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Liquidity Management – Where Next?

Liquidity Management – Where Next?. 13th April 2010. Martyn Hoccom RBS. Overview. 1. Markets 2. Regulatory Developments 3. Funds Transfer Pricing. Bid-ask spreads on selected assets. Source: Bank of England, Speeches: The Debt Hangover, Haldane, Andrew.

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Liquidity Management – Where Next?

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  1. Liquidity Management – Where Next? 13th April 2010 Martyn Hoccom RBS

  2. Overview • 1. Markets • 2. Regulatory Developments • 3. Funds Transfer Pricing

  3. Bid-ask spreads on selected assets Source: Bank of England, Speeches: The Debt Hangover, Haldane, Andrew. 1. MarketsHas the storm passed? – recent evidence from prices.. Bank CDS Prices • The impacts of the crisis were stark. • Prices are reducing from in-crisis highs.. • .. but have not (yet) returned to pre-crisis levels. Source: Bank of England, Financial Stability Report, Dec 09 (b) Excludes Co-operative Financial Services. Major UK banks’ Libor spreads Source: Bank of England, Financial Stability Report, Dec 09

  4. And from volumes / volatilities. Global Issuance of Corporate Bonds and Loans • As prices spiked, volumes fell.. • .. volatilities were huge.. Source: Bank of England, Financial Stability Report, Dec 09 Global Issuance of Structured Financial Assets VIX Index Source: Bank of England, Financial Stability Report, Dec 09 Source: Bloomberg

  5. Remaining challenges: macro / political environment $/£ • Public sector bailouts have left government finances around the world weaker.. • .. central bank balance sheets are historically large.. • .. and in some countries, forthcoming elections add another element of uncertainty. Source: Bloomberg Government Debt as a % of GDP Central banks’ balance sheets as a percentage of GDP Source: CIA, The World Factbook, 2009 Source: Bank of England, Financial Stability Report, Dec 09

  6. Refinancing / funding challenges Major UK banks’ maturing funding: selected wholesale liabilities • The banking sector has a lot of debt to refinance, in particular as public sector schemes close… • .. at the same time as building up liquid asset buffers. • There is also a desire to refinance from more stable sources. Source: Bank of England, Financial Stability Report, Jun 09 Major UK Banks’ Customer Funding Gap Aggregate Data from FSA Liquidity Risk Profile Source: Bank of England, Financial Stability Report, Jun 09

  7. 2. RegulationRegulatory Avalanche • FSA - Policy Statement 09/16Strengthening Liquidity Standards, October 2009 • Basel Committee on Banking Supervision – Principles for Sound Liquidity Risk Management and Supervision, September 2008 • CEBS – Guidelines on Liquidity Buffers & Survival Periods, December 2009 • CEBS – Guidelines on Stress Testing, December 2009 • Basel Committee on Banking Supervision – International Framework for Liquidity Risk Measurement, Standards and Monitoring, December 2009 • European Commission – CR04, March 2010 • CEBS - CP36: Guidelines on Liquidity Cost Benefit Allocation, March 2010 • FRB – SR 10-6: Interagency Policy Statement on funding and Liquidity Risk Management, March 2010 • And structural change proposals that could impact on environment, eg: • Obama proposals; limits on size and / or functions • Macro-prudential policy / instruments • Recovery and resolution plans – Living wills

  8. FSA Individual Liquidity Adequacy Assessment • FSA’s new regime for liquidity risk management • Purpose is to ensure that Banks and financial institutions have sufficient liquid assets to survive periods of stress • In periods of stress, banks experience outflows of funds which are driven by the nature of the funds (wholesale / retail) and behaviours.. • .. and can lead to an extremely short survival period • In order to cover the outflows banks must hold liquid assets • Liquid assets include eligible assets - central bank balances and government bonds • ILAA: self- and supervisory- assessment • Result of the ILAA: Individual Liquidity Guidance • ‘Back stop’ regime for 2010 – 2 week and 3 month limits

  9. FSA Backstop Limits • 1. Two-Week Wholesale Mismatch

  10. FSA Backstop Limits • 2. Three-Month Liquid Asset Ratio

  11. Behaviourlisation • “All history is bunk” - Henry Ford • Status of behaviourlisation vs. forward looking judgement in stress models • Differentiate experience in crisis vs. normal market conditions • Nature of liquidity stress

  12. Basel ≥100% ≥100% • European Commission aim to agree for draft EU law in 2010 in line with BSCS timetable • FSA will ensure consistency of UK regime with final EU regulations

  13. The Liquidity Coverage Ratio (LCR) • The LCR aims to ensure that a bank maintains an adequate level of unencumbered, high quality assets which are sufficient to cover outflows in a 30 day period of acute short-term stress scenario defined by the regulators and which entails: • a significant downgrade of the institution’s public credit rating; • a partial loss of deposits • a loss of unsecured wholesale funding • a significant increase in secured funding haircuts • increases in derivative collateral calls • substantial calls on contractual and non-contractual off-balance sheet exposures, including committed credit and liquidity facilities

  14. The LCR has two components • 1. Numerator: The Liquidity Buffer • Whether the narrow or broad definition is used assets must include only those unencumbered assets which meet the criteria of being easily and immediately converted into cash at little or no loss of value. They must therefore have the following fundamental characteristics: • Low Credit and Market Risk • Ease and Certainty of valuation • Low correlation with risky assets • Listed on an exchange • Active and sizable market • Presence of committed market makers • Low market concentration • Evidence that assets have been used in flight to quality

  15. LCR Denominator • 2. Denominator: Cash outflows • The Committee has been quite prescriptive in converting contractual flows into behaviour flows for the purpose of the calculation: • Unsecured deposits • Secured funding • Drawdown of unutilised committed credit and liquidity • 100% of liquidity needs associated with downgrade triggers in respect of additional collateral needs for up to and including a 3 notch downgrade • A percentage (to be agreed by local regulators) of the increased liquidity needs related to changes in market valuation of derivative contracts. Where the collateral is non core an additional 20% of the value of the collateral should be held due to the potential price volatility of the underlying securities. • 100% of liquidity exposure to abcp, conduits, SIVs, and other such financing facilities • 100% of maturing funding of asset backed securities maturing in the 30 day period

  16. The Net Stable Funding Ratio (NSFR) • The NSFR aims to increase the amount of medium and long term funding to support illiquid assets • Objectives include: • reduce level of reliance on short-term funding • ensure that investment banking inventories, off-balance sheet exposures, securitisation pipelines funded with at least a minimum of stable liabilities • limit over-reliance on wholesale funding • encourage better assessment of liquidity risk across on and off balance sheet items • counterbalance possible “cliff edge” effects of using 1m period in the LCR

  17. RBS Net Stable Funding Ratio • Published in RBS annual report and accounts 2009 • HSBC has published industry wide indicator in research paper

  18. NSFR Unintended Impacts?! • Macro • Less maturity transformation – more term funding => credit creation? • Micro • 0% factors for secured borrowing => reduces market? • Corporate bonds funded in CP more favourably traded => increases market?

  19. 3. Funds Transfer PricingOrganisational Structure Board / GALCO Market access Function Divisions Capital Markets Money Markets Retail Liquidity FTP Centre Wealth Markets Wholesale Corporate Execution Clearing Clearing Etc. • Risk Control: • Limits • Mismatch Gaps • Liquidity Cover

  20. Balance Sheet Liquidity Breakdown Liquidity Behavioural Assumptions • Need to map products to maturities • Basis for mapping to be determined

  21. Liquidity Cost Benefit Allocation • “1.The liquidity cost benefit allocation mechanism is an important part of the whole liquidity management framework. As such, the mechanism should be consistent with the framework of governance, risk tolerance and decision-making process. • 2.The liquidity cost benefit allocation mechanism should have a proper governance structure supporting it. • 3.The output from the allocation mechanism should be actively and properly used and appropriate to the business profiles of the institution. • 4.The scope of application of internal prices should be sufficiently comprehensive to cover all significant parts of assets, liabilities and off-balance sheet items regarding liquidity. • 5.The internal prices should be determined by robust methodologies, taking into account the various factors involved in liquidity risk.” • CEBS Principles

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