Question

a) Which assets have a high required stable funding factor? Why?

b) Which liabilities have a high available stable funding factor? Why?

c) Explain the reason for the choice of the numerator and denominator in the Liquidity coverage ratio.

Answer 1

1. Which assets have a high required stable funding factor? Why?

Assets assigned a 100% RSF factor comprise:

(a) All assets that are encumbered for a period of one year or more;

(b) Derivatives receivable net of derivatives payable if receivables are greater; and

(c) All other assets not included in the above categories, including non-performing loans, loans to financial institutions with a residual maturity of one year or more, non-exchange-traded equities, fixed assets, pension assets, intangibles, deferred tax assets, retained interest, insurance assets, subsidiary interests and defaulted securities.

The amount of required stable funding is measured based on the broad characteristics of the liquidity risk profile of an institution’s assets and OBS exposures. The amount of required stable funding is calculated by first assigning the carrying value of an institution’s assets to the categories listed. The amount assigned to each category is then multiplied by its associated required stable funding (RSF) factor and the total RSF is the sum of the weighted amounts added to the amount of OBS activity (or potential liquidity exposure) multiplied by its associated RSF factor. Definitions mirror those outlined in the LCR, unless otherwise specified.

The RSF factors assigned to various types of assets are parameters intended to approximate the amount of a particular asset that would have to be funded, either because it will be rolled over, or because it could not be monetised through sale or used as collateral in a secured borrowing transaction over the course of one year without significant expense. Under the standard, such amounts are expected to be supported by stable funding.

Assets should be allocated to the appropriate RSF factor based on their residual maturity or liquidity value. When determining the maturity of an instrument, investors should be assumed to exercise any option to extend maturity. For amortising loans, the portion that comes due within the one-year horizon can be treated in the less than a year residual maturity category.

2. Which liabilities have a high available stable funding factor? Why?

Liabilities and capital instruments receiving a 100% ASF factor comprise:

(a) The total amount of regulatory capital, before the application of capital deductions, as defined in paragraph 49 of the Basel III text, 5 excluding the proportion of Tier 2 instruments with residual maturity of less than one year;

(b) The total amount of any capital instrument not included in (a) that has an effective residual maturity of one year or more excluding any instruments with explicit or embedded options that, if exercised, would reduce the expected maturity to less than one year; and

(c) The total amount of secured and unsecured borrowings and liabilities (including term deposits) with effective residual maturities of one year or more. Cash flows falling below the one-year horizon but arising from liabilities with a final maturity greater than one year should not qualify for the 100% ASF factor.

The amount of available stable funding (ASF) is measured based on the broad characteristics of the relative stability of an institution’s funding sources, including the contractual maturity of its liabilities and the differences in the propensity of different types of funding providers to withdraw their funding. The amount of ASF is calculated by first assigning the carrying value of an institution’s capital and liabilities to one of five categories as presented below. The amount assigned to each category is then multiplied by an ASF factor, and the total ASF is the sum of the weighted amounts. Carrying value represents the amount at which a liability or equity instrument is recorded before the application of any regulatory deductions, filters or other adjustments.

When determining the maturity of an equity or liability instrument, investors are assumed to redeem a call option at the earliest possible date. For funding with options exercisable at the bank’s discretion, banks should assume that they will be exercised at the earliest possible date unless the bank can demonstrate to its supervisor’s satisfaction that the bank would not exercise this option under any circumstances. For long-dated liabilities, only the portion of cash flows falling at or beyond the six-month and one-year time horizons should be treated as having an effective residual maturity of six months or more and one year or more, respectively.

3. Explain the reason for the choice of the numerator and denominator in the Liquidity coverage ratio

Liquidity coverage ratio: High liquid assets / expected cash outflow

LCR, which is the minimum percentage of a bank's expected cash outflows to be held in highly liquid assets. Expected net cash outflows are the bank's anticipated 30-day liquidity needs in a stress scenario and the highly liquid assets include only those of high quality and immediately convertible into cash. The minimum LCR of 100% is recommended. Anything less would indicate an inability to meet liquidity needs.

In simple words: In a stress scenario, A bank's ability to survive for 30 days. You can think of this COVID situation, let's say if the bank is not earning anything and have to meet some short term obligation, the bank can meet this obligation by selling its highly liquid assets to survive the situation.