NBDT are a diverse bunch, and their approach to management of liquidity is somewhat different from registered banks. The RBNZ has recently introduced quantative liquidity requirements for registered banks, and is considering a similar approach to NBDTs.
I am intending to make a submission, probably arguing against quantative liquidity requirements, and suggesting variations in the types of quantative liquidity requirements that should be applied if they are to be. Please let me know:
- Anything you know about liquidity management practices in the NBDT sector.
- About prior charge security allowances in NBDT trust deeds
- About what kinds of assets NBDTs use to get short term liquidity from
- About sources of liquidity risk for NBDTs.
5 comments:
It is good to see the RBNZ recognise that, despite many failed finance companies blaming their failure on "liquidity issues", the underlying problem was asset quality and lack of capital (along with the well publicised poor, and in some cases fraudulent, business models). - refer point 16 in the paper.
The problem is that, despite recognising that, are they still seeking to impose a solution seeking a problem?
I have been disappointed how many solutions have been imposed in the financial sector seeking problems, our constitution and policy making are quite piss poor, more to do with copying the Australian errors and/or regulating because other countries do, or regulating because FATF says we should.
I assume you will submit in favour of option 1 - status quo then? Whilst liquidity issues didn't cause collapses I believe investors would benefit from being able to compare 'apples with apples' and understanding what "liquidity" actually is. Liquidity is not just a number, it is a financial institutions ability to match assets and liabilities over the short, medium and long term.
Andrew,
I do favour leaving it as it is, i.e. unregulated. There are standardised disclosures already, in the form of maturity analysis of assets and liabilities, however some reporting entities use different maturity buckets than others. There are also standardised definitions of cash and cash equivilents. I believe there are also mandatory disclosures of funding lines, and narrative descriptions of liquidity and financial risk management policies. Although you could quibble about different institutions using different maturity brackets, this is quite a lot of standardised and other disclosures required already. For the size and nature of the issue, surely this is enough disclosure already, and investors can make decisions based on this, don't you think?
But you have touched on the real issue: what is liquidity? I'm still trying to get my head around this, and this is one of the reasons I'm posting about this now. So far I'm inclined to believe that measurement of liquidity is very difficult, and I believe I know why this is: liquidity is a cash flow scenario, and therefore it all depends on the circumstances assumed and the management responses to those circumstances. Liquidity is therefore measured in cash inflows and outflows over time. However these flows cannot be measured, they can only be modeled. Furthermore, what an institution's objectives should be and what scenarios it should model and what assumptions it should use are far from obvious.
Nevertheless, from the above analysis, some further characteristics of liquidity management become evident. The scenario analysis is based on modeling other people's behaviour, and this makes it more difficult and more subjective. The most significant factors in liquidity outcomes will be the degree of investor confidence the institution retains or losses. If you draw a graph of 'degree of deterioration' of the entity's position and prospects on the x axis, and 'net cash outflows during a time period' on the y axis, you would get an increasing line, probably with an increasing slope too. The institution will run out of cash when its degree of deterioration reaches the point where the cash outflows equals its cash position at the beginning of the period, and the higher the initial cash holding (and the higher its holdings of assets that can be turned to cash and liabilities that will not require settlement in cash), the longer the institution can avoid running out of it. (continued next comment)
(continued from previous comment)
The above institutional deterioration variable is like 'systematic risk' but there is also an 'idiosyncratic risk' related to the individual sources and demands on cash. Individual funding lines, borrowings and assets represent sources of idiosyncratic risk that the institution can reduce the impact on its cash flows by diversification of assets and funding sources.
So, getting back to measurement of liquidity, any quantative requirements can end up being arbitrary and having little connection with any policy objectives of either the institution or a government regulator. At best regulatory requirements can be proxies for either a) the institution's level of liquidity risk and/or b) the institution's current liquidity position. Quantative requirements for long term funding have some advantages: the institution should be able to maintain them, and if it breaches them, the long term funding should provide some liquidity benefits for a reasonable period of time (e.g. 3-6 months) for the institution to raise new capital. Quantative requirements for liquid assets, however, only provide a more short term buffer, and these liquid assets can disappear quickly, however they provide a good real time indicator of the institution's ability to control its liquidity by obtaining any funding it requires.
Long term funding measurements appear to be seriously flawed compared to liquid assets measurements, in banking regulations. Long term funding includes funding instruments that are not long term, and that could be secured or secured by prior charge, and that could be repayable early, i.e. it is a low quality or broad measure of long term funding. But measures of liquid assets are very narrow. I would therefore like to see a more strict definition of long term funding and a more wide definition of liquid assets. For both, you could have tiers.
Tier 1 long term funding would be unsecured funding, without any right for early repayment outside payment default that is not remedied within, say 14 days, with a residual maturity of 6 months or more. Tier 2 long term funding could include retail funding and other funding with a residual maturity of more than 3 months.
Tier 1 liquid assets could be cash and cash equivilents, with a rating of AA- or better and a residual term of not more than 3 months, and that is able to be turned into cash within 1 business day. Tier 2 liquid assets could be any marketable debt security that can reliably be sold or turned into cash within 1 week. Tier 3 liquid assets could include liquidity available within 1 month from other sources, including from committed funding lines, and from loan repayments due within 1 month (with haircut), and from use of less liquid assets as security for borrowings (with haircut reflecting the proportion of the asset that can extracted as cash).
The tiers would represent shorter amounts of time, and would thus bring liquidity measurement back to a proxy for scenario cash flow analysis. The tiers also represent scenario conditions: higher quality liquid assets would produce cash during stressed market conditions, lower quality liquid assets would represent lower stress market conditions. All the scenarios would assume that the institution is under deteriorated conditions and its ability to raise long term replacement unsecured funding at reasonable cost has been lost.
I think the RBNZ would not like this approach because it is too complex, however they may be willing to entertain a wider definition of liquid assets and a more narrow definition of long term funding, should they decide to recommend introduction of quantative liquidity requirements.
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