The Basel Committee on Banking Supervision (BCBS) proposed certain reforms to strengthen global capital and liquidity regulations with the objective of promoting a more resilient banking sector. “Basel III: International framework for liquidity risk measurement, standards and monitoring” was issued in December 2010 which presented the details of global regulatory standards on liquidity.
Twfunding o minimum standards, viz., Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) for liquidity were prescribed by the Basel Committee for achieving two separate but complementary objectives. The LCR promotes short-term resilience of banks to potential liquidity disruptions by ensuring that they have sufficient high quality liquid assets (HQLAs) to survive an acute stress scenario lasting for 30 days.
The NSFR promotes resilience over a longer-term time horizon by requiring banks to fund their activities with more stable sources of funding on an ongoing basis.
The latest RBI guideline has taken care of unintended consequences for financial market functioning and the economy, and on improving its design with respect to several key issues, notably: (i) the impact on retail business activities; (ii) the treatment of short-term matched funding of assets and liabilities; and (iii) analysis of sub-one year buckets for both assets and liabilities.
Definition of NSFR
The NSFR is defined as the amount of available stable funding relative to the amount of required stable funding. “Available stable funding” (ASF) is defined as the portion of capital and liabilities expected to be reliable over the time horizon considered by the NSFR, which extends to one year.
The amount of stable funding required (“Required stable funding”) (RSF) of a specific institution is a function of the liquidity characteristics and residual maturities of the various assets held by that institution as well as those of its off-balance sheet (OBS) exposures.
Minimum Requirement of Stable Fund
The above ratio should be equal to at least 100% on an ongoing basis. However, the NSFR would be supplemented by supervisory assessment of the stable funding and liquidity risk profile of a bank. On the basis of such assessment, the Reserve Bank may require an individual bank to adopt more stringent standards to reflect its funding risk profile and its compliance with the Sound Principles.
NSFR would be binding on banks with effect from a date which will be communicated in due course. The NSFR would be applicable for Indian banks at the solo as well as consolidated level. For foreign banks operating as branches in India, the framework would be applicable on stand-alone basis for Indian operations only.
Calibrations of ASF and RSF – Criteria and Assumptions
ASF and RSF reflect the amount of funding available and required for liabilities and assets (including off balance sheet assets).The amounts of ASF and RSF specified in the BCBS standard are calibrated to reflect the presumed degree of stability of liabilities and liquidity of assets.
The calibration reflects the stability of liabilities across two dimensions:
- Funding tenor – The NSFR is generally calibrated such that longer-term liabilities are assumed to be more stable than short-term liabilities.
- Funding type and counterparty – The NSFR is calibrated under the assumption that short-term (maturing in less than one year) deposits provided by retail customers and funding provided by small business customers are behaviorally more stable than wholesale funding of the same maturity from other counterparties.
In determining the appropriate amounts of required stable funding for various assets, the following criteria are taken into consideration, recognizing the potential trade-offs between these criteria:
- Resilient credit creation – The NSFR requires stable funding for some proportion of lending to the real economy in order to ensure the continuity of this type of intermediation.
- Bank behavior – The NSFR is calibrated under the assumption that banks may seek to roll over a significant proportion of maturing loans to preserve customer relationships.
- Asset tenor – The NSFR assumes that some short-dated assets (maturing in less than one year) require a smaller proportion of stable funding because banks would be able to allow some proportion of those assets to mature instead of rolling them over.
- Asset quality and liquidity value – The NSFR assumes that unencumbered, high- quality assets that can be securitized or traded, and thus can be readily used as collateral to secure additional funding or sold in the market, do not need to be wholly financed with stable funding.
Additional stable funding sources are also required to support at least a small portion of the potential calls on liquidity arising from Off balance sheet (OBS) commitments and contingent funding obligations.
- Definition and computation of Available Stable Funding(ASF)
The amount of ASF is measured, based on the broad characteristics of the relative stability of an institution’s funding sources, including the contractual maturity of its liabilities and the differences in the propensity of different types of funding providers to withdraw their funding.
The amount of ASF is calculated by first assigning the carrying value of an institution’s capital and liabilities to one of five categories as presented below. The amount assigned to each category is then multiplied by an ASF factor, and the total ASF is the sum of the weighted amounts.
Carrying value represents the amount at which a liability or equity instrument is recorded before the application of any regulatory deductions, filters or other adjustments.
- Liabilities and capital instruments receiving 100% ASF factor comprise:
- the total amount of regulatory capital, before the application of capital deductions, excluding the proportion of Tier 2 instruments with residual maturity of less than one year;
- the total amount of any capital instrument not included in (a) that has an effective residual maturity of one year or more, but excluding any instruments with explicit or embedded options that, if exercised, would reduce the expected maturity to less than one year; and
- the total amount of secured and unsecured borrowings and liabilities (including term deposits) with effective residual maturities of one year or more. Cash flows due before the one-year horizon but arising from liabilities with a final maturity greater than one year do not qualify for the 100% ASF factor.
- Liabilities receiving 95% ASF factor
- Liabilities receiving a 95% ASF factor comprise “stable” non-maturity (demand) deposits and/or term deposits with residual maturities of less than one year provided by retail and small business customers.
- Liabilities receiving 90% ASF factor
- Liabilities receiving a 90% ASF factor comprise “less stable” non-maturity (demand) deposits and/or term deposits with residual maturities of less than one year provided by retail and small business customers.
- Liabilities receiving 50% ASF factor comprise:
- funding (secured and unsecured) with a residual maturity of less than one year provided by non-financial corporate customers;
- operational deposits
- funding with residual maturity of less than one year from sovereigns, public sector entities (PSEs), and multilateral and national development banks (NABARD, NHB & SIDBI); and
- other funding (secured and unsecured) not included in the categories above with residual maturity between six months to less than one year, including funding from RBI and/or other central banks and financial institutions.
- Liabilities receiving 0% ASF factor comprise:
- all other liabilities and equity categories not included in the above categories, including other funding with residual maturity of less than six months from RBI and/or other central banks and financial institutions;
- other liabilities without a stated maturity. This category may include short positions and open maturity positions. Two exceptions can be recognized for liabilities without a stated maturity:
- first, deferred tax liabilities, which should be treated according to the nearest possible date on which such liabilities could be realized
- second, minority interest, which should be treated according to the term of the instrument, usually in perpetuity.
These liabilities would then be assigned either a 100% ASF factor if the effective maturity is one year or greater, or 50%, if the effective maturity is between six months and less than one year;
c). NSFR derivative liabilities as calculated in following descriptions, net of NSFR derivative assets as calculated below, if NSFR derivative liabilities are greater than NSFR derivative assets; and
d). “trade date” payables arising from purchases of financial instruments, foreign currencies and commodities that (i) are expected to settle within the standard settlement cycle or period that is customary for the relevant exchange or type of transaction, or (ii) have failed to, but are still expected to, settle.
- ASF – Other Requirements
Calculation of derivative liability amounts
Derivative liabilities are calculated first based on the replacement cost for derivative contracts (obtained by marking to market) where the contract has a negative value. If the derivative exposure is covered by an eligible bilateral netting contract, the replacement cost for the set of derivative exposures covered by the contract will be the net replacement cost.
In calculating NSFR derivative liabilities, collateral posted in the form of variation margin in connection with derivative contracts, regardless of the asset type, must be deducted from the negative replacement cost amount.
When determining the maturity of an equity or liability instrument, investors are assumed to redeem a call option at the earliest possible date. For funding with options exercisable at the bank’s discretion, the RBI may take into account reputational factors that may limit a bank’s ability not to exercise the option.
In particular, where the market expects certain liabilities to be redeemed before their legal final maturity date, banks should assume such behavior for the purpose of the NSFR and include these liabilities in the corresponding ASF category. For long- dated liabilities, only the portion of cash flows falling at or beyond the six-month and one-year time horizons should be treated as having an effective residual maturity of six months or more and one year or more, respectively.
- Definition and computation of Required Stable Funding (RSF)
The amount of required stable funding is measured based on the broad characteristics of the liquidity risk profile of an institution’s assets and OBS exposures. The amount of required stable funding is calculated by first assigning the carrying value of an institution’s assets of different categories.
Unless explicitly stated otherwise in the NSFR standard, assets should be allocated to maturity buckets according to their contractual residual maturity. However, this should take into account embedded optionality, such as put or call options, which may affect the actual maturity date.
The amount assigned to each category is then multiplied by its associated required stable funding (RSF) factor, and the total RSF is the sum of the weighted amounts added to the amount of OBS activity (or potential liquidity exposure) multiplied by its associated RSF factor.
- Assets assigned 0% RSF factor comprises:
- coins and banknotes immediately available to meet obligations;
- CRR (including required reserves and excess reserves);all claims on RBI with residual maturities of less than six months;
- “trade date” receivables arising from sales of financial instruments, foreign currencies and commodities that (i) are expected to settle within the standard settlement cycle or period that is customary for the relevant exchange or type of transaction, or (ii) have failed to, but are still expected to, settle.
- Assets assigned 5% RSF factor
- Assets assigned 5% RSF factor comprise unencumbered Level1* assets excluding assets receiving a 0% RSF as specified above, and including:
- marketable securities representing claims on or guaranteed by sovereigns, central banks, PSEs, the Bank for International Settlements, the International Monetary Fund, the European Central Bank and the European Community, or multilateral development banks that are assigned a 0% risk weight under the Basel II Standardized Approach for credit risk;
- certain non-0% risk-weighted sovereign or central bank debt securities
- Unencumbered SLR securities
- Assets assigned a 10% RSF factor
- Unencumbered loans to financial institutions with residual maturities of less than six months, where the loan is secured against Level 1* assets and where the bank has the ability to freely re- hypothecate the received collateral for the life of the loan.
- Assets assigned a 15% RSF factor comprise:
- unencumbered Level 2A** assets including:
- marketable securities representing claims on or guaranteed by sovereigns, central banks, PSEs or multilateral development banks that are assigned a 20% risk weight under the Basel II Standardized Approach for credit risk; and
- corporate debt securities (including commercial paper) and covered bonds with a credit rating equal or equivalent to at least AA–;
- all other standard unencumbered loans to financial institutions with residual maturities of less than six months not included
- Assets assigned a 50% RSF factor comprise:
(a) Unencumbered Level 2B*** assets as defined and subject to the conditions as defined in LCR (liquidity coverage ratio) including:
- residential mortgage-backed securities (RMBS) with a credit rating of at least AA;
- corporate debt securities (including commercial paper) with a credit rating of between A+ and BBB–; and
- exchange-traded common equity shares not issued by financial institutions or their affiliates;
(b) any HQLA as defined in the LCR that are encumbered for a period of between six months and less than one year;
(c) all loans to financial institutions and central banks with residual maturity of between six months and less than one year; and
(d) deposits held at other financial institutions for operational purposes that are subject to the 50% ASF factor ; and
(e).all other non-HQLA not included in the above categories that have a residual maturity of less than one year, including loans to non-financial corporate clients, loans to retail customers (i.e. natural persons) and small business customers, and loans to sovereigns, PSEs and national development banks (NABARD, NHB & SIDBI).
- Assets assigned a 65% RSF factor comprise:
(a) unencumbered residential mortgages with a residual maturity of one year or more that would qualify for the minimum risk weight under the Basel II Standardized Approach for credit risk; and
(b) other unencumbered loans not included in the above categories (including loans to sovereigns and PSEs with a residual maturity of one year or more), excluding loans to financial institutions, with a residual maturity of one year or more that would qualify for a 35% or lower risk weight under the Basel II Standardized Approach for credit risk.
- Assets assigned an 85% RSF factor comprise:
(a) Cash, securities or other assets posted as initial margin for derivative contracts (regardless of whether these assets are on- or off-balance sheet) and cash or other assets provided to contribute to the default fund of a central counterparty (CCP).
Where securities or other assets posted as initial margin for derivative contracts would otherwise receive a higher RSF factor, they should retain that higher factor. For OTC transactions, any fixed independent amount a bank was contractually required to post at the inception of the derivatives transaction should be considered as initial margin, regardless of whether any of this margin was returned to the bank in the form of variation margin (VM) payments.
If the initial margin (IM) is formulaically defined at a portfolio level, the amount considered as initial margin should reflect this calculated amount as of the NSFR measurement date, even if, for example, the total amount of margin physically posted to the bank’s counterparty is lower because of VM payments received.
For centrally cleared transactions, the amount of initial margin should reflect the total amount of margin posted (IM and VM) less any mark-to- market losses on the applicable portfolio of cleared transactions.
(b) .other unencumbered performing loans that do not qualify for the 35% or lower risk weight under the Basel II Standardized Approach for credit risk and have residual maturities of one year or more, excluding loans to financial institutions;
(c) unencumbered securities with a remaining maturity of one year or more and exchange- traded equities, that are not in default and do not qualify as SLR/ HQLA according to the LCR; and
(d) Physical traded commodities, including gold.
- Assets assigned a 100% RSF factor comprise:
(a) all assets that are encumbered for a period of one year or more;
(b) NSFR derivative assets net of NSFR derivative liabilities, if NSFR derivative assets are greater than NSFR derivative liabilities;
(d) all other assets not included in the above categories, including non-performing loans, loans to financial institutions with a residual maturity of one year or more, non-exchange- traded equities, fixed assets, items deducted from regulatory capital, retained interest, insurance assets, subsidiary interests and defaulted securities; and
(d) 5% of derivative liabilities (i.e. negative replacement cost amount) (before deducting variation margin posted).
(e) All ‘standard’ restructured loans which attract higher risk and/or additional provisioning.
- RSF – Other Requirements
The RSF factors assigned to various types of assets are intended to approximate the amount of a particular asset that would have to be funded, either because it will be rolled over, or because it would not be monetized through sale or used as collateral in a secured borrowing transaction over the course of one year without significant expense. Under the standard, such amounts are expected to be supported by stable funding.
Assets should be allocated to the appropriate RSF factor based on their residual maturity or liquidity value. When determining the maturity of an instrument, investors should be assumed to exercise any option to extend maturity.
For assets with options exercisable at the bank’s discretion, RBI may take into account reputational factors that may limit a bank’s ability not to exercise the option and prescribe higher RSF Factor.
In particular, where the market expects certain assets to be extended in their maturity, banks should assume such behavior for the purpose of the NSFR and include these assets in the corresponding RSF category. If there is a contractual provision with a review date to determine whether a given facility or loan is renewed or not, RBI may authorize banks on a case by case basis, to use the next review date as the maturity date.
For purposes of determining its required stable funding, an institution should
- include financial instruments, foreign currencies and commodities for which a purchase order has been executed, and
- exclude financial instruments, foreign currencies and commodities for which a sales order has been executed, even if such transactions have not been reflected in the balance sheet under a settlement-date accounting model, provided that (i) such transactions are not reflected as derivatives or secured financing transactions in the institution’s balance sheet, and (ii) the effects of such transactions will be reflected in the institution’s balance sheet when settled.
- Off balance Sheet Items which require stable Funding
- OBS exposure assigned 5% of RSF- Currently undrawn portion
- Irrevocable and conditionally revocable credit and liquidity facilities to any client
- Other contingent funding obligations, including products and instruments
- Unconditionally revocable credit and liquidity facilities
- Non OBS exposure assigned 3% of RSF of the currently undrawn portion
- -contractual obligations such as:
- potential requests for debt repurchases of the bank’s own debt or that of related conduits, securities investment vehicles and other such financing facilities
- structured products where customers anticipate ready marketability, such as adjustable rate notes and variable rate demand notes (VRDNs)
- managed funds that are marketed with the objective of maintaining a stable value
- Trade finance-related obligations (including guarantees and letters of credit)
- Guarantees and letters of credit unrelated to trade finance obligations
Assets on the balance sheet that are encumbered for one year or more receive a 100% RSF factor. Assets encumbered for a period of between six months and less than one year that would, if unencumbered, receive an RSF factor lower than or equal to 50%, receive a 50% RSF factor.
Assets encumbered for between six months and less than one year that would, if unencumbered, receive an RSF factor higher than 50%, retain that higher RSF factor. Where assets have less than six months remaining in the encumbrance period, those assets may receive the same RSF factor as an equivalent asset that is unencumbered.
In addition, for the purposes of calculating the NSFR, assets that are encumbered for exceptional central bank liquidity operations may receive RSF factor which must not be lower than the RSF factor applied to the equivalent asset that is unencumbered.
Encumbrance treatment applied to secured lending (e.g. reverse repo) where collateral received does not appear on bank’s balance sheet, and it has been re-hypothecated or sold thereby creating a short position. The encumbrance treatment should be applied to the on- balance sheet receivable to the extent that the transaction cannot mature without the bank returning the collateral received to the counterparty.
For a transaction to be “unencumbered”, it must be “free of legal, regulatory, contractual or other restrictions on the ability of the bank to liquidate, sell, transfer or assign the asset”. Since the liquidation of the cash receivable is contingent on the return of collateral that is no longer held by the bank, the receivable should be considered as encumbered.
When the collateral received from a secured funding transaction has been re-hypothecated, the receivable should be considered encumbered for the term of the re-hypothecation of the collateral.
When the collateral received from a secured funding transaction has been sold outright, thereby creating a short position, the receivable related to the original secured funding transaction should be considered encumbered for the term of the residual maturity of this receivable. Thus, the on-balance sheet receivable should:
- be treated accordingly, if the remaining period of encumbrance is less than six months (i.e. it is considered as being unencumbered in the NSFR);
- be assigned a 50% or higher RSF factor if the remaining period of encumbrance is between six months and less than one year. and
- be assigned a 100% RSF factor if the remaining period of encumbrance is greater than one year.
Encumbrance treatment applied to secured lending (e.g. reverse repo) transactions where collateral received appears on bank’s balance sheet, and it has been re-hypothecated or sold thereby creating a short position- Collateral received that appears on a bank’s balance sheet and has been re-hypothecated (e.g. encumbered to a repo) should be treated as encumbered.
Consequently, the collateral received should:
- be treated as being unencumbered if the remaining period of encumbrance is less than six months according to the NSFR standard, and receive the same RSF factor as an equivalent asset that is unencumbered;
- be assigned a 50% or higher RSF factor if the remaining period of encumbrance is between six months and less than one year.
- be assigned a 100% RSF factor if the remaining period of encumbrance is greater than one year..
Calculation of derivative asset amounts:
Derivative assets are calculated first based on the replacement cost for derivative contracts (obtained by marking to market) where the contract has a positive value. When an eligible bilateral netting contract is in place, the replacement cost for the set of derivative exposures covered by the contract will be the net replacement cost.
In calculating NSFR derivative assets, collateral received in connection with derivative contracts may not offset the positive replacement cost amount, regardless of whether or not netting is permitted under the bank’s operative accounting or risk-based framework, unless it is received in the form of cash variation margin of the Revised Framework for Leverage Ratio .
Any remaining balance sheet liability associated with (a) variation margin received that does not meet the criteria above or (b) initial margin received may not offset derivative assets and should be assigned a 0% ASF factor.
If an on-balance sheet asset is associated with collateral posted as initial margin to the extent that the bank’s accounting framework reflects on balance sheet, for purposes of the NSFR, that asset should not be counted as an encumbered asset in the calculation of a bank’s RSF to avoid any double-counting.
Derivative transactions with central banks arising from the latter’s short-term monetary policy and liquidity operations to be excluded from the reporting bank’s NSFR computation and to offset unrealized capital gains and losses related to these derivative transactions from ASF.
These transactions include foreign exchange derivatives such as foreign exchange swaps, and should have a maturity of less than six months at inception. As such, the bank’s NSFR would not change due to entering a short-term derivative transaction with its central bank for the purpose of short-term monetary policy and liquidity operations.
Frequency of calculation and reporting
Banks are required to meet the NSFR requirement on an ongoing basis and they should have the required systems in place for such calculation and monitoring. The NSFR as at the end of each quarter (starting date will be announced in due course) should be reported to the RBI (Department of Banking Supervision, CO) in the prescribed format (Base-III Liquidity Returns-BL R 7) within 15 days from the end of the quarter.
NSFR Disclosure Standards
To promote the consistency and usability of disclosures related to the NSFR, and to enhance market discipline, banks will be required to publish their NSFRs according to a common template as stipulated by RBI.
Banks must publish this disclosure along with the publication of their financial statements, irrespective of whether the financial statements are audited. The NSFR information must be calculated on a consolidated basis and presented in Indian Rupee.
Banks must also make available on their websites, or through publicly available regulatory reports, an archive of all templates relating to prior reporting periods. Both un-weighted and weighted values of the NSFR components must be disclosed unless otherwise indicated.
Weighted values are calculated as the values after ASF or RSF factors are applied. In addition to the prescribed common template, banks should provide a sufficient qualitative discussion around the NSFR to facilitate an understanding of the results and the accompanying data.
NSFR is to ensure that banks maintain a stable funding profile in relation to the composition of their assets and off-balance sheet activities. A sustainable funding structure is intended to reduce the probability of erosion of a bank’s liquidity position due to disruptions in a bank’s regular sources of funding that would increase the risk of its failure and potentially lead to broader systemic stress.
The NSFR limits overreliance on short-term wholesale funding, encourages better assessment of funding risk across all on- and off-balance sheet items, and promotes funding stability.
*Level 1: these assets is the stock of liquid assets without any limit as also without applying any haircut:i. Cash including cash reserves in excess of required CRR. ii. Government securities in excess of the minimum SLR requirement etc
Level 2 assets (comprising Level 2A assets and Level 2B assets) , the Stock of liquid assets, subject to the requirement that they comprise not more than 40% of the overall stock of HQLAs after haircuts have been applied.
(a) **Level 2A Assets: A minimum 15% haircut should be applied to the current market value. Level 2A assets are limited i. Marketable securities representing claims on or claims guaranteed by sovereigns, Public Sector Entities (PSEs) or multilateral development banks that are assigned a 20% risk weight.
(b)*** Level 2B Assets: Corporate debt securities (including commercial paper) in this respect include only plain-vanilla assets whose valuation is readily available. A minimum 50% haircut should be applied to the current market value of each Level 2B asset held in the stock.