Title: Recent International Initiatives to Strengthen the Management and Supervision of Liquidity Risk
1Recent International Initiatives to Strengthen
the Management and Supervision of Liquidity Risk
- Andrew Cunningham
- Presentation to the High Level Meeting for the
Middle East and North Africa Region, organized by
the Financial Stability Institute and the Arab
Monetary Fund. - Abu Dhabi, 8-9 November 2010
2Outline of the Presentation
- Examples of liquidity regulations introduced by
national supervisors. - Examples of supra-national initiatives on
liquidity. (The BCBS proposals are being
addressed in a separate presentation.) - Examples of initiatives being taken in the Middle
East. - General themes and ideas contained in recent
regulations and initiatives.
3U.K. Financial Services Authority (1)
- Policy Statement 09/16 issued in October 2009
concluded review of U.K. framework for liquidity
regulation which began in 2007. - New Liquidity Standards for most banks, building
societies and investment firms effective as
BIPRU 12 in 1 December 2009. - Two-tier regime
- Standard ILAS BIPRU firms
- Simplified ILAS BIPRU firms
- Provision also made for Non-ILAS BIPRU firms
(Consultation Guidance published October 2010) - BIPRU Prudential Sourcebook for Banks,
Building Societies and Investment Firms, in
contrast to, e.g., GENPRU General Prudential
Sourcebook, or INSPRU Prudential Sourcebook
for Insurers.
4U.K. Financial Services Authority (2)
- BIPRU 12.2.1 Overall Liquidity Adequacy Rule
- A firm must at all times maintain liquidity
resources which are adequate, both as to amount
and quality, to ensure that there is no
significant risk that its liabilities cannot be
met as they fall due. - BIPRU 12.3 Liquidity Risk Management
- Requirements related to systems, controls and
management of liquidity risk, (including
responsibility of the board) and provisions
related to specific areas such as liquidity
pricing and management of collateral. - BIPRU 12.4 Stress Testing and Contingency
Funding - BIPRU 12.5 Standard ILAS BIPRU firms conduct
Individual Liquidity Adequacy Assessments (ILAA)
which address - A name-specific liquidity stress lasting two
weeks - A market-wide liquidity stress lasting three
months - Simultaneous occurrence of both of the above
- BIPRU 12.6 Simplified ILAS BIPRU firms must
- comply with a simplified buffer requirement and
- submit an Individual Liquidity Systems Assessment
(ILSA) detailing compliance with BIPRU 12.3 and
BIPRU 12.4.
5U.K. Financial Services Authority (3)
- BIPRU 12.7 defines nature of assets which may be
used in a liquidity buffer. - BIPRU 12.8 recognises that in some circumstances
it may be appropriate for a firm to rely on (a)
resources available by other members of its group
or (b) resources elsewhere within the firm.
Firms may apply for - An intra-group liquidity modification, or
- A whole-firm liquidity modification
- (modification modification to the Overall
Liquidity Adequacy Rule expressed in BIPRU 12.2)
- BIPRU 12.9 Taking into account, inter alia, a
firms ILAA, the FSA will issue Individual
Liquidity Guidance (ILG) to all Standard ILAS
firms and may issue ILG to Simplified firms. ILG
will address - The amount and quality of liquidity resources
- The prudence of a firms funding profile
6Reserve Bank of New Zealand
- Liquidity Policy (Document BS13) issued March
2010 and effective from 1 April 2010. - Includes quantitative and qualitative
requirements. - Quantitative requirements are prescriptive
- one week mismatch ratio
- one month mismatch ratio
- one year core funding ratio (CFR)
- CFR requires banks to fund 65 of loans from
either retail deposits or long-term wholesale
funding (gt one year). Ratio to rise to 70 and
75 by mid 2012. RBNZ recognizes that, to meet
the CFR, banks will need to adjust funding
profiles and that the system may have to develop
new funding products such as covered bonds.
7U.S. Regulators Interagency Policy Statement (1)
- Interagency Policy Statement on Funding and
Liquidity Risk Management, issued March 2010 and
effective May 2010. - Summarises the principles of liquidity risk
management issued in the past and, where
appropriate, harmonizes them with the Basel
committees September 2008, Principles.
8U.S. Regulators Interagency Policy Statement (2)
- Principles based approach
- E.g. The sections entitled, Stress Testing (IV.
18) and Contingency Funding Plan (IV. 31) do
not prescribe specific scenarios (e.g. loss of
market access for for 30 days.) - Firms must maintain liquidity at both a
consolidated and at the level of all significant
legal entities. - (Comment This may increase the incidence of
trapped pools of liquidity but may also make
individual legal entities safer.)
9Swiss Financial Market Supervisory Authority
(Finma) and Swiss National Bank (SNB)
- New liquidity regime for Swiss big banks (Credit
Suisse and UBS) came into force on 30 June 2010. - Core element of the new regime is a stress
scenario entailing a general crisis in financial
markets and a loss of trust in the individual
bank. Banks must have a reserve of first-class
liquid assets able to cover outflows over at
least 30 days. - The new requirements have countercyclical
elements, allowing liquidity to be accumulated
during periods of strong economic growth and
drawn down during times of stress.
10Committee of European Banking Supervisors (CEBS)
(1)
- Guidelines on Liquidity Buffers and Survival
Periods published in December 2009. - Follows up on CEBSs September 2008 document,
Advice to the European Commission on liquidity
risk management and in particular its
Recommendation 16 which referred to the need for
robust liquidity buffers. - The Guidelines are directed at banks internal
risk management processes, but CEBS says that
they may be useful for the purpose of supervisory
review. - There are six Guidelines.
- CEBS says that implementation of the Guidelines
will entail a significant strengthening of
firms liquidity positions. CEBS notes the need
to take into account the broad economic climate
and the need to avoid placing unnecessary
constraints on bank lending. - CEBS expects its members to ensure firms comply
with the Guidelines by 30 June 2010.
11Committee of European Banking Supervisors (CEBS)
(2)
- A liquidity buffer is shaped in three dimensions
1. the severity and characteristics of the
stress scenarios 2. the time horizon over which
the stress lasts - Institutions should apply three types of stress
scenarios 1. idiosyncratic 2. market specific
and 3. a combination of 1 and 2. Note that 3 is
not just a combination of 1 and 2. It is possible
that 3 gt (1 2) or that 3lt (1 2). - A survival period of at least one month should be
applied to the stress scenarios and, within this,
a survival period of at least one week should be
considered, reflecting the need for a higher
degree of confidence over the very short term. - For any given maturity scenario, banks should
calculate expected outflows and expected in
flows. Where outflows gt inflows, the gap needs to
be filled either with counterbalancing capacity
or with excess flows carried over from other
periods. - Counterbalancing capacity includes but is
much broader than the liquidity buffer. It
includes not only access to excess liquidity but
also, e.g. recourse to new funding sources or
changes to the business model. - Idiosyncratic stress scenarios should assume an
outflow of retail deposits. - Liquidity buffers should not assume changes by
central banks to their eligibility criteria and
should also take account of regulatory
requirements.
12IMF Global Financial Stability Report, October
2010
- The crisis exposed a bank-centric rather than a
systemic approach to liquidity risk management by
supervisors. - Role and influence of non-bank funding sources
(e.g. U.S. money market funds) were
underestimated - Potential for idiosyncratic risks (e.g. U.S.
sub-prime credit risk) to translate into
system-wide liquidity risk was underestimated. - The IMFs report focuses heavily on the growth
and role of money market funds within the
financial system, and also on the growth and
functioning of repo markets.
13Examples of Initiatives by Middle East Regulators
- In July 2010, the Central Bank of Bahrain issued
a second consultation paper on liquidity risk
management for conventional banks. The second
consultation paper proposed relaxing to 80 (from
75) the maximum loan/deposit ratio, and removing
the Net Stable Funds requirements (in line with
the Basel delay on this point). - The Saudi Arabian Monetary Agency expects to
issue new regulations in line with the BCBS
approach once the BCBS makes final decisions on
the liquidity coverage ratio and the net stable
funding ratio. - Bankers in the UAE are expecting the Central Bank
of the UAE to start consultations soon regarding
the introduction of a new liquidity regime. - Banque du Liban and the (Lebanese) Banking
Control Commission had developed a daily
liquidity reporting model for local banks before
the recent financial crisis (as a result of
external shocks such as the assassination of P.M.
Harriri in 2005). Following the issuance of the
Proposals to Strengthen the Resilience of the
Banking System by the BCBS in December 2009, the
authorities are developing a comprehensive
framework for the measurement of banks liquidity
risk.
14Key Themes of Recent Initiatives
- Liquidity management explicitly inserted into
expectations of board of directors oversight - Liquidity management at the level of the
regulated/legal entity rather than at the group
level. - Definitions of what is a liquid asset are
being made more explicit. - Distinction between contractual obligations and
behavioral expectations. - Consideration of the functioning of financial
markets (e.g. repo markets) and systems (e.g.
clearing systems).
15Final thoughts three dimensions of the crisis
- The liquidity we thought we hadwe hadnt
- For example
- Liquidity you thought you could get from other
entities within your group turned out to be
trapped - High quality assets did not yield 100 cents/
- Contractual obligations did not reflect the way
people behaved - The way we thought markets behavedthey didnt
- For example
- Off-balance sheet became on balance sheet
- The third party repo market froze
- Collateral valuations and margin calls pushed
firms into crisis - What we thought was the financial
systemwasnt - For example
- Money market funds in the U.S. had far more
influence than we thought they would - The behaviour of hedge funds had huge impact on
day-to-day financial intermediation.
16- Andrew Cunningham
- andrew_at_darienmiddleeast.com
- www.darienmiddleeast.com