Liquidity Risk Management

One year ago

Agenda

Definition

Facts and figures

Regulatory Response

Measurement & Management

3

Liquidity Risk Management

11

Funding
Providers
Capital
market
funding providers

Funding
liquidity risk

22

Money market funding providers

(liabilities
run-off)
Lenders of last resort central banks

33

securitization
Assets

Based on DHaese W. (2008) Liquidity risk comes in three loops

Structu
ural

Repo- Sale securities borrowing

and lending

Long term liquidity risk mgt

(asset
decreasing
liquidity value)

Standing facilities
discount windows

Operational

Market
liquidity risk

Short term liqu

uidity risk mgt

Management of liquidity value

in secured funding sources

liquidity risk
r mgt

Liquidity
risk

Conting
gency

Management of funding
sources

Specificities of Liquidity Risk

Consequential risk

Not a solvency capital issue (unlike market/credit

risk)

Little historical data

data, need for stress testing
A quick killer!

Funding LR is very institution specific

A solvent bank can have liquidity problems and vice versa

Low frequency, high impact and rapid onset

Follows credit
credit, market
market, operational or reputational crisis

Need to test endogenous factors (reputation, rating)

Contingencies must be planned well before trouble

Hard to borrow your way out of a liquidity crisis

Market confidence is key a well executed contingency plan
prevents a downward spiral

Agenda

Definition

Facts and figures

Regulatory Response

Measurement & Management

6

Risk Management Investments

7
Source: Economist Intelligence Unit, Entreprise Risk Management Services Survey, Sep 2008

Asset mix

Market Liquidity evaporated

180,000

Spread Euribor 3M - Eonia (bp)

160,000

140,000

120,000

100,000

80,000

60 000
60,000

40,000

20,000
,

0,000

-20,000

-40,000
9

Liquidity Buffers

10

Open market operations and lending

11

Agenda

Definition

Facts and figures

Regulatory Response

Measurement & Management

12

Regulatory Initiatives

No true international framework yet

Basel II COREP (June 2004)
BIS Principles for Sound Liquidity Risk Management
p
((Sep
p 2008))
and Supervision
CEBS Interim Report on Liquidity Buffers & Survival
Periods
FSA Strengthening Liquidity Standards (Dec 2008,
June 2009)
BIS Principles for Sound Stress Testing (May 2009)
Global & Local stress test exercises (all supervisors)
More to come
13

Overall regulatory message

14

CEBS Report on Liquidity

Three types of stress scenarios

Idiosyncratic
9

Market
9

D li iin liliquidity
Decline
idit value
l +d
deteriorating
t i ti ffunding
di conditions
diti

Combination of both

1 month survival period for determining

g buffer
Composition buffer

No rollover of (unsecured) funding + retail deposits outflows

Short term: Cash + assets eligible by National Bank

L
Longer
tterm: M
More iis eligible
li ibl if liliquid
id iin private
i t markets
k t under
d
stress conditions and given the survival period

Location and size of the buffer need to reflect the

organisation within a banking group
15

CEBS Report on Liquidity

Buffer: the liquidity available to cover the gap

between the cumulative sum of all cash inflows and the
cumulative sum of all cash outflows within a certain time
period.
Counterbalancing capacity: refers to the liquidity that a
firm is expecting to be able to access over a given
timeframe to fund this gap.
gap .
Liquidity Gap, Cash Flow Projections under different
Scenarios

16

Agenda

Definition

Facts and figures

Regulatory Response

Measurement & Management

17

LR Measurement - components
Cash flow projections
- Intra-day, short, medium
long term
g
- Contractual and contingent
- Retail & wholesale

External sources
- Diversity (Committed lines,
lines
repo facilities, CP programs,
)
- Contingency Funding Plan

Best
Practice

- Internal & external

- Supply & demand factors
- Adequacy of buffer
St
Stress
ttests
t

- High quality, diverse liquid

assets
- Active collateral
management
Internal sources

Source: Principles for Sound Liquidity Risk Management and Supervision,

Basel Committee on Banking Supervision, September 2008

18

Cash Flow Projections

known

known

TIMING

unknown

AMOUNT

unknown
Fix rate loans and
Variation margins
mortgages
t
Options with fixed
Cash/repos/collaterali exercise date
sed lending
(european)
Term deposits
Floating rate loans
and deposits
Fixed coupons from
bonds swaps etc
Travelers cheques
Callable bonds
Flexible amortisation
loans

Revolving
loans/cards
Current accounts
Savings accounts
Investment assets
American options
19

Static Liquidity Measures

Ratios

Current: Short-Term
Short Term Assets/ ST Liabilities

Quick : (Cash + unencumbered securites + facilities) / S-T

liabilites

Liquidity gap reports: net cash outflow per time bucket

S
Survival time : time at which cumulative cash flow
<0 (with no rollovers)

20

Typical static liquidity gap report

21

Dynamic Analysis

Inflows, outflows and counterbalancing capacity

modelling according to drivers

Scenario analysis

Change in drivers has different changes on balance sheet

components

Net liquidity position

For each scenario

9
9
9

Forward
F
d liquidity
li idit exposure
Counterbalancing capacity
Net Liquid Position

Definition of scenarios!

Modelling Scenarios
Specify supply and demand for liquidity
Risk appetite:
Maturing assets
how low can we go?
Assets for sale/
collateral
Maturing liabilities
Lines in favour
Lines against
Renewed term
Sight funds
f di
funding
New production
Deposit growth
OBS liabilities

and
d stress
t
th parameters
the
t
that
th t affect
ff t their
th i volume
l
23

Balance Sheet organisation

Assets

Debt asset liquidity

Equity asset liquidity
Liquid loans
9

9
9
9
9

Interbank

Retail
Private
MidCap
Wholesale
Interbank

(long optionality)

Callable
ll bl
Term (CP, CD, MT, LT)

Fiduciary funding
Midcap funding
Intragroup funding
Retail funding
g
Private banking funding
Other unsecured funding

Off-Balance

Committed lines received Deposit breakdowns

Call
O/N
Term

Wholesale funding
3

Rights

Interbank funding
9

Illiquid
q
loans
9

Liabilities

On-Balance

Commitments

(short optionality)

Committed lines given

ABCP conduit facilities
Uncommitted lines given
Margin requirements
9
Credit support annex
Other

A/L sensitive to credit quality of the bank

A/L sensitive to loan refusal

All loan business

LR amplified by maintaining the business franchise

A/L sensitive to asset quality criteria (eligibility)

All funding
g business
Derivative exposures (CSA)
LR amplified by liquidity call option (on the bank)

Liquid assets in the trading book

A
Assets
t in
i the
th process off securitization
iti ti

A/L sensitive to external factors not related to the above

Credit facilities
Derivative exposures (margin requirements)

Exogenous to
E
o the
firm

End
dogenous to
o the
firm

Defining Liquidity Risk Profile for A/L

Parameters for Scenario Analysis

Example parameters to estimate and stress:

Run off of retail funding

Asset price vol, market
liquidity
Availability and tenor of
(un)secured funding
C
Correlation
l ti b
between
t
sources of funds
Haircuts, margin/collateral
calls
ll
Behaviour of contingent
claims on and by bank
Performance of clearing
and settlement

Loan and deposits growth

Liquidity effect of
SPVs/Conduits
SPVs/Conduits,
securitisation programs
Credit rating triggers
FX rates
t and
d access to
t
forex markets
Transferability of cash
within
ithi group
Access to Central Bank
facilities
Planned mergers and
aquisitions

26

Scenario procedure Conditional CF

Callable accounts (e.g. sight dep. and credit committed lines)
CCLD+5 = (1 - wrD+5) x CCLD0

SDD+25 = (1 - wrD+25) x SDD20

Assumed Committed
e withdrawal
t da a
Line

D0

D+5

D+10

D+15

D+20

D+25 D+30

Assumed Retail
withdrawal rate

D+35 D+40

Cumulated CF

D0

D+5

D+10

D+15

D+20

D+25 D+30

D+35 D+40

C a e ge :
Challenge
Estimate behavioral and modeled withdrawal rates
by types of client (retail, corporate, bank, fiduciary,)
for each scenario

Legend :
= outstanding undrwan CCL
= outstanding sight dep.

Scenario procedure Scheduled CF

Dynamics of Term Deposits

< 0 ECF

(1 - rrD+5) x tDD-15/D+5

tDD-15/D+5

1.

(1 - rrD+25) x tDD+5/D+25

tDD+5/D+25 =
rrD+5 x tDDD-15/D+5
15/D+5

2.

3.

-tDD+5/D+25

-tDD-15/D+5
D-15

D-10

D-5

D0

D+5

D+10

tDD+25/D+45 = rrD+25 x tDD+5/D+25

D+15

D+20

D+25 D+30

1.

20 days maturity deposit received 15 days ago (notional = tDD-15/D+5)

2.

Part of deposit is renewed for 20 days

Renewed notional = rrD+5 x tDD-15/D+5

D 15/D+5

Withdrawn part generates a claimed CF of (1-rrD+5) x tDD-15/D+5

3.

Part of renewed deposit is renewed again for 20 days

Renewed notional = rrD+25 x tDD+5/D+25 = rrD+25 x rrD+5 x tDD-15/D+5

Withdrawn part generates a claimed CF of (1-rrD+25) x tDD+5/D+25

D+35 D+40

Assumed
renewal rate

Challenge :
Estimate the renewal rates per type of client and depending on the type and severity of the event
Allow to change the maturity of the renewals instead of using the initial maturity

Liquidity Risk Components

29

Net Liquidity Position

200.000

200.000

150.000

150.000

100.000

100.000
Counterbalancing CF

50.000

50.000

+1day

+1day

+1week

+1month

+3month

Contractual CF
(50.000)

Future Contractual CF
Potential CF

(50.000)

(100.000)

(100.000)

(150.000)

(150.000)

(200.000)

(200.000)

Counterbalancing Capacity
CounterbalancingCapacity

ECBeligibledebtsecurities
BoEeligibledebtsecuirities
Fedeleiibledebtsecurities
DebtsecuritiesS&Prating[A;AAA]
DebtsecuritiesS&Prating<A
Equityassets
Committedlinesinfavorofthebank
Collateralflowsfromrepo/tendertransactio
p

CounterbalancingCapacity

Today
9/17/2008

LV

_ON_
9/18/2008

Marketvalue
20.4
0.7
1.0
32.3
4.3

_ON_
9/18/2008

_ON_
9/18/2008

_ON_
9/18/2008

Haircut
5%
5%
5%
15%
35%

Liquidation
capacity
75%
100%
100%
20%
10%

LV

14.55

0.63

0.95

5.49

0.28

_TN_
9/19/2008

Marketvalue
25.4
0.7
1.2
32.1
5.1

_TN_
9/19/2008

_TN_
9/19/2008

_TN_
9/19/2008

Haircut
5%
5%
5%
15%
35%

Liquidation
capacity
0.75
1.00
1.00
0.20
0.10

LV

18.08

0.63

1.14

5.46

0.33

21.9

25.6

Sett off unencumbered

S
b d assets,
t in
i particular
ti l d
debt
bt assets
t th
thatt
generate liquidity via repo, tenders with CB or sale (Treasury mgt)

CBC has its own dynamics and better not considered as a stock

Collateral flows from existing deals

Expected time to cash from hypothetic transactions
Expected maturity affects dynamics of cash and collateral flows

Constructing richer and relevant scenarios

Objective: to evaluate the impact of sudden abnormal

events on the liquidity position of the bank

Scenarios can be based on historic events

((acknowledging
g g the impossibility
p
y of historys
y recurrence))

Plausibility of scenarios means credibleness,

reasonability.

Most of the time we remain on the credible (possible) because

they have happened.
Instead of focusing on the reasonability sense of the word.

Assessments in terms of reasoning the inherent logic of

a scenario

In search of vulnerabilities of the underlying business model

Stress test design

Test liquidity capacity beyond static business as usual

cases
Scope

All entities, currencies and products

Multiple time horizons
Institution-specific stress and market stress

Design of scenarios

Extreme but plausible

Forward looking (expert assessment to supplement poor history)
Short as well as protracted crises (typically < 2M has been used)
All material drivers/assumptions should be stressed
in a way that reflects relations between drivers
Si
Signed-off
d ff by
b top management
Consistent with Contingency Funding Plan

33

We can start with

Scenario name
Legal

Display of net liquidity and CBC according to their contractual

maturities, assuming that:

Going concern (GC)

Business plan (BP)

Name (confidence) crisis

Systemic market crisis

Name-crisis amid
market turmoil

all contracts are legally binding and credit risk assumptions are avoided
no renewall off maturing
i
businesses
b i
counterparties exercise options at the shortest maturity
CBC can generate cash if needed through repo or sale i.e. no contingency
funding doors are closed.
the business franchise is kept at the current level; i.e. maturing cash flows are
replaced by identical anticipated cash flows in a way to keep the overall
amount of assets and liabilities constant
modeled conditional cash flows follow a historical/normal trend
CBC can generate cash if needed through repo or sale; i.e. no contingency
funding doors are closed
as GC, but mimicking the growth/decline behavior of the business franchise
as defined in the yearly business plans
CBC can generate cash if needed through repo or sale; i.e. no contingency
funding doors are closed
the business franchise is affected by the partial loss of funding, the
impossibility of cash flow renewal, the contraction of funding maturities and/or
the expansion of generated credit maturities
modeled conditional cash flows experience severe deviations from
historical/normal trend
CBC: cash generating assets experience significant haircuts and contingency
funding channels can be partially or completely closed
similar to name crisis with intensity of assumptions varying according to how
much the reputation and trust of the institution might be affected
CBC: cash generating assets experience significant haircuts and funding
channels can be partially or completely closed
similar to name crisis with higher intensity
CBC: cash generating assets experience significant haircuts and funding
channels can be partially or completely closed

About stochastic measures

Source: Onorato, M. (2007) Liquidity Risk Management: Assessing and Planning for Adverse Events.
Algorithmics Withe Papers.

 Survival time

The maturity at which, with no rollover of funding, the

bank will be unabe to meet obligations
20

15

10

0
O /N

8D

14D

1M

3M

1Y

3Y

6Y

> + 10Y

-5

-1 0

-1 5

-2 0

Measure of maximum intervention horizon

This could be subject to an inferior limit
36

Expressing Liquidity Risk Appetite

What are the plausible if rare internal and external

scenarios we need to survive?

How many downgrade notches should we be able to cope with?

How long should we be able to survive without funding source X

What is the target liquidity buffer (eg as % of 1Y gap)?

How much of our funding should come from a particular

source? Whats the asset mix

What is the acceptable ratio of maturing liabilities to

assets

Intra-day, overnight, Short term, Long term

37

Contingency Funding Plans

Purpose: survive freeze with minimal reputational damage

Clear procedures embedded in roles and responsibilities

Communication plan

Triggers and actions

Timing
Alternatives and alternates
Priorities
Legal
g and regulatory
g
y requirements
q
Operational constraints
Who tto contact
Wh
t t for
f what
h t and
d when?
h ?
Manage reputation risk (minimise vicious circle)

Test CFP in Stress Testing

g framework ensure
consistency with business and risk appetite
38

Intra-day LR issues

Identify critical intraday obligations and ensure they are

met

Time specific items, clearing systems (rules for

payment/settlement)
Non critical payments can be delayed as needed

Typically requires use of sources in addition to deal

capture systems to get real time picture
Daily gross in/out flows amount and timing
Know your large customers - forecasts of their anticipated
injection and withdrawal
Frequent monitoring of key positions
Understanding
g of p
procedure and timing
g of use of collateral
Impact of operational disruptions at clearing, custodian
correspondent banks ?

39

Liquidity Limits

High-level appetite statements shoud be translatable

into quantitative limits on liquidity KRIs

These should be reviewed regularly by management

Breaches must trigger review and action

For management purposes they must be further

articulated into more detailed drivers e.g.
eg

Volumes of specific balance sheet items

Anticipated loan and deposit growth
Correlations between funding sources
Number and frequency of use of facilities
Market liquidity:
q
y Bid-ask spreads,
p
, trading
g volume/size/frequency
q
y
VaR of collateral
40

Pricing Liquidity Risk

Identifying liquidity characteristics should be an integral

part of the Product Approval Process
Attributing a LR premium in transfer pricing further
aligns business decisions with LRM
LR premium = expected costs incurred due to LRM

Yield sacrifice on assets in required liquidity reserve

Commitment fees
etc

Should reflect marginal contribution of each particular

asset/liability to expected and stressed liquidity
requirement

Impact of maturity profile

Impact of embedded options
41

Collateral management

Testing the adequacy of the reserves means more data

to allow monitoring & management:

Pledged/unpledged status (including duration of pledge)

Eligibility for CB + counterparties
Haircut, collateral value volatility
Depth of market (traded vols vs banks holding)
Time to settlement
Custodian, clearing and correspondent arrangements
Legal entity, maturity, currency
Maturity of collateralised deal affects the type of collateral
Trigger events in securitisations can affect liquidity pos and
need to be modelled explicitly
And more
more
42

Technology Implications

Data

Across allll subsidiaries,

A
b idi i
business areas,
currencies, products
O version
One
i off the
th ttruth
th
Frequent upload
(especially for intra day)
Enhanced to include all
liquidity characteristics of
balance sheet, OBS and
collateral
Non-contractual
parameters
(customer/counterparty
behaviour, market data,
)

Analytics

Statistics market and

customer/counterparty
parameters
Cash flow generation
flexible and customisable
Scenario generation and
evaluation

Reporting Tools

Flexibility essential

43

Can we to capitalize liquidity risk?

Can or should we capitalize liquidity risk (assuming that

p
measure for liquidity-at-risk)?
q
y
)
we find a comprehensive

No! Capital is extremely rigid compared to securities available

for repo
Capital
p
ratios might
g be impeccable
p
but still illiquid
q
Liquidity crisis affecting trust might quickly erode capital

But just as capital, contingency funding capacities and

its publicity should mitigate reputation risk

LR is a consequential risk, contingency funding (stock of

U.A. and iron buffer) is a second line of defense

Conclusions

ALM: Liquidity risk no longer the poor cousin of IR risk

Regulatory emphasis on governance,
governance management and
measurement
Stress testing
g & dynamic
y
analysis
y
will be one of the
pillars of measurement
This will typically require investment in

Analysis
A
l i off the
th liquidty
li idt characteristics
h
t i ti off contracts,
t t collateral
ll t l
and funding sources
Enhancement of data stores to reflect thes characteristics
Integration of data sources & systems near time,
consolidated view
Dynamic modelling of the liquidity stock and flow under
different combinations of internal and external risk factors
Software

45

Thank you!
Pieter.de.saeger@finalyse.com