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LCR - Liquidity Coverage Ratio

Basel-III
by

vikram jain

on 28 May 2015

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Transcript of LCR - Liquidity Coverage Ratio

Thank you
Questions
Next steps
Why Liquidity?
Challenges while calculating LCR

Banks need liquidity because they cannot always control the timing of their needs for cash.
Background of LCR
What is LCR
Why is LCR important
What are banks supposed to do?
When does it come in force
LCR in detail
LCR Ratio
HQLA - Numerator
Net Cash Outflow - Denominator
Overview of the LCR model
Next Steps
Q & A
So, What’s new?
WHEN does it come in force
Previous attempts by regulators to manage Liquidity risk
HOW can we (KPMG) help
when LCR calculated
Agenda
LCR falling below 100% during period of stress
What’s the Risk, if bank can’t meet liquidity requirements?
Question
Example of Level 1 asset
Different Outflow/Inflow categories
Example
HQLA Amount - Numerator
Excluded assets
LCR Ratio
Total Net Cash Outflow Amount - Denominator
Hour of Power Session # 8
Liquidity Coverage Ratio (LCR)
U.S LCR [Basel - III]
May 28th, 2015
Reasons:
Unexpected withdrawals by depositors,
sudden unavailability of interbank loans,
need for cash to meet line-of-credit agreements,
need to honor off-balance sheet obligations
Regulations can moderate liquidity risks by setting rules for both the asset and liability sides of bank balance sheets.
Basel II did not prevent the most recent global financial crisis. Failure of banks required
rescues and restructurings
that ran to billions of dollars.
Early in the crisis, a few weak banks were
forced to dump assets
to cover deposit losses, collateral calls, or other liquidity needs.
Falling asset prices
weaken the balance sheets of other banks
, and force them, too, to sell assets at fire sale prices. Soon even healthy banks are subject to stress.
In the fall of 2008, such a liquidity crunch helped spread the financial crisis throughout the globe from its origins in the U.S. subprime mortgage market.
LCR liquidity regulation require measuring the liquidity of various kinds of assets and liabilities of a banking organization.

It requires a banking organization’s stock of UNENCUMBERED high-quality liquid assets (HQLAs) to be at least 100% of its total net cash outflows over a 30-day stress period.

The latest regulation covers all the specific details of:
Assets that qualifies as liquid assets
Percentage of liquidity to be considered (Haircuts)
Limit for proportion of different levels of liquid assets
Different rates for various outflow/inflow categories

LCR Regulation is not currently in force
KPMG is helping banks prepare much ahead of the timelines communicated
Developed a model to help banking clients achieve compliance with LCR regulations.

Model forecasts LCR and help banking organization withstand a 30-day standardized stress scenario.

Key point here is that even if one calculates the LCR at the end of the day and finds out that they are non compliant with the regulatory requirements, they can't do anything.  Hence, LCR needs to be managed on a forecasting basis.

Model flexible enough to cater to both Cash Outflow and Inflow rates sensitivities – to be discussed later.
There is a transition period to the daily LCR calculation for banking organizations that become subject to the regulation.

Monthly LCR calculation - for the first 9 months in the first year of compliance.
Daily LCR calculation – post first 9 months of the first year of compliance.

A banking organization must calculate its LCR at the same time on each calculation day. A banking organization must select a calculation time by written notice to its primary federal banking regulator

Reserves of liquid assets provide a first line of defense, but as those are depleted, a bank may have to sell less liquid assets at “fire sale” prices below book value. Doing so erodes its capital and may lead to INSOLVENCY.
HQLA Amount - Numerator
Total Net Cash Outflow Amount on a calculation date represents

The amount of liquidity that a banking organization should expect to flow out of the consolidated organization over a 30-day stress period following the calculation date.
minus certain inflows that offset the outflows (capped at 75% of outflows)
plus an add-on to account for maturity mismatches from early inflows and late outflows
using standardized quantitative assumptions about the effects of the stress on outflow and inflow rates for different instrument and transaction types
A banking organization must generally maintain a LCR of ≥ 100%.However, the Agencies recognize that under certain circumstances, it may be necessary for a banking organization’s LCR to briefly fall below 100% to fund unanticipated liquidity needs.

Liquidity Compliance Plan: Banking organizations must promptly consult with the supervisory agency and provide to the agency a plan for achieving compliance with the minimum LCR and all other requirements of the LCR Rule.
We will be working in collaboration with data teams to identify what data needs to be extracted from which systems to feed into the model, so that we can deploy this for various banks.
Calculating LCR is not straight forward
A banking organization has various portfolios with separate logic to calculate values of different portfolios.
Need to understand different banking systems to extract data, understand data classification the periodicity of data updates - Batch processing.
Need to forecast LCR with accuracy for the next 30 days.

Defines which instruments constitute HQLAs;
Prescribes standardized cash inflow and outflow rates that a banking organization must use to calculate its total net cash outflows over the 30-day stress period.
Prescribes the methodology for calculating total net cash outflows.
Level 1 Assets
Level 2A Assets
Level 2B Assets
Excess reserves held at Federal Reserve Bank
Withdrawable reserves held at a Foreign Central bank
Securities issued/guaranteed by US Treasury
Securites issued by BIS, IMF, ECB, European Community etc
Securities, guaranteed by US Govt, such as Fannie Mae and Freddie Mac
Securities guaranteed by Sovereign entity or Multilateral Development Bank (MDB)
Corporate Debt Securities
Certain publicly traded common equities
Caps on Level 2 assets are meant to ensure that the majority of a banking organization’s HQLAs consist of Level 1 assets
The amount of Level 1 assets thus acts as a constraint on the recognition of Level 2 assets as HQLAs
Vault Cash
State and municipal securities
Asset-backed securities
Private label Mortgage-backed securities
Mortgage loans
Investment company shares (Shares of Mutual Funds etc)
0%
Answer
Percentage haircut applicable to Level-1 assets?
a) 0%
b) 15%
c) 20%
d) 50%
are just few of many reasons that banks need liquidity.
The U.S LCR
Retail funding
Retail cash inflow amount
Structured transaction outflow amount
Net derivative cash outflow (inflow) amount
Mortgage commitment outflow amount
Excluded mortgage cash inflows
Commitment outflow amount
Excluded credit or liquidity facility inflow
Collateral outflow amount – Collateral substitution
Retail brokered deposit outflow amount
Unsecured wholesale funding outflow amount
Unsecured wholesale cash inflow amount
Excluded Inflows from operational deposits
Debt security buyback outflow amount
Secured funding outflow amount
Asset exchange outflow amount
Maturity Mismatch Add-on
Impact of 2008 financial crisis
Full transcript