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Instruments addressing liquidity and financing risks


Liquidity coverage ratio

The liquidity coverage requirement expects banks to hold a sufficient quantity and quality of liquid assets for the eventuality of a short-term (30-day) liquidity shock.

The introduction of liquidity coverage requirements may increase the resilience of financial institutions, as a higher liquidity buffer allows them to withstand higher liquidity shocks. In the event of a crisis, the absence of sufficient liquid assets may drive institutions to fire sales in order to maintain sufficient liquidity, which may induce a downward spiral in the given asset market.

Compliance with the liquidity coverage requirement can be ensured by raising the stock of high-quality liquidity assets and by borrowing longer-term funds. On the whole, these steps may reduce the profitability of the financial sector, as the holding of liquid assets and the use of long-term funds are associated with relatively higher costs. Therefore, to avoid a significant deterioration of lending activity, the adequate timing of the instrument’s introduction is essential.

According to EU legislation, the institutions must satisfy 60 per cent of the liquidity coverage ratio from 1 October 2015 and 70 per cent from 1 January 2016. The MNB prescribes 100 per cent compliance with the liquidity coverage ratio from 1 April 2016.

Foreign exchange funding adequacy ratio

The instrument expects institutions to hold a sufficient amount of stable foreign currency funds in proportion to their foreign currency assets that require stable financing.

The impact mechanism of the regulation is twofold. On the one hand, the instrument requires the use of stable foreign currency funds to finance foreign currency assets requiring stable financing. This reduces the risks stemming from on-balance sheet currency mismatches. In addition, with respect to foreign currency liabilities, it orients banks towards the use of funds embodying long-term financing, thereby reducing the maturity mismatches on the balance sheets of credit institutions as well.

Supplemented by other instruments, such as the Foreign Exchange Coverage ratio, the instrument can also mitigate the external vulnerability of the banking sector.

Foreign exchange coverage ratio

The regulation imposes a limit on the degree of currency mismatches between assets and liabilities relative to the balance sheet total.

The instrument lowers the risks associated with excessive currency mismatches. The reduction of on-balance sheet currency mismatches also reduces institutions’ reliance on off-balance sheet instruments (mainly swaps) which, in turn, lowers the risks stemming from these instruments as well (renewal, liquidity and margin call risks).

With its simple structure and targeted effect on risks, the indicator lowers the probability of regulatory arbitrage. Supplemented by other instruments, such as the Foreign Exchange Funding Adequacy Ratio, the instrument can also mitigate risks stemming from the vulnerability of external financing.

Mortgage Funding Adequacy Ratio

Setting a minimum required level of mortgage-backed securities relative to the amount of household mortgage loans.

Thanks to their favourable risk rating, mortgage bonds and other bank securities backed by mortgage loans are considered to be stable, long-term liabilities with relatively low cost of funds.  This allows credit institutions to reduce their on-balance sheet maturity mismatches at relatively low cost. Owing to the increasing popularity of loans with longer interest periods, reliance on long-term securities for funding also lowers interest rate risk.

The instrument is fairly simple and well-targeted, which reduces the probability of regulatory arbitrage.

Interbank Funding Ratio

The regulation sets a maximum limit for the weighted amount of liabilities based on denomination and time to maturity which are originated from all financial corporations divided by the balance sheet total excluding own funds.

Excessive reliance on funds from financial corporations can carry a significant systemic risk and the possible materialization of this can have serious implications for the financial system and the real economy. The targeted measure and the established regulatory limit may prevent the build-up of over-reliance on wholesale financing.

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