Question

1. Explain the difference between the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR).

2. Why is it risky to rely on wholesale deposits for funding?

3. What was the nature of the funding risk problems of Ashanti Goldfields and Metallgesellschaft?

Answer 1

Answer A: Both are part of Basel III Norms.

LCR is to make sure that Banks hold sufficient high quality liquid reserves to service the demands of customers in times of significant liquidity stress of up to 30 calendar days. Its a short term measure it does not restriction from where bank gets the funding as such but just want to ensure banks to hold funds in such a manner to service demands for up to 30 days in times of stress

NSFR it aims to promote resilience over a longer period of time by creating incentives for banks to fund their activities with the help of more stable sources of funding on the ongoing basis. It is a long term measure which changes the fundamental of bank fund sourcing.

Answer B: Wholesale deposits are risky as in times of stress/ panic, if these wholesale funds together try to withdraw their money it could create huge issues for the banks to service their demands (as it will be difficult to arrange big money), creating issues of liquidity for the bank where as if a lot small retail investors have deposited money in the bank there are less chances of them coming together and start withdrawing their funds in short span of time.

Answer C: The hedging these companies did led to a loss on the hedge done and gain on the position being hedged. The margin calls were asked for the loss done on the hedge. Unfortunately, the gain on the position being hedged increased value of the company but was not liquid leading to liquidity issues to fund the margin calls.