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Basel III
liquidity risk
Banking insight
June 2011
Managing new
regulatory burdens
Why is liquidity being regulated?
During a financial crisis, banks may encounter
liquidity problems despite sound levels. In times of
stress it is quickly turn assets into cash overall capital
levels. stress, difficult to for all but the most liquid,
high credit quality securities in preferred currencies.
This flight to quality may force a bank in need of
cash to accept substantial haircuts on held assets the
immediate financial costs these haircuts may assets.
In addition to costs, erode confidence in the bank’s
solvency, create follow-on mark-to-market losses at
other institutions, and lead to a run on a bank’s funds.
Responding to this, the Basel Committee on Banking
Supervision (BCBS) issued liquidity supervision
guidance in December 2010. The guidance introduced
metrics for monitoring a bank’s liquidity needs in times
of stress. Key developments are:
• The Liquidity Coverage Ratio (LCR) guards against
short term (30 days) liquidity shortfalls.
• The Net Stable Funding Ratio (NSFR) encourages
banks to maintain high quality, long-term funding
over a medium term (one year) time horizon.
How will liquidity regulation affect my bank?
Liquidity regulations are designed to promote
bank health through periods of stress. They do this
by encouraging long term, high quality funding,
and by discouraging long-term, high risk business
activities. The flow on effects will be:
• Wholesale funding channels will become less
attractive as regulators emphasise the most
stable, long-term sources.
• Some business practices will become
nonviable due to increased liquidity
requirements.
• Competition will intensify for sound borrowers,
and for collateral as banks seek to minimise their
exposure to risky borrowers who are likely to draw
down loans during times of stress.
Yields on banking products and costs of funding
sources will adjust in the new environment. Despite
re-pricing, some products will not survive in their
present form.
Arbitrage opportunities may also arise, facilitated
by financial institutions outside Basel III’s
influence, or through alternative channels.
• Compliance costs will rise as new layers of
regulation impede management agility.
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Basel III liquidity risk | Managing new regulatory burdens
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Which products will suffer?
We believe that regulatory liquidity costs will be concentrated in the following products:
Product
Rationale
Wholesale funding
Wholesale funding is more mobile than retail funding, and will
therefore be subject to higher regulatory charges.
Inter-bank transactions
BCBS regulators are wary of reliance on other financial institutions,
as stress events are felt industry-wide.
High-risk loans
Cash flows from low credit quality counterparties are viewed as
vulnerable and illiquid during crises.
Lines of credit, overdrafts,
and credit cards
Undrawn credit limits currently cost banks very little in terms of
liquidity penalties. However, these facilities will be used during a crisis.
Collateral
Demand for high quality collateral will rise, lowering the yields on
collateralised transactions.
Looking forward
The impact of BCBS funding and
liquidity regulations is yet to be felt,
with the standards still in draft format.
What is clear is that regulators have
recognised:
• The need for both a long-term
measure (NSFR) and a short-term
measure (LCR)
• That the source of funding (retail
versus wholesale) has implications
during a stress event.
• That the level of risk within a bank’s
assets will affect its ability to raise funds
during a stress event.
• That liquidity will need to be held
for committed, undrawn lending
products.
All of which means that banks will need
to focus on their funding programs.
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Enhanced
liquidity
strategies &
frameworks
We:
Assess,
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If you require advice on this topic, please contact your
PwC representative or alternatively these Partners:
Sydney
Melbourne
Ashley Rockman
Steven Lim
Jason Slade
+61 (2) 8266 1882
[email protected]
+61 (2) 8266 8016
[email protected]
+61 (3) 8603 4803
[email protected]
© 2011 PricewaterhouseCoopers. All rights reserved. In this document, “PwC” refers to PricewaterhouseCoopers a partnership formed in
Australia, which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.
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Basel III capital reforms | Managing new regulatory burdens
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