The Basel III liquidity standards
and their implementation into
EU legislation
Seminar on Basel II Enhancements
Basel, Switzerland, 27–29 April 2010
Stefan W. Schmitz
stefan.schmitz@oenb.at
Disclaimer: The opinion expressed in this presentation is that of the author
and does not necessarily reflect that of the OeNB/the Eurosystem/CEBS.
Overview
1. Main Challenges
2. Why regulate? Feedbacks and Externalities
3. Basel III liquidity standards
4. Liquidity Identity Card (CEBS 2009 127 June 2009)
5. Liquidity Buffers & Survival Periods (CEBS December 2009)
6. Implementation in the EU
7. Impact on monetary policy implementation
8. Conclusions
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1. Main challenges
• Liquidity risk – low frequency/high impact & each crisis different &
highly institution specific risk
– Probabilistic approach based on historical frequencies not feasible
• Psychological factors/confidence crucial for bank‘s liquidity situation
• Externalities can be substantial
– Partly determined by psychological factors/confidence themselves
– Partly determined by very broad set of economic/financial conditions and individual
bank characteristics
-3-
2.1 Why regulate? Feedbacks and externalities
•
Due to asymmetric information a liquidity crisis at one bank can lead to a loss
of reputation and increasing uncertainty
– Bank runs on banks that are sound (often includes flight to quality)
– Dry-up of interbank markets (liquidity hoarding)
•
Large and increasing share of interbank exposures and money market
instruments in banks’ funding
– Expected positive cash flow does not materialise
•
Market liquidity in the capital markets
– Asset fire sales trigger market meltdown and cash flow from counter-balancing capacity falls
short of expectations
-4-
2.2 Why is liquidity risk management an issue for central
banks?
•
Central banks rely on efficient and stable money markets
•
Liquidity problems at one bank can negatively affect money market efficiency
and stability
– Due to asymmetric information a liquidity crisis at one bank can lead to a loss of reputation and
increasing uncertainty
– Large and increasing share of interbank exposures and money market instruments in banks’
funding
– Market liquidity in the capital markets
•
Negative externalities of individual liquidity problems – a form of market
failure – provide the major rationale for public intervention
-5-
2.3 Central bank tasks affected by liquidity problems
Liquidity provision
Crisis
management
Monetary policy
implementation
Impact on
central banks
Financial stability
Payment system
-6-
2.4 Policy implications
Applicable to business
as usual and under distress
Allow for
institution specifity
Liquidity regulation
necessary to address
contagion
All sources of
material liquidity risk included
Reflect severity of potential
contagion (proportionality)
Closely reflect
underlying risk
(risk based)
-7-
2.5 A functional approach
Business as usual
• Banks should manage their expected liquidity needs in a
prudential manner under business as usual and …
• … be able to absorb liquidity shocks
Stress
• … also under times of market stress
• … for a pre-specified period of time
• … at acceptable costs.
• Supervision based on banks’ internal approaches.
Regulation &
Supervision
• Minimum quantitative requirements.
 Concerted rounds of common liquidity stress tests
Sources: Schmitz/Ittner (2007) Why central banks should look at liquidity risk, Quarterly Journal Central Banking Vol. XVII No. 4, 32-40;
BSC (2008) Report on EU banks liquidity stress tests and contingency funding plans, European Central Bank.
-8-
3.1 The Basel III liquidity standards
• No harmonisation of (quantitative) liquidity regulation
– Not even at the EU level
• Important high-level principles for qualitative liquidity regulation
– BCBS: Principles for Sound Liquidity Risk Management and Supervision in September
2008
– CEBS: CEBS’S Technical Advise on Liquidity Risk Management (2nd part) September
2008
• Liquidity Identity Card (June 2009), Guideline on Liquidity Buffers & Survival Periods
(December 2009), Guideline on Liquidity Cost Benefit Allocation (work in progress)
– Widely accepted as standards for the assessment of banks‘ liquidity risk management
practices
-9-
3.2 Overview over the consultation document
International framework for liquidity risk measurement, standards and
monitoring – BCBS December 2009
•
Standards
– Liquidity Coverage Ratio
– Net Stable Funding Ratio
•
Monitoring tools
–
–
–
–
Contractual Maturity Mismatch
Concentration of funding
Available unencumbered assets – collateral
Market related monitoring tools
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3.3 Liquidity Coverage Ratio (LCR)
Objective
• Liquidity even under very severe
liquidity stress over 30 days w/o gov &
CB assistence
• Minimum requirements
Narrow definition of liquid assets
•
Cash, CB excess reserves
• Government bonds & gov guaranteed bonds
Definition LA
(liquide Assets) • Bonds of other public authorities
Broader definition
+ Covered bonds & non-financial corporate
bonds (> A-) & high HC (20-40%) &
substantial restrictions
LA
1
 Net  Cash  Outflow
•
Stress scenario
30T
•
•
•
•
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Combination of market- & idiosynkratic
stress
Rating downgrade (3 notches)
Run-off of retail- & wholesale deposits
Primary & secondary markets (repo &
securitisation) dry-up for many assets
Large cash outflows due to off-balance items
3.4 LCR: net-cashflow calibration
Cash outflows over 30 days
Retail deposits
Unsecured
funding
Secured
funding
Credit &
liquidity lines
•
15%: Less stable deposits
•
7.5%: Stable retail deposits
•
100%: Unsecured wholesale funding
(financials, banks, CBs & govs w/o
operational relationship)
Cash intflows over 30 days
Retail loans
Unsecured
funding
•
75%: Unsecured wholesale funding (nonfinancials, non-operational balance)
•
25%: Unsecured wholesale funding (nonfinancials, operational balance)
•
100%: Repos w asstes not eligible under
LCR, margin calls (3 notche DG), ABCP &
SIVs, Term ABS
0%: Repos w assets eligible under LCR
Secured
funding
100%: Planned outflows (e.g. new loans)
100%: non-financial (li) & financials &
governments
10%: Retail clients (credit & li), nonfinancials (credit)
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Credit &
liquidity lines
•
•
•
•
•
100%: Planned inflows from performing
retail loans
•
100%: Planned inflows from performing
wholesale loans
•
100%: Receivable from repo/reverse repo
w assets not eligible under LCR
•
0%: Receivable from repo/reverse repo w
assets eligible under LCR
•
0%: Undrawn liquidity lines & other
facilities
(Summary)
3.5 Net Stable Funding Ratio (NSFR)
Objective
• Reduce maturity mismatch between
funding and assets
– Assets > 1 y funded by liabilities > 1y
•
ASF (Available • 85%: Stable deposits
Stable
• 70%: Less stable deposits
Funding)
• Longterm stress scenario (market &
idiosyncratic stress)
•
50%: Wholesale funding (non-financials)
•
0%: Rest
 2 x LCR run-offs
– Decline in profitability and/or
solvency, downgrade in credit rating,
reputational event
ASF
1
RSF
100%: Capital, hybrids, liabilities w residual
maturity > 1 y
•
•
•
RSF (Required
Stable
•
Funding)
•
•
•
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0%: Cash, CP, bonds w residual maturity < 1
y, non-renewable interbank loans
5%: Govies et al. ( AA)
20%: Corporate bonds & covered bonds (
AA), residual maturity  1 y
50%: Corporate bonds & covered bonds ( A-)
 1 y, loans to non-financial corporates < 1 y
85%: Retail loans < 1 y
10%: Off-balancesheet
100%: Rest (incl. Govies > AA?)
(Summary)
3.6 Application issues
•
Scope of application
– At least on concolidated basis
– Potentially also on sub-consolidated basis: treat affiliated entities same as third parties.
•
Currencies
– At least aggregated across transferable and convertible currencies
– Potentially on per currency basis
•
Frequency of calculation & reporting
– Calculation
– Ongoing basis
– Meet requirements continuously
– Reporting
– At least monthly, in stressed situation possibly weekly or daily
– Time lag between calculation and reporting < two weeks
•
Public disclosure
– Value and level of the metrics, Size and composition of the components, drivers behind the
metrics. Frequency? Time lag?
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3.7 Monitoring tools
•
Contractual Maturity Mismatch
–
Report contractual inflows and outflows for the periods: overnight, 7 and 14 days; 1, 2, 3 and 6 months; 1, 3,
and 5 years; and beyond 5 years.
•
•
Concentration of funding
–
Counterparties
–
Products or instruments
–
Currencies
Available unencumbered assets that can be used as collateral in market and/or central
bank facilities
•
Market related monitoring tools: market-wide information, financial sector information,
bank-specific information
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4.1 Liquidity Identity Card (I)
•
•
Issued as CEBS 2009 127 in June 2009
Purpose
– Enable supervisors of EU cross-border banking groups to assess the liquidity risk
exposure and risk bearing capacity of such groups
1. General and qualitative information to be provided at the group level
Objective: To clarify the degree of centralised management of liquidity risk and liquidity
support of the group
2. Quantitative information
Objective: To allow supervisors to have a view on: short-term resilience as indicated by a
liquidity buffer longer-term resilience and changes in balance sheet structure
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4.2 Liquidity Identity Card (II)
2.1 Liquidity Buffer
•
Size of the buffer(s)
•
Composition of the buffer(s) (type of assets, duration, and principal currencies)
•
Contextual information (principal assumptions used for the combined stress scenario and
time horizons considered)
2.2 Long-Term Funding Ratio
(Retail dep + wholesale funding > 1 y + equity instruments)/(Illiquid assets + contingent liabilities)
2.3 Diversification of the funding structure
- Wholesale funding ratio
● Wholesale funding / total liabilities
● Unsecured wholesale funding as a percentage of total wholesale funding
- Funding Counterparty Concentration indicator
The amount of each of the five largest depositors held at the parent institution across all currencies
2.4 Domestic quantitative ratio (if any)
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4.3 Liquidity Identity Card (III)
3. Additional “à la carte” information
3.1 Market indicators
3.2 Synthetic Maturity ladder
3.3 “Core funding ratio” (Stable funding over liabilities)
3.4 Examples of additional metrics for specific vulnerabilities
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5.1 Liquidity Buffers & Survival Periods (I)
Issued in December 2009
Guideline 1 – A liquidity buffer represents available liquidity, covering the additional
need for liquidity that may arise over a defined short period of time under stressed
conditions.
Guideline 2 – Institutions should apply three types of stress scenarios: idiosyncratic,
market specific, and a combination of the two. The core of the idiosyncratic
stress should assume no rollover of unsecured wholesale funding and some
outflows of retail deposits. The market-wide stress should assume a decline in the
liquidity value of some assets and deterioration in funding market conditions.
Guideline 3 – A survival period of at least one month should be applied to
determine the overall size of the liquidity buffer under the chosen stress scenarios.
Within this period, a shorter time horizon of at least one week should also be
considered to reflect the need for a higher degree of confidence over the very short
term.
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5.2 Liquidity Buffers & Survival Periods (II)
Guideline 4 - The liquidity buffer should be composed of cash and core assets that
are both central bank eligible and highly liquid in private markets. For the
longer end of the buffer, a broader set of liquid assets might be appropriate,
subject to the bank demonstrating the ability to generate liquidity from them under
stress within the specified period of time.
Note: A few members advocate a more restrictive definition of eligible assets.
Guideline 5 – Credit institutions need to manage their stocks of liquid assets to
ensure to the maximum extent possible that they will be available in times of
stress. They should avoid holding large concentrations of particular assets, and
there should be no legal, regulatory, or operational impediments to using these
assets.
Guideline 6 – The location and size of liquidity buffers within a banking group should
adequately reflect the structure and activities of the group in order to minimize the
effects of possible legal, regulatory or operational impediments to using the
assets in the buffer.
Annex 1: Institutions should develop cash-flow projections covering expected cash
inflows and outflows and expected counterbalancing
- 20 -
5.3 Example: behavioural maturity mismatch (I)
- 21 -
5.4 Example: behavioural maturity mismatch (II)
Simple embedded stress test
Source: OeNB. Schmitz/Weidenholzer (2009) Recent Developments in the Austrian Banking System’s Liquidity Situation and the
International Regulatory Debate, Financial Stability Report No. 18, 60-66
- 22 -
6.1 CRD IV: Procedure
Tentative procedure and time table
• Public Consultation regarding further possible changes to the Capital
Requirements Directive (“CRD”)
– Launched on 26 February 2010
– Ended on 16 April 2010
• Analysis of consultation documents
• Next draft of CRD IV – end of 2010
• EU directive – end of 2011
• Implementation at national level – end 2012
• Bank compliance – as of 2013
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6.2 Public consultation EU COM
Regulation on EU level – Current State as of March 2010
• No quantitative regime as for example minimum ratios for liquidity risk
• No common reporting requirements in COREP
• High-level provisions for Liquidity risk management in Pillar II
– Measuring liquidity risk is broadly stipulated in Annex V (net funding requirements)
– Contingency funding plans and Stress Testing are compulsory
– ICAAP does not require to hold capital against liquidity risk
• More detailed C-EBS Guidelines
- 24 -
6.3 Public consultation EU COM
1. Scope of application
–
Individual stand-alone basis
–
EU parent credit institution at consolidated level
–
Investment firms (>730 K)
2. Waivers
–
Application to individual firms can be waived at domestic level
–
–
Application of waiver for legal entities located in different MS
–
–
–
Li risk managed centrally, legally binding mutual agreements and assets are freely transferrable even
under stress, EU parent is subject to CRD IV and entities belong to the same group
: Assessed and agreed by all competent authorities of all relevant MS
Disagreement supervisor of subsidiary takes final decision
No waiver for EU subsidiaries of non-EU parent credit institution
–
Free transferability questioned
- 25 -
6.4 Public consultation EU COM
3. Treatment of intragroup exposure
–
–
EU COM favours symmetrical treatment
–
Intra-group liquidity/credit lines: neither in- nor outflows of liquidity at respect group members
–
Intra-group loans/deposits are assumed to be rolled
Alternative 1 (symmetrical)
–
–
Intra-group liquidity/credit lines: consider in- and outflows
Alternative 2 (non-symmetrical)
–
Intra-group liquidity/credit lines & loans/deposits: consider outflows but not inflows
4. Supervisory responsibility for branches
–
Article 41 sub-para 1, EU Directive 2006/48EC
–
Host supervision of branch liquidity „pending further coordination“
–
Harmonised li-standards  home supervisor for branch liquidity
–
Legally all obligations of branch are obligations of the credit institution and subject to home country insolvency
procedure
- 26 -
6.5 Public consultation EU COM
5. Monitoring tools
– Contractual maturity mismatch, concentration of funding, available unencumbered
assets (for CBs and repos), market related m,onitoring tools
– Problems: behavioural maturity mismatch preferrable for < 12 months, less detailed
contractual maturity mmismatch for > 12 months less detailed
6. FX
– LCR not to calculated on currency basis
7. Liquid assets
– Broader definition than Basel III envisaged
8. Public disclosure currently not required
- 27 -
6.6 Critique (I)
1. Positive: binding quantitative li-standards based on functional approach
2. Ratios can be circumvented
–
Insufficient picture of li-situation
–
Definition of components product specific
3. Liquid assets too narrow
–
Inconsistent with functional approach
–
Unintended consequences
– Feedback on market liquidity through frozen portfolios?
– Increasing reliance on CRAs
– Feedback & contagion: fire sales  price  mark-to-market  downward spiral
–
Prudent risk management calls for portfolio diversification
–
Exclusion of bank bonds – market for bank bonds?
- 28 -
6.7 Critique (II)
4. Ratios too strict
–
Fight past battle
5. Scope of application
–
Size of liquidity reserves
–
Trapped pools of liquidity
–
Use of reserves under stress
6. Non-level playing field
–
Decentralised sectors, commercial banks, custodian banks
–
Non-rated banks – challenges to issue long-term debt
–
Standards developed for large cross-border banking groups – applied across EU  bifurcated
approach needed
–
Shift liquidity transformation outside banking system?
- 29 -
6.7 Critique (III)
7. Inconsistencies between CRD IV and CEBS Guidelines
8. Potential impact
–
Additional long-term funding in EU: 1,100 bn EUR to 3,000 bn EUR  priced into liquidity
intensive products
–
Competition for deposits intensivies – deposit growth/long-term debt issuance constrain loan
growth
–
Challenges for emerging, fast growing economies
–
Asymmetric treatment of intra-group exposure extremely liquidity intensive
–
Interbank market – liquidity insurance, structural li-deficit & monetary policy implementation
9. Preferrable approach – concerted rounds of common liquidity stress tests
- 30 -
7.1 Impact on monetary policy implementation – first thoughts
r
Until 08/07: Unsecured and repo
market close substitutes 
OMOs anchored unsecured M
S1
S
LF
rpol
DF
∆RS
= structural liquidity deficit
∆RD
D
R
D(rpol)
Source: Schmitz (2006) Monetary Policy in a World without Central Bank Money, in: Stefan W. Schmitz, Geoffrey E. Wood (eds.), Institutional Change in
the Payments System and Monetary Policy, Routledge, London, 131-157
- 31 -
- 32 2.3.2010
2.1.2010
2.11.2009
3MEuribor
2.9.2009
2.7.2009
2.5.2009
2.3.2009
2.1.2009
2.11.2008
2.9.2008
2.7.2008
2.5.2008
2.3.2008
2.1.2008
2.11.2007
2.9.2007
2.7.2007
1
2.5.2007
2.3.2007
2.1.2007
6
2.00
3MEurepo
1.80
5
1.60
4
1.40
Spread (rhs)
1.20
3
1.00
0.80
2
~ 28 Bp
0.60
0.40
~7 Bp
0.20
0
0.00
7.2 Impact on monetary policy implementation
Individual bank
– Net short
position on IB
market < 30 days
requires 100% liquid
asset coverage
– Strong
disincentive to
borrow unsecured,
rather repo in
eligible assets
– Collateral
demand increases
Interbank market
– Reduced volume
on unsecured
interbank market
– EONIA loses
relevance &
information content
– Market loses
insurance function
– Market loses
distribution &
allocation function
Demand for CB
money
– Banks self-insure
 higher, more
volatile excess
reserves
– More aggressive
bidding behaviour
– Structural
liquidity deficit
more volatile
- 33 -
OMOs
– More banks
participate
– Structural
liquidity deficit
harder to estimate
 more volatile
allotment rate
– Collateral bias
towards less liquid
assets  earmaking?
7.3 Impact on monetary policy implementation
r
S1
S
S²*
S²
S²*
LF
rpol
DF
∆RS
= structural liquidity deficit
D²*
∆RS²
D²
D²*
D
D(rpol)
- 34 -
R
7.4 Reform options
•
EONIA loses information content  target Eurepo instead of Euribor
•
Loss of allocation & distribution function  broader participation & shift to repo
market in eligible assets  demand for collateral increases
•
Higher volatility of structural liquidity deficit  more frequent OMOs/FTOs & more
LTRO
•
More volatile short-term rate  narrower interest rate corridor
•
Collateral arbitrage  higher, more risk sensitive haircuts
- 35 -
8. Conclusions
+ Harmonisation important step forward
+ Functional approach welcomed
– Basel III and CEBS diverge in some points
– CRD IV: consultation – not final directive
– Fundamental divergence of opinions across MS and with industry
– Number of critical points
– Monetary policy implementation needs to be adapted
- 36 -