RBI prescribes new liquidity norms for banks

The Reserve Bank of India (RBI) has prescribed new limits for inter-bank liabilities and overnight borrowings for effective liquidity risk management and lowering their liability concentration.

The apex bank has directed banks to restrict their inter-bank liabilities (IBL) to the current limit of a maximum 200 per cent of their net worth for the previous financial year (ending 31 March). Banks are allowed to fix a lower limit for inter-bank liabilities with the approval of their boards of directors.

However, banks whose capital to risk-weighted assets ratio (CRAR) is at least 25 per cent more than the minimum CRAR (9 per cent), ie, 11.25 per cent as of 31 March of the previous year, are allowed to have a higher limit up to 300 per cent of the net worth for IBL, RBI said.

These limits will include only fund-based IBL within India (including inter-bank liabilities in foreign currency to banks operating within India) and not IBL outside India. It will also exclude collateralised borrowings under collateralised borrowing and lending obligation (CBLO) and refinance from NABARD, SIDBI, etc. RBI said.

RBI has set the overnight borrowing (call money) limit for banks (on a fortnightly basis) at 100 per cent of individual bank's capital funds. Money market operations will act as a sub-limit within the above limit. However, banks are allowed to borrow a maximum of 125 per cent of their capital funds on any day, during a fortnight.

Banks are also required to ensure adherence to the call money lending limit prescribed by RBI for call / notice money market operations, which at present, on a fortnightly average basis, should not exceed 25 per cent of its capital funds. However, banks are allowed to lend a maximum of 50 per cent of their capital funds on any day, during a fortnight, RBI said.

Banks having high concentration of wholesale deposits (ie, Rs15 lakh or any such higher threshold as approved by the banks' board) should frame suitable policies to contain the liquidity risk arising out of excessive dependence on such deposits. Banks should also evolve a system for monitoring high value deposits (other than inter-bank deposits) say Rs1crore or more to track the volatile liabilities, both in normal and stress situation.

The management of liquidity risks relating to certain off-balance sheet exposures on account of special purpose vehicles, financial derivatives, and guarantees and commitments should be given particular importance due to the difficulties that many banks have in assessing the related liquidity risks that could materialise in times of stress.

Thus, the cash flows arising out of contingent liabilities in normal situation and the scope for increase in cash flows during periods of stress should also be estimated and monitored, RBI said.

In case of securitisation transactions, an originating bank should monitor, at the inception and throughout the life of the transaction, potential risks arising from the extension of liquidity facilities to securitisation programmes.

In measuring contingent funding risks a bank should also consider the nature and size of its potential non-contractual obligations, which could give rise to the bank supporting related off-balance sheet vehicles in times of stress. This is particularly true of securitisation programmes where the bank considers such support critical to maintaining ongoing access to funding.

Banks should also foresee times of stress, when reputational concerns might prompt it to purchase assets from money market or other investment funds that it manages or with which it is otherwise affiliated.

Where a bank provides contractual liquidity facilities to a special purpose vehicle (SPV), or where it may otherwise need to support the liquidity of an SPV under adverse conditions, the bank should consider how the SPV's illiquidity might adversely affect its own liquidity.

In such cases, the bank should monitor the SPV's inflows (maturing assets) and outflows (maturing liabilities) as part of the bank's own liquidity planning, including in its stress testing and scenario analyses. In such circumstances, the bank should assess its liquidity position with the SPV's net liquidity deficits (net liquidity surplus to the SPV to be ignored since such surplus in an SPV will not increase the liquidity position of the bank).

Banks should also consider the long-term use of securitisation SPVs as a source of funding, under adverse scenarios, RBI said.

Collateral management
A bank should have sufficient collateral to meet expected and unexpected borrowing needs and potential increases in margin requirements over different timeframes, depending upon the bank's funding profile. A bank should also consider the potential for operational and liquidity disruptions that could necessitate the pledging or delivery of additional intra-day collateral.

Banks should have proper systems and procedures to calculate all collateral positions in a timely manner, including the value of assets currently pledged relative to the amount of security required and unencumbered assets available to be pledged and monitor them on an ongoing basis. Banks should also be aware of operational and timing requirements associated with accessing collateral given its physical location.

Managing intra-day liquidity
A bank should develop and adopt an intra-day liquidity strategy that allows it to monitor and measure expected daily gross liquidity inflows and outflows and ensure that arrangements to acquire sufficient intraday funding to meet its intraday needs is in place and it has the ability to deal with unexpected disruptions to its liquidity flows. An effective management of collateral is essential component of intra-day liquidity strategy.

In this regard, RBI has asked banks to follow the consultative document of Basel Committee on Banking Supervision on Monitoring indicators for intraday liquidity management issued in July 2012  and thereafter the final document as and when it is issued.

A bank should have policies, procedures and systems to support the intra-day liquidity risk management in all of the financial markets and currencies in which it has significant payment and settlement flows, including when it chooses to rely on correspondents or custodians to conduct payment and settlement activities, RBI said.

Banks should endeavour to develop a process to quantify liquidity costs and benefits so that these same may be incorporated in the internal product pricing, performance measurement and new product approval process for all material business lines, products and activities. This will help in aligning the risk taking incentives with the liquidity risk exposure and board approved risk tolerance of individual business lines.

Banks should establish funding strategies that provide effective diversification in the sources and tenor of funding. They should maintain an ongoing presence in chosen funding markets and strong relationships with fund providers to promote effective diversification of funding sources.

Banks should regularly gauge their capacity to raise funds quickly from each source. They should identify the main factors that affect banks' ability to raise funds and monitor those factors closely to ensure that estimates of fund raising capacity remain valid. These factors may also be incorporated in banks' stress test scenario and contingent funding plan.

Funding strategy should take into account both quantitative dimensions as also the qualitative dimensions of the concentrated behavior of deposit withdrawal in typical market conditions and overdependence on non-deposit funding sources arising out of unique business model. Funding diversification may be implemented by way of placing limits (say by tenor, counterparty, secured versus unsecured market funding, instrument type, currency wise, geographic market wise, and securitization, etc.).

Banks should also take into consideration liquidity risks due to intra group transfers – ie when entities within a group carry out operations among themselves. With a view to recognising the likely increased risk arising due to ITEs, the head of any banking conglomerate should develop and maintain liquidity management processes and funding programmes that are consistent with the complexity, risk profile, and scope of operations of the financial conglomerate.

The liquidity risk management processes and funding programmes should take into account lending, investment, and other activities, and ensure that adequate liquidity is maintained at the head and each constituent entity within the financial conglomerate. Processes and programmes should fully incorporate real and potential constraints, including legal and regulatory restrictions, on the transfer of funds among these entities and between these entities and the head.

Stress testing
A bank should conduct stress tests on a regular basis for a variety of short term and protracted bank specific and market wide stress scenarios (individually and in combination). In designing liquidity stress scenarios, the nature of the bank's business, activities and vulnerabilities should be taken into consideration so that the scenarios incorporate the major funding and market liquidity risks to which the bank is exposed. These include risks associated with its business activities, products (including complex financial instruments and off-balance sheet items) and funding sources. The defined scenarios should allow the bank to evaluate the potential adverse impact these factors can have on its liquidity position. While historical events may serve as a guide, a bank's judgment also plays an important role in the design of stress tests, RBI said.

The bank should specifically take into account the link between reductions in market liquidity and constraints on funding liquidity. This is particularly important for banks with significant market share in, or heavy reliance upon, specific funding markets. It should also consider the insights and results of stress tests performed for various other risk types when stress testing its liquidity position and consider possible interactions with these other types of risk.

Stress events may simultaneously give rise to immediate liquidity needs in different currencies and multiple payment and settlement systems. Banks should consider in the stress tests, the likely behavioural response of other market participants to events of market stress and the extent to which a common response might amplify market movements and exacerbate market strain as also the likely impact of its own behaviour on that of other market participants. The stress tests should consider how the behaviour of counterparties (or their correspondents and custodians) would affect the timing of cash flows, including on an intraday basis.

RBI has advised banks to take a conservative approach when setting stress testing assumptions.

Contingency funding plan
A bank should formulate a contingency funding plan (CFP) for responding to severe disruptions, which might affect the bank's ability to fund some or all of its activities in a timely manner and at a reasonable cost. CFPs should prepare the bank to manage a range of scenarios of severe liquidity stress that include both bank specific and market-wide stress and should be commensurate with a bank's complexity, risk profile, scope of operations. Contingency plans should contain details of available / potential contingency funding sources and the amount / estimated amount which can be drawn from these sources, clear escalation / prioritisation procedures detailing when and how each of the actions can and should be activated and the lead time needed to tap additional funds from each of the contingency sources.

The CFP's design, plans and procedures should be closely integrated with the bank's ongoing analysis of liquidity risk and with the results of the scenarios and assumptions used in stress tests. As such, the plan should address issues over a range of different time horizons including intraday.

CFPs should contain clear policies and procedures that will enable the bank's management to make timely and well-informed decisions, execute contingency measures swiftly and proficiently, and communicate effectively to implement the plan efficiently, including:

  • Clear specification of roles and responsibilities, including the authority to invoke the CFP (establishment of a crisis team may facilitate internal coordination);
  • Names and contact details of members of the team responsible for implementing the CFP and the locations of team members; and
  • The designation of alternates for key roles.

Contingency plans must be tested regularly to ensure their effectiveness and operational feasibility and should be reviewed by the Board at least on an annual basis.

A bank's liquidity policy and procedures should provide detailed procedures and guidelines for their overseas branches/subsidiaries to manage their operational liquidity on an ongoing basis.

Banks should not normally assume voluntary risk exposures extending beyond a period of ten years. Banks should endeavour to broaden their base of long- term resources and funding capabilities consistent with their long term assets and commitments.

The limits on maturity mismatches should be established within the such levels so that long term resources should not fall below 70 per cent of long term assets; and long and medium term resources together should not fall below 80 per cent of the long and medium term assets. These controls should be undertaken currency-wise, and in respect of all such currencies, which individually constitute 10 per cent or more of a bank's consolidated overseas balance sheet. Netting of inter-currency positions and maturity gaps is not allowed.

For the purpose of these limits, RBI has defined short term as those maturing within 6 months, medium term as those maturing in 6 months and longer but within 3 years, and long term as those maturing in 3 years and longer.

The monitoring system should be centralised in the international division (ID) of the bank for controlling the mismatch in asset-liability structure of the overseas sector on a consolidated basis, currency-wise. The ID of each bank should review the structural maturity mismatch position at quarterly intervals and submit the review/s to the top management of the bank.

Supervisory authorities in several foreign countries regulate the levels of short term funding by banks. They either require banks generally to raise long-term resources so as to reduce the levels of maturity mismatches or stipulate prudential ceilings or tolerance limits on the maturity mismatches permitted to them. In countries, where the mismatches in the maturity structures are subject to regulatory or supervisory guidelines, those should be controlled locally within the host country regulatory or prudential parameters, RBI said.

Liquidity decentralisation
RBI has advised Indian banks to adopt a decentralised model with some flexibility allowed in the form of some regional centres/hubs that may fund/manage liquidity for some jurisdictions/currencies keeping in view the constraints on the transfer of liquidity across jurisdictions/entities. Such of those banks which do not currently have this kind of decentralised approach should put in place such approach within a period of six months from the date of this circular, RBI said.

However, it is essential for banks with multiple platforms and legal entities to have a central liquidity management oversight function. The group's strategy and policy documents should describe the structure for monitoring institution-wide liquidity risk and for overseeing operating subsidiaries and foreign branches.

RBI expects banks to maintain adequate liquidity both at the solo bank and consolidated level, irrespective of the organisational structure and degree of centralisation or decentralization of liquidity risk management.

Indian banks' branches and subsidiaries abroad are required to manage liquidity according to the host or home country requirements, whichever is more stringent.

Similarly, foreign banks operating in India should also be self reliant with respect to liquidity maintenance and management.

Cross-currency liquidity

Banks should have a measurement, monitoring and control system for liquidity positions in the major currencies in which they are active. For assessing the liquidity mismatch in foreign currencies, as far as domestic operations are concerned, banks are required to prepare maturity and position (MAP) statements according to the extant instructions.

In addition to assessing its aggregate foreign currency liquidity needs and the acceptable mismatch in combination with its domestic currency commitments, a bank should also undertake separate analysis of its strategy for each major currency individually by taking into account the outcome of stress testing, RBI said.

A bank should have a reliable management information system (MIS) designed to provide timely and forward-looking information on the liquidity position of the bank and the group to the board and ALCO, both under normal and stress situations. The MIS should cover liquidity positions in all currencies in which the bank conducts its business – both on a subsidiary / branch basis (in all countries in which the bank is active) and on an aggregate group basis. It should capture all sources of liquidity risk, including contingent risks and those arising from new activities, and have the ability to furnish more granular and time sensitive information during stress events.

Liquidity risk reports should provide sufficient detail to enable management to assess the sensitivity of the bank to changes in market conditions, its own financial performance, and other important risk factors. It may include cash flow projections, cash flow gaps, asset and funding concentrations, critical assumptions used in cash flow projections, funding availability, compliance to various regulatory and internal limits on liquidity risk management, results of stress tests, key early warning or risk indicators, status of contingent funding sources, or collateral usage, etc.

The draft guidelines also cover two minimum global regulatory standards, viz, liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) as set out in the Basel III rules text.

While the enhanced liquidity risk management measures are to be implemented by banks immediately after finalisation of the draft guidelines, the Basel III regulatory standards, viz, LCR and NSFR, will be binding on banks from 1 January 2015 and 1 January 2018, respectively. Till then, banks will have to comply with Basel III guidelines on a best effort basis, RBI said

Banks are required to adhere to the following regulatory limits prescribed to reduce the extent of concentration on the liability side of the banks within a month from the reporting date, ie, the 15th and last date of each month.

RBI has asked banks to submit the revised liquidity return to the chief general manager-in-charge in the department of banking supervision of RBI at its central office at World Trade Centre, Mumbai.