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Capacity Building for Market Players (CBM)
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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 Sharī`ah-compliant securities/Sukūk in many jurisdictions
The unavailability of an Sharī`ah-compliant active trading or repurchase (repo) market
The lack any form of a Sharī`ah-compliant lender-of-last-resort (SLOLR) and Sharī`ah-compliant deposit insurance scheme.
Market conditions Sharī`ah 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
Sharī`ah-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 Sharī`ah-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
• Sharī`ah-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 Sharī`ah-compliant repo market
Sharī`ah-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 Sharī`ah-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 Sharī`ah-
compliant marketable securities issued by sovereign or
central banks that have a non-0% risk weight
Qualifying foreign currencies’ Sukūk and other Sharī`ah-
compliant marketable securities issued by sovereign or
central banks that have a non-0% risk weight
A. Level 1 Assets
Sharī`ah-compliant Instruments that Meet the Requirements for HQLA
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Item Amount Factor Total
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)
Sharī`ah-compliant Instruments that Meet the Requirements for HQLA
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Item Amount Factor Total
Qualifying Sukūk and other Sharī`ah-compliant securities75%
Qualifying Sharī`ah-compliant equity shares not issued
by financial institutions
50%
Qualifying other Sharī`ah-compliant liquidity instruments
that are widely recognised in the jurisdictions of the
home country
50%
C. Level 2B Assets: (maximum of 15% of HQLA)
Sharī`ah-compliant Instruments that Meet the Requirements for 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 Sharī`ah-compliant instruments meet most of the fundamental characteristics of HQLA, they may not fulfil the criteria with regard to market-related characteristics.
Although some Sharī`ah-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 Sharī`ah-compliant lender-of-last-resort (LOLR) facility that is key to meeting short-term obligations when there is a liquidity disruption.
Sharī`ah-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 Sharī`ah-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