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Stefan W. Schmitz
Macroprudential Supervision
Oesterreichische Nationalbank
IMF
STI course on Macro Stress Testing,
Singapore 09/29-10/03
The opinions expressed in this presentation are the authors and do not necessarily reflect those
of the OeNB.
Session 1
Low
frequency
Probabilistic
approach
not
meaningful
Highly Psycholo-
institution gical
specific factors
Insufficient
history
Data
Scenario design
Scenario calibration
Parameter uncertainty
Treatment of CB
Liquidity/solvency integration
4
Data
FX-regime
FX-convertability
Market sentiment
External
factors
Funding
mix
Maturity mismatch
Products Business
Markets model
Counterparties
Product oriented/accounting
Single currency / multiple Frequency, cut-off date and Reporting period and bucket
balance sheet based versus
currencies reporting time lag size (9 buckets)
functional items
Differentiation according to
Consolidated / solo business model /
comprehensive template
Allow for differentiated analysis of liquidity risk exposure more risk sensitive
Gross cash flows
More granular stress tests possible
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Net cash flows and stock of liquid assets
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Gross cash flows and stock of liquid assets
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Gross cash flows and stock of liquid assets
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Gross cash flows and counterbalancing capacity
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Gross cash flows and counterbalancing capacity
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Example I: EBA LRA 2011
Cash-Outflows
Own issuances due
Unsecured wholesale funding due
thereof: from non-financial corporates
thereof: from financial corporates
thereof: from financial institutions
thereof: from government/public entities
thereof: from institutional networks
Secured wholesale funding due
thereof: secured by sovereign debt 0% r/w
thereof: secured by sovereign debt 20% r/w, covered bonds up to AA-, non-financial corporates)
thereof: secured by equity
thereof: secured by other instruments
Repos due with central banks
Retail (incl. SME) funding due
thereof: sight deposits
New loans granted
Outflows from derivatives
Undrawn volume of committed credit/liquidity lines to financial institutions and SPV.
Undrawn volume of committed liquidity lines to financial corporates.
Undrawn volume of committed credit/liquidity lines to retail/sme/non-financial corporates and credit lines to financial
corporates
Additional outflows due to a two-notch rating downgrade
Others
Sum of Cash-Outflows
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Example (contd)
Cash-Inflows
Retail funding
Loans maturing
thereof: other
Reverse repos
thereof: secured by sovereign debt 20% r/w, covered bonds up to AA-, non-financial corporates
Others
Sum of Cash-Inflows
Net Funding Gap
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Example (contd)
Counterbalancing capacity
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Example II: Austrian maturity mismatch template
six currencies*)
Outflows (16)
New loans, advances, calling of lines, ...
Tender, Repos, Issuances (due)
Expected deposit outflows (un/secured, retail / wholesale)
*) Six currencies include: EUR, USD, CHF, GBP, YEN and a basket of other currencies.
**) Five maturity buckets cover: up to 5 days, 1 month, 3 months, 6 months and 12 months. 19
Session 2
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Scenario design
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Scenario design
Issues to consider
Internal consistency
Time horizon(s)
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Risk factors components of liquidity stress tests I
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Scenario calibration
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Fundamentals
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Scenario calibration
Case studies
Bank, market & country level
27
Elements of scenario calibration
Type of
scenario
Time
Scope
dimension
Counterparties Liabilities
CBC Assets
What types of stress test scenario do you consider: adverse market conditions (1), idiosyncratic shocks (2), combinations
of (1) and (2), other scenarios?
Idiosyncratic
shocks: 7
Other: 5
Combinations
& idiosyncratic
shocks : 1
No reply: 3
At what level do you perform your liquidity stress tests? Did the recent turmoil encourage your
institution to perform liquidity stress tests at
group level (if it had not already done so)?
No reply: 2
Yes:
Both group and 7
entity level:
32
Entity
level:
28 No:
20
No reply:
1
Group level:
14
31
ABCP & CP (Liabilities II)
High stress Very quick evaporation of liquidity under stress & substantial
sensitivity spread increases
Distinction Intitially run on the market then selective reopening for higher
across quality issuers
issuers takes
time
32
Issuences (Liabilities III)
33
Repo (Liabilities IV)
1. Collateral valuation,
2. Haircuts,
4. Rehypothecation chains,
6. Tenors/maturities
34
Secured funding (contd)
Tri-party repo more stable than bilateral, but riskier/less liquid collateral still
subject to shocks
35
Haircuts in US Tri-party repos for selected collateral
classes
Haircuts in bilateral repos for selected collateral
classes I
Haircuts in bilateral repos for selected collateral
classes I
39
Counterbalancing capacity I
Only assets that are expected to be liquid on private markets under stress should be eligible for
the counterbalancing capacity
Market liquidity can decrease very quickly for many asset classes
Diversification
Encumbrance
40
Counterbalancing capacity II
41
Unsecured interbank market (Counterparties I)
42
Counterparties II
43
Systemic liquidity
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Systemic liquidity
Systemic High systemic liquidity is high banks might reduce self-insurance (i.e.
liquidity can they are more willing to lend and supply-side tenors are longer) and rely
evaporate more heavily on future availability of liquidity.
quickly Positive feedback-loops and network externalities exacerbate shocks!
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Systemic liquidity & liquidity stress tests
Network models: indirect contagion via systemic liquidity more important than via
networks of bilateral exposure
Intrinsic interaction of banks capital, leverage, and liquidity dynamics & money and
capital market dynamics
Shocks can origniate from outside the banking sector soundness/capital not
sufficient insurance against liquidity shocks
Combination of runs by wholesale creditors, fire sales of assets, and risks of a general credit
crunch
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Implications for macroprudential supervision
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Parameter uncertainty
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Embedded scenarios
Scenario 1
Closure of unsecured interbank markets
Scenario 2
Cumulative severity
Scenario 4
Combines scenario 3 with idiosyncratic shock
51
LoLR: focus on markets rather than failing bank
Arguments for reliance on LoLR
Historical experience
Theory
Potential efficiency gains under restrictive assumption (e.g. prevent asset fire sale contagion)
Qualitative liquidity regulation aims at self-insurance (CEBS 2009, 2010a, BCBS 2010)
Liquidity Address asset fire sale externality assumes other market participants cannot exploit
underpricing due to liquidity constraints
provision to
market rather Enables other market participants to profit from
than illiquid Original concept of the LoLR underpricing
according to Thornton and Bagehot
bank Limits negative price effect
53
Conclusions: No LoLR in liquidity stress testing
Ensure sufficient liquidity risk
bearing capacity
HQLA must be composed of assets that are
(extremely) highly liquid no asset fire
sale externality
54
Scenario & parameter uncertainty
30 day Scenario
CBC Type Baseline Market Mild Market Medium Market Severe Combined
Full CBC
Market liquidity
90 day Scenario
CBC Type Baseline Market Mild Market Medium Market Severe Combined
Full CBC
Market liquidity
1 Year Scenario
CBC Type Baseline Market Mild Market Medium Market Severe Combined
Full CBC
Market liquidity
55
Session 3
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Example
Structure
64
Concerted rounds of common liquidity stress tests
Disclosure policy of stress testing
Does your bank disclose the results of its liquidity stress tests to one of the following audiences?
Rating agencies
0 10 20 30 40 50 60 70 80
Regularly Upon request Not foreseen no reply
The disclosure of liquidity stress test results is quite rare. What do you consider to be possible reasons
for this from your bank's point of view? (multiple answers possible)
Results
Results cannot
can notbe
beinterpreted
interpretedwithout
withoutdetailed
detailedunderstanding
understandingofofthe
thescenarios
scenarios
and the considerations
and the considerations underlying them underlying them
Lack of comparability across banks
Our bank does not see value added in disclosing liquidity stress test results
0 10 20 30 40 50 60 70 80
Strongly agree Agree Disagree Strongly disagree no reply
Concerted rounds of common liquidity stress tests
How would you rank (from 1 most important to 5 least important) Would standardisation of the following liquidity stress test
the benefits for your bank of standardisation of liquidity stress elements help to improve comparability among banks?
tests?
Standardisation of
Benchmarking the scenarios in
exercise liquidity stress test
Standardisation of
Learning effect the output metrics
Standardisation of
Knowledge transfer the scope of liquidity
stress tests
Standardisation of
Other
the time horizon
0 20 40 60 80 0 20 40 60 80
1 2 3 4 5 no response yes no no response
Other
Given standardisation of liquidity stress tests, would disclosure
Worthy as a leader (1)
Use in risk rating of bank counterparty (3) requirements foster market discipline in liquidity risk management?
Counterparty risk measurement (4) 6
Market discipline (4)
19 yes
Comparability across banks (5)
no
no reply
59
Concerted rounds of common liquidity stress tests
Hedging measures
o.w. interest rate contracts
o.w. equity contracts
o.w. CDS contracts
Restructuring maturity profile
Debt issuance
o.w. short-term debt instruments
o.w. medium, long-term debt instruments
o.w. ABS
o.w. government-guaranteed debt**
Cutting dividends
* stating counterparties
** Central bank policy and governmental support facilities are assumed to be left unchanged, save for changes described in the scenario
68
Session 4
Practical session
Session 5
Interaction solvency/liquidity
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Interlinkages solvency / liquidity
73
Timing / sequenzing of interaction
Solvency Liquidity
Bank B Bank B
(quarterly freq.) (weekly freq.)
...
Complex interaction of solvency and liquidity
Solvency Stress Test Liquidity Stress Test
reduced pledgeability of assets
Rating (-) Counter
Migration Collateral Balancing
Quality reduced Capacity
Credit inflows
Losses Defaulted (-) Cash
(-) Assets
Inflows
Operating
Result price (+/-)
Cash
(-) effect Outflows
(-) Valuation
Losses Cost of Funding
81
Measuring the impact of interaction channels
Liquidity Stress Test . Solvency Stress Test
(share of total impact on cumulated counter balancing capacity) (share of total impact on P&L losses)
11% 15% 8%
<4%
25%
54%
31%
52%
Losses on inflows from paper in own portfolio maturing (iii.) Credit risk costs
Market funding due to solvency position (iv.) Other risk costs through P&L
82
Conclusions, policy recommendations &
discussion
Policy implications (I)
Parameter uncertainty
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Policy implications (II)
No reliance on LoLR
Parameter uncertainty
No reliance on LoLR
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Literature
BCBS (2013 a), Liquidity stress testing: a survey of theory, empirics and current industry and
supervisory practice, Basel Committee on Banking Supervision WP No. 24, Basel.
BCBS (2013 b), Literature review of factors relating to liquidity stress extended version, Basel
Committee on Banking Supervision WP No. 25, Basel.
ECB (2008) Report on EU banks liquidity stress tests and contingency funding plans, Frankfurt
Puhr, C. and S. W. Schmitz (2013), A View From The Top The Interaction Between Solvency And
Liquidity Stress, Journal of Risk Management in Financial Institutions 7(4), 2014, 38-51
Schmieder, C., H. Hesse, B. Neudorfer, C. Puhr and S. W. Schmitz (2012), Next generation system-
wide liquidity stress testing, IMF Working Paper, 12/03, Washington D.C.
Schmitz, S. W. (2013), The impact of the Liquidity Coverage Ratio (LCR) on the implementation of
monetary policy, Economic Notes, 32/2, 1-36.
Schmitz, S.W., A. Ittner (2007) Why central banks should look at liquidity risk, Quarterly Journal
Central Banking Vol. XVII No. 4, 32-40
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