Chapter 14 - Funding liquidity risk management [Compatibility Mode]

The Presentation Slides for Teaching
Financial Regulations and Compliance Practices
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Chapter 14
Funding Liquidity
Risk Management
Copyright © 2016 CapitaLogic Limited

Declaration
Copyright © 2016 CapitaLogic Limited.
All rights reserved. No part of this presentation file may be
reproduced, in any form or by any means, without written
permission from CapitaLogic Limited.
Authored by Dr. LAM Yat-fai (林日辉林日辉林日辉林日辉),
Principal, Structured Products Analytics, CapitaLogic Limited,
Adjunct Professor of Finance, City University of Hong Kong,
Doctor of Business Administration (Finance),
CFA, CAIA, CAMS, FRM, PRM.
2

3
Liquidity investment strategies
Funding liquidity risk
Basel III funding liquidity framework
Outline

4

5

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Bank’s deposits taking
and lending businesses
Deposits
1 day to
1 year
Bank
1 year to
30 years
Lending

7
HKD interbank rate 31 Dec 2014

8
A typical interest rate curve
0.0
0.5
1.0
1.5
2.0
2.5
1 2 3 4 5 7 10 15
Maturity (year)
HKDtreasuryrate(%)

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Long-short interest rate strategy
Investment strategy
Borrow short term at lower interest rate
Lend longer term at higher interest rate
Continue to renew short term borrowing
Risky assumption on interest rates
Short term interest rates remain at lower level
Risky assumption on funding liquidity
Short term borrowing CAN be renewed

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Financial tsunami 2008
Funding sources stopped to lend
Short term borrowing CANNOT be renewed
Banks’ loss as a result of lacking funding liquidity
Fire sale on banks’ assets at discounted prices
Realized loss
Downward pressure on capital market
Unrealized mark-to-market loss
Bankruptcy
Total loss

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Outline

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Funding liquidity and
funding liquidity risk
Funding liquidity is the ability of a bank to fund
increases in assets and meet obligations as they come
due, without incurring financial and/or non-financial
losses
Funding liquidity risk is the risk that a bank will not
be able to meet efficiently both expected and
unexpected current and future cash flows and
collateral needs without affecting either daily
operations or the financial condition of the bank

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Funding liquidity risk identification
Funding
liquidity risk
Funding
sources
(-)
Liquefiable
assets
(-)
Funding
obligations
(+)
Funding
concentration
(+)
Liquidity
period
(+)

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Funding liquidity risk factors
Funding sources
The sources from which funds are available
Liquefiable assets
The assets which can be converted into cash quickly
Funding obligations
The obligations to which funds must be paid to
Funding concentration
The concentration of funding sources
Liquidity period
The period over which liquidity activities will take place

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Funding liquidity risk measurement
Liquidity sufficiency
The probability that over a certain liquidity period
Funds from funding sources + Liquefiable assets
> Funds to funding obligations
Modelling of liquidity sufficient probability is
still an active and difficult research topic

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Funding liquidity risk monitoring
Contractual maturity mismatch
Concentration of funding
Available unencumbered assets
Market-related monitoring tools

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Funding liquidity risk mitigation
More funding sources
More liquefiable assets
Less funding obligations
Lower funding concentration
Shorter liquidity period
Retail funding is preferred over wholesale
funding

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Outline

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Basel Committee’s initiative
on funding liquidity risk

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Basel III sufficiency requirements
on regulatory funding liquidity
Standards
Liquidity coverage ratio
Net stable funding ratio
Monitoring tools
Market-related monitoring tools

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Stock of high quality liquid assets
LCR =
Total net cash outflows over the next 30 calendar days
100%
Stock of high quality liquid assets
+ Total cash inflows over the next 30 calendar days
Total cash
≥
≥ outflows over the next 30 calendar days

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To ensure that a bank maintains a sufficient level of
unencumbered, high quality liquid assets that can be
converted into cash to meet its liquidity needs for a
30 calendar day time horizon under a significantly
severe liquidity stress scenario specified by
supervisors
The stock of liquid assets should enable the bank to
survive until day 30 of the stress scenario, by which
time it is assumed that appropriate corrective actions
can be taken by management and/or supervisors,
and/or the bank can be resolved in an orderly way

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A minimum acceptable amount of stable funding based on the liquidity
characteristics of an institution’s assets and activities over a one year
horizon
To act as a minimum enforcement mechanism to complement the LCR
and reinforce other supervisory efforts by promoting structural changes in
the liquidity risk profiles of institutions away from short-term funding
mismatches and toward more stable, longer-term funding of assets and
business activities
To ensure that long term assets are funded with at least a minimum
amount of stable liabilities in relation to their liquidity risk profiles
To limit over-reliance on short-term wholesale funding during times of
buoyant market liquidity and encourage better assessment of liquidity risk
across all on- and off-balance sheet items
To offsets incentives for institutions to fund their stock of liquid assets
with short-term funds that mature just outside the 30-day horizon for that
standard

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Available amount of stable funding
NSFR =
Required amount of stable funding
100%
Available amount of stable funding
Required amount of stable funding
≥
≥

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To identify the gaps between the contractual inflows
and outflows of liquidity for defined time bands
To indicate how much liquidity a bank would
potentially need to raise in each of these time bands
if all outflows occurred at the earliest possible date
To provide insight into the extent to which the bank
relies on maturity transformation under its current
contracts

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To identify those sources of wholesale funding that
are of such significance that withdrawal of this
funding could trigger liquidity problems
To encourage the diversification of funding sources
Thresholds
Major counterparties > 1%
Major instruments / products > 1%
Major currencies > 5%

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Funding liabilities sourced from each significant counterparty
The bank's balance sheet total
Funding liabilities sourced from each significant product/instrument
Funding liabilities sourced by each significant currency

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The assets that have the potential to be used as
collateral to raise additional secured funding in
secondary markets and/or are eligible at central
banks and as such may potentially be additional
sources of liquidity for the bank
A list of quantity of available unencumbered assets
that are marketable as collateral in secondary
markets and/or eligible for central banks’ standing
facilities by denominating currency, location and
other major characteristics

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LCR by major currency
To evaluate banks’ ability to raise funds in foreign currency
markets and the ability to transfer a liquidity surplus from one
currency to another and across jurisdictions and legal entities
Higher currency LCR expected for currencies in which a
bank has limited ability to raise funds in foreign currency
markets and/or the ability to transfer a liquidity surplus from
one currency to another and across jurisdictions and legal
entities
Amount of total net foreign exchange cash outflows to be net
of foreign exchange hedges
Foreign currency LCR
Stock of high quality liquid assets in each major currency
=
Total net cash outflows over the next 30 calendar days in each major currency

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Liquidity risk monitoring
Market-wide information
Currency rates, interest rates, equity market indices, commodity
prices, volatility indices and credit indices
Information (news) on the financial sector
To track whether the financial sector as a whole is mirroring broader
market movements or is experiencing difficulties
Bank-specific information
The confidence of market in a particular institution or has identified
risks at an institution, e.g. equity prices, volatilities, credit spreads and
credit ratings

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Market based monitoring
To monitor a manageable number of
systematic market monitoring factors (30 to
100) in a lender’s lending universe within
limited time frame
To take mitigation actions if systematic
market risk factors exhibit a confirmed trend
of deterioration

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Systematic market
monitoring factors (1)
Major currency rates
USD, EUR, GBP, JPY, CNY
Major interest rates
Zero treasury rates
Short term 1-year, medium term 5-year, longer
term 10-year
Liquidity spreads for major currencies
Difference between 3-month LIBOR and 3-month
OIS

34
Systematic market
monitoring factors (2)
Major equity market indices
S&P500, DAX, CAC 40, FTSE, Nikkie 225, China SSE
Major volatility indices
S&P500, DAX, CAC 40, FTSE, Nikkie 225
Major commodity prices
Gold, oil
Major credit indices
CapLogic Eurozone and SiFi credit indices

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Weekly percentage change
Market value
of monitoring factor
current week
= - 1 100%
Market value
of monitoring factor
previous week
 
 
 
 
× 
 
 
  
 

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Early detection with change instead of levels
What is this week’s percentage change relative to the
most recent business cycle (5 years or 260 weeks) ?
Emergency – extremities (+1%)
Warning – wing regions (+1% to +5%)
Attention – side regions (+5% to +10%)
Normal – middle region (-10% to 10%)
Snapshot analysis
Trend analysis

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Weekly percentage changes
80% = 4 year

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Snapshot analysis

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Snapshot summary

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Trend analysis

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Reference
LM-1 Liquidity risk management, HKMA,
2011.
LM-2 Sound systems and controls for
liquidity risk management, HKMA, 2011.

Chapter 14 - Funding liquidity risk management [Compatibility Mode]

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