8 Liquidity Risk

7/29/2019 8 Liquidity Risk

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Liquidity risk

Giampaolo Gabbi


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Agenda

Liquidity risk: what it is and where it comes from

Funding liquidity risk

Stock-based approach

Cash flow based approach

Hybrid approach

Stress tests and contingency funding plans

The Basel Committee framework

Principles for liquidity risk management and supervision Liquidity coverage ratio

Net stable funding ratio

Market liquidity risk


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One of the main reasons the economic and financial crisis became sosevere was that the banking sectors of many countries had built upexcessive on- and off-balance sheet leverage.

This was accompanied by a gradual erosion of the level and quality of thecapital base.

At the same time, many banks were holding insufficient liquidity buffers. The banking system therefore was not able to absorb the resulting systemic

trading and credit losses nor could it cope with the re-intermediation oflarge off-balance sheet exposures that had built up in the shadow bankingsystem.

The crisis was further amplified by a procyclical deleveraging process andby the interconnectedness of systemic institutions through an array ofcomplex transactions

Basel Committee, Strengthening the resilience of the banking sector - consultative

document

The Basel Committee December 2009

proposals


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Some figures from the market:

Interbank Interest Rates


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Interbank Interest Rates Volatility


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Infra Day Interbank Interest Rates


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Interbank Volumes


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Interbank Trades


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Interbank Market Active Banks


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Liquidity

Asset and liability mismatch generates not only interest raterisk liquidity risk

Different meaning of liquidity:

Security ease with which it can be cashed back or traded, even

in large amounts, on a secondary market

Market liquidity of the securities traded in the market differentproxies of liquidity (e.g. bid-ask spread, volume)

Affected by many factors: n. mkt participants, size & frequency of trades,degree of informational asymmetry, time needed to carry out a trade

Function of tightness (markets ability to match supply and demand at lowcost) and depth (ability to absorb large trades without significant price impact)

Financial institutionability to fund increases in assets and meetobligations as they come due, without incurring high losses

Generally proxied by the difference between the average liquidity of assetsand that of liabilities


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Liquidity risk

Liquidity risk risk that a financial institution may not be able to pay back its

liabilities in a timely manner because of an unexpectedly largeamount of claims

more realistically, it may be able to meet those requests only byquickly selling (fire sale) large amounts of assets, at a price that isbelow their current market value, thereby suffering a loss

The role of banks in the maturity transformation of short-term deposits into long-term loans makes banks

inherently vulnerable to liquidity risk

Liquidity risk depends not only on the final maturity ofassets and liabilities, but also on the maturity of eachintermediate cash flow, including the early pre-payment

of loans or the unforeseen usage of credit lines


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Liquidity risk

2 types of liquidity risk

Funding risk risk that a F.I. may not be able to faceefficiently (i.e. without jeopardising its orderly operationsand its financial balance) any expected or unexpected

cash outflows Market liquidity risk risk that a F.I., to liquidate a sizable

amount of assets, will affect the price in a considerable(and unfavourable) manner, because of the limited depthof the market where the assets are traded

The two risk types are connected a F.I. wishing to faceunexpected cash outflows may need to sell a largeamount of securities potential sharp fall in price


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Relevant factors Contractual maturity of assets and liabilities Optionality in bank products e.g. demand deposits,

guarantees issued, irrevocable loan commitments (e.g.

SPVs related to securitization or CP programs),derivatives involving margin requirements

Two main type of events

Bank specific events events that distress the

confidence of third parties rating downgrades(especially relevant when covenants or triggers minimum rating required)

Systemic events e.g. market disruption, liquidity dry up(e.g. recent financial crisis)


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Three main measurement approaches Stock based approach

Measures the stock of financial assets that can promptly beliquidated to face a possible liquidity shock

Cash flow based approach Compares expected cash inflows and outflows, grouping them in

homogeneous maturity buckets and checking that cash inflowsare large enough to cover cash outflows

Hybrid approach Potential cash flows coming from the sale (or use as collateral) of

financial assets are added to actual expected cash flows

Actual cash flows - adjusted to take into account expectedcounterparties behaviour are used in all approaches(not contractual ones)


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Stock based approach

Measures the stock of financial assets that can promptlybe liquidated to face a liquidity shock

Requires the banks BS be re-stated contribution eachitem gives to creating/hedging funding risks

Cashable assets (CA) all assets that can quickly beconverted into cash

Volatile liabilities (VL) short term funds for which there isa risk that they may not be rolled over (wholesale fundingand volatile portion of customer deposits)

Commitments to lend (CL) OBS items representingirrevocable commitment to issue funds upon request

Steadily available credit lines (AL) irrevocablecommitments to lend issued to the bank by third parties(usually, other F.I.s)


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Cashable assets (CA)

Short-term deposits

Loans short-term credit lines (e.g., o/n and other interbankfacilities) than can be easily and effectively claimed back

without endangering the customer relationships Securities only unencumbered positions (not used as

collateral against loans or derivative contracts) may alsoinclude long term bonds or shares. Does not include securitiesnot traded on a liquid market and not eligible not accepted

as collateral (e.g., shares in private companies held formerchant banking purposes, unrated bonds, etc.)

Need of a haircut for: possible loss relative to the market price

difference between current value and value of the short-term loans that

could be obtained by pledging them as collateral


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Assets Liabilities

Cash & equivalent 10 Sort term deposits 100

Loans (cashable) Customer deposits

- O/n and similar int/bank fac.s, easily cashable 200 - volatile portion 600

Securities (unencumbered)

- Not used as collateral 1.000- Less haircut -120

Total cashable assets (CA) 1,090 Total volatile liabilities (VL) 700

Loans (others) Customer deposits

- Credit lines not easily cashable 580 - Stable portion 1,600

- Maturity loans 1,500 Medium to long term funding 1,000

Securities (others) Other long term funds 300

- used as collateral 400 Capital 400- Not cashable nor accepted as collateral 20

- haircut 120

Fixed fin. assets (minorities, participations, etc.) 150

Fixed real assets 100

Goodwill 40

Total per cassa 4,000 Total 4,000

Commitments to lend (CL) 300 Steadily available credit lines (AL) 80

Assets Liabilities

Cash & equivalent 10 Sort term deposits 100

Loans (cashable) Customer deposits

- O/n and similar int/bank fac.s, easily cashable 200 - volatile portion 600

Securities (unencumbered)

- Not used as collateral 1.000- Less haircut -120

Total cashable assets (CA) 1,090 Total volatile liabilities (VL) 700

Loans (others) Customer deposits

- Credit lines not easily cashable 580 - Stable portion 1,600

- Maturity loans 1,500 Medium to long term funding 1,000

Securities (others) Other long term funds 300

- used as collateral 400 Capital 400- Not cashable nor accepted as collateral 20

- haircut 120

Fixed fin. assets (minorities, participations, etc.) 150

Fixed real assets 100

Goodwill 40

Total per cassa 4,000 Total 4,000

Commitments to lend (CL) 300 Steadily available credit lines (AL) 80

Example of a reclassified B/S


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Cash Capital Position (CCP)

Share of cashable assets not absorbed by volatile liabilities

Signals banks ability to withstand liquidity shortages due to:

greater-than-expected volatility in funding sources unexpected difficulties in the mgmt of cashable assets

(e.g. increase haircuts due to unfavourable fin. markets)

To control for banks size, CCP sometimes scaled by total

assets

Example previous slide

CCP = CA VL = 390 = 9.75% TA

CCP = CA VL CL = 90 = 2.25% TA

CCP CA VL CL


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Long term funding ratios (LTFR) alternative measure ofliquidity based on stocks

% of assets with a maturity > 5 years funded with

liabilities with maturity > 5 years or with capital

Portion of assets with a maturity greater than n years

which is being funded with liabilities having an equally

great maturity

Banks transform ST liabilities into MTL term loans

LTFR usually below 100%

Low values (or a deterioration over time) may indicate

unbalances/weaknesses in the maturity structure of

assets & liabilities


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CCP based on simplified approach assets and liabilitiesare either stable or unstable (binary approach)

In reality many different degrees of stability/liquidity exist

Underlying logic of CF based approaches: restate BS items going beyond a binary logic maturity ladder

also called mismatch based approach

Cash flows are sorted across the different maturitiesbased on:

contractual maturities (including intermediate cash flows)

banks expectations

past experience

Mismatch or liquidity gap (Gt) net unbalance inflowsand outflows


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Maturity

bucket

(upper limit)

Expected cash inflows Expected cash outflows Net

flows

Net

cum.tive

flowsLoans Securities

Cash &

equivalent

Customer

deposits

Other

funding Bonds

Comm.ts

to lend

Overnight 40 10 -20 -20 -10 0 0

1 week 30 -50 -20 -15 -55 -55

2 weeks 80 -70 -15 -20 -25 -80

1 month 70 100 -200 -15 -50 -10 -105 -185

2 months 100 90 -330 -10 -50 -10 -210 -395

3 months 200 110 -300 -10 -100 -10 -110 -505

1 year 400 100 -400 -110 -100 -110 -615

3 years 400 200 -300 -200 -300 -200 -815

5 years 300 700 -650 -450 -100 -915

10 years 650 100 750 -165

Beyond 200 50 250 85

Total 2470 1450 10 -2320 -400 -1050 -75 85

Maturity

bucket

(upper limit)


flows

Net

cum.tive


Cash &

equivalent

Customer

deposits

Other

funding Bonds

Comm.ts

to lend

Overnight 40 10 -20 -20 -10 0 0

1 week 30 -50 -20 -15 -55 -55

2 weeks 80 -70 -15 -20 -25 -80

1 month 70 100 -200 -15 -50 -10 -105 -185

2 months 100 90 -330 -10 -50 -10 -210 -395

3 months 200 110 -300 -10 -100 -10 -110 -505

1 year 400 100 -400 -110 -100 -110 -615

3 years 400 200 -300 -200 -300 -200 -815

5 years 300 700 -650 -450 -100 -915

10 years 650 100 750 -165

Beyond 200 50 250 85

Total 2470 1450 10 -2320 -400 -1050 -75 85

Example of expected cash flows

As in the stock-based approaches, demand deposits and loans are dealt with based on

their expected actual maturity


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Two type of indicators

Cumulative liquidity gap unbalance between flowsassociated with a given band and all shorter maturities

Marginal liquidity gaps Gts related to one time band

Note that, when sorting assets and liabilities across time

bands, we are considering: cash flows not stocks

their expected maturity, not their repricing period

titt GCG


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Negative cumulative liquidity gap bank cannot cover

foreseeable cash payments with expected inflows

severe warning of potential liquidity shortage

However, one weakness cash flows associated with

securities (including unencumbered assets) are basedon contractual maturities and coupons assets can be

used as collateral to get new loans, also at a very short

notice

re-write the maturity ladder taking into account role ofunencumbered assetsin facing liquidity risks

Hybrid approach


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Hybrid approach

CF based approach CFs from securities are sorted

into maturity buckets based on contractual maturity a

10-year ZC bond face value10 mln entirely associated

with 10 year band

Banks treasurer can manage liquidity shortages by

selling the bond or using it to get funded through a

collateralised loan or repo

Haircut funds raised would only be a share (e.g.,

90%) of the bonds mkt value (which would be less thanface value) e.g. 7 million 70% can be cashed

quickly, rest (interest and haircut) available in 10 years

This only applies to unencumbered eligible assets

assets the bank can freely sell or pledge as collateral


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Hybrid approach

Maturity

bucket

(upper limit)


flows

Net

cum.tive


Cash &

equivalent

Customer

deposits

Other

funding Bonds

Comm.ts

to lend

Overnight 40 600 10 -20 -20 -10 0 600

1 week 30 100 -50 -20 -15 -55 645

2 weeks 80 100 -70 -15 -20 -25 720

1 month 70 80 -200 -15 -50 -10 -105 595

2 months 100 -330 -10 -50 -10 -210 295

3 months 200 -300 -10 -100 -10 -110 75

1 year 400 -400 -110 -100 -110 -135

3 years 400 150 -300 -200 -300 -200 -385

5 years 300 300 -650 -450 -100 -885

10 years 650 120 750 -115

Beyond 200 250 85

Total 2470 1450 10 -2320 -400 -1050 -75 85

Maturity

bucket

(upper limit)


flows

Net

cum.tive


Cash &

equivalent

Customer

deposits

Other

funding Bonds

Comm.ts

to lend

Overnight 40 600 10 -20 -20 -10 0 600

1 week 30 100 -50 -20 -15 -55 645

2 weeks 80 100 -70 -15 -20 -25 720

1 month 70 80 -200 -15 -50 -10 -105 595

2 months 100 -330 -10 -50 -10 -210 295

3 months 200 -300 -10 -100 -10 -110 75

1 year 400 -400 -110 -100 -110 -135

3 years 400 150 -300 -200 -300 -200 -385

5 years 300 300 -650 -450 -100 -885

10 years 650 120 750 -115

Beyond 200 250 85

Total 2470 1450 10 -2320 -400 -1050 -75 85

Modified expected CFs taking into account unencumbered assets

Net cash flows look much better using this approach


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Hybrid approach

-1500

-1000

-500

0

500

1000

Loans

Securities

Cash and short-term

Customer deposits

Other deposits

Bonds

Commitments lo lend

Cumulative net flows

Liquidity gaps(marginal andcumulative) forshortermaturities are

now positive

The bank looksimmune toliquidity

shortages forthe shortermaturities


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Hybrid approach

Results achieved so far are affected by

assumptions on timing and amounts uncertainty

concerning:

Amount e.g. floating rate securities, IRS, European options Timing e.g. long-term mortgages being pre-paid, demand

deposits left with the bank for years

Both amount and timing cash flows associated to open

credit lines or commitments to lend

It is important to consider not only an expected scenario, but

also check how the liquidity gaps would deteriorate in worst

case scenarios stress test


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Stress test

Stress test simulation exercise aimed at quantifying the

effects of an especially adverse scenario

Three main approaches

Historical approach historical scenarios (e.g., % of demand deposits

unexpectedly withdrawn within 2 or 4 weeks) Statistical approach historical data to infer probability distribution of risk

factors reasonable estimate of potential shocks (e.g., on deposits,

haircuts, interbank loans, etc.)

Judgement-based approach subjective appraisals by the banks

management (support of risk management, supervisors or consultants)

These approaches can be used to simulate individual risk

factors separately or jointly (worst case scenarios)

A. bank run on demand deposits

B. increase in market volatility increase haircuts on unencumbered assets

C. A+B jointly


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Stress test

Stressed scenarios are rather intuitive in principle, but theirpractical implementation can prove difficult:1. A stress exercise is usually limited to a number of selected B/S

items (e.g. effect of an extreme scenario on the time profile of cash

flows associated only with securities, ignoring other assets andliabilities) a market turmoil may be accompanied by an increasein customer deposits as investors would postpone their assetallocation choices indirect effects should also be included

2. When more risk factors are considered jointly (e.g., a bank run andan increase in market volatility) a simple algebraic summation of

their effects may not be correct pessimistic if risk factors are not strongly correlated (probability)

optimistic., if the two shocks are mutually reinforcing (impact) e.g.confidence crisis hitting a bank in the midst of a market-wide currencycrisis the pressure on deposits might be stronger than it would be ina quiet macroeconomic environment


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Contingency funding plans (CFP)

Stressed scenarios can prove useful in building contingency

funding plans (CFP) to be triggered in case of extreme scenario

CFP surveys all possible sources of extra funds in the event of a

liquidity shock (e.g. temporary withdrawals of compulsory

reserves, repos with CB, secured or unsecured interbank loans)

CFP sets priority order (ranking) in which they should be tapped

cost and flexibility of the sources and type of liquidity shock

(e.g. interbank loans in case of an institution-specific shock vs.

intervention of Central Bank in case of a market-wide crisis CFP describes people and structures responsible for

implementing emergency policies and actions to be taken

A credible CFP can quickly bring panic under control, limiting

the duration and breadth of the liquidity shortage


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Some peculiarities of funding liquidity risk vs other risks

Liquidity risk not necessarily risk of losses

Assets & Liabilities mismatch does not need to be faced

by capital by high quality liquid (unencumbered)assets more capital simply makes a liquidity crisis

less likely

If the bank is made up of different legal entities, in the

event of a liquidity crisis liquid funds cannot freely bemoved from one entity to the other due to the opposition

of some supervisory authorities


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Organizational issues

Liquidity risk management requires systematic approach with clear

organizational rules systematic approach also required by Basel

E.g. Liquidity risk management (LRM)

LRM policy key role of board of directors

ensures liquidity risk is correctly identified, measured, monitored andcontrolled

defines risk tolerance and strategy for liquidity risk management

identifies roles and responsibilities of the LRM Unit

receives periodic reports on the liquidity situation

Examples of periodic reports

analysis of the flow of funds contingency funding plan

list of largest providers of funds

funding gap and maturity structure

structure and composition of the bank's balance sheet

size and cost of more recent very short term funding


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Limits are generally imposed to risk-taking units they may

refer to different measures examples:

Max absolute maturity gap

Max volume of overnight funding in relation to total assets

Max gap between liquid assets and ST liabilities Min liquid assets net of expected erosion in case of stress

Max concentration of liabilities across counterparties

Key role internal audit in LRM process e.g. consistency

between policies set by senior mgmt and day-by-day risk mgmt,

adequacy of processes and soundness of measures Often an ALM Committee (ALCO) representatives of all

business areas that affect liquidity risk responsible for development of specific policies for LRM

ensuring adequacy of measurement system


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Liquidity Risk Management unit responsible for:

identifying liquidity risks incurred by the bank

monitoring evolution of liquidity profile

developing policies for controlling and mitigating liquidity risk

developing appropriate rules for liquidity risk management

roles,responsibilities and organizational structure; limits; policies and formats for

reporting to senior management

Developing liquidity contingency plan

Early warnings events signalling liquidity shortages in

advance Internal early warnings e.g. increased concentration of assets orliabilities, increase of assets funded by volatile funding

External indicators e.g. rating downgrades, decline in the banks stock

price; increase in the banks CDS spread; increase in the trading volume

of securities issued by the bank, increase in requests for guarantees,

increase in the cost of funding, request for (additional) collateral by

Basel Committee: Principles for the


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Basel Committee: Principles for themanagement and supervision of liquidity

risk

Key elements of a robust framework for liquidity risk mgmt:

board and senior management oversight

establishment of policies and risk tolerance

use of liquidity risk management tools such ascomprehensive cash flow forecasting, limits and liquidity

scenario stress testing

development of robust and multifaceted contingency

funding plans maintenance of a sufficient cushion of high quality liquid

assets to meet contingent liquidity needs

ase omm ee: r nc p es or e


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ase omm ee: r nc p es or emanagement and supervision of

liquidity riskFundamental principle for the mgmt and supervision of liquidity risk 1. A bank is responsible for the sound management of liquidity risk. A

bank should establish a robust liquidity risk management frameworkthat ensures it maintains sufficient liquidity, including a cushion ofunencumbered, high quality liquid assets, to withstand a range ofstress events, including those involving the loss or impairment of both

unsecured and secured funding sources.Governance of liquidity risk management

2: A bank should clearly articulate a liquidity risk tolerance that isappropriate for its business strategy and its role in the financialsystem.

3: Senior management should develop a strategy, policies and

practices to manage liquidity risk in accordance with the risk toleranceand to ensure that the bank maintains sufficient liquidity.

4: A bank should incorporate liquidity costs, benefits and risks in theinternal pricing, performance measurement and new product approvalprocess for all significant business activities (both on- and off-balancesheet)



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liquidity riskMeasurement and management of liquidity risk 5: A bank should have a sound process for identifying, measuring, monitoring

and controlling liquidity risk projecting cash flows arising from assets,liabilities and off-balance sheet items

6: A bank should actively monitor and control liquidity risk and funding needswithin and across legal entities, business lines and currencies

7: A bank should establish a funding strategy that provides effectivediversification in the sources and tenor of funding.

8: A bank should actively manage its intraday liquidity positions and risks tomeet payment and settlement obligations on a timely basis under both normaland stressed conditions

9: A bank should actively manage its collateral positions, differentiatingbetween encumbered and unencumbered assets

10: A bank should conduct stress tests on a regular basis and use stress testoutcomes to adjust its liquidity risk management strategies, policies, andpositions

11: A bank should have a formal contingency funding plan (CFP) that clearlysets out the strategies for addressing liquidity shortfalls in emergencysituations

12: A bank should maintain a cushion of unencumbered, high quality liquidassets to be held as insurance against liquidity stress scenarios



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liquidity riskPublic disclosure 13: A bank should publicly disclose information on a regular basis that

enables market participants to make an informed judgement aboutthe soundness of its liquidity risk management framework and liquidityposition

The role of supervisors 14: Supervisors should regularly perform a comprehensive

assessment of a banks overall liquidity risk management frameworkand liquidity position

15: Supervisors should supplement their regular assessments of abanks liquidity risk management framework and liquidity position bymonitoring a combination of internal reports, prudential reports and

market information 16: Supervisors should intervene to require effective and timely

remedial action by a bank to address deficiencies in its liquidity riskmanagement processes or liquidity position.

17: Supervisors should communicate with other supervisors andpublic authorities, to facilitate effective cooperation regarding the

supervision and oversight of liquidity risk management

C


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Basel Committee recent proposals

(Dec. 2009)

Two internationally consistent regulatory standards

Liquidity coverage ratio

Aimed at ensuring that a bank maintains an adequate level of high

quality assets that can be converted into cash to meet its liquidity

needs for a 30-day horizon under a liquidity stress scenario Stock of high quality liquid assets/Net cash outflows over a 30-day

time period 100%


Aimed at promoting more medium and long-term funding of the

assets and activities of banking organisations

Minimum acceptable amount of stable funding based on the

liquidity of a banks assets and activities over a 1 year horizon

Available amount of stable funding/Required amount of stable

funding > 100%


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High quality assets

Net cash outflows over

30 days Andrea Resti


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High quality assets Unencumbered not pledged either explicitly or implicitly in any way to

secure, collateralise or credit enhance any transaction (e.g. covered bonds)

and not held as a hedge for any other exposure

Liquid during a time of stress and, ideally, central bank eligible

Fundamental characteristics

Low credit and market risk

Ease and certainty of valuation

Low correlation with risky assets

Listed on a developed and recognised exchange market

Market-related characteristics

Active and sizable market

Presence of committed market makers

Low market concentration

Flight to quality


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High quality assets unencumbered, high quality liquid assets

(ununcumbered: not pledged either explicitly or implicitly in any way tosecure, collateralise or credit enhance any transaction and not held as

a hedge for any other exposure) examples:

a) Cashb) CB reserves

c) Marketable securities representing claims guaranteed by sovereigns,

CBs, non-central gov.t public sector entities (PSEs), BIS, IMF, or

multilateral dev.t banks as long as all the following criteria are met:

i. 0% risk-weight under the Basel II standardised approachii. deep repo-markets exist for these securities

iii. the securities are not issued by banks or other financial services entities

d) Gov.t or CB debt issued in domestic currencies by the country in which

the liquidity risk is being taken or the banks home country



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Net cash outflows

Cumulative expected cash outflows minus cumulative

expected cash inflows arising in the specified stress

scenario in the time period under consideration

Net cumulative liquidity mismatch position under the

stress scenario measured at the test horizon

Cumulative expected cash outflows are calculated by multiplying

outstanding balances of various categories of liabilities by

assumed % that are expected to roll-off, and by multiplyingspecified draw-down amounts to various OBS commitments

Cumulative expected cash inflows are calculated by multiplying

amounts receivable by a percentage that reflects expected inflow

under the stress scenario



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Scenario combined idiosyncratic & market-wide shock:a) a three-notch downgrade in the institutions public credit rating;

b) run-off of a proportion of retail deposits;

c) a loss of unsecured wholesale funding capacity and reductions ofpotential sources of secured funding on a term basis;

d) loss of secured, short-term financing transactions for all but highquality liquid assets;

e) increases in market volatilities that impact the quality of collateral orpotential future exposure of derivatives positions and thus requiringlarger collateral haircuts or additional collateral;

f) unscheduled draws on all of the institutions committed but unused

credit and liquidity facilitiesg) need for the institution to fund balance sheet growth arising from

non-contractual obligations honoured in the interest of mitigatingreputational risk

many of the shocks actually experienced during the financialcrisis



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Available amount of stable funding/Required amount of

stable funding > 100%

NSFR standard is structured to ensure that investment

banking inventories, off-balance sheet exposures,

securitisation pipelines and other assets and activities are

funded with at least a minimum amount of stable liabilities

in relation to their requirement as these inflows and

outflows are assumed to off-set each other

The NSFR aims to limit over-reliance on wholesale fundingduring times of buoyant market liquidity and encourage

better assessment of liquidity risk across all on and off-

balance sheet items



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Goal:To reduce the

mismatching ofasset and liabilities

We could say banks

should drive a bikewhose liabilityturns over morerapidly than assetspeed

Stable asset must becovered by thesame volume ofstable liabilities

Assets

Liabilities

Andrea Resti


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ASF Factor Component of AFS Category

100% Capital (both Tier 1 and Tier 2) Preferred stock not included in Tier 2 (maturity > 1 year) Secured and unsecured borrowings and liabilities (including term deposits) with

maturities > 1year

85% Stable" non-maturity retail deposits and/or term retail deposits with residualmaturities < 1 year "Stable" unsecured wholesale funding, non-maturity deposits and/or term deposits

with a residual maturity < 1 year, provided by small business customers

70% "Less stable" non-maturity retail deposits and/or term retail deposits with residualmaturities of less than one year.

"Less stable" unsecured wholesale funding, nonmaturity deposits and/or termdeposits with a residual maturity of less than one year, provided by small businesscustomers

Less stabledeposits not covered by deposit insurance, high value-deposits,deposits of high net worth individuals, deposits which can be withdrawn quickly (eginternet deposits) and foreign currency ones

50% Unsecured wholesale funding, non-maturity deposits and/or term deposits with aresidual maturity < 1 year, provided by non-financial corporate customers

0% All other liabilities

Available amount of stable funding (ASF)


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Required Stable Funding (RSF): Asset Categories and Associated FactorsRSF Factor Summary Composition of Asset Categories RSF Factor

0% Cash, money market instruments Securities with effective remaining maturities of less than one year Outstanding loans to financial entities having effective maturities of less than one

year.

5% Unencumbered marketable securities with residual maturities one yearrepresentingclaims on sovereigns, central banks, BIS, IMF, EC, noncentral government PSEs ormultilateral development banks which are rated AA or higher and are assigned a 0%risk weight under the Basel II standardised approach, provided that active repo-markets exist for these securities.

20% Unencumbered corporate bonds (or covered bonds) rated at least AA with aneffective maturity of one year which are traded in deep, active and liquid marketsand which also have a demonstrated history of being a reliable liquidity source in astressed market environment.

50% Gold

Unencumbered equity securities listed on a major exchange and included in a largecapital market index and unencumbered corporate bonds (or covered bonds) ratedAA- to A- with an effective maturity of one yearwhich are traded in deep, active andliquid markets and which also have a demonstrated history of being a reliable liquiditysource in a stressed market environment.

Loans to non-financial corporate clients having a residual maturity of less than oneyear.

85% Loans to retail clients with a residual maturity < 1 year

100% All other assets


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LCR

Similar to a CCP minimum requirement where the

denominator is substituted by a net cash outflow

estimate Combination of a stock based and a cash flow based

measure

NSFR

Similar to a long term funding ratio (LTFR)

More sophisticated as different items are assigned

different weights

The Basel requirements


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Market liquidity risk risk that a F.I., to liquidate a sizable

amount of assets, will end up affecting the price in a

considerable (and unfavourable) manner, because of the limited

depth of the market where the assets are traded

Market liquidity risk can be twofold Exogenousgeneral market characteristics outside control of bank

Endogenousbanks characteristics (e.g. composition and size of itsportfolio)

Market liquidity is measured through the lack of it transaction

costs explicit and implicit incurred by investors to trade: Bid-ask spread

Market impact difference between actual transaction price and price that

would have prevailed if the transaction had not taken place the higher

the lower is market liquidity



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If no uncertainty on market impact liquidation value is

equal to bid price transaction cost

If large sale impact on spread deviation from its

mean value s + k(increasing function of position size

Pand decreasing function of market size M)

2

SPC

t

bid/ask spread

mid-quote at time t

,2

s k P M C P


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askprice

mid price

price

s

bid price

Quote depth Sizeof the Position (P)

Transaction costs

can be expected toincrease with the

transaction size, or,

namely, with its

impact in relation to

market depth

Traded volume and bid-ask spread(Bangia, et al. 1999)


53/54


1

21 ( )

2

hpPS STC AL e

MS

The function linking kto Pand Mis not easy and tends to

change over time

Transaction costs also depend on the time period (e.g.

gradual liquidation vs. sudden fire sale)

Dowd (2002) more sophisticated version of the function

Relative size ofthe position to

liquidate

Hp is the time period thebank wants to liquidateits position (holding

period)2is the elasticity ofTCto hpBoth need to beestimated empirically

Elasticity oftransaction costs

to the relative

position size


54/54

Liquidity risk has been overlooked in the recent past

As clearly shown by the financial crisis, liquidity risk is

crucial for individual financial institutions and for the

stability of the financial system as a whole

Liquidity risk measurement methodologies are still at an

initial stage in the financial services industry

Some indicators are already used by most banks cashcapital position, liquidity gaps, long term funding ratios

It is more complex to deviate from expected future cash

flows and take into account stress scenarios

The regulators are stepping in with some new

requirements and general principles

Conclusions

Date post:	04-Apr-2018
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8 Liquidity Risk

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