Advanced Bank Liquidity Stress: Testing & Management

Day One

How Liquidity Risk Arises For Banks

• Defining liquidity risk

• Key sources of liquidity risk – maturity mismatch (in particular non-maturity deposits and short-term unsecured wholesale funding), derivative collateral posting requirements and off-balance sheet facilities

• Fractional reserve banking and liquidity risk

• Why perception of creditors (invested in write-downable capital instruments and in bail-inable liabilities) in respect of bank’s forward-looking capital position is key in triggering liquidity stress and resolution risk

Case Study 1 – Liquidity stress data across a range of European and US banks during 2007-09 financial crisis and for European banks during 2010-12 European peripheral sovereign and banking crisis

Case Study 2 – Liquidity stress at Silicon Valley Bank over 2022-23

Regulatory Liquidity Requirements

• Liquidity Coverage Ratio (LCR) – rationale; calculation; implications for funds transfer pricing, funding mix, liquid assets buffer management

• Net Stable Funding Ratio (NSFR) – rationale; calculation; treatment of derivatives; implications for funds transfer pricing, funding mix, business model choices

Case Study 3 – LCR and NSFR at Barclays

Liquidity Management Framework Overview

• Specification of liquidity risk appetite (LRA)

• Liquidity stress test – net cash flow projections, liquidity buffer, survival horizon

• Contingency funding plan

• Liquidity risk pricing – funds transfer pricing

Case Study 3 – Barclays – Liquidity management framework

Case Study 4 – Example liquidity stress test results template

Liquidity Stress-Testing

• Liquidity stress-testing approaches – deterministic scenarios vs historic vs stochastic factor models. Regulatory expectations

• Scenario construction and progression through severity levels

• Linkages between capital and liquidity

• Consolidated vs deconsolidated stress-testing – importance of different regulatory sub-groups and capital account restrictions for cross-border banking groups

• Stress-testing steps

Stressing Non-Maturity Deposits (NMDs) & Time Deposits

• How to segment deposits according to likely “stickiness” – balance proportion testing based on hypothesised segmentation criteria

• Liquidity scoring and ranking of deposit segments

• Why interest rate risk in banking book (IRRBB) NMD modelling does not work for liquidity stress-testing purposes

Case Study 5 – Historic deposit outflows at failed banks for benchmarking purposes

Case Study 6 – Illustrative scenario-based liquidity stress test of NMDs

• Stochastic factor model of NMDs – making NMD volume a function of explanatory variables; allowing for non-linear depositor behaviour when certain threshold levels for explanatory variables are breaches

• Using stochastic factor model as complement to scenario-based method

Case Study 7 – Stochastic factor model of NMDs driven by ratio of deposit rate to market rate and by bank’s credit default swap (CDS) level

• Expanding stochastic factor model to other explanatory variables

• Treatment of time deposits

Stressing Credit & Facility Drawdowns & Other Off-Balance Sheet Components

• Key off balance sheet components contributing to liquidity stress – credit facilities, liquidity facilities, credit guarantees, undisbursed loan commitments, SIV / conduit support

• Typical scenario-based assumptions and why quantitative approaches are not well suited

Case Study 8 – Illustrative scenario-based liquidity stress test of off-balance sheet

Wholesale Funding Stress

• Types of wholesale funding – CP, CDs, interbank, repos, covered bonds, senior unsecured (preferred, non-preferred, holdco, opco)

• Typical rollover / non-rollover assumptions in liquidity stress across range of senior unsecured and secured funding

• Generating liquidity from self-held covered bond and ABS issuance

Case Study 9 – Wholesale funding stress at US and European banks during 2007-09 financial crisis and for European banks during 2010-12 European peripheral sovereign and banking crisis

Central Bank Liquidity Facilities

• Overview of liquidity facilities and market operations of Federal Reserve, European Central Bank and Bank of England

Case Study 10 – Asset eligibility and haircuts for repo to ECB

Case Study 11 – Exceptional Liquidity Assistance (ELA) in euro-zone

Day 2

Derivatives Collateral Posting Requirements

• Derivative collateral posting requirements – initial margin vs variation margin; collateral valuation changes; ratings downgrade triggers; derivative receivables and payables; how CSA and netting work; centrally vs non-centrally cleared derivatives

• Initial margin / independent amount – central clearer calculation methodologies and bilateral SIMM

• New regulatory requirements for initial margin

• Central clearing

• Collateral management – rehypothecation v segregation; “cheapest to deliver” collateral optionality; managing the liquidity buffer composition in different stress scenarios

• Funding Value Adjustment (FVA) as a measure of the net cost of variation margin collateral posting

Case Study 12 – scenario based liquidity stress testing of derivative collateral posting requirements

Case Study 13 – using XVA infrastructure to liquidity stress test derivative collateral posting requirements

• Funding Value Adjustment (FVA) and Margin Value Adjustment (MVA) as term liquidity premium for derivatives for FTP purposes

Case Study 14 – calculating FVA and MVA (also CVA and KVA for economic value added purposes)

Complete Liquidity Stress Test

Case Study 15 – Fully worked example of liquidity stress test, stressing deposits, off balance sheet and derivatives using both scenario and stochastic factor methods

Case Study 16 – Public information-based creditor stress test of bank’s capital and liquidity as key driver of likely liquidity stress and resolution risk

Contingency Funding Plan

• Key Risk Indicators (KRIs) / early warning signals – number of KRIs, thresholds to trigger KRIs, selection of KRIs

• Which KRIs tend to be most powerful in predicting liquidity stress?

• Escalation process and crisis management committee

Case Study 16 – Example key KRIs and escalation process

• Components of a strong contingency funding plan (CFP)

• Linkage between stress tests and CFP

• Key liquidity management tools in stress

Case Study 17 – Example CFPs and assessment thereof

• Have CFPs been adequately adapted for today’s world of resolution regimes?

Case Study 18 – Intra-day liquidity risk

Funds Transfer Pricing

• Why liquidity risk pricing through funds transfer pricing (FTP) is necessary

• Dual FTP – term liquidity premium (TLP) vs liquidity premium (LP)

• Distinguishing TLP from interest rate risk term premium (IRRTP) and relevance for pricing fixed vs floating rate assets and liabilities

• Options for calculating FTP curve and consequences of choice made

• Frequency of curve update

• FTP of non-base currency assets and liabilities

• Measuring LP across a range of contingent liquidity risks

• Measuring TLP across demand deposits, customer loans, derivatives and bonds on trading book funded by repo

Case Study 19 – Implementing FTP at a Global Systemically Important Bank (GSIB) with significant investment banking operations – Barclays Plc

• (Liquidity) FTP as a subset of full transfer pricing which is itself an input into economic value added (EVA) to measure the performance of business units after accounting for the full economic costs

Case Study 20 – What does a complete EVA framework look like