Riassunto esame Risk management, Prof. Gioia Aldo, libro consigliato Risk Management, Mario Valletta

International regulatory framework for liquidity risk measurement

17 Now, we see the international regulatory framework for liquidity risk measurement, standards and monitoring, which is rather recent because the most effective measures have been introduced in 2008 and 2010, even if certain guidelines and recommendations have been issued by the Basel Committee for Banking Supervision even before.

But, as said before, the level of attention devoted to liquidity risk had been rather low until the uppers of the global financial crisis.

So, we remember the guidelines issued in 1992, which had been updated in 2000 and which “for [dal punto 2] [no ultimo punto] related to some practices managing liquidity in banking”… [punto 3]… “threat As said before, to the banks”… the development of capital markets and of various securitization techniques induced banks to rely more on source of funds represented by securities placed in capital markets: in particular, bonds and various types of bonds.

But this wholesale fundraising was rather volatile (and it's still), as we have seen during the sovereign debt crisis in 2011 and 2012. 440

The 1st relevant document which has been published after the out verse of the global financial crisis and the foundation of the regulatory framework that has been developed in the following years is represented by the principles for some liquidity risk management and supervision, which is actually an update and an integration of other documents.

But these sound principles, presented and published in 2008, really provide the guidance on the risk management and supervision of funding (!) liquidity risk.

And these principles are addressed in particular to regulatory authorities in order to enhance their commitment to supervise banks as far as this risk is concerned.

To complement these rather general principles, the Basel Committee developed 2 minimum standards for funding liquidity which are aimed at achieving 2 complementary objectives:

• A short-term objective; and
• A longer term objective.

Which in any case always refer to the liquidity position of banks.

In particular, these 2 new constraints, that is to say the Liquidity Coverage Ratio, LCR (as far as the short term is concerned) and the Net Stable Funding Ratio, NSFR (as far as the longer term is concerned), they are mainly addressed to large (!) banks that are highly interconnected and that can be considered as very significant banks within the banking system.

Actually, these 2 instruments have been extended to all (!) banks, as it is typical for the recommendations and the guidelines provided by the Basel Committee.

So… 441 [punto 1]… “for So, one month”… the purpose of this LCR is to induce banks to be endowed with [essere dotato di] a sufficient amount of High Quality Liquid Assets (HQLA), so that they can survive for 1 month, even (!) in a very stressed scenario.

[ultimo punto]… “jurisdiction So, specific conditions”… the national supervisors are entitled to adjust parameters to take into account specific conditions characterizing their jurisdiction.

The 2 standards quoted establish minimum levels of liquidity for internationally active banks [solo sottolineato] (even if we said that they become a benchmark for banks in general) and… 442

Liquidity Coverage Ratio

So, let's take into consideration the short-term constraints, that is to say the LCR…

[punto 2]… “in So, an orderly way”… in case of difficulties, a bank should, first of all, survive for the period of time which is necessary to implement certain policies/decisions that are effective in order to solve the problem.

Then, the problem could be solved with a substantial strengthening of the bank's liquidity position or, in the worst case, with the resolution of the bank.

[punto 3]… “at least 100%”… So, the Basel Committee decided that the stock of HQLA should be at least 100% of the net cash outflow.

Where the net cash outflow is calculated making reference to the following 30 days.

“minus the inflow”… [penultimo punto]… So, the type of approach that is chosen is, in practice, an expected cash flow-based approach.

[penultimo punto]… “to So, “under 75% of the outflow”… this means that a floor is placed the LCR”… [penultimo punto]… “25% of So, let’s outflows”… suppose that total outflows amount to 1.000 and total inflows to 850. 443

The net cash outflow would be 150. But this is let's say the managerial view.

Instead, from the regulatory point of view, there's a floor for the measure of the net cash outflow because total inflows cannot exceed 75% of total outflows: therefore, as far as the LCR is concerned, in this example, the maximum amount of inflows is fixed at 750, so that the net cash flow is 250.

This means that HQLA, in this case, should be, at least, equal to 250.

[ultimo punto]… “scenario”… So, actually, these outflows and inflows are weighted with certain coefficients that have been chosen in order to take into account the real capability of the bank to prudently manage the liquidity gap.

One important aspect in the construction of the liquidity coverage ratio is the definition of the “the requirements that apply to HQLA: liquidity of an asset depends on”… [punto 1]… “even So, in times of stress”… what are the fundamental characteristics of all… [ultimo punto].

HQLA: 444

dell’ultimo punto]… “Easy [punto 2 and certain valuation”…, which means that the market on which they are traded should be enough liquid, that is to say enough ample, deep and resilient.

“Flight [ultimo punto del punto 1]… to quality”… What does it mean? At the times of high volatility and low risk tolerance on the part of investors, even those investors that had decided to invest in long-term assets, in rather risky assets, tend to return to more liquid and less risky assets: this phenomenon is known as flight quality.

For instance, it happened that, during the global financial crisis, many investors (even retail) decided to replace their funds by investing them in bonds or shares issued by emerging market borrowers, for instance.

And this was due to the fact that they were quite dissatisfied with the rather low yields to maturity that were offered by US bonds or by Euro government bonds issued by the German government or other well-rated borrowers and issues.

But anytime the market conditions have worsened, these retail investors decided to return, that is to say to move their investments towards more liquid and less risky assets. 445

And this change in the orientation of investors is known as flight to quality.

Quando i rischi aumentano troppo, coloro che avevano investito in titoli di mercati emergenti alla ricerca di rendimenti più allettanti, in funzione della loro tolleranza al rischio, ad un momento, disinvestono e riportano sui titoli di migliore qualità.

E questo fenomeno è chiamato flight to quality.

Naturalmente, questo fenomeno non è originato da valutazioni oggettive, ma molto dalle percezioni e dalle aspettative degli investitori.

Perciò, capita anche che magari qualche dichiarazione poco avveduta da parte di un banchiere centrale o di un ministro delle finanze o qualche aspettativa irrealistica degli investitori che poi venga delusa origini queste trasmigrazioni di capitali nella direzione del flight to quality.

We refer to High Quality Liquid Assets, but, actually, these are not perfectly homogeneous, that is to say that, within the category of HQLA, we can distinguish different sub-categories because some are less safe and less liquid that certain others: therefore, we have level 1 HQLA, level 2 HQLA, and so on.

“At least 60% of the stock of the HQLA held by a single bank must consist of the so-called level [punto 1 dell’ultimo punto]… “0% 1 HQLA”… risk weight)”… So, at least 60% of the stock of the high quality liquid assets that are held in the bank's portfolio should consist of level 1 HQLA.

And these level 1 HQLAs are included without any haircut, even if national supervisory authorities may impose some haircuts, taking into account specific local conditions.

“Up to 40%”… [punto 2 dell’ultimo punto]… “debt So, securities”… the total amount of this level 2A HQLA cannot exceed 40% of the stock of total HQLA, but a minimum haircut of 15% is applicable, in this case.

So, not the entire market value, but a haircut of 15% is applied.

“National discretion”… [ultimo punto dell’ultimo punto]. 446

So, 60% should be level 1, 40% level 2 and, within this 40%, no more than 15% percent can consist of level 2 HQLA.

No haircut is applied to level 1 HQLA, while haircuts ranging from 15% to 50% or more are applicable to level 2 HQLA.

We talked about stressed scenarios: indeed, we said the Basel Committee wants to achieve a specific objective, that is the stock of HQLA held by a bank should enable this bank to survive a 30-day stress scenario.

So, what are the features of such a stressed scenario: which conditions should materialize in order to qualify a scenario as stressed?... [solo sottolineato] c

So, these are the typical facts whose materialization determines conditions of stress in the forcible scenario.

“implemented The constraint referring to the Liquidity Coverage Ratio has been in January, 2015” and a road map has been agreed upon to ensure that this new constraints application is gradual, just to give banks the time needed to get accustomed with this new regulatory constraint. 447

“provides”… So, the LCR

We mentioned the agreement about a roadmap.

We remember that, at least, the minimum LCR should be equal to 100%, but this objective has been placed starting from January, 1st, 2019, while lower percentages have been defined making reference to certain previous dates.

So, we said the minimum LCR has been implemented in 2015 and that, for 1 year, for a bank, it was sufficient that HQLA reached a percentage of 60% of the net cash outflow; then, this percentage was elevated to 70% starting from the January, 1st, 2016; and so on, up to 100% [leggo] starting from January, 1st, 2019… 448

Net Stable Funding Ratio

Let's consider now the longer term liquidity requirement that has been decided in 2010, that is “to the Net Stable Funding Ratio. The purpose is ensure”…

[punto 1]… “off-balance sheet activities”… Quindi, è un indicatore che diventa utilizzato per garantire o per fondare le aspettative di una posizione di liquidità gestibile nella contingenza di uno scenario caratterizzato dagli eventi di stress.

Perciò, mentre l’LCR è stato costituito come indicatore della capacità della banca di fronteggiare temporaneamente (!) una situazione di crisi di liquidità e guadagnare tempo per risolverla in maniera definitiva, il NSFR è una misura di natura strutturale.

Quest’ultimo, infatti, vuole incidere sul grado di trasformazione delle scadenze che l’attività ordinaria caratterizza di una banca e, quindi, è un indicatore che serve per rafforzare la coerenza tra la composizione delle passività e quella delle attività dal punto di vista delle scadenze.

[punto 3]… “required So, stable funding”… the numerator refers to the actual (!) condition of the bank (total available stable funding), while the denominator reflects the desirable (!) situation because it is measured by the total required stable funding. 449

[punto 2]… “their So, liquidity”… in the table of the slide (Graph 1), we find the ASF-factors.

Well, regulatory capital, further capital instrument and any liability maturing longer than 1 year have an ASF-factor of 100%; and so on.

So, this is the weighting (!) scale which is adopted to measure the stability of liabilities……

On the other end, as far as the liquidity of assets is concerned, the RSF-factors are as follows… 450

So, these are weights used to calculate total available stable funding and total required stable funding, that is to say the numerator and the denominator of the NSFR.

Liquidity conditions on Italy’s financial markets

Now, we provide some information and comments on the current liquidity conditions on Italy’s financial markets and we make reference to a report which is periodically published by the Bank of Italy: the Financial Stability Report, which is published twice in a year (the 1st in April and the 2nd in November).

So, the most recent report has been published in April, 2021.

We find a chart in the following slide, which represents the evolution of an indicator of systemic (!) liquidity risk in the Italian financial markets.

This indicator has been calculated on the basis of daily data, it is an index and it ranges from 0 to 1, making reference to various financial markets:

• Stock and corporate bond market; 451
• Money market;
• Government securities market.

So, this systemic risk indicator measures the combined risk in these markets.

The minimum risk corresponds to a level of 0, while the maximum to a level of 1.

The evolution of the overall level of this indicator is shown by the black line and also the values of these indicators are shown in the chart making use of different colors……

But we notice that, at a given point in time, the level of the systemic risk indicator does not correspond to the total sum of the indicator measuring the liquidity conditions of the 3 markets.

Why? Perché l’indicatore del rischio sistemico di liquidità non si ottiene semplicemente come somma dei valori degli indicatori di rischio nei 3 mercati che vengono individuati?

Perché si deve tenere conto anche delle correlazioni (!) tra le condizioni di rischio di questi 3 mercati considerati a 2 a 2 (!).

Cioè, la volatilità sul mercato obbligazionario potrebbe accompagnarsi ad una minore volatilità nel mercato azionario perché gli investitori, timorosi della volatilità sul mercato obbligazionario, si spostano sull’azionario e l’azionario tende ad avere minori oscillazioni. 452

Dunque, le correlazioni incontriate tra coppie dei mercati devono essere tenute in considerazione nel valutare le condizioni complessive dei mercati finanziari in un dato Paese.

E gli effetti di cross-correlations, che naturalmente riducono il valore dell’indicatore di rischio di liquidità complessivo per i mercati italiani, è rappresentato, nel grafico, con le linee blu in basso.

E, nel considerare queste linee blu, sembra evidente come un’elevata correlazione negativa vada a contribuire a far sì che l’indicatore complessivo di rischio sia inferiore (!) alla somma degli indicatori di rischio valutati per i singoli mercati considerati isolatamente.

What about the comments that are written by the Bank of Italy’s researchers: “Liquidity conditions”…

“remained (reference relaxed”… is made to the period between November, 2020 and April, 2021) (because we see that the value of the indicators is rather low in this period)… “favored public and private sector securities which by the Eurosystem’s purchase programs”…, entail massive purchases of securities on the part of the Eurosystem and, therefore, they help to sustain the market prices of these securities and to reduce the excess of volatility.

“The slide… “financial We have to indicator of systemic”… market”… note that the value of this indicator was very high at the beginning of 2012 and that was just the period in which the sovereign debt crisis was traveling in the Euro area financial markets.

(“whatever it takes”) La famosa frase di Draghi fu pronunciata a luglio del 2012 e vediamo che, da quel momento in poi, il rischio si è decisamente abbassato.

Ma, ai primi mesi del 2012, l’indicatore di rischio sistemico era molto elevato non solo in Italia, ma anche negli altri Paesi PIIGS, quelli a più elevato debito pubblico e considerati più rischiosi. 453

1]… “for And [paragrafo government securities”… the Bank of Italy, as all the other important central banks, during the pandemic crisis, introduced special assistance programs to help financial institutions to overcome possible liquidity problems: therefore, a special line of refinancing, which is supposed to be temporary, of course.

[paragrafo 3]… “MTS” = Mercato Telematico secondario dei titoli di Stato, dove intervengo, però, investitori istituzionali e, quindi, wholesale investors and not retail investors. 454

Italian Government securities market

And, in the following slide, we have 2 charts showing the improved conditions in the Italian Government securities market.

Firstly, the attention is focused on trading volumes, depth and bid-ask spread on the secondary market for Government securities.

The depth of the market is calculated as the average of the bid and ask quantities recorded during the entire trading day on BTPs listed on the MTS: therefore, the depth makes reference to the quantities.

As we already know, the bid-ask spread is a measure of the market liquidity risk.

And, in the left panel, we have the trading volumes for different kind of Government securities:

• BOTs and CTZs,
• BTPs, and
• [grafico a sx]. CCTs…

The chart we find on the right side shows the impact of large orders on the prices quoted on MTS and intraday volatility.

The impact on prices is represented by the red line, while the intraday volatility is shown through the pink area.

So, we see that, apart certain circumstances, the capability of the market to absorb even very relevant orders without a strong fluctuation in market prices is quite good.

Of course, in 2018 and at the end of 2019 and during 2020 we had problems, but these dangerous situations are expla