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Liquidity Risk Standards and Measurement (& Liquidity Measures taken during & after the crisis). 23rd BSCEE Conference Ohrid, 16 June2010 Jean-Philippe Svoronos Senior Financial Sector Specialist Financial Stability Institute. Outline. Financial crisis and emergency measures

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liquidity risk standards and measurement liquidity measures taken during after the crisis

Liquidity Risk Standards and Measurement (& Liquidity Measures taken during & after the crisis)

23rd BSCEE Conference

Ohrid, 16 June2010

Jean-Philippe Svoronos

Senior Financial Sector Specialist

Financial Stability Institute

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


fx and maturity mismatches optimistic assumptions
FX and maturity mismatches: Optimistic assumptions

“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

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

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.


triggers and transmission the us subprime crisis
Triggers and transmission: the US subprime crisis

Strains in funding markets started in mid-2007: growing unease about the exposure of US FIs to US subprime mortgages and related securitizations

Contagion spreads to European banks (large buyers of structured products and large borrowers of USD)

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


Liquidity dries up

Shortening of interbank lending tenors

Closures of markets for lengthy periods (e.g. “private label” MBSs, CP, etc…)

Several episodes destroy market confidence over time: Sept-Dec 2007, March 2008 and Sept 2008 to March 2009.


private sector responses to liquidity pressures
Private sector responses to liquidity pressures

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)

“Fire sales” of seized collateral (SIVs) increase falls in asset prices

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

US dollar shortages increased in Europe after failure of Lehman and MMMF “breaking the buck”.


central banks emergency measures
Central Banks’ emergency measures

“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)


governments and central banks emergency measures
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

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

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 and Magyar Nemzeti Bank

Swap line between ECB and Nat. Bank of Denmark

Repos between ECB and Hungarian and Polish central banks.


lessons learned
Lessons learned


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

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


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.


objectives and components of liquidity supervision
Objectives and components of liquidity supervision
  • Ensure the bank maintains sufficient liquidity
    • cushion of unencumbered, high quality liquid assets
    • withstand loss of both secured and unsecured funding sources
  • 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.


lcr definition
LCR – definition

Stock of high quality liquid assets

≥ 100%

Net cash outflows over a 30-day time period

  • 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


lcr liquid assets narrow wider definitions
LCR – liquid assets (narrow & wider definitions)

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

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)

BCBS decision to use broader definition pending on QIS results.


lcr net cash outflows denominator
LCR – net cash outflows (denominator)

Net cash outflows = cumulative expected cash outflows minus cumulative expected cash inflows in a given time bucket under specified stress scenario

Most ‘factors’ harmonized but some subject to national discretion

No double-counting with assets included in numerator

All cash outflows and inflows based on assumptions

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


nsfr definition
NSFR – definition

Available amount of stable funding (i.e. sources)

> 100%

Required amount of stable funding (i.e. uses)

  • Uses with maturity > 1 year should be funded by sources that are expected to be available for a period > 1 year
  • Supervisory scenario = mild idiosyncratic (longer-term focus)
    • decline in profitability and/or solvency
    • downgrade in credit rating
    • reputational event


monitoring tools firm based
Monitoring tools – firm-based

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

Concentration of funding: identify wholesale funding sources whose significance could result in liquidity problems if funding is withdrawn

Unencumbered assets: collateral for funding in secondary markets and for central bank facilities

monitor amount, type and location

also consider haircut and currency


monitoring tools market related
Monitoring tools – market-related

Market-wide information

absolute level of, and trend in, major markets (e.g. equity indices, debt markets, FX markets)

Financial sector market information

equity/debt markets for financial sector broadly

Bank-specific information

equity prices, CDS spreads, price/yield of debentures in the secondary market – for individual banks


application issues
Application issues

Scope of application

at least on a consolidated basis

potentially also on sub-consolidated (legal entity) basis (ring-fencing?)


at least aggregated across transferable and convertible currencies

potentially also by ‘significant’ currency

Frequency of calculation and reporting

at least monthly, as often as daily in stressed conditions

maximum two-week lag

standards to be met ‘continuously’

Public disclosure

value and level of the metrics, drivers behind the metrics

size and composition of the components

frequency? not specified in consultative document …