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Chapter 16 Macroprudential Liquidity Stress Testing in FSAPs for Systemically Important Financial Systems

Author(s):
Li Lian Ong, and Andreas A. Jobst
Published Date:
September 2020
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Author(s)
Andreas A. Jobst Li Lian Ong and Christian Schmieder

This chapter is based on IMF Working Paper 17/102 (Jobst, Ong, and Schmieder 2017). The authors would like to thank Chikako Baba, Mario Catalán, Martin Čihák, Hee-Kyong Chon, Silvia Iorgova, Michael Lau, Sylwia Nowak, Steven Phillips, Jay Surti, and Yunhui Zhao as well as the national authorities of Canada, P.R. China, Finland, India, Japan, Korea, Poland, Sweden, the United Kingdom, and the United States for their helpful comments and suggestions. The views expressed in this chapter do not represent those of the authors’ current employers.

Bank liquidity stress testing, which has become de rigueur following the costly lessons of the global financial crisis, remains underdeveloped compared to solvency stress testing. The ability to adequately identify, model, and assess the impact of liquidity shocks, which are infrequent but can have a severe impact on financial systems, is complicated not only by data limitations but also by interactions among multiple factors. This chapter provides a conceptual overview of liquidity stress testing approaches for banks and discusses their implementation by the IMF staff in the Financial Sector Assessment Program for countries with systemically important financial sectors between 2010 and 2016.

1. Introduction

The global financial crisis underscored the critical importance of sound liquidity risk management for individual financial institutions, and consequently, for overall financial stability. A defining characteristic of the crisis was the simultaneous and widespread dislocation in funding markets, which uncovered the weaknesses in banks’ liquidity profiles, particularly their increased reliance on short-term wholesale funding and high levels of leverage. Funding weaknesses were rapidly propagated through a highly interconnected global financial system, triggering contagion across financial institutions and systems and amplifying solvency concerns (IMF 2008, 2010a, 2011a).

In the wake of the crisis, the focus of the financial industry and country authorities rapidly turned to the shortcomings in liquidity risk-management practices. The now-obvious vulnerabilities had been, for the most part, undetected leading up to the crisis. In hindsight, the omission could be attributed to a general lack of understanding (compared to the more familiar solvency risk) of— and hence insufficient attention to—funding maturity and currency mismatches at the time. The postcrisis regulatory reforms widened the prudential perimeter to encourage better liquidity risk management.

This chapter provides a conceptual overview of liquidity stress testing approaches developed by the IMF staff and surveys the staff’s application to assessing system-wide vulnerabilities to market and funding liquidity risks. In particular, it focuses on the Financial Sector Assessment Programs (FSAPs) in countries with systemically important financial sectors. It is the companion work to Jobst, Ong, and Schmieder 2013, which reviews the IMF’s system-wide bank solvency stress testing. In keeping with the mandate of the FSAP, the chapter focuses on the bilateral surveillance of bank liquidity risk for macroprudential purposes, that is, the extent to which disruptions to banks’ liquidity management result in system-wide vulnerabilities. The information in this chapter complements an internal guidance note on liquidity stress testing for the IMF staff (Catalán 2015) and includes cross-country comparisons.1

Consistent with market and regulatory developments, liquidity stress testing has become a core element of financial stability analysis in FSAPs, which has historically focused on solvency stress testing. In doing so, the IMF staff has taken steps to:

  • take stock of liquidity risk-management practices (for example, IMF 2010a, 2011a);
  • improve liquidity stress tests by examining gaps in their previous design (for example, Ong and Čihák 2010; Schmieder and others 2012; Schmitz 2015; Jobst 2017);
  • develop methods to identify systemic liquidity risk (for example, IMF 2011a; Jobst 2014); and
  • build models linking liquidity and solvency risks for more robust stress tests (for example, Basel Committee for Banking Supervision 2013b, 2015); the IMF’s last Review of the FSAP (IMF 2014a) explicitly examines systemic effects encompassing the interaction of different risk types within and across the various financial sectors.2

The chapter considers FSAPs undertaken in 34 significant jurisdictions that completed an FSAP exercise between September 2010 and December 2016. This group comprises: (1) 29 countries identified by the IMF as having systemically important financial systems (S-29), which are subject to mandatory assessments every five years (IMF 2010b, 2013a, 2014a);3 and (2) the five G20 members that are not among the S- 29, as presented in Table 16.1. However, the sample for this chapter excludes three of these 34 FSAPs for which liquidity stress tests were not undertaken (European Union, Luxembourg, Mexico).

Table 16.1S-29 and Other G20 Countries: FSAPs over the FY 2011 to FY 2017 Period
RankJurisdictionGroupingCompleted FSAPs since FY2010Reference
1United Kingdom2011, 2016S-25/S-29*, G20, G7IMF (2011d), IMF (2016b)
2GermanyS-25/S-29*, G20, G72011, 2016IMF (2011h), IMF (2016c)
3United StatesS-25/S-29*, G20, G72010, 2015IMF (2010c), IMF (2015c)
4FranceS-25/S-29*, G20, G72012IMF (2013f)
5JapanS-25/S-29*, G20, G72012IMF (2012c)
6ItalyS-25/S-29*, G20, G72013IMF (2013h)
7NetherlandsS-25/S-29*2011IMF (2011b)
8SpainS-25/S-29*2012IMF (2012b)
9CanadaS-25/S-29*, G20, G72014IMF (2014c)
10SwitzerlandS-25/S-29*2014IMF (2014e)
11ChinaS-25/S-29*, G202010IMF (2011f)
12BelgiumS-25/S-29*2013IMF (2013d)
13AustraliaS-25/S-29*, G202012IMF (2012g)
14IndiaS-25/S-29*, G202013IMF (2013c)
15IrelandS-25/S-29*2016IMF (2016e)
16Hong Kong SARS-25/S-29*2014IMF (2014d)
17BrazilS-25/S-29*, G202012IMF (2013e)
18Russian FederationS-25/S-29*, G202011, 2016IMF (2011g), IMF (2016d)4
19KoreaS-25/S-29*, G202014IMF (2015a)
20AustriaS-25/S-29*2013IMF (2014b)
21LuxembourgS-25/S-29*2011IMF (2011c)
22SwedenS-25/S-29*2011IMF (2011e)
23SingaporeS-25/S-29*2014IMF (2013i)
24TurkeyS-25/S-29*, G202012IMF (2012d), IMF (2017b)
25MexicoS-25/S-29*, G202012IMF (2012a)3
26DenmarkS-25/S-29*2014IMF (2014f)
27FinlandS-25/S-29*2010, 2016IMF (2010e), IMF (2017a)
28NorwayS-25/S-29*2015IMF (2015d)
29PolandS-25/S-29*2013IMF (2013g)
ArgentinaG2020131IMF (2016a)
European UnionG2020132IMF (2013b)
IndonesiaG202010IMF (2010d)
Saudi ArabiaG202011IMF (2012f)
South AfricaG202014IMF (2015b)
Sources: IMF 2010b; IMF 2013a; and authors.Note: See http://www.imf.org/external/np/fsap/fssa.aspx (IMF 2017c) for published FSAP country reports. S-29 countries are ranked according to the size and interconnectedness of their financial systems. The IMF’s fiscal year (FY) runs from May 1 of the previous year to April 30 of the current year. FSAP = Financial Sector Assessment Program; G7 = Group of Seven; G20 = Group of Twenty; S-25 = Systemic-25 jurisdictions; S-29 = Systemic-29 jurisdictions. *Four additional countries (Denmark, Finland, Norway, Poland) were added to the original S-25 list following the 2013 decision of the IMF’s Executive Board (IMF 2014a).

Publication delayed until February 2016.

Stress tests were not conducted for the 2012/13 European Union FSAP.

No separate liquidity stress test.

Liquidity stress test integrated in solvency stress test in the 2011 FSAP.

Sources: IMF 2010b; IMF 2013a; and authors.Note: See http://www.imf.org/external/np/fsap/fssa.aspx (IMF 2017c) for published FSAP country reports. S-29 countries are ranked according to the size and interconnectedness of their financial systems. The IMF’s fiscal year (FY) runs from May 1 of the previous year to April 30 of the current year. FSAP = Financial Sector Assessment Program; G7 = Group of Seven; G20 = Group of Twenty; S-25 = Systemic-25 jurisdictions; S-29 = Systemic-29 jurisdictions. *Four additional countries (Denmark, Finland, Norway, Poland) were added to the original S-25 list following the 2013 decision of the IMF’s Executive Board (IMF 2014a).

Publication delayed until February 2016.

Stress tests were not conducted for the 2012/13 European Union FSAP.

No separate liquidity stress test.

Liquidity stress test integrated in solvency stress test in the 2011 FSAP.

In reviewing the general concepts underpinning liquidity stress tests and their implementation in FSAPs, the chapter:

  • provides the rationale (and introduces the conceptual underpinnings) for liquidity stress testing, including the regulatory framework established in recent years as well as general challenges of liquidity stress testing;
  • defines a framework for system-wide liquidity stress testing by introducing a taxonomy of the main building blocks— the scope, data requirements, methodology, and final output— to classify and compare the various approaches applied to FSAPs;
  • reviews the parameters adopted in past FSAPs for the systemically important financial systems based on a comprehensive, cross-country Stress Test Matrix (STeM), which reflects the extent to which countries have elected to disclose the methodology and findings of the stress testing exercise in the respective Financial System Stability Assessment (FSSA) reports and accompanying Technical Notes on Stress Testing (Appendix 16.1, Appendix Table 16.1.1); and
  • provides publicly available information on liquidity stress testing to help country authorities prepare for future FSAPs and readers seeking to develop their own stress testing framework.4

While some standardization of FSAP liquidity stress tests can improve comparability and efficiency, it may not be possible or desirable to do so under all circumstances. In fact, FSAP liquidity stress tests are far more heterogeneous than solvency stress tests. There are several reasons for this:

  • Each financial system has its own special features, which also require qualitative assessment and consequently, expert judgment that can influence the stress test.
  • The availability and quality of data influence the choice of appropriate methods in ensuring the reliability and credibility of the results.
  • The extent of the collaboration with the authorities (and individual banks) plays a crucial role.

The chapter is organized as follows. Section 2 sets out the premise for running liquidity stress tests and discusses the conceptual underpinnings. Section 3 details the various components and elements of the liquidity stress testing framework and their application to individual FSAPs. The caveats to liquidity stress tests are presented in Section 4. Section 5 concludes with a discussion on advances in liquidity stress tests and areas for future improvement.

2. Why Stress Test for Liquidity Risk?

Premise

The global financial crisis provided a stark reminder of how the realization of liquidity risks can undermine financial stability and underscored the need for regular liquidity stress tests on banks and banking sectors. Unlike bank solvency, which tends to deteriorate gradually during times of stress, liquidity shocks can manifest rapidly as demonstrated in the scale and scope of their impact across financial systems during the crisis. This has made liquidity risk a central element of postcrisis regulatory reforms; notably, the last revisions to the Basel Accord (“Basel III”) contain a strong emphasis on liquidity risk-management practices (Basel Committee for Banking Supervision 2017c). These practices comprise both quantitative (a range of metrics) and qualitative (related to risk management and supervision) measures, as documented in Table 16.2.

Table 16.2Liquidity Risk: Regulatory Initiatives on Liquidity Risk
InitiativesRelated Documents
A. Basel Committee on Banking Supervision (BCBS)
  • Established the Working Group on Liquidity to review liquidity supervision of national authorities and transposed some basic principles of liquidity risk management into standard liquidity ratios, the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR).
BCBS (2008a)
  • Issued guidance on liquidity risk-management processes around 17 principles, focusing on medium and large complex banks.
BCBS (2008b)
  • Developed Principles for Sound Stress Testing Practices and Supervision based on review of supervisory authorities’ implementation of stress testing principles, which integrated liquidity risk in the formulation of stress testing frameworks of banks.
BCBS (2012b)
  • Proposed minimum liquidity standards via two quantitative measures (LCR and NSFR), complemented by other monitoring tools to be applied at a global level under the Basel III rules.
BCBS (2010a, 2012a, 2013a, and 2014)
  • Issued guidance on the design of proposed monitoring indicators for intraday liquidity management with the aim of enabling bank supervisors to monitor banks’ intraday liquidity risk management and their ability to meet payment and settlement obligations in a timely manner and even under stressed scenarios.
BCBS (2013b)
  • Issued consultative document on Stress Testing Principles, aimed at replacing existing principles published in 2009 with governing principles.
BCBS (2017d)
  • Reviewed regulatory consistency of the national rules with the Basel framework (including liquidity standards) in its jurisdictional assessments (published in annual monitoring reports).
BCBS (2018)
B. Bank for International Settlements Research Task Force
  • Surveyed existing industry and supervisory practices in liquidity stress testing with a view to improving methodologies and practices, in particular, with respect to the interaction with solvency and contagion stress testing.
BCBS (2013c)
  • Surveyed existing literature on risk drivers of liquidity stress consistent with categories and concepts of LCR.
BCBS (2013d)
  • Outlined several approaches to modeling the interaction between liquidity and solvency risks from a macroprudential perspective.
BCBS (2015)
  • Surveyed the impact assessment of liquidity requirements and their interaction with capital requirements.
BCBS (2016b)
Sources: BCBS; and authors.
Sources: BCBS; and authors.

Liquidity stress tests inform a comprehensive assessment of whether banks’ own internal resources (in the form of liquidity buffers) are sufficient to withstand adverse shocks. They aim to shed light on the potential need for emergency liquidity assistance to viable banks. Parent banks represent another important external source of liquidity support during times of stress, although any assessment of their capacity to do so may be limited if they are in another jurisdiction (or supervisory guidance on ring-fencing restricts cross-border transfers).

Concept

Liquidity stress tests aim to capture the risk that a bank fails to generate sufficient funding to satisfy short-term payment obligations arising from a sudden realization of liabilities. The tests assess the adequacy of available funding sources over a defined stress horizon. These tests would usually— and appropriately— examine the resilience of individual banks or banking sectors without considering central banks’ lender-of-last-resort liquidity support (Box 16.1).5 There are two broad, mutually reinforcing types of liquidity risk (Figure 16.1 and Appendix 16.2):

  • Funding liquidity risk is the risk that a bank will not be able to meet its current and future cash-flow needs in case of a runof of its funding liabilities, contingent payment obligations, and/or disruptions to cash in-flows. Specifically, a bank’s funding capacity depends on whether it can manage scheduled and unscheduled cash outflows (including the loss of funding sources and contingent lending through existing commitments) against cash inflows that are related to maturing assets, the rollover risk stemming from any maturity mismatches, and the ability to access unsecured retail/wholesale funding markets.
  • Market liquidity risk is the risk that a bank will not be able to sell a sizeable volume of securities without impacting the prevailing market price (IMF 2015f). Market liquidity is reflected in volume (for example, turnover ratios) and price-based measures (bid-ask spreads, price impact of large trades). For liquidity (and partly also solvency) stress tests, banks assess the expected cash inflows from asset sales in a stressed environment. This involves mark-to-market valuation changes (of securities that are classified as either trading or available for sale) and possible extraordinary impairment losses of held-to-maturity assets in the banking book from a defaulting obligor or the forced (discounted) sale of assets by the bank (prior to the maturity date). The decline in asset values owing to market risk, and the extent to which assets are subject to haircuts when used as collateral for wholesale funding, influence the severity in changes of cash flows.

Conceptualization of Liquidity Risk

Sources: Jobst 2012; and authors.

The self-reinforcing downward liquidity spiral during the global financial crisis underscored the potentially crippling relationship between both types of liquidity risk (Figure 16.1). The repricing of risk occurs when market illiquidity turns into funding illiquidity, such as when banks refuse to accept withdrawals. Funding illiquidity can also lead to market illiquidity, such as when swap markets dried up in late 2007 due to concerns over the rising counterparty credit risk of European banks seeking US dollar funding (IMF 2008). Both funding and market liquidity risks characterize liquidity stress tests and differentiate them from solvency stress tests. The latter assess the capital impact of asset price shocks from valuation losses and impairments that are not directly triggered by adverse funding conditions, although there is a close link to liquidity though this channel.

Central Banks and Parent Banks as Liquidity Backstops

Central banks can counterbalance rising funding risk during times of stress by acting as a lender of last resort to banks. For instance, during the global financial crisis, the US Federal Reserve entered into swap agreements with several central banks, which, in turn, provided much needed US dollar funding to their own domestic banks.1 These facilities were extended twice, enabling the European Central Bank, for instance, to provide unlimited three-month US dollar funding. In addition, the European Central Bank’s own longer-term refinancing operation program provided stable funding to eligible banks and removed intermittent funding problems during the European sovereign debt crisis.

There is also contingent liquidity support within banking groups. Parent banks could maintain or increase credit lines to subsidiaries or branches during stress periods. However, ring-fencing could hinder cross-border liquidity flows, as occurred during the global financial crisis (Cerutti and others 2010), but in the case of branches and subsidiaries in Central and Eastern Europe, funding by their Western parent banks turned out to be more reliable than alternative funding sources (for example, euro wholesale markets). Historically, parent banks typically have not provided additional liquidity to subsidiaries when they are affected by idiosyncratic liquidity shocks as a result of severe (perceived) solvency problems.

1 The US Federal Reserve also provided liquidity to large international banks (in addition to the domestic US financial institutions), but only to the US branches of foreign banking organizations.

The proper identification, monitoring, and mitigation of both market and funding liquidity risks require both price-and quantity-based information on bank balance sheets, monetary dynamics, and developments in securities and funding markets (Table 16.3). Institution-level funding vulnerabilities are captured by liquidity ratios, including the share of noncore funding (short-term, wholesale, foreign exchange) in total liabilities. These indicators are normally supplemented with a detailed decomposition of assets and liabilities, for example the share of high-quality liquid assets (HQLAs) in total assets (see Appendix 16.3), asset-liability maturity mismatches, and gross open currency positions. The assessment of liquidity risk based on this information varies with the development of monetary and general market conditions, for example, interbank market turnover, securities issuance, or the volume of secured/unsecured borrowing. For small open economies, trends in short-term capital inflows through financial institutions (as captured in positions and flows of other investments and portfolio investments received by banks) are often important indicators of noncore funding and can represent sources of instability in the funding market (Nier and others 2014).

Table 16.3Overview of Liquidity Indicators
QuantitiesPrices
Monetary conditions and capital flowsBase money and broader monetary aggregates

Access to central bank liquidity

(for example, bidding volumes)

Excess bank reserves

Volume of short-term capital inflows

(especially if intermediated by banks)
Policy and money market interest rates Monetary conditions index1
Institutional and funding liquidityVolume of secured/unsecured funding via securities financing transactions (SFTs)2

Liquidity ratios (LCR, NSFR, loan-to-deposit ratio, share of noncore funding, liquid asset ratio)

Maturity mismatch measures

Net cash flow estimates

Gross open foreign currency position
Spread between secured/unsecured wholesale funding rate and effective policy rate

Unsecured lending rate and counterparty risk

(for example, LIBOR and LIBOR-OIS spread) Valuation haircuts on collateral for SFTs2 FX swap basis

Violation of arbitrage conditions

(for example, bond-CDS basis and covered interest parity)

Spreads between assets with similar credit characteristics

Qualitative surveys of funding conditions
Market liquidityVolume of securities issuance

Transaction volumes

(including average transaction size)
Bid-ask spreads on selected assets

Qualitative fund manager surveys
Sources: Committee on the Global Financial System (CGFS) 2011; Jobst 2012; and Nier and others 2014.Note: CDS = credit default swap; FX = foreign exchange; LCR = liquidity coverage ratio; NSFR = net stable funding ratio.

Such as the elasticity of aggregate demand to the real short-term interest rate and the real effective exchange rate.

Includes repo and securities lending. See also IMF 2015f, CGFS 2011, and Markets Committee 2016 for recent studies on market liquidity.

Sources: Committee on the Global Financial System (CGFS) 2011; Jobst 2012; and Nier and others 2014.Note: CDS = credit default swap; FX = foreign exchange; LCR = liquidity coverage ratio; NSFR = net stable funding ratio.

Such as the elasticity of aggregate demand to the real short-term interest rate and the real effective exchange rate.

Includes repo and securities lending. See also IMF 2015f, CGFS 2011, and Markets Committee 2016 for recent studies on market liquidity.

The potential buildup of systemic vulnerabilities warrants comprehensive monitoring of liquidity risks, especially where the impact of disruptions to funding markets could be most widespread (Jobst 2014). These risks are related to different funding sources that determine the time dimension of liquidity risk, such as the balance between secured/unsecured funding sources via capital markets and the more structural (bank-specific) aspects of asset-liability management. Money markets and deposit funding represent short-term funding channels that meet operational requirements, while central bank money via standing facilities and tenders help reduce funding contingencies (mostly overnight and over very short time periods). Meanwhile, traditional deposits still form the funding backbone of many banks, so liquidity risk relating to deposits also needs to be part of the risk framework.

Liquidity stress tests follow either a cumulative or a noncumulative approach in identifying liquidity shortfalls. The economic importance of inflows and outflows for the liquidity position of a bank or banking sector under stress can be assessed either in terms of a cumulative effect during a specified survival period (using implied-cash- flow [ICF] tests) or non-cumulatively by means of a limit system (such as liquidity ratios and associated minimum requirements). Both approaches share the common objective of capturing the risk that a bank or banking sector fails to generate sufficient funding to satisfy short-term payment obligations. Key benchmarks are two standard liquidity metrics introduced under Basel III— the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR) (see Appendix 16.3 for further information).

More comprehensive macroprudential stress tests should, where possible, incorporate negative feedback loops between solvency conditions and liquidity risk to support a more nu-anced assessment of potential systemic risk and differentiate across banks’ varying susceptibility of solvency-induced liquidity stress. While solvency stress tests examine the impact of credit and market risk-related losses on bank capital, they would ideally also account for diminishing funding opportunities and the price impact of rising counterparty risk under stress, particularly in the wake of a significant deterioration of solvency conditions (see Appendix 16.4 for examples of research on this issue). Empirical evidence suggests that solvency and liquidity stress tests that do not account for the interaction between solvency and liquidity shocks substantially underestimate the risk exposure of individual banks and banking sectors (Puhr and Schmitz 2014). However, the practical implementation of this concept in liquidity stress testing remains at an early stage (BCBS 2013c, 2015).

The design and calibration of scenarios for liquidity stress tests tend to be more challenging than for the solvency ones because of the following factors:

  • Liquidity crises are partly attributable to psychological factors or confidence effects, which tend to be idiosyncratic in nature and difficult to capture in any model.
  • Limited availability of requisite granular data (for example, asset encumbrance levels, information on collateral), and the existence of available or existing repurchase agreements (“repos”) (or reverse repos) and/or the confidentiality of bank liquidity information have constrained the development of comprehensive liquidity stress testing models.

Funding liquidity risk has been a specific focus of recent system-wide stress tests. For instance, the 2011 and 2014 EU-wide solvency stress tests conducted by the European Banking Authority included a shock to the cost of funding, which was linked to the bank-specific impact of sovereign stress. It was also assumed that higher short-and long-term interest rates as well as lower collateral values would increase banks’ wholesale and retail funding needs (without changes to their funding structure under stress) in both the baseline and adverse scenarios. In the latter case, an explicit funding volume shock was simulated as part of the European Central Bank’s macroeconomic stress testing framework.

3. A Framework for Bank Liquidity Stress Testing

Liquidity stress testing has become a core element of the IMF’s financial sector surveillance since the global financial crisis. It is now a regular component of the financial stability module of FSAP exercises undertaken by the IMF staff (Table 16.4). Also, many countries have adopted comprehensive approaches to assessing system-wide liquidity conditions under stress, in most cases to support national versions of standard liquidity ratios.6 The following sections discuss the IMF’s liquidity stress testing framework using examples of applications to FSAPs (Appendix 16.1 provides detailed information alongside these dimensions for 31 jurisdictions). This also includes a brief review of the implementation of liquidity risk measures under national liquidity reporting frameworks in the context of different types of liquidity stress tests.

Table 16.4A Framework for Macroprudential Bank Liquidity Stress Testing
ComponentDescription
1. Scope
Approach
  • Bottom-up (BU) by banks (using supervisory templates/assumptions; guidance from authorities/IMF staff)
  • Top-down (TD) by authorities (own assumptions/templates, possibly aligned with assumptions in IMF TD stress test)
  • TD by authorities (IMF templates/assumptions)
  • TD by IMF staff (IMF templates/assumptions)
Coverage
Institutions Market shareMostly the largest banks, including foreign subsidiaries and branches In most countries >80 percent of total banking sector assets
Data
SourceBanks’ own data, supervisory data, and public data
Cutof dateEnd-quarter or end of last fiscal year
Reporting basisMostly consolidated banking groups, but also unconsolidated domestic businesses/solo basis in many countries
2. Scenario Design
Test(s)
  • Implied-cash-flow test (cumulative/noncumulative) over 5/30 days with focus on the sudden, sizeable withdrawal of funding (liabilities), and the sufciency of existing assets to withstand those shocks under stressed conditions after taking into account valuation haircuts to liquid assets and amortization of outstanding assets; alternative scenarios: (1) restricted run-off to deposit and wholesale funding (that is, selected customer deposits are unaffected), (2) availability of intergroup funding, and (3) unexpected cash outflows and drawdown of unused credit lines (behavioral cash flows) due to withdrawal of contingent liabilities and inability to roll over maturing unsecured wholesale funding
  • Asset-liability mismatch analysis over different risk horizon/maturity buckets (with and without rollover restrictions)
  • Basel III standard liquidity measures (Liquidity Coverage Ratio [LCR] and Net Stable Funding Ratio [NSFR]); often approximated based on assumptions about contractual maturities and credit quality of securities; for LCR, in most cases, the minimum parameters for deposit outflows were chosen; results were checked against the outcome of the preceding quantitative impact study (QIS-6) of the Basel III framework
Risk HorizonOne or five working days (one week) and/or one month
Risk(s)
  • Funding liquidity risk: runoff rates, renewal/callback/rollover rates
  • Market liquidity risk: valuation haircuts (market-based or predefined)
Calibration
  • Historical experience of banks after the collapse of Lehman Brothers and other episodes of liquidity stresses in the past
  • Expert judgment: assumptions about the performance of banks under stress (that is, liabilities runof, taking into account valuation haircuts to liquid assets, and amortization of outstanding assets)
Other issues
  • Asset encumbrance
  • Link to solvency stress test (and scenarios)
  • Buffer: counterbalancing capacity; offsetting contractual inflows due to central bank support
Benchmarks
Metrics/Output
  • Positive net cash inflow: ability of banks’ liquidity buffers under stressed scenarios to cover expected and potential outflows over a given time period (that is, liabilities runof, taking into account valuation haircuts to liquid assets, and amortization of outstanding assets)
  • Regulatory liquidity ratio(s): LCR, NSFR, and/or national liquidity risk measure
3. Methodology
Model
4. Communication
Presentation
  • Standardized output template for BU and TD results provided to banks and national authorities
  • Results discussed in Financial System Stability Assessment (FSSA) (supported by more detailed description of both methodologies and findings in a Technical Note [TN]); in most cases, both FSSA and TN are published
Source: Authors.
Source: Authors.

Scope

Approach

In FSAPs, surveillance stress testing of banks’ liquidity risk usually consists of either a top-down (TD) approach or, less used to date, a bottom-up (BU) approach. Underlying assumptions and calibrations are generally agreed to between the national authorities and the IMF staff:

  • TD tests are often conducted by the authorities with inputs from the IMF staff (for example, Austria, Brazil, Italy, and Poland) or jointly with the IMF staff (for example, Australia, Belgium, Germany, Hong Kong SAR, Ireland, Russia, Saudi Arabia, Spain, and the United Kingdom) if required owing to the confidential nature of prudential data. However, there are instances where some (or all) TD tests are conducted independently by national authorities (for example, Canada, Hong Kong SAR, India, Korea, Sweden, and Switzerland) or by the IMF staff only (for example, France, Norway, and the United St ate s).
  • Increasingly, banks have been involved in BU liquidity stress tests for FSAPs (for example, Belgium, China, Denmark, Korea, Singapore, and South Africa), which involve both the national authorities and the IMF staf. This approach has enhanced the technical detail of liquidity stress tests, given the granular data available at the bank level compared to the higher-level aggregated information that is used in most TD stress tests.
Coverage

Complete institutional coverage is important for the usefulness of the exercise. In most financial systems, banks that are systemically important from a solvency perspective also tend to be relevant for the analysis of system-wide liquidity risk; however, the aggregate effect of many vulnerable, smaller banks with similar business models can also undermine the stability of the system. Sometimes, smaller banks may also account for an important share of liquidity provision in the financial system. In this regard, the selection of relevant banks to include in the sample could be more complicated than in solvency stress tests, where the systemically important institutions may be more obvious. Thus, some FSAP liquidity stress tests covered the entire banking sector, including cooperative and savings banks (for example, Brazil, Denmark, and Switzerland). Between September 2010 and December 2016, nine of the 29 FSAPs that incorporated liquidity stress tests (for which detailed information is made publicly available) included nearly all banks in their respective systems (for example, Germany, India, Italy, Korea, Russia, Saudi Arabia, South Africa, Sweden, and the United Kingdom); more than 80 percent of system assets were covered in eight other cases (Australia, Belgium, Canada, China, Denmark, France, India, and Turkey).7

Increasingly, bank liquidity stress tests would also need to be attuned to risks emanating from systemically relevant shadow banking activities and entities (Financial Stability Board 2012; IMF 2014a). As an example, US money market mutual funds are important providers of non-deposit (US dollar) funding to European banks; they were subject to runs themselves during the peak of the crisis in 2008 and had to be rescued either by their bank sponsors or the government. Furthermore, banks are sometimes inherently intertwined with hedge funds or finance companies (that are dependent on short-term funding), both of which could also be susceptible to funding runs, resulting in spillover effects to the banking sector.

Data

Characteristics Liquidity stress tests require granular bank-level information. The comprehensiveness, comparability, and consistency of these tests depend on the access to quality data that cover essential elements of funding and market liquidity risks to a sufficient degree of accuracy. Data granularity increases with the complexity of the system, including the diversity of sources, and the use of funds:

  • TD tests typically rely on confidential prudential information gathered from the supervisory liquidity reporting process. In many cases, the data also cover broad categories of assets and liabilities with breakdowns of maturity terms (for example, Australia, Austria, Brazil, Germany, Hong Kong SAR, Korea, Poland, Spain, Sweden, Turkey, and the United Kingdom) and differentiation by currency (for example, Austria, Korea, Singapore, and Turkey). However, in some countries, public data also have been used (for example, Norway and the United States).
  • Separately, BU tests using banks’ own data (for example, Belgium, China, Denmark, France, India, Japan, Korea, Singapore, and South Africa) would require careful cross-validation with available supervisory data as well as an assessment of the quality of internal controls, risk management, and corporate governance to include the findings in the FSAP assessment.
  • The data cutof date for a liquidity stress test would ideally coincide with that of the (parallel) solvency stress test, which ensures time consistency in assessing banks’ health and facilitates including feedback effects between the two exercises (if applicable).

Reporting Basis (Consolidation) One dimension of liquidity stress that has received little attention so far is the level of consolidation of banks’ financial accounts. Liquidity stress tests may be carried out on consolidated level data (which is very common) or on a legal entity (solo) basis. The latter is only relevant if the stress test includes financial conglomerates and/or international groups, which may have considerable intragroup funding arrangements in place that could be disrupted by cross-border restrictions (that is, “ring-fencing”) of liquidity (and capital) during times of stress. This aspect becomes even more important in countries where significant market share is held by (1) host-supervised banks, which could experience high liquidity outflows owing to intragroup funding obligations to subsidiaries abroad; or (2) large subsidiaries and branches that depend on contingent intragroup funding. For these countries, stress tests have been implemented either (1) on a solo basis (for example, Germany, Ireland, South Africa, and the United Kingdom); or (2) on both solo and consolidated bases (for example, Belgium, Hong Kong SAR, and Singapore). In most FSAPs, however, stress tests have been applied on consolidated data. Cross-border liquidity stress tests using consolidated data are applied in the Spain FSAP IMF 2012b using the Espinosa-Vega and Sole 2011 methodology.

Scenario Design

Once the scope of the liquidity stress test has been determined, the scenario design is defined. It comprises: (1) the definition of the scenarios (for example, scope and severity); (2) the exogenous stress assumptions; and (3) the pass/fail benchmarks. Liquidity stress tests assess the short-term or, in some cases, medium-term resilience of banks to sudden, sizeable withdrawals of funding (liabilities) together with in-sufficient callbacks on outstanding claims. Some tests are aimed at gauging the magnitude of shocks required to cause severe distress, that is, constitute reverse stress tests (“until it breaks”), in addition to “traditional” tests that project liquidity positions under specified scenarios, usually involving one of the following:

  • Cash-flow mismatch analyses over different risk horizons, with a focus on the sudden, sizeable withdrawal of short-term funding sources and the sufciency of selling (unencumbered) existing assets to withstand those shocks under stressed conditions (with asset-specific haircuts).
  • Liquidity ratio-based analysis over a longer risk horizon.
Types of Test Metrics

FSAP stress tests typically assess changes to the funding condition of banks under different adverse scenarios within the framework of existing (or useful) liquidity risk-management measures. The following policy measures promote a more stable funding profile and improve the resilience of the banks to funding shocks (Nier and others 2014):

  • Liquidity buffer requirements encourage banks to hold sufficient liquid assets to cover outflows during time of stress.
  • Stable funding requirements ensure that illiquid assets are funded by stable sources of funding.
  • Liquidity charges impose a levy on noncore funding.
  • Reserve requirements ensure that banks hold certain amounts of reserves with their central bank.
  • Restrictions on open foreign currency positions and/or foreign currency-denominated funding aim to limit banks’ exposure to exchange rate risk.

Most exercises combine ICF modeling with standard liquidity risk measures, benchmarked on national regulatory standards, which are calibrated to (or closely aligned with) the Basel III liquidity framework. Examples include:

  • ICF tests: Balance sheet information is used to simulate a bank-run- type withdrawal of deposits and wholesale funding (including the nonrenewal of contracted funding), together with drawdowns of contingent claims and related party funding obligations (usually not decomposed into maturity buckets). Cash inflows from contingent funding sources and receipt of payments for maturing claims as well as assumed proceeds from selling available liquid assets and/or using them as collateral for secured funding are applied fully, or in part, to counterbalance the assumed outflows. These cash-flow projections may be augmented with market-based measures of the sensitivity of funding costs to changes in the asset risk of banks based on observed or market-implied default probabilities and expected losses.
  • Basel III standard liquidity measures: Under Basel III, banks are expected to maintain a stable funding structure, limit maturity transformation, and hold a sufficient stock of available assets to meet their funding needs in times of stress (BCBS 2010b, 2011, 2012b, 2013a). The framework is based on two standardized ratios, the LCR and the NSFR, which are applied to banks on a consolidated basis.8
  • Standard liquidity ratios by national authorities: Many bank regulators have enhanced their national liquidity reporting frameworks to support the implementation of liquidity risk measures (for example, the former UK Financial Supervisory Authority’s liquidity reporting profile, which has been complemented by the liquidity metric monitor,9 and the National Bank of Belgium’s liquidity ratio). Most standard liquidity ratios are assessed as noncumulative measures of potential liquidity shortfall for stress periods covering the short-and medium-term resilience of individual banks and the overall system.

Risk(s) and Risk Horizon These tests cover both funding and market liquidity risks. In most FSAPs, stress tests are modeled as cash-flow tests of bank-run-type funding shocks over short consecutive periods. Liquidity metrics focusing on structural asset-liability mismatches (similar to the NSFR) are applied to longer horizons. Commonly, the former is used to analyze either consecutive (cumulative) daily cash outflows over several days (typically five working days or one week) or one-of, noncumulative aggregate cash outflows over 30 days, whereas the latter assesses the adequacy of stable sources to continuously fund cash-flow obligations inside a one-year time horizon.

Calibration Most liquidity stress tests in FSAPs entail deterministic stress scenarios based on ICF approaches and fully fedged cash-flow tests. This is distinct from simulation approaches (possibly combined with network modeling), which have also been used in past exercises, albeit less frequently. Scenario assumptions are meant to be sufficiently “extreme yet plausible” to effectively cover the scope of existing vulnerabilities. This application is particularly challenging during benign times when there is greater uncertainty about the realization of risks. In some cases, it might also be useful to reconcile the characteristics of liquidity shocks with the sudden-stop and boom-bust scenarios of solvency stress tests. ICF tests and standard liquidity measures, including regulatory ratios such as LCR and NSFR, contain a predefined set of assumptions (which can be subject to sensitivity analysis). Other deterministic stress tests may be based on historical worst-case scenarios, expert judgment, or statistical models/valuation approaches (and then mainly on the a sset side).

Other Considerations

The scenarios define the scope of the liquidity buffer as well as the contractual maturities of expected cash flows in stress situations. The quantification of assets and liabilities generating cash flows should, if possible, be supplemented with assumptions about potential cash flows from related and third parties in the form of committed but unused credit lines/ liquidity facilities. These contingent claims/liabilities are an essential element of projected behavioral cash flows and are recorded either (1) “ off-balance sheet” (for example, liquidity facilities to special investment vehicles and long/short derivatives positions) or (2) “ on-balance sheet” if they are “instantaneous” or have no specific maturities (for example, sight deposits) (Catalán 2015). They receive special treatment, different from that accorded to assets and liabilities with non-contingent payofs and an explicit maturity structure.

Asset Encumbrance The design of liquidity stress tests should, where possible, also include granular information about banks’ asset encumbrance or liquidity from eligible collateral ex post haircuts (European Systemic Risk Board 2012). The assessment of banks’ funding risks under stress conditions is critically dependent on the market value of liquid assets, their current (or expected) encumbrance, and/or the ability to monetize them.

Banks with high asset encumbrance levels (for example, through secured refinancing activities and on-balance sheet structured finance, such as covered bonds) have less capacity to withstand severe liquidity shocks, as their access to collateral-backed funding is constrained. Other unsecured creditors, such as depositors, are also subordinated, increasing the risk of a run during stressful periods. Hence, the liquidity buffer considered in tests comprises only unencumbered liquid assets, that is, assets that can be (but have not been) used as collateral to receive funding (except for cash or cash equivalents). The stock of liquid assets normally excludes encumbered assets in cases when banks do not have the operational capability to sell them or use them as collateral for a repurchase agreement with the central bank or other banks to meet outflows during the stress period, that is, if repo operations for commercial and/or central bank money are not possible.

In most cases, liquidity reporting requirements of banks already include assumptions on asset encumbrance affecting the valuation of liquidity buffers and/or assumptions on the depletion of funding sources under stress (“behavioral adjustments”), such as in the United Kingdom. In other cases (for example, Australia, Belgium, Brazil, Hong Kong SAR, Italy, Japan, Korea, and Turkey), any encumbered assets were excluded from the scope of liquid assets from the exercise. Stress tests that include public data or supervisory data, for which a consistent application of these adjustments cannot be verified, assume a uniform degree of asset encumbrance for the valuation of liquid assets, in addition to the application of haircuts (Jobst 2017).

Link to Solvency Estimated changes in funding costs during times of stress (and their impact on net cash flows) can help link liquidity scenarios to the capital adequacy assessment in solvency stress tests. The macro-financial transmission of shocks affecting the capital assessment also applies to corresponding liquidity stress tests insofar as any change in funding costs affects the assumptions of interest expenses (and cost of capital) applied to the solvency tests. Solvency stress tests in recent FSAPs estimate the impact of shocks to banks’ balance sheets through the cost of funding of short-term debt and the maturing portion of long-term debt with a lag (for example, Brazil, Germany, Spain, and the United Kingdom).

Changes in funding costs influence the expected availability and maturity tenor of available funding over the risk horizon. Banks’ applications of internal pricing mechanisms, which often include hedging of funding cost changes, are also important elements of the chosen cost-of-funding method. These costs typically take the form of an additional interest expense. The elasticity of funding costs is nonlinear to changes in solvency conditions and could be differentiated across maturity tenors and types of funding, such as checking/term deposits, secured/ unsecured wholesale funding, and short-term debt that would need to be rolled over within the risk horizon of the stress test. In the case of noncommoditized bank debt, such as interbank funding arrangements, lending rates adjust in response to changes in counterparty risk.

Liquidity stress tests should, where possible, incorporate feedback (or second-round) effects when considering the reaction to funding shocks. Funding costs are influenced by banks’ solvency conditions and changes in market prices during stress periods.10 Impairment losses could also raise funding costs (Aiyar and others 2015) in a dynamic between bank liquidity and solvency, but this issue remains to be addressed in stress tests. Outright rationing of funding, in addition to increases in cost, may arise for banks that are perceived to be weak vis- à- vis their peers. Moreover, liquidity stress can spill over to other (stronger) banks by affecting market liquidity and, ultimately, the availability of funding for these banks, which could lead to solvency concerns. In this regard, sources of macro-financial shocks can be triggered, or at least propagated, by vulnerabilities to the adverse effects of such interactions in times of collective distress. Finally, there can be additional spillover effects associated with counterparty risk if weak banks are unable to honor, in part or entirely, their interbank exposures. However, the operational implementation of feedback loops in the context of system-wide stress tests remains at a seminal stage (Appendix 16.4).

Liquidity Buffer

Counterbalancing capacity. The liquidity buffer represents banks’ “counterbalancing capacity” under stress. It comprises cash and cash balances with central banks (excluding minimum reserve requirements) as well as unencumbered assets, which could generate inflows from outright sales or collateralized lending (“secured funding,” for example, repo and securities lending transactions). The evolution of trading assets in response to market risk shocks, such as to foreign exchange rates and interest rates, determines the degree of illiquidity affecting both price/valuation changes of fixed income holdings and their speed of disposal.

The buffer may be applied to cover short-term payment obligations (that is, available assets that could be sold under stress). Different haircuts are imposed on assets that are included in the buffer, depending on their perceived (or assumed) liquidity under stress. Haircuts account for estimated valuation losses due to potential illiquidity of tradable exposures and the resulting changes in funding (costs).11 Recent European FSAPs (for example, Belgium, France, Germany, Italy, Spain, and the United Kingdom) have also acknowledged sovereign risk by estimating haircuts for relevant government debt holdings based on the impact of changes to credit risk on bond prices assuming an increase in sovereign default risk that is consistent with market expectations impacting the valuation of local and foreign government debt (see Chapter 9).

Contractual and behavioral cash inflows. The amortization of existing (contractual) claims/obligations, depending on the renewal/ call back rate, and the emergence of contingent (behavioral) assets/liabilities generate cash flows, which can be modeled on a cumulative (that is, multiperiod) or noncu-mulative basis. Contractual cash flows remain firm and unchanged under stress while behavioral cash flows could change significantly.12 Behavioral flows could either mitigate or amplify contractual cash flows through (1) additional in-flows related to either new secured and unsecured funding at shorter but also longer maturity terms (for example, as new deposits, wholesale funding, and debt issuance) or rollover/ refinancing of contractual liabilities (for example, part of the maturing time deposits are likely to be rolled over); and (2) additional outflows associated with expected new loans, investments, or undrawn committed credit lines.13

The most important funding sources that generate cash inflows are:

  • Contractual: Expected cash inflows related to (1) the repayment of amortized lending with/without liquid financial assets as collateral (that is, secured/ unsecured lending); and (2) transactions with liquid securities and bank loans (that is, asset sales) and funding from related parties (intragroup funding).
  • Behavioral: Potential cash inflows from related and third parties in the form of committed or uncommitted but unused credit lines/liquidity facilities as contingent liabilities (situation on reporting date).

Scenarios encompass both systematic shocks affecting all banks and idiosyncratic shocks that impact individual banks only. Given that market-wide stresses amplify the individual liquidity risk, Schmieder and others 2012 advocate including combined scenarios similar to the one underlying the LCR. Where possible, scenarios should also be accompanied by consistent narratives underpinning the assumptions on all relevant cash-flow parameters and risk factors, including: (1) callback rates for lending and runof rates for funding,14 (2) valuation haircuts for assets sold at fre sale prices and drawings of contingent liabilities (Coval and Staford 2007; Shleifer and Vishny 2010), and (3) the impact of banks’ rating downgrades as a result of deteriorating solvency conditions.

Benchmark(s)

The existing framework caters largely to TD stress tests. Hence, the emphasis is placed on running a set of consistent tests for all banks within a system (and relevant banks and nonbanks outside of it, if necessary) against common benchmarks, such as positive net cash flows, the ability of banks’ liquidity buffers to withstand stressed scenarios, and regulatory liquidity ratios.

Methodology

The methods selected for FSAP liquidity tests depend on the sophistication of the relevant banking sector. Considerations include, among others:

  • The importance of deposits relative to wholesale-based funding
  • The role of off-balance sheet funding (especially via structured finance and derivatives transactions)
  • The concentration of lending to related parties in the banking book
  • The nature of counterparty risk (for example, the relevance of market-based transmission channels of funding impacting the availability and pricing of funding, such as margin calls)

Usually, one or more quantitative stress test methods are applied to estimate potential liquidity shortfalls under the predefined shocks. Peer comparisons facilitate the assessment of liquidity risk relative to other banks within and outside the banking sector, based on common scenarios and benchmarks, especially if assumptions carry a high degree of uncertainty. For example:

  • TD tests are commonly confgured as ICF tests, which complement standard liquidity ratios and minimum prudential requirements. For banks with simple funding structures, these tests are the most appropriate. A key prerequisite for carrying out ICF tests is access to a wide range of data on contractual cash flows for different maturity buckets and possibly behavioral data based on banks’ financial/funding plans. In addition to assessments of maturity mismatches for specific time horizons under stress, they also include duration gap analyses. Deterministic liquidity stress tests developed by Čihák (2007), Schmieder and others (2012) as well as Jobst (2017) are applied in most FSAPs (see Appendix 16.5).15
  • Regulatory minimum measures such as the LCR and NSFR from the Basel III liquidity risk framework have become staple stress test methods.
  • For more sophisticated financial systems (and banks) for which market data are available, stochastic methods may be used as a complement. These market-based models incorporate uncertainty using historical volatility and/or market information (for example, Jobst 2011 and 2012). They allow for sensitivity analysis (that is, stress of one risk factor/type) or scenario analysis (that is, stress of multiple risk factors/types).
  • Macro-financial econometric models that combine liquidity stress with solvency feedback effects have been developed but their application remains scarce (for example, Barnhill and Schumacher 2011; Valderrama 2016; Gray and others 2017; Krznar and Matheson 2017).

Communication

Presentation

The main objective of stress tests is to draw the attention of bank management, supervisors, and regulators to potential risks and, if necessary, to galvanize action aimed at mitigating the impact of associated vulnerabilities. As noted in Jobst, Ong, and Schmieder 2013, it is important that the findings be appropriately conveyed. In FSAPs, liquidity stress tests are based on bank-by- bank analyses but results are generally aggregated for confidentiality reasons, underscoring the importance of meaningful firm-level data. Hence, the templates that are designed by the FSAP team for input by the authorities (Appendix 16.6, Appendix Figure 16.6.1) are:

  • consistent with any local regulatory requirements and, where relevant, any international regulatory standards (for example, Basel III) for cross-country comparison purposes; and
  • sufficiently granular, showing (1) peer groups; (2) some measure of dispersion, such as different “buckets” of liquidity ratio results or maturity tenors; (3) the number of banks failing to meet the liquidity benchmark; (4) the percentage of total sample assets of banks failing to meet the benchmark; and (5) detailed assumptions, which also clarify key limitations to the implementation of the stress test.

As with solvency stress tests, the findings of liquidity stress tests are used for two main purposes: (1) to provide quantitative support for FSAP stability risk assessments by estimating the impact from the realization of the predefined shocks, and (2) to facilitate policy discussions with the authorities on risk-mitigation strategies and crisis preparedness.

Publication

The communication of stress test results is a critical element of any publicly announced stress testing exercise, especially if enhanced transparency has immediate benefits for financial stability. Any published analysis should aim to provide a complete assessment of the system-wide resilience to liquidity risk while avoiding causing either complacency or undue alarm. Moreover, the disclosure of system-wide liquidity conditions (if based on prudential data) is particularly sensitive given that market participants may be able to take positions against those banks in short-term money markets. For FSAP exercises, the following aspects are especially relevant:

  • The objectives, definitions, assumptions, methods, and limitations of stress tests are provided in The Technical Notes on Stress Testing and/or, as supplementary information, in FSSA reports. Publication of these documents is voluntary for country authorities. The presentation of the stress test results requires the use of a standard format, that is, the STeM, to improve transparency and facilitate cross-country comparisons.
  • The aggregated results are almost always disclosed. As a minimum, information about the performance of banks under stress (that is, liabilities runof, after accounting for valuation haircuts to liquid assets and the amortization of outstanding assets) is presented in the form of liquidity ratios and/or maximum days of resilience. As with solvency stress tests, authorities rarely agree to make available the liquidity stress test results of individual banks.

To date, all the jurisdictions in this chapter’s sample (30) have authorized the publication of at least the main results and general information on the stress testing framework of the FSAP. Almost two thirds (19) have authorized the full publication of Technical Notes containing all details of the liquidity stress test component of their respective FSAPs (that is, Argentina, Austria, Belgium, Brazil, Canada, Denmark, France, Germany, Hong Kong SAR, Ireland, Italy, Korea, Norway, Russia, South Africa, Sweden, Switzerland, the United Kingdom, and the United States). For the remaining countries, the basic information on the methodologies and results of the stress testing exercise are published in the main FSAP document, the FSSA report.

4. Caveats

Liquidity stress tests that aggregate individual liquidity risk measures across all banks do not necessarily capture the scope of system-wide risks. Prudential measures, such as ICF tests, or standard indicators, such as prudential ratios, have an institutional focus. They assume that sufficient liquidity greatly reduces the likelihood of firm-specific funding shortfalls and any associated knock-on effects on capital adequacy. So, they ignore the system-wide effects from potential herding behavior by banks and their joint sensitivities to funding shortfalls.

Liquidity stress tests do not explicitly assume potential refinancing via central banks that act as lenders of last resort. Assumptions made on haircuts to unencumbered assets for banks’ counterbalancing capacity are often silent as to whether banks need to seek central bank funding or may still be able to secure wholesale funding (which is likely to be severely impaired during times of stress). Sufficient liquidity in interbank markets implies that central banks would only be required to act as lenders of last— not first— resort (Jobst 2014). However, funding shocks often represent extreme outcomes, which could lead banks to draw on their “expensive” liquidity buffers to cover the probability of tail events.

Liquidity stress test results need to be put in context given their static nature and the implicit assumption that all banks face escalating liquidity risk at the same time. Depending on the stress testing methodology, any estimated liquidity shortfall is assumed to be the result of coincidental and mostly predefined funding shocks. The results should be interpreted in terms of a general vulnerability to certain assumptions characterizing adverse liquidity conditions, rather than being representative of actual liquidity needs (given the role played by central banks as a liquidity backstop). In other words, the calculated effect might overstate the actual impact from the realization of assumptions about varying cash-flow scenarios. In addition, Schuermann 2012 cautions that the “dynamism” of liquidity positions that are subject to rapid change means that stress test results may not be very informative by the time they are disclosed.

Stress test results need to be suitably qualified based on mitigating considerations. An example would be the likely reallocation of deposits within the banking sector when funding shocks do not affect all banks simultaneously; in most cases, deposits largely remain in the banking sector and are swiftly reallocated with weaker banks, which would need to offer above-average deposit rates to retain or attract depositors. Other mitigating factors include: (1) contractual capital inflows from maturing wholesale lending, (2) possible central bank support via committed liquidity facilities and widening of eligible collateral, and (3) the likely compensating outcome for the system from the deposit insurance scheme.

5. Conclusion

This chapter provides a conceptual overview of liquidity stress testing of banks in the context of the IMF staff’s application in FSAPs for countries with systemically important financial sectors. The implementation of these stress tests varies— depending on the structural characteristics of financial systems and national prudential requirements—but there are general principles and elements that are common to all jurisdictions and facilitate the consistent implementation of comparable liquidity stress tests.

As with all other aspects of stress testing, the evolving nature of bank business models, financial instruments, and capital market conditions requires adaptability. The future of liquidity stress testing will likely be multipronged with a shift toward comprehensive cash-flow-based tests. Liquidity stress testing approaches will also require a deeper understanding of the interrelationship between solvency and liquidity risks.16

Appendix 16.1. FSAP Liquidity Stress Tests since FY2011
Appendix Table 16.1.1Liquidity Stress Test Matrix (STeM) for FSAPs of Systemically Important Financial Systems (Illustrative)
1 G20 Indonesia 3 S29 Netherlands 4 S29 Luxembourg 6 S29 Sweden 9 G20, S29 China 10 G20, S29 Mexico 11 G20 Saudi Arabia 12 S29 Spain 13 G7, G20, S29 Japan 15 G20, S29 Australia 16 G20, S29 Brazil
Publication Date Stress Testing FrameworkSeptember 2010June 2011June 2011July 2011November 2011March 2012April 2012June 2012August 2012November 2012June 2012
1. Scope
Approach
  • TD by authorities (Bank Indonesia), in collaboration with IMF staff.
  • TD by authorities (De Nederlandsche Bank).
  • TD by authorities (Riksbank)
  • BU by banks.
  • TD jointly by authorities (Saudi Arabia Monetary Authority) and IMF staff.
  • TD by authorities (Banco de España), in collaboration with IMF staff.
  • BU by banks using supervisory templates and assumptions.
  • TD by authorities (Bank of Japan).
  • TD by authorities (Australian Prudential Regulation Authority) using IMF templates and assumptions.
  • TD by authorities (Banco Central do Brasil), aligned with IMF framework (used as a benchmark).
Coverage
Institutions
  • All (121) banks, except rural banks, which account for about 1 percent of total financial sector assets, and are subject to different and regulatory requirements.
  • 11 largest banks.
  • 4 largest banks (plus group of large European banks as a benchmark).
  • 17 largest commercial banks
  • 12 locally incorporated banks.
  • 29 banks
  • BU: Three mega banks.
  • TD: All major and regional banks (111), Including 11 major banks, 63 “tier 1” regional banks, and 37 “tier 2” regional banks.
  • 5 largest banks
  • All banks (137)
Market share
  • 99 percent of total sector assets.
  • >90 percent of total sector assets.
  • 90 percent of total sector assets.
  • 83/66 percent of total assets of commercial banks/all banks
  • 98 percent of total sector assets (large bank s 59 percent; medium-sized banks 26 percent; small banks: 13 percent).
  • 91 percent of total sector assets
  • BU: About 50 percent of the banking sector (40/30 percent of total sector assets based on a narrow/broad definition of the banking sector ).6
  • TD: About 77/62 percent of total sector assets based on a narrow/broad definition of the banking sector.6
  • 80 percent of total sector assets
  • 100 percent of total sector assets.
Data
Source
  • Supervisory data.
  • Supervisory data.
  • Supervisory data
  • Banks’ own data
  • Supervisory data
  • Supervisory data
  • BU: Banks’ own data
  • TD: Supervisory data
  • Supervisory and banks’ own data.
  • Supervisory data.
Cut-off date
  • End-Q3 2009
  • End-Q2 2010.
  • End-Q3 2010
  • End-2010
  • End-2010
  • End-2011
  • End-Q3 2011
  • End-Q1 2012
  • End-2011
Reporting basis
  • n.a
  • Consolidated banking groups.
  • Consolidated banking groups
  • Consolidated banking groups.
  • Consolidated local entities
  • Consolidated for domestic business only
  • Consolidated banking groups
  • Consolidated banking groups
  • Consolidated banking groups
2. Scenario Design
Test(s)
  • Implied cash flow test calibrated to a short-lived episode of liquidity stress experienced between September and October 2008, assuming a sizeable withdrawal of deposit funding and restricted funding access to interbank funding markets, subject to a deteriorating counterbalancing capacity via the sale of of existing assets to withstand those shocks under stressed conditions
  • Implied cash flow test over 12 months, assuming deposit run, dry-up of wholesale funding markets, and haircuts on liquid assets (as counterbalancing capacity).
  • Buffer: Counterbalancing capacity.
  • Liquidity measures similar to the Basel III liquidity ratios (LCR and NSFR): on the assets side, cash is allocated a zero weight while loans are allocated an 85 percent weight; on the liabilities side, equity capital and liabilities maturing in less than a year are allocated a weight of 100 percent, while short-term market funding is allocated a zero weight; unexpected cash outflows from sudden, sizeable loss of funding (wholesale/deposits), drawdown of unused credit lines, and the sufficiency of existing assets to compensate for those shocks under stressed conditions
  • Tests combine funding liquidity with haircut on liquid assets.
  • Three scenarios for each risk horizon:(i) 7-day: decline in bond prices (1, 3, and 5 percent), deposit drawdown (2, 4, and 6 percent), decline in interbank funding (5, 10, and 15 percent), and higher required reserve ratio (0, 0.5, and 1 pcp);(ii) 30-day: share of maturing loans that become NPLs (4, 7, 10 percent), decline in bond prices drop (3, 5, and 8 percent); deposit drawdown (4, 6, and 8 percent); decline in interbank funding (5, 10, and 15 percent), and higher required reserve ratio (0, 0.5, and 1 pcp)
  • General deposit run of 25 percent.
  • Short-term deposit run of 40 percent
  • Implied cash flow test (bank-run type funding shock for 5 and 30 consecutive days).
  • LCR, NSFR, maturity mismatch analysis.
  • BU: Cash flow mismatch analysis (implied cash flow test) over two different risk horizon (1 week and 1 month), with focus on the sudden, sizeable withdrawal/market freeze of U.S. dollar funding (with run-rates applied to interbank funding and deposits by banks/central banks) and the sufficiency of selling (unencumbered) existing assets to withstand those shocks (with asset-specific haircuts); U.S. dollar funding through FX spot purchases and BoJ’s U.S. dollar funds supplying operations are excluded as mitigating actions.
  • TD: Liquidity ratio-based analysis based on the impact of a withdrawal/market freeze of wholesale funding and deposit withdrawal over a 3-month risk horizon; no haircut applied to the liquidity value of government bonds (JGB), which constitutes a large share of liquid assets.
  • Buffer: Counterbalancing capacity taking nto account haircuts to liquid assets.
  • Cash flow mismatch analysis mplied cash flow test of bank-run type funding shock for 5 consecutive periods (30 days), with focus on the sudden, sizeable withdrawal of funding and the sufficiency of selling (unencumbered) existing assets to withstand those shocks under stressed conditions (with asset-specific haircuts); only but only on-balance sheet items (i.e., no contingent claims/liabilities); also maturity mismatch analysis.
  • Buffer: No consideration of the RBA Committed Liquidity Facility ( which is permitted under LCR).
  • Cash flow mismatch analysis based on bank-run type funding shock developed by authorities (similar to LCR): Run-off rates for funding and market liquidity stress levels (for unencumbered assets) equivalent to historical evidence at the 99th percentile, simulated for a 21-day stress period, and without recourse to the reserve requirements. For the run-off rates, the bank-specific concentration of funding and the historical volatility of deposits were taken into account.
  • Basel III ratios (LCR a on “old” 201 0 BCBS rules) for 15 banks.
  • Buffer: Counterbalancing capacity taking into account haircuts to liquid assets.
Benchmarks
Metrics/Output
  • Performance of banks liabilities run-off, taking into account valuation haircuts to liquid assets, and amortization of outstanding assets)
  • Number of months banks can withstand stocks, accounting for the concentration of liquid assets.
  • Ability of banks’ liquidity buffers under stressed scenarios to cover unexpected outflows over three months.
  • Relates the weighted aver of liabilities to the weighte average of assets.
  • Performance of banks under stress (are they able to maintain a liquidity ratio of 25 percent and a liquidity gap of zero).
  • Performance of banks under stress (are they able to maintain regulatory liquidity ratio, i.e., liquid assets to deposit liabilities, of 20 percent)
  • Performance of banks under withstand shock, how many banks fail, liquidity needs, Base II ratios, etc.).
  • BU: Performance of bank s under stress i.e., deposit withdrawal, liabilities run-off interbank funding], and cash outflows of commited asset-backed commercial paper and credit facilities), taking into account valuation haircuts to liquid assets) under two scenarios (adverse/extreme). Hurdle metrics: Net cash inflow position after mitigating actions.
  • TD: Performance of banks under stre i.e., deposit withdrawal and liabilities run-off [interbank funding]) under two scenarios:(i) market freeze scenario (no wholesale funding but also no deposit run-off), and (ii) deposit withdrawal scenario (escalates market freeze scenario by assuming deposit run-off by 5–10 percent. Hurdle metrics: Liquid asset ratio (> 100 percent)
  • Performance of banks under stress (i.e., bank run and liabilities run-off, taking into account valuation haircuts to liquid assets but only on balance sheet items).
  • Hurdle metrics: Asset and iability maturity profile, liability gap (funding shortfall).
  • Performance of banks under str ased on hurdle rate for all three ratios (the BCB liquidity ratio, the LCR and the NSFR).
  • Analysis of key drivers by banking group (large/medium-sized/small banks, foreign banks): Comparison of outflow of funds and inflow of fire sale assets relative to total assets and distribution of corresponding liquidity ratios under stress; relative performance of banks with respect to LCR and NSFR (to identify banks vulnerable in both dimensions); sensitivity analysis for run-off rates.
3. Methodology
Model
  • B/S using authorities’ templates and assumptions
  • B/S using authorities’ templates and assumptions.
  • B/S using authorities’ templates and assumptions
  • B/S
  • B/S
  • B/S using IMF templates and assumptions.
  • B/S
  • B/S
  • B/S
4. Communication
Publication
  • No Technical Note.
  • Methodology and results published in FSSA.
  • No Technical Note.
  • Methodology and results published in FSSA.
  • Technical Note, published.
  • Results discussed in FSSA, 1 published.
  • Technical Note, not published.
  • Results discussed in FSSA, published
  • Technical Note, not published.
  • Results discussed in FSSA, published.
  • No Technical Note.
  • Methodology and results published in FSSA.
  • No Technical Note.
  • Methodology and results published in FSSA.
  • Technical Note, not published.
  • Results discussed in FSSA; technical details included as Appendix.
  • Technical Note, published.
  • Results discussed in FSSA, published.
URLhttps://www.imf.org/external/pubs/ft/scr/2010/cr10288.pdfhttps://www.imf.org/external/pubs/ft/scr/2011/cr11144.pdfhttp://www.imf.org/external/pubs/ft/scr/2011/cr11288.pdfhttp://www.imf.org/external/pubs/ft/scr/2011cr11321.pdfhttp://www.imf.org/external/pubs/ft/scr/2012/cr1292.pdfhttps://www.imf.org/external/pubs/ft/scr/2012/cr12137.pdfhttps://www.imf.org/external/pubs/ft/scr/2012/cr12210.pdfhttps://www.imf.org/external/pubs/ft/scr/2012/cr12308.pdfhttp://www.imf.org/external/pubs/ft/scr/2013/cr13147.pdf
Contributors: sting team*J. Gobat

R. Vermeulen
Central bank routine stress test results shared with FSAP team.N. Oulid

S. Stolz
M. CihakE. YèhouéA. Jobst

L. L. Ong

S. Kwoh
S. ArslanalpI. Kaminska (INS)C. Schmieder
Source: Compiled by authors with contributions from respective FSAP stress testers.Note: The table presented here is for illustration only—the full-sized matrix is available as an MS Excel® fle (entitled Stress Testing Matrix [STeM] – Liquidity Stress Testing Approaches in IMF FSAPs) on the IMF eLibrary at www.elibrary.imf.org/page/stress-test2-toolkit. BCB = Banco Central do Brasil; BCBS = Basel Committee on Banking Supervision; BoE = Bank of England; BoJ = Bank of Japan; BU = bottom-up; CRR = Capital Requirements Regulation; ECB = European Central Bank; ELST = enhanced liquidity stress test; FSSA = Financial System Stability Assessment; FX = foreign exchange; HKMA = Hong Kong Monetary Authority; LCR = liquidity coverage ratio; NBB = National Bank of Belgium; NPL = nonperforming loan; NSFR = net stable funding ratio; MFRAF = Macro-Financial Risk Assessment Framework; PRA = Prudential Regulatory Authority; TD = top-down.* Staff from the Monetary and Capital Markets Department (MCM) of the IMF unless specified otherwise.** Four additional countries (Denmark, Finland, Norway and Poland) were added to the original S-25 list following the 2013 decision of the IMF’s Executive Board (IMF 2014a). At the time of the FSAP, Finland was not a S-29 country (subject to the mandatory five-year FSAP cycle). Since the 2016 FSAP for Finland has not been completed by end-September 2016, the description of the last FSAP (2010) is shown here.

Basel Committee on Banking Supervision (2013a).

Basel Committee on Banking Supervision (2010b).

The CDP is a specialized lending entity, which is majority-owned by the Italian government and funds itself mostly by postal and customer deposits. It is required to deposit the liquidity provided by postal savings with the Italian Treasury, which makes up nearly half of total assets.

Each outflow item is a sum of the corresponding outflow item across 31 bank holding companies. The run-off rate is then defined as the percentage difference between the value of a given outflow items at its peak and its value next quarter or three quarters from the peak.

High-quality liquid assets in the US final rule on the LCR does not include securities issued or guaranteed by public sector enterprises (for example, state, local authority, or other governmental subdivision below the sovereign level), such as municipal securities or residential mortgage-backed securities (RMBS). Moreover, claims issued or guaranteed by a US government–sponsored enterprise (GSE) are not included in Level 1 liquid assets and corporate debt securities are not included in Level 2A assets.

The narrow banking system includes city, trust, regional (Tier 1 and 2), foreign, bridge, and internet banks as well as shinkin banks and credit cooperatives. The broader system also includes J-Post bank and Norinchukin bank.

The end-2014 data were based on the high-quality liquid asset (HQLA) definition (and related haircuts) of the European Commission’s Delegated Act on the LCR (Oct. 2014), whereas the LCR data as of end-Sept. 2014 were based on the original Basel III definition. The use of two alternative specifications was motivated by the need to evaluate the impact of the broader definition of HQLA under EU regulations (by including highly rated covered bonds) on the LCR.

17 G7, G20, S29 France18 G20, S29 India19 G20 European Union20 S29 Belgium21 S29 Poland22 G7, G20, S29 Italy23 S29 Singapore24 S29 Austria25 G7, G20, S29 Canada26 S29 Hong Kong SAR27 S29 Switzerland28 S29 Denmark
December 2012January 2013March 2013May 2013July 2013September 2013November 2013January 2014February 2014July 2014May 2014December 2014
  • BU by banks using MF staff/Banque de France templates and assumptions following EBA assessment.
  • TD by IMF staff.
  • BU by banks using joint IMF staff/Reserve Bank of India
  • TD jointly by authorities and IMF staff.
  • BU by banks using authorities’ templates and assumptions
  • TD by authorities, in collaboration with IMF staff.
  • TD by authorities (National Bank of Poland) with inputs from IMF staff.
  • TD by authorities (Banca d’Italia) with inputs from IMF staff.
  • BU by banks using supervisory assumptions.
  • TD by authorities of Singapore).
  • TD by authorities (Oesterreichische Nationalbank) with inputs from IMF staff.
  • TD by authorities (Bank of Canada and Office of the Superintendent of Financial Institutions).
  • TD by authorities (Hong Kong Monetary Authority), including Wong-Hui (2009) approach.
  • TD by IMF staff (with data input from authorities), using IMF templates and assumptions.
  • TD by authorities (Swiss Financial Market Supervisory Authority and Swiss Nationa Bank).
  • TD by IMF staff.
  • BU by banks using supervisory (Finanstilsynet)
  • 8 largest banks
  • BU: 10 commercial banks
  • TD: 60 scheduled commercial banks
  • 6 largest banks (and entire banking sector excluding foreign branches, Euroclear and Bank of NY Mellon [for NBB Liquidity Ratios]).
  • 20 largest banks
  • 33 largest banks, including 6 foreign banks’ subsidiaries.3
  • 3 domestic banks, 1 foreign subsidiary, and 3 foreign branches.
  • 29 banks (subject to weekly cash flow liquidity reporting).
  • 6 commercial banks
  • TD: All large, locally incorporated, licensed banks (19) and selected foreign branches (8)
  • Wong-Hui (2009) approach: Largest locally ncorporated, licensed banks (9) and two
  • TD by authorities: Almost al banks.
  • TD by IMF staff: 30 banks
  • Excess liquidity coverage test 81 banks.
  • LCR: 16 banks and mortgage credit institutions (MCIs).
  • Funding ratio: 85 banks.
  • 80 percent of total sector assets
  • BU: 50 percent of total sector
  • TD: 99 percent of total sector assets.
  • BU: 86 percent of total sector assets (excluding foreign branches).
  • TD (Basel III measure): 82 (excluding foreign branches) on a solo basis and 90 percent on a consolidated basis.
  • TD (NBB Liquidity Ratios): 93 percent of total sector assets (excluding foreign branches)
  • 85 percent of assets.
  • >90 percent of total sector assets.
  • 74 percent of total sector assets.
  • 80 percent of total sector assets.
  • 93 percent of total sector assets.
  • TD by authorities: 68 percent of total sector assets.
  • TD by IMF staff: 60 percent of total sector assets (Basel III standard measures).
  • Wong-Hui (2009) approach: 63 percent of total sector assets.
  • TD by authorities: Almost total sector assets [TD authorities].
  • TD by IMF staff: 85 percent of total sector assets.
  • 87 percent of total sector assets.
  • BU: Banks own data
  • TD: Publicly available data (results not reported).
  • BU: Banks’ own (proprietary) data.
  • TD: Supervisory data
  • BU: Banks’ own (proprietary) data.
  • TD: Supervisory data
  • Supervisory data
  • Supervisory data (including data on sovereign risk, collateral, and retail deposit volatility in weekly/ monthly intervals).
  • Banks’ own data
  • Supervisory data
  • Banks’ own data
  • Supervisory data
  • Authorities: Supervisory data
  • FSAP team: Publicly available data.
  • Supervisory and banks’ own data.
End-2011
  • End-Q2 2011
  • End-Q2 2012
  • End 2012
  • End-2012 (for liquidity position data).
  • End-March 2013 (for rating and other market valuation data)
  • End-Q1 2013
  • End-2012
  • End-April 2013
  • End-Q2 2013
  • End-2012
  • End-Q1 2014
  • Consolidated banking groups
  • Unconsolidated domestic businesses.
  • BU: Solo basis.
  • TD: Solo/consolidated basis
  • Only unencumbered liquid assets (generating cash inflows), ie, that can be sold or used as a collateral to receive funding (with the exception of cash/cash-equivalents).
  • Solo basis for largest 20 commercial banks (including both domestically controlled banks and subsidiaries of foreign banks).
  • Consolidated banking group for domestic banks (based on Bank of Italy’s standard weekly liquidity medium-/long-term maturities for both retail deposit and wholesale funding, including durations.
  • Consolidated banking group for domestic banks.
  • Solo basis for foreign subsidiaries and branches.
  • Consolidated banking group for domestic banks; granular data based on contractual and behavioral expected cash flows over five maturity buckets (5 days, 1 month, 3 months, 6 months, and 12 months).
  • Consolidated banking group
  • Solo basis, with the exception of consolidated/combined basis for selected locally incorporated, licensed banks (10) for Basel III standard measures (LCR and NSFR).
  • Consolidated basis for Wong-Hui (2009) approach.
  • n.a
  • Unconsolidated (for excess liquidity coverage test and funding ratio).
  • Consolidated (for LCR)
  • Systemic and diosyncratic risk.
  • Bank run and drying up of wholesale funding markets, taking into account haircuts to liquid assets.
  • A 30-day deposit and, separately, wholesale funding withdrawal of 10 percent.
  • A 5-day deposit (wholesale funding) withdrawal of 5 (3) percent.
  • Maturity mismatch
  • Rollover risk
  • BU: LCR and NSFR (old version, Dec. 2010) [BU].
  • TD: LCR (revised as per guidance published in Jan. 2013 [including assessment of assumption on expected and contingent cash in- and outflows]) and NBB Liquidity Ratios (one week/one month) reflecting a bank-run type market/funding liquidity risk scenario similar to the LCR.
  • Also alternative scenarios for NBB Liquidity Ratios:(i) the absence of a deposit run (ii) the escalation of sovereign risk (requiring higher valuation funding with central banks); and (iii) the absence of contingent cash inflows from related” parties.
  • Only unencumbered liquid inflows), ie, that can be sold or funding (with the exception of cash/cash-equivalents).
  • Liquidity shock scenarios defined by authorities.
  • Cash flow mismatch analysis over 30-day horizon with cash outlows due to refinancing risks, with wholesale funding and deposit outflows/reduction of liquidity buffer due to sovereign and bank downgrades (increasing ECB haircuts) and declining market valuation of sovereign debt securities.
  • Scenarios:(i) “Adverse scenario” (motivated by actual distress experience at end-2011), including refinancing risk (0 percent rollover), changes to ECB haircut (up to two-noth downgrades), increased volatility of deposits (up to 33 percent depending on type, with LCR-prescribed outflow rates as floors), widening of credit spreads and(ii) “Alternative scenario” (focusing on market factors), which excludes deposit outflows.
  • Buffer: Counterbalancing capacity refinancing, as at market values tnet of ECB haircuts (at security-by-security level).
  • BU: Cash flow mismatch analysis.
  • TD: Basel III framework (LCR as per revised guidance published in Jan 2013).
  • Buffer: Minimum [BU] and monetary authority’s liquidity facilities.
  • Cash flow mismatch analysis using six major currency based on macro scenario of the solvency stress test (i) PD shifts feed into the counterbalancing capacity and cash inflows; (ii) feedback effects are included due to the rising funding costs projected under the adverse macro
  • Scenarios are grouped into a baseline, “market mild,” severe,” and combined including instantaneous outflow of funding and gradual outflow over 30-day, 90-day, and 1-year
  • Buffer: Counterbalancing capacity taking into account haircuts to liquid
  • MFRAF: Supervisory model to quantify the funding liquidity risk (and network effects) as ‘ endogenous outcome of the interaction between market and the structure of the sample banks’ funding under different scenarios; approach mimicks the effect of a n on cumulative liabilities run-off based on a sudden, sizeable withdrawal of funding (short-term time horizon, triggered by a certain level of credit losses, and the sufficiency of existing shock. Changes in liquidity affecting the capital position of each bank; calibrated parameters of the liquidity measure are in large part consistent with parameters of the LCR.
  • Buffer: Minimum liquid assets reserve.
  • TD by authorities: HKMA’s 7-day test (noncumulative) and enhanced liquidity stress test (ELST), Basel III ratios (LCR as per revised guidance published in Jan. 2013 and NSFR based on BCBS guidance (Dec 2010); and liquidity risk model by Wong and Hui (2009).
  • TD by IMF staff: implied cash flow test (cumulative) and 30-day implied cash flow test (noncumulative), with focus on the sudden, sizeable withdrawal of funding retail deposit run.(liabilities) and the sufficiency of existing assets to withstand those shocks under stressed conditions; also maturity mismatch analysis (both local and foreign currencies).
  • Also one alternative scenario (for IMF TD test and ELST), which assumes the absence of a deposit run.
  • Only unencumbered liquid assets (generating cash inflows), ie, that can be funding (with the exception of cash/cash-equivalents).
  • Buffer: Counterbalancing capacity and Hong Kong Monetary Authority’s liquidity facilities.
  • TD by authorities: Basel III ratio (LCR as per revised guidance published in Jan. 2013 and issued by Swiss authorities, effective as of Jan. 1, 2016).
  • TD by IMF staff: Implied cash flow test (cumulative) of different deposit run-off and predetermined period of time (five working days); assesses counterbalancing capacity of banks at the end of each day deposit run-off rates and asset disposal rates were based on expert judgment.
  • Buffer: Counterbalancing capacity.
  • BU: Assessment of the counterbalancing capacity via liquidity coverage and LCR); structural maturity mismatch ratio via cash flow-based test using maturity buckets (funding ratio); excess liquidity coverage and funding ratios according to Section 152 DFBA and Supervisory Diamond, LCR according to CRD-IV.
  • Buffer: Counterbalancing capacity.
  • Performance of banks under stress (estimated survival period in days, number of banks which still meet their contractual obligations).
  • Performance of banks under stress (how many banks fail in 5 days, or 30-day period, liquidity needs, maturity mismatch profile, and prospective Basel III ratios).
  • Performance of banks under stress (i.e., bank run and liabilities run-off, taking into account valuation haircuts to liquid assets, amortization of outstanding assets, related party lending, and contingent claims/liabilities (undrawn/uncommitted).
  • Hurdle metrics: Distribution of ratios, number of failed banks, and liquidity shortfall relative to unencumbered assets.
  • Performance of banks under stress in maintaining net positive liquidity position.
  • Hurdle metrics: Available liquid assets to cover liquidity needs under each scenario.
  • Performance of banks under stress (i.e., bank run and liabilities run-off, taking into account valuation haircuts to liquid assets) in maintaining net positive liquidity position (i.e., counterbalancing capacity above potential cash outflows in stress scenario over 30-day horizon).
  • Hurdle metrics: Change in net liquidity position and counterbalancing capacity; drivers of main results (liquidity position/ counterbalancing capacity), for each scenario; number of banks (pass rate) below the minimum requirement, for each scenario; and differentiation of results between Italian banks (top five, large-/medium-/small-sized) and foreign banks’ subsidiaries.
  • BU: Performance of banks under stress (i.e., bank run and liabilities run-off, taking into account valuation haircuts to liquid assets). Hurdle metrics: Liquidity funding gap by bank/currency, and consolidated across currencies.
  • TD: Idiosyncratic and market-wide shock as described in the LCR. Hurdle metrics: Finalized LCR rules by bank/currency (and consoliated across currencies).
  • Performance of banks under stress (i.e., bank run and liabilities run-off, taking into account valuation haircuts to liquid assets) over 45 scenarios including full/limited/restricted/closed access to money markets covering funding in local/foreign currency, euro currency, and FX swap markets.
  • Hurdle metrics: Liquidity funding gap by bank/currency and percentage of assets that “fail” under each scenario (i.e., not covered by cash inflows).
  • Performance of banks under stress (i.e., bank run and liabilities run-off, taking into account valuation haircuts to liquid assets); liquidity losses are assumed to be equal to 2.25 percent of RWAs.
  • Funding and market liquidity risk (including information contagion risk) due to solvency issues.
  • The “run point” serves as an indication of how bank capital, liquid assets, and the term structure of outstanding debt impact liquidity risk.
  • Hurdle metrics: Expected losses from liquidity funding gap.
  • Performance of banks under stress (i.e., bank run and liabilities run-off, taking into account valuation haircuts to liquid assets, amortization of outstanding assets, related party lending, and contingent claims/ liabilities [undrawn/uncommitted]).
  • Hurdle metrics: Distribution of ratios, number of failed banks, and liquidity shortfall relative to unencumbered assets; expected first cash shortage time (CST), probability of cash shortage (CSP), expected default time due to liquidity problems (LFT), and probability of default due to liquidity problems (LFP) according to the model by Wong and Hui (2009).
  • Performance of banks under stress (i.e., bank run and liabilities run-off, taking into account valuation haircuts to liquid assets, amortization of outstanding assets).
  • Hurdle metrics: Distribution of ratio (LCR); pass rate and remaining buffers (systemwide and by bank type).
  • Performance of banks under stress (i.e., bank run and liabilities run-off, taking into account valuation haircuts to liquid assets).
  • Funding and market liquidity risk scenarios with different shocks to market values of liquid assets and downgrades of financial institutions.
  • Hurdle metrics: Distribution of ratios (systemwide and different bank size buckets); pass rate and liquidity shortfall/potential liquidity shortfall.
  • B/S.
  • B/S.
  • B/S.
  • B/S.
  • B/S using IMF assumptions.
  • B/S using IMF assumptions.
  • B/S using IMF assumptions.
  • B/S
  • B/S.
  • B/S.
  • Technical Note, published.
  • Results discussed in FSSA, published.
https://www.imf.org/external/pubs/ft/scr/2013/cr13185.pdf
  • Technical Note, not
  • Results discussed in FSSA, published
http://www.imf.org/external/pubs/ft/scr/2013/cr1308.pdf
  • Technical Note, published.
  • Results discussed in FSSA, published.
http://wwwimf.org/external/pubs/ft/scr/2013/cr13137.pdf
  • Technical Note,
  • Results discussed in FSSA.
http://www.imf.org/external/pubs/ft/scr/2013/cr13221.pdf
  • Technical Note, published.
  • Results discussed in FSSA, published.
http://www.imf.org/external/pubs/ft/scr/2013/cr13349.pdf
  • Technical Note, not published.
  • Results discussed in FSSA, published
https://www.imf.org/external/pubs/ft/scr/2013/cr13325.pdf
  • Technical Note, published.
  • Results discussed in FSSA, published.
http://www.imf.org/external/pubs/ft/scr/2014/cr1416.pdf
  • Technical Note, published.
  • Results discussed in FSSA, published.
http://www.imf.org/external/pubs/ft/scr/2014/cr1469.pdf
  • Technical Note, published.
  • Results discussed in FSSA, published.
https://www.imf.org/external/pubs/ft/scr/2014/cr14210.pdf
  • Technical Note, published.
  • Results discussed in FSSA, published.
https://www.imf.org/external/pubs/ft/scr/2014/cr14267.pdf
  • Technical Note, published.
  • Results discussed in FSSA, published.
http://www.imforg/external/pubs/ft/scr/2014/cr14348.pdf
L. Schumacher

S. Munoz
E. LoukoianovaA. Jobst

S. Nowak (EUR)
J.A. Chan-LauH. Oura

E. Kopp
J.A. Chan-Lau

I. Guerra
L. ValderramaI. Krznar

J. Surti
A. Jobst

C. Baba
C. CaceresE. Kopp
Source: Compiled by authors with contributions from respective FSAP stress testers.Note: The table presented here is for illustration only—the full-sized matrix is available as an MS Excel® fle (entitled Stress Testing Matrix [STeM] – Liquidity Stress Testing Approaches in IMF FSAPs) on the IMF eLibrary at www.elibrary.imf.org/page/stress-test2-toolkit. BCB = Banco Central do Brasil; BCBS = Basel Committee on Banking Supervision; BoE = Bank of England; BoJ = Bank of Japan; BU = bottom-up; CRR = Capital Requirements Regulation; ECB = European Central Bank; ELST = enhanced liquidity stress test; FSSA = Financial System Stability Assessment; FX = foreign exchange; HKMA = Hong Kong Monetary Authority; LCR = liquidity coverage ratio; NBB = National Bank of Belgium; NPL = nonperforming loan; NSFR = net stable funding ratio; MFRAF = Macro-Financial Risk Assessment Framework; PRA = Prudential Regulatory Authority; TD = top-down.* Staff from the Monetary and Capital Markets Department (MCM) of the IMF unless specified otherwise.** Four additional countries (Denmark, Finland, Norway and Poland) were added to the original S-25 list following the 2013 decision of the IMF’s Executive Board (IMF 2014a). At the time of the FSAP, Finland was not a S-29 country (subject to the mandatory five-year FSAP cycle). Since the 2016 FSAP for Finland has not been completed by end-September 2016, the description of the last FSAP (2010) is shown here.

Basel Committee on Banking Supervision (2013a).

Basel Committee on Banking Supervision (2010b).

The CDP is a specialized lending entity, which is majority-owned by the Italian government and funds itself mostly by postal and customer deposits. It is required to deposit the liquidity provided by postal savings with the Italian Treasury, which makes up nearly half of total assets.

Each outflow item is a sum of the corresponding outflow item across 31 bank holding companies. The run-off rate is then defined as the percentage difference between the value of a given outflow items at its peak and its value next quarter or three quarters from the peak.

High-quality liquid assets in the US final rule on the LCR does not include securities issued or guaranteed by public sector enterprises (for example, state, local authority, or other governmental subdivision below the sovereign level), such as municipal securities or residential mortgage-backed securities (RMBS). Moreover, claims issued or guaranteed by a US government–sponsored enterprise (GSE) are not included in Level 1 liquid assets and corporate debt securities are not included in Level 2A assets.

The narrow banking system includes city, trust, regional (Tier 1 and 2), foreign, bridge, and internet banks as well as shinkin banks and credit cooperatives. The broader system also includes J-Post bank and Norinchukin bank.

The end-2014 data were based on the high-quality liquid asset (HQLA) definition (and related haircuts) of the European Commission’s Delegated Act on the LCR (Oct. 2014), whereas the LCR data as of end-Sept. 2014 were based on the original Basel III definition. The use of two alternative specifications was motivated by the need to evaluate the impact of the broader definition of HQLA under EU regulations (by including highly rated covered bonds) on the LCR.

29 G20, S29 South Africa30 G20, S29 Korea31 G7, G20, S29 United States32 S29 Norway33 G20 Argentina34 G7, G20, S29 United Kingdom35 G7, G20, S30 Germany36 S29 Ireland37 G20, S29 Russian Federation38 S29 Finland**39 S29 Turkey
December 2014January 2015July 2015September 2015February 2016June 2016June 2016September 2016September 2016January 2017February 2017
  • BU by banks using templates and assumptions provided by FSAP team.
  • BU by banks using supervisory (Financi a Supervisory Service) templates and assumptions.
  • TD by authorities (Financia Supervisory Service).
  • TD by IMF staff.
  • TD by IMF staff.
  • BU by banks using templates and assumptions provided by IMF staff.
  • TD by authorities (Bank of England), using IMF staff templates and assumptions.
  • BU by banks using supervisory templates and assumptions.
  • TD by authorities (Bundesbank) with inputs from IMF staff.
  • TD by Central Bank of Ireland and MF staff.
  • TD by authorities (Centra Bank of Russia), in collaboration with IMF staff.
  • TD by authorities (FSA), in collaboration with IMF staff.
  • BU by banks, in collaboration with authorities and IMF staff (only LCR-based reverse liquidity stress test)
  • TD by authorities (FSA), in collaboration with IMF staff.
  • 6 largest banks (local and foreign operations in order to adequately assess the risks associated with the rapid expansion in cross-border business).
  • BU and TD: All nationwide commercial banks (7).
  • TD only: All other commercial banks, on an aggregate basis
  • 31 largest bank holding companies (BHCs).
  • 6 largest commercial and savings banks.
  • 22 major banks.
  • 10 large financial institutions comprising seven major banks building societies and the three largest subsidiaries of foreign investment banks; firms were selected to provide desired coverage (see below) as measured by the PRA048 liquidity returns
  • BU: 44 banks participating in the Basel Committee’s Quantitative Impact Study (QIS).
  • TD: All 1,800 banks operating in Germany.
  • 5 largest banks.
  • 681 banks.
  • 4 largest banking groups.
  • 10 largest (domestic) banks.
  • 94 percent of total sector assets.
  • BU: 76 percent of total sector assets.
  • TD: 86 percent of total sector assets
  • 75 percent of total sector assets.
  • 67 percent of total sector assets.
  • 90 percent of total sector assets.
  • 80 percent of total sector assets.
  • BU: >90 percent of total sector assets.
  • TD: 100 percent of total sector assets.
  • 61 percent of total sector assets.
  • 99.1 percent of total sector assets.
  • 93 percent of total sector assets.
  • >80 percent of total sector assets.
  • Banks’ own data
  • BU: Banks’ own data.
  • TD: Supervisory data.
  • Publicly available data (FR Y-9C).
  • Supervisory data from FSA
  • Banks’ own data
  • LCR: Supervisory data from the PRA return (using interim LCR reporting on all currencies based on the EU Delegated Act [European Commission Delegated Regulation No. 2015/61], which implements the LCR in the U.K.).
  • Implied cash flow test: Supervisory data based on prudential return (PRA048).
  • Supervisory and banks’ own data.
  • Supervisory data
  • Supervisory and public data
  • Supervisory and banks’ own data
  • Supervisory and banks’ own data.
  • End-Q1 2014.
  • End-Q1 2013.
  • End-Q3 2014.
  • End-2014 (and end-Q3 2014).7
  • End-Q3 2012.
  • End-2015.
  • BU: End-Q2 2015.
  • TD: End-Q2 and end-Q4 2015.
  • End-Q2 2015.
  • End-2015.
  • End-2015.
  • End-2015 (and sensitivity analysis of data for previous years).
  • Solo basis
  • Consolidated banking group.
  • Consolidated.
  • Consolidated.
  • Solo basis.
  • Solo basis.
  • n.a.
  • Solo basis.
  • Solo basis.
  • Solo basis.
  • Consolidated banking groups.
  • BU: Basel III ratios (LCR as per revised guidance published in Jan. 2013 and NSFR based on BCBS guidance of Dec 2010).
  • Buffer: Central bank’s provision of committed liquidity facility.
  • Cash flow mismatch analysis: 30-day implied cash flow test, with focus on the sudden, sizeable withdrawal of funding funding, derivatives, and committed credit lines) and the sufficiency of selling (unencumbered) existing assets to withstand those shocks under stressed conditions; the magnitude of wholesale funding shock in line with historical experience (global financial crisis) and the deposit withdrawal rates are calibrated to be more severe than the historica experience in Korea.
  • BU buffer: Counterbalancing capacity, with banks allowed to generate cash inflows via asset sales, use central bank deposits), and access to the central bank liquidity facilities.
  • TD: Assesses the counterbalancing capacity of banks based on the ratio of their stock of liquid assets to the total (noncumulative) cash outflow over two different time periods (one/three consecutive quarters); deposit run-off rates were calbrated to the historical experience during the 2008/09 episode of the financial crisis, and asset disposal rates were taken from the LCR. 4,5
  • Buffer: Counterbalancing capacity.
  • Basel III ratios (LCR as per revised BCBS guidance published in Jan. 2013 and NSFR based on BCBS guidance, Oct. 2014).
  • Two scenarios with varying shocks calibrated to (i) the market experience after the collapse of Lehman Brothers in 2008; and (ii) other past episodes of liquidity stresses—both scenarios were more severe than the historical experience in Norway—in order to simulate the combined effect of(a) the inability of rolling over maturing secured funding, deposit run, and withdrawal of contingent liabilities; and(b) the inability of rolling over maturing unsecured wholesale funding.
  • Buffer: Counterbalancing capacity.
  • Basel III ratios (LCR and NSFR per BCBS guidance [Dec. 2010])
  • Implied cash flow test (with maturity buckets), with focus on the sudden, sizeable withdrawal of funding (i.e., bank run and dry-up of wholesale funding markets calibrated to Argentina’s experiences with banking panics during the convertibility period between 1995 and 2001, taking into account haircuts to liquid assets) and the sufficiency of existing assets to withstand those shocks under stressed conditions; run-off rates calculated following historical test.
  • Macro stress tests using authorities’ macroeconomic and satellite models with FSAP team guidance.
  • Reserve liquidity test for cross-validation in order to assess the capacity of banks to withstand maximum wholesale deposit withdrawals.
  • Buffer: Counterbalancing capacity and central bank facilities.
  • Basel III ratio (LCR) on three scenarios: (i) standard assumptions according to BCBS guidance; (ii) “U.K. retail stress” scenario: calibration of this deposit run-off scenario replicates the peak stress during the 2007 Northern Rock run, with run-off rates for retail deposits of up to 15 percent and for corporate deposits of 60 percent, and with liquidity risk from committed but undrawn liquidity facilities of 50 percent; and (iii) “U.K. wholesale stress” scenario: replicates the liquidity stress observed during the global financial crisis, characterized by a freeze of wholesale funding and liquidity risk from sizeable margin calls related to secured funding, derivatives and foreign currency funding due to market liquidity shocks, derivative assignments, and unwinds and disruptions in the FX swap market (with rollover of secured funding backed by other than Level 1 and Level 2A assets of up to 0 percent).
  • Implied cash flow test (cumulative over five days and noncumulative over 30 days), with focus on the sudden, sizeable withdrawal of funding and the sufficiency of existing assets to withstand those shocks; outflow shocks are applied to a range of liabilities, including deposits, wholesale funding and intergroup funding, while haircuts to assets include investment and trading securities, derivatives and secured assets; does not consider offsetting contractual cash inflows from maturing wholesale lending and central bank support via the BoE’s discount window.
  • A general maturity mismatch analysis by maturity bucket.
  • A single currency analysis based on PRA’s ILG regime.
  • Buffer: Counterbalancing capacity.
  • TD: Implied cash flow test to assess resilience to multifactor scenario, with focus on the sudden, sizeable withdrawal of funding and the sufficiency of existing assets to withstand those shocks; approximates banks’ liquidity coverage ratio (LCR) under CRD IV, consistent with Regulation (EU) No. 575/2013 of the European Parliament and the European Council on prudential requirements for credit insitutions and investment firms and guidance by the BCBS (2013) on the LCR and liquidity risk monitoring pools.
  • BU: Basel III ratios (LCR as per revised BCBS guidance published in Jan. 2013 and NSFR based on BCBS guidance, Oct. 2014).
  • Proxy measures of the Basel III ratios (LCR as per Commission Delegated Regulation (EU) 2015/61 of Oct. 2014 and NSFR based on BCBS guidance published in Oct. 2014).
  • Implied cash flow test (using maturity buckets by banks), with focus on the sudden, sizeable withdrawal of funding and the sufficiency of existing assets to withstand those shocks.
  • Buffer: Counterbalancing capacity, central bank facilities.
  • Implied cash flow test (sudden outflows due to liabilities run-off and sufficiency of existing assets to withstand those shocks under stressed conditions [after application of haircuts]); range of run-off rate between 10 percent (household deposits) to 50 percent (nonresident, interbank deposits); range of haircuts between 5 percent (highly liquid assets) and 65 percent (less liquid assets).
  • Buffer: Counterbalancing capacity.
  • Implied cash flow test (by maturity bucket) simulating a sudden, sizeable withdrawal of funding and the sufficiency of existing assets to withstand those shocks, after considering effect on liquid assets.
  • Basel III ratios (LCR as per Commission Delegated Regulation (EU) 2015/61 of Oct. 2014 and NSFR based on BCBS guidance published in Oct. 2014); for the LCR-based analysis, two alternative scenarios were examined: (i) a more severe withdrawal rate of deposits and (ii) a dry-up of unsecured wholesale funding, calibrated to meet very severe stress conditions, such as those experienced during the 2008/09 global financial crisis; also a separate LCR-based analysis of foreign currency positions and a reverse LCR-based liquidity stress test were carried out.
  • Buffer: Counterbalancing capacity, central bank facilities.
  • Implied cash flow test (by maturity bucket) simulating a sudden, sizeable withdrawal of funding and the sufficiency of existing assets to withstand those shocks, after considering effect on liquid assets.
  • Basel III ratio (LCR as per revised BCBS guidance published in Jan. 2013), for each currency and consolidated across all currencies.
  • Buffer: Counterbalancing capacity, central bank facilities.
  • Performance of banks under stress (i.e., liabilities run-off, taking into account valuation haircuts to liquid assets, amortization of outstanding assets, related party lending, and contingent claims/liabilities [undrawn/uncommitted]).
  • Hurdle metrics: Number of banks that fell within certain ratios.
  • Performance of banks under stress (i.e., liabilities run-off and asset sales after valuation haircuts).
  • Hurdle metrics: Liquidity shortfall; total cash inand outlows by type of funding (indiv. institutions), deparated by local and foreign currency.
  • Performance of banks under stress (i.e., bank run and liabilities run-off, taking into account valuation haircuts to liquid assets).
  • Alternative scenario: Run-off rates calibrated based on historical experience (not LCR).
  • Hurdle metrics: Distribution of ratio of the stock of liquid assets to the total cumulative cash outflow (systemwide).
  • Performance of banks under stress (i.e., liabilities run-off after accounting for scheduled cash in- and outflows and the counterbalancing capacity of unencumbered liquid assets).
  • Funding and market liquidity risk scenarios comprising a deposit run, dry-up of wholesale funding markets, and different shocks to market values of liquid assets.
  • Hurdle metrics: Distribution of ratio (LCR/NSFR); liquidity gaps.
  • Performance of banks under stress (i.e., bank run and liabilities run-off, taking into account valuation haircuts to liquid assets).
  • Alternative scenario: Run-off rates calibrated based on historical experience (not LCR).
  • Hurdle metrics: Liquidity gap, i.e., distribution of ratio of the stock of liquid assets to the total cumulative cash outflow (systemwide) and survival period in days by bank.
  • LCR: Assessment of the short-term resilience of banks to sudden, sizeable withdrawals of funding (liabilities) consistent with PRA’s transitional arrangement for the LCR ratio, which is more front-loaded than that prescribed by the CRR (Art. 460).
  • Implied cash flow test: post-shock net liquidity position and counterbalancing capacity above net cash outflows under stress scenario.
  • Changes in average liquidity position and counterbalancing capacity for each scenario.
  • Liquidity ratios, disaggregated by type and size of bank for give set of idiosyncratic and marketwide shock as described in the LCR [BU].
  • Hurdle metrics: liquidity funding gap by bank [joint TD].
  • Liquidity gap by bank (and aggregated).
  • Survival period in days by bank; number of banks that can still meet their obligations.
  • Amount of liquidity deficit and number of banks with liquidity deficit.
  • Liquidity gap by bank (and aggregated).
  • Survival period in days by bank; number of banks that can still meet their obligations.
  • For LCR: bank-specific and sector-wide stressed LCR ratios, by currency and overall, by type of banks (small/large).
  • Liquidity gap by currency and aggregated, by time band and type of bank (large/small).
  • B/S.
  • B/S.
  • B/S.
  • B/S.
  • n.a.
  • B/S using IMF templates and assumptions.
  • Technical Note, published.
  • Results discussed in FSSA, published.
  • Technical Note, published.
  • Results discussed in FSSA, published.
  • Technical Note, published.
  • Results discussed in FSSA, published.
  • Technical Note, published.
  • Results discussed in FSSA, published.
  • Technical Note, published.
  • Results discussed in FSSA, published.
  • Technical Note, published.
  • Results discussed in FSSA, published.
  • Technical Note, published.
  • Results discussed in FSSA, published.
  • Technical Note, published.
  • Results discussed in FSSA, published.
  • Technical Note, published.
  • Results discussed in FSSA, published.
  • Technical Note, published.
  • Results discussed in FSSA, published.
  • No Technical Note.
  • Results discussed in FSSA, published.
https://www.imf.org/external/pubs/ft/scr/2015/cr1554.pdfhttps://www.imf.org/external/pubs/ft/scr/2015/cr1506.pdfhttps://www.imf.org/external/pubs/ft/scr/2015/cr15173.pdfhttps://www.imf.org/external/pubs/ft/scr/2015/cr15258.pdfhttps://www.imf.org/external/pubs/ft/scr/2016/cr1665.pdfhttps://www.imf.org/external/pubs/ft/scr/2016/cr16163.pdfhttps://www.imf.org/external/pubs/ft/scr/2016/cr16191.pdfhttps://www.imf.org/external/pubs/ft/scr/2016/cr16315.pdfhttps://www.imf.org/external/pubs/ft/scr/2016/cr16306.pdfhttps://www.imf.org/~/media/Files/Publications/CR/2017/cr1706.ashxhttp://wwwmforg/~/media/Files/Publications/CR/2017/cr1735.ashx
L. LinS. Iorgova

P. Jeasakul

H. Wong
I. Krznar

B. Huston

F. Lipinsky
S. IorgovaM. CatalanL. ValderramaE. KoppH. Kang

C. Pouvelle
A. Alter

N. Belhocine

R. Cervantes

F. Lipinsky
C. PouvelleN. Valkx
Source: Compiled by authors with contributions from respective FSAP stress testers.Note: The table presented here is for illustration only—the full-sized matrix is available as an MS Excel® fle (entitled Stress Testing Matrix [STeM] – Liquidity Stress Testing Approaches in IMF FSAPs) on the IMF eLibrary at www.elibrary.imf.org/page/stress-test2-toolkit. BCB = Banco Central do Brasil; BCBS = Basel Committee on Banking Supervision; BoE = Bank of England; BoJ = Bank of Japan; BU = bottom-up; CRR = Capital Requirements Regulation; ECB = European Central Bank; ELST = enhanced liquidity stress test; FSSA = Financial System Stability Assessment; FX = foreign exchange; HKMA = Hong Kong Monetary Authority; LCR = liquidity coverage ratio; NBB = National Bank of Belgium; NPL = nonperforming loan; NSFR = net stable funding ratio; MFRAF = Macro-Financial Risk Assessment Framework; PRA = Prudential Regulatory Authority; TD = top-down.* Staff from the Monetary and Capital Markets Department (MCM) of the IMF unless specified otherwise.** Four additional countries (Denmark, Finland, Norway and Poland) were added to the original S-25 list following the 2013 decision of the IMF’s Executive Board (IMF 2014a). At the time of the FSAP, Finland was not a S-29 country (subject to the mandatory five-year FSAP cycle). Since the 2016 FSAP for Finland has not been completed by end-September 2016, the description of the last FSAP (2010) is shown here.

Basel Committee on Banking Supervision (2013a).

Basel Committee on Banking Supervision (2010b).

The CDP is a specialized lending entity, which is majority-owned by the Italian government and funds itself mostly by postal and customer deposits. It is required to deposit the liquidity provided by postal savings with the Italian Treasury, which makes up nearly half of total assets.

Each outflow item is a sum of the corresponding outflow item across 31 bank holding companies. The run-off rate is then defined as the percentage difference between the value of a given outflow items at its peak and its value next quarter or three quarters from the peak.

High-quality liquid assets in the US final rule on the LCR does not include securities issued or guaranteed by public sector enterprises (for example, state, local authority, or other governmental subdivision below the sovereign level), such as municipal securities or residential mortgage-backed securities (RMBS). Moreover, claims issued or guaranteed by a US government–sponsored enterprise (GSE) are not included in Level 1 liquid assets and corporate debt securities are not included in Level 2A assets.

The narrow banking system includes city, trust, regional (Tier 1 and 2), foreign, bridge, and internet banks as well as shinkin banks and credit cooperatives. The broader system also includes J-Post bank and Norinchukin bank.

The end-2014 data were based on the high-quality liquid asset (HQLA) definition (and related haircuts) of the European Commission’s Delegated Act on the LCR (Oct. 2014), whereas the LCR data as of end-Sept. 2014 were based on the original Basel III definition. The use of two alternative specifications was motivated by the need to evaluate the impact of the broader definition of HQLA under EU regulations (by including highly rated covered bonds) on the LCR.

Source: Compiled by authors with contributions from respective FSAP stress testers.Note: The table presented here is for illustration only—the full-sized matrix is available as an MS Excel® fle (entitled Stress Testing Matrix [STeM] – Liquidity Stress Testing Approaches in IMF FSAPs) on the IMF eLibrary at www.elibrary.imf.org/page/stress-test2-toolkit. BCB = Banco Central do Brasil; BCBS = Basel Committee on Banking Supervision; BoE = Bank of England; BoJ = Bank of Japan; BU = bottom-up; CRR = Capital Requirements Regulation; ECB = European Central Bank; ELST = enhanced liquidity stress test; FSSA = Financial System Stability Assessment; FX = foreign exchange; HKMA = Hong Kong Monetary Authority; LCR = liquidity coverage ratio; NBB = National Bank of Belgium; NPL = nonperforming loan; NSFR = net stable funding ratio; MFRAF = Macro-Financial Risk Assessment Framework; PRA = Prudential Regulatory Authority; TD = top-down.* Staff from the Monetary and Capital Markets Department (MCM) of the IMF unless specified otherwise.** Four additional countries (Denmark, Finland, Norway and Poland) were added to the original S-25 list following the 2013 decision of the IMF’s Executive Board (IMF 2014a). At the time of the FSAP, Finland was not a S-29 country (subject to the mandatory five-year FSAP cycle). Since the 2016 FSAP for Finland has not been completed by end-September 2016, the description of the last FSAP (2010) is shown here.

Basel Committee on Banking Supervision (2013a).

Basel Committee on Banking Supervision (2010b).

The CDP is a specialized lending entity, which is majority-owned by the Italian government and funds itself mostly by postal and customer deposits. It is required to deposit the liquidity provided by postal savings with the Italian Treasury, which makes up nearly half of total assets.

Each outflow item is a sum of the corresponding outflow item across 31 bank holding companies. The run-off rate is then defined as the percentage difference between the value of a given outflow items at its peak and its value next quarter or three quarters from the peak.

High-quality liquid assets in the US final rule on the LCR does not include securities issued or guaranteed by public sector enterprises (for example, state, local authority, or other governmental subdivision below the sovereign level), such as municipal securities or residential mortgage-backed securities (RMBS). Moreover, claims issued or guaranteed by a US government–sponsored enterprise (GSE) are not included in Level 1 liquid assets and corporate debt securities are not included in Level 2A assets.

The narrow banking system includes city, trust, regional (Tier 1 and 2), foreign, bridge, and internet banks as well as shinkin banks and credit cooperatives. The broader system also includes J-Post bank and Norinchukin bank.

The end-2014 data were based on the high-quality liquid asset (HQLA) definition (and related haircuts) of the European Commission’s Delegated Act on the LCR (Oct. 2014), whereas the LCR data as of end-Sept. 2014 were based on the original Basel III definition. The use of two alternative specifications was motivated by the need to evaluate the impact of the broader definition of HQLA under EU regulations (by including highly rated covered bonds) on the LCR.

Appendix 16.2. Funding and Market Liquidity

For funding liquidity risk, the assessment reflects the realization (and potential change) of expected and contingent cash in-and outflows during times of stress, which includes assumptions about:

  • Runoff rates for secured/unsecured wholesale and retail funding.
  • Amortization/renewal rates for secured/unsecured wholesale and retail lending (at contractual maturities).
  • Draw-down rates for interbank credit and liquidity facilities.
  • The convertibility of foreign currency-denominated net cash flows and the scope of unsecured support in convertible currencies from related and third parties in the form of committed/uncommitted lines.
  • The treatment of expected and contingent liabilities from related and third parties.
  • The capacity to access unsecured financing and complete securitization during times of stress.

The degree of market liquidity risk (that is, valuation haircuts) affecting expected cash inflows from asset sales and the col-lateralization of secured funding are influenced by:

  • The asset concentrations and banks’ asset encumbrance.
  • The potential impact of downgrades of marketable assets.
  • The composition of the bank’s liquidity buffer comprising marketable, or otherwise realizable, assets.
  • The magnitude of foreign currency funding n eeds— on aggregate and for each currency (if there is no full convertibility between currencies over the stress testing time horizon).
  • The relevance of derivatives trading for the management of liquidity risk, including asset and foreign currency swaps (with the attendant potential for collateral and margin calls).
  • The extent to which assets might be encumbered and are subject to haircuts when used as collateral for central bank and securities financing transactions during times of stress, such as repos and securities lending.
  • The availability of funding via potentially reusable securities received as collateral (“rehypothecation”).
Appendix 16.3. Regulatory Liquidity Risk Measures under Basel III: Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR)

In the wake of the global financial crisis, the Basel Committee on Banking Supervision (BCBS) added liquidity risk to the regulatory perimeter of the Basel III framework (BCBS 2009, 2010a, 2010b, 2017d). Internationally active banks must meet two quantitative liquidity metrics (and related monitoring tools) for two different time horizons (one month and one year, respectively) (Appendix Table 16.3.1) and comply with qualitative guidance liquidity risk-management practices. As such, banks are expected to maintain a stable funding structure to withstand liquidity shocks by holding a sufficient stock of assets that should be available to meet their funding needs in times of stress and by limiting maturity transformation (BCBS 2011, 2012b).17 Recent work by the BCBS (2016b) sought to shed light on effects of the liquidity reforms under Basel III and their interaction with capital standards.

Liquidity Coverage Ratio (LCR)

The LCR is intended to promote short-term resilience to potential liquidity shocks by requiring banks to hold a sufficient stock of unencumbered, high-quality liquid assets (HQLAs) to withstand a liabilities runof over a stressed 30-day scenario specified by supervisors. The potential funding shortfall is defined as cash outflows less cash inflows (subject to a cap of 75 percent of total expected cash outflows). A liquidity coverage ratio value of less than 100 percent indicates a liquidity shortfall. More specifically,

“… the LCR numerator consists of a stock of unencumbered, high-quality liquid assets that must be available to cover any net [cash] outflow, while the denominator is comprised of cash outflows less cash inflows (subject to a cap at 75 [percent] of total outflows) that are expected to occur in a severe stress scenario” (BCBS 2012b, 2013a).

In January 2013, BCBS finalized the specification of the LCR by reaching an agreement on a composition of HQLAs and parameters for net cash outflows resulting from deposits and contingent liabilities, as well as a transition period for introduction of the LCR (BCBS 2013a). The changes to the definition of the LCR include an expansion in the range of assets eligible as HQLAs and some refinements to the assumed inflow and outflow rates to better reflect actual experience in times of stress. More specifically, the modifications comprise the following:18

  • Extending the Level 2B category of the HQLA to include (1) residential mortgage-backed securities (rated “A A” and higher) with a haircut of 25 percent as well as lower-rated corporate bonds (between “A+” and “ BBB-”) and common equity (each subject to a 50 percent haircut); and increasing the cap of Level 2B assets from 10 to 15 percent.
  • Applying a lower runof rate of 3 percent to stable deposits where prefunded and explicitly g overnment-guaranteed deposit insurance schemes exist and where access to deposits is available the next day after deposit insurance is triggered.
  • Lowering the drawdown rates from 100 to 30 percent for undrawn but committed liquidity facilities to nonfinancial firms, sovereigns and central banks, public sector enterprises, and multilateral development banks19 from 100 to 40 percent for undrawn but committed credit/liquidity facilities to banks subject to prudential supervision, and from 75 to 40 percent for deposits from nonfinancials, sovereigns, and public-sector enterprises.
  • Increasing liquidity needs related to derivatives.
  • Applying a zero percent haircut/discount factor for operations with central banks for all types of assets (in addition to secured funding backed by Level 1 assets with any counterparty).
  • Providing for national treatment of trade finance obligations.

Net Stable Funding Ratio (NSFR)

The NSFR restricts liquidity mismatches from excessive maturity transformation to encourage longer term borrowing by limiting the stock of unstable funding (BCBS 2014, 2016). It was implemented on January 1, 2018, following an observation period that included a review clause to address any unintended consequences. Based on the current definition, banks are required to establish a stable funding profile over the short term, that is, the use of stable ( long-term and/or stress-resilient) sources to continuously fund cash-flow obligations that arise from lending and investment activities inside a one-year time horizon.

The NSFR reflects the proportion of longer term (and less liquid) assets that are funded by stable sources of funding, including customer deposits, wholesale funding with maturities of more than one year, and equity (but excludes short-term liabilities). These sources and uses of funds are not equally weighted but enter as risk-adjusted components into the calculation of the NSFR. A value of this ratio of less than 100 percent indicates a shortfall in stable funding based on the difference between balance sheet positions after the application of available stable funding factors and the application of required stable funding factors for banks where the former is less than the latter (BCBS 2010c, 2014b).20

Appendix Table 16.3.1Overview of the Basel II and III Minimum Capital Requirements and Liquidity Standards
Year201120122013201420152016201720182019
Leverage RatioSupervisory MonitoringParallel Run January 2012-January 2017; Disclosure Started in January 2015Migration to Pillar I
Minimum Common Equity Capital Ratio3.504.004.504.504.504.504.50
Capital Conservation Buffer0.6251.251.8752.50
Minimum Common Equity + Capital Conservation Buffer3.504.004.505.1255.756.3757.00
Phase-in of Deductions from Core Equity Tier 120406080100100
Minimum Tier 1 Capital4.505.506.006.006.006.006.00
Minimum Total Capital8.008.008.008.008.008.008.00
Minimum Total Capital + Capital Conservation Buffer8.008.008.008.6259.259.87510.50
Phase-out of instruments that no longer qualify as non-Core Tier 1 or 2 capitalPhased out over a 10-year horizon beginning 2013
Liquidity Coverage RatioStart of obs. periodIntroduce minimum standard
60708090100
Net Stable Funding RatioStart of obs. periodIntroduce minimum standard
Source: Basel Committee for Banking Supervision (BCBS), http://www.bis.org/bcbs/basel3.htm (BIS 2017).Note: See BCBS (2010b and 2010c). The introduction of the Liquidity Coverage Ratio (LCR) was graduated (BCBS 2013a). Specifically, the LCR was introduced on January 1, 2015, but the minimum requirement began at 60 percent, rising in equal annual steps of 10 percentage points to reach 100 percent on January 1, 2019. Obs = observation.
Source: Basel Committee for Banking Supervision (BCBS), http://www.bis.org/bcbs/basel3.htm (BIS 2017).Note: See BCBS (2010b and 2010c). The introduction of the Liquidity Coverage Ratio (LCR) was graduated (BCBS 2013a). Specifically, the LCR was introduced on January 1, 2015, but the minimum requirement began at 60 percent, rising in equal annual steps of 10 percentage points to reach 100 percent on January 1, 2019. Obs = observation.
Appendix 16.4. The Interaction and Integration of Solvency and Liquidity Risks

More comprehensive macroprudential stress tests incorporate feedback effects between solvency conditions and liquidity risk in banking sectors. While several papers have taken a systematic approach for analyzing their interaction, the practical implementation of this concept remains at an early stage (BCBS 2013c, 2015). For example:

  • Van den End (2008) develop a stress testing model that endogenizes market and funding liquidity risks by including feedback effects, which capture both behavioral and reputational effects.
  • Aikman and others (2009) integrate funding liquidity risk and solvency risk in the Bank of England’s Risk Assessment Model for Systemic Institutions. The framework simulates banks’ liquidity positions conditional on their capitalization under stress, and other relevant dimensions such as a decrease in confidence among market participants under stress.
  • Wong and Hui (2009) explicitly capture the link between default risk and deposit outflows. Their framework simulates the impact of mark-to- market losses on banks’ solvency positions leading to deposit outflows; asset fre sales by banks are evaporating and contingent liquidity risk sharply increases.
  • Barnhill and Schumacher 2011 develop a more general empirical model, incorporating the previous two approaches that attempt to be more comprehensive in terms of the source of the solvency shocks and compute the long-term impact of funding shocks.
  • Schmieder and others (2012) construct an Excel-based tool that allows liquidity tests informed by banks’ solvency conditions and simulates the increase in funding costs resulting from deteriorating solvency.
  • Jobst (2014) combines option pricing with market data and balance sheet information in the Systemic Risk-adjusted Liquidity model to generate a probabilistic measure of the frequency and severity of multiple entities experiencing a joint liquidity event. The model links a bank’s maturity mismatch between assets and liabilities affecting the stability of its funding with the characteristics of other banks, subject to individual changes in risk profiles and common changes in market conditions.
  • Anand, Bédard-Pagé, and Traclet (2014) include a top-down liquidity stress test in the Bank of Canada’s M acro-Financial Risk Assessment Framework, which takes into account additional sources of pressure of banks’ solvency due to outright rationing of funding— in addition to increases in its cost— and secondary effects from potential spillovers with counterparty risk as weak banks may be unable to honor, in part or entirely, their interbank exposures.
  • Hesse, Salman, and Schmieder (2014) integrate macro-financial linkages, namely spillovers from the European periphery, to banks’ solvency and liquidity resilience in a stress testing framework.
Appendix 16.5. Liquidity Stress Testing Using Implied Cash Flows

Over the years, the IMF staff has developed several liquidity risk stress testing tools for the system-wide assessment of the impact of negative shocks to banks’ funding conditions. This appendix presents one of these tools (Jobst 2017), which was applied in the financial stability assessment modules of the Financial Sector Assessment Programs (FSAPs) for Hong Kong SAR (IMF 2014d) and the United Kingdom (IMF 2016b).21 The tool provides instructions regarding data requirements and assumptions and contains a complete calculation methodology consistent with the specific liquidity stress testing requirements of FSAPs.

The liquidity stress test captures the risk of a bank failing to generate sufficient funding to satisfy its short-term payment obligations over a predefined stress horizon. It follows a top-down implied-cash- flow (ICF) approach of modeling the impact of the sudden, sizeable withdrawals of funding (that is, liabilities runof) and unscheduled cash outflows after taking into account the repayment of outstanding claims and availability of existing liquidity buffers (“counterbalancing capacity”). The funding shock is calibrated to assumptions about the expected (that is, scheduled) and potential cash inflows and outflows related to existing claims and obligations (“funding liquidity risk”) and the application of haircuts to available assets (“market liquidity risk”) over risk horizons of five days (cumulative) and 30 days (noncumulative). The ability to survive funding constraints is also influenced by the degree to which saleable assets are encumbered and the rollover risk stemming from maturity mismatches of assets and liabilities, which are assessed for both local and foreign currencies.

More specifically, several channels affecting the severity of cash-flow calculations are considered (Appendix Table 16.5.1). They comprise: (1) the decline in asset values under stress and the extent to which they can be either used as collateral for secured wholesale funding or sold at stressed market values (“market liquidity risk”), (2) callback/renewal rates of scheduled and unscheduled cash flows from maturing assets and liabilities (“funding liquidity risk”), and (3) the utilization rate of contingent claims and liabilities/funding swap arrangements.22 More specifically:

  • Liquid assets available for sale or collateralized funding under the assumption of varying degrees of asset-specific valuation haircuts and encumbrance levels comprise: (1) cash and cash balances with central banks, (2) securities and bank loans eligible for refinancing operations at the domestic and major central banks, (3) securities and bank loans that can be mobilized in repo transactions (or another type of lending against financial collateral), and (4) marketable securities in general.
  • Cash inflows are determined by the expected repayment amount of outstanding credit with/without liquid financial assets as collateral, comprising: (1) expected inflows of cash and decline of liquid assets related to maturing transactions with/without liquid securities and bank loans (for example, repo and securities lending transactions), (2) expected and potential net cash flows related to derivatives (excluding credit derivatives), and (3) potential inflows from committed/ uncommitted credit lines to related and third parties.
  • Cash outflows are defined by the runof of maturing and nonmaturity funding with/without liquid financial assets as collateral, comprising: (1) expected inflows of cash and increase of liquid assets related to transactions with/without liquid securities and bank loans (for example, reverse repo and securities borrowing transactions), (2) maturing repayments to related parties, and (3) committed/uncommitted contingent claims to related and third parties.

The liquidity stress test is evaluated numerically as the ratio between potentially available liquidity and potentially required liquidity, which should be at least 100 percent or greater. A value lower than 100 percent would imply a liquidity shortage if the assumed stress scenario materialized. The test also includes several additional assumptions:

  • Only unencumbered liquid assets (generating cash inflows), that is, assets used as collateral to receive funding (except for cash/ cash-equivalents), are included in the test (“liquidity scope”). Funding via potentially reusable securities received as collateral (“rehypothecation”) and cash inflows from new or renewed (secured/unsecured) wholesale lending (at contractual maturities) but full renewal of secured retail lending (for example, secured lending with illiquid collateral such as residential mortgages) are not considered.
  • There is limited potential unsecured support in convertible currencies from related and third parties (for example, in the form of committed line) but full convertibility between currencies (within one week).

In the recent FSAP for the United Kingdom (IMF 2016b), for example, the liquidity stress testing tool was applied to 10 institutions, consisting of seven major commercial banks and building societies, and the three largest subsidiaries of foreign investment banks covering 80 percent total banking assets. Results for the five-day and 30-day ICF tests suggest that the protracted noncumulative cash flows over a longer time horizon have a greater impact on the banks’ liquid buffers than cumulative stresses over a shorter period (Appendix Table 16.5.2 and Appendix Figure 16.5.1).

Appendix Table 16.5.1Liquidity Stress Test Tool—Summary of Assumptions
Basic Assumptions
TestDefinitionAssets (cash inflows)Liabilities (cash outflows)Other Assumptions
Five-day implied-cash-flow testCumulative inflow and outflow over five consecutive daysLiquid financial assets: (1) cash and cash balances with central banks [haircut: 0 percent], (2) securities and bank loans eligible at major central banks [0–15], (3) securities and bank loans that can be mobilized in repo transactions (or another type of lending against financial collateral) [5–30], and (4) marketable securities [10–35].

Cumulative cash inflows: (1) expected cash inflows related to credit extension without liquid financial assets as collateral [callback rate: 20 percent per day], (2) expected inflows of cash and liquid assets related to maturing transactions with liquid securities and bank loans (for example, repo and securities lending transactions) [20], and (3) potential inflows from committed/ uncommitted credit lines to related and third parties [drawdown rate: 3/5 percent per day].
Cumulative net cash flows: expected and potentia (excluding credit derivatives)—net contractualCumulative cash outflows: (1) maturing and nonmaturity funding without liquid financial assets as collateral [runof rate: 5 percent per day] (that is, all deposits and funding from financial and nonfinancial corporates as well as private households and SME clients) with the exception of sovereign and other public sector and central bank clients [0], (2) expected outflows of cash and liquid assets related to transactions with liquid securities and bank loans (for example, reverse repo and securities borrowing transactions) [20], (3) maturing outflows to related parties [20], and (4) committed/uncommitted contingent claims to related and third parties [drawdown rate: 3/5 percent per day].A ratio lower than 100 percent implies a liquidity shortage if the stress scenario would materialize at the reporting date (that is, potentially required liquidity > potentially available liquidity); only unencumbered liquid assets (generating cash inflows), that is, assets used as collateral to receive funding (with the exception of cash/cash-equivalents) are included in the test (“liquidity scope”); new unsecured financing and securitiza-tion impossible within the time horizon; no offsetting cash inflows from new or renewed (secured/unsecured) wholesale lending (at contractual maturities) but full renewal of secured retail lending (for example, secured lending with illiquid collateral [residential mortgages]); central bank eligible collateral can be monetized at appropriate haircuts; repo markets are open at appropriate haircuts; fresale of assets possible at appropriate haircuts; no consideration of funding via potentially reusable securities received as collateral (“rehypothecation”); limited potential unsecured support in convertible currencies from related and third parties (for example, in the form of committed lines); no renewal of term retail and wholesale deposits; and full convertibility between currencies (within one week).
Cumulative net cash flows: expected and potential net cash flows related to derivatives (excluding credit derivatives)—net contractual cash flows [20]1
30-day implied-cash-flow testNoncumulativeLiquid financial assets: (1) cash and cash balances with central banks [0], (2) securities and bank loans eligible at major central banks [0–20], (3) securities and bank loans that can be mobilized in repo transactions (or another type of lending against financial collateral) [10–60], and (4) marketable securities [20–70].

Noncumulative cash inflows: (1) expected cash inflows related to credit extension without liquid financial assets as collateral [callback rate: 100 percent], (2) expected inflows of cash and liquid assets related to maturing transactions with liquid securities and bank loans (for example, repo and securities lending transactions) [100], (3) expected and potential net cash flows related to derivatives (excluding credit derivatives)—net contractual cash flows [100], and (4) potential inflows from committed/uncommitted credit lines to related and third parties [drawdown rate: 23/12 percent].
Noncumulative cash outflows: (1) maturing and nonmaturity funding without liquid financial assets as collateral [runoff rate: 10–75 percent] (that is, all deposits and funding from financial and nonfinancial corporates as well as private households and SME clients) with the exception of sovereign and other public sector and central bank clients [0], (2) expected outflows of cash and liquid assets related to transactions with liquid securities and bank loans (for example, reverse repo and securities borrowing transactions) [100], (3) maturing outflows to related parties [100], and (4) committed/uncommitted contingent claims to related and third parties [drawdown rate: 12/23 percent].
Noncumulative net cash flows: expected and potential net cash flows related to derivatives (excluding credits derivatives)—net contractual cash flows [100]1
Source: Jobst, Ong, and Schmieder 2017.Note: SME = small-and medium-sized enterprise.

Note that many derivatives positions might be non-deliverable (typically, foreign exchange and interest rate swaps and forwards), and their valuation tends to be highly variable based on prevailing market conditions and expectations. For these positions, the valuation using the firm’s chosen accounting treatment should be considered, and potential net cash flows (variation margin/cash settlement cost) would need to be checked for consistency with the calibration of market risk under the Basel framework.

Source: Jobst, Ong, and Schmieder 2017.Note: SME = small-and medium-sized enterprise.

Note that many derivatives positions might be non-deliverable (typically, foreign exchange and interest rate swaps and forwards), and their valuation tends to be highly variable based on prevailing market conditions and expectations. For these positions, the valuation using the firm’s chosen accounting treatment should be considered, and potential net cash flows (variation margin/cash settlement cost) would need to be checked for consistency with the calibration of market risk under the Basel framework.

Appendix Table 16.5.2Liquidity Stress Test Results—Implied-Cash-Flow Tests (In billions of pounds sterling)
Test 1a: Implied-Cash-Flow Test (Five Days)
Cumulative Loss of Unsecured Funding (up to one week) (percent)Cumulative Loss of Secured Funding (up to one week) (percent)Minimum Number of Days of SurvivalBanks Illiquid (number)Banks Illiquid (percent of banking sector assets)Net Cash Shortfall Relative to Total Liquid Assets (percent)Net Cash Shortfall Relative to Total Assets (percent)
Day 15.25.410000
Day 210.610.220000
Day 316.414.530000
Day 422.418.540000
Day 531.524.450000
Test 1b: Implied-Cash-Flow Test (30 Days)
Cumulative Loss of Unsecured Funding (percent)Cumulative Loss of Secured Funding (percent)SurvivalBanks Illiquid (number)Banks Illiquid (percent of banking sector assets)Net Cash Shortfall Relative to Total Liquid Assets (percent)Net Cash Shortfall Relative to Total Assets (percent)
30 Days27.5100.0No00.00.00.0
Source: Bank of England staff estimates.
Source: Bank of England staff estimates.

Implied-Cash-Flow Tests—Distribution (In percent, solo basis)

Sources: Bank of England and IMF staff estimates.

Note: The sample of banks included in the IMF top-down implied-cash-flow stress test includes the seven largest UK banks and three large subsidiaries of foreign banks representing 80 percent of the banking sector based on a Prudential Regulation Authority liquidity reporting. Boxplots include the mean (yellow dot), the 25th and 75th percentiles (grey box, with the change of shade indicating the median), and the 10th and 90th percentiles (whiskers). The green line indicates the lowest acceptable ratio value of 100 percent (threshold).

Appendix 16.6. Liquidity Stress Testing: Reporting Template

Example of Output Template Provided to Authorities

Source: Jobst 2017.

Note: This summary table was taken from the liquidity stress testing tool presented in Appendix 16.5. abs = absolute; avg = average; B/S = balance sheet; CET1 = Common Core Equity Tier 1; FX = foreign exchange; max = maximum; min = minimum; No = number.

Appendix 16.7. Cash-Flow-Based Liquidity Stress Tests

Fully fledged cash-flow- based liquidity stress tests have been implemented by several central banks and the internal liquidity risk assessment by the European Banking Authority in 2011 (and ever since then). They offer distinct advantages compared to “stock approaches” underpinning standard liquidity ratios (such as the liquidity coverage ratio [LCR]). Tey:

  • Are forward-looking by including banks’ contractual cash outflows and inflows as well as banks’ expected counterbalancing capacity and should benefit from enhanced data availability and disclosure especially with regard to, for instance, asset encumbrance and securities funding such as repos or off-balance sheet funding.
  • Enable detailed liquidity analysis and hence are better suited for capturing a bank’s funding resilience and its liquidity risk bearing capacity compared to the rather limited stock approach (IMF 2013b).
  • Better capture banks’ cumulative cash flows. Standard measures follow a noncumulative approach by focusing on a specific stress test window without accounting for other detailed maturity buckets (for example, 30 days in the LCR ca se).

The Basel III regime23 has moved toward cash-flow-based liquidity monitoring and reporting through the LCR requirement. Cash-flow- based liquidity stress tests have several advantages compared to other approaches. These include:

  • Providing a more detailed analysis of liquidity positions similar to those carried out by banks (often daily) for their internal risk-management purposes. The cash-flow approach incorporates securities flows and ensures consistency between cash flows and securities flows.24
  • Allowing for more granular maturity buckets (and may also be adapted to accommodate different currencies).
  • Integrating granular information on banks’ asset encumbrance levels from secured wholesale funding.
  • Accommodating off-balance sheet activities, such as FX swaps or credit liquidity lines, and banks’ behavioral cash out-flow and inflows, which might be more difficult in a standard stock approach.

Weaknesses of the cash-flow approach include the high data intensity as well as initial setup costs. A key prerequisite to carry out cash-flow- based liquidity tests is access to a wide range of data on contractual cash flows for different maturity buckets and possibly behavioral data based on banks’ financial/funding plans. Additionally, while banks typically use a cash-flow-based approach for internal liquidity monitoring and liquidity stress testing, regulatory liquidity ratios are often based on stock accounting data with often less data granularity than the cash-flow- based templates.25

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    International Monetary Fund (IMF). 2013d. “Belgium: Stress Testing the Banking and Insurance Sectors—Technical Note.” IMF Country Report 13/137 Washington DC May. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/Belgium-Technical-Note-on-Stress-Testing-the-Banking-and-Insurance-Sectors-40573.

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    International Monetary Fund (IMF).2013e. “Brazil: Stress Testing the Banking Sector—Technical Note.” IMF Country Report 13/147 Washington DC June. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/Brazil-Technical-Note-on-Stress-Testing-the-Banking-Sector-40589.

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    International Monetary Fund (IMF). 2013h. “Italy: Stress Testing the Banking Sector—Technical Note.” IMF Country Report 13/349 Washington DC December. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/Italy-Thechnical-Note-on-Stress-Thesting-The-Banking-Sector-41090.

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    International Monetary Fund (IMF). 2013i. “Singapore: Financial System Stability Assessment.” IMF Country Report 13/325 Washington DC November. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/Singapore-Financial-System-Stability-Assessment-41051.

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    International Monetary Fund (IMF). 2014a. “IMF Executive Board Reviews Mandatory Financial Stability Assessments under the Financial Sector Assessment Program.” IMF Press Release 14/08 Washington DC January. https://www.imf.org/en/News/Articles/2015/09/14/01/49/pr1408.

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    International Monetary Fund (IMF). 2014b. “Austria: Stress Testing the Banking Sector—Technical Note.” IMF Country Report 14/16 Washington DC January. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/Austria-Publication-of-Financial-Sector-Assessment-Program-Documentation-Technical-Note-on-41266.

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    International Monetary Fund (IMF). 2014c. “Canada: Stress Testing—Technical Note.” IMF Country Report 14/69 Washington DC March. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/Canada-Financial-Sector-Assessment-Program-Stress-Testing-Technical-Note-41405.

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    International Monetary Fund (IMF). 2014d. “People’s Republic of China–Hong Kong Special Administrative Region: Stress Testing the Banking Sector— Thechnical Note.” IMF Country Report 14/210 Washington DC July. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/Peoples-Republic-of-ChinaHong-Kong-Special-Administrative-Region-Financial-Sector-Assessment-41755.

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    International Monetary Fund (IMF). 2014e. “Switzerland: Stress Testing the Banking System— Thechnical Note.” IMF Country Report 14/267 Washington DC September. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/Switzerland-Thechnical-Note-Stress-Thesting-the-Banking-System-41883.

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    International Monetary Fund (IMF). 2014f. “Denmark: Stress Testing the Banking, Insurance, and Pension Sectors—Technical Note.” IMF Country Report 14/348 Washington DC December. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/Denmark-Stress-Testing-the-Banking-Insurance-and-Pension-Sectors-Technical-Note-42536.

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    International Monetary Fund (IMF). 2015a. “Korea: Stress Testing and Financial Stability Analysis—Technical Note.” IMF Country Report 15/6 Washington DC January. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/Republic-of-Korea-Financial-Sector-Assessment-Program-Stress-Testing-And-Financial-Stability-42585.

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    International Monetary Fund (IMF). 2015b. “South Africa: Stress Testing the Financial System—Technical Note.” IMF Country Report 15/54 Washington DC March. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/South-Africa-Financial-Sector-Assessment-Program-Stress-Testing-the-Financial-System-42756.

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    International Monetary Fund (IMF). 2015c. “United States: Stress Testing—Technical Note.” IMF Country Report 15/173 Washington DC July. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/United-States-Financial-Sector-Assessment-Program-Stress-Testing-Technical-Notes-43058.

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    International Monetary Fund (IMF). 2015d. “Norway: Stress Testing the Banking Sector— Technical Note.” IMF Country Report 15/258 Washington DC September. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/Norway-Financial-Sector-Assessment-Program-Technical-Note-Stress-Testing-the-Banking-Sector-43271.

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    International Monetary Fund (IMF). 2015e. “The Financial Sector Assessment Program— Factsheet.” International Monetary Fund Washington DC September 21.

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    International Monetary Fund (IMF). 2015f. Global Financial Stability Report—Vulnerabilities Legacies and Policy Challenges Chapter 2. Washington DC October. http://www.imf.org/en/Publications/GFSR/Issues/2016/12/31/Vulnerabilities-Legacies-and-Policy-Challenges.

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    International Monetary Fund (IMF). 2016a. “Argentina: Financial Sector Stability—Technical Note.” IMF Country Report 16/65 Washington DC February. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/Argentina-Financial-Sector-Assessment-Program-Financial-Sector-Stability-Technical-Note-43739.

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    International Monetary Fund (IMF). 2016b. “United Kingdom: Stress Testing the Banking Sector—Technical Note.” IMF Country Report 16/163 Washington DC June 17. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/United-Kingdom-Financial-Sector-Assessment-Program-Stress-Testing-the-Banking-Sector-43974.

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    International Monetary Fund (IMF). 2016c. “Germany: Stress Testing the Banking and Insurance Sectors—Technical Note.” IMF Country Report 16/191 Washington DC June 29. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/Germany-Financial-Sector-Assessment-Program-Stress-Testing-the-Banking-and-Insurance-Sectors-44015.

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    International Monetary Fund (IMF). 2016d. “Russian Federation: Technical Note Stress Testing.” IMF Country Report 16/306 Washington DC September. https://www.imf.org/en/Publications/CR/Issues/2016/12/31/Russian-Federation-Financial-Sector-Assessment-Program-Technical-Note-Stress-Testing-44288.

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    International Monetary Fund (IMF). 2016e. “Ireland: Stress Testing the Banking System— Technical Note.” IMF Country Report 16/315 Washington DC September. http://www.imf.org/en/Publications/CR/Issues/2016/12/31/Ireland-Financial-Sector-Assessment-Program-Thechnical-Note-Stress-Thesting-the-Banking-System-44308.

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    International Monetary Fund (IMF). 2017a. “Finland: Stress Testing the Banking System and Interconnectedness Analysis—Technical Note.” IMF Country Report 17/6 Washington DC January. https://www.imf.org/en/Publications/CR/Issues/2017/01/11/Finland-Financial-Sector-Assessment-Program-Technical-Note-Stress-Testing-the-Banking-System-44516.

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    International Monetary Fund (IMF) . 2017b. “Turkey: Financial System Stability Assessment.” IMF Country Report 17/35 Washington DC February. https://www.imf.org/en/Publications/CR/Issues/2017/02/03/Turkey-Financial-Sector-Assessment-Program-Financial-System-Stability-Assessment-44617.

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    JobstAndreasA.2011. “Systemic Liquidity Risk and Macropru-dential Stress Testing” Presentation Stream 2 – Liquidity Risk Modelling and Management ALM Europe/Basel III Congress RISK Magazine 28 September (London).

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1

The guidance note is centered on the implementation of a stress testing methodology that focuses on the time structure of contractual cash flows. While the guidance note is an internal document for use by the IMF staff, the current version is also available upon request.

2

See also IMF 2015e and 2018.

3

Note that Hong Kong SAR is not an independent country but part of China; however, it was included in the sample due to its classification as a jurisdiction with a systemically relevant financial sector.

4

Detailed information on the scope and specifications of the FSAP exercises may serve as a useful reference for these purposes, together with the existing guidance note for staff (Catalán 2015).

5

However, most liquidity stress tests assume that in a systemic crisis, part of the eligible collateral would be pledged to the central bank (subject to the applicable haircut) for secured funding via repos as part of the open market operations (Chailloux and Jobst 2010).

6

For instance, the US Federal Reserve Board completes the Comprehensive Liquidity Assessment and Review as a complement to the annual Comprehensive Capital Analysis and Review for large financial institutions covered by the Large Institution Supervision Coordinating Committee; the scope of the exercises includes 16 firms consisting of US global systemically important banks, US systemically important insurance companies, and international broker dealers with a significant US presence in accordance with the Supervision and Regulation Letter SR 15–7 (April 17, 2015). Similarly, the Hong Kong Monetary Authority conducts the enhanced liquidity stress test, which forms part of the liquidity reporting framework for banks. The Österreichische National-bank (OeNB) uses a cash-flow-based liquidity stress approach. During the financial crisis in 2008, the Austrian Financial Market Authority and OeNB required banks to report weekly cash flows based on a newly developed standardized liquidity reporting template, which allows the simulation of impact of common shocks based on a uniform methodology (OeNB 2009; Schmitz and Ittner 2007). See also Appendix 16.7.

7

Investment banks (but also foreign branches and subsidiaries), which may not be included in corresponding solvency stress tests, tend to play an important role in funding markets and should ideally be incorporated (for example, Ireland, Hong Kong SAR, and the United Kingdom).

8

The Basel liquidity rules only prescribe that the standards be applied on a consolidated basis. Legal entity application is left to national discretion.

9

The liquidity metric monitor is designed to demonstrate some of the liquidity metrics calculated by the Prudential Regulation Authority using prudential information in accordance with FSA047 and FSA048. It also provides estimates of the Basel III liquidity ratios (LCR and NSFR). See https://www.bankofengland.co.uk/prudential-regulation/publication/2013/supervisory-tools-liquidity-tools.

10

Schmitz, Sigmund, and Valderrama 2017 find evidence of nonlinear effects between solvency and funding costs using a simultaneous-equation approach drawing on supervisory data for 54 large banks from six advanced countries between 2004 and 2013. The study confirms earlier evidence in Annaert and others 2013, which shows that the interaction between solvency and funding costs is indeed significant in a sample of 31 large euro area banks over the precrisis period from 2004 to October 2008. Similarly, Hasan, Liu, and Zhang 2016 show that solvency has significant impact on bank funding costs, using a sample of 161 global banks from 23 countries between 2001 and 2011. This is confirmed by Caceres and others (2016) when they examine the sensitivity of bank funding costs to bank solvency drawing on the Federal Deposit Insurance Corporation call report covering 10,000 US banks between 1993 and 2013.

11

Haircuts would ideally be applied irrespective of whether assets are held in the trading or banking books (since a bank’s access to funding markets [and thus its funding costs] will depend on the market’s current valuation of the bank’s entire portfolio and not on the accounting valuation on a hold- to- maturity basis). See Chapter 9 for a discussion of the scope of valuation haircuts in the context of sovereign exposures.

12

Projected cash flows that stem from contractual rights or obligations and have a known maturity date are differentiated from those that are likely to materialize but have not yet been contracted and could exceed expectations (based on historical experience) or existing cash reserves.

13

Note that expected cash inflows (outfows) reflect changes in available (required) funding through assets (liabilities); however, this relationship reverses for potential cash flows. For instance, the possible use of a committed credit line (as an asset) by a related or third party to obtain funding during stress represents a potential cash outflow, while access to contingent intragroup funding (as a liability) contributes to potential cash inflows.

14

This also includes the discount factors for contingent claims and liabilities to related and third parties.

15

A comprehensive ICF test approach and the related tool have been applied in FSAPs (Jobst 2017), which can be found on the IMF eLibrary.

16

In this regard, the work of the Research Task Force of the Basel Committee on Banking Supervision on liquidity stress testing provides useful insights into the important interaction of liquidity and solvency risks.

17

See Bucalossi and others 2016 for a detailed analysis of the potential impact of standardized liquidity risk measures on banks’ liquidity management in the European context.

18

See also BCBS 2014.

19

For committed credit facilities the drawdown rate declines to 10 percent. The assumed drawdown rate for both credit (liquidity) facilities extended to other nonbank financial institutions including securities firms, insurance companies, fduciaries, and beneficiaries is 40 (100) percent (BCBS 2013a).

20

Compliance with the NSFR, which emphasizes the availability of long-term sources of funding, could conflict with plans to make senior bondholders absorb bank losses under so-called “ bail-in” clauses (Pengelly 2012). Banks might find it difficult to lengthen the maturity of their balance sheet by issuing additional unsecured debt if mandatory bail-in clauses were attached to them, which would also result in higher funding costs compensating for investors for accepting bail-in risk.

21

The tool is available as an MS Excel® fle (entitled “IMF FSAP Liquidity Stress Testing Tool”) on the IMF eLibrary at https://www.elibrary.imf.org/page/stress-test2-toolkit.

22

The workbook requires firm-level data on liquid assets, inflows and outflows from specified assets and liabilities, and net flows from derivatives, which are separated into two “maturity buckets” of either: (1) one week/open maturity; or (2) longer than one week but up to one month, corresponding to the respective implied-cash- flow tests. The five-day test includes only data provided for the first maturity bucket, which are subject to the cumulative impact of specific callback and runof rate assumptions of assets and liabilities. The assumptions on valuation haircuts (for liquid assets), callback rates (for cash inflows from the rollof of outstanding claims and potential funding from contingent liabilities), and runof rates (for cash outflows from the withdrawal/termination of funding and potential payments from contingent claims) are organized in separate worksheets and can be amended according to country-specific circumstances.

23

For instance, the Österreichische Nationalbank (OeNB) uses a cash-flow- based liquidity stress approach. Given the implementation of Basel III via the CRR/ CRD-IV framework in the European Union, uniform cash-flow templates for liquidity reporting/stress testing are likely to become a standard in other jurisdictions as well.

24

This is especially important given the fundamental role unsecured and secured wholesale funding play for many large banks.

25

For EU banks, the phase-in of cash-flow-based maturity mismatch templates by the European Banking Authority provides regulators and banks with a standardized reporting format.

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