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FACILITATING THE IMPLEMENTATION OF THE IFSB STANDARDS

FIS WORKSHOP SERIES

Capacity Building for Market Players (CBM)

Workshop

Organised By: Hosted By:


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GN-6: Quantitative Measures for Liquidity Risk Management Guidance Note

Day 1 - Session 1

Sani Tazara MuhammadMember of the Secretariat, Technical and Research, IFSB

14 – 15 November 2019 | Jakarta, Indonesia


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Outline of the Presentation

The Need for the GN-6

Application of the LCR in IIFS

Definition and Categorisation of HQLA

Operational Considerations for HQLA

Infrastructure Issues in the Availability of Sharī`ah-compliant HQLA


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These specificities are fully taken into account in the calculation of ratios in this GN-6.

The lack of the interbank market for short-term fund generation

The shortage or unavailability of Sharīàh-compliant securities/Sukūk in many jurisdictions

The unavailability of an Sharīàh-compliant active trading or repurchase (repo) market

The lack any form of a Sharīàh-compliant lender-of-last-resort (SLOLR) and Sharīàh-compliant deposit insurance scheme.

Market conditions Sharīàh requirements Balance sheet structure

The Need for the GN-6


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Objectives

• To provide guidance on the application of global liquidity standards – LCR and NSFR- for

the IIFS, with suitable adjustments based on the specific operational characteristics;

• to provide guidance to supervisory authorities on the application of the LCR and NSFR

in their jurisdictions

• to delineate the disclosure requirements alongside the application of liquidity standards;

and

• to present the templates of the LCR and NSFR

Scope

• A minimum level of liquidity for IIFS for both full-fledged IIFS and Islamic windows of

conventional banks on an individual and a consolidated basis.

• Supervisory authorities can extend the application of this GN to Islamic investment

banks and other financial institutions at their discretion.

Objectives and Scope of GN-6


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* Subject to Supervisory Authority Requirement

The objective of the LCR is to promote IIFS’s resilience

against short-term liquidity shocks.

Liquidity Coverage Ratio (LCR)

To meet this requirement, an IIFS is obliged to have anadequate stock of unencumbered HQLA that can beconverted easily and immediately into cash with no or littleloss of value, in order to meet its liquidity needs for a 30-calendar-day period under a liquidity stress scenario.


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LCR =

Stock of Sharī`ah-compliant HQLA

≥ 100%*Total net cash outflows over the next 30 calendar days

The LCR requirement is based on a scenario that entails a combination of

idiosyncratic and market-wide shocks

IIFS are required to maintain the LCR at a level no lower than

that required by the supervisory authority in both

normal and financial stress times.

However, IIFS may use, with approval from the relevant

supervisory authority, their stock of HQLA during stress

conditions in order to minimisethe negative impact of the crisis.

* Subject to Supervisory Authority Requirement

Total net cash outflows over the next 30 calendar days = Total gross expected cash outflows – Lesser

of (total expected cash inflows; 75% of total expected cash outflows)

Formula for Calculating LCR


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Such as liquidity risk, market risk,

credit risk, foreign exchange risk,

and legal and operational risk

including Sharī`ah non-compliance risk

• Central banks should consider

Sharī`ah-compliant securities

that they accept as eligible

collateral.

• This requirement has to be

fulfilled at all times, including

during an underlying stress

scenario.

• Particularly in terms of low risk,

ease and certainty of valuation,

and low volatility. Fundamental and market-

relatedcharacteristics

Low correlation with risky assets, an active and sizeable

market, and low volatility

Consideration of the inherent risk of HQLA

by Supervisory Authorities

Eligible for intraday and

overnight liquidity facilities

Definition of High Quality Liquid Assets (HQLA)

HQLA are defined as assets unencumbered by liens and other restrictions on transfer which

can be converted into cash easily and immediately, with no or little loss of value, including

under the stress scenario. The assets are required to meet fundamental and market-related

characteristics.


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• Level 1

• Level 2A

• Level 2B

• ALA treatments (if any)

Components of HQLA

• Cash outflows• Retail Deposits and PSIA

• Unsecured Wholesale Funding

• Secured Funds

• Sharī`ah-compliant hedging instruments

• CMT-based Deposits

• Sharī`ah-compliant Interbank Contracts

• Cash Inflows• Secured financing

• Inflow from committed facilities

• Inflow from various counterparties

Components of Total Net Cash

Outflows

Form

ula

of LC

RApplication of LCR in IIFS


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Stock of high-

quality liquid

assets (HQLA)

Expected net

cash outflows(next 30 days)

Outflows minus

inflows

LCR =

Level 1 – 0% haircut*

Sovereign/central bank issuances, central bank reserves, coins

and banknotesLevel 2

Level 2A : 15% haircut

Securities issued by entities with a 20% risk-weight, corporate

sukuk rated AA- and above

Level 2B : 25-50% haircut

Corporate sukuk rated between A+ and BBB-, RMBS, common

equity shares

• ‘Run-off rates’ are prescribed to calculate expected cash

outflows in a stress scenario**

• Expected cash inflows are subject to a cap of 75% of total

expected cash outflows

• Includes both on and off-balance sheet risks

≤ 40%

of total

HQLA

the run-off of a proportion of retail funding, including current accounts, UPSIA, RPSIA, and other accounts; a partial loss of unsecured wholesale funding capacity; a partial loss of secured, short-term financing with certain collateral and counterparties additional contractual outflows that would arise from a downgrade in the IIFS’s public credit rating by up to and

including three notches, including additional collateral posting requirements; increases in market volatilities that impact the quality of collateral or potential future exposure of Sharī`ah-compliant

hedging positions and thus require larger collateral haircuts or additional collateral unscheduled draws on committed but unused credit and liquidity facilities the potential need for the IIFS to buy back or honour contractual and non-contractual obligations for the purpose of

mitigating reputational risk.

Stress Scenario

Formula for Calculating LCR (2)


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Level 1 Level 2A Level 2B

Assets which qualify as

HQLA should have

certain fundamental and

market-related

characteristics,

particularly in terms of

low risk, ease and

certainty of valuation,

and low volatility

Sharīàh-compliant securities that may serve as HQLA are unlikely to have a well-established history of trading in liquid secondary markets

The GN-6 proposes that central banks should consider according HQLA status to Sharīàh-compliant securities that they accept as eligible collateral, up the limit of the liquidity facility thatthey would accord to the IIFS holding such securities on the basis of such collateral.

Fundamental Characteristics

• High credit rating of the instruments or issuer

• Easy to value

• Preferably listed

• Sharīàh-compliant

Market – Related Characteristics

• Liquefiable at all times

• Historical evidence of market breadth and market depth

• High trading volumes

• Stable asset prices even in stress times

• Large, active and deep Sharīàh-compliant repo market

Sharīàh-compliant Instruments that Meet the Requirements for HQLA


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Item Amount Factor Total

Coins and banknotes

100%

Qualifying central bank reserves

Qualifying Sukūk and other Sharīàh-compliant

marketable securities issued or guaranteed by

sovereigns, central banks, public-sector entities (PSEs),

multilateral development banks or relevant international

organisations assigned a 0% risk weight for credit risk

under IFSB-15

Qualifying domestic currency Sukūk and other Sharīàh-

compliant marketable securities issued by sovereign or

central banks that have a non-0% risk weight

Qualifying foreign currencies’ Sukūk and other Sharīàh-

compliant marketable securities issued by sovereign or

central banks that have a non-0% risk weight

A. Level 1 Assets




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Sharī`ah-compliant marketable securities issued or

guaranteed by sovereigns, central banks, PSEs,

multilateral development banks or relevant international

organisations, qualifying for a 20% risk weighting for

credit risk under IFSB-15.

85%

Qualifying Sharī`ah-compliant securities (including

commercial paper) and Sukūk that satisfy all of the

conditions

B. Level 2A Assets: (maximum of 40% of HQLA)




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Qualifying Sukūk and other Sharīàh-compliant securities75%

Qualifying Sharīàh-compliant equity shares not issued

by financial institutions

50%

Qualifying other Sharīàh-compliant liquidity instruments

that are widely recognised in the jurisdictions of the

home country

50%

C. Level 2B Assets: (maximum of 15% of HQLA)



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Max 40%

Sharī`ah-Compliant HQLA Stock

Level 1 Level 2BLevel 2A

Haircuts

100%

15%

50%25%

Qualifying Sukūk

backed by

commodity(ies)

and other real

asset(s)

(min AA)

Sharī`ah-compliant equity

shares, other qualifying Sukūk

(A+ to BBB).

CashCB reserves, Qualifying

Sukūk issued or guaranteed by sovereign, MDBs and

relevant international organizations (0% risk weight under IFSB-15) and Sukūk in

domestic and foreign currency issued by home

jurisdiction’s sovereign and central bank.

Qualifying Sukūk issued or guaranteed by sovereigns,

central banks, PSEs, MDBs or relevant international

organisations (20% risk weight under IFSB-15) and

Sukūk issued by non-financial institutions

(min AA-), etc.

Max 15%

Categorisation of HQLA


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Assets meeting the fundamental and market-related characteristics cannot automatically be recognised as HQLA.

The assets are subject to operational requirements that are designed to ensure that the stock of HQLA is managed in such a way that an IIFS can convert into cash through Sharī`ah-compliant mechanisms with no restriction on the use of the liquidity generated.

• All assets included in HQLA should meet the requirement to be unencumbered.

• The stock should be under the control of the IIFS’s liquidity risk management function.

• IIFS should mitigate market and rate of return risk associated with ownership of the stock of HQLA.

• Any surplus of HQLA held by a legal entity within a group can be included at the consolidated level only if those assets would also be freely available to the consolidated (parent) entity in times of stress.

• An IIFS should develop and implement procedures, systems and controls that enable it to determine the stock of HQLA.

• An IIFS should periodically monetise a representative proportion of the assets in its stock of HQLA.

Operational Considerations for HQLA


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Infr

astr

uct

ure

Issu

es This GN acknowledges that it is difficult for IIFS to find liquid

instruments that can meet the definition and operational requirements of HQLA.

While some Sharīàh-compliant instruments meet most of the fundamental characteristics of HQLA, they may not fulfil the criteria with regard to market-related characteristics.

Although some Sharīàh-compliant assets may be less risky than many conventional instruments, such assets are as yet untested during stress conditions.

IIFS tend to have high holdings of liquid assets due to the absence of a reliable Sharīàh-compliant lender-of-last-resort (LOLR) facility that is key to meeting short-term obligations when there is a liquidity disruption.

Sharīàh-compliant deposit insurance is another area which needs the attention of supervisory authorities to improve the “stability” of the deposits and UPSIA, and to reduce the risk of withdrawals on the occurrence of adverse idiosyncratic or systemic events.

Infrastructure Issues in the Availability of Sharīàh-compliant HQLA


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Option 3 – Additional use of Level 2 assets with a higher haircut:

Option 3 is available for jurisdictions where there are insufficient Level 1 assets, as determined through a supervisory liquidity review process (SLRP), but where

there are sufficient Level 2A assets.

Option 2 – Foreign currency HQLA to cover domestic currency liquidity needs:

Sukūk issued by MDBs, as well as other international Islamic infrastructure institutions such as the Islamic Development Bank (IDB) and the

IILM fall under this category.

Option 1 – Contractual committed liquidity facilities from the relevant central bank, with a fee:

The facility can be constructed by using a Wakālah, Muḍārabah or Commodity Murābahah Transaction (CMT) contract, or any other or a combination of various

Sharī`ah-compliant contracts.

Insufficient HQLA? …

HQLA

Available

ALA

Req

uir

ed

HQ

LA

ALA Treatments for IIFS


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Questions?


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Capacity Building for Market Players (CBM)

Workshop

Organised By: Hosted By:

Thank you


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Sani Tazara Muhammad

Member of the Secretariat, Technical and Research, IFSB

[email protected]

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