6. Liquidity Adequacy and ILAAP
This section should, at minimum, cover the following:
6.1 Liquidity Risk Appetite
In this section, banks should describe their liquidity risk appetite, how it was devised, approved, monitored and reported, and how it is communicated throughout the bank. Banks should, at a minimum, cover the following key areas:
i. A full and clear articulation of the bank’s liquidity risk appetite and a discussion of why the risk appetite is appropriate.
ii. A discussion on how the bank’s liquidity risk appetite is used to define and assess liquidity levels and limits, including, at minimum, the following:
- An outline of all relevant liquidity risk management limits as derived from the risk appetite and a discussion of how the limits support the risk appetite.
- Limits for each of the liquidity risk drivers the bank assesses. Given that not all limits will necessarily be quantitative; some may be qualitative and describe subjective risk metrics.
- A brief outlining the bank’s risk appetite and liquidity risk limits, I.e. monitoring limits on periodic dates used for reporting of the Liquidity Coverage Ratio (LCR), Net Stable Funding Ratio (NSFR), Loan to Deposit Ratio (LDR) and SAMA Liquidity Ratio and a demonstration of how the liquidity limits are reflected in SAMA’s returns.
- A brief outlining the limits and positions against limits under “normal” and “stressed” liquidity environments, with a full and complete discussion of positions against limits.
6.2 Disclosure of Liquidity Requirements
This section should provide a distinction from the bank's perspective of the following liquidity measures indicating their purpose, minimum requirements and other attributes:
i. Regulatory Liquidity requirements under LCR, NSFR, LDR, and SAMA Liquidity Ratio.
ii. Liquidity requirements internally specified by Treasurer based on limits.
6.3 Funding Strategy
This section should provide full details of a bank’s three-year funding strategy, with more detail on the first 12-18 months of the funding strategy. The following requirements should be met:
i. The strategy should be approved by the Board Directors or its delegated authority.
ii. The strategy should demonstrate how it will support the projected business activities in both business as usual and stress, implementing any required improvements in the funding profile and evidencing that the risk appetite and key metrics will not be breached by the planned changes.
iii. Risks to the plan should be discussed.
iv. Where a funding strategy is new, implementation procedures should be detailed.
v. The funding risk strategy and appetite, and the profile, both the sources and uses should be described.
Banks should analyse the stability of the liabilities within the funding profile and the circumstances in which they could become unstable. This could include market shifts such as changes in collateral values, excessive maturity mismatch, inappropriate levels of asset encumbrance, concentrations (including single or connected counterparties, or currencies).
Banks are also required to analyse market access and current or future threats to this access, including the impact of any short-term liquidity stresses or negative news.
6.4 Risks Covered and Assessed in the ILAAP
In this section, banks are required to identify, measure and provide mitigation strategies for the most significant liquidity risks they are exposed to. At a minimum, the ILAAP should describe, assess and analyse the following pillar 2 liquidity risk drivers:
i. Wholesale secured and unsecured funding risk
a. Identification of risk, and behavior under normal and stress conditions
b. Deposit concentration risk – exposures concentrated on a limited number of customers, industries, certain sectors or geographic area, etc. entailing vulnerability.
ii. Retail funding risk
a. Gross retail outflows under liquidity stresses.
b. Higher than average likelihood of withdrawal.
iii. Intra-day liquidity risk
c. Net amount of collateral and cash requirement under stresses.
iv. Intra-group liquidity risk
d. Access to other groups, Central Bank funding, Parent Company and other commitments.
v. Cross-currency liquidity risk
e. Significant outflows and inflows with respect to maturities under stress.
f. Foreign Exchange (FX) mismatch risks – banks typically assume that currencies are fungible given the depth of liquidity in the spot FX and FX swap markets, particularly in reserve currencies. However, a bank may not be able to access FX markets as normal in times of stress
vi. Off-balance sheet liquidity risk.
g. Impact on cash flows arising from derivatives, contingent liabilities, commitments and liquidity facilities.
vii. Franchise-viability risk.
h. Stresses where the bank does not have sufficient liquidity resources to maintain its core business and reputation.
viii. Marketable assets risk (under normal and stressed forced sale conditions).
a. High Quality Liquid Assets (HQLA) monetisation risk – a bank may not be able to monetise sufficient non-cash HQLA to cover cumulative net outflows under the LCR stress on a daily basis, because of limitations to the speed with which cash can be raised in the repo market or through outright sales.
ix. Non-marketable assets risk (under normal and stressed forced sale conditions).
x. Funding concentration risk e.g. Flexible funding strategy according to instrument type, currency, counterparty, liability term structure and market for their realization.
xi. Other risks e.g.
a. Liquidity correlation factors associated with other risks i.e. reputational risk, asset concentration risk, Profit Rate Risk in the Banking Book (PRRBB), strategic risks etc. which have a bearing on Bank’s overall liquidity position.
b. Balance sheet mismatch risk - assess whether a bank would have sufficient cash from the monetisation of liquid assets and other inflows to cover outflows on a daily basis, under a defined stress scenario.
c. Macroeconomic and Business cycle risks – risks relating to changes in macroeconomic country specific variables such as oil prices, government spending and GDP.
d. Initial margin on derivatives contracts, where during a period of stress counterparties may, for a number of reasons, increase a bank’s initial margin requirements.
e. Securities margin financing liquidity risks.
The quantification of liquidity risk should fully incorporate the following:
i. Product pricing – it should include significant business activities and both on and off balance sheet products.
ii. Performance measurement and pricing incentives.
iii. Clear and transparent attribution to business lines.
iv. Management of collateral – clearly distinguishing between pledged and unencumbered assets.
v. Management of liquidity risks between intra-day, overnight keeping in view uncertainty or potential disruption.
vi. Managing liquidity across legal entities, business lines and currencies.
vii. Funding diversification and market access keeping in view:
- Business planning process.
- Correlations between market conditions and ability to access funds.
- Adequate diversification keeping in view limits according to maturity, nature of depositor, level of secured and unsecured funding, instrument type, currency and geographic market.
viii. Regular testing the capacity to raise funds quickly from choosing funding sources to provide short, medium and long term liquidity.
ix. An explanation of how each of the above risks have been identified, assessed, measured and the methodology and models currently or to be employed in the future, and the quantitative results of that assessment.
x. Where relevant, a comparison of that assessment with the results of the LCR and NSFR calculations.
xi. A clear articulation of the bank's risk appetite by risk category.
xii. Where relevant, an explanation of method used to mitigate these risks
6.5 Intraday Liquidity Risk
In this section, banks should describe the following:
i. How intraday risk is created within their business, whether part of the payments system or not, their appetite for and approach to managing intraday liquidity risk of both cash and securities accounts and in both business as usual and stress conditions.
ii. Details of how the bank assesses the adequacy of the process of measuring intraday liquidity risks, especially that resulting from the participation in the payment, settlement and clearing systems.
iii. Details of how the bank adequately monitors measures to control cash flows and liquid resources available to meet intraday requirements and forecasts when cash flows will occur during the day.
iv. How the bank carries out adequate specific stress-testing for intraday operations.