The Implementation of Basel III Liquidity Standards in CRD IV

The 2011 Forum on Basel III Implementation July 12, 2011, Zurich

Stefan W. Schmitz

Disclaimer: The opinion of the presenter does not necessarily reflect those of the OeNB or the Eurosystem. stefan.schmitz@oenb.at

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Structure

1. Liquidity in the CRD IV – Pillar I

2. Harmonised liquidity reporting

3. QIS results

4. Liquidity in the CRD IV – Pillar II

5. Assessment

6. Impact on monetary policy implementation

7. Conclusions

Liquidity in the CRD IV – Pillar I

Current status

1. EU liquidity regulation

– Heterogeneuous quantitative liquidity regulation

– Heterogeneuous liquidity reporting (COREP)

2. High-level principles for liquidity risk management in

pillar II

– CRD II Annex

3. CEBS Guidelines

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Basel III liquidity standards

BCBS International framework for liquidity risk measurement, standards and monitoring, December 2009

1. Objectives– Harmonisation of quantitative liquidity regulation– Stability of individual institutions under stress– Systemic stability under stress

2. Liquidity stress tests– Instrumental to achieve more risk sensitive ratios– Static minimum stress scenarios

3. Standards– Liquidity Coverage Ratio (2015)– Net Stable Funding Ratio (2018)

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Liquidity Coverage Ratio (LCR)

Objective– Liquidity even under very severe

liquidity stress over 30 days w/o

gov & CB assistence

– Minimum requirements

Definition LA (liquide Assets)

Level 1

• Cash, CB excess reserves

• Government bonds & gov guaranteed bonds (0% risk weight ; AA-)

• Bonds of other public authorities (etc)

Level 2 (HC 15%) [max. 40%]

+ Govies, PSEs (20% risk weight)

+ Covered bonds & non-financial corporate bonds ( AA-) & high (HC 15%) & substantial restrictions

Stress scenario

1. Combination of market- & idiosynkratic stress

2. Rating downgrade (3 notches)

3. Run-off of retail- & wholesale deposits

4. Primary & secondary markets (repo & securitisation) dry-up for many assets

5. Large cash outflows due to off-balance items

25.0min

1

30%75max

OutflowCash

InflowsOutflow

LA

T

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LCR: net-cashflow calibration

Cash outflows over 30 days

Retail deposits

10%: Less stable deposits

5%: Stable retail deposits

Unsecured wholesale funding

100%: Financials, banks w/o operational relationship

75%: Non-financials, CBs & PSE, non-operational balance

25%: Operational balance (all legal entities)

5, 10%: SMEs

Secured funding

100%: Repos w non-eligible assets, margin calls (3 notche DG), ABCP & SIVs, Term ABS

25%: PSE/CBs repos w non-eligible assets

15%: Repos w level 2 assets 0%: Repos w level 1 assets

Credit & liquidity lines

100%: Contractual outflows100%: Non-financial (li) & financials &

governments10%: Non-financials, PSEs, CBs (credit) 5%: Retail clients (credit & li)

Cash inflows over 30 days (cap 75%)

Retail loans50%: Planned inflows from performing

retail loans

Unsecured funding

100%: Planned inflows from performing wholesale loans (financials)

50%: Planned inflows from performing wholesale loans (non-financials)

0%: Operational balances

Secured funding

100%: Receivable from repo w assets non- eligible assets

15%: Receivable from repo w level 2 assets

0%: Receivable from repo/reverse repo w level 1 assets

Credit & liquidity lines

0%: Undrawn liquidity lines & other facilities

(Summary)

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Net Stable Funding Ratio (NSFR)

Objective

– Reduce maturity mismatch

between funding and assets

– Assets > 1 y funded by

liabilities > 1y

ASF (Available Stable Funding)

100%: Capital, hybrids, liabilities w residual maturity > 1 y

90%: Stable deposits

80%: Less stable deposits

50%: Wholesale funding (non-financials)

0%: Rest

2 x LCR run-offs

RSF (Required Stable Funding)

0%: Cash, CP, bonds w residual maturity < 1 y, non-renewable interbank loans

5%: Govies et al. ( AA), off-balancesheet

20%: Corporate bonds & covered bonds & govies ( AA), residual maturity 1 y

50%: Corporate bonds & covered bonds ( A-) 1 y, loans to non-financial corporates < 1 y

65%: Unencumbered mortgages (35% RW)

85%: Retail loans < 1 y100%: Rest

1RSF

ASF

(Summary)

Challenges (I)

Challenges (II)

Challenges (III)

Challenges (IV)

Harmonised liquidity reporting

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Maturity mismatch template

Challenges

1. WGL plans to develop a similar template– Focus on LCR– EBA template focuses on liquidity monitoring

2. Proportionality– Majority of banks should report monthly– Largest banks weekly– Rest quarterly – Similar waiver as for LCR can apply for liquidity sub-

groups

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QIS results

QIS results

-1,730 bn € -2,890 bn €

Source: BIS (2011).

Main drivers LCR outflows

Source: BIS (2011).

Main drivers LCR inflows

Source: BIS (2011).

Composition of liquid assets

Source: BIS (2011), Chart 6.

Challenges

1. Potential behavioural reactions

– Reduction of refinancing via unsecured interbank deposits

– Terming out and staggering of funding via unsecured interbank deposits

– Promoting stable deposits

– Substitution of liquid for illiquid assets & within liquid assets towards lower

hair-cuts

– Off-balance-sheet: Reduction of undrawn liquidity/credit lines unless fairly

priced

– Improvement of data quality

Practical challenge in terms of costs/economic impact low

Liquidity in the CRD IV – Pillar II

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Pillar II – CRD II Annex V

Qualitative liquidity regulation

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Relevant CEBS Guidelines

1. CEBS’S Technical Advise on Liquidity Risk

Management (2nd part)

2. Guideline on Liquidity Buffers & Survival Periods

3. High level principles for risk management

4. Guidelines on Stress Testing CEBS

5. Guidelines on Liquidity Cost Benefit Allocation

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Challenges

1. Coherence across directives/regulations/guidelines

2. Coherent implementation/interpretation/application

across EU

3. Principles based detailed guidance

4. Supervisory authorities often prefer „box-ticking“

approach

5. Expertise & judgement rule of law/liability of

authorities

Assessment

Assessment (I)

1. International harmonisation of standards & reporting (EU)

2. Binding quantitative liquidity standards– Internalise negative externalities

But LCR/NSFR not binding for most banks

– Maintain confidence under stress

3. Risk sensitive across balance sheet structures– Across banks/time improvement wrt to simple stock

approaches– But not risk sensitive with respect to market/banking

environment More refined stock approach with static run-off rates

– Definition of components product specific Liquidity risk characteristics/product innovation?

Assessment (II)

4. Stress testing stocks problematic

– Insufficient picture of li-situation

– Preferrable gross cash-flows & counterbalancing capacity

5. Approach to liquid assets inconsistent with stress test

approach

– Unintended consequences

Feedback on market liquidity through frozen portfolios/fire sales?

Increasing reliance on CRAs cliff-effects feedback on markets

6. Scope of application

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Assessment (III)

7. Consistency between CRD IV and CEBS Guidelines?– Distinction pillar I & pillar II

8. Potential impact

– Ratios watered down substantially after QIS – still binding?

– Competition for deposits intensivies – deposit growth/long-

term debt issuance constrain loan growth

Challenges for emerging, fast growing economies

– Interbank market – liquidity insurance, structural li-deficit &

monetary policy implementation

Impact on monetary policy implementation

Impact on monetary policy (I)

Arbitrage via CB Unsecured

interbank market

Impact of crisis

Main target rate

Structural liquidity deficit

LCR

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Impact on monetary policy (II)

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Impact on monetary policy (III)

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Challenges for monetary policy

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Conclusions

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Conclusions

Liquidity Risk Management Workshop, RiskMinds 2010 37

Background material

BCBS (2008) Principles for Sound Liquidity Risk Management and Supervision, Basel

BCBS (2009) International framework for liquidity risk measurement, standards and monitoring, Basel

CEBS (2008) CEBS’S Technical Advise on Liquidity Risk Management (2nd part), London

CEBS (2009) Guideline on Liquidity Buffers & Survival Periods, LondonCEBS (2010a) High level principles for risk management, LondonCEBS (2010b) Guidelines on Stress Testing (GL32), London

ECB (2008) Report on EU banks liquidity stress tests and contingency funding plans, Frankfurt

Schmitz, S.W., A. Ittner (2007) Why central banks should look at liquidity risk, Quarterly Journal Central Banking Vol. XVII No. 4, 32-40

Schmitz, S. W. (2011) The Impact of the Basel III Liquidity Standards on the Implementation of Monetary Policy, mimeo OeNB, Vienna

Appendix

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