Closing the gap Liquidity management survey of European banks
Contents Introduction
3
Executive summary
4
Key findings Agenda and strategy
6
Targets and requirements
8
Project management
14
Where are we now?
18
Contacts
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Liquidity management survey of European banks
1
Introduction
2
In the post-financial crisis world, no European bank can afford to ignore the importance of strong liquidity risk management. During 2011, we will also see this issue move to the center of the regulatory agenda, as European supervisors are beginning to draft the rules for local implementation of the new Basel Committee standards. The liquidity requirements of the Basel III regime are well-known within the European banking industry. In simple terms, the key elements are the Liquidity Coverage Ratio (LCR), designed to ensure banks can survive a month of acute liquidity stress; the Net Stable Funding Ratio (NSFR), intended to encourage the funding of illiquid assets by stable deposits; and the Principles for Sound Liquidity Risk Management and Supervision, requiring banks to enhance their internal controls, supervisory reporting and public disclosure of liquidity risks. The new global rules may not enter into force for several years, but the issuance of timelines for their introduction during 2010 marked the beginning of the compliance process. Furthermore, many banks are keen to demonstrate full compliance as early as possible; after all, the global financial crisis showed that liquidity crunches can be dangerous for even the largest banks. With this in mind, Ernst & Young surveyed 26 European banks ranging from local, retail banks to international, universal institutions. The results of the survey touch on several issues of strategic significance, including national variations in regulation and banks’ level of preparedness for the new regime. This paper sets out the key findings of our survey. We believe they are thoughtprovoking; we hope you will agree. If you would like to explore any aspect of the survey findings in more detail, please get in touch with one of us, or with your usual Ernst & Young contact. We look forward to hearing from you.
Patricia Jackson Head of Financial Regulatory Advice, Financial Services, EMEIA +44 (0)20 7951 7564 pjackson@uk.ey.com
Closing the gap
Liquidity management survey of European banks
Anne Le Henaff Director, Financial Services Risk, EMEIA +33 (0) 1 46937966 anne.le.henaff@fr.ey.com
3
Executive summary
Our survey explores banks’ plans for enhancement, as well as their views on the likely challenges and potential benefits. At the end of 2010, Ernst & Young surveyed 26 banks based in France, the UK, Switzerland, Germany and the Netherlands. Interviewees were asked a range of questions about their plans for, and progress with, enhancements to their liquidity risk management frameworks. The survey group included local and international banks, spread across retail banking, investment banking and universal banking. The survey shows that the majority of European banks are focused on improving their liquidity risk management, but it also reveals considerable variation among countries and subsectors. In particular, we highlight these key findings: ►► Most European banks have established a regulatory agenda, with liquidity risk management identified by many as their top priority ►► Surprisingly few banks feel they have a considerable way to go to achieve compliance with the liquidity requirements of Basel III. Given the experience of UKbased banks in introducing similar requirements, particularly with regard to liquidity reporting, this might be overconfident ►► Uncertainty over the final shape of new regulation is affecting banks’ ability to make improvements to their liquidity frameworks ►► Banks are keen to improve their liquidity risk management capabilities quickly, and are hoping this will optimize their funding costs ►► Stress testing, risk appetites, contingency planning and scenario analysis are some of the areas most often identified for improvement. Some banks are also hoping to link liquidity management with Internal Capital Adequacy Assessment Process (ICAAP) processes, but so far awareness of this issue is low ►► To deliver these changes, implementation teams are focusing their efforts on adapting IT systems, improving data management, updating documentation and strengthening reporting and governance. Cultural factors are also seen as a potential challenge
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The survey results reveal some further underlying themes Drawing on our understanding of the European banking industry, our analysis of the findings identifies some further themes that cut across the survey data. The first is that liquidity risk management is not just a regulatory imperative, but something vital to every bank’s business model. Banks remain sensitive not only to their actual liquidity risks but also to external perceptions of their liquidity profiles. Each wishes not only to minimize its funding costs but also to avoid being seen as “off the pace.” The second theme is that the largest and most sophisticated banks believe that the rules will have a much greater impact on their business than is the case for smaller banks. These are also the banks putting the greatest efforts into liquidity risk management improvements. The third theme is that many banks’ approach to liquidity risk management is undergoing a permanent change. Dedicated liquidity management by Asset and Liability Committees (ALCOs) appears to be on the wane, with group-wide risk management functions taking a larger role.
Basel III liquidity rules have a number of potential strategic implications The survey underlines the fact that, despite the Basel Committee’s decisions to extend compliance deadlines and widen the definition of eligible liquid assets, the new rules will have a profound impact on individual banks’ business models and on the wider industry in Europe and beyond. While the public debate over banking reform has concentrated on capital levels and industry structure, we feel that many banks — particularly the larger, more complex groups — may be more concerned about the impact of liquidity regulation, especially when viewed in tandem with the development of “recovery and resolution planning.” Taken together, these issues will have a significant impact on the way that banks function and the way their balance sheets are constructed. They will, in fact, determine the extent to which banks can perform their unique functions of maturity and liquidity transformation. The new requirements will therefore have an effect on such diverse areas as legal structures, interbank relationships, the products banks offer to customers, business unit strategy, performance management and remuneration. They will also require banks to make credit and funding decisions within an integrated balance sheet management framework — something that will often run counter to traditional approaches.
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Key findings
1 Agenda and strategy Most European banks are establishing a regulatory agenda A large majority (85%) of the banks surveyed say they have set up a regulatory agenda. This is no great surprise, given the sheer volume of new regulations confronting the European banking industry. This includes not only Basel III but also the various effects of the Dodd-Frank Act, the impact of Solvency II on banks that sell insurance products and local requirements for the establishment of recovery and resolution planning. The ongoing debate over banking regulation may be global, but implementation remains the province of local supervisors. It is therefore no surprise that all of the UK banks surveyed have established a regulatory agenda, given the FSA’s rapid rollout of new requirements over the past two years. The relative complexity of international banks’ business models means that they are particularly aware of regulatory challenges, with 95% having set up a compliance agenda. In contrast, only 57% of local banks have set up a regulatory agenda. This reflects a combination of lower awareness, less exposure to new requirements and fewer available resources.
Q. Have you established an agenda on regulatory subjects?
Yes
No
85%
15%
Liquidity risk is the leading area of focus for most banks Liquidity risk is the leading risk management topic on most banks’ regulatory agendas, cited by 81% of banks surveyed. It is interesting to note that this is more prevalent than capital definition (cited by 58%) and leverage ratio (46%), which have arguably been more widely covered in the financial media. This suggests that the banks fully appreciate the importance of liquidity transformation and maturity transformation to their business models — and balance sheet structures. Other risks on regulatory agendas include counterparty/credit risk (identified by 38%) and market risk (31%).
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Q. What are the topics with regards to risk management covered by this agenda?
Liquidity risk management
81%
New capital deďŹ nition
58%
Leverage ratio
46%
Counterparty/ credit risk
38%
Market risk
31%
Liquidity risk management is also most likely to be identified as one of banks’ two greatest regulatory risk priorities (by 84%). Again, this demonstrates not only that liquidity is a hot regulatory topic, but also that banks are only too aware of how quickly failings in liquidity management can become a critical threat to their status as a going concern. Unsurprisingly, it is the investment banks, with their dependence on wholesale funding, that are most likely to put liquidity risk management on their agenda and to identify it as a high priority. Retail banks, benefiting from a large base of slow-moving customer deposits, are much less concerned about new liquidity rules than they are about tighter capital requirements.
Q. How do you prioritize liquidity risk management compared with the other risk management topics? 67%
Priority 1 17%
Priority 2 Priority 3
4%
Priority 4
4%
Priority 5
8%
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2 Targets and requirements Compliance with current rules falls short of the requirements set out by Basel III and the Committee of European Banking Supervisors All survey respondents believe they are in compliance with current local liquidity management regulation, with only a minority (18%) identifying minor areas of required enhancement. Local and retail banks tend to see more room for improvement than most, and there are some apparent country differences. For example, all UK respondents say they meet but do not beat current requirements, while most Swiss respondents feel they exceed local regulations.
Q. What do you consider to be the level of compliance of your liquidity management framework with the current local regulatory requirements? Above the level required
41%
According to the regulatory requirements
41%
According to the regulatory requirements with minor areas of enhancement
18%
Below regulatory 0% expectations with major areas of enhancement
Compliance with Basel III liquidity management requirements is lower, with 64% of all respondents identifying areas for enhancement and only 5% of banks feeling they exceed the requirements of the new regulations. Even so, a remarkably small proportion of respondents (5%) say they are clearly below the expectations of Basel III. Given the considerable challenges that UK-based banks faced when introducing similar requirements, some banks may be at risk of overconfidence. Following the UK FSA’s early adoption of tighter liquidity rules, 60% of UK banks feel they are compliant with the new Basel III requirements, a much more confident response than that of their counterparts in France (11%) and Switzerland (29%).
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Q. What do you consider to be the level of compliance of your liquidity management framework with the Basel III requirement? Above the level required
5%
According to the regulatory requirements According to the regulatory requirements with minor areas of enhancement Below regulatory expectations with major areas of enhancement
27%
64%
5%
The picture is similar when it comes to the Principles of Sound Liquidity Risk Management and Supervision (“the Principles”) published by the Basel Committee. However, awareness is lower here, with a quarter of respondents unaware of their level of compliance with the Principles. Again, UK banks are the most confident, with all respondents stating they are compliant with the requirements of the Principles; in contrast, only 10% of French respondents feel they meet the Principles, with 40% unsure of what is required. This again reflects the FSA’s early move to a much tighter liquidity approach akin to Basel III.
Q. What do you consider to be the level of compliance of your liquidity management framework with the “Principles of Sound Liquidity Risk Management and Supervision” published by the Basel Committee? Above the level required 0% According to the regulatory requirements
31%
According to the regulatory requirements with minor areas of enhancement Below regulatory expectations with major areas of enhancement
35%
8%
Don’t know
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Liquidity risks are a key driver of planned enhancement to risk management frameworks The large majority of respondents (91%) believe their current liquidity risk management framework is fit for the purpose. Even so, this does not mean they are perfect, and most banks appear to have plans for improvement.
Q. Do you consider your current liquidity management framework appropriate for management purposes?
Yes
No
91%
9%
Optimizing liquidity management is, of itself, the most common motive for making improvements to existing risk management frameworks. This desire is seen as chiefly stemming from management teams themselves, especially among universal and investment banks. With the exception of investment banks, most respondents see the views of investors and rating agencies as being less important, although it is anticipated that there will be an increased focus from rating agencies on liquidity management frameworks, particularly on contingency funding planning and liquidity stress testing. Nonetheless, a majority still identify satisfaction of regulatory requirements as an important driver for enhancement in its own right.
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Q. What are the main drivers for the enhancement of your liquidity management framework?
Satisfaction of regulatory requirements
23%
Management optimization
32%
Both
45%
Q. If your main driver is management optimization, where does it come from? (state all that apply) 18%
Regulator Shareholders
12% 89%
Management 18%
Rating agencies Capital Allocation Committee
6%
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Banks see liquidity risk enhancement as urgent — and expect it to deliver valuable benefits Among banks planning significant improvements to their liquidity risk management frameworks, stress testing (27% of respondents) and the management framework (36% of respondents) are commonly identified areas for development. This reflects the importance of stress testing to the Liquidity Coverage Ratio (LCR) requirements of Basel III. In fact, the Basel Committee for Banking Supervision has identified stress testing as a key weakness at many firms before and during the crisis, noting that the crisis was far more severe than indicated by many bank’s stress tests and that the crisis itself was “possibly compounded by weaknesses in stress testing practices in reaction to the unfolding events.” Contingency planning is also seen as a comparatively important area for improvement (27% of respondents), as many financial institutions have failed to demonstrate a comprehensive liquidity contingency plan with measures and responsibilities to handle the liquidity crunch.
Q. If the target model for liquidity risk management is a major evolution compared to with your current approach, which are the main areas of enhancement? 36%
Management framework Stress test
27%
Contingency plan
27%
Collateral (ECB eligibility)
9%
Buffer
9%
IT
9%
The large majority of respondents (79%) expect to make improvements to their liquidity risk management framework during 2011, reflecting the start of LCR monitoring by local regulators. In the UK, where there has already been considerable and continuing investment in the frameworks, that figure rises to 100%. Far fewer respondents expect enhancement plans to continue into 2012 and 2013. This reinforces not only the urgency of compliance deadlines but also the importance that the banks themselves have attached to improvements in liquidity risk management following the crisis.
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Q What is the time frame being considered for the enhancement of the framework? 2011
11%
2012
11%
2013
11%
79%
It is interesting — and welcome — to find that stronger liquidity risk management frameworks are expected to deliver a number of positive benefits beyond regulatory compliance. In fact, the survey shows that satisfying regulatory requirements is far from being seen as the greatest anticipated benefit. Better liquidity management is itself identified as the most valuable benefit by 50% of respondents, but it is notable that 12% of banks primarily expect improved liquidity risk management to optimize although not necessarily lower funding costs. If achieved, this would be particularly valuable at a time when the requirements of the LCR and the NSFR might otherwise be expected to increase banks’ funding costs.
Q. What is the main benefit that you expect from the enhancement of the liquidity management framework? Improvement of the liquidity risk management
50%
Optimization of liquidity cost
12%
More involvement of the senior management in liquidity management policy
12%
Improvement of our image in the market Satisfaction of regulatory requirements
4%
12%
A further qualitative benefit is closer anticipated involvement of senior management in setting and overseeing liquidity management parameters.
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3 Project management Project management approaches vary widely between larger and smaller banks Approaches to liquidity risk management improvements vary considerably among banks. Slightly more than half of the banks surveyed have a central function such as treasury, risk or finance taking the lead, with that figure rising to 100% in the UK. Only 23% of respondents have asset and liability management (ALM) teams taking sole charge of the project, although that figure rises to 43% for Swiss-based banks. A further 23% say that their ALM team is working on the issue in conjunction with other departments. French banks are the most likely to adopt a joint approach combining ALM teams with capabilities from other areas.
Q. Which team is the project sponsor?
ALM team only
23%
ALM team in association
23%
Outside ALM team
54%
The majority of respondents (67%) have set up dedicated project coordination teams, and even more have established dedicated project implementation teams (77%). Even so, that still means that, on average, 33% of those surveyed have no coordination team and 23% no implementation team.
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The contrast is stronger when banking subsectors are compared. Universal banks, facing the greatest implementation challenges, are the most likely to have set up coordination (86%) and implementation teams (85%). Retail banks are more notable for their absence of dedicated teams, with 67% having no coordination teams and a remarkable 75% no implementation teams. Although retail banks will be much less affected by the liquidity provisions of Basel III, we would still expect these figures to decrease with time.
Q. Is there a dedicated team in charge of the project coordination?
Yes
67%
No
33%
Q. Is there a dedicated team in charge of the project realization? Multidisciplinary team
Team within a speciďŹ c department
73%
5%
No dedicated team
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Project management priorities are closely aligned with the key challenges to improvement Respondents are pursuing a wide range of themes as part of their liquidity management improvement projects. On average, the most important work streams are seen as being IT infrastructure (65%), changes to documentation (54%) and the production of key indicators through analysis and reporting (54%). Defining scenarios, setting risk appetites and limits, improving governance and managing data quality are all identified by more than 40% of respondents. The emphasis applied to these themes varies among sectors of the industry. For instance, IT infrastructure is seen as a dominant theme by investment banks and universal banks, reflecting the challenge of coordinating change across complicated corporate structures. The fact that no single work stream is identified as having overriding priority illustrates how changes to liquidity management affect many different areas of a bank’s systems, processes and controls. This may explain why comparatively few respondents (19%) are integrating liquidity management improvements with other strategic processes. There is strong read-across between the most important elements of liquidity management improvement projects and the greatest challenges they need to overcome. Again, the emphasis given to each obstacle varies slightly between country and industry sector, but on average data management and IT systems are seen as the greatest challenges (by 46% and 42% respectively). This reflects the data and IT challenge that Basel III will pose in terms of aggregation of data across groups and internal MI as well as regulatory reporting. Cultural factors are not seen as receiving much attention from implementation teams, but it is notable that respondents identify them as the third-biggest obstacle to enhancement (38%) after data management and IT systems. This is a reminder of the fact that changes to liquidity management have the potential to affect every area of a bank’s balance sheet and, by extension, its business. Other notable obstacles to improving the liquidity management framework include changing methodologies and the availability of resources (both identified by 27% of respondents).
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Q. What are the main themes within the projects? 54%
Documentation
65%
Infrastructure IT Governance Indicators production/ analysis and reporting Financing resources inventory
42% 54% 23% 42%
Risk appetite and limits Scenarios deďŹ nition
46% 35%
Stress tests implementation 15%
Behavior models
35%
Contingency funding plans
46%
Data quality Integration with other strategy processes Others (to be deďŹ ned)
19% 4%
Q. What do you consider to be the main challenges to be faced during this enhancement process? Cultural changes within organization
38%
Cost
23%
IT systems
42%
Data management Implementation of a day-to-day decision-making process
46% 8%
Methodologies
27%
Resources
27%
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4 Where are we now? European banks’ liquidity risk management enhancement efforts are at very different stages European banks’ progress with their liquidity risk management improvement projects varies widely. More than half of those surveyed think they are already past the midpoint, including 33% who say their projects are more than 75% complete. Following the UK FSA’s early action to toughen liquidity requirements, UK banks are the most likely to say they have completed their work. In contrast, Swiss-based banks are much less advanced.
Q. What percentage of your project is complete? 0%-25%
26%-50%
42%
8%
51%-75%
17%
76%-100%
33%
Many banks are pleased with their comparative progress with liquidity risk management improvements. Relative to domestic rivals, 38% feel they are ahead of their peers and a further 42% believe they are at least at a comparable stage, responses that suggest a surprising degree of confidence. However, it is notable that a third of French banks think they are behind the curve, compared with none in the UK and Switzerland.
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Q. How would you position yourself compared with the competitors within your country in terms of status of the project? Advanced
38%
Same level as competitors
42%
Late
Don’t know
17%
4%
Respondents are less certain about their progress at an international level, but a remarkable 43% of those surveyed see themselves as being ahead of international competitors. In contrast, only 1 in 6 respondents think they have fallen behind their peers, although another 17% are unsure how their progress compares with foreign rivals. Country differences are more marked, depending largely on the local regulator’s approach to liquidity risk. All UK respondents believe they are ahead of their international competitors, but 22% of French banks think they have fallen behind and a further 33% are unsure how they compare with international peers.
Q. How do you position yourself compared with international competitors in terms of status of the project? Advanced
43%
Same level as competitors
22%
Late
17%
Don’t know
17%
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Banks expect to put particular effort into stress testing and links with ICAAP Finally, the banks surveyed were asked what level of effort they expected to apply to a range of areas crucial to improving liquidity risk management frameworks. The result was clear, with reverse stress testing identified as the area requiring the greatest effort. This reinforces the survey’s earlier finding that stress testing is the area of liquidity risk management most commonly targeted for improvement. Stress tests are essential to defining liquidity risk appetite, and reverse stress tests are the key tool for understanding sources of potential vulnerability in funding models.
Q. What is the effort level to be applied to the following topics? Reverse stress tests Link with ICAAP Data quality Documentation IT Reporting Fund transfer pricing/liquidity cost Emergency plans/contingency plans Intraday liquidity risk management Stress scenarios definition excluding reverse Limits management Governance/organization Risk appetite framework Diversification and inventory of the financing Indicators definition Senior management involvement within the management policy and the monitoring Determination of the perimeter covered
2.5 2.3 2.3 2.3 2.2 2.2 2.0 2.0 2.0 1.8 1.8 1.7 1.7 1.6
3.2
1.4 1.3
The second greatest area of effort was to establish links with ICAAP processes. Given the potential overlap between solvency and liquidity in areas such as strategy and balance sheet management as well as governance and management oversight this clearly makes sense and might be a good way to focus the minds of senior management on the interplay between credit risks and liquidity risks. At the same time — as we have already seen — most banks have yet to link liquidity improvement programs to other strategic work streams. After reverse stress testing and links to ICAAP, other issues predicted to receive significant levels of effort include several themes already identified in the survey, such as data quality, documentation, liquidity costs, contingency planning, IT and reporting.
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Contacts
Belgium
France
Emmanuel Villaire
SĂŠbastien Hamelin
+32 (0) 2 774 6223 emmanuel.villaire@be.ey.com
+33 1 46 93 57 56 sebastien.hamelin@fr.ey.com
Germany
Italy
Dirk Chan-Muller
Marco Rosso
+49 6196 996 26161 dirk.chan-mueller@de.ey.com
+39 0272212330 marco.rosso@it.ey.com
Netherlands
Nordics
Nico Warmer
Pehr Ambuhm
+31 884071400 nico.warmer@nl.ey.com
+46 85 2059682 pehr.ambuhm@se.ey.com
Spain
Switzerland
Manuel Vaca de Osma
Bruno Oppliger
+34 915727489 manuel.vacadeosmaulacia@es.ey.com
+41 58 286 4667 bruno.oppliger@ch.ey.com
UK Tomas Marroquin +44 (0) 20 7951 8546 tdiazmarroquin@uk.ey.com
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