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IMF Country Report No. 22/280

WEST AFRICAN ECONOMIC AND MONETARY UNION

FINANCIAL SECTOR ASSESSMENT PROGRAM

TECHNICAL NOTE ON ANALYSIS OF SYSTEMIC LIQUIDITY

August 2022

This technical note on Bank Stress Test for Climate Change Risks was prepared by a staff team of the International Monetary Fund and World Bank in the context of a joint IMF-World Bank Financial Sector Assessment Program (FSAP). It is based on the information available at the time it was completed in July 2022.

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Title page

WEST AFRICAN ECONOMIC AND MONETARY UNION

FINANCIAL SECTOR ASSESSMENT PROGRAM

TECHNICAL NOTE

ANALYSIS OF SYSTEMIC LIQUIDITY

July 20, 2022

Prepared by

Monetary and Capital Markets Department (MCM)

Contents

• Glossary

• EXECUTIVE SUMMARY

• INTRODUCTION

• LIQUIDITY RISKS

• A. Liquid Assets

• B. Stability of Funding

• C. Liquidity Stress Tests

• MEASURES TO INTERNALIZE LIQUIDITY RISKS

• A. Reserve Requirement

• B. Liquidity Ratios

• CENTRAL BANK LIQUIDITY INTERVENTIONS

• A. Monetary Policy Operations

• B. Emergency Liquidity: Instrument and Risk Control Measures

• BCEAO RISK CONTROL MEASURES

• A. Funding Plans

• B. Collateral Framework

• C. Risk Control Measures within the Emergency Liquidity Framework

• FIGURES

• 1. Potentially Liquid Assets in the WAEMU

• 2. Liquidity Indicators of Government Securities (2019–21)

• 3. Customer Funding Stability Indicators

• 4. Top 5th Percentile of Withdrawals by Bank

• 5. Interbank Transactions

• 6. Development of the Network of Interbank Exposures (2015–20)

• 7. Coverage of the Liquidity Stress Test

• 8. Run-Off Rate Scenarios

• 9. Results of Liquidity Stress Tests

• 10. Liquidity Gaps under Unfavorable Conditions

• 11. Distributions of Liquidity Coverage Ratios

• 12. Coverage Rate of Liquidity Gaps with BCEAO Refinancing

• 13. Systemic Liquidity and Interest Rates

• TABLES

• 1. Table of Recommendations

• 2. Obligations and Privileges of Primary Dealers

• 3. Description of Customer Funding Stability Indicators

• 4. Withdrawal Rate Scenarios

• 5. Haircut Assumption for Liquid Assets

• 6. Funding Plans: Key Parameters

• APPENDIX

• I. Considerations for the Establishment of an MMCG

Glossary

Executive Summary

The limited development of markets in the region represents a key risk factor for financial stability.¹ Since the previous Financial Sector Assessment Program (FSAP) in 2008, the bank deposit base has increased from 18 percent to 30 percent of gross domestic product (GDP) and the buoyancy of the government securities market has benefited from the interruption of public deficit financing by the Central Bank of West African States (BCEAO). Nevertheless, a significant portion of bank funding cannot be considered stable, due to the concentration of deposits held by large corporations. Apart from reserves held with the BCEAO, banks have little in the way of liquid assets, although the secondary market for government securities is beginning to grow for some issuers. Insufficient secondary market liquidity and the prevalence of unsecured intragroup transactions (60 percent of the total) in the interbank market exacerbate the risk and extent of potential losses for banks in the event of liquidity distress.

The exchange rate regime and the setting of monetary policy have implications for the management of systemic liquidity. Under fixed exchange rate regimes, fluctuations in external assets can have an unpredictable impact on systemic liquidity. The introduction of full allotment of the refinancing demand to the BCEAO’s seven- and 28-day operations in 2020, in a context where the market does not represent a reliable alternative, has eliminated uncertainty about access to refinancing, and this has reduced the liquidity premium in the market.

The stability of the system’s liquidity relies on refinancing by the BCEAO. For its range of eligible instruments, the BCEAO accepts all government securities and private debt under the same conditions regardless of their different risk profiles. This approach has helped absorb systemic fluctuations and idiosyncratic liquidity shocks. On the other hand, it has encouraged risk-taking through reliance on the BCEAO’s support, it has resulted in the dependence of some banks on the BCEAO, and it has led the BCEAO to accumulate risk on its balance sheet. In response to this situation, the BCEAO applied limits on refinancing in proportion to bank assets and capital, which have the disadvantage of being procyclical and run the risk of preventing refinancing for banks that might have additional needs.

The mission supports the authorities’ efforts to encourage banks to manage liquidity risk internally. The regulator will have to choose objective and verifiable liquidity indicators to determine the assets eligible for Level 1 of the liquidity coverage ratio (LCR) numerator and the haircuts, including those for government securities. If the regulator does not wish to apply different haircuts for different sovereign issuers, a uniform haircut should at least be applied to account for the limited liquidity of the overall market. Ultimately, the LCR should consider the different risk profiles of banks based on a study of the time series of deposits for each bank under Pillar II of Basel III.

Markets need to be developed further to reduce liquidity risk. Improved liquidity in secondary markets reduces liquidity risk and supports the development of repo operations, which are more resilient to confidence shocks than unsecured lending. The secondary government securities market is the cornerstone on which the rest of the market develops. Therefore, it is necessary to: (i) include the development of this market as an objective in the states’ medium-term debt management strategies; (ii) resolve the market segmentation linked to the syndication procedure (by unifying the legal depository, in particular); and (iii) review the privileges and obligations of the market makers, called treasury securities dealers (TSDs) in the Union. Institutional cooperation between the West African Monetary Union (WAMU) Securities Agency (WSA)² and the Public Savings and Financial Markets Regional Board (CREPMF) should be strengthened to promote the best standards of transparency and supervision in both market segments and to contribute to the fungibility of securities.

The mission proposes that the problem of dependence on BCEAO refinancing be resolved on the basis of funding plans. A funding plan is a projection of a bank’s balance sheet over a predetermined period of time (for example, three years) that shows changes in funding needs. Banks that exceed a predetermined threshold of dependence on the central bank will have to prepare a funding plan that is reviewed and monitored by the supervisor. In the context of the plan, the bank concerned must reduce its funding requirement below the threshold through asset sales and recapitalizations, by reducing growth in its assets or by actively raising funding from customers or the market. The trigger threshold specified in the plans should be lower than the quantitative limits currently imposed. Subject to diligent execution of the funding plans, the banks concerned would retain access to BCEAO operations.

The collateral framework should include additional haircuts based on risk types. The objective is to maintain a diversified collateral framework while achieving risk equivalence among different kinds of collateral once haircuts have been applied. The haircuts reflect the usual risks, in particular, credit risk and liquidity risk, and apply to both government securities and private debt. For government securities, the credit risk haircut would be based on international ratings, with a larger haircut for unrated sovereign debt. In addition to haircuts, the BCEAO should introduce concentration limits to ensure the diversity of collateral provided.

The BCEAO should introduce a framework for emergency liquidity assistance (ELA). Most central banks have the ability to provide emergency liquidity to viable banks that are facing persistent liquidity shortages and that have exhausted collateral eligible for monetary policy operations. With ELA, the central bank can provide refinancing on the basis of expanded collateral because the additional assumption of risk is offset by strict conditionality and monitoring of repayment plans. ELA is the responsibility of the BCEAO, but close coordination with the supervisor is necessary to assess the viability of counterparties and impose conditionality.

^{Table 1.}

WAEMU: Table of Recommendations

¹ST = short term (between one and two years); MT = medium term (between three and five years).

^{Table 1.}

WAEMU: Table of Recommendations

Recommendation	Authority	Priority1
Ex Ante Risk Control Measures
Introduce Basel-type liquidity ratios to improve liquidity risk management and strengthen resilience to liquidity shocks.	BCEAO	ST
Include the reserve requirement in Level 1 liquid assets in order to reflect the limited universe of liquid assets.	BCEAO	ST
Use the turnover per security to determine the liquidity coverage ratio haircuts. If the regulator does not wish to introduce differentiated haircuts for sovereign issuers, at least apply a uniform non-zero haircut.	BCEAO	MT
Require banks to provide detailed information on the maturities and interest rates of their assets and liabilities in order to monitor maturity mismatches and interest rate risk.	Banking Commission	MT
Consider the stability of each bank’s funding estimated on a time series basis in order to impose higher LCR requirements on banks with a higher liquidity risk profile under Pillar II of Basel III.	BCEAO	MT
Local Market Development Measures
Prepare a regional strategy for the development of the public debt market.	BCEAO, WSA	MT
Consolidate the central securities depository for auction and syndication issues at the BCEAO or within an independent infrastructure to increase the fungibility of securities.	BCEAO	CT
Strengthen cooperation between the WSA and CREPMF on securities issues, including mixed auction-syndication issues in order to increase competition in syndication and reduce costs.	BCEAO, WSA, CREPMF	MT
Strengthen cooperation between the WSA and CREPMF to establish common transparency and market supervision standards for securities issued through auctions and syndications.	BCEAO, WSA, CREPMF	MT
Enhance the privileges of TSDs by: (i) reserving access to issues for them; (ii) reserving securities lending for them; and (iii) paying them a commission.	BCEAO, WSA	MT
Create a regular forum for contact among the key players in the interbank market: the Money Market Contact Group (MMCG).	BCEAO, WSA	MT
Monetary Policy Operations
Introduce funding plans to reduce dependence on the BCEAO without creating risks for the financial sector. Eventually, they would replace the quantitative limits on refinancing by the BCEAO.	BCEAO	MT
Introduce additional haircuts on public and private collateral for BCEAO refinancing to reduce distortions in the market and better protect the central bank’s balance sheet.	BCEAO	MT
Introduce concentration limits for public and private collateral for BCEAO refinancing to diversify the collateral available.	BCEAO	MT
Emergency Liquidity Assistance (ELA)
Determine the collateral universe for ELA as well as the risk management measures that apply to ELA collateral.	BCEAO	MT
Prepare a framework agreement to be signed by the counterparties benefiting from the ELA that defines the conditions of the ELA.	BCEAO	MT
Align funding plans with ELA repayment for ELA recipients.	BCEAO	MT
Establish in an agreement the procedures for the sharing of information and the coordination of tasks between the BCEAO and the Banking Commission in the context of ELA.	BCEAO	MT

¹ST = short term (between one and two years); MT = medium term (between three and five years).

View Table

^{Table 1.}

WAEMU: Table of Recommendations

Recommendation	Authority	Priority1
Ex Ante Risk Control Measures
Introduce Basel-type liquidity ratios to improve liquidity risk management and strengthen resilience to liquidity shocks.	BCEAO	ST
Include the reserve requirement in Level 1 liquid assets in order to reflect the limited universe of liquid assets.	BCEAO	ST
Use the turnover per security to determine the liquidity coverage ratio haircuts. If the regulator does not wish to introduce differentiated haircuts for sovereign issuers, at least apply a uniform non-zero haircut.	BCEAO	MT
Require banks to provide detailed information on the maturities and interest rates of their assets and liabilities in order to monitor maturity mismatches and interest rate risk.	Banking Commission	MT
Consider the stability of each bank’s funding estimated on a time series basis in order to impose higher LCR requirements on banks with a higher liquidity risk profile under Pillar II of Basel III.	BCEAO	MT
Local Market Development Measures
Prepare a regional strategy for the development of the public debt market.	BCEAO, WSA	MT
Consolidate the central securities depository for auction and syndication issues at the BCEAO or within an independent infrastructure to increase the fungibility of securities.	BCEAO	CT
Strengthen cooperation between the WSA and CREPMF on securities issues, including mixed auction-syndication issues in order to increase competition in syndication and reduce costs.	BCEAO, WSA, CREPMF	MT
Strengthen cooperation between the WSA and CREPMF to establish common transparency and market supervision standards for securities issued through auctions and syndications.	BCEAO, WSA, CREPMF	MT
Enhance the privileges of TSDs by: (i) reserving access to issues for them; (ii) reserving securities lending for them; and (iii) paying them a commission.	BCEAO, WSA	MT
Create a regular forum for contact among the key players in the interbank market: the Money Market Contact Group (MMCG).	BCEAO, WSA	MT
Monetary Policy Operations
Introduce funding plans to reduce dependence on the BCEAO without creating risks for the financial sector. Eventually, they would replace the quantitative limits on refinancing by the BCEAO.	BCEAO	MT
Introduce additional haircuts on public and private collateral for BCEAO refinancing to reduce distortions in the market and better protect the central bank’s balance sheet.	BCEAO	MT
Introduce concentration limits for public and private collateral for BCEAO refinancing to diversify the collateral available.	BCEAO	MT
Emergency Liquidity Assistance (ELA)
Determine the collateral universe for ELA as well as the risk management measures that apply to ELA collateral.	BCEAO	MT
Prepare a framework agreement to be signed by the counterparties benefiting from the ELA that defines the conditions of the ELA.	BCEAO	MT
Align funding plans with ELA repayment for ELA recipients.	BCEAO	MT
Establish in an agreement the procedures for the sharing of information and the coordination of tasks between the BCEAO and the Banking Commission in the context of ELA.	BCEAO	MT

¹ST = short term (between one and two years); MT = medium term (between three and five years).