liquidity risk pds

8/21/2019 Liquidity Risk PDS

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Liquidity Risk Management


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One year ago

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Agenda

Definition

Regulatory Response

Measurement & Management

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Liquidity Risk Management

Funding

Capital market funding providers 1

Funding

Funding Providers 1

liquidity risk

(liabilitiesrun-off)

Money market funding providers

Lenders of last resort central banks

2

3

liquidity risk

(liabilitiesrun-off)

Money market funding providers

Lenders of last resort central banks

2

3

Liquidityrisk

Struct

Longtermliqu

Op

erat

Shortte

rmliq

Co

ntin

liq

uidity

Management of fundingsources

Liquidityrisk

Struct

Longtermliqu

Op

erat

Shortte

rmliq

Co

ntin

liq

uidity

fundingsources

ral

idityriskmgt

ional

idityriskmgt

ency

iskmgt

Standing facilities

discount windows

Management of liquidity valuein secured fundingsources

ral

idityriskmgt

ional

idityriskmgt

ency

iskmgt

Standing facilities

discount windows

liquidityvaluesources

liquidity risk(asset

decreasing

liquidity value)

Repo-Sale securities borrowingand lending

liquidity risk(asset

decreasing

liquidity value)

Repo-Sale securities borrowingand lending

securitizationAssets

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


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Specificities of Liquidity Risk

Consequential risk

, ,

Not a solvency capital issue (unlike market/creditrisk)

A solvent bank can have liquidity problems and vice versa

Low frequency, high impact and rapid onset ,

A quick killer!

Funding LR is very institution specific

Need to test endogenous factors (reputation, rating)

Contingencies must be planned well before trouble

Market confidence is key a well executed contingency planprevents a downward spiral5


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Agenda

Definition

Regulatory Response


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Risk Management Investments

7Source: Economis t Intelligence Unit, Entrepr ise Risk Management Services Survey, Sep 2008


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Asset mix

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Market Liquidity evaporated

160,000

180,000

Spread Euribor 3M - Eonia (bp)

120,000

140,000

80,000

100,000

20,000

40,000

,

-20,000

0,000

9

-40,000


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Liquidity Buffers

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Open market operations and lending

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Agenda

Definition

Regulatory Response


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Regulatory Initiatives

No true international framework yet

BIS Principles for Sound Liquidity Risk Management

and Su ervision Se 2008

CEBS Interim Report on Liquidity Buffers & Survival

Periods FSA Strengthening Liquidity Standards (Dec 2008,

June 2009)

Global & Local stress test exercises (all supervisors)

More to come

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Overall regulatory message

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CEBS Report on Liquidity

Three types of stress scenarios

No rollover of (unsecured) funding + retail deposits outflows Market

ec ne n qu y va ue + e er ora ng un ng con ons

Combination of both

1 month survival period for determining buffer

Composition buffer

Short term: Cash + assets eligible by National Bank

onger erm: ore s e g e qu n pr va e mar e s un erstress conditions and given the survival period

Location and size of the buffer need to reflect the

organisation within a banking group

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CEBS Report on Liquidity

Buffer: the liquidity available to cover the gap

cumulative sum of all cash outflows within a certain timeperiod.

Counterbalancing capacity: refers to the liquidity that a

firm is expecting to be able to access over a given

Liquidity Gap, Cash Flow Projections under different

Scenarios

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Agenda

Definition

Regulatory Response


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LR Measurement - components

Cash flow projectionsExternal sources

-- Intra-day, short, medium

long term

- Contractual and contin ent

,

repo facilities, CP programs,)

- Retail & wholesale-

Best

- Internal & external- High quality, diverse liquidassets

- Supply & demand factors

- Adequacy of buffer-Active collateralmanagement

tress tests Internal sourcesSource: Principles for Sound Liquidi ty Risk Management and Supervision,

Basel Committee on Banking Supervision, September 200818


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Cash Flow Projections

Fix rate loans and Variation margins

AMOUNTknown unknown

mor gages

Cash/repos/collateralised lending

Options with fixed

exercise date(european)known

Term deposits

Fixed coupons from

bonds swaps etc

Floating rate loans

and deposits

TIMING

Travelers cheques

Callable bonds

Revolving

loans/cards

Current accounts

loans Savings accounts

Investment assets

unknown

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Static Liquidity Measures

Ratios

-

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

liabilites

Survival time : time at which cumulative cash flow


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Typical static liquidity gap report

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Dynamic Analysis

Inflows, outflows and counterbalancing capacity

Scenario analysis

Change in drivers has different changes on balance sheet

components

Net liquidity position

For each scenario

orwar qu y exposure

Counterbalancing capacity

Net Liquid Position

Definition of scenarios!


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Modelling Scenarios

Specify supply and demand for liquidity

Maturing assets

Assets for sale/

how low can we go?

Lines in favour

Renewed term

Maturing liabilities

Lines againstun ng

Deposit growth

New production

OBS liabilities

an s ress e parame ers a a ec e r vo ume

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Balance Sheet organisation

Assets On-Balance Liabilities

Debt asset liquidity

Equity asset liquidity Liquid loans

Interbank

Illi uid loans

Interbank funding Call O/N Term

Wholesale funding

Retail Private MidCap Wholesale

Interbank

Ca a e Term (CP, CD, MT, LT)

Fiduciary funding Midcap funding

Intragroup funding Retail fundin Private banking funding Other unsecured funding

Rights(long optionality)

Off-BalanceCommitments

(short optionality)

Committed lines received Deposit breakdowns Committed lines given ABCP conduit facilities Uncommitted lines given Margin requirements

Credit support annex


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Defining Liquidity Risk Profile for A/L

A/L sensitive to credit quality of the bank

All fundin business the

Derivative exposures (CSA)

LR amplified by liquidity call option (on the bank)

ogenou

st

firm

All loan business

LR amplified by maintaining the business franchise

En

A/L sensitive to asset quality criteria (eligibility)

Liquid assets in the trading bookothe

sse s n e process o secur za on

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

Credit facilitiesxogenous

t

firm

Derivative exposures (margin requirements)


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Parameters for Scenario Analysis

Example parameters to estimate and stress:

Run off of retail funding Asset price vol, market

Loan and deposits growth Liquidity effect of

Availability and tenor of

(un)secured funding

,

securitisation programs

Credit rating triggers orre a on e ween

sources of funds

Haircuts, margin/collateral

ra es an access o

forex markets

Transferability of cash

ca s Behaviour of contingent

claims on and by bank

w n group Access to Central Bank

facilities

Performance of clearing

and settlement

Planned mergers and

aquisitions26


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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 SDD20Assumed Committed

Line withdrawal

D+10 D+15 D+20 D+25 D+30 D+35 D+40D 0 Assumed RetailD+5

Cumulated CF

Chal len e : Legend :

D+5 D+10 D+15 D+20 D+25 D+30 D+35 D+40D 0

Estimate behavioral and modeled withdrawal rates

by types of client (retail, corporate, bank, fiduciary,)

for each scenario

= outstanding undrwan CCL

= outstanding sight dep.


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Scenario procedure Scheduled CF

Dynamics of Term Deposits< 0 ECF

tDD-15/D+5

tDD+5/D+25 =

rr + x tD - +

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

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

tDD+25/D+45 = rrD+25 x tDD+5/D+253.

D-15 D-10 D-5 D+5 D+10 D+15 D+20 D+25 D+30 D+35 D+40D 0

. .

-tDD-15/D+5

-tDD+5/D+25

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 = rr x tD

Assumed

renewal rate -

Withdrawn part generates a claimed CF of (1-rrD+5) x tDD-15/D+53. Part of renewed deposit is renewed again for 20 days

Renewed notional = rr D+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

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


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Liquidity Risk Components

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Net Liquidity Position

200.000200.000

100.000

150.000

100.000

150.000

Counterbalancing CF

-

50.000

-

50.000

Contractual CF

Future Contractual CF

Potential CF

(50.000)(50.000)

+1day +1day +1week +1month +3month

(150.000)

(100.000)

(150.000)

(100.000)

(200.000)(200.000)


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Counterbalancing Capacity

Today _ON_ _ON_ _ON_ _ON_ _TN_ _TN_ _TN_ _TN_

9/17/2008 9/18/2008 9/18/2008 9/18/2008 9/18/2008 9/19/2008 9/19/2008 9/19/2008 9/19/2008

CounterbalancingCapacity

20.4 5% 75% 14.55 25.4 5% 0.75 18.08

0.7 5% 100% 0.63 0.7 5% 1.00 0.63

1.0 5% 100% 0.95

1.2 5% 1.00 1.14

32.3 15% 20% 5.49 32.1 15% 0.20 5.46

4.3 35% 10% 0.28 5.1 35% 0.10 0.33

Liquidation

capacity LV

Liquidation

capacity LV Marketval ue HaircutMarketvalueLV Haircut

DebtsecuritiesS&Prating


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Constructing richer and relevant scenarios

Objective: to evaluate the impact of sudden abnormalevents on the liquidity position of the bank

Scenarios can be based on historic eventsacknowled in the im ossibilit of histor s recurrence

Plausibility of scenarios means credibleness,

Most of the time we remain on the credible (possible) becausethey have happened.

Instead of focusing on the reasonability sense of the word.

Assessments in terms of reasoning the inherent logic ofa scenario In search of vulnerabilities of the underlying business model


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Stress test design

Test liquidity capacity beyond static business as usual

Scope All entities, currencies and products

Multiple time horizons

Institution-specific stress and market stress

Extreme but plausible

Forward looking (expert assessment to supplement poor history)

All material drivers/assumptions should be stressed

in a way that reflects relations between drivers

Signed-off by top management

Consistent with Contingency Funding Plan33


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We can start with

Scenario name

Display of net liquidity and CBC according to their contractualmaturities, assuming that:

Legal all contracts are legally binding and credit risk assumptions are avoidedl no renewal o matur ng us nesses

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

Going concern (GC) the business franchise is kept at the current level; i.e. maturing cash flows arereplaced by identical anticipated cash flows in a way to keep the overallamount 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


Business plan (BP) as GC, but mimicking the growth/decline behavior of the business franchiseas defined in the yearly business plansdefined in the yearly business plans CBC can generate cash if needed through repo or sale; i.e. no contingency


Name (confidence) crisis the business franchise is affected by the partial loss of funding, theimpossibility of cash flow renewal, the contraction of funding maturities and/orthe expansion of generated credit maturities

severe deviations from severe deviations fromhistorical/normal trend

CBC: cash generating assets experience significant haircuts and contingencyfunding channels can be partially or completely closed

Systemic market crisis similar to name crisis with intensity of assumptions varying according to howmuch the reputation and trust of the institution might be affected

channels can be partially or completely closed

Name-crisis amid

market turmoil

similar to name crisis with higher intensity

CBC: cash generating assets experience significant haircuts and fundingchannels can be partially or completely closed


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About stochastic measures

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


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Survival time

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

1 5

2 0

0

5

1 0

O / N 8 D 1 4 D 1 M 3 M 1 Y 3 Y 6 Y > + 1 0 Y

- 1 5

- 1 0

- 5

Measure of maximum intervention horizon

-

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Expressing Liquidity Risk Appetite

What are the plausible if rare internal and external

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 term37


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Contingency Funding Plans

Purpose: survive freeze with minimal reputational damage

Triggers and actions Timing

Alternatives and alternates

Priorities

Le al and re ulator re uirements

Operational constraints

Communication plan

o o con ac or w a an w en

Manage reputation risk (minimise vicious circle)

Test CFP in Stress Testin framework ensure

consistency with business and risk appetite38


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Intra-day LR issues

Identify critical intraday obligations and ensure they are

Time specific items, clearing systems (rules forpayment/settlement)

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

Frequent monitoring of key positions

Understandin of rocedure and timin of use of collateral

Impact of operational disruptions at clearing, custodian

correspondent banks ?39


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Liquidity Limits

High-level appetite statements shoud be translatable

These should be reviewed regularly by management Breaches must trigger review and action

For management purposes they must be further

. .

Volumes of specific balance sheet items

Anticipated loan and deposit growth

Correlations between funding sources Number and frequency of use of facilities

Market li uidit : Bid-ask s reads, tradin volume/size/fre uenc

VaR of collateral40


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Pricing Liquidity Risk

Identifying liquidity characteristics should be an integral

Attributing a LR premium in transfer pricing furtheraligns business decisions with LRM

LR premium = expected costs incurred due to LRM

Yield sacrifice on assets in required liquidity reserve

etc

Should reflect marginal contribution of each particular

asset/liability to expected and stressed liquidityrequirement

Impact of embedded options41


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Collateral management

Testing the adequacy of the reserves means more data

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

Trigger events in securitisations can affect liquidity pos and

need to be modelled explicitly

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Technology Implications

Data Analytics

cross a su s ar es,

business areas,currencies, products

customer/counterparty

parameters

ne vers on o e ru

Frequent upload

(especially for intra day)

flexible and customisable

Scenario generation and

Enhanced to include all

liquidity characteristics of

balance sheet, OBS and

Reporting Tools

Flexibility essential

Non-contractual

parameters

behaviour, market data,

)43


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Can we to capitalize liquidity risk?

Can or should we capitalize liquidity risk (assuming thatwe find a com rehensive measure for li uidit -at-risk ? No! Capital is extremely rigid compared to securities available

for repo

Ca ital ratios mi ht be im eccable but still illi uid

Liquidity crisis affecting trust might quickly erode capital

But just as capital, contingency funding capacities andits publicity should mitigate reputation risk

LR is a consequential risk, contingency funding (stock ofU.A. and iron buffer) is a second line of defense


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Conclusions

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

,

measurement Stress testin & d namic anal sis will be one of the

pillars of measurement

This will typically require investment in

na ys s o e qu y c arac er s cs o con rac s, co a era

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

Software45


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Thank you!

[email protected]

liquidity risk pds

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