By Luciano Fantin: This article talks about the publication of Resolution 4,401 as of February 2nd 2015 by the National Monetary Council, which regulates the local implementation of the LCR, a new short-term liquidity indicator introduced by Basel III.
An important aspect of Basel III was the introduction of indicators for the short-term liquidity risk management: The Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR). The revised accord has also introduced the Leverage Ratio (LR), which is a leverage indicator. The implementation timeline is as follows:
- The LR will be gradually introduced. The test period started in 2013 and will last until 2017;
- The LCR will also be gradually introduced as from 2015 on and will demand from banks the maintenance of high quality liquid assets (HQLA) to cater for the necessity of funds in the short-term under stress scenarios;
- The NSFR, which will be demanded as from 2018 on and seeks to limit the excessive dependency on short-term wholesale funding, encourages a broader funding risk assessment as well as more stable funding sources.
This article focuses on the LCR. The objective of the LCR is to promote the short-term resilience of the liquidity risk profile of banks. It allows banks to adequately manage their HQLA. These are unencumbered assets held by banks, which can be easily and rapidly converted into cash in order to cater for their funds needs in a period of 30 days under a standard liquidity stress scenario.
This indicator is an answer to the global financial crisis of 2007, which has its origin in the real estate financing market in the US (subprime mortgage crisis), when many banks faced difficulties despite adequate capitalization levels, due to the fact that they did not manage the liquidity in a prudent manner.
Although Basel III sees liquidity as an essential component, it also recognizes that the imposition of minimum liquidity limits impacts the monetary and credit markets, as well as the economic growth especially in challenging global moments. In this sense Basel III foresees a gradual LCR implementation, as it was the case with the capital requirements.
The chart below shows the implementation schedule, which is also valid for Brazil except for the first item, which was locally foreseen as October 1st 2015.
Min. LCR As of
60% Jan 1st 2015
70% Jan 1st 2016
80% Jan 1st 2017
90% Jan 1st 2018
100% Jan 1st 2019
Basel III allows banks to sell their HQLA, during stress periods, falling momentarily under the established limits, as well as in the case of certain countries, which find themselves still under financial support for macroeconomic and structural reforms, in which case there might be a different implementation schedule.
The standard requires an index not lower than 100%, i.e. the HQLA should at least be equal to the projected net cash outflow as per following computation:
HQLA / total net cash outflow during 30 days ≥ 100%
According to the public consultation paper n. 45/14 as of July 25th 2014, the Brazilian Central Bank (BCB) informs that, in addition to the liquidity cushion established by the LCR, the Brazilian financial system has at its disposal the compulsory deposits, which have been excluded from the HQLA. This is an important prudential tool in Brazil, which can be utilized during liquidity stress moments.
The Monetary Council regulates, through its Resolution 4,401/15 that the LCR be applied only for banks with assets over BRL 100 billion, since Basel III foresaw the LCR development for internationally active commercial banks.
Independently of this limit, it is our understanding that it is very important that all banks introduce this new indicator as a regular risk management tool. It is worthwhile investing in it. As we learned from recent crisis, liquidity stress can be fatal.