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Basel III – Liquidity Framework- Net Stable Funding Ratio (NSFR)

Basel III – NSFR

In our previous posts we had addressed the Liquidity Coverage Ratio, the short term resilience liquidity standard to be introduced with the Basel III reforms. In this post we discuss the long term supervisory measure for assessing liquidity risk, the Net Stable Funding Ratio (NSFR).

As mentioned earlier in our introductory post, this ratio aims to capture short term structural mismatches in liquidity so as to discourage the bank’s over-reliance on funding long term assets with short term liabilities and to move the focus to longer term liquidity funding sources. The ratio is calculated over a one year horizon under an extended firm-specific stress liquidity scenario.

Firm specific stress scenarios could entail a significant decline in the bank’s profitability, a potential ratings downgrade or a reputational risk event.

The metric is the ratio of the available amount of stable funding to the required amount of stable funding and it should be greater than or equal to 100%, .i.e. the amount required for stable funding, representing the amount of assets that cannot be monetized on an extended basis during a one-year liquidity event, should at the very least be fully covered by reliable and stable funding sources available to the entity.

Available amount of Stable Funding (ASF)

The ASF comprises of the bank’s capital, preferred stock and liabilities with maturities greater than or equal to one year, portions of demand and term deposits by retail customers and wholesale funding having residual maturities < 1 year which are not expected to be withdrawn during the stress event. It does not include borrowings from the central bank other than those available through regular open market operations. Each of these components are slotted into 5 separate ASF categories which are assigned ASF factors representing the amount of that components’ carrying value that will be included in the calculation of the numerator of the ratio.

Broadly the ASF factors are as given below. However for more specific details on the categories and factors you may like to see the Basel Committee’s published liquidity reforms document “International framework for liquidity risk measurement, standards and monitoring”:

  • Bank’s capital, preferred stock and liabilities with maturities greater than or equal to one year will be assigned a factor of 100%
  • Stable and less stable portions of demand and term deposits by retail customers having residual maturities < 1 year will be assigned ASF factors of 90% and 80% respectively
  • Unsecured wholesale funding having residual maturities < 1 year will have an ASF factor of 50%
  • All other liabilities and equity categories not specified in the ASF categories mentioned in the Basel document will be assigned a factor of 0%

The available amount of stable funding is calculated as the weighted sum of the carrying values of each ASF component where the weights are ASF factors assigned to each component category.

Required amount of Stable Funding (RSF)

As in the case of the numerator of the NSFR ratio, the RSF is calculated as the weighted sum of the value of assets held and funded by the entity including off-balance sheet exposures where the weights are RSF factors assigned to each RSF asset category. The weights represent the portion of the asset that would not be able to be monetized either by its sales or its use as collateral in an extended firm-specific liquidity stress scenario- assets in effect that would need to be covered by more stable sources of funds. Hence more liquid assets will be assigned a lower RSF factor whereas a higher RSF factor will be applied to values of the more illiquid assets.  For specific details on the asset categories and related RSF factors you may like to see the Basel Committee’s published liquidity reforms document “International framework for liquidity risk measurement, standards and monitoring.” A brief outline of asset categories and RSF factors is given below:

  • Cash, unencumbered short-term unsecured actively traded securities, securities with exactly offsetting reverse repo, securities and non-renewable loans with residual maturities < 1 year will have an RSF factor of 0%
  • Unencumbered debt issued or guaranteed by sovereigns, central banks, BIS, IMF, EC and PSEs/ multilateral development banks with risk weights of 0% under the Basel II standardized approach are assigned a RSF factor of 5%
  • Unencumbered non-financial sector corporate and covered bonds having residual maturities > 1 year with rating grade of AA- or higher and debt issued or guaranteed by sovereigns, central banks, PSEs with risk weights of 20% are assigned a RSF factor if 20%
  • Unencumbered listed equity securities or non-financial senior unsecured corporate bonds with residual maturities > 1 year and rating grades A+ to A-, gold and loans to non-financial corporate clients, sovereigns, central banks and PSEs with residual maturities > 1 year will have an RSF factor of 50%
  • Unencumbered residential mortgages of any residual maturity and non-financial entity loans with residual maturities > 1 year having risk weights ? 35% will be an assigned RSF factor of 65%
  • Unencumbered retail loans with residual maturities < 1 year will have an RSF factor of 85%
  • All other assets are assigned an RSF factor of 100%
  • Off-balance sheet undrawn committed credit and liquidity lines are assigned RSF factors of 5%
  • Other off-balance sheet contingent funding obligations will be assigned a RSF factor as determined by national supervisory authorities for their respective jurisdictions.

In the next post we will present an overview of the metrics proposed as liquidity monitoring tools under the Basel III liquidity reforms document.

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