BCM International Regulatory Analytics LLC                     Barbara C. MatthewsBCM International Regulatory Analytics L...
BCM International Regulatory Analytics LLC                             Overview         The Basel framework: summary & sho...
BCM International Regulatory Analytics LLC                               Main themes                                      ...
BCM International Regulatory Analytics LLC                          The Basel Framework                      Summary & Sho...
BCM International Regulatory Analytics LLC                                                   G20 Members                  ...
BCM International Regulatory Analytics LLC                              Basel 1 2 3         Early 1970s: Basel Committee c...
BCM International Regulatory Analytics LLC                          The Great Dollar Shortage “Taken together, Graphs 2 an...
BCM International Regulatory Analytics LLC                           The Great Dollar Shortage“ In sum, the run on US doll...
BCM International Regulatory Analytics LLC                         The Great Dollar Shortage        This vulnerability hig...
BCM International Regulatory Analytics LLC               The Liquidity Risk Framework – The Big Picture         Underlying...
BCM International Regulatory Analytics LLC             Liquidity Coverage Ratio (LCR): An OverviewStock of high quality un...
BCM International Regulatory Analytics LLC                Liquidity Coverage Ratio (LCR)              What = “high quality...
BCM International Regulatory Analytics LLC                         Rhetorical Question:         Do eurozone sovereign bond...
BCM International Regulatory Analytics LLC                      Tier 1                             Tier 2    Cash         ...
BCM International Regulatory Analytics LLC                 Liquidity Coverage Ratio (LCR)                         Stress S...
BCM International Regulatory Analytics LLC                       Net Stable Funding Ratio (NSFR)    Goal: Limit or elimina...
BCM International Regulatory Analytics LLC                Additional “Tools” (just regulatory reporting – for now)    Cont...
BCM International Regulatory Analytics LLC                      Regulatory Compliance Parameters    Reporting Frequency   ...
BCM International Regulatory Analytics LLC                      Liquidity and Cross border Resolution                     ...
BCM International Regulatory Analytics LLC   Liquidity: Preventing Cross Border Resolution Problems?    “taking into accou...
BCM International Regulatory Analytics LLC                      A Few Questions for CROs & Scenario Analysis Designers1.1 ...
BCM International Regulatory Analytics LLC             Mapping Liquidity & Cross Border Resolution                Timing &...
BCM International Regulatory Analytics LLC                  Liquidity Risk Beyond the Banking Sector:                     ...
BCM International Regulatory Analytics LLC                                              p                            Focus...
BCM International Regulatory Analytics LLC                      Liquidity Risk and the Trading Bookwww.bcmstrategy.com    ...
BCM International Regulatory Analytics LLC                      Feedback Effects Point to Longer Maturities               ...
BCM International Regulatory Analytics LLC                        Rhetorical Question:         Why bother with the Volcker...
BCM International Regulatory Analytics LLC                                  Timeframe    Currently: QIS    January 2012: f...
BCM International Regulatory Analytics LLC                                Conclusion       The debate regarding appropriat...
BCM International Regulatory Analytics LLC Providing boards and senior executives with strategic analytical tools tonaviga...
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Risk Europe April 2011

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Some background & implications of Basel\'s liquidity risk rules.

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Risk Europe April 2011

  1. 1. BCM International Regulatory Analytics LLC Barbara C. MatthewsBCM International Regulatory Analytics LLC www.bcmstrategy.com April 2011 p
  2. 2. BCM International Regulatory Analytics LLC Overview The Basel framework: summary & short political history Liquidity & Cross Border Resolution: charting the intersections Liquidity Risk Regulation beyond the banking sector: who falls within the framework? Liquidity Risk Regulation & the Trading Book: charting the feedback effectswww.bcmstrategy.com ©2011 all rights reserved
  3. 3. BCM International Regulatory Analytics LLC Main themes g The measurement and management of bank funding g liquidity risk is not merely a quantification challenge Shifts in the cost structure of bank funding will have p profound effects on how economic growth is managed, g g , how sovereign debt management functions are executed, and how monetary policy will be formed. Public policy interests in the liquidity profile of sovereign debt will affect (i) the shape and contours of bank liquidity risk management and (ii) the cost of corporate finance for the foreseeable future. Are your risk management systems ready to incorporate these non quantitative risk factors?www.bcmstrategy.com ©2011 all rights reserved
  4. 4. BCM International Regulatory Analytics LLC The Basel Framework Summary & Short Political Historywww.bcmstrategy.com ©2011 all rights reserved
  5. 5. BCM International Regulatory Analytics LLC G20 Members 19 Sovereign States S i S 1 International Grouping I i lG i Argentina European Union (Council Presidency) + ECB Australia Brazil 4 Ex Officio Participants Canada Managing Director, International Monetary China Fund France President, World Bank Germany Chair, International Monetary and Financial India Committee (IMF) Indonesia Chair, Development Committee (World Bank) Italy Japan J Mexico Russia Saudi Arabia South Africa BUT NOT South Korea Financial Stability Board Turkey BIS United Kingdom Basel Committee United States of America IOSCO IAIS IASBwww.bcmstrategy.com ©2011 all rights reserved
  6. 6. BCM International Regulatory Analytics LLC Basel 1 2 3 Early 1970s: Basel Committee created to address FX settlement/Herstatt risk 1980s: Latin American debt crisis (“sovereigns 9 ( g don’t go bankrupt”; TBTF; Continental Illinois) 1988: Basel 1 (OECD sovereigns don’t go bankrupt; risk is mostly in the assets) i ki tl i th t ) 2000s: Basel 2 (AAA rated entities don’t go bankrupt; risk is mostly in the assets) 2010: Basel 3 (Liquidity & high reg cap can help a bank avoid bankruptcy; return of ALM) p y; )www.bcmstrategy.com ©2011 all rights reserved
  7. 7. BCM International Regulatory Analytics LLC The Great Dollar Shortage “Taken together, Graphs 2 and 3 thus show that several European banking systems expanded their long US dollar positions significantly after 2000 and funded them primarily by 2000, borrowing in their domestic currency from home country residents. This is consistent with European universal banks using their retail banking arms to fund the expansion of investment banking activities, which have a large dollar component…In aggregate, European banks’ combined long US dollar positions grew to more than $800 billion by mid 2007 (Graph 5, top left hand panel), funded by short positions in pounds, sterling, euros and Swiss francs.” BIS Quarterly Review ( l (March 2009), p. 52 53. h )www.bcmstrategy.com ©2011 all rights reserved
  8. 8. BCM International Regulatory Analytics LLC The Great Dollar Shortage“ In sum, the run on US dollar money market funds after the Lehman I h d ll k f d f h L h failure stressed global interbank markets because the funds bulked so large as suppliers of US dollars to non US banks. Public policies stopped the run and replaced the reduced private supply of dollars with public funding…European banks increased their dollar assets sharply (from 1999 to 2008). Since this growth outran that of their retail dollar deposits, they bid for dollars from nonbanks and banks…As banks As European banks relied more on the foreign exchange swap market to obtain dollars against European currencies, they did not meet US banks with a complimentary need for European currencies. Under these circumstances, this asymmetry led to skewed foreign exchange swap prices that hiked the cost of raising d ll well above h i h hik d h f i i dollars ll b an already elevated Libor dollar rate.” BIS Quarterly Review (March 2009), p. 65 66.www.bcmstrategy.com ©2011 all rights reserved
  9. 9. BCM International Regulatory Analytics LLC The Great Dollar Shortage This vulnerability highlights why the IMF reform (especially SDR reform) issues are at the top of the French Presidency f )i h f h F h P id agenda for the G20 and why the Basel Committee went forward with the liquidity risk framework over the objection of European banks banks. However, global monetary reform requires long timeframes and implies significant shifts of economic policy sovereignty. Current experience in Europe suggests this is not likely to occur quickly, if at all. These issues and their implications for the global economy are beyond the scope of today’s p presentation. As the eurozone and its banks continue to experience stress in the near term, an alternative framework is needed to decrease European banks’ reliance on short term dollar funding. Enter Basel 3 and the liquidity risk framework. f d l d h l d kf kwww.bcmstrategy.com ©2011 all rights reserved
  10. 10. BCM International Regulatory Analytics LLC The Liquidity Risk Framework – The Big Picture Underlying Premise: “During the early ‘liquidity’ phase of the financial crisis that began in in 2007, many b k – d banks despite adequate capital l l – still it d t it l levels till experienced difficulty because they did not manage their liquidity in a prudent manner.” Para. 2 (emphasis added). Focus: Funding Liquidity Risk Short t Sh t term f di risk (Liquidity C funding i k (Li idit Coverage R ti ) + Ratio) Longer term (1 year) funding risk (Net Stable Funding Ratio)www.bcmstrategy.com ©2011 all rights reserved
  11. 11. BCM International Regulatory Analytics LLC Liquidity Coverage Ratio (LCR): An OverviewStock of high quality unencumbered liquid assetsTotal cash outflows for 30 days (stress scenario) =100% 100% PER CURRENCY Goal: Identify and segregate assets that can be y g g converted into cash to support a firm under severe stress assumptions to avoid emergency government liquidity supportwww.bcmstrategy.com ©2011 all rights reserved
  12. 12. BCM International Regulatory Analytics LLC Liquidity Coverage Ratio (LCR) What = “high quality liquid asset ? high asset”? Low credit & market risk Easy, reliable valuation E li bl l ti Low correlation w/risky assets Listed Li d on a d l developed & well recognized market d ll i d k Active & sizeable market/low market concentration Flight to quality beneficiary Committed market makers What besides cash could fit these parameters?www.bcmstrategy.com ©2011 all rights reserved
  13. 13. BCM International Regulatory Analytics LLC Rhetorical Question: Do eurozone sovereign bonds and/or bonds issued by EU entities (e.g., EFSF; ESM) fit these parameters ? ( g, ; ) pwww.bcmstrategy.com ©2011 all rights reserved
  14. 14. BCM International Regulatory Analytics LLC Tier 1 Tier 2 Cash (40% cap; 15% haircut) Central Bank reserves Marketable sovereign Marketable M k t bl securities iti debt that attracts a 20% issued or guaranteed by a risk weight government Corporate and covered Anything with a 0% RW bonds rated at least AA Local sovereign debt of ( (or with an equivalent PD q any rating or currency if using IRB) NO financial firm debtwww.bcmstrategy.com ©2011 all rights reserved
  15. 15. BCM International Regulatory Analytics LLC Liquidity Coverage Ratio (LCR) Stress Scenario Regulator determined run off rates for specific liabilities (See Annex A) over a 30 day period The short version: Limited (5 10%) runoff: retail deposits if deposit insurance exists and unsecured wholesale deposits p High (75% 100%) runoff: deposits from clearing, correspondent banking, custody, cash management, financial institution, derivatives, ABCP or other asset backed instruments & any , y instrument with a ratings based downgrade trigger No (0%) runoff: reverse repos & securities borrowing with maturities in excess of 30 days; lines of credit; operational 3 y p deposits.www.bcmstrategy.com ©2011 all rights reserved
  16. 16. BCM International Regulatory Analytics LLC Net Stable Funding Ratio (NSFR) Goal: Limit or eliminate reliance on short term wholesale funding Mechanism: Instrument specific “required stable funding” required funding (RSF) coverage/haircuts based on liquidity profile of the instrument. The higher the liquidity profile, the lower the RSF: RSF buckets: 0%, 2%, 5%, 20%, 50%, 65%, 85%, 100% b k t % % % % % 6 % 8 % % Instruments with maturity less than one year: RSF buckets structured across 4 maturity buckets (one per quarter), with shorter maturities attracting a higher RSF factor National discretion applies for setting RSF amounts on most off balance sheet instruments, including letters of credit and trade finance. Preference for capital and preferred stock with maturities in excess of 365 days.www.bcmstrategy.com ©2011 all rights reserved
  17. 17. BCM International Regulatory Analytics LLC Additional “Tools” (just regulatory reporting – for now) Contractual Maturity: Regulators to identify maturity C lM i R l id if i mismatches/gaps using standardized raw data from banks plus regulatory assumptions regarding behavioral components (e.g., outlays to promote going concern operation and franchise protection payments Funding Concentration: Regulatory reporting regarding funding g g y p g g g g from significant counterparties (over 1% of balance sheet), significant products/investments (over 1% of balance sheet), and significant currencies (over 5% of total liabilities) across four quarterly maturity buckets Unencumbered Assets: Reporting of non client assets not otherwise pledged as collateral that are eligible at the central bank by asset and with any applicable haircutswww.bcmstrategy.com ©2011 all rights reserved
  18. 18. BCM International Regulatory Analytics LLC Regulatory Compliance Parameters Reporting Frequency LCR: monthly (but can increase to weekly, daily, etc. as needed) NSFR: quarterly Scope: All internationally active banks on a consolidated basis + all individual legal entities, foreign branches and subsidiaries g g “taking into account legal, regulatory and operational “ limitations to the transferability of liquidity” in the local jurisdiction such as: ring fencing requirements; currency convertibility restrictions; foreign exchange controls Home State rules apply extraterritorially: except regarding retail & SME d t il deposits if th H t state h more stringent it the Host t t has ti t standardswww.bcmstrategy.com ©2011 all rights reserved
  19. 19. BCM International Regulatory Analytics LLC Liquidity and Cross border Resolution Charting the Intersectionswww.bcmstrategy.com ©2011 all rights reserved
  20. 20. BCM International Regulatory Analytics LLC Liquidity: Preventing Cross Border Resolution Problems? “taking into account legal, regulatory and operational limitations to the transferability of liquidity” in the local j jurisdiction such as: ring fencing requirements; currency g g q ; y convertibility restrictions; foreign exchange controls Vickers Report (UK)/subsidiarization? IMF sanctioned FX controls Vienna Initiative Dodd Frank resolution authority at FDIC (wind up y p activities should seek to maximize the value of the entity in administration) EU Commission resolution proposals (going p p (g g concern/stability priorities)www.bcmstrategy.com ©2011 all rights reserved
  21. 21. BCM International Regulatory Analytics LLC A Few Questions for CROs & Scenario Analysis Designers1.1 How do you adjust your liquidity risk models and scenario analysis for the possibility that access or distribution of liquidity within your firm or counterparties could be constrained due to political or economic policy priorities?2.2 How do you track regulatory and economic policy trends that will impact the ability of governments to implement the Basel framework for the flow of liquidity support within a financial firm? Are you evaluating the impact that a tradeable SDR could have on (i) liquidity profiles and/or (ii) the performance of existing sovereign debt? g3. Have you simulated the market impact of a bank tapping its liquidity reserves to avoid a bail out or other government support? Would reliance on the liquidity cushion require y to restrict credit or trading relationships with that bank even q you g p if no resolution activity were triggered?4. Have you simulated potential differences in path dependencies and correlations in interest rate inputs if a firm (a) begins to stockpile sovereign debt to meet Basel p ( ) g p g standards and/or (b) begins to liquidate sovereign debt in order to meet the Basel standards? In other words: are you ready for sovereign debt market dynamics to shift based on different demand profiles?www.bcmstrategy.com ©2011 all rights reserved
  22. 22. BCM International Regulatory Analytics LLC Mapping Liquidity & Cross Border Resolution Timing & Behavioral Considerations Government Policies • Cash • Short term? • Gov’t securities • Competition • Going Concern? • Fiscal Policy • CP • Monetary Policy relationships? • Macroprudential d l Policy Liquidity support • FX Controls Liquidity Needswww.bcmstrategy.com ©2011 all rights reserved
  23. 23. BCM International Regulatory Analytics LLC Liquidity Risk Beyond the Banking Sector: Who Falls Within the Framework?www.bcmstrategy.com ©2011 all rights reserved
  24. 24. BCM International Regulatory Analytics LLC p Focus: INDIRECT Impacts Winners Losers Issuers of S I f Sovereign D bt (d ’t i Debt (don’t CCPs, Custodians, and C h CCP C t di d Cash worry; supply will be plentiful for Managers years to come) Any company requiring short term y p y q g Niche (non bank) financial firms (below 365 days) funds specializing in short term lending Banks seeking to serve as market Maybe the covered bond market market, makers but only up to a point Exchangeswww.bcmstrategy.com ©2011 all rights reserved
  25. 25. BCM International Regulatory Analytics LLC Liquidity Risk and the Trading Bookwww.bcmstrategy.com ©2011 all rights reserved
  26. 26. BCM International Regulatory Analytics LLC Feedback Effects Point to Longer Maturities g p And Higher Costs for Corporates Increased cost and maturity d t it structure for Bank demand corporate debt for corporate p debt limited to Disincentives for the banking banks to hold book (hold to corporate bonds maturity), and in the liquidity then subject to cushion = fewer LCR and NSFR Shorter bank purchases coverage; maturities Disincentives generate higher for banks to LCR and NSFR serve as market k requirements makers.www.bcmstrategy.com ©2011 all rights reserved
  27. 27. BCM International Regulatory Analytics LLC Rhetorical Question: Why bother with the Volcker Rule when the Basel liquidity framework exists?www.bcmstrategy.com ©2011 all rights reserved
  28. 28. BCM International Regulatory Analytics LLC Timeframe Currently: QIS January 2012: first reporting starts J fi t ti t t Mid 2013: LCR revisions Mid 2016: NSFR revisions 6 i i 1 January 2015: LCR final 1 January 2018: NSFR finalwww.bcmstrategy.com ©2011 all rights reserved
  29. 29. BCM International Regulatory Analytics LLC Conclusion The debate regarding appropriate bank funding models is only just starting. Changes to bank funding models will profoundly impact the shape and cost of corporate finance….and, finance and thus, the scale and scope of economic recovery. A broader range of policymakers will have a voice in defining banks functions and f di structures going d fi i b k f i d funding i forward given the fiscal and monetary policy implications of new funding liquidity profiles for banks. The definition , measurement, and application of liquidity risk standards will be driven as much by non quantitative and economic policy priorities as by formal risk measurement processes. Are you ready? i k A d ?www.bcmstrategy.com ©2011 all rights reserved
  30. 30. BCM International Regulatory Analytics LLC Providing boards and senior executives with strategic analytical tools tonavigate today’s challenging financial market and regulatory environmentAwareness – The Risk Telescope Analytics Confidential, customized analysis of how specific regulatory and political trends may affect the strategic interests of individual li i di id l clients.Twice monthly analysis of keydevelopments for chief executives, chiefrisk officers, and chief strategists linkingG20 litiG politics with substantive research ith b t ti hand analysis of regulatory policy trends www.bcmstrategy.com

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