liquidity risk – regulatory framework london, 8 th august 2006 vincent baritsch wholesale and...
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Liquidity Risk – Regulatory Framework
London, 8th August 2006
Vincent Baritsch Wholesale and Prudential Policy Division
UK Financial Services Authority
Overview• Current FSA regimes
– Qualitative
– Quantitative
• Problems
• FSA ideas for change and DP24
• International developments
• Challenges
Liquidity Risk – Regulatory Issues
Stress testing and contingency funding plans – SYSC 11 applying to all CRD firms
• New requirements in force since end-2004, amended for CRD
• Apply to deposit-takers, insurers, all BIPRU investment firms
• A firm must carry out stress tests and scenario analyses for liquidity risk …
• … and must estimate the resources it would need in each of the scenarios considered
• Depends on “nature, scale, and complexity” of a firm’s business
• Considerations for branches and subsidiaries
Liquidity Risk – Regulatory Issues
GENPRU 1.2 – Adequacy of financial resources
• Applies to all BIPRU firms
• Maintain adequate liquidity resources to cover all liabilities, including contingent and prospective liabilities
• Realistic valuation methodologies
• Stress testing and CPF’s
• Manage major sources or risks, including liquidity risk
• Document risk assessments
Liquidity Risk – Regulatory Issues
Deposit-takers
• Deposit-takers must maintain a policy statement on liquidity management
– Should cover both normal and crisis management
– Should include details of the bank’s contingency funding plan
Liquidity Risk – Regulatory Issues
Existing FSA quantitative banking regimes
(1) ‘Sterling stock’ regime for major retail banks
(2) Maturity mismatch approach for other banks
Liquidity Risk – Regulatory Issues
Existing regimes: sterling stock • Five working day survival period
• Assumes no renewal of wholesale funding, outflow of 5% of retail deposits
• Covers sterling cash flows only
• Net outflows must be covered 100% by a stock of high-quality liquid assets
– defined as those eligible in Bank of England Open Market Operations
• Some allowance for holdings of other banks’ CDs
• Additionally, agreed floor for the stock (£ amount, not ratio) – ‘belt and braces’
• Consolidated reporting
Liquidity Risk – Regulatory Issues
Existing regimes: mismatch (1)• Applies to UK banks (solo) including all overseas
branches, and to UK branches of overseas banks
• Contractual cash flows (worst case) allocated to maturity bands
• Mismatch ratio for each time band calculated as net cash flow / total deposits
• Individual limits set on cumulative mismatch ratios out to 1 week and 1 month
• Quarterly reporting but daily requirement – breaches to be notified to FSA immediately
Liquidity Risk – Regulatory Issues
Existing regimes: mismatch (2)• Marketable assets assumed to deliver cash inflows on
sale/ repo rather than maturity
– Normally within the 1 week time band
– Minimum criteria include – • Prices regularly quoted• Asset regularly traded• Can be sold or repo’d on an exchange or in a deep and liquid
market for cash
– Subject to a range of discounts according to volatility, eg • 0 – 10% for Zone A central government debt• 5 – 15% for ‘qualifying’ Zone A non-government debt• 20% for equities listed on a recognised exchange• 20 – 50% for certain Zone B securities
Liquidity Risk – Regulatory Issues
Existing regimes: mismatch (3)
• FSA can agree ‘behavioural adjustments’ on some cash flows. Eg -
– reduces outflow on undrawn credit card commitments from 100% to 75%
– inflow allowed of 90% of committed lines received
• ‘Global liquidity concessions’ possible for overseas branches
– FSA to be satisfied with home country liquidity supervision
– Branch integrated with head office
– Home supervisor happy with the arrangement
Liquidity Risk – Regulatory Issues
Investment Firms regimes
• Illiquid assets either deducted from capital, or 8% charge (on top of market risk charges) + liquidity adjustments
• Aim is to promote orderly winding down in a crisis by ensuring sufficient liquid resources are available
Liquidity Risk – Regulatory Issues
Problems with the Sterling Stock regime
• Focus is on the immediate, first week period;
• No general requirements in relation to the non-sterling parts of firms' business;
• Relatively limited set of assets qualifying as part of the stock and has some undesirable behavioural and market-structural consequences; and
• Double duty of regulatory stock of sterling liquid assets with intra-day collateral needs for payment systems
Liquidity Risk – Regulatory Issues
Problems with the Mismatch regime
• Increasingly divergent from banks LRM;
• Discount factors and hair cuts applied to instruments are based on limited criteria;
• Is not tailored for different kinds of firm; and
• Marketable assets allowed are based on potentially outdated material.
Liquidity Risk – Regulatory Issues
Problems with investment firms regime
• Illiquid asset regime / liquidity adjustment relatively penal and not risk sensitive
• For many firms changes resulting from CRD may mean no effective liquidity buffers, except those from P2
• Unlevel playing field
Liquidity Risk – Regulatory Issues
FSA ideas for change
• FSA Discussion Paper 24 – October 2003
• DP, ie ‘greener’ than a Consultation Paper
• To be part of FSA’s integrated prudential sourcebook
– FSA as the single regulator
• All firms with significant liquidity risk – and all areas of business giving rise to risk
• Shortcomings in predecessor regimes
Liquidity Risk – Regulatory Issues
DP24 – main principles
• Maturity ladder with stressed cash flows
• Stress factors to approximate stress behaviour
• Limits on 1 week and 1 month gaps
• Normally solo, but recognition of groups
Liquidity Risk – Regulatory Issues
DP24 – main principles (2)
• Scope for some firms to use own approaches
• Embedded “Core Marketable Assets Requirement”
• No more “double duty”
Liquidity Risk – Regulatory Issues
DP24 Feedback
Generally agreed with –
• Need for reform
• Focus on cash flow mismatch
• Integrated approach
• Scope for group treatment
Liquidity Risk – Regulatory Issues
DP24 Feedback (2)
Concerns –
• Attempting a standard stress
• Including stress in quantitative approach
• Level of detail, degree of prescription
• Too little room for firms’ own approaches
Liquidity Risk – Regulatory Issues
DP24 Feedback (3)
More concerns – • Insufficient allowance for group-wide
management of liquidity risk
– Firms don’t like solo requirements within ILGs
– Does not fit well with central liquidity management – “trapped pockets of liquidity”
– Problem of standardising intra-group flows
Liquidity Risk – Regulatory Issues
DP24 Feedback (4)
Yet more concerns -
• Requirement for core marketable assets
• Impact of ending double duty
• Investment firms unhappy –
– too banking-oriented
– and not flexible enough
Liquidity Risk – Regulatory Issues
DP24 Feedback (5)
Other concerns –• Treatment of marketable assets• “Continuation of business”
– Some don’t like whole concept– Many concerns about debt buyback assumptions– Should not assume new wholesale placements
• Concerns about currency treatment
Liquidity Risk – Regulatory Issues
After DP24 – where next?
• Wait and see what international work brings
• Why do we need a Pillar 1 approach?
• Pillar 2 and/ or Pillar 3?
Liquidity Risk – Regulatory Issues
International context• Qualitative
– Basel Committee paper on sound practices for managing liquidity in banks (2000)
– IOSCO - Sound Practices for the Management of Liquidity Risk at Securities Firms 2002-
– IAIS – Guidance Paper on Investment Risk Management, 2004
– CRD (Capital Requirements Directive) Annex V to be implemented across the EEA
• Quantitative – no agreed international standard
Liquidity Risk – Regulatory Issues
International developments
• Joint Forum Working Group on Risk Assessment and Capital
– Looking at how firms manage the funding of liquidity risk and how it is regulated
– Stage 1 (2004) drew on regulators’ existing knowledge
– Stage 2 (2005) filled in gaps in knowledge with a detailed questionnaire for firms
– Range of Practices Paper published on the 3rd May 2006 http://www.bis.org/publ/joint16.pdf
Liquidity Risk – Regulatory Issues
Joint Forum results (1)
• Diversity of approaches across sectors• Centralisation – range of practices
– Across entities/ countries/ sectors• Diversity of approaches within sector• Main sources of liquidity risk
– reliance on volatile or concentrated sources of funding
– rating triggers
Liquidity Risk – Regulatory Issues
Joint Forum results (2)• Stress testing
– Firm-specific vs. general
– How severe?
• Contingency funding plans
– Reliance on secured funding
• Impact of regulation
– Liquidity rules in each jurisdiction
– Limits on intra-group flows
Liquidity Risk – Regulatory Issues
The future
• Lessons from DP24
• Basel Committee
– International Standards?
• EU involvement
• Balance in a proportionate way –
– Efficiency of firms’ own approaches
– Benefits of harmonisation
– Prudential concerns
Liquidity Risk – Regulatory Issues
European work - WGBD
• Re-assess major groups LRM
• Focus on potential impact on financial stability and cross-border banking activities
• Report early 2007
Liquidity Risk – Regulatory Issues
International work – Basel Committee
• New WG
• Mandate:
– Analytical stock take
– Sharing of supervisory experience
• No presumption of new standards
Liquidity Risk – Regulatory Issues
Challenges for FSA
• Promote compatibility of international approaches
• Understanding of internal models and how they could be used
• Need for simple back stop?• Ensure sectoral comparability• Group implications• Pillar 2 / Pillar 3
Liquidity Risk – Regulatory Issues
Questions?
Tel: 020-7066-0526
Fax: 020-7066-0527
Liquidity Risk – Regulatory Issues
Existing regimes: other
Building societies
• Must hold ‘8 day liquidity’ > 3.5% of total share and deposit liabilities
• 8 day liquidity includes CDs, CP, bank deposits
• Limits on inter-society holdings
Liquidity Risk – Regulatory Issues
Bank of England reform of its operations in the Money Market
Overview
• Voluntary remunerated reserve scheme
• Standing facilities
Liquidity Risk – Regulatory Issues
Voluntary reserve scheme – LRM benefits
• Secure repository – Highly rated
• Liquidity buffer
• Double duty
Liquidity Risk – Regulatory Issues
Standing Facilities – LRM benefits
• Ability to borrow unlimited amounts against eligible collateral
• Major role in banks CFP’s
Liquidity Risk – Regulatory Issues
References
• Sterling stock and mismatch regimes – See Chapters LS and LM in
http://fsahandbook.info/FSA/html/handbook/IPRU-BANK
• Stress testing and CFPs– See sections GENPRU 1.2 and SYSC 11 in
http://www.fsa.gov.uk/pages/library/policy/cp/2006/06_13.shtml
Liquidity Risk – Regulatory Issues