Implementation of Basel III Liquidity Requirements in Emerging Markets

Christopher Wilson

Monetary and Capital Markets DepartmentInternational Monetary Fund

October 31, 2017

2017 Seminar for Senior Bank Supervisors from Emerging Economies

Outline

1. Overview of BIII liquidity framework

2. Implementation challenges for EMDEs

3. Policy recommendations

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1. Overview of BIII Liquidity framework

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BIII introduced the first global liquidity framework

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Basel III

Sound

PrinciplesLCR NSFR

Monitoring

Tools

Taken together, it is a comprehensive framework for liquidity

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• Five monitoring tools

to breakdown the LCR

calculation and drivers

of liquidity

•Complete suite of risk

management –

governance, strategies,

policies, processes risk

appetite etc.

•30 day time horizon,

builds liquid buffers

under stressed

conditions

•A full balance-sheet

metric, one year time

horizon, contractual

maturity mismatch

NSFR LCR

Monitoring

Tools

Sound

Principles

LCR has a number of benefits to calculate short-term liquidity requirements

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Forward

looking

•Forward looking

estimates

•Calibrated using

behavioral data

Stressed

assumptions

•Market-wide &

idiosyncratic

•Applied to assets

and liabilities

Rigorous

eligibility for

HQLA

•Strict tests for

inclusion

•Limits on

composition

Bespoke

treatment of

liabilities

•Differentiates run-off rates

•Breaks down the liability structure

Experience from adopting countries suggest that business models are adjusting

Banks are moving toward lower more resilient funding structures business models to risk business models

Less reliance on market-based funding

Less reliance on short-term market financing

Bank‘s holding greater amounts of better quality liquids

Greater focus on transfer pricing e.g. internalizing cost of liquidity

Overall, risk management improved

As a result, banks’ business models are more resilient to short- term liquidity and funding shocks

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Benefits of implementing LCR for EMDEs include….

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Accurate, forward looking and risk sensitive measure of liquidity

in a stress

Incentivizes resilience to short term liquidity shocks via

management of the liability structure and HQLA

Discourages a reliance on short term, unstable sources of

funding e.g. wholesale, St repo

Encourages banks to improve management of liabilities

2. Implementation challenges for emerging economies

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While the LCR offers benefits, implementation is challenging

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Availability of HQLA

•Capital markets often not sufficiently deep and liquid

•Scarcity of assets

Calibration of stressed outflows

•Liability structure not easily segmented

•Dearth of data on behavior of liabilities in a stress

Implementation challenges more acute for EMDEs

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Less

developed

capital

markets

Less availability of

assets to qualify as

HQLA

uniqueness

Challenges in

meeting strict

definitions and

criteria in LCR

framework

Diversity

Dollarization, pegged

exchange rate regimes,

role of central bank,

role of required

reserves etc.

Implementation and policy challenges in EMDEs so far include

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Bank-Sovereign

Nexus

Fixed or Pegged

Exchange Rate

Dollarization

•May further entrench

negative feedback

loop

• Impact on reserves

•Potential pressure on

peg in a stress

•How does the central

bank guarantee

supply of FX?

3. Policy Recommendations

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The priority for Emerging economies should be the implementation of robust standards of risk management

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Liquidity

Sound

Principles,

BCBS 2008

Intraday

liquidity risk

and collateral

Contingency

funding plan

Severe stress

scenarios

Liquidity risk

tolerance

Adequate

liquidity

cushion

Allocate costs,

benefits and

risks

Identify &

measure full

range of

liquidity risks

Market

discipline

Adopt or adapt...

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Primary goal is to aim for strengthened liquidity

risk management

LCR has a number of benefits compared with

traditional coverage ratios

Convergence with LCR framework over times is

sensible

Local circumstances of economy and banking

system need to be accounted for

Following principles help implementation for emerging economies:

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•Modify initially with a view to reducing over time

Reduce variance over time

•Informs calibration, repeat throughout policy development

QIS absolutely essential

•Future-proof framework as markets and banks develop

Closely transpose LCR framework into local rules

•Understand impact, frictions

Strong industry engagement necessary

•Integrate LCR monitoring into offsite, regular onsite inspections

Develop supervisory capacity

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Making an assessment of whether a transition to Basel III liquidity makes sense – where to start?

Step 1: Assess the pre-conditions for

the applicability of the LCR

Can be made by looking at the money market conditions and the liquidity of

government securities. Does a repo market exist for government securities? Is the

market for government securities liquid (look at bid-ask spread, volumes, price

volatility, etc). Does the market exhibit different liquidity at different maturities? Are

there other liquid markets?

Step 3: Assess the current level of the

banks’ short term liquidity position

Can be made by looking at a number of ratios. Liquid Assets to Total Assets is a

commonly used but not fully appropriate measure as it does not provide information

about the adequacy of a given stock of liquid assets.

More in line with the rationale of the LCR is the ratio of Liquid Assets to Short Term

Funding (where deposits should not or should only partially be included).

Loans to Deposits ratio can also provide some useful insight with high values calling for

more in depth analysis.

Step 4: Assess the banks’ structural

liquidity position and the possible

impact of the NSFR

Requires an evaluation of banks’ maturity mismatch. The banks’ reliance on short term

wholesale funding should be investigated. The ratio of such funding to total liabilities

(excluding equity) should also be determined. At aggregate level, a large external debt

can be a signal of potential vulnerability.

A proxy impact of the NSFR can be assessed at bank level if adequate data is disclosed

using methodology proposed by IMF WP/14/106

Step 2: Consider evaluating

assumptions for the LCR

Particularly in the cases of crisis countries, with somewhat unstable banking systems,

the appropriateness of the assumptions used for the LCR could be usefully reviewed in

light of the current country’s experience.

Stylized BIII Liquidity Implementation Plan

BIII Strategic Road Map 2018 2019 2020

Q1 Q2 Q3 Q4 H1 H2

Basel III – Liquidity

Issue LCR draft rules for consultation

Establish a dedicated team of specialists

Perform initial stock-take QIS 1

Issue QIS results with specific guidance to industry

Assess QIS 2, perform calibration and issue final regulations

Commence work on NSFR

Enhancement of Supervisory Framework

Integrate the ILAAP review with the onsite supervision activities to produce a more risk-based approach

Integrate LCR monitoring tools into offsite supervision

Ensure LCR monitoring tools feed into the risk-rating of banks and onsite resource planning

Integrate LCR monitoring tools into offsite supervision

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Market

Monitoring

Significant

currencies

Concentration

of Funding

Available

unencumbered

Assets

Contractual

maturity mis-

match

If not implementing LCR now?

LCR: good benchmark for own

requirements

• Definition of liquid assets robust enough?

• Penalize Short-term wholesale funding?

• Reward stable source of funding (e.g., retail deposits)?

• Cover all possible cash outflows (e.g., off-B/S items)?

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Implementation of the NSFR should be undertaken after the LCR has been fully embedded.

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Sequence LCR first

Many of the definitions of assets and liabilities used in NSFR derive

from the LCR

Definitions

A sensible approach is to ensure banks are using these definitions

consistently and in line with the intent of the regulations before

moving into the NSFR

Calibration essential

Calibration of haircuts (ASF and RSF) need to be informed by

extensive quantitative analysis of impact on bank liquidity and

management of assets and liabilities

Summary

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BIII liquidity reforms

• Comprehensive regulatory framework for liquidity

• Significantly strengthen resilience of banks to liquidity shocks, disruptions

to funding markets

• Changed banks’ approach to liquidity risk management, internalized the

cost of liquidity

Policy recommendations for emerging economies

• Implement risk management standards as a priority, based on BCBS’s

Liquidity Sound Principles

• Adapt or adopt LCR on a time horizon that makes sense to suit local

conditions

• Integrate LCR monitoring into offsite supervision

• Once LCR implemented, consider NSFR

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Thanks & Happy Halloween!!

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Key resources

Liquidity Risk: management and supervisory challenges, BCBS, February, 2008

Liquidity Stress Testing: a survey of theory, empirics and current industry and

supervisory practices, BCBS, October 2013

Comptroller’s Handbook: Liquidity, OCC, June 2012

Principles for Sound Liquidity Risk Management and Supervision, BCBS, 2008

Managing Liquidity Risk, Swift, June 2011