Advanced Bank Liquidity Management

This is a three-day in-depth course on best practice liquidity management for banks.

Liquidity stress testing forms the backbone of measuring liquidity risk. In this program, participants will develop a complete liquidity stress testing framework. Particular emphasis is placed on stressed modeling of behavioral elements of the on- and off-balance sheet, namely non-maturity liabilities, prepayment risks, and liquidity/credit facilities. Derivatives collateral posting requirements are also modeled under stressed conditions.

The liquidity risk measurement through stress testing is then related to the bank’s liquidity buffer to give a survival horizon, which is in turn linked to the contingency funding plan. Finally, liquidity funds transfer pricing techniques for the full range of banking activities are explained as a means to instil the correct pricing of liquidity risk throughout the bank.

Detailed case studies and workshops are provided throughout, drawing on the experiences of a range of US and European banking groups.

• Liquidity risk analysts and liquidity risk modelers
• Liquidity risk managers
• ALCO and risk committee members
• Treasurers and treasury staff members
• FTP managers and staff members
• Internal audit or risk control
• External auditors and regulators

• Learn how to implement a state-of-the-art liquidity stress-testing model, capturing the most challenging to model stressed behavioral drivers, including non-maturity liabilities, prepayments, liquidity/credit facilities, and derivatives collateral posting requirements
• Review and implement a best-practice liquidity funds transfer pricing framework spanning the full range of banking activities
• Learn how to manage liquidity through a crisis - recognizing crisis onset early on through key risk indicators and activating a well-designed contingency funding plan

• Basic understanding of financial risks
• Familiarity with liquidity risk is recommended
• Microsoft Excel

Liquidity Risk Key Concepts

• What is liquidity risk for a bank?
• Why are banks’ liquidity profiles inherently vulnerable?
• Three broad sources of liquidity risk – maturity mismatch, collateral posting requirements, and off-balance sheet
• Why is it almost exclusively liquidity shortfalls that trigger bank failure before capital shortfalls subsequently emerge?

Case Study 1: Depfa Bank Plc – Liquidity problems trigger bank failure

Case Study 2: Northern Rock Plc – Liquidity problems according to Bank of England; capital problems according to markets

Regulatory Liquidity Requirements

• Liquidity Coverage Ratio (LCR) – rationale, high quality liquid assets, cash inflows, cash outflows
• LCR calculation example
• Timetable for LCR phase-in
• Implications of LCR for banks and responses – funds transfer pricing, funding mix, liquid assets buffer management
• Net Stable Funding Ratio (NSFR) – rationale, available stable funding, required stable funding
• NSFR calculation example
• Timetable for NSFR phase-in
• Implications of NSFR for banks and responses – funds transfer pricing, funding mix, business model choices

Liquidity Management Framework Overview

• Cash flow projections, buffer, total counterbalancing capacity, survival horizon
• Contingency funding plan
• Liquidity risk pricing

Case Study 3: Barclays Plc – Liquidity management framework

Liquidity Stress-Testing

• Why stress test liquidity in addition and separately to capital?
• Liquidity stress scenario construction and linkage to capital stress scenarios
• Liquidity stress severity
• Why regulatory Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) requirements do not, in isolation, provide reliable evaluations of sound liquidity
• Forward cash exposure framework – key components: liquid assets buffer; contractual cash flows; behavioral cash flows; collateral posting; on- and off-balance sheet
• Buffer survival horizon
• Key behavioral options – deposits (demand and time); pre-payable/revolving loans; liquidity/credit facilities

Stressing Deposit Withdrawals

• Segmenting deposits
• Modeling withdrawals of non-maturity liabilities with stochastic factor overlay
• Incorporating stress in the model
• Reality check – deterministic approach and peer review

Case Study 4: Deposit modeling at Barclays Plc. Modeled deposits under stress

Case Study 5: Deposit behavior at Washington Mutual, 2007-2008

Case Study 6: Historic deposit outflows at failed banks

Workshop 1: Building a deposit model from a hypothetical data set. Stressing the deposit model. Deterministic reality check versus historic failed bank data

Stressing Pre-Payment Rates

• Prepayment modeling
• Hedging prepayment risk
• Incorporating stress in the model
• Reality check – deterministic approach and peer review

Case Study 7: Modeling stressed pre-payments at Bank of America Corporation

Case Study 8: Historic prepayment rates at failed banks

Stressing Liquidity/Credit Facility Drawdowns

• Drawdown intensity modeling
• Incorporating stress in the model

Case Study 9: Modeling stressed liquidity/credit facility drawdowns at Deutsche Bank AG

Case Study 10: Historic liquidity/credit facility drawdowns at failed banks

Workshop 2: Building pre-payment and facility drawdown models from a data set. Stressing the models. Deterministic reality check versus historic failed bank data

Wholesale Funding Stress

• Types of wholesale funding – CP, CDs, interbank, repos, covered bonds, ABS, senior unsecured
• How accurate is the no rollover assumption in stress?

Case Study 11: Wholesale funding in stress at Bear Stearns, Lehman Brothers, Irish banks and Hypo Real Estate Group

Derivatives Collateral Posting Requirements

• Understanding Credit Support Annexes (CSAs) – thresholds, minimum transfer amounts, frequency, initial and variation margin
• New regulatory requirements for initial margin
• Central clearing
• Collateral management – rehypothecation v segregation; “cheapest to deliver” collateral optionality; managing the liquidity buffer composition in different stress scenarios
• Funding Value Adjustment (FVA) as a measure of the net cost of variation margin collateral posting

Case Study 12: Calculating FVA

• Margin Value Adjustment (MVA) as a measure of the cost of initial margin collateral posting

Case Study 13: Calculating MVA

• Stressed derivative collateral posting requirements – modeling for ratings triggers and stressed financial market conditions

Case Study 14: Stress testing collateral posting requirements for a derivatives portfolio

Central Bank Liquidity Facilities

• Overview of liquidity facilities and market operations of the Federal Reserve, European Central Bank, Bank of England and Bank of Japan

Completing The Liquidity Stress Test

• Loan volume forecasting
• Linking balance sheet and non-performing loan evolution from capital into liquidity stress tests
• Cash flow from securities
• Bringing together contractual and behavioral cash flows into a forward cash exposure profile
• Calculating the buffer survival horizon
• Interpretation and application of liquidity stress test results. Is the buffer survival horizon long enough to activate the Contingency Funding Plan (CFP)?
• Best practice liquidity stress test reporting

Workshop 3: Completing the liquidity stress test for our hypothetical bank. Incorporating the results from Workshops 1 and 2

Contingency Planning

• Key Risk Indicators
• Internal and external indicators of balance sheet risk, credit risk, funding risk, concentrations and diversification
• Escalation process and crisis management committee

Case Study 15: Key Risk Indicators and escalation process at Deutsche Bank AG

Contingency Funding Plan

• Contingency funding plan and its key components
• Identifying and estimating secondary sources of funds

Case Study 16: Stretching the secondary sources at Irish and Greek banks

• Linking stress tests to contingency planning
• The event management committee
• Confidence management
• Internal and external communication
• Priorities in managing the liquidity buffer in the crisis
• Actions to impact cash inflows and outflows
• Intraday liquidity risk
• Best practice liquidity reports

Case Study 17: Sample contingency funding plan

Funds Transfer Pricing

• The need for liquidity risk pricing and funds transfer pricing (FTP) as the mechanism to do this
• Regulatory requirements for FTP
• Options for calculating the FTP curve
• What effective maturity should be used to determine the FTP for assets and liabilities with significant behavioral elements?
• Pricing contingent liquidity risk – liquidity/credit facilities, derivatives collateral posting

Case Study 18: Implementing FTP at a predominantly retail bank – Lloyds Banking Group Plc

• How should FTP be applied for investment banking operations where positions tend to have a shorter holding period than their contractual maturity and contingent liquidity risks are high?

Case Study 19: Implementing FTP at a Global Systemically Important Bank (GSIB) with significant investment banking operations – Barclays Plc

• (Liquidity) FTP as a subset of full transfer pricing which is itself an input into economic value added (EVA) to measure the performance of business units after accounting for the full economic costs

Case Study 20: What does a complete EVA framework look like?

Workshop 4: Implementing FTP for a hypothetical GSIB balance sheet

Course overview and booking information