Liquidity Coverage Ratio (LCR) Final Rule: Implications for U.S. Financial Institutions

RISK

DATA CAPITAL

LCR Final Rule Implications for U.S. financial institutions

November 7, 2014

Agenda

Overview1

2

Current challenges3

After implementation4

Key changes in Final Rule

3© 2014 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. NDPPS 313573

OverviewCourse objectives

■ Understanding Liquidity Coverage Ratio (LCR) preparedness is an important component of your program to comply with U.S. liquidity regulations.

■ Evaluate the LCR preparedness at your institution relative to latest market developments and regulators’ expectations.

■ Compare your institution’s LCR methodologies to industry-leading practices.

1


OverviewIntroduction to the Liquidity Coverage Ratio

The LCR requires a banking organization’s stock of high-quality liquid assets (HQLAs) to be at least 100 percent of its total net cash outflows over a specific time horizon.

1

0/N

Liquidity Coverage Ratio

30 day

Time horizon

≥ 100%*High-quality liquid assetsTotal net cash outflows

Examples include: ■ Cash■ Treasuries ■ GSE Securities1

Examples include: ■ Stable/less stable deposits■ Undrawn credit and liquidity facilities ■ Credit card minimum payments

Calculation must be completed daily for full LCR banks and monthly for modified LCR banks

1 Subject to concentration limits


OverviewCurrent range of practices in LCR implementation and reporting1

■ We are aware of a number of domestic BHCs who have just initiated projects this summer.

■ Banks are assessing new rules for HQLAs, outflows, and inflows, and evaluating the impact of the net cash outflows using add-on approach.

■ Due to changes in the Final Rule, banks have to enhance underlying data models to support new requirements.

■ Rebalancing will be necessary for some banks with shortfalls.

■ Leading institutions are internally reporting LCR under Basel Committee for Banking Supervision (BCBS) rules.

Full LCR

Monitoring regulatory

developmentsImplementationPlanning Review and

rebalancing Disclosures

Modified LCR

Range of practice

Range of practice

*

*

*

Benchmark for where the typical bank stood at the release of the Liquidity Coverage Ratio: Liquidity Risk Measurement Standards; Final Rule.

Banks that were reporting under BCBS rules are revising calculations to reflect new requirements.


Key changes in Final RuleTime lines/reporting requirements

Treatment under proposed rule Treatment for full LCR banks Treatment for modified LCR

banks

Daily monitoring requirement Daily calculation required for all covered institutions.

Delayed implementation for full LCR banks (tiered delay according to bank size)

Revised to monthly calculation for modified banks

Implementation timeline January 1, 2015 for all covered

institutionsNo change January 1, 2016

Peak day outflow approach/net cash outflows using add-on approach

Required banks to calculated a worst day cash outflow during the 30-day time period.

Revisied to add-on approach, still adds layer of complexity

Does not apply/no change from proposed rule.

Application of modified LCR

21-day calculation as of January 1, 2015. 70 percent of outflow rate for determinate instruments

N/A

Changed to 30-day calculation.

70 percent scale-down applied to cumulative net cash outflow amount, reducing complexity of calculation.

2


Treatment under proposed Rule Treatment for full/modified LCR banks

Inclusion of municipal securities as HQLA

Municipal securities fully excluded from HQLA amounts

No change.

However, the federal government stated its intention to publish additional guidance that would allow certain liquid municipal securities to be considered HQLA. Proposed rule expected in coming months.

Collateralized deposit treatment for adjusted HQLA

Definition of secured funding would have subjected collateralized deposits to be unwound in the calculation of adjusted HQLA.

Final Rule removes requirement to unwind secured deposits for the purposes of calculating adjusted HQLA.

Reward liabilitiesNo specific language on reward liabilities. Proposed rule interpretation implies a 100 percent outflow on Day 1.

Adjustment to unsecured retail funding rates imply a decrease in rewards outflow rate to 40 percent.

Affinity deposits as brokered

Broad definition of brokered deposits results in affinity deposits being classified as brokered, subjecting the accounts to higher outflow rates.

Final rule adjusts outflow rates for transactional brokered deposits, including affinity accounts (20 percent outflow for fully - insured, 40 percent for not fully insured)

2 Key changes in Final RuleNumerator/denominator


Treatment under proposed Rule Treatment for full/modified LCR banks

Exclusion of non regulated funds from operational deposits

All deposits sourced from non regulated funds excluded from operational deposit classification

No change

Definition of non regulated fund includes consolidated subsidiaries

Revised definition removes inclusion of consolidated subsidiaries

Definition of operational services versus prime brokered services

Definition of operational services potentially excluded non-prime brokerage clients from the operational deposit classification

Final Rule narrows language to only exclude deposits provided as part of more clearly defined prime brokerage services from the operational deposit classification

Treatment of callable debt Institutions projected to call debt with optionality at earliest possible date

Adjusted to treat the original maturity date of longer-term callable bonds as the outflow date for purposes of the LCR

Treatment of liquidity commitments to special purpose entities (SPEs)

Broad definition of committed liquidity facility No change

All liquidity/credit commitments to SPE subject to 100 percent outflow

SPEs subject to 100 percent outflow narrowed to only include those reliant on market funding (i.e., issuer or past issuer of commercial paper)

2 Key changes in Final RuleDenominator


► Potential need to disclose information that could create a liquidity event.► The different types of interpretation and application of the LCR by various

institutions would make the ratios difficult to compare. ► The Basel Committee recognizes that immediate disclosure of liquidity positions

could undermine a bank’s ability to execute transactions to eliminate the liquidity shortfall and unnecessarily compromise confidence in the financial system.

► The publication of lagged average ratios for the disclosure period, as proposed by Basel, may be preferred as the publication of a highest and lowest ratio in the previous quarter may create undue negative perceptions.

Current challengesUnknown disclosure requirements

■ Regulators will release disclosure requirements for public comment. ■ Methodologies for certain characteristics (e.g., definition of readily

marketable, operational/excess operations deposit classification) may vary from firm to firm.

■ Undesirable market outcomes may result from the incorrect public disclosure of an institution's LCR.

3


• No clear guidance provided in Final Rule

• Wide range of interpretation and methodologies being developed

• Wide range of calculation methodologies

• FDIC insurance classifications could be difficult to apply based on system limitations

• Wide range of calculation methodologies

• Methodologies based on organizational roll up, aggregated amount of customer deposits, GL categories, customer hierarchies

• Difficult to determine nature of each facility, without analyzing each facility on a stand-alone basis.

Current challengesInterpretation3

Operational deposit

methodology

Retail deposit classification

(FDIC insurance)

Small business classification

Credit or liquidity facility

Final Rule interpretation challenges


Current challengesInterpretation - operational/excess operational requirements3

Operational/excess operational requirements:• Refer to the final rule for the seven requirements

• Cash management, custody, and clearing balances behave differently; use separate methodologies for each category.

• Cash management methodologies range from portfolio aggregation by customer types/product type applying statistical analysis… to calculating an excess balance for each individual customer based on transaction activity.

• Custody and clearing balances lend well to strong statistical correlations; including strong rational for understanding the customer relationship.

• If possible use the lowest level of data to start building your methodology (bottoms up approach).


Current challengesInterpretation – Retail stable3

Challenges with retail balances > $250k FDIC insurance limit

Difficult to aggregate due to complex FDIC ownership categories:• Single accounts• Joint accounts• Trust accounts• Retirement account• Employee benefit plan accounts

Wide range of approaches:

• No customer aggregation, applying FDIC rule to each balance by product

• Customer balance aggregation by TAX ID, but inability to look across customer FDIC multiple ownership categories

• Ability to take all FDIC balance ownership categories into aggregation


Current challengesInterpretation – Small business3

Requirements:

■ Customer is managed the same way as an individual

■ Transactions with small business customers have the liquidity risk characteristics are similar to comparable transactions with individuals

■ Total aggregate funding raised from small business customers is less than $1.5 million

Challenges to classify:

■ Small business division

■ Organizational roll-up

■ Specific products

■ Customer hierarchy


Current challengesInterpretation – credit and liquidity facilities3

Comprehend specific LCR definitions:Committed facilityCredit facilityLiquidity facility

Varied interpretations:

■ “Use of purpose” language in committed facilities tends to be very board, and “refinancing debt” is not clearly defined in the LCR, making it challenging for banks to clearly define what is a credit/liquidity facility.

■ Banks are unsure how to treat Letters of Credit.

■ Banks are engaging their legal and credit departments to ensure they are capturing the nuances of this issue.


Current challengesImplementation3

net cash outflow

Liquidity facilities

Multiple calculations of LCRs (consolidated and subsidiary-

level LCRs)

Tracking outstanding customer issued debt on liquidity facilities

Implementation challenges

Development of net cash outflows using add-on approach


3 Current challengesDocumentation

Key activities

■ Assumptions used to classify treatment of all LCR categories should be fully documented.

Example“Documentation is not maintained on the methodology for identifying deposit balances as established relationships, a key component in the determination of balances as qualifying for the ‘stable’ category.”


Current challengesCompeting resources3

Treasury

Resolution and recoveryplanning

CCAR/DFAST

Enhancedprudentialstandards

Crosssectional

review2052a, 2052b

4-G, 5-G

Intradayliquidity


4 After implementationOverview

LCR

Trend analysis

6.

Determine buffer requirements

1.

2.

On boarding new products

5.

Daily review and signoff

4.

Internal and third-party gap analysis

and validation

3.

Buffer monetization


4 After implementationDetermine a buffer

Determine causes to volatility (e.g., reserve requirements, vault cash, volatile deposits)

Evaluate historical calculations to gauge volatility

Optimize the liquidity buffer


4 After implementationBuffer monetization

Operational requirements for HQLA

■ Have procedures and systems in place to execute monetization at any time

■ Periodically monetize a sample of HQLA

■ Ensure polices state that eligible HQLA is under management unit charged with managing liquidity risk

– By either segregating securities

– Demonstrating monetization does not impede a business or risk management strategy

■ Polices and procedure must state

– Geographic location, currency, or other identifying factors

– Security meets eligibility requirements

– Ensure appropriate diversification

■ These operational requirements can be challenging if the security is “owned” by an affiliate desk of the bank.


4 After implementationKey learnings from validations

Lessons learned


4 After implementationDaily review and sign-off

■ A series of controls need to be implemented to help ensure accurate and timely submissions

■ Some institutions are setting up a process to review data overnight

■ Manual adjustments should be transparent to approvers and fall within established thresholds

■ On production of the LCR ratio, review and sign-off should be obtained from the designated approver (senior management)

■ In the event of a breach of internal or regulatory limits, predefined escalation, approval and follow-up procedures will be activated (depending on severity)

Liquidity monitoring checklistData validation and CorrectionIdentification of outliers in:‒ Large balances‒ New transactions‒ Negative balances‒ Null balances‒ Unusual maturity dates.Day-over-day comparison in reported metricsCheck changes in balances and cash flows from previous day to the current day to identify changes to:‒ Asset and liability trial balances‒ Concentration of funding by counterparty‒ Concentration of funding by product type‒ Average duration of funding by product type‒ HQLA level and mix‒ Contractual maturity mismatch/maturity ladder to identify

upcoming• Changes to funding obligations/rollovers; • Maturing asset inflows/rollovers.

Assessment of controlsConduct ongoing and/or separate sample assessment of controlsRoot cause analysisProvide root cause analysis for any inefficiencies in LCR calculation or reporting processes


4 After implementationNew product boarding

This process should:■ Attribution of impact on resulting

calculation■ Map product to correct LCR bucket■ Update methodology

documentation as needed■ Reevaluation of thresholds■ Configuration of forecast

assumptions.

New product

When validating LCR disclosure, an institution should confirm the process for incorporating new business activities in the process


4 After implementationTrend analysis

■ Trends in LCR (and other liquidity metrics) should be assessed at the reporting line level and capabilities should exist to drill down to assist with an attribution analysis.

■ Trend analysis enables the business to tailor strategies to the LCR constraint and helps recognize monthly or seasonal patterns (such as payroll or taxation).

■ Senior management should closely monitor current trends and potential market developments that may present challenges for managing liquidity risk so that they can make appropriate and timely changes to the liquidity strategy, as needed.

90

95

100

105

110

115

120Reported LCR (%)

Consolidated LCR Regulatory Minimum Threshhold for Warning


Maintain dialogue with peers and regulators Take a broader view than the minimum of the next requirement

Invest in infrastructure to automate and standardize daily analytical reporting Move data quality upstream

Gather requirements for other analytical systems while building LCR Plan for Phase 2

Plan for a third-party validation Focus on process for ongoing monitoring

Understand if the LCR is your binding constraint Begin to build a buffer today

Good project management Taking time to articulate the target state

SolutionsKey learnings from the field

Financialimpact

Movingtargets

Competingpriorities

Breadth

Frequency

Disclosures


To learn more, explore...

KPMG Regulatory

Alerts

Regulatory alerts highlight emerging issues in the financial services industry as well as considerations for response.www.kpmg.com/us/regulatoryalerts

KPMG Regulatory

Practice Letters

Regulatory practice letters highlight and detail important developments in the financial services industry.www.kpmg.com/us/regulatorypracticeletters

The Washington Report

The Washington Report provides a weekly update of the legislative and regulatory developments in the financial services industry.www.kpmg.com/us/thewashingtonreport

To subscribe to newsletters, e-mail [email protected]

KPMG Treasury Services Web

site

This site showcases white papers and points of view on topical treasury management issues.www.kpmg.com/us/treasury

http://www.kpmg.com/us/regulatoryalerts

http://www.kpmg.com/us/regulatorypracticeletters

http://www.kpmg.com/us/thewashingtonreport

mailto:[email protected]

http://www.kpmg.com/us/treasury

Contacts

Rob CeskePrincipal, AdvisoryFinancial Risk Management

Tel. [email protected]

Jeff DykstraDirector, AdvisoryLiquidity Risk Management


Marshal S. AuronDirector, AdvisoryFinancial Risk Management


Marcia RyderDirector, AdvisoryLiquidity Risk Management


Q & A

* Please note, if we are limited on time we will do our best to follow up with individuals on outstanding questions. Feel free to reach out to any of us as further issues and questions arise at your institution.

kpmg.com/socialmedia kpmg.com/app

© 2014 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International. NDPPS 313573.

http://kpmg.com/socialmedia

http://www.kpmg.com/socialmedia

http://twitter.com/kpmg

http://twitter.com/kpmg

http://www.linkedin.com/company/kpmg

http://www.linkedin.com/company/kpmg

https://plus.google.com/u/0/114185589187778587509/posts

https://plus.google.com/u/0/114185589187778587509/posts

http://www.facebook.com/kpmg

http://www.facebook.com/kpmg

http://www.kpmg.com/app


http://kpmg.com/socialmedia


Liquidity Coverage Ratio (LCR) Final Rule: Implications for U.S. Financial Institutions

Economy & Finance

Transcript of Liquidity Coverage Ratio (LCR) Final Rule: Implications for U.S. Financial Institutions