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Liquidity management in the context of the new regulatory environment

AFGAP – Scientific Committee’s annual seminar - April 5, 2012

© 2012 Deloitte

European regulatory landscape before Basel IIIA regulatory liquidity framework partially disconnected from the day to day LRM

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• Not harmonized regulation across Europe

• Application on an individual basis

• Regulatory framework does not cover all the components of liquidity risk management => generally limited to liquidity ratios

Accordingly, few resources and little weight given to regulatory ratios

Liquidity Management in the context of a new regulatory environment

Arrêté du 5 mai 2009

Circular CBFA 2009 – 18 (May 8 2009)

• Decree of October 12 2006

• Consultation Paper April 21st 2009

Liquiditäts-verordnung Bafin Dec. 06

• Law of April 5th 1993

• Circular IML 93 104

• Circular CSSF 07/301 6 July 2007

• Circular CSSF 09/403 • § 25 ABA

(Austrian Banking Act) • Liquiditätsverordnung

(FMA ,1993)

© 2012 Deloitte

New regulation emerged to address the liquidity issue

3 Liquidity Management in the context of a new regulatory environment

As a consequence of a financial turnmoil, a large number of governmental, regulatory and industry organisations are proposing regulations and other means to sthrengthen frameworks for monitoring Liquidity Risk

BIS = Basel III Framework FSA

* “International framework for liquidity risk measurement, standards and monitoring“ of the BIS / December 2009

** “Principles of Sound Liquidity Risk Management and Supervision” of the BIS / September 2008

International Regulatory Framework

Capital Liquidity

Risk

Credit Risik

Market Risk

Op. Risk

Liquidity Risk

International Framework*

Sound Principles**

Strenghtening Liquidity Standards (I & II)Dec 08-Dec 09

ACP

Arrêté du 05 mai 2009

CEBS

•Technical advice on Liquidity risk management - 2007 / 2008

•Guidelines on liquidity buffer -2009•Guideline on Stress Testing – Dec 09•Draft guidelines on Liquidity cost benefit allocation - 2010

© 2012 Deloitte

Characteristics of current LRM Overview


• Taken into account the difficulties experienced during the recent financial crisis and the recommendations from regulators / market expectations, banks have already significantly improved their Liquidity Risk Management framework since several years

• LRM is, in general, articulated around the following areas :

Short Term Long Term Structural Liquidity buffer

•Short Term ratio•Survival time (cash flow)• Liquidity gaps • Intra-day framework

•Structural limits•Liability / Asset ratios

•Level of highly liquid marketable securities

Concentration of funding sources

Contingency Funding Plan Stress tests

•Counterparties•Market / Instrument type• Tenor concentration

•Triggers to initiate CFP•Escalation procedure•Definition of countermeasures

•Idiosyncratic• Systemic• Hybrid

© 2012 Deloitte

Characteristics of current LRM Short term monitoring : cash flow planning


Deterministic view on future cash flows

Cashflow in

Cashflow out

time

Data Warehouse Risk Warehouse

ADIDAS AG INHABER-AKTIEN O.N. Risk Factor 1 = Risk Factor 1 (time, amount,…)

BGL BNP PARIBAS MEDIUM TERM…. Risk Factor 2 = Risk Factor 2 (time, amount,…)

… …

Mapping ProcessMapping Process

Stochastic viewStochastic view

Cash flow Planning

•All foreseeable cash flows shall be captured (incl. those from off-balance sheet commitments and liabilities)

© 2012 Deloitte

Characteristic of current LRMStress tests


Liquidity Stress Tests - Micro structural Approach

Question: “How much can be liquidated at once and at which discount?”

Understanding of the order book and its dynamic

495 shares can be sold at once at an average price of 95,15But how is this result dependent on different market conditions?

Actual Distribution of Orders

Price

Vo

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f O

rder

s

Price

Vo

lum

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f O

rder

s

Stressed Distributions of Orders

average liquidation price:

94,1793,06

91,29

Answer: modeling the order book:

© 2012 Deloitte

Basel III international framework : a new deal ?

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More pressure on the liquidity risk management


From the regulator : Basel III framework • LCR• NSFR• Other metrics to

monitor liquidity risk

From the market : •Consequences of the difficulties experencied by the financial institutions during the recent financial crisis•Expect Basel III requirements to be met today !

Europe's debt crisis prompts central banks to provide dollar liquidityEuropean and US stocks surge on news that world banks will flood markets – but Lagarde warns of 'dangerous' new phase

The Guardian Sept 15, 2011

Five Steps to Solving Europe’s Debt Crisis

NY times August 21, 2011

Regulators poised to soften new bank rulesThe move follows complaints from banks that the new Basel III standards on liquidity – the first international rules of their kind – would force them to sharply curtail lending to consumers and businesses.

Financial times Sept 5, 2011

© 2012 Deloitte

Basel III international framework : a new deal ?


• Basel III framework will not lead to ‘deep’ changes in the LRM as it, most of the time, already allows to cover the different liquidity risk components

• This will allow for a convergence between operational LRM and regulatory framework

Short Term Long Term Structural Liquidity buffer

•Reduction of the scope of the eligible assets to the liquidity buffer

Concentration of funding sources

Contingency Funding Plan Stress tests

•Counterparties•Market / Instrument type• Tenor concentration

•Triggers to initiate CFP•Escalation procedure•Definition of countermeasures

•Complementary scenarios (EBA, FMI)

© 2012 Deloitte

Impacts on Liquidity Risk ManagementProduce LCR & NSFR ratios


• Challenge in terms of IT architecture.

• Key points to address are the following

• On the top of that, a lot of points to be precised by the EBA with respect to The format of the reportings The criteria for liquid assets % on off B/S items

Frequency

•Quarterly publication required by CRD 4

•However, ratio to be monitored on a more frequent basis(at least monthly)

Data

•Rely as much as possible on accounting data

•Additional data from other sources (FO or ALM systems,…)

Scope

•By default, calculated on an individual basis

•Weavers for a calculation on a consolidated basis

•Consolidated ratio required for financial communication

© 2012 Deloitte

Impacts on Liquidity Risk ManagementManage the Liquidity buffer


• Modify current investment policies in order to focus on eligible liquid assets

• Governments bonds

• Corporate bonds with high rating

• Increase the stock of liquid assets through « auto-securitizations »

• Control of the costs through active management of assets and liabilities

Example : asset swap inflation linked government bonds strategies

Assets AA / AAA Notes

Bank A

Liquidity buffer

SPV

• A very tightened Collateral management :

• Post as much as possible securities not eligible as liquid assets

© 2012 Deloitte

Impacts on Liquidity Risk ManagementInvoice liquidity costs (1/2)

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• Liquidity spread was–generally- included in the FTP calculation methodology :

FTP : Interest Rate Component + liquidity Component


• FTP should now take into account the cost related to Liquidity Buffer

FTP : Interest Rate Component + liquidity Component + Liquidity buffer costs

Liquidity spread is the premium for a specific

contractual maturity relevant to cost of funding

Based on money market rates for a given maturity

%time

FundingSwapGovies

© 2012 Deloitte

Impacts on Liquidity Risk ManagementInvoice liquidity costs (2/2)

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• How to calculate costs related to liquidity buffer ?

• Other points to consider : should or can liquidity premium be fixed at origin ?


Yield of the assets Cost of carry

Low credit riskCentral bank eligible

…

•Shortest maturity = 30 day

•More longer maturities can be chosen to ensure the buffer can withstand significant periods of market stress

© 2012 Deloitte

Impacts on Liquidity Risk ManagementCartography of the Off Balance Sheet Commitments

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• Off Balance sheet commitments will be weighted more :‒ Retail : 5%

‒ Sovereign / non financial : 10%


• Operational impacts : ‒ Be able to screen off balance sheet commitments more precisely than today (by

type of counterparts).

‒ Invoice the liquidity costs to the business lines holding the OBS positions

© 2012 Deloitte

Impacts on Liquidity Risk ManagementStill time to change Basel III rules !

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• Many open points for which regulatory rules may evolve :‒ Criteria for the definition of liquid assets (level 1 or 2)

‒ Run off factors on Corporate deposits (75%)

‒ …


• Other points to discuss with local regulators / authorities :‒ ECB repos : decrease of the haircuts on collaterals

© 2012 Deloitte

Next step : to an integrated monitoring framework for P&L, capital and liquidity


Monitoring by P&L

Liquidity and capital are included

P&L oriented Monitoring

based on budget forecasts

Limited actions (cost cutting)

Basel II has led to the set up of ICAAP & capital planning processes

More and more constraints in terms of solvability and complex analysis rules implying a more refined and more frequent monitoring framework for capital

To an integrated monitoring framework

Metrics by business line : LCR ? Liquidity B/S ?

Regulatory and operational perimeters differ

Operational insertion to be done by invoicing liquidity costs to the business lines

Challenges in terms of process and IT architecture : internal contracts, day to day monitoring, collateral management

Monitoring framework including 3 pillars : P&L, Capital and Liquidity

Challenges in terms of IT Architecture : volume of operations, data model, calculations capacities

Insertion in the Group’s strategy through common metrics

A monitoring of business lines to be adapted : change management, renewal of performance indicators

• Pressure on costs reductions in order to maintain ROE levels

A new framework for monitoring the performance of business lines to be implemented

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