1. 4/1/2017
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

2. Outline Financial crisis and emergency measures Lessons learned
4/1/2017
Outline
Financial crisis and emergency measures
Lessons learned
International framework for liquidity risk measurement, standards and monitoring (Dec 2009 consultative paper) 2

3. FX and maturity mismatches: Optimistic assumptions
4/1/2017
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. 3 3

4. Triggers and transmission: the US subprime crisis
4/1/2017
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
Consequences:
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. 4 4

5. Private sector responses to liquidity pressures
4/1/2017
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”. 5 5

6. Central Banks’ emergency measures
4/1/2017
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 (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) 6 6

7. Governments and Central Banks’ emergency measures
4/1/2017
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. 7 7

8. Lessons learned Markets:
4/1/2017
Lessons learned
Markets:
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
Supervision
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. 8 8

9. Objectives and components of liquidity supervision
4/1/2017
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. 9 9

10. Stock of high quality liquid assets
4/1/2017
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 10 10

11. LCR – liquid assets (narrow & wider definitions)
4/1/2017
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. 11 11

12. LCR – net cash outflows (denominator)
4/1/2017
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 12 12

13. NSFR – definition Available amount of stable funding (i.e. sources)
4/1/2017
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 13 13

14. NSFR – available stable funding (sources)
4/1/2017
NSFR – available stable funding (sources)
Components of ASF
ASF Factor
Tier 1 & 2 capital
100%
Other pref shares with effective maturity ≥ 1 year
Other liabilities (e.g. secured and unsecured, including term deposits) with effective maturity ≥ 1 year
‘Stable’1 retail and SME non-maturity deposits and term deposits with residual maturity ≤ 1 year
85%
‘Less stable’1 retail and SME non-maturity deposits and terms deposits with residual maturity ≤ 1 year
70%
Unsecured wholesale funding, non-maturity and term deposits from non-financial corporates with residual maturity ≤ 1 year
50%
All other liabilities and equity not included above 0%
1. As defined for the LCR 14 14

15. NSFR – required stable funding (uses)
4/1/2017
NSFR – required stable funding (uses)
Summary composition of asset categories
RSF Factor
i) Cash
ii) Securities with effective residual maturity < 1 year
iii) Non-renewable loans to financials with residual maturity < 1 year 0%
Unencumbered marketable debt issued or guaranteed by sovereigns, central banks, BIS, IMF, MDBs eligible for 0% risk weight and with residual maturity > 1 year 5%
Unencumbered corporate bonds (or covered bonds) rated ≥ AA with residual maturity ≥ 1 year AND traded in deep, active market
20%
i) Gold
ii) Unencumbered listed equities and unencumbered corporate bonds (or covered bonds) rated ≥ A- with residual maturity ≥ 1 year AND traded in deep, active market
iii) Loans to non-financial corporates with residual maturity < 1 year
50% 15 15

16. NSFR – required stable funding (uses) – cont’d
4/1/2017
NSFR – required stable funding (uses) – cont’d
Summary composition of asset categories
RSF Factor
Loans to retail clients with residual maturity < 1 year
85%
All other assets
100%
Off-balance sheet categories
Undrawn amount of conditionally revocable and irrevocable credit and liquidity facilities provided to retail clients, corporates, financials, sovereigns, etc
10%
Other contingent funding obligations, including:
- unconditionally revocable uncommitted credit and liquidity facilities
- guarantees
- letters of credit
national discretion 16 16

17. Monitoring tools – firm-based
4/1/2017
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 17 17

18. Monitoring tools – market-related
4/1/2017
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 18 18

19. Application issues Scope of application Currencies
4/1/2017
Application issues
Scope of application
at least on a consolidated basis
potentially also on sub-consolidated (legal entity) basis (ring-fencing?)
Currencies
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 … 19 19