Prepared for COMESA Workshop on Financial Stability 24 th August to 1 st September 2015 Session Objectives Understand key drivers of liquidity stress Provide an overview of liquidity risk measurement indicators ID: 618117
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LIQUIDITY STRESS TESTING
Prepared for COMESA Workshop on Financial Stability24th August to 1st September 2015Slide2
Session Objectives Understand key drivers of liquidity stress
Provide an overview of liquidity risk measurement indicatorsIdentify issues that are important for liquidity stress design8/28/2015Liquidity Stress Testing
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INTRODUCTIONLiquidity stress testing has become very important tool for the Supervisor in recent timesCase studies have shown that it can materialize very fast and translate into solvency risk
Northern Rock (2008)Lehman Brothers (2008)The Basel Committee on Banking Supervision responded by introducing two new ratiosThe Liquidity Coverage Ratio (LCR)The Net Stable Funding Ratio (NSFR)8/28/2015Liquidity Stress Testing
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INTRODUCTIONComputation of these ratios provides a better understanding of key drivers of liquidity stress
Some of the tests being designed will address major sources of funding in banking sector.Retail FundingSimulated Bank run testWithdrawals by large depositorsWholesale FundingNon-Resident FundingNon Bank Financial Institutions
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SOURCES OF LIQUIDITY STRESSScheduled contractual gross cash outflows
Counterparty runs (deposit runs, cash hoarding)Lost access to funding Run offHaircut increasesClosure of interbank market creditFailure in payment systems settlement8/28/2015Liquidity Stress Testing
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SOURCES OF LIQUIDITY STRESSCorrelation shocks to prices and bid-ask spreadsSignaling
Discretional cash flows to customersRequirement to always pass liquidity stress test!8/28/2015Liquidity Stress Testing6Slide7
TIERED LIQUIDITY SOURCES
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TIERED LIQUIDITY SOURCES
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LIQUIDITY ALERTS
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LIQUIDITY COVERAGE RATIOCash InflowsLoans and advances maturing in 30 days
Due from Financial Institutions Cash outflowsDemand and savings depositsTime depositsDue to Financial Institutions Stock of High Quality Liquid AssetsCash, balances with Central Bank, government securities8/28/2015Liquidity Stress Testing
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LIQUIDITY COVERAGE RATIOTotal net cash outflows = Total cash outflows minus min [total cash inflows, 75% of gross outflows]
Liquidity coverage ratio = (Total value of stock of high quality liquid assets / Net cash outflows) Check LCR by significant currency8/28/2015Liquidity Stress Testing11Slide12
LIQUIDITY COVERAGE RATIOLCR ALERTS
LCR test is done on over 30 day period not beforeNor hair cut on “liquid” government securitiesRun off rate for stable deposits is smallRepos are assumed not to fail8/28/2015Liquidity Stress Testing
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NET STABLE FUNDING RATIOAvailable Stable Funding (Sources)Capital and Reserves (100%)
Demand and savings deposits (95%)Time deposits with maturity greater than one year (90%)Balances due to banks greater than one year (90%)Balances due to Central Bank greater than on year (90%)Required Stable Funding (Uses)Marketable securities maturing in less than one year (5%)Investment securities maturing in less than one year (15%)Loans and advances maturing in less than 6 months (15%)
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Required Stable FundingDue from banks and non banks with maturity greater than one year (50%)Loans and advances with maturity of 6 months to one year (50%)
Other assets with maturity less than one year (50%)NSFR = Total Available Stable Funding/Required Stable Funding8/28/2015Liquidity Stress Testing14
NET STABLE FUNDING RATIOSlide15
FRAMEWORK Objective of a liquidity stress test is to:
Identify key risk factors affecting assets and liabilitiesDesign scenarios which align with assets and liabilitiesTest the resilience of funding sources under idiosyncratic and systemic eventsFramework suggested by Tata Consultancy Services (TCS) consists of four stages:AssessIdentifyBuild and executeQuantify and control8/28/2015
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FRAMEWORK
8/28/2015Liquidity Stress Testing16Source: Tata Consultancy Services (2013)Slide17
FRAMEWORK Assess
Understand composition of balance sheetAssets and liabilities differ for each institutionConcentration of funding sources needs to be analyzedRetail FundingWholesale fundingStructured fundingLarger haircuts may be required for sensitive and more complex funding sources
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FRAMEWORK Identify
What are the key liquidity risk drivers affecting the balance sheet?Risk factors to be considered for liquidity crisis are manyMarket riskCredit riskOperational riskChoose factor that explains most of the historically observed liquidity risk scenarios8/28/2015Liquidity Stress Testing
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FRAMEWORK
Build and ExecuteConsider both idiosyncratic and system wide stress
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Quantify and controlApply different scenarios and identify those that produce negative cashflowsNeed for plan of action to counterbalance these actionsBanks should have sufficient High Quality Liquid Assets (HQLA) to counter each scenario
FRAMEWORK 8/28/2015Liquidity Stress Testing20Slide21
REFERENCESBCBS (2013), “Liquidity Stress Testing: A survey of theory, empirics and current industry and supervisory practices”, Working Paper No.24
Darrell Duffie (2012), “Liquidity and stress testing”, Financial Advisory Round Table, Federal Reserve Bank of New YorkTata Consultancy Services (2013), “A stress testing framework for liquidity risk”8/28/2015Liquidity Stress Testing21