Concerns that effects of the COVID-19 pandemic could lead to a global liquidity crisis have caused a surge in regulatory requirements for liquidity monitoring and reporting that have hugely strained financial institutions. Meeting the net stable funding ratio (NSFR) lies at the heart of this operational and strategic challenge.
New Standards On The Horizon
The Basel Committee on Banking Supervision (BCBS) introduced two new standards of measurements for liquidity under Basel III as part of an effort to revamp liquidity reporting requirements following the 2008 financial crisis: liquidity coverage ratio (LCR) and NSFR. The latter is intended to ensure that financial institutions’ sources of funding are sufficiently stable to support their assets and activities on a one-year horizon, and is calculated by dividing a firm’s available stable funding (ASF) by its required stable funding (RSF).
To allay concerns of a possible COVID-19-driven global liquidity crisis, financial institutions are in the throes of addressing more stringent and more frequent liquidity monitoring and reporting requirements. As if this is not enough turbulence, organizations are also trying to accommodate new NSFR requirements. And they may not have adequate resources available to accommodate both changing requirements and increased levels of regulatory scrutiny, making confident NSFR reporting more difficult.
Strong Headwinds — Deteriorating Funding Conditions And Greater Scrutiny
Since 2008, compliance with liquidity reporting requirements has consistently improved. While this provided buffers for financial institutions before the COVID-19 pandemic, headwinds from COVID-19 are reversing these gains. The global economy is facing unprecedented challenges, with spreads widening substantially and new unsecured debt issuance virtually coming to a halt. In addition, worsening economic conditions mean that firms are performing daily monitoring for internal liquidity management needs. All this while accommodating changing regulatory requirements, resulting in a significant increase in reporting and operational resources.
As financial institutions accommodate a post-COVID-19 new normal in which regulators are shining a spotlight on liquidity monitoring; they are asking themselves whether they are functionally, technologically, and operationally ready for the upcoming NSFR regulation changes. Timely compliance must not be compromised.
The Unfortunate Timing Of A Perfect Storm: Highlights Of Jurisdictional Specificities
As previously noted, COVID-19-driven challenges translate into less time and resources available to address medium-term strategic changes. Such changes include accommodating new regulations and altered NSFR rules based on jurisdictional requirements, which vary across the globe.
The following are highlights of jurisdictional specificities and recent developments, including where there have been COVID-19 rule changes and/or related impacts.
In February 2020, Banco Central do Brasil reduced the reserve requirement ratio on time deposits (compulsory deposits) and increased the amount of reserves considered high quality liquid assets (HQLA). This added flexibility to LCR and NSFR frameworks and encouraged banks to utilize liquidity pools.
In April 2019, the Office of Superintendent of Financial Institution (OSFI) issued a final version of the NSFR disclosure requirement guidelines in which the implementation was set for January 2020 for Canadian internationally active D-SIBs on a consolidated basis, and January 2021 for all Canadian D-SIBs.
Canadian D-SIBs, in addition to completing the NSFR reporting template, will also need to complete two additional disclosure templates: the NSFR disclosure template, which captures key quantitative data on a consolidated basis; and NSFR qualitative disclosures, which contain qualitative data to support and clarify the NSFR data reported. The latter includes details behind the NSFR results, intra-period changes and changes over time, and compositions of interdependent assets and liabilities.
Columbia’s regulatory body, Superintendencia Financiera de Colombia, sets requirements for NSFR with Circular 019. According to the circular, the initial requirement for NSFR was set at a minimum of 80% by March 31, 2020, with a requirement of reaching 100% by March 31, 2022. The first NSFR reports were submitted in January 2020, with reporting currently mandated on a monthly basis.
In response to COVID-19, the regulator has developed a framework to address the current economic crisis. This framework contains measures to decrease bank reserve requirements, resulting in an injection of liquidity into the economy.
In 2017, the Bank of Mexico published specific rules for NSFR reporting in which financial institutions must report monthly on the ratio through a report entitled “Fondeo Estable”. The report is comprised of three sections for classifying funding types: stable required (assets, loans portfolio, deposits, derivatives, securities operations, and assets available); stable available (guaranteed financing, derivatives, other liabilities, and capital); and consolidated (operations between subsidiaries and the institution).
To prevent liquidity problems because of COVID-19, the Bank of Mexico has published allowable exceptions to LCR reporting, including a re-classification of certain types of assets and calculations subject to the Basel look-back approach.
The Federal Reserve Bank, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation agencies jointly published an NSFR Notice for Public Review in 2016, with the final rule expected in 2017 and an effective date of 2018. The final rule, however, remains pending, with no clear timeframe as to when the agencies will publish a revised NSFR notice of proposed rulemaking.
Meanwhile, in October 2019, the joint agencies revised the LCR reporting by adjusting the net cash outflow amount by various coefficients, depending on the size, complexity, and liquidity vulnerability of an institution. The revision, dubbed the tiering rule, consists of four levels. Financial institutions that fall under level IV are relieved from LCR compliance provided that their average short-term wholesale funding over a calendar quarter is less than $50 billion. In the preamble of the tiering rule, the agencies stated that NSFR would be subject to the same tiering coefficients applied to the RSF measure of NSFR, which are not contained in the 2016 notice of proposed rulemaking. Accordingly, the joint agencies are expected to publish a revised NSFR notice of proposed rulemaking that conforms with the LCR tiering scheme.
In May 2020, the Federal Reserve mandated that within the FR 2052a report, liquidity reporting frequency be conducted daily rather than monthly for 24 of the 39 U.S. and foreign banking organizations subject to liquidity reporting. FR 2052a reports are used to monitor the overall liquidity profile of institutions supervised by the Federal Reserve. Additionally, as a consequence of COVID-19-related support programs instituted by the U.S. Treasury in which the Federal Reserve provides funding assistance to financial institutions, the joint agencies have relaxed some of the rules pertaining to LCR net cash outflows.
Because of the current fragile condition of the financial markets and the U.S. economy, it is not clear when the joint agencies will publish a revised NSFR notice of proposed rulemaking.
Overall, regulators within several jurisdictions in Asia have decided to focus on granularity and traceability of data in their NSFR reporting requirements. Another key trend among regulators in the region, led by the Australian Prudential Regulation Authority (APRA), is to focus on cross validation of NSFR reports with data reported for the LCR and attribution of the underlying reasons for variance.
A key challenge for financial institutions is change management complexities resulting from the evolving regulatory taxonomy of APRA. Compliance with NSFR became effective in January 2018 and is applicable only to Category 1 authorized deposit-taking institutions, with reporting required on a quarterly basis. In response to the COVID-19 crisis, the Reserve Bank of Australia announced the establishment of a term funding facility on March 19, 2020 and APRA confirmed its regulatory approach to the facility. Per the approach, as of March 31, 2020, authorized deposit-taking institutions may include the benefit of the initial allowance when calculating the following: LCR, the minimum liquidity holdings ratio, and NSFR — as long as they have the necessary unencumbered collateral to access the facility.
Implementation of NSFR is currently under review. The Japan Financial Services Agency published draft regulations for NSFR in June 2018. In April 2020, the agency indicated that the regulation would not be implemented in the next year to allow for further review of its implementation status in other countries around the world, and perhaps to better assess the COVID-19 driven strain placed on institutions.
In its role as the monetary and banking authority of the country, the Reserve Bank of India is responsible for the supervision and control of the banking sector. It issued guidelines for the implementation of NSFR in May 2018, and subsequently set April 1, 2020 as the date those guidelines would take effect. However, in a circular issued on March 27, 2020, the implementation of the NSFR guidelines was deferred by six months as a response to COVID-19.
The NSFR regulation will become effective in July 2020, and will be applicable to all licensed banking institutions, with reporting required on a quarterly basis. However, Bank Negara Malaysia has recently lowered the minimum NSFR requirement to 80% from 100%, as a response to COVID-19.
The NSFR regulation came into effect in October 2019, with reporting required on a quarterly basis. Since then, the Monetary Authority of Singapore has issued four iterations. However, the regulation’s latest changes, published on April 8, 2020, are aimed at providing relief measures to financial institutions coping with the effects of COVID-19. These changes enable financial institution to reduce RSF, which will have a positive impact on the NSFR ratio. One aspect of the RSF reduction is the relaxation of the RSF factor for loans issued to non-financial corporates, retail customers and small business customers with residual maturities of less than six months as follows:
- 25% RSF for loans issued between April 8, 2020 and September 30, 2021
- 35% RSF for loans issued between October 1, 2021 and December 31, 2021
- 45% RSF for loans issued between January 1, 2022 and March 31, 2022
In line with the European Banking Authority’s Capital Requirements Regulation 2 (CRR2) reforms, financial institutions need to comply with all new NSFR requirements beginning in June 2021. These requirements are not subject to extensions of the implementation period given due to COVID-19. Since these requirements are new, current processes and calculations must be enhanced to meet these requirements, thus creating one more step for financial institutions as they struggle to collect the relevant data and complete all calculations required for NSFR reporting and compliance.
In some parts of Europe, including Switzerland for example, deadlines are even sooner. The Swiss Federal Council has announced its intention to adopt the new NSFR rules in early summer 2020 and bring them into force by mid-2021, but early adopters may be required to implement them under the new rules in the first quarter of 2021.
Further NSFR-related complications will put pressure on financial institutions’ already stretched resources. For example, the NSFR rules within the CRR2 framework differ from the Basel framework due to several EU-specific adjustments aimed at small and non-complex firms. The use of a simplified NSFR by those types of firms will be subject to supervisory approval by national competent authorities (NCAs) based on criteria related to size of assets, trading book size and derivative positions. NCAs can adjust these criteria at their discretion.
New NSFR Templates And Instructions
In order to meet new NSFR compliance requirements in Europe, financial institutions need to complete two sets of templates and instructions — one for the standard NSFR (C.80.00 and C.81.00) and one for the simplified NSFR (C.82.00 and C.83.00), in line with the revised CRR2 requirements. Two templates have been included in each case: one on ASF items and one on RSF items. Moreover, a common summary template (C 84.00) has been included for both the standard and the simplified versions. These new templates are designed to be aligned with LCR templates (C.72.00 to C.77.00) by asset level and LCR haircut.
These changes echo recent new technical standards within CRR2, which are being enforced for LCR compliance changes in line with the move to the reporting framework 2.9 taxonomy in April 2020. The reporting framework package for LCR includes a waiver for the minimum issue size for third-country assets and their conditional recognition as liquid assets. The standards also incorporate a conditional waiver option for unwinding secured transactions in accordance with the guidelines of the European Central Bank (ECB) or the central bank of the relevant member state. Upcoming NSFR changes are quite substantial and financial institutions should plan accordingly in terms of the required time, effort, and cost of compliance.
The NSFR regulation was implemented in Qatar in 2012 and in Bahrain, Kuwait, Oman, Saudi Arabia, and the United Arab Emirates in 2018. Gulf Cooperation Council (GCC) countries currently have no plans to adjust the NSFR regulation already in place.
Avoiding Capsizing At Sea
As exemplified in the preceding jurisdictional highlights, compliance with NSFR will not be smooth sailing for many financial institutions. NSFR is a complex requirement and its implications will vary based on an organization’s size and business mix, particularly under COVID-19 stresses.
To survey conditions in the regulatory seascape, financial institutions must be able to adapt to both anticipated as well as unexpected challenges. No one wants to be left struggling to understand a set of black box calculations in an environment where regulators are requiring full transparency. This would be rather like an oil tanker having to change course with no visibility into its navigation system in the midst of a storm. Unless they have adaptable, transparent, flexible, and holistic best practices in place, financial institutions risk capsizing.
They must be adept and nimble to effectively tackle the following:
- Tight timeframes
- Regulation changes
- Huge data volumes
- Stress testing scenarios
Going forward, financial institutions must ensure their functional, technological, and operational readiness for the upcoming NSFR regulation changes to ensure that timely NSFR compliance is not compromised. Especially in a challenging COVID-19 environment where regulators’ focus on liquidity monitoring has greatly increased, it is even more important than ever for financial institutions to have complete transparency into their data and calculations and be prepared to manage change.
By future-proofing their risk and regulatory reporting, organizations can strengthen their resilience in times of crisis, and ultimately, enhance their decision-making to drive business growth. With finely tuned instruments that enable a complete surveillance of satellite weather conditions and their vessel’s positioning, financial institutions can be confident that they are on the right course to successful NSFR compliance.