Net stable funding ratio

• Prepared by Markus Behn, Renzo Corrias and Magdalena Rola-Janicka The post-crisis regulatory framework introduced multiple requirements on banks capital and liquidity positions, sparking a discussion among policymakers and academics on how the various requirements interact with one another.
• This article contributes to the discussion on the interaction of different regulatory metrics by empirically examining the interaction between the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR) for banks in the euro area.
• The findings suggest that the two liquidity requirements are complementary and constrain different types of banks in different ways, similarly to the risk-based and leverage ratio requirements in the capital framework.

1 Introduction

• With multiple requirements applicable in parallel, the new framework has led to some discussion on the interaction of the various metrics.
• [1] This article contributes to the discussion on the interaction of different regulatory metrics by empirically examining the interaction between the LCR and the NSFR for banks in the euro area.
• Moreover, their relative tightness depends on the composition of each banks balance sheet, with significant differences across business models.
• In other words, the two different types of requirements are binding on different types of banks, depending on the risk profile of their liquidity positions.
• Both requirements thus complement each other and are needed to address liquidity risks in the banking sector.

2 Regulatory requirements on bank liquidity: the LCR and the NSFR

• During the early phases of the global financial crisis, funding liquidity evaporated and many banks experienced difficulties despite still adequate capital levels (see, for example, Brunnermeier, 2009).
• The objective of the LCR is to promote short-term resilience of a bank's funding profile by ensuring that it has sufficient liquid assets to cover possible short-term liquidity outflows.
• The NSFR aims to prevent banks from excessively financing long-term assets with short-term liabilities and thus seeks to mitigate the potential for future funding stress.
• While there is broad agreement on the necessity of complementing regulatory capital with liquidity standards, there has recently been some discussion on whether both the LCR and the NSFR are needed.
• In addition, they assume that banks have off-balance sheet exposures that affect both the LCR and the NSFR (OBSL and OBSN respectively).
• TableA Simplified bank balance sheet for liquidity requirements
• This trivially implies that when NOP > 0, a bank that meets the LCR also meets the NSFR and, conversely, if NOP
• First, as noted above, the framework implies that when NOP>0, a bank that meets the LCR also meets the NSFR.
• However, it does not imply that when a bank meets the LCR, then NOP>0.
• There can obviously be cases in which NOP
• The reverse logic applies to the opposite case: if NOP>0, a bank meeting the NSFR may or may not meet the LCR.
• TableB Simplified bank balance sheet for liquidity requirements amended with actual numbers
• Put differently: the statement that when NOP>0, a bank that meets the LCR also meets the NSFR is true, but it does not imply that when NOP>0 the LCR will be tighter or less slack than the NSFR.
• To see this, consider the slightly modified balance sheet shown in TableC.
• TableC Simplified bank balance sheet for liquidity requirements with modified actual numbers

Empirical analysis

3.1 Data and descriptive statistics

• The empirical analysis in this article is based on bank group-level supervisory data that includes information on 224banks in Europes Single Supervisory Mechanism (SSM).
• The data is reported by banks using COREP and FINREP templates and spans the period from the first quarter of 2015 to the fourth quarter of 2017.
• All banks in the sample meet the minimum LCR requirement, but not all banks meet the NSFR requirement.
• The average LCR for the banks in our sample is 2.7, considerably higher than the average NSFR of 1.3 (see Table1).
• Chart1 shows a scatterplot of each banks LCR and NSFR for the fourth quarter of 2017.
• However, there is significant dispersion, which appears inconsistent with a strong mechanical interaction.
• Chart1 LCR and NSFR for the sample of banks (x-axis: NSFR ratio; y-axis: LCR ratio)
• To empirically examine the interaction between LCR and NSFR, we use the bank-level data to construct the measures of surplus liquid assets, surplus stable funding and net other positions as described in Box1.
• We reconstruct the stylised balance sheet of the CK framework by using granular information on the composition of banks assets and liabilities, and the relative weights that each item receives in the LCR and the NSFR.
• Surplus stable funding is the amount of stable liabilities in excess of the minimum amount required to fulfil the NSFR requirement, while surplus liquid assets is the amount of liquid assets in excess of the minimum amount required to fulfil the LCR requirement.

3.2 Examining the interaction between LCR and NSFR

• Chart2 shows that depending on the sign of NOP either surplus liquid assets will be larger than surplus stable funding, or vice versa.
• For these banks, meeting the LCR automatically implies also meeting the NSFR (since surplus stable funding > surplus liquid assets > 0).
• Conversely, for banks with NOP surplus stable funding > 0).
• In fact, at the very left of the chart there are several banks that meet the LCR (surplus liquid assets > 0) but do not meet the NSFR (surplus stable funding
• Chart2 Surplus liquid assets and surplus stable funding (x-axis: surplus stable funding; y-axis: surplus liquid assets)
• Whether one requirement is slack or not when the other requirement is binding depends on the relative importance of the different asset and liability classes.
• Since each liquidity ratio captures different types of risks, the requirements will constrain different types of banks in different ways, depending on their business models.
• This is similar to the capital framework, where different capital ratios are the binding constraint for different types of banks.
• [5] The relative amounts of surplus liquid assets and surplus stable funding tend to vary substantially across banks, depending, for example, on the banks business models.
• Chart3 Fraction of banks for which surplus liquid assets and surplus stable funding is smaller, by business model
• The left-hand panel in Chart4 shows that the elements of the balance sheet used for the calculation of the LCR tend to correspond to a significantly smaller portion of the total balance sheet than the elements used for the NSFR.
• For the vast majority of banks, the LCR numerator and denominator correspond to 20% or less of the total balance sheet, whereas for the NSFR the numbers are centred between 75 and 80%.
• As explained in Box1, this implies that a bank for which the amounts of surplus liquid assets and surplus stable funding are roughly similar may still have a significantly higher LCR than NSFR.
• Importantly, the fact that the LCR tends to be higher than the NSFR does not imply that only the NSFR is needed, since the two ratios address different types of risks (see Section2).
• Chart4 LCR and NSFR (left-hand panel: x-axis: denominator of the ratios; y-axis: numerator of the ratios; right-hand panel: x-axis: NSFR; y-axis: LCR)
• Chart5 shows that NOP changes both over time and in correlation with changes in surplus liquid assets and surplus stable funding.
• This also holds in terms of ratios, where the co-movement between LCR and NSFR is not statistically significant, while there is significant co-movement between NOP and the two ratios (see PanelB).
• Overall, the chart shows that movements in the NSFR do not automatically imply movements in the LCR and that the interaction between the LCR and the NSFR may also change over time, since NOP is not static.
• Chart5 Co-movement between LCR, NSFR and other assets and liabilities PANEL A Surplus measures

4 Conclusion

• This article empirically examines the interaction between the LCR and the NSFR for a sample of euro area banks.
• The results suggest that the two requirements are complementary and should not be regarded as shadow measures of each other.
• While the LCR has already been implemented in all major regions, the process for implementing the NSFR has not been initiated in all relevant jurisdictions.
• The findings in this article illustrate that the LCR and the NSFR are complementary, constraining banks with different liquidity risk profiles in different ways.

5 References