Liquidity Risk Supervision of Large Banking Organizations Any - PowerPoint PPT Presentation

Liquidity Risk Supervision of Large Banking Organizations Any opinions expressed are the authors’ alone and do not October 28, 2014 necessarily reflect the views of the Federal Reserve Bank of Chicago or the Federal Reserve System

Topics  Reflecting (just a bit) on lessons learned from the crisis  Supervisory Response  Quantitative Liquidity Measures  LCR and NSFR  Interagency Policy Statement on Funding and Liquidity Risk Management  Liquidity requirements of Reg YY (DFA Section 165)  Reporting Requirements  2052 and LCR reporting  Horizontal Liquidity Reviews 2

Lessons Learned from the Crisis  Firms had a high reliance on short ‐ term wholesale funding  Firms did not fully capture all the liquidity risks in their portfolio and size them appropriately  Firms relied on contingency funding sources to meet liquidity outflows and did not have robust on ‐ balance sheet liquidity buffers  Firms overall contingency funding plans were not well articulated  Senior management and the board of directors were not well ‐ informed of overall liquidity risk 3

Supervisory Response  More differentiation, based on size and systemic footprint (and a focus on SIFIs)  More horizontal coordinated views and reviews  Expansion of purview beyond banks  Increased International Coordination  Introduction of standardized minimum quantitative liquidity requirements (for the first time) 4

Overview of select Liquidity Guidance and Rules  September 2008  Basel issued principles for Sound Liquidity Risk Management  March 2010  Interagency Policy Statement on Funding and Liquidity Risk Management  January 2013 Basel III  Liquidity Coverage Ratio  January 2014  BCBS NSFR Consultative Document  Feb 2014  DFA 165 Enhanced Liquidity Requirements  Sept 2014  U.S. LCR for largest, internationally ‐ active banking organizations  U.S. Modified LCR for BHCs above $50 billion but below internationally ‐ active 5

Quantitative Liquidity Standards  BCBS approved two liquidity rules for global banks in December 2010:  Liquidity Coverage Ratio (LCR) – 30 ‐ day horizon (effective 2015 ‐ 2019)  Requires firms to have a stock of high ‐ quality liquid assets that exceeds standardized net cash outflows over a 30 ‐ day stress period.  Net Stable Funding Ratio (NSFR) – one ‐ year horizon (effective in 2018)  NSFR is a longer term structural metric designed to ensure banks’ funding structures are appropriate relative to their asset and off ‐ balance sheet profile. 6

Scope of Application: U.S. LCR  US LCR rule  Applies to internationally active banking organizations, and non ‐ bank financial companies designated by the FSOC that do not have substantial insurance operations.  Generally includes BHCs and SLHCs with at least $250 billion in consolidated assets or $10 billion in foreign exposures, and their largest bank subsidiaries (>$10 billion in assets).  Less ‐ rigorous LCR (“Modified LCR”)  Applies to non ‐ internationally active BHCs and SLHCs (but not banks) that are subject to DFA 165.  Generally includes BHCs and SLHCs with at least $50 billion but less than $250 billion in consolidated assets.  Separately considering how best to tailor the liquidity requirements for companies not covered by this proposal (e.g. those with substantial insurance operations, and the IHCs of FBOs) 7

Rationale for Modified LCR  BHCs subject to Modified LCR are sufficiently large/ complex to be subject to a quantitative liquidity requirement promoting their liquidity resilience and allowing market participants and supervisors to better compare firms liquidity position  BHCs subject to Modified LCR face a less ‐ stringent liquidity requirement because:  Tend to be less complex due to smaller asset size and lower level of foreign activity  Activities are less systemic in nature than internationally active firms  Consistent with gradation requirement in DFA 165, and help mollify the “cliff” affect 8

Differences of Proposed Modified and Required LCR Required LCR Modified LCR • Applied to internationally active • Applied only to the consolidated banking organizations, and non ‐ BHC and not to the bank bank financial companies subsidiaries designated by the FSOC that do • non ‐ maturity outflow rates not have substantial insurance subject to a multiplier of 70% operations. • Net outflows and inflows would • Contractual outflows and inflows be calculated only at the end of recognized in the first 30 days the 30 day period and not on the • Full non ‐ maturity outflow rates peak maximum cumulative apply outflow date within the 30 day period • Net outflows and inflows calculated on the peak maximum cumulative outflow date within the 30 day period. 9

How U.S. LCR fits into Regulatory Framework Establishes a stress scenario  Assigns specific  Haircuts to assets  Runoff rates to liabilities  Draw rates to commitments  Calculates surplus/deficit So far so good, but . . . .  One scenario, one time frame, cannot reveal all liquidity vulnerabilities specific to a firm  Assumptions are standard, not tailored to the products and markets in which each institution is operating Not designed to be a risk management program  Regulatory compliance is necessary, but not sufficient  Can provide a useful framework from which to build/improve liquidity stress ‐ testing exercise 10

Interagency Policy Statement on Funding and Liquidity Risk Management (SR 10 ‐ 6)  Corporate Governance – board of directors and senior management  Strategies, policies, procedures and risk tolerances  Liquidity risk measurement and reporting  Intraday liquidity position management  Diversified funding  Cushion of liquid assets  Contingency funding plans  Internal controls 11

DFA 165: Enhanced Liquidity Requirements  Section 165 of the DFA directed the FRB to establish stricter prudential standards for all BHCs with $50 billion or more in total assets and nonbank SIFIs, and that the stricter standards must include liquidity requirements.  The rule includes:  Governance requirements that specify board, risk committee, and senior management responsibilities, in addition to independent evaluation requirements.  Requires firms to conduct regular stress testing, conduct cash flow analysis, and set certain liquidity risk limits.  Requires covered companies to maintain a buffer of highly liquid assets against internal 30 day (bank ‐ derived, supervisor ‐ reviewed) liquidity stress tests.  Requirements for foreign companies to maintain asset buffers in the U.S. 12

Internal Stress Test and LCR, complementary tools  Limitations of one ‐ size ‐ fits ‐ all regulatory construct  Reg YY provides expectations and framework for conducting liquidity stress testing (scenario type, time buckets, etc)  Buffer ‐ sizing requirement based upon meeting outflow estimates under 30 day internal stress test  Some stipulations on buffer qualification  Watching that does not create disincentive to run sufficiently stressful scenarios  Defaulting to LCR scenario, asset/liability categorization, and assumptions (haircuts/runoffs) for internal stress tests is not sufficient 13

Internal Stress Test coverage vs. LCR 450% 400% 350% 300% Coverage Ratio 250% 200% 150% 100% 50% 0% LCR FIST FIST = Firm Internal Stress Test: results of firms’ most severe scenario, including all contingent sources, as measured by internal MIS 14

Timeline for Liquidity Rules and Reviews  DFA 165/Reg YY liquidity standards  Compliance required for domestic firms and foreign ‐ owned US BHCs January 1, 2015  Foreign firms’ IHC formation plans to be submitted by Jan 2015, to be formed by mid ‐ 2016  US implementation of Basel III LCR  Finalized Sept 2014  Muni HQLA inclusion proposal (an amendment to the final rule) to come  Application to FBOs to come  Basel NSFR  Expect to be finalized at the BCBS in 2014 (for 2018 implementation)  Expect US proposal to implement the NSFR to follow  Liquidity supervisory reporting  Finalized 2052 (a + b) liquidity reporting in August 2014, reporting to begin soon  LCR reporting requirement to come  Horizontal Liquidity Reviews  CLAR for top LISCC firms in its third year  LBO horizontal liquidity reviews commenced in 2014 15

Liquidity Supervisory Reporting As-of Submission Report Reporter Description Frequency Date Date Number U.S. BHCs that the Financial Stability Board FR 2052a designated as Global Daily 09/11/2014 09/15/2014 Systematically Important Banks (G-SIBs) On Occasion (FR 2052a; TBD TBD Foreign banking complete Advanced Advanced organizations with U.S. report) notice from notice from FR 2052a broker/dealer assets > Twice a supervisors supervisors $100 billion month (FR 2052a; 09/11/2014 09/15/2014 abbreviated report) U.S. BHCs (excluding G-SIBs) with total consolidated assets FR 2052b Monthly 11/30/2014 12/15/2014 greater than $50 billion (including FBO subsidiaries) U.S. BHCs (not controlled by FBOs) with FR 2052b total consolidated assets Quarterly 12/31/2014 01/15/2015 of between $10 billion and $50 billion. 16

Bart Miller Market & Liquidity Risk Supervision Federal Reserve Bank of Chicago Bart.Miller@chi.frb.org 17