basel iii liquidity risk compliance and stress testing approaches and best practices

1. Basel III Liquidity Risk Compliance and Stress Testing Approaches and Best Practices Basel III For Taiwan Academy of Finance and Banking 11 Aug 2014 , PAN Wei You, FRM, PMP, SCEA, [email protected]

2. Agenda 1. Basel III Liquidity Risk Overview 2. Challenges of Basel III Liquidity Risk Compliance 3. Best Practices in Managing the Compliance Challenges 4. Conclusion Enterprise Risk Solutions 2

4. Basel III Liquidity Risk Ratios Liquidity risk ratios : A short term ratio (LCR) with a 30 days time horizon : Liquidity Coverage Ratio = Stock of High Quality Liquid Assets Total Net cash outflow over 30 days 100% A long term ratio (NSFR) with a 1 year time horizon relying on regulatory factors Enterprise Risk Solutions Net Stable Funding Ratio = Available stable funding Required stable funding 100% defined for stress test scenarios 4

6. Key Challenges of Basel III Liquidity Risk Compliance Credit Risk Integration Challenges Multiple Regulators Compliance Challenges Operational Challenges Enterprise Risk Solutions Stress Testing Challenges 6

7. LCR - HQLA 100% 100% 0% 100% 100% 0% 100% (L1) LCR = HQLA TNCO ---------- Enterprise Risk Solutions 7 A 20% 85% twAA-85% twAA-85% A(L2A) B 75% twA+twBBB-50% 50% B(L2B) LCR Liquidity Coverage Ratio HQLA High Quality Liquid Asset TNCO Total Net Cash Outflows (for 30 calendar days) twAA- twA+twBBB

8. Basel Credit Risk Challenges Enterprise Risk Solutions 8 Reference : 5. -

9. Basel Credit Risk Challenges What if we have multiple ratings for the same issue eg. AA-, A-, BBB+, BBB ??? 3 Enterprise Risk Solutions 9 Reference : 5. -

10. Key Challenges of Basel III Liquidity Risk Compliance Credit Risk Integration Challenges Multiple Regulators Compliance Challenges Operational Challenges Enterprise Risk Solutions Stress Testing Challenges 10

11. Multiple Regulator Compliance Challenges Enterprise Risk Solutions 11

12. Multiple Regulatory Compliance National Discretions National Discretions Example : HQLA Eligibility Comparison HQLA 2B TW Eligibility SG Eligibility HK Eligibility RMBS Case by Case Common Equity Different Eligibility or Factors due to National Discretions eg. HQLA example above Different Applicability of Rules eg. banks classified into different tiers (FED, HKMA, MAS, CBRC, etc) Simplified Rules eg. TW Stable Deposits definition for 3% and 5% runoff Additional Rules eg. APRA Less Stable Deposits scorecard approach to determine 10% and 25% runoff Higher Benchmark eg. FED Peak Cumulative Net Cash Outflow Other Differences Enterprise Risk Solutions 12

13. MAS Foreign Bank Branch Compliance MLA Minimum Liquid Assets Enterprise Risk Solutions 13

14. HKMA - Foreign Bank Branch Compliance For Foreign Bank Branch, the inclination is towards qualitative considerations - HKMA considers it appropriate to adopt an approach that focuses more on the qualitative elements (including the home factors) in determining the classification status of FBBs. Ref : Consultation Paper Implementation of Basel III Liquidity Standards in Hong Kong (L3) Adequacy of home jurisdiction liquidity requirements Group compliance with home jurisdiction liquidity requirements Global liquidity risk management system Effective home-host information-sharing arrangements Enterprise Risk Solutions 14

15. Home Compliance Not Forget Foreign Branches Host - () 3% 5% 10% LCR = HQLA TNCO ---------- : 5% 10% Enterprise Risk Solutions 15

16. BCBS vs TW : Different Deposit Runoff Rates Enterprise Risk Solutions 16

17. BCBS Stable vs Less Stable Deposit Data Challenges Established Relationships depositor and account based analysis How many type of banking relationship ? How long has been for each relationship ? How long has the account be dormant or inactive ? Enterprise Risk Solutions Transactional Accounts account based analysis Funds receive on regular basis ? Eg. Salary account automatically deposited ? Used for payments on regular basis ? Eg. bill payments ? Number of transactions monthly ? 17

18. Regulatory Compliance Changes and Time Pressures Enterprise Risk Solutions 18

19. Key Challenges of Basel III Liquidity Risk Compliance Credit Risk Integration Challenges Multiple Regulators Compliance Challenges Stress Testing Challenges Enterprise Risk Solutions Operational Challenges 19

20. Stress Testing and Scenario Analysis Stress tests and Scenario Analysis help banks to identify and quantify exposures to risks and also impacts on cashflows, liquidity position, profitability and solvency. BCBS requires internal stress test beyond LCR stress scenarios. Internal stress tests allows incorporate of banks construct their own stress scenarios and for longer time horizon. Besides historical stress events, regulators may require banks to consider the impact of portfolios changes, customer behavior changes and other potential risks. US FED liquidity stress test requirement for qualifying BHO and FBO Monthly stress test Cash flows, liquidity profile, profitability, solvency Overnight, 30d, 90d, 1y, custom horizons (driven by business model) Adverse, combined, idiosyncratic and custom scenarios (driven by business model) Enterprise Risk Solutions 20

21. Challenges of Stress Testing and Scenario Analysis Stress Testing Approach ? Scenarios Design ? Behavior Model ? Data Availability ? Enterprise Risk Solutions System and Infrastructure ? 21

22. Key Challenges of Basel III Liquidity Risk Compliance Credit Risk Integration Challenges Multiple Regulators Compliance Challenges Stress Testing Challenges Enterprise Risk Solutions Operational Challenges 22

23. Operational Challenges Daily LCR BCBS recommended Min Monthly and Weekly or Daily LCR regulatory reporting in times of stress BCBS requested LCR reporting using Daily Averages over financial reporting period (eg. quarterly or semi-annually) Global trend on practicing Daily monitoring and compliance Daily LCR Monitoring : For example - Singapore MAS Enterprise Risk Solutions 23

24. U.S. Financial Industry - Operational Challenges Collect Daily Collect extensive data to classify Classify counterparties Alter current deposit systems to determine Enterprise Risk Solutions 24 Contractual Cash Flow operational and non-operational deposits based on various definitions coverage by deposit insurance on daily basis Reference: 20140519 Joint Trades Comment Letter on LCR Daily Calculation Requirement

26. Data Granularity and Quality Management Best Practices Data Granularity and Consolidation Data Quality Team Data Quality Improvement Process Data Quality Management Tool Enterprise Risk Solutions 26 Liquidity Credit Risk ALM

27. Liquidity Risk Indicators Computation Best Practices Cash Inflow, Outflow Classification and Factors Retail, Wholesale, Stable vs Less Stable, Operational vs Non-Operational, Derivatives, etc HQLA Eligibility, Classification and Haircuts Rules Level 1, 2A, 2B, Haircut , Caps and Adjustments Home/Host Rules Enterprise Risk Solutions 27 Management Granular Liquidity Cashflows Asset/Liability, Off-Balance Commitments and Derivatives Principal vs Interests Daily Cashflows Generation Basel II/III Credit Risk Framework Counterparty Type, Rating/PD, Country, Aggregated Exposure, etc Daily Risk Weight Calculations Account and Transaction Characteristics and Operational Requirements Data

28. Compliance Rules Management Best Practices Make use of a systematic and transparent management approach Train up a team with risk, compliance and system knowledge Build a cooperative structure within bank HQ, Subsidiaries and Branches for compliance Enterprise Risk Solutions 28

29. Stress Testing and Scenario Analysis Best Practices Country Outlook Macroeconomic Context Risk Factors Outputs Risk Maps Scenarios Creation Enterprise Risk Solutions Behavior Models Assets (Modeled) Assets (Non Modeled) Liabilities (Modeled) Liabilities (Non Modeled) Off balance Sheet (Modeled) Off balance sheet (Non Modeled) Mild Moderate Severe Market Institutional Combined Balance Sheet

30. Scenario Design ( Example- Risk Maps Bank Specific ) Concern (Solvency) Regulatory Concern Retail Depositors Large withdrawal Large Interest Rate Early Warning Indicators Internal Risk and Profitability Indicators No rollover Enterprise Risk Solutions Bank Credit Downgrade Corporate Depositors Withdrawal of Funds Rollover less than 50 -70% Rollover more than 70%

31. Operational Best Practices Cash Flows Cash Flows Cash Flows Balance Sheet Market Data Shifts Behaviour Models Credit Factors Enterprise Risk Solutions 31 Finance, Risk and Scenario Management Platform Cash Flows Cash Flows Cash Flows Forecast

32. Multiple Regulator Reporting Best Practices Enterprise Risk Solutions 32

33. Report Compliance Audit Best Practices Enterprise Risk Solutions 33

34. Strategy Refinement for Compliance and Profitability Enterprise Risk Solutions 34

36. Conclusion New Era for Liquidity Management Liquidity management is now part of Basel regulatory indicators framework. This triggers a new wave for managing Basel compliance challenges and implied business challenges for ALM team and banks. Multiple Challenges Posed By Basel III Liquidity Management New considerations and challenges : credit risk, multiple regulatory compliance, operational and the associated data requirement and will be worsen by daily LCR Enterprise Risk Solutions reporting requirements. Stress Testing and Scenario Analysis Key to managing liquidity risk and balancing profitability expectations. Should be an at the forefront of banks liquidity risk management strategy. Addressing Basel III Liquidity and Stress Testing Challenges Employ industry best practices of integrating liquidity and credit data, risk calculation processes and stress testing/scenario analysis into a common platform to manage the new compliance and induced profitability challenges. 36

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basel iii liquidity risk compliance and stress testing approaches and best practices

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