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Recent International Initiatives to Strengthen the Management and Supervision of Liquidity Risk

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Title: Recent International Initiatives to Strengthen the Management and Supervision of Liquidity Risk


1
Recent 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

2
Outline 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.

3
U.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.

4
U.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.

5
U.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

6
Reserve 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.

7
U.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.

8
U.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.)

9
Swiss 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.

10
Committee 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.

11
Committee 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.

12
IMF 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.

13
Examples 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.

14
Key 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).

15
Final 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
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