CAIIB BFM Module B Unit 8 : Basel III Framework on Liquidity Standards

19/09/2023

Table of Contents

CAIIB Paper 2 BFM Module B Unit 8 : Basel III Framework on Liquidity Standards (New Syllabus)

IIBF has released the New Syllabus Exam Pattern for CAIIB Exam 2023. Following the format of the current exam, CAIIB 2023 will have now four papers. The CAIIB Paper 2 (Bank Financial Management) includes an important topic called “Basel III Framework on Liquidity Standards”. Every candidate who are appearing for the CAIIB Certification Examination 2023 must understand each unit included in the syllabus.

In this article, we are going to cover all the necessary details of CAIIB Paper 2 (BFM) Module B (RISK MANAGEMENT) Unit 8 : Basel III Framework on Liquidity Standards, Aspirants must go through this article to better understand the topic, Basel III Framework on Liquidity Standards and practice using our Online Mock Test Series to strengthen their knowledge of Basel III Framework on Liquidity Standards. Unit 8 :Basel III Framework on Liquidity Standards

Objective

The LCR standard aims to ensure that a bank maintains an adequate level of unencumbered HQLA, that can be converted into cash to meet its liquidity needs for a 30 calendar day time horizon under a significantly severe liquidity stress scenario specified by supervisors.
At a minimum, the stock of liquid assets should enable the bank to survive until day 30 of the stress scenario, by which time it is assumed that appropriate corrective actions can be taken.

Scope

To start with, the LCR and monitoring tools would be applicable for Indian banks at whole bank level only i.e. on a stand-alone basis including overseas operations through branches.
However, banks should endeavour to move over to meeting the standard at consolidated level also. For foreign banks operating as branches in India, the framework would be applicable on stand-alone basis (i.e. for Indian operations only).

Liquidity Coverage Ratio (LCR)

The Liquidity Coverage ratio is computed as under:

Calculation of LCR

As stated in the definition of LCR, it is a ratio of two factors, viz. the Stock of HQLA and the Net Cash Outflows over the next 30 calendar days.
Therefore, computation of LCR of a bank will require calculations of the numerator and denominator of the ratio, as detailed in the RBI Circular.

Liquidity Risk Monitoring Tools

In addition to the two liquidity standards, the Basel III framework also prescribes five monitoring tools/ metrics for better monitoring a bank’s liquidity position. These metrics along with their objective and the prescribed returns are as under:

Contractual Mismatch Maturity

The contractual maturity mismatch profile identifies the gaps between the contractual inflows and outflows of liquidity for defined time bands. These maturity gaps indicate how much liquidity a bank would potentially need to raise in each of these time bands if all outflows occurred at the earliest possible date.
This metric provides insight into the extent to which the bank relies on maturity transformation under its current contracts.

Concentration of Funding

This metric is meant to identify those sources of funding that are of such significance, the withdrawal of which could trigger liquidity problems. The metric thus encourages the diversification of funding sources recommended in the Basel Committee’s Sound Principles.
This metrics aims to address the funding concentration of banks by monitoring their funding from each significant counterparty, each significant product/instrument and each significant currency.

Available Unencumbered Assets

This metric provides supervisors with data on the quantity and key characteristics of banks’ available unencumbered assets. These assets have the potential to be used as collateral to raise additional secured funding in secondary markets and/or are eligible at central banks.

LCR by Significant Currency

While the LCR standard is required to be met in one single currency, in order to better capture potential currency mismatches, the LCR in each significant currency needs to be monitored.

Market-related Monitoring Tools

This includes high frequency market data that can serve as early warning indicators in monitoring potential liquidity difficulties at banks.

Basel III Liquidity Returns

S. No.	Name of the Basel III Liquidity Return (BLR)	Frequency of Submission	Time Period by which Required to be Reported
1.	Statement on Liquidity Coverage Ratio (LCR)-BLR-1	Monthly	within 15 days
2.	Statement of Funding Concentration- BLR-	Monthly	within 15 days
3.	Statement of Available Unencumbered Assets – BLR-3	Quarterly	within a month
4.	LCR by Significant Currency – BLR-4	Monthly	within a month
5.	Statement on Other Information on Liquidity – BLR-5	Monthly	within 15 days

Net Stable Funding Ratio

RBI, vide its circular dated May 17, 2018 released the final guidelines on Net Stable Funding Ratio (NSFR). The NSFR guidelines was issued to ensure reduction in funding risk over a longer time horizon by requiring banks to fund their activities with sufficiently stable sources of funding in order to mitigate the risk of future funding stress. The objective of NSFR is to ensure that banks maintain a stable funding profile in relation to the composition of their assets and off-balance sheet activities. A sustainable funding structure is intended to reduce the probability of erosion of a bank’s liquidity position due to disruptions in its regular sources of funding that would increase the risk of its failure and potentially lead to broader systemic stress.

The NFSR limits overreliance on short-term wholesale funding, encourages better assessment of funding risk across all on- and off-balance sheet items, and promotes funding stability. The Reserve Bank originally proposed to make NFSR applicable to banks in India from January 1, 2018. However, these time lines have undergone changes. RBI vide its Circular dated 5th February, 2021 deferred the implementation of NSFR upto 30th September, 2021 in view of the ongoing stress on account of COVID-19. Accordingly, the NSFR Guidelines came into effect from October 1, 2021. The NSFR would be applicable for Indian banks at the solo as well as consolidated level. For foreign banks operating as branches in India, the framework would be applicable on stand-alone basis (i.e., for Indian operations only).

The NSFR is defined as the amount of available stable funding relative to the amount of required stable funding. “Available stable funding” (ASF) is defined as the portion of capital and liabilities expected to be reliable over the time horizon considered by the NSFR, which extends to one year. The amount of stable funding required (“Required stable funding”) (RSF) of a specific institution is a function of the liquidity characteristics and residual maturities of the various assets held by that institution as well as those of its off-balance sheet (OBS) exposures.

The above ratio should be equal to at least 100% on an ongoing basis. However, the NSFR would be supplemented by supervisory assessment of the stable funding and liquidity risk profile of a bank.

Definition and Computation of Available Stable Funding

The amount of 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.

Definition and Computation of Required Stable Funding (RSF)

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 in the Table