NSFR LIQUIDITY FRAMEWORK:

Practical Implementation Requirements

IMPLEMENTATION REQUIREMENTS TO ADAPT TO NEW NSFR LIQUIDITY PARAMETERS

WORKSHOP

4 th AnnualPractical Funds Transfer Pricing and Balance Sheet Management Forum17 th September 2014, London, UK

Rodrigo ZepedaIndependent Consultant

Section 1: Diversified funding: Problems with steering towards long-term stable funding

Section 2: Analysing the best internal mechanism for managing new liquidity requirements

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Diversified funding: Problems with steering towards long-term stable fundingSECTION 1

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“Assuming a 50 percent retained earnings payout ratio and nominal annual balance-sheet growth of 3 percent through 2019, capital requirements in Europe are expected to increase to about €1.2 trillion, short-term liquidity requirements to €1.7 trillion, and long-term funding needs to about €3.4 trillion.” (McKinsey 2010, p.1)

“The task is monumental however. Banks face a significant challenge merely to achieve technical compliance with the new rules and ratios, let alone to reorient the institution for success.” (McKinsey 2010, p.2)

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What is Long Term Stable Funding? GLOBAL FINANCIAL CRISIS FUNDING

Wholesale Funding

• Cheaper wholesale funds with shorter maturities.

• Funds secured against collateral (e.g. securitized debt or repurchase agreement transactions).

• Increasingly interconnected bank and non-bank financial system, drying up liquidity and triggering calls on collateral.

• Not sufficiently monitored.

• e.g. Interbank loans.

• e.g. Brokered deposits.

• e.g. Repurchase agreements (“Repos”).

• e.g. Commercial paper.

BASEL III FUNDING

Long Term Stable Funding (“LTSF”)

• Customer deposits.

• Regulatory capital (equity).

• Debt with maturities of more than one year.

• Deposits with maturities of less than one year (but expected to continue to be held in a stress scenario).

• Preferred stock.

• Covered bonds.

• Domestic and international capital markets.

• Diversified funding, but not necessarily all maturity matched (i.e. limited maturity transformation).

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Problems faced by Banks pre-Basel IIISenior Supervisors Group (“SSG”) Findings (SSG, 2009):

• Only 7 out of 20 major global financial firms stated they had fully aligned liquidity risk with transfer pricing practices (13 firms were stated to be partially aligned).

• Managers acknowledged that if robust Funds Transfer Pricing (“FTP”) practices had been in place which factored in liquidity as well as funding risks, firms would not have carried the significant levels of illiquid assets and off-balance sheet (“OBS”) risks that led to sizeable losses

• Many firms’ information technology (“IT”) infrastructure was inadequate to accurately monitor risk exposures.

• It was noted that firms need to re-examine the priority that was traditionally given to revenue-generating businesses over reporting/control functions.

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Impact of the New Basel III Liquidity Risk ParadigmMcKinsey Report Findings (McKinsey, 2010):

• By 2019 European banking sector will (absent any mitigating actions) need:• €1.1 trillion of additional Tier 1 capital;• €1.3 trillion of short-term liquidity; and• €2.3 trillion of long-term funding.

• By 2019 US banking sector will (absent any mitigating actions) need:• US$870 billion (€600 billion) of additional Tier 1 capital;• US$800 billion (€570 billion) of short-term liquidity; and • US$3.2 trillion (€2.2 trillion) of long-term funding.

• By 2019 pre-tax Return on Equity (“ROE”) of European banks will decrease by 3.7-4.3 percentage points (“pp”) (from pre-crisis levels of 15%) (there will be a gradual decline in ROE, 2013 (-0.3 pp), 2016 (-2.1 pp)):

• 0.8pp – capital quality;• 1.3pp – increased risk weighted-assets (“RWA”);• 1.3pp – increased capital ratios (made up of 0.3pp (new minimum ratios), 0.8pp (additional cushion), and 0.2pp

(further national discretions));• 0.1pp – leverage ratio;• 0.2pp – expense of holding more liquid assets; and• 0.6pp – cost of holding more long-term funding.

[Assessment based on an analysis of the balance sheets of the top 45 European banks as of their most recent filings at November 2010]

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Impact of the New Basel III Liquidity Risk ParadigmDeloitte European Bank FTP Survey Findings (Deloitte, 2014):• Larger banks displayed more advanced methodologies and more integrated processes and systems; smaller banks had more

limited methodologies and low levels of integration; but many had a long way to go to meet Liquidity Transfer Pricing (“LTP”) requirements.

• Many banks did not estimate the Liquidity Asset Buffer in their FTP frameworks.

• Many banks still lacked independent validation of their FTP models (e.g. 40% did not have it carried out by risk area).

• Only the biggest banks adopted behavioural adjustments (from Internal Rate of Return (“IRR”) and liquidity risk models) which reflected the behavioural characteristics of financial instruments and contractual profiles of transactions involved.

• Weaknesses in banks’ FTP infrastructure included: (1) manual processes; (2) limited granularity of single components; and (3) poor integration.

[Deloitte survey involved functions (Treasury, ALM, Risk and Performance Management) of 15 financial institutions from the UK, France, Germany, Italy, the Netherlands, and Greece]

BCBS and Committee of European Banking Supervisors (“CEBS”) (2010) Findings:

• Group 1 banks have an estimated average LCR of between 67% (CEBS, 2010) and 83% (BCBS, 2010).

• Group 2 banks have an estimated average LCR of between 87% (CEBS, 2010) and 98% (BCBS, 2010).

• Group 1 banks have an estimated average NSFR of between 91% (CEBS, 2010) and 93% (BCBS, 2010).

• Group 2 banks have an estimated average NSFR of between 94% (CEBS, 2010) and 103% (BCBS, 2010).

[BCBS findings based on a survey of 94 Group 1 banks and 169 Group 2 banks; CEBS findings based on a survey of 50 Group 1 banks and 196 Group 2 banks]

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Basel III Effects on Risk Coverage

Anticipated effects of the changes to risk coverage (Linklaters 2011, p.3)

Anticipated effects of the changes to risk coverage (Accenture 2011, p.5)

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The New Basel III Regulatory LandscapeBasel II Implications

• Increased capital reserves, liquidity buffers and funding costs under the Basel III framework.

• New global minimum liquidity standards and two new liquidity ratios, i.e. the Liquidity Coverage Ratio (“LCR”) and the Net Stable Funding Ratio (“NSFR”).

• Increased need for equity funding in the market.

• Decreased availability of funding by central banks.

• Increased capital requirements for counterparty credit risks for (1) derivatives; (2) securities financing; and (3) repo transactions.

• Some bank lobbyists are claiming Basel III NSFR will increase repo transactional costs by more than 850% (from 7 bp to 67 bp) (Becker, 2014).

• Hedge funds face higher prime broker charges under Basel III (Devasabai, 2014).

• Banks exiting or scaling back from aircraft financing or leasing operations (e.g. BNP Paribas, Société Générale, and Royal Bank of Scotland) (loans with maturities of between 6-12 years) (Watt, 2012).

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GENERAL Problems With Steering Towards LTSF • Banks are still struggling to return to pre-crisis ROE levels.

• Banks have additional high compliance costs, i.e. EMIR, Dodd-Frank, SEPA, AML/CTF, etc.

• Decreased ROE and overall profitability levels:

• Banks must adhere to lower levels of leverage under Basel III (and must include OBE when calculating leverage);

• Minimum solvency ratio of 7% Core Tier 1 Capital (2019), but with changes in Regulatory Capital and RWA necessitating increased capital or decreased lending leading to crowding out effects on capital;

• Increased bank equity capital (4.5% common equity Tier 1 ratio) will reduce small and medium-sized (“SME”) lending capacity and overall SME ROE (higher risk, higher capital);

• Mandatory conservation and countercyclical buffer; and

• Adherence to new monitoring metrics.

• General reduced lending capacity or credit availability, and/or increased cost of credit.

• Likely overall ‘crowding out’ of smaller and weaker banks.

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SPECIFIC Problems With Steering Towards LTSF • Change in sourcing demand from short-term funding to long-term funding arrangements.

• Likely negative impact on pricing (higher) and margins (lower) in the short-term (as banks adjust).

• NSFR assets: increasing HQLA holdings or shortening loan maturities (<1 year) will significantly increase costs and reduce product offerings.

• NSFR liabilities: increased demand for long-term wholesale funding making it more costly (squeezing smaller banks), and there will now be increased aggressive competition for retail deposits.

• Likely significant pressures on operating capacity as pre-existing high volumes of specific product segments are likely to translate to increased liquidity operating costs.

• Likely significant changes in business operating models of some banks needed.

• Potential for international regulatory arbitrage (e.g. US Basel III proposals stricter).

• Basel III is not a panacea for all structural banking problems, it is likely the beginning not the end, and future proposals such as ‘ring-fencing’ may make liquidity rules even more complex or expensive.

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Problems With Steering Towards LTSF

•Increased allocation of capital to larger trading books.

•Changing tenor structures (greater than 7-10 years).

•Capital efficiency measures.

Financial

•Adjusting or changing existing business models.

•Evaluating and improving capital and liquidity management practices.

•Restructuring of balance sheet.

Operational

•Integrating new risk management standards and regulatory requirements into existing or new IT architecture and reporting systems.

•Auditing (new or required) of data availability, quality, and completeness.

Technological

•Maturity transformation practices are affected and must be re-optimised.

•Exiting from unprofitable product lines.

•Questioning what drives balance sheet consumption.

Strategic

•Loan agreement terms.

•Group reorganisations.

•Disposing of part/whole portfolios or operating entities.

Legal

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Changes in Funding Structures

Basel III transition challenges to stability (IMF, 2013):

• Advanced economies rely more on wholesale funding, whereas emerging market economies (and Japan) have large retail deposit bases, and are much more homogenous in their use of funding instruments.

• Banks have diverse funding structures that change only gradually over time.

• Bank funding structures are affected mainly by bank-specific factors and to a lesser extent by macrofinancial and market variables.

• The overall (ambiguous) effect on funding costs will depend on:

• the proportion of various types of funding instrument;

• relative funding costs;

• level of equity capital; and

• underlying riskiness of banks’ assets (encumbered and unencumbered).

• Basel III regulatory reforms can affect bank funding structures positively and negatively, so reforms need to be calibrated to ensure that there is not an overuse of secured funding or banks excessively encumber assets.

[IMF empirical study based on liability structure (equity, non-deposit liabilities, deposits) and loan-to-deposit ratio (indicates need for wholesale funding ) for 751 banks, applying a dynamic panel regression with bank-specific fixed effects for a large set of countries]

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Changes in Funding Structures

Breakdown of Bank Liabilities (IMF 2013, p.108)

Customer depositsAt Par/On Demand deposits – high liquidity risk owing to maturity mismatch (and runs), but retail deposits relatively stable in practice (may be covered by deposit guarantee scheme).Other deposits – i.e. uninsured, foreign currency, internet banking, non-residents, corporations, money market fund, high-net-worth individuals, are less stable.Wholesale fundingEncumbered (assets secured as collateral) – designated for payment of secured creditors; senior unsecured funds may rank equal to depositors or below depositors (depends on country).Encumbered (short-term secured funds) – repos; swaps; asset-backed commercial paper.Unencumbered (short-term unsecured funds) – interbank loans; commercial paper (“CP”); wholesale certificates of deposit (“CDs”). Long-term funds - bonds; different securitizations (e.g. covered bonds, private-label mortgage-backed securities).Regulatory capital (retail/wholesale)Common equity, certain types of subordinated debt – highest quality is “Common Equity Tier 1” (“CET1”). Subordinated debt types (paid after other debt holders) include contingent convertible debt (“CoCos”), preferred shares, and perpetual bonds which qualify as additional Tier 1 and Tier 2 capital.

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Changes in Funding StructuresBanks’ Long-Term Wholesale Funding across Major Economies and Regions (as of 31 July 2013) (IMF 2013, p.109)

Determinants of Bank Funding (Relative sizes of factors; percentage points) (IMF 2013, p.112)

Sources: Bloomberg, L.P.; and IMF staff estimates.Note: CA= current account, cap. =capitalization; FX = foreign exchange; LDV = lagged-dependent variable; Nil share = net interest income in percent of operating income. Regulation and disclosure are the first and second principal component scores, derived from four World Bank indicators of regulatory and institutional quality. Figures show the economic relevance of bank characteristics and macrofinancial regulatory factors on bank funding through equity, deposits, and debt (as a percent of total assets), and on loan-to-deposit ratios based on panel estimations for all banks, advanced economy banks, emerging market economy banks (from developing Asian and central and eastern Europe), and global and domestic systematically important banks. Economic relevance is computed as coefficients multiplied by 1 standard deviation of each variable (averaged across banks). Variables shown are chosen using the general-to-specific selection method, which starts with a general regression model and narrows it down to a model with only significant variables.

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Analysing the best internal mechanism for managing new liquidity requirementsSECTION 2

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Overview of New Basel III Operational Elements

Increasing quality, consistency and

transparency of the capital base; increas-

ing Tier 1 Capital, harmonizing Tier 2

Capital instruments, and eliminating Tier

3 Capital instruments

Raising capital re-quirements (trading book, complex secu-ritizations); capital

for counterparty credit risk; capital charges for credit

valuation adjustment (CVA); and establish-

ing standards for central counterpar-ties (CCPs) and col-lateral management

Introducing Leverage Ratio to new risk-based Basel framework

Introducing counter-cyclical buffer and

capital conservation buffer; addressing systemic risk (and

interconnectedness); and promoting for-ward looking provi-

sioning and dampen-ing cyclicality pa-

rameters

Introducing LCR and NSFR, and a new

common set of moni-toring tools

(Accenture 2011, p.2)

Regulatory Capi-talRisk CoverageLeverage RatioProcylicalityLiquidity Standards

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Responses to Managing Basel III: (KPMG, 2011) “Stronger banks with a higher NSFR will be able to influence market pricing of assets. Weaker banks will see their competitiveness reduced, which will potentially decrease the level of competition” (KPMG 2011, p.11).

• Banks need to consider improving their performance of current internal assessment methodologies – credit risk (ratings-based) and market risk (models).

• Banks need to consider reorganising legal entities in order to optimise the impact of capital deductions.

• Banks need to consider increasing active balance sheet management and hedging strategies.

• Banks need to consider redesigning business models and reviewing portfolio strategies.

• Banks will very likely have to increase proportion of wholesale/corporate deposits (maturities >1 year), due to continuing limited market demand.

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Responses to Managing Basel III: (Accenture, 2011)For the NSFR banks must consider whether: (1) they must increase HQLA; (2) obtain more long-term stable sources of funding; and (3) improve liquidity risk management systems.

1. Operational Responses

• Banks need to consider (1) processes; (2) methods; and (3) data.

• e.g. improve liquidity risk management (i.e. stress testing, contingency funding plans); closer integration of risk and finance functions; reducing credit exposure (i.e. limits, credit approval processes); RWA optimization; and subsidiary integration through group-wide risk and capital management standards.

2. Tactical Responses

• Banks need to consider (1) pricing; (2) funding; and (3) asset restructuring.

• e.g. increasing HQLA levels; changing funding mix and liquidity reserves to long-term debt and extending maturity of deposits; reducing total exposure (risk and profitability); shifting to higher-value clients or less risky portfolio segments.

3. Strategic Reponses

• Banks need to consider (1) business model; (2) group organisation; and (3) equity.

• e.g. more active balance sheet management; issuing new capital; more active client management (e.g. segmentation); strategic cost reductions; changing business model or group structure; changing liquidity risk and funding strategies.

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Responses to Managing Basel III: (McKinsey, 2010)

• Improve capital efficiency

• Identify and ameliorate subpar liquidity and funding management

No-regret moves

• Capital quality and deductions

• Balance-sheet management

• Reduced long-term funding costs

Balance-sheet

restructuring

• Product design/mix

• Customer mix• Geographical mix• Risk transfer• Cost and pricing

Business-model

adjustments

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Financial Conduct Authority (“FCA”)‘Liquidity Standards’• BIPRU 12.3 (Liquidity Risk Management)

• A firm must have in place robust strategies, policies, processes and systems that enable it to identify, measure, manage and monitor liquidity risk over an appropriate set of time horizons, including intra-day, so as to ensure that it maintains adequate levels of liquidity buffers. These strategies, policies, processes and systems must be tailored to business lines, currencies, branches and legal entities and must include adequate allocation mechanisms of liquidity costs, benefits and risks [12.3.4 R].

• The strategies, policies, processes and systems referred to in [12.3.4 R] should include those which enable it to assess and maintain on an ongoing basis the amounts, types and distribution of liquidity resources that it considers adequate to cover: (1) the nature and level of the liquidity risk to which it is or might be exposed; (2) the risk that the firm cannot meet its liabilities as they fall due [12.3.4A G].

• A firm must, taking into account the nature, scale and complexity of its activities, have liquidity risk profiles that are consistent with and not in excess of those required for a well-functioning and robust system.

• In complying with [12.3.4 R], a firm must ensure that it has access to funding which is adequately diversified, both as to source and tenor [12.3.29 R].

• In relation to all significant business activities, a firm should ensure that it accurately quantifies liquidity costs, benefits and risks and fully incorporates them into: (a) product pricing; (b) performance measurement and incentives; and (c) the approval process for new products [12.3.4A G].

• A firm should ensure that liquidity costs, benefits and risks are clearly and transparently attributed to business lines and are understood by business line management.

[Prudential sourcebook for Banks, Building Societies and Investment Firms (“BIPRU”), Chapter 12]

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Internal Mechanisms for Managing New Liquidity Requirements

• Ideal basic solution for smaller BFIs that are limited in size or distribution, or have a narrow range of products in their portfolios or balance sheets, and have already achieved 100% (or more) compliance with LCR and NSFR ratios. Automated solutions are able to adjust existing financial reporting software or systems.

(1) Manual/Automated LCR/NSFR Reporting

• An installed and integrated LCR forecasting and reporting software solution, but without NSFR capabilities. This may reflect the situation in many banks and financial situations which are awaiting finalisation of the Basel III NSFR rules.(2) LCR Software (Reporting/Steering)

• An fully installed and integrated LCR and NSFR forecasting and reporting software solution. This will allow banks and financial institutions to start adjusting LTSF strategies now, and allowing them to ‘fine tune’ settings with the finalised Basel III NSFR rules.

(3) LCR/NSFR Software (Reporting/Steering)

• Many banks and financial institutions may have developed pooled or MM FTP systems, but have not yet integrated LCR and/or NSFR reporting and steering functions. These functions may be currently undertaken separately, either manually or automatically.

(4) Separate FTP and LCR/NSFR Reporting/Steering

• This solution has managed to integrate FTP and LTP systems, but is still utilising separate LCR and/or NSFR reporting and/or steering functions, which may be undertaking manually or automatically.

(5) FTP/LTP and LCR/NSFR Reporting/Steering

• This solution has managed to fully integrate LTP systems into FTP systems in a centralised way, and has also fully integrated LCR and NSFR reporting and steering functions, allowing banks to undertake LCR/NSFR optimisation strategies whilst considering comparative transfer prices.

(6) Fully Integrated FTP/LTP/LCR/NSFR Solution

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Manual/Automated Basel III (LCR/NSFR) Reporting

• Discuss Basel III Monitoring Reporting Template (Version 2.6.1) (Bank of Luxembourg) – separate Microsoft Excel sheet.

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A Select Review of Existing Software Applications

No.

Software Application(s) Abbrev. Provider Abbrev.

1 Financial Services Funds Transfer Pricing Financial Services Liquidity Risk Management

FSFTPFSLRM

Oracle Financial Services Oracle

2 ABACUS/LiMa ABACUS/LiMa

Bearing Point Software Solutions

BESS

3 EPM Funds Transfer Pricing EPMFTP Axiom EPM® Axiom

4 Transfer Price ManagerLiquidity Manager

MORS TPMMORS LM

MORS Software MORS

5 RiskConfidence™

Liquidity Risk Management and Compliance

RCLRMC

Moody’s Analytics Moody’s

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Oracle FSFTP, FSLRM: Company OfferingOracle FSFTP

• Uses Matched Maturity (“MM”) FTP to enable accurate assessment of profitability along product, channel, and business lines.

• Centralises IRR, and calculates option costs, e.g. prepayments, impact of rate caps and floors, early redemption on deposits.

• Fully integrated with Oracle’s Financial Services Analytical Applications (shares common customer account level data model) allowing accurate central control of pricing and profitability.

• Provides 9 stochastic techniques:

• (1) Monte Carlo (pseudo-random numbers); (2) Monte Carlo (low discrepancy sequences); (3) Ho and Lee (TS); (4) Merton (TS); (5) Vasicek (TS); (6) Extended Vasicek (TS); (7) Straight Line; (8) Cubic Spline; and (9) Quartic Spline.

• Provides 12 transfer pricing methods:

• (1) Cash Flow Weighted Term; (2) Cash Flow Zero Discount factor; (3) Cash Flow Duration; (4) Cash Flow Average Life; (5) Caterpillar; (6) Moving Average; (7) Spread from Interest Rate Code; (8) Spread from Note Rate; (9) Straight Term; (10) Redemption Curve; (11) Weighted Average; (12) Unpriced Account.

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Oracle FSFTP, FSLRM: Company OfferingOracle FSLRM

• Can estimate a bank’s liquidity under normal and stressed business conditions; can identify and manage liquidity threats by comparing liquidity gaps (under baseline assumptions and stress conditions); and can focus on countering liquidity hotspots.

• Can define business assumptions based on multiple dimensions allowing banks to specify business-as-usual (“BAU”) conditions (e.g. rollovers, run-offs, prepayments, asset value changes or book growth, recoveries from delinquent accounts) at any required level of granularity (contractual cash flows affected by absolute values or percentages).

• Can estimate LCR and NSFR ratios based on Basel III guidelines based on pre-specified parameters such as liquidity horizon, liquidity haircuts, and funding factors.

• Can be used to specify and assign liquidity haircuts, available and required funding factors, and can estimate the LCR and funding concentrations for each significant currency, product, and counterparty.

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Oracle FSFTP, FSLRM: Company OfferingLCR and NSFR and components are reported in line with Basel III requirements.

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Oracle FSFTP, FSLRM: Company OfferingDetailed Bucket-Wise Gap report providing a multi-dimensional view of liquidity gaps including currency, product, line of business, customer type, etc.

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Oracle FSFTP, FSLRM: Company OfferingDetailed liquidity Gap Report after applying counterbalancing strategies to bridge liquidity gaps.

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Advantages• Oracle FSFTP and FSLRM seamlessly

integrate data, analytics, business rules, hierarchies, and reporting, to allow superior risk, performance and strategic management, customer insight, and compliance.

• Oracle FSFTP and FSLRM can be integrated at a very core level owing to the common/shared data model (including shared dimension attributes).

• Oracle FSFTP’s core strengths are scalability, ability to accept data from any source, trustworthy results, multidimensional reporting, and sophisticated analysis capabilities.

• Oracle FSLRM is also designed to work with Asset Liability Management systems already used by leading global institutions (including Oracle Financial Services Asset Liability Management).

• Oracle FSLRM provides clarity on liquidity positions, and allows BFIs to develop contingency funding plans that are tailor-made to manage liquidity hotspots.

Disadvantages

• Oracle FSFTP is sophisticated, advanced, and complex, and with a huge variety of transfer pricing methods, add-on rates, and stochastic methods for calculating option costs such as Monte Carlo, Merton, and Cubic Spline, extensive training and support may initially be required in both pre-installation and post-installation phases.

• Oracle FSFTP and FSLRM are some of the most advanced systems on the market, so they are priced accordingly at the higher end of relevant FTP and liquidity management software solutions currently available.

• Oracle systems are often found in larger Tier 1 banking frameworks, and therefore design and installation time frames for these types of systems are typically much longer.

Oracle FSFTP, FSLRM: Evaluation

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BESS Abacus LiMa: Company OfferingBackground, Functionalities and Key Benefits

• BESS are a very well established company, which holds over 65% of the German market (i.e. banks and financial institutions) for legal reporting software, and are expanding to other international markets (i.e. Luxembourg, Romania, Sweden, and the United Kingdom).

• BESS have significant market operational experience, and prime examples of LCR/LiMa working partnerships include ‘Commerzbank AG’ and the National Bank of Romania (LCR/NSFR data gathering).

• BESS Abacus LiMa users can interconnect regulatory and business requirements, and can take profit and loss effects (plus effects on RWA) into account.

• BESS Abacus LiMa offers a centralised data repository for legal reporting and economic steering based on the same interface.

• Data is presented via a cockpit in a management-oriented form. The system enables the regulatory as well as the economic examination of the liquidity risk on the basis of a standardised and consistent database.

• Optimization of LCR (including different regulatory caps/limits) possible, as well as simulation of cash flows and single positions such as high liquid assets.

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BESS Abacus LiMa: Company OfferingOnline Simulation -

Overview

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BESS Abacus LiMa: Company Offering

LCR Forecast

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BESS Abacus LiMa: Company Offering

User Interface

LCR 20-Days Forecast Simulation

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Advantages

• ABACUS/DaVinci product can be used to provide high quality data for international and national reporting (e.g. CoRep, FinRep, Large Exposures, Statistical Reporting, Leverage Ratio, LCR, NSFR).

• ABACUS/LiMa product can currently be used for LCR forecasting and steering purposes, e.g. with graphical charts produced for Single Deal and Portfolio Simulation (single transactions or aggregated data).

• ABACUS/LiMa product enhancements planned for 2015 (Collateral Swap Simulation, Reporting Engine, GUI Manager, and Backtesting Tools).

• ABACUS/LiMa used in conjunction with ABACUS/Da Vinci is an ideal software solution platform for banks and financial institutions that do not believe implementing a full FTP system would be cost-effective, but wish to have a near-comprehensive Basel III and LCR reporting, forecasting, and steering solution.

Disadvantages

• BESS do not currently offer a completely integrated FTP and liquidity management solution, BESS only focus on liquidity management and reporting, not FTP.

• ABACUS/LiMa product does not currently offer NSFR simulation capabilities. BESS are waiting for the Basel III NSFR requirements to be finalised, and they also note that German financial institutions currently prefer to deal with the NSFR through business modelling, rather than NSFR scenario analysis.

• ABACUS/LiMa product does not currently offer cash flow simulation with deterministic or stochastic flows, but these developments are listed as future development opportunities.

• Software operating literature is not comprehensively offered in English language translations yet.

BESS Abacus LiMa: Evaluation

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Axiom EMPFTP: Company Offering• Axiom’s EPMFTP calculates accurate FTP rates to view the value created by funds users,

funds providers and interest rate risk managers, with detailed and granular analysis, and the ability to apply external cost factors.

• Axiom’s EPMFTP utilises projected MM cash flows (at origination) to produce highly accurate FTP rates at the customer level; the system calculates time and balance-weighted transfer funding rates for each cash flow strip.

• Axiom’s EPMFTP can:

• price the balance sheet;

• produce a range of analytical reports and processes (accessed via a finance-friendly Microsoft Excel® interface);

• drill down and analyse information by organisation, product, or officer;

• undertake incremental analysis which facilitates segmentation analysis at the product portfolio levels and by origination month; and

• produce rate volume reports (i.e. detail spread income into days, spread, volume) and funding centre reports (net profit and loss for all assets and crediting all liabilities).

• Axiom’s EPMFTP aims to provide analytical richness through the incorporating more detailed analysis of margin results (e.g. credit score, risk rating, officer code, zip code, collateral code), and other analysis options (e.g. segmentation, ranking, charting, drill through and derived calculations such as weighted averages).

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Axiom EMPFTP: Company Offering

End-to-end integrated tools to facilitate balance sheet monitoring and planning, and align incentives with planning.

Axiom’s EPMFTP multilayered dashboards provide banks and financial institutions with a rich data repository from which to draw financial, operational, or risk information.

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Axiom EMPFTP: Company Offering

Historical Performance (PP1-x)Analysis of a banking officer’s historical pricing trends by product for any designated year, can be compared to the overall bank’s FTP spread for the same product.

Prospective Performance (FP1-x) Analysis of the principal runoff of the current portfolio for any product and any officer, which can assist in the budgeting process, i.e. determining new volumes and rates needed to meet targets.

Current Performance (T0) Facilitates analysis of pricing decision by ranking of loan officers by volume origination over x period, and by average FTP Spread and net income effect (balance x spread) booked for volumes.

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Axiom EMPFTP: Company Offering

• Axiom EMPFTP offers mobile dashboards which crucially make critical performance information available anywhere at any time.

• Axiom EMPFTP mobile dashboards are available on all major operating platforms, including tablets (e.g. Apple iPad) and smartphones (e.g. Apple iPhone and Android BlackBerry).

• Axiom notes that end users can interact with dashboards, spot trends, conduct ad hoc analysis and make timely, informed decisions regardless of location, based on rich and highly customizable performance data.

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Advantages

• Axiom EPM offers an integrated financial planning and decision support platform for banks and financial institutions, providing them with sophisticated planning, report and strategic decision making tools and functions.

• Axiom EPMFTP offers both precision in calculating FTP rates and deep and insightful analytical reporting options, which leads to better pricing decision overall.

• Axiom EPMFTP offers three time perspectives (i.e. historical performance, current performance, prospective performance) for a more holistic view, facilitating analysis of pricing consistency over time, as well as helping understand the impact of maturing spreads on portfolio performance.

• Axiom financial software solutions offer rich and robust enterprise dashboards from which banks and financial institutions can visualise and manage data and components.

Disadvantages

• Axiom EMP does not currently offer comprehensively integrated LTP and LCR/NSFR calculation, forecasting, and reporting solutions.

• Integrating Axiom EPMFTP software solutions with other LCR/NSFR software solutions may require significant planning and customisation.

• The comprehensive nature of Axiom EMPFTP’s FTP analysis means that the software packages will require significant and comprehensive training in order to be able to get the most out of FTP analytics, e.g. including and calculating the impact of the time dimension.

Axiom EPMFTP: Evaluation

1.5

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MORS TPM and LM: Company Offering• MORS TPM and MORS LM can be used in conjunction with each other and with other

software offerings, such as MORS ‘Balance Sheet Manager’, for 3600 strategic management evaluation of e current and future FTP and liquidity situation.

• MORS TPM is transparent, agile, and informative, and can cover all cost layers (i.e. CLC, term liquidity/funding premium, basis/hedging costs, base rate).

• MORS TPM pricing is based on an infinite amount of user-defined curves; with CLC included (e.g. Liquidity buffer cost); complete drill-down and monitoring of FTP transactional effects; and dynamic alteration of FTP levels for any product, business line, client segment.

• MORS LM combines internal liquidity metrics and scenarios with Basel III LCR regulatory requirements, which allows identification of funding gap, funding mismatch, concentration risk, and stress testing for monitoring, forecasting, and steering purposes.

• MORS LM allows for liquidity buffer management (unencumbered, encumbered), OBS contingent exposure follow-up and cash flow monitoring (net, gross) by counterparty (intra-day liquidity).

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MORS TPM and LM: Evaluation (cont)

MORS is Different

It offers multi-dimensional, real-time, drill down capabilities, in order to facilitate balance sheet forecasting, steering and optimisation – the result is customer profitability.

Example of MORS Transfer Pricing Calculator

0.5

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MORS TPM and LM: Company Offering

Example of MORS

LCR Breakdo

wn

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MORS TPM and LM: Company Offering

Example of MORS

LCR Liquidity Scenario Cashflow Details

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MORS TPM and LM: Company Offering

Example of MORS NSFR Balance Sheet Scenario Set-up0.5

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MORS TPM and LM: Company Offering

Example of MORS NSFR Balance Sheet Scenario Totals/Ratio

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MORS TPM and LM: Company Offering

MORS Scenario Analysis Tools

0.5

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MORS TPM and LM: Evaluation

Advantages• MORS has decades of experience in developing and

refining market leading middle office and front office integrated software functions.

• MORS offers a comprehensive range of fully integrated treasury and risk management solutions, i.e. TPM, LM, Trading Book, Balance Sheet Manager, Treasury Front & Middle, and Multi Site Manager.

• MORS TPM and LM offer real-time FTP and liquidity monitoring capabilities which can be dynamically interfaced with the majority of financial data providers such as Reuters and Bloomberg.

• MORS TPM liquidity costs can be determined based on maturity , rate bases, currency, business unit, counterparty type, product or any other classification criteria in order to provide an efficient steering tool.

• MORS LM allow LCR forecasting, steering, and optimisation with Basel III metrics, or other RWA settings or haircuts available through the application of different rule mapping profiles.

Disadavantages• MORS software has a very high dominance in the

Nordic banking markets (e.g. Stockholm, Copenhagen, Oslo, Helsinki) and has extended across Europe (e.g. Warsaw), but has yet to reach high market shares in global markets (e.g. New York, Moscow, Singapore, Hong Kong, Shanghai).

• MORS software solutions have been primarily installed across a large number of Tier 2 banks, so MORS has yet to compete on a global level for installation within Tier 1 banks.

• MORS software solutions are generally installed in a short-time frame as they traditionally rely on interfacing existing data connections. Therefore building completely new FTP, liquidity and risk management systems may require longer installation and post-installation timeframes.

• MORS software solutions have been designed to work most efficiently as a comprehensive set of treasury and risk management solutions, so may possibly not work as effectively when integrated with other custom-built software applications.

1

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Moody’s LRMC and RC: Company OfferingMoody’s LRMC and RC

• Moody’s LRMC enables the quantification of liquidity risk and management of stress-testing capabilities, e.g. quantification of sources and uses of funds, developing cashflow-based liquidity metrics, and centralising liquidity inputs such as capital market and origination data.

• Moody’s LRMC assesses daily cash flows; examines liquidity risk exposures; and monitors liquidity risk via dynamic dashboard which offers key customised management reports, i.e. LCR/NSFR, RWA, forecast income statement and balance sheet.

• Moody’s RC has multi-currency capacity; parameter deal mapping; balance sheet strategy capabilities; stress testing (e.g. scenario simulation, funding stress testing); and custom asset liability/FTP/liquidity management, e.g. funding and behavioural models, and contingent liquidity and buffers.

• Moody’s offers comprehensive enterprise risk management via its ‘Liquidity Risk Solution Family’, which includes RiskConfidence ™(IRR, FTP), RiskAuthority™(regulatory capital), Scenario Analyzer (stress testing models), and Regulatory Reporting Module (regulatory reports), RiskFoundation™ (optimized platform).

1

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Moody’s LRMC and RC: Company Offering

Ability to define transfer price settings at the account or Parameter Deal Mapping levels. MM FTP calculations performed at instrument level (including deal level adjustments to base transfer pricing curve).

1

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Advantages

• Moody’s LRMC facilitates the calculation of LCR and NSFR and all the relevant risk indicators need for populating Basel III Pillar 1 and 3 risk reports.

• Moody’s LRMC allows banks to manage multi-jurisdictional liquidity regulatory requirements for over 50 jurisdictional supervisors.

• Moody’s LRMC facilitates centralised liquidity risk management; advanced cash flow deposit modelling (non-maturing deposits); high performance grid computing; and comprehensive advisory services.

• Moody’s RC manages liquidity risk (LCR, NSFR, and liquidity gaps and buffers); allows liquidity modelling; computes net interest income and economic value of equity; defines multi-factor behaviour models; and integrates and managers maturity-matched FTP capabilities.

Disadvantages

• Moody’s LRMC and RC offer top-of-the-line operating software so will be priced at the top-end of the relevant software vendor purchase and installation costs.

• Moody’s LRMC and RC offer a wide array of complex computational and analysis tools which may require a lot of initial training and installation and post-installation support.

• Moody’s LRMC and RC architecture may need significant IT and change management planning, so may have prolonged installation and testing phases.

• Moody’s Liquidity Risk Solution Family has been specifically designed to function as a comprehensive and modular solution, so may not work as seamlessly integrated with other IT architecture.

Moody’s LRMC and RC: Evaluation

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THE END

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Appendix: Basel III and Liquidity Guiding Principles

• Basel Committee on Banking Supervision, Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools, (January, 2013) Bank for International Settlements.

• Basel Committee on Banking Supervision, Consultative Document Basel III: The Net Stable Funding Ratio, (February, 2014) Bank for International Settlements.

• Basel Committee on Banking Supervision, Instructions for Basel III Monitoring, (25 March, 2014) Bank for International Settlements.

• Basel Committee on Banking Supervision, Principles for Sound Liquidity Risk Management and Supervision, (September, 2008) Bank for International Settlements.

• Committee of European Banking Supervisors (CEBS), Guidelines on Liquidity Cost Benefit Allocation, (27 October, 2010).

• Financial Services Authority, Strengthening liquidity standards, Policy Statement 09/16, (October, 2009).

• Financial Stability Institute, Liquidity transfer pricing: a guide to better practice, (Occasional Paper No 10). (December 2011). Financial Stability institute, Bank for International Settlements, by JoelGrant (Australian Prudential Regulation Authority).

• Moody's Analytics, Eleven Best Practice Principles for Implementing High-Value FTP Systems, (September, 2011).

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References: (1)

• Accenture (2011). Basel III and Its Consequences: Confronting a New Regulatory Environment. Accenture Management Consulting, by Michael Auer, (Executive Principal, Accenture Risk Management, Munich), Georg von Pfoestl (Manager, Accenture Risk Management, Vienna), and Jacek Kochanowicz (Manager, Accenture Risk Management, Frankfurt).

• Axiom EPM (2012). Extracting More Value from Funds Transfer Pricing. (April). White Paper.

• BCBS (2010). Results of the comprehensive quantitative impact study. (December). Basel Committee on Banking Supervision, Bank for International Settlements.

• BCBS (2013). Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools. (January). Basel Committee on Banking Supervision, Bank for International Settlements.

• BCBS (2014). Basel III: The Net Stable Funding Ratio. (January). Basel Committee on Banking Supervision, Bank for International Settlements.

• Becker, L. (2014). Repo desks up in arms about NSFR. (7 April), Risk magazine.

• CEBS (2010). Results of the comprehensive quantitative impact study. (16 December). Committee of European Banking Supervisors.

• Devasabai, K. (2014). Hedge funds face higher prime broker charges under Basel III. (18 June). Risk Magazine.

• Farooqui, S. (2011). Development of Simulation based Model to quantify the degree of Bank’s Liquidity Risk. 2011 ERM Symposium (14-16 March), Swissôtel Chicago, Chicago, IL.

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References: (2)• Felder, R. and Mahlknecht, M. (2013). Basel III: Solving the Liquidity Business Challenge. (April). Capco Journal 37:

Cass-Capco Institute Paper Series on Risk, pp.76-94.

• FSI (2011). Liquidity transfer pricing: a guide to better practice (Occasional Paper No 10). (December). Financial Stability institute, Bank for International Settlements, by JoelGrant (Australian Prudential Regulation Authority).

• IMF (2013). Changes in Bank Funding Patterns and Financial Stability Risks, In Global Financial Stability Report: Transition Challenges to Stability, pp.105-148. (October), International Monetary Fund.

• IMF (2014). The Net Stable Funding Ratio: Impact and Issues for Consideration. IMF Working Paper, (WP/14/106) by Jeanne Gobat, Mamoru Yanase, and Joseph Maloney (This Working Paper should not be reported as representing the views of the IMF).

• King, M.R. (2013). The Basel III Net Stable Funding Ratio and bank net interest margins. Journal of Banking & Finance, 37, pp.4144-4156.

• Kratky, A. (2012). Incorporating Liquidity Risk into Funds Transfer Pricing: Progress and Challenges. Commerzbank (Group Treasury – Liquidity Analytics), presentation for the Professional Risk Managers’ International Association.

• Leon, C. (2012). Estimating the intraday liquidity risk of financial institutions: a Monte Carlo simulation approach. (27 September 2012), Journal of Financial Market Infrastructures.

• Linklaters (2011). Basel III and project finance. (July), Briefing by Matthew Worth and Edward Chan, as published in Project Finance International, 29 June 2011, Issue 460.

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References: (3)• Matz, L. (2011). Liquidity Risk Measurement and Management. Xlibris Corporation.

• McKinsey (2010). Basel III and European banking: Its impact, how banks might respond, and the challenges of implementation. (November), McKinsey Working Papers on Risk, Number 26, McKinsey & Company, by Philipp Härle, Erik Lüders, Theo Pepanides, Sonja Pfetsch, Thomas Poppensieker, and Uwe Stegemann.

• Moody’s Analytics (2011). Implementing High Value Funds Transfer Pricing Systems. (September) Modeling Methodology by Robert J. Wyle, CFA and Yaakov Tsaig, Ph.D.

• Moody’s Analytics (2013). Liquidity Risk Management is a Game Changer. (December) Research /Whitepaper by Cayetano Gea-Carrasco (Stress Testing, Balance Sheet Management, and Liquidity Practice Leader) and David Little (Managing Director, Head of the US Enterprise Risk Solutions and Sales Team).

• Oracle Financial Services (2011). Oracle Financial Services Liquidity Risk Management. Oracle Data Sheet.

• Pokutta, S. and Schmaltz, C. (2012). Optimal Bank Planning Under Basel III Regulations. Capco Journal of Financial Transformation, Journal 34, pp.165-174.

• PwC (2014). Stretched to the limit: Dealing with the implications of the NSFR (Basel III breakfast briefing series). PricewaterhouseCoopers LLP.

• SSG (2009). Risk Management Lessons from the Global Banking Crisis of 2008. (21 October). Senior Supervisors Group.

• Taylor, S. (2011). Unlocking Liquidity Premiums. (April) Novantas Review, pp.1-4.

• Watt, M. (2012). Basel III blamed for aircraft financing drought. (9 May), Risk magazine.

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Presentation InformationDECLARATION OF CONFLICTING INTERESTSThe author declares that to the best of his knowledge he has no potential conflicts of interest with respect to the research or authorship of this presentation.

ABOUT THE PRESENTER Rodrigo Zepeda is an independent consultant who specialises in derivatives and financial services law, regulation, and compliance. He holds a LLM Masters degree in International and Comparative Business Law, has been an Associate of the Chartered Institute for Securities and Investment since 2004, and has passed the New York Bar Examination. He has also published widely in leading industry journals such as the Capco Institute’s Journal of Financial Transformation, the Journal of International Banking Law and Regulation, as well as e-books on derivatives law. Noted publications include “Optimizing Risk Allocation for CCPs under the European Market Infrastructure Regulation”; “The ISDA Master Agreement 2012: A Missed Opportunity”; “The ISDA Master Agreement: The Derivatives Risk Management Tool of the 21st Century?”; and “To EU, or not to EU: that is the AIFMD question”.

CONTACT DETAILS Email: rodrigo@zepeda.co.ukLinkedIn: http://www.linkedin.com/in/rodrigozepedaMobile: UK + (0)7592457373

NSFR LIQUIDITY FRAMEWORK:

Practical Implementation Requirements

IMPLEMENTATION REQUIREMENTS TO ADAPT TO NEW NSFR LIQUIDITY PARAMETERS

WORKSHOP

4 th AnnualPractical Funds Transfer Pricing and Balance Sheet Management Forum17 th September 2014, London, UK

Rodrigo ZepedaIndependent Consultant