7c leonard matz some thoughts on liquidity scenarios

7/31/2019 7c Leonard Matz Some Thoughts on Liquidity Scenarios

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Some Thoughts on LiquidityScenarios


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LIQUIDITY RISK STRESS SCENARIO

Events triggered by no changeat all (public misinformation or

market perception)

Eventstriggered by

changes in

customerbehaviour

Eventstriggered by

changes in

businessstrategy

Eventstriggered by

changes in

other financialrisks

Events triggered bychanges in macro or

economic factors

Source: Jaqui Outram

Liquidity Risk Measurement Is VERY ScenarioSpecific


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1. Credit risk 415 adverse economic conditions and unexpected events

2. Credit risk 415 range or economic conditions likely to occur over a business cycle

3. Credit risk 434 economic or industry downturns

4. Credit risk 434 market-risk events

5. Credit risk 434 liquidity conditions

6. Credit risk 435- mild recession scenarios, (e.g., two consecutive quarters of zero growth)

7. Credit risk 436 changes in the banks rating

8. Credit risk in equities 527(j) hypothetical or historical scenarios that reflect worst case losses

9. Operations Risk 665 bank specific business environment

10.Operations Risk 665 scenario analysis defined in 675 to be statistical loss analysis

11.Interest Rate Risk 826 (6) upward and downward rate shocks

Eleven Scenarios Mentioned in the Basel II

Document


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1. Principal 1: ability to withstand stressful events in the marketplace as part of day-to-day management.

2. Principal 6: internal (bank-specific) what if scenarios {alsorequired by Basel II for operations risk}.

3. Principal 6: external (market related) what if scenarios {alsorequired by Basel II for credit risk}.

Three More in Sound Practices for Managing

Liquidity in Banking Organizations, February2002


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Market experience in the form of Systemic

Crises A Wide Variety of scenarios haveoccurred over time

1987199019911992

1994199519971998

19992000200120022007

U.S. stock market crashCollapse of U.S. high yield (junk) bond marketOil price surgeERM (European Exchange Rate Mechanism) crisis

U.S. bond market crashMexican CrisisAsian crisisRussian default, Ruble collapse. LTCM

Gold pricesTMT (telecommunications, media & technology ) sector collapseSeptember 11 payments system disruptionArgentine crisisU.S. sub-prime mortgage collapse


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Risk equals the product of

probability and severity.

PROBABILITY

SEVERIT

Y

HIGH

MEDIUM

LOW

($)

LOW MEDIUM HIGH

Normal

Painful

Catastrophic


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Scenario Selection and Application

1. Use at least three: normal, bank specific and

systemic.2. Define three characteristics for each: business

and market characteristics, duration and stress

level.

3. Use at least three stress levels for all non-normal scenarios.

31


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Stress Testing Should Reflect Both Internaland External Scenarios

Capital markets disruptions

Systemic shocks Payment system disruptions

Prolonged global recession

External

Credit lossesOperational lossesProblem merger or acquisition

Internal


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What is Marketable?

A 2005 survey of large U.S. andCanadian banks found that only 4

out of 17 reported that they variedthe projected quantity of liquid assetsto fit the scenario.


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No current funding problem, but an elevated level of risk

Some funding problems

Serious funding problems



No current funding problem, but an elevated level of riskSystemic Crisis

scenario

Bank specific

crisis scenario

Ordinary course ofbusiness scenario

Stress

Level 3

????????????Stress

Level 2

Same quantity /

higher cost

Same quantity /

higher costUnimpairedUp 100Stress

Level 1

Until we run out of

collateralNoneSeverely impairedAs per budgetStressLevel 3

DiminishedNoneSeverely impairedAs per budgetStress

Level 2

UnimpairedDiminishedMildly impairedAs per budgetStress

Level 1

UnimpairedUnimpairedUnimpairedAs per budgetNo stress

Access to New

Secured

Borrowings

Access to New

Unsecured

Borrowings

Counter Party

Confidence

Liability

Rates


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No current funding problem, but an elevated level of risk





No current funding problem, but an elevated level of riskSystemic Crisis

scenario

Bank specific

crisis scenario

Ordinary course ofbusiness scenario

Stress

Level 3

????????????Stress

Level 2

As per budgetAs per budgetAs per budgetUp 100Stress

Level 1

Severely impairedNo growthSignificant increaseAs per budgetStress

Level 3

Severely impairedLittle growthSlight increaseAs per budgetStress

Level 2

Mildly impairedAs per budgetAs per budgetAs per budgetStress

Level 1

As per budgetAs per budgetAs per budgetAs per budgetNo stress

Changes in Credit

Quality

Other Changes in

Loan Volume

Draws Under

Commitments

Asset

Rates


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Perception Risk

The Southdown Building Society suffered abnormalwithdrawals of 35 million during three eventful days in

August 1991, owing to unfounded rumors of links with the

failed Bank of Credit and Commerce International, whichled to a pre-tax loss of 9.8m in 1991. The members of

Southdown were consulted and, at a Special General

Meeting in March 1992, voted in favor of a merger with the

Leeds Permanent.

FURTHER GLOOM IN THE BUILDING SOCIETIES' CHALLENGING NEW WORLD,Magazine: Management Accounting, January, 1994, vol. 72 Issue 1, p28, 4p, 6

7c leonard matz some thoughts on liquidity scenarios

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