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Three More in Sound Practices for Managing Liquidity in Banking Organizations, February 2002
1. 2. 3. Principal 1: ability to withstand stressful events in the market place as part of day-to-day management. Principal 6: internal (bank-specific) what if scenarios {also required by Basel II for operations risk}. Principal 6: external (market related) what if scenarios {also required by Basel II for credit risk}.
Market experience in the form of Systemic Crises A Wide Variety of scenarios have occurred over time
1987 1990 1991 1992 1994 1995 1997 1998 1999 2000 2001 2002 2007 U.S. stock market crash Collapse of U.S. high yield (junk) bond market Oil price surge ERM (European Exchange Rate Mechanism) crisis U.S. bond market crash Mexican Crisis Asian crisis Russian default, Ruble collapse. LTCM Gold prices TMT (telecommunications, media & technology ) sector collapse September 11 payments system disruption Argentine crisis U.S. sub-prime mortgage collapse
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S E V E R I T Y
($)
Catastrophic
MEDIUM
Painful
Normal
LOW LOW MEDIUM HIGH
PROBABILITY
3.
31
Stress Testing Should Reflect Both Internal and External Scenarios Capital markets disruptions Systemic shocks Payment system disruptions Prolonged global recession
External
Internal
What is Marketable?
A 2005 survey of large U.S. and Canadian banks found that only 4 out of 17 reported that they varied the projected quantity of liquid assets to fit the scenario.
Liability Rates
No stress
As per budget
Stress Level 1
As per budget
Mildly impaired
Diminished
Unimpaired
No current funding problem, but an elevated level of risk As per budget Severely impaired None Diminished
Serious funding problems Same quantity / higher cost Same quantity / higher cost
Stress Level 1
Up 100
Unimpaired
No current funding problem, but an elevated level of risk ??? ??? ??? ???
10
Asset Rates
No stress
As per budget
Stress Level 1
As per budget
As per budget
As per budget
Mildly impaired
No current funding problem, but an elevated level of risk As per budget Slight increase Little growth Severely impaired
Some funding problems As per budget Significant increase No growth Severely impaired
Stress Level 1
Up 100
As per budget
As per budget
As per budget
No current funding problem, but an elevated level of risk ??? ??? ??? ???
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Perception Risk
The Southdown Building Society suffered abnormal withdrawals 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, which led 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 12