US Regulators Refine Their Approach To Liquidity Risk Measurement

The US Regulator has recently proposed changes which will impact firms required to report the 2052a and NSFR. Firms will need to consider the impact in areas such as data acquisition and regulatory calculations in advance of these changes coming into force and I’ll summarize both proposals and their impacts in this blog.

FR 2052a Revisions

The Board of Governors of the Federal Reserve System (“Board”) has proposed to extend for three years, with revision, the Complex Institution Liquidity Monitoring Report, the  “FR 2052a.”

This report collects quantitative information on select assets, liabilities, funding activities, and contingent liabilities of eligible banks which is then used to monitor the liquidity profile of these organizations.  In short, the data collected by the FR 2052a provide detailed information about the liquidity risks within different business lines of an organization.

Currently, the report consists of inflows, outflows, and supplemental items, subdivided into 10 distinct data categories. These categories are designed to stratify the assets, liabilities, and supplemental components of a firm’s liquidity risk profile based on products that can be described with common data structures while maintaining a coherent framework for liquidity risk reporting.

The key updates to the report entail, apart from clarifications and general guidance:

1) Additional counterparty types

2) Extended segregations of secured in- and outflows

3) Additional products in deposits outflows

4) Additional collateral classes

5) New fields in existing tables such as risk weights and Loss Absorbency

6) New tables, (Supplemental Balance Sheet, Supplemental Liquidity Risk Measurement (“S.LR”),  and Supplemental Derivative Collateral (“S.DC”)).

These changes are designed to accurately reflect the Net Stable Funding Ratio (NSFR) final rule and to capture other data elements necessary to monitor liquidity positions and compliance with Liquidity Risk Measurement (LRM) Standards. In fact, the Federal Reserve System (Board) has developed a document to assist the banks in mapping the provisions applicable to the Net Stable Funding Ratio (NSFR) to the unique data identifiers reported on FR 2052a.

https://www.federalreserve.gov/reportforms/formsreview/Appendix%20VIII_NSFR.pdf

NSFR

In June 2016, the Board, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) proposed the NSFR rule to implement a stable funding requirement which would have introduced a quantitative metric to measure a banking organization’s funding stability over a one-year time horizon.  Vice Chair for Supervision, Quarles, of Federal Reserve system, stated that:

“As a measure of the medium-term funding health of banks, the net stable funding ratio, or NSFR, final rule will complement and reinforce the liquidity coverage ratio (LCR) rule, which addresses the risk of short-term cash outflows in an acute period of stress.” (Oct. 20, 2020)

The final rule on NSFR, due to become effective in July 1, 2021, will require large banks to maintain a minimum level of stable funding, relative to each institution’s assets, derivatives, and commitments. As a result, the NSFR rule will support the ability of banks to lend to households and businesses in both normal and adverse economic conditions by reducing liquidity risk and enhancing financial stability.

Moreover, the NSFR’s requirements are tailored to the risks of large banks with the most stringent requirements applying to the largest and most complex firms and less stringent requirements applying to firms with less risk. The NSFR complements the agencies’ liquidity coverage ratio rule, which focuses on short-term liquidity risks.

Specifically, regulatory capital elements and liabilities would each be assigned an available stable funding factor, which represents the extent to which the capital element or liability is considered available for use by the banking organization over a one-year time horizon.

The Available Stable Funding (“ASF”) factors are scaled from zero (least stable) to 100 percent (most stable) – determined by taking into account the tenor of the funding, type of funding, and type of counterparty.

Required Stable Funding (“RSF”) Amount, NSFR Denominator, is  based on the liquidity characteristics of the banking organization’s assets, commitments, and derivative exposures.

The RSF factors are scaled from zero (most liquid and least likely to need ongoing funding during the one year time horizon) to 100 percent (least liquid and most likely to need ongoing funding during the one year time horizon).

The RSF amount for a banking organization’s derivatives would reflect three components:

(1) the current net value of the banking organization’s derivatives assets and liabilities, taking into account variation margin provided and received (current net value component);

(2) contributions by the banking organization to a central counterparty’s default fund in connection with cleared derivative transactions and initial margin provided by the banking organization pursuant to the derivative transactions (initial margin component);

(3) potential changes in the value of the banking organization’s derivative transactions (future value component).

Taken together, NSFR regulation requires that the ratio of ASF to RSF be greater than 100%.

Both of these measures will require the implementation of changes to the existing data used for the production of these returns as well as associated calculations, e.g., simple daily average computations. It is also significant in the sense that not only do the regulatory agencies require compliance with respect to LCR and NSFR, they also ask for the data that are used to produce the results so that agencies themselves could verify.  We’re seeing a continually increasing emphasis on both the accuracy of the data and the efficiency with which to respond to the agencies’ demand.

All of the capability to support these and all ongoing regulatory changes are supported in VERMEG’s regulatory platform. We’re always happy to discuss these and other regulatory changes and what VERMEG can do to help. Please feel free to get in touch communications@vermeg.com

Paul Baik – Regulatory Enablement Manager, North America