a problem elsewhere at a bank, such as a severe deterioration in asset quality or the uncovering of fraud, or where a crisis reflects a generalised loss of confidence in financial institutions, the time available to a bank to address the problem will be determined by its liquidity. Indeed, the importance of liquidity transcends the individual institution, since a liquidity shortfall at a single institution can have system-wide repercussions.”
• Maturity ladder and the calculation of a cumulative net excess or deficit of funds at selected maturity dates.
• Stress testing and liquidity planning.
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History – Basel
• 2000: Sound Practices for Managing Liquidity in Banking Organizations
• Principle 5: Each bank should establish a process for the ongoing measurement and monitoring of net funding requirements.
• Principle 6: A bank should analyze liquidity using a variety of “what-if” scenarios
• Principle 7: A bank should revise frequently the assumptions utilized in managing liquidity to determine that they continue to be valid.
• Four categories of assets, based on degree of relative liquidity, including. • Cash, government securities that are eligible as collateral in central banks’ routine
open market operations. • “Other marketable securities, for example equities, and interbank loans which may
be saleable but which may lose liquidity under adverse conditions.” • Bank’s discretion to determine run-off rates for liabilities.
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History – Basel
• 2006: The Management of Liquidity Risk in Financial Groups • Review of liquidity risk management practices at 40 internationally active
financial organizations. • No best practices identified or recommendations made. • Three metrics used by the industry:
• Liquid assets approach: firm maintains liquid instruments on its balance sheet that can be drawn upon when needed.
• Cash flow-matching approach: firm attempts to match cash outflows against contractual cash inflows across a variety of near-term maturity buckets.
• Hybrid approach: firm attempts to match cash outflows in each time bucket against a combination of contractual cash inflows plus inflows that can be generated through the sale of assets, repurchase agreement or other secured borrowing. Assets that are most liquid are typically counted in the earliest time buckets, while less liquid assets are counted in later time buckets.
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History – Basel
• 2006: The Management of Liquidity Risk in Financial Groups, cont’d
• “Firms nearly universally expect to raise funds through secured borrowing during times of stress.”
• “Firms take into account the possibility that they will face operational risk in the short-term secured funding market or in clearing and other market mechanisms during a liquidity stress event.”
• “However, an implicit, and in some cases explicit, assumption that the official sector would address any operational risk that causes widespread disruption across multiple markets is embedded in certain firms’ scenario analyses.”
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History – Basel
• December 2006: Working Group on Liquidity established. • Take stock of liquidity supervision practices across member countries.
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History – Basel
• 2007: Financial crisis begins. • February: Freddie Mac announces it will not buy risky subprime
loans. • June: Bear Stearns suspends redemptions on two funds.
• The result of “unprecedented declines in the valuations of a number of highly rated (AA and AAA) securities.”
• August: BNP Paribas halts redemptions on three MBS funds. • “The complete evaporation of liquidity in certain segments of the U.S. securitization market has made it impossible to value assets fairly regardless of the quality or credit rating.”
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History – Basel
• February 2008: Liquidity Risk: Management and Supervisory Challenges
• Overly optimistic assumptions about liquidity of mortgage securitizations and asset-backed commercial paper.
• Risks of off-balance sheet activity and contingent commitments underestimated.
• March 2008: Bear Stearns failure.
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History – Basel
• June 2008: Consultative Document: Principles for Sound Liquidity Risk Management and Supervision
• More detailed version of Sound Practices document from 2000. • No prescribed ratios • New Principle 12 – liquidity buffer
• Most reliably liquid assets are cash and high quality government bonds or similar instruments.
• Next level are unencumbered assets that can be sold or used as collateral in repos without excessive loss or discount.
• Qualitative factors that anticipate Level 2. • Principle 5 – liquidity risks and funding needs
• No specific inflow or outflow rates.
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History – Basel
• September 2008 • GSEs conservatorships • Lehman Brothers bankruptcy • AIG • Reserve Primary Money Fund
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History – Basel
• September 25, 2008: Principles for Sound Liquidity Risk Management and Supervision.
• 17 principles from June Consultative Document confirmed. • Principle 5 – assessing funding needs but no rates or haircuts specified. • Principle 12 – liquidity buffer; no further guidance on specific assets;
qualitative factors remain in place. • Reiterated in July 2009: Enhancements to the Basel II framework.
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History – United States
• Federal Reserve Letter SR 08-9: large and complex U.S. banking organizations and regional bank holding companies
• October 2008. • Federal Reserve to assess “ability of the parent company and nonbank
subsidiaries to maintain sufficient liquidity, cash flow, and capital strength to service their debt obligations and cover fixed charges.”
• Interagency Policy Statement on Funding and Liquidity Risk Management (March 2010)
• Formal codification of Basel Principles for Sound Liquidity Risk Management.
• High quality liquid assets include U.S. Treasury securities, securities issued by U.S. government-sponsored agencies, excess reserves at the central bank, or similar instruments.
• No inflow or outflow rates specified.
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Liquidity Framework
• International Framework for Liquidity Risk Measurement, Standards, and Monitoring (December 2010)
• Ratios designed to strengthen 2008 Sound Principles. • Sound Principles from 2000 still in effect.
• Ratios • Liquidity Coverage Ratio: ability to fund liabilities over a 1-month horizon. • Net Stable Funding Ratio: ability to fund liabilities over a 1-year horizon. • Both LCR and NSFR subject to observation and study period.
• NSFR still in process.
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Liquidity Framework
• In order to calculate ratios, assets available to secure additional funding must be quantified.
• Level 1 • Cash • Central bank reserves • Certain marketable securities of sovereigns, central banks, and related
entities, generally if risk-weighted at 0%. • Level 2
• Certain marketable securities of sovereigns, central banks, and related entities, if risk-weighted at 20%.
• Plain vanilla corporate debt • Covered bonds
• Asset floor equal to 25% of expected cash outflows.
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Liquidity Framework
• Cash inflows and outflows and the likely loss of funding also must be quantified.
• Inflows capped at 75% of outflows. • Inflow rates
• Reverse repos and securities borrowing: 15%, if collateral is Level 2; 100% for all other assets. (See Level 1 below.)
• Amounts receivable from retail counterparties: 50%. • Amounts receivable from non-financial wholesale counterparties: 50%. • Amounts receivable from financial institutions: 100% • Net derivative receivables: 100%.
• 0% credit • Reverse repos and securities borrowings, if collateral is Level 1. • Credit or liquidity facilities. • Operational deposits at other financial institutions.
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Liquidity Framework
• Outflows – book ends • 0%
• Certain term deposits. • Secured funding transactions backed by Level 1 assets. • Unsecured wholesale funding.
• 100% • Unsecured wholesale funding with non-sovereigns, backed by non-HQLAs. • Default rate for secured funding. • Collateral required to cover derivative contracts in event of 3-notch
downgrade. • Liabilities from maturing ABCP and SPVs. • Asset-backed securities, including covered bonds. • Undrawn portions of liquidity facilities for certain entities. • Default rate for undrawn portions of credit or liquidity facilities. • Other contractual outflows and net derivative payables.
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Liquidity Framework
• Outflows – by category • Retail deposits: 5-10%, with 0% for term deposits longer than 30 days
and either no right to withdraw or substantial penalty. • Unsecured wholesale funding:
• Small business: 5-10%. • Entities with operational relationships: 25% (5-10% if insured). • Cooperative banks in institutional network: 25%. • Sovereigns, central banks, PSEs, and non-financial corporates: 75%. • Others: 100%.
• Secured funding • Backed by Level 1 assets: 0%. • Backed by Level 2 assets: 15%. • Transactions with sovereigns, central banks, PSEs (if domestic) and not
backed by HQLAs: 25%. • Transactions with all others, not backed by HQLA: 100%.
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Liquidity Framework
• Outflows – by category, cont’d • Derivative transactions
• Liabilities related to collateral calls for 3-notch downgrade: 100%. • Market valuation changes: national supervisor to determine. • Valuation changes on posted collateral securing derivative transactions: 20%.
• ABCPs, SIVs, conduits: 100% of maturing amounts and returnable assets.
• Undrawn portions of committed credit and liquidity facilities • Retail and small business: 5%. • Credit facilities to sovereigns, central banks, PSEs, and non-financial
corporates: 10%. • Liquidity facilities to same: 100%. • All other credit and liquidity facilities: 100%.
• Other contingent funding liabilities: national supervisor to determine. • Contractual outflows and net derivative payables: 100%.
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Liquidity Framework
• Results of the Basel III Monitoring Exercise as of 31 December 2011
• For approximately the 100 largest banks, weighted average LCR was 91%.
• For another approximately 100 banks, weighted average LCR of 98%. • Globally, shortfall of approximately €1.8 trillion in eligible assets for all of
these banks to meet LCR.
• Concerns about the 2011 ratios • Narrow range of qualifying assets. • Interbank funding. • Central bank and government support. • Timing.
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Liquidity Framework
• United States developments • Enhanced prudential standards (December 2011)
• Liquidity buffer: highly liquid and unencumbered assets that are sufficient to meet projected net cash outflows and the projected loss or impairment of existing funding sources for 30 days over a range of liquidity stress scenarios.
• Size of buffer based on stress test results. • Assets in buffer must be discounted to reflect credit risk and market
volatility. • Assets not specified (although diversification required).
• Basel III proposal (June 2012) • Not included – agencies will engage in separate rulemaking.
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Revised LCR
• Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools
• Highly qualified liquid assets • Level 1. • Level 2A—with Level 2B, cannot constitute more than 40% of HQLA. • Level 2B—cannot constitute more than 10% of HQLA.
• Changes to outflow rates
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Revised LCR
• Level 1 • Cash. • Central bank reserves, to the extent that they may be drawn down. • Marketable securities representing claims on sovereigns, central banks,
public sector entities, BIS, IMF, ECB, EC, and multilateral development banks, if
• 0% risk weight. • Non-0% risk-weighted securities may qualify if designated in currency of country in
which risk is taken or in domestic currency of issuer. • 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 during period of stress (no
quantitative measure). • Not an obligation of a financial institution or affiliate.
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Revised LCR
• Level 2A • Largely the same as Level 2 under the previous LCR.
• Marketable securities representing claims on or guaranteed by sovereigns, central banks, PSEs or multilateral development banks.
• Corporate debt, commercial paper, covered bonds. • Common requirements
• 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: no more than 10% downward movement in price or haircut.
• 15% haircut. • May constitute (together with Level 2B) no more than 40% of HQLA.
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Revised LCR
• Level 2A – special requirements • Claims on sovereigns and similar entities
• 20% risk weight under Basel II standardized approach. • Not an obligation of a financial institution or any affiliate.
• Corporate debt securities, commercial paper, covered bonds. • External credit ratings
• Long-term credit rating of at least AA-. • Equivalent short-term rating. • Probability of default equivalent to rating of at least AA-.
• Corporate debt securities – not issued by financial institution or affiliate. • Covered bonds – not issued by bank itself or any affiliate.
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Revised LCR
• Level 2B • Assets not previously includable in HQLA
• Residential mortgage-backed securities • Corporate debt. • Common equity.
• Limited to 10% (after haircuts) of HQLA • Ceiling is in addition to 40% ceiling on Levels 2A and 2B combined.
• Common elements • Traded in large, deep and active repo or cash markets characterized by a low
level of concentration. • Proven record of reliability, although range of price declines varies. • External ratings required, but vary by asset class.
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Revised LCR
• RMBS • Not issued by bank itself or any affiliate. • Underlying mortgages not originated by bank itself or any affiliate. • Credit rating
• Long term rating AA or higher or • Short term rating equivalent.
• Proven record as a reliable source of liquidity during a period of significant liquidity stress.
• Decline in price of no more than 20% during a stressed period or • No increase in haircut of no more than 20% over a 30-day period.
• Underlying asset pool limited to residential mortgages; no structured products.
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Revised LCR
• RMBS, cont’d • Underlying mortgages are full recourse.
• In case of foreclosure, borrower remains liable for shortfall in sales proceeds. • State laws not uniform – approximately half have laws that may protect
borrower to some degree. • Underlying mortgages have a maximum LTV ratio of 80% on average at
issuance. • Securitizations are subject to “risk retention” regulations which require
issuers to retain an interest in securitized assets. • Impact of U.S. risk retention rule and QRM.
• 25% haircut.
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Revised LCR
• Corporate debt • Not issued by a financial institution or any affiliate. • Credit rating
• Long term rating between A+ and BBB-; • Short term rating equivalent; or • If no external rating, a probability of default corresponding to a rating between
A+ and BBB-. • Proven record as a reliable source of liquidity during a period of
significant liquidity stress. • Decline in price of no more than 20%, and • No increase in haircut of no more than 20% over a 30-day period.
• 50% haircut.
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Revised LCR
• Common equity • Not issued by a financial institution or any affiliate. • Exchange traded and centrally cleared. • A constituent of a major stock index in the issuer’s home jurisdiction or in
the jurisdiction where the liquidity risk is taken. • Denominated in the domestic currency of the banking organization’s
home jurisdiction or in the currency of the jurisdiction where the liquidity risk is taken.
• Proven record as a source of liquidity during stressed market conditions: • Performance shows a price decline of no more than 40% during a stress
period. • Increase in haircut of no more than 40% over a 30-day period.
• Haircut: 50%.
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Revised LCR
• Reductions in cash outflow rates • Deposits
• Fully insured retail core deposits: 3% from 5%. • Other insured retail deposits: remain at 5%. • Fully insured non-operational deposits from sovereigns, central banks, PSEs,
and non-financial corporates: 20% from 40% • Unused portions of liquidity and credit facilities
• To sovereigns, central banks, PSEs, and non-financial corporates: 30% from 100%.
• Interbank credit and liquidity facilities: 40% from 100%. • Rate for inter-financial facilities remains at 100%.
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Revised LCR
• Reductions in cash outflow rates, cont’d • Maturing secured funding transactions with central banks: 0% from 25%. • Trade finance: guidance that outflow rate of 0% to 5% expected to apply. • Client servicing brokerage:
• Clarify treatment of different activities. • Overall, an increase in net outflow rates.
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Revised LCR
• Changes to Outflow Rates on Derivatives • New outflows identified; outflow rate of 100%.
• Collateral substitution. • Excess collateral.
• Standardized approach on liquidity risk related to market value changes. • Derivatives and commitments that are contractually secured or
collateralized by HQLA: 0%.
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Revised LCR
• Proposed enhanced prudential standards • Automatic: cash and securities issued by the U.S. government, a U.S.
government agency, or a GSE. • Discretionary: asset demonstrates to Board’s satisfaction
• Low credit risk. • Low market risk. • Traded in an active two-way secondary market with
• Observable market prices. • Committed market makers. • Large number of market participants. • High trading volume.
• Type of asset investors historically have purchased in periods of financial market distress during which market liquidity is impaired.
• No substantive discussion of haircuts or discounts.
