NSFR: final leg of liquidity regulation by Ashish Deccannawar

NSFR: final leg of liquidity regulation!

by Ashish Deccannawar

Liquidity risk management is critical for the stability of the global financial ecosystem. Net Stable Funding Ratio (NSFR) is an important long-term liquidity requirement to be implemented in the United states. The aim of this article is to provide a high level viewpoint on U.S. NSFR requirements, timeline, and potential implementation challenges the industry may face.

what is NSFR?

NSFR stands for Net Stable Funding Ratio. NSFR is a quantitative measure that validates banks have stable long-term funding to support the long-term stress. NSFR is measured as below:

Net Stable Funding Ratio (NSFR) = Available Stable Funding (ASF)

Required Stable Funding (RSF) > 100%

Available Stable Funding (ASF) is composed of regulatory capital and liabilities, which are then multiplied by ASF factors to calculate the available stable funding. Characteristics that drive ASF factors include:

1. Funding tenor (longer maturities have a higher factor than shorter maturities due to rollover risk)

2. Funding type (stable deposits with deposit insurance have higher factor compared to other types of funding due to funding stability)

3. Counterparty type (Non-financial counterparties will have a higher factor compared to financial counterparties; Financial counterparties are typically a less reliable source of funding as they tend to be more sensitive to market fluctuation)

Required Stable Funding (RSF) factors are assigned to the bank’s assets, off balance sheet commitments, and derivative exposures. Characteristics that drive RSF factors include:

1. Tenor (long-term assets need more stable funding to support long dated inflows)

2. Encumbrance (longer the asset encumbered, the more stable funding required)

3. Type of counterparty (higher stable funding to non-financial counterparties compared to financial counterparties; financial companies have alternate funding arrangements and are less likely to renew the loans in stress)

4. Credit quality (assets with lower quality requires greater stable funding to capture the risk of default)

5. Market characteristics (assets that are traded in transparent, standardized markets with large numbers of participants and dedicated intermediaries will need less stable funding compared to assets traded in less transparent markets)

why is NSFR requirement necessary?

rule timeline and overview in the U.S.

As described in the Federal Reserve Board’s recent joint press release1, the 2007-2009 financial crisis revealed significant weaknesses in banking organizations’ liquidity risk management and positions, including how banking organizations managed their liabilities to fund their assets in light of the risks inherent in their on-balance sheet assets and off-balance sheet commitments. The 2007-2009 financial crisis also revealed an overreliance on short-term, less-stable funding, and demonstrated the vulnerability of large and internationally active banking organizations to funding shocks.

Based on the lessons learned from the 2007-2009 crisis, Basel Committee on Banking Supervision (BCBS) established two main international liquidity standards, with the intent to absorb short- and long-term shock to the banking system. First international liquidity standard focused on surviving short term stress, Liquidity Coverage Ratio (LCR), to absorb 30-day liquidity stress in the system. Currently, all major US banks have implemented LCR and demonstrated their resilience and compliance even during the liquidity crisis caused by pandemic COVID19. Second international liquidity standard is a complement to the LCR and is a longterm liquidity metric called Net Stable Funding Ratio (NSFR). It is a long-term liquidity stress metric that requires banks to hold sufficient stable funding over the period of one year. NSFR is very well designed to manage maturity mismatch risk that may arise due to banks’ relatively short funding profile and will require banks to hold stable funding profile to support banks’ assets, derivatives, and off-balance sheet commitment activities.

BCBS established the NSFR requirements in October 2014 to mitigate the risks and weaknesses presented by the banking organizations supporting their assets with insufficient stable funding. In June 2016, the US agencies opened up the comment period on a proposal to implement a net stable funding requirement for the U.S. banking organizations that were subjected to the LCR rule.

Based on the comments received from US banks, FBOs, trade groups, public interest groups, and other interested parties, regulators published the final rule implementing the NSFR in October 2020 with expectation that firms subject to the NSFR will be generating the NSFR reporting by July 1, 2021.

The finalized NSFR rule also impacted the current Fr2052a liquidity reporting (also called Complex Institution Liquidity Monitoring Report), and regulators also proposed revisions to the FR 2052a on March 29, 2021 with a 60-day comment period closing on May 28, 2021, with an effective date of implementation as July 1, 2021. In addition to this, banks are also required to start publishing NSFR disclosures by 2023.

The below a high-level view of NSFR implementation timeline.

implementation challenges

One would argue the notion that firms should be prepared to implement these changes on short notice, as the proposal to implement NSFR was first introduced in June 2016. This means regulators gave banks over 4 years to adopt the changes. However, a lot has changed since 2016 as the Trump administration with their anti-regulatory agenda led industry experts to predict that NSFR may not be finalized in the US. Generally, banks are reluctant to implement the system changes based on the proposed rule. Banks would prefer to wait for the final rule prior to implementing NSFR-related data mappings. Implementing a final solution based on the proposed rule may lead to additional cost impact, if any of the mappings are changed in the final rule.

The COVID-19 pandemic led to liquidity stress in short-term unsecured funding markets, but bold Federal Reserve Board actions and introduction of several emergency facilities calmed the liquidity stress in the market. Liquidity teams in the banks largely spent their year closely monitoring banks’ liquidity, with little time left to worry about NSFR implementation.

Also, during the 2020 period of the peak COVID crisis in the U.S., regulators leaned towards loosening the regulatory requirements to increase the liquidity in the market. This is contrary to the NSFR rule, where banks are required to hold even more liquidity buffer to satisfy long-term liquidity metric. It is not odd to say that banks were caught off-guard when the rule was finalized in October 2020.

Although a lot of large firms, including Foreign Banking Organizations (FBOs), have already implemented the NSFR reporting for their Office of the Superintendent of Financial Institutions (OSFI), European Union (EU), and other local regulators, where banks are required to comply with regulatory requirements in international jurisdictions. The fact that banks are reporting NSFR for other international regulators just confirms that banks have somewhat of a head start to implement the U.S.

NSFR requirements, but I would say this certainly is a challenging and monumental task to achieve this implementation within a month of closing the comment period. As industry experts know, systems and reporting within the banks are interlinked and any change in the Fr 2052a report (also called “golden source” by many) may impact other closely related reporting such as LCR, internal liquidity stress test, and other internal liquidity metrics.

It is likely that US banks, FBOs, trade groups, public interest groups, and other interested parties would not be in favor of implementing the revised FR2052a and NSFR reporting by 1st July 2021 and are likely to request for extension2 for implementing the revised FR2052a and NSFR reporting capability.

This disclaimer informs readers that the views, thoughts, and opinions expressed in the text belong solely to the author, and not necessarily to the author’s employer, organization, committee or other group or individual.

references

1. https://www.federalreserve.gov/newsevents/pressreleases/bcreg20201020b.htm 2. https://www.aba.com/advocacy/policy-analysis/joint-trades-comment-on-revisions-to-the-complexinstitution-liquidity-monitoring-report

author

Ashish Deccannawar

Ashish Deccannawar is a Senior Manager at one of the top 10 largest Banks in the U.S. and leads Liquidity Strategy and Governance function for their Consolidated U.S. Operations. Ashish is an expert in Liquidity risk, and Bank’s balance sheet management functions. Prior to his current role, he worked as a Senior advisor at one of the Big four consulting firms advising Global Systemically important Banks (G-SIBs).

Ashish has extensive experience in advising US and foreign Banks in the Liquidity Risk space. Topics of his interest include Liquidity Stress Testing, Cash Flow Projections, Fr2052a reporting, Funds Transfer Pricing (FTP), and Net Stable Funding Ratio (NSFR).