Restricted Liquidity Risk Standards and Measurement Liquidity Measures

Restricted Liquidity Risk Standards and Measurement (& Liquidity Measures taken during & after the crisis) 23 rd BSCEE Conference Ohrid, 16 June 2010 Jean-Philippe Svoronos Senior Financial Sector Specialist Financial Stability Institute 1

Restricted Outline l Financial crisis and emergency measures l Lessons learned l International framework for liquidity risk measurement, standards and monitoring (Dec 2009 consultative paper) 2

Restricted FX and maturity mismatches: Optimistic assumptions l “Mitigating” factors: • Access to short-term FX funding through subsidiaries of foreign banking groups (E and C Europe), branches in the US (W Europe) • Use of FX market rather than US funding markets • “Diversification”: access funding markets in Asia for USD funding l Liquidity/credit risk assumptions: • Structured bonds (securitization assumed to be liquid because highly rated • Some private label MBSs (in USD) considered fully liquid and made part of banks’ liquidity/treasury reserves l Underestimation/”hidden” liquidity risks • Increasing complexity of products & lack of transparency • “Shadow” banking system and use of OBS vehicles (SIVs) • Secured funding always available provided you have good quality collateral. 3

Restricted Triggers and transmission: the US subprime crisis l Strains in funding markets started in mid-2007: growing unease about the exposure of US FIs to US subprime mortgages and related securitizations l Contagion spreads to European banks (large buyers of structured products and large borrowers of USD) l Factors increasing uncertainty and contagion: • complexity of products and off-balance sheet leverage (SIVs) • “deleveraging” and fire sales • increasing reliance on short-term funding and secured funding l Consequences: • Liquidity dries up • Shortening of interbank lending tenors • Closures of markets for lengthy periods (e. g. “private label” MBSs, CP, etc…) l Several episodes destroy market confidence over time: Sept-Dec 2007, March 2008 and Sept 2008 to March 2009. 4

Restricted Private sector responses to liquidity pressures l Uncertainty led to: • Tightening of counterparty limits: less lending, shorter lending & more expensive • Hoarding and flight to quality (growth of bank deposits with the ECB, fall in yields on US notes and Treasuries) l “Fire sales” of seized collateral (SIVs) increase falls in asset prices l Illiquid, fall in asset prices and one-sided markets meant: • Hard and sometimes impossible to price in a reliable way • Lack of visibility: unknown losses, size of hit to P&L unknown l US dollar shortages increased in Europe after failure of Lehman and MMMF “breaking the buck”. 5

Restricted Central Banks’ emergency measures l “Pre-Lehman” measures: • Extraordinary market operations (outside of regular schedule, longer terms and/or larger than usual amounts. Some 17 ECB operations between 9 August & 20 December 2007) • 12 Dec. 2007 (FED): • Introduction of a Term Auction Facility (TAF): gives depository institutions (including foreign bank branches & subsidiaries) access to term funds via auctions against a wider range of collateral • Complementary USD term auctions by ECB and SNB funded by USD swap lines with Federal Reserve (put in place the same day) • Other measures (extending range of eligible collateral): • FED for primary dealers: • Term Securities Lending Facilities (TSLF) lending UST for 28 days against high quality MBSs • Primary Dealer Credit Facility (PDCF) overnight loans against investment grade debt securities • Bank of England (April 2008): Special Liquidity Scheme: asset swaps (high quality illiquid assets versus UK Treasury bills) 6

Restricted Governments and Central Banks’ emergency measures “Post-Lehman” measures to address acute USD global shortage, impact on local currency liquidity and seizing up of unsecured funding markets l Unprecedented range of measures to support financial institutions: • Increase in deposit insurance to prevent bank runs • Government guarantees on banks’ liabilities (prevent run on wholesale funding) • Asset purchase or guarantee schemes to protect financial institutions from extreme losses • Recapitalizations with public funds l Measures to address FX currency shortages • In some countries (Brazil, Korea, Mexico), wider use of FX reserves to help banks and corporates • Expansion of USD swap lines in number (2 to 14), size (unlimited for 4 central banks) and reach (1 to 5 continents) • Policy responses within euro and Swiss franc markets • Swap lines between SNB, ECB, National Bank of Poland Magyar Nemzeti Bank • Swap line between ECB and Nat. Bank of Denmark • Repos between ECB and Hungarian and Polish central banks. l 7

Restricted Lessons learned l Markets: • Even interbank markets and secured funding can freeze up • Some key assumptions were misguided • Interaction of market liquidity, credit risk, and funding liquidity under stress misunderstood, under-appreciated l Current shifts in banks’ liquidity risk management • Improved monitoring, analysis, stress testing of tenor and FX mismatches • Centralization of collateral management, contingent liabilities and access to central bank facilities • More stringent counterparty limits • Efforts to develop retail deposit bases and/or longer-term (more stable) funding l Supervision • Banks’ liquidity risk management needs improving • Regulation & supervision of liquidity is just as crucial as capital adequacy • Cross-border supervisory cooperation is essential for supervising liquidity at large international banks. 8

Restricted Objectives and components of liquidity supervision l Ensure the bank maintains sufficient liquidity • cushion of unencumbered, high quality liquid assets • withstand loss of both secured and unsecured funding sources l Key components of framework • Standards • Liquidity Coverage Ratio (LCR) – 30 days horizon • Net Stable Funding Ratio (NSFR) – 1 year horizon • Monitoring tools • Contractual maturity mismatch • Concentration of funding • Available unencumbered assets • Market-related monitoring tools. 9

Restricted LCR – definition Stock of high quality liquid assets ≥ 100% Net cash outflows over a 30 -day time period l Supervisory scenario (idiosyncratic and market-wide) • 3 -notch downgrade (triggers) • partial loss of retail deposits • loss of unsecured wholesale and secured, short-term funding (except for ‘liquid’ assets per this standard) • increased collateral calls and/or haircuts • draws on committed lines, non-contractual obligations 10

Restricted LCR – liquid assets (narrow & wider definitions) l Narrow definition • Cash and central bank reserves that can be drawn in time of stress • Marketable securities issued / guaranteed by sovereigns, central banks, other PSEs, IMF, MDBs if: • 0% risk weight under Basel II SA • deep repo markets, and not issued by banks, other financial institutions • Government or central bank debt issued in domestic currency where the risk is taken, or by home country l Wider definition • Level 1: assets eligible for narrow definition (at least 50% of the stock) • Level 2: haircut of 20% (AA- corporate & covered bonds) • Level 3: haircut of 40% (A- corporate or covered bonds) l BCBS decision to use broader definition pending on QIS results. 11

Restricted LCR – net cash outflows (denominator) l Net cash outflows = cumulative expected cash outflows minus cumulative expected cash inflows in a given time bucket under specified stress scenario l Most ‘factors’ harmonized but some subject to national discretion l No double-counting with assets included in numerator l All cash outflows and inflows based on assumptions l Example for retail demand funding • Stable … ≥ 7. 5% runoff • covered by deposit insurance • denominated in local currency • transactional account (e. g. salary deposited) or other established relationship • Less stable … ≥ 15% runoff - all other 12

Restricted NSFR – definition Available amount of stable funding (i. e. sources) > 100% Required amount of stable funding (i. e. uses) l Uses with maturity > 1 year should be funded by sources that are expected to be available for a period > 1 year l Supervisory scenario = mild idiosyncratic (longer-term focus) • decline in profitability and/or solvency • downgrade in credit rating • reputational event 13

Restricted NSFR – available stable funding (sources) Components of ASF Factor Tier 1 & 2 capital 100% Other pref shares with effective maturity ≥ 1 year 100% Other liabilities (e. g. secured and unsecured, including term deposits) with effective maturity ≥ 1 year 100% ‘Stable’ 1 retail and SME non-maturity deposits and term deposits with residual maturity ≤ 1 year 85% ‘Less stable’ 1 retail and SME non-maturity deposits and terms deposits with residual maturity ≤ 1 year 70% Unsecured wholesale funding, non-maturity and term deposits from non-financial corporates with residual maturity ≤ 1 year 50% All other liabilities and equity not included above 0% 1. As defined for the LCR 14

Restricted NSFR – required stable funding (uses) Summary composition of asset categories i) Cash RSF Factor 0% ii) Securities with effective residual maturity < 1 year iii) Non-renewable loans to financials with residual maturity < 1 year Unencumbered marketable debt issued or guaranteed by sovereigns, central banks, BIS, IMF, MDBs eligible for 0% risk weight and with residual maturity > 1 year 5% Unencumbered corporate bonds (or covered bonds) rated ≥ AA with residual maturity ≥ 1 year AND traded in deep, active market 20% i) Gold 50% ii) Unencumbered listed equities and unencumbered corporate bonds (or covered bonds) rated ≥ A- with residual maturity ≥ 1 year AND traded in deep, active market iii) Loans to non-financial corporates with residual maturity < 1 year 15

Restricted NSFR – required stable funding (uses) – cont’d Summary composition of asset categories RSF Factor Loans to retail clients with residual maturity < 1 year 85% All other assets 100% Off-balance sheet categories RSF Factor Undrawn amount of conditionally revocable and irrevocable credit and liquidity facilities provided to retail clients, corporates, financials, sovereigns, etc 10% Other contingent funding obligations, including: - unconditionally revocable uncommitted credit and liquidity facilities national discretion - guarantees - letters of credit 16

Restricted Monitoring tools – firm-based l Contractual maturity mismatch • Provides insight into the extent to which the bank relies on ‘maturity transformation’ contractually • Standardization enables comparison, identification of outliers • Contractual cash and security inflows and outflows in specified time buckets: overnight; 7 - and 14 -day; 1 -, 2 -, 3 - and 6 -month; 1 -, 3 - and 5 -year; beyond 5 years • Asset flows per latest / liability flows per earliest possible date l Concentration of funding: identify wholesale funding sources whose significance could result in liquidity problems if funding is withdrawn l Unencumbered assets: collateral for funding in secondary markets and for central bank facilities • monitor amount, type and location • also consider haircut and currency 17

Restricted Monitoring tools – market-related l Market-wide information • absolute level of, and trend in, major markets (e. g. equity indices, debt markets, FX markets) l Financial sector market information • equity/debt markets for financial sector broadly l Bank-specific information • equity prices, CDS spreads, price/yield of debentures in the secondary market – for individual banks 18

Restricted Application issues l Scope of application • at least on a consolidated basis • potentially also on sub-consolidated (legal entity) basis (ring-fencing? ) l Currencies • at least aggregated across transferable and convertible currencies • potentially also by ‘significant’ currency l Frequency of calculation and reporting • at least monthly, as often as daily in stressed conditions • maximum two-week lag • standards to be met ‘continuously’ l Public disclosure • value and level of the metrics, drivers behind the metrics • size and composition of the components • frequency? not specified in consultative document … 19