Managing liquidity risk under regulatory pressure May 2012 Kunghehian Nicolas
Impact of the new Basel III regulation on the liquidity framework 2
Liquidity and business strategy alignment 79% of respondents felt that the 77% of respondents felt that the new regulatory rules for liquidity are board & senior management have a expected to have a strong impact on thorough understanding of the roles of business operations and strategy of liquidity and funding risks in shaping the organisations business strategy Thorough and Significant complete 42% 23% impact understanding Somewhat of an 37% impact Good understanding 54% Little impact 13% Little understanding 23% No impact 8% 3
Liquidity and business strategy alignment: going forward 70% of organisations have seen 94% expect their liquidity risk changes implemented to their liquidity tolerance to change further as a result risk tolerance due to Basel III of Basel III requirements requirements Thus far: Going forward: Complete overhaul Complete overhaul 3% 9% Significant change Significant change 20% 48% Minimal change Minimal change 47% 36% No change No change 6% 30% 4
And yet, the alignment between strategy and processes is unclear 76% of respondents are unclear how 72% of respondents do not feel fully confident that their organisation’s liquidity the new rules have been incorporated into their organisation’s key business processes position is well understood and pricing Has the impact of the new liquidity rules on Are you satisfied that your organisation currently profitability been factored into key business understands its liquidity position in sufficient detail and knows where the stress points are? processes and pricing? Yes Don't know (24%) Very satisfied (20%) (28%) Don't know Not satisfied (13%) (50%) Somewhat No satisfied (26%) (39%) 5
Liquidity: seeing the full picture 61% of respondents are unsure » Compliment regulatory requirements with additional measures to give a full picture whether the new liquidity measures are of liquidity and funding positions sufficient in providing a holistic view of liquidity » Ensure that there is a close dialogue between strategy / risk / treasury / finance Is the liquidity regulation is too simplistic as only two key ratios are being introduced? » Understand the impact of strategy on day- to-day operations and processes and Don't focus on top-down / bottom-up know Yes (26%) communication (35%) No (40%) 6
Modeling and data/infrastructure are recurrent pain points Validation Validation Validation Validation 6 1 2 3 4 5 7 Define scope Define Scenarios Data and Model the impact of Calculate Stressed Reporting Management and governance Infrastructure scenarios on key risk KPI actions parameters • Scope of stress • Shock selection: • Define data and • Enter stressed inputs • Consolidation of ST • Calculate risk Credit risk • Regulatory (given) • Model the impact of the testing data granularity into software and run results (capital and exposure and • Regulatory only • Business-specific: requirements scenarios on the the calculations to liquidity) compare with • Business-specific: • Formatting and macroeconomic (financial internal, incidence of default by obtain: risk appetite Group/LOB ST ; (GDP, macro/ default borrowers (by individual Credit (capital) auditing (modify planning • Risks to stress: • Regulatory capital ratio • Internal reporting to unemployment, /market data...) balance sheets and by and limits, reduce • Define credit, liquidity, interest rates..); portfolios) (total RWA, RWA ratio) management (within concentration..) • Model the incidence of • Stressed net income • Liquidity interest rates/FX, budgeting/ infrastructure Risk /Treasury/ALM) • Economic capital ratio • Periodic reporting to performance.. planning; financial requirements default to losses on planning and Description of Activities • Define the risk • Data sourcing: • “Book” capital ratio markets, liquidity- single obligors and on Board, ALCO, and asset growth factors : credit (PD, related (financial internal, loan portfolios (via Liquidity (cash-flows) other Committees limits • Liquidity gap and • Public disclosures to LGD, rating, EAD), (concentration, macro/ default specific models for retail, adjustments • Contribute to liquidity 1 , ALM 2 , reputation risk..) /market data...) corporate, CRE, SME..) liquidity ratios (buffer) local regulator or other • Type of scenario • Compilation and bodies (EBA, FMI…) operational.. Liquidity risk Market contingency • Governance of • Model the impact of • Stressed VAR • ICAAP & ILAA to test: data formatting funding plan • Sensitivity analysis • Data audit • Leverage ratio stress testing scenarios on key liquidity reporting • Scenario analysis • Aggregate and validate (ownership, risk parameters • Reverse ST contributions, Market risk results • Validation of • Model market risk to frequency of tests, reporting process, severity, duration estimate the impact on reporting lines..) of shocks and risk P&L transmission channels • Yearly • Yearly / Quarterly • Market and macro- • Stressed PD, EAD, LGD : • Stressed capital and • Internal reporting: • Yearly / data : ongoing from quarterly to yearly leverage ratio: quarterly quarterly to yearly Quarterly or ad- Frequency • Internal financial • Stressed liquidity risk • Reporting to Board/ to yearly hoc • Stressed cash-flows: data and liquidity parameters, stressed Committees and positions : monthly cash-flows and monthly 2 disclosures: quarterly, • Stressed VaR: daily financials : monthly ad-hoc • Scope and • Scenarios • Data input into • Stressed PD, EAD, LGD • Stressed EcCap / • Reporting and • Risk appetite (regulator’s • Stressed cash-flows governance rules models and/or RegCap disclosed information and limit Output • Stressed financials (loan • Liquidity gap and of ST programme and/or platforms (internally and management idiosyncratic) loss provisions, interest ratios externally) process • Stressed VaR income, refinancing costs..) 1 Sources of Liquidity Risk (FSA): Wholesale secured and unsecured funding risk, Retail funding risk, Intra-day liquidity risk, Intra-group liquidity risk, Cross-currency liquidity risk, Off-balance sheet liquidity risk, Franchise viability risk, Marketable assets 7 risk, Non-marketable assets risk, and Funding concentration risk 2 Sources of risk from ALM perspective: client’s behavior, funding risk, facility utilization, prepayments, runoff
Basel III and best practices for Asset & Liability Management 8
ALM within a regulatory framework Capital Buffers Liquidity Risk Market Risk Regulatory Buffers Appetite Compliance Calculation Bank Engines P&L Stress Counterparty Testing Risk Scenario -Who is in Charge? - The most important constraint is… 9
ALM/Liquidity risk and Stress Testing Contingency Funding Plans The ALM/Treasury point of view Different sources of funding are available Which one is the less expensive? Stress tests for ALM Data is available in the Bank Scenarios and behaviors How to Build plausible scenarios Link all the liquidity risk drivers 10
Liquidity management and liquidity risk ALM scenarios are not Stress Tests Stress test calculation for Liquidity Stressing market data Behavioral models (data is needed) Cash flow generation Adding the impact of the Contingency Funding Plan See how the Bank will behave during the crisis Estimate the cost Stress Test for Stress Test for liquidity RISK liquidity Best management management practices sensitivity Crisis analysis scenario 11
Economic scenario generation and calculation techniques 12
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