ALM, FTP and Liquidity Emerging Trends in Asia

Pacific Region
GARP Melbourne Chapter, Australia
13th March 2013

Zaffar Habib
Risk Practice Lead
Senior Director, ERS Services
Moodys Analytics

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No.

Topics

Page No.

Overview of BASEL III Regulations

Emerging Trends in Balance Sheet Management in APAC region

17

Quantitative Easing, Liquidity and Exchange Rates

27

Funding Trends in APAC

30

Fund Transfer Pricing (FTP)

46

Case Studies

6i. Liquidity Transfer Restrictions

53

6ii. Liquidity Stress Testing

56

Shareholder Value Consideration

70

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Overview of BASEL III

Regulations

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The Basel III Framework New Developments

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Implementation phases
2011

Leverage ratio

Phase-in Arrangements (all dates as of Jan 1)

2012
2013
2014
2015

Supervisory Monitoring

Minimum common Equity capital

ratio

4%

4.5%

Capital Conservation Buffer

3.5%

Phase-in of deductions from CET1

(including amounts exceeding the
limit for DTAs, MSRs and
financials)
Minimum Tier 1 Capital
Minimum Total Capital
Minimum Total Capital plus
Conservation Buffer
Capital instruments that no longer
qualify as Non-core Tier 1 Capital
or Tier 2 Capital

Liquidity Coverage Ratio

Net Stable Funding Ratio

2017

Parallel run 1 Jan 2013 - 1 Jan 2017; Disclosure

starts 1 Jan 2015
3.50%

Minimum Common Equity plus

Capital Conservation Buffer

2016

2018

2019

Migration to
Pillar 1

4.5%

4.5%

4.5%

4.5%

0.625%

1.25%

1.875%

2.5%

4.0%

4.5%

5.125%

5.75%

6.375%

7.0%

20%

40%

60%

80%

100%

100%

4.50%
8.0%

5.50%
8.0%

6.0%
8.0%

6.0%
8.0%

6.0%
8.0%

6.0%
8.0%

6.0%
8.0%

8.0%

8.0%

8.0%

8.625%

9.25%

9.875%

10.50%

Phased out over 10 year horizon beginning 2013

Introduce
minimum
Standard
60%

Observation
period begins

Observation
period begins

70%

80%

90%

100%

Introduce
minimum
Standard
(Gray shading indicates transition period)

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BCBS January 2013 changes to the formulation of the

liquidity coverage ratio (LCR) under BASEL III
High Quality Liquid Assets (HQLA)
Expand the definition of HQLA by including Level 2B assets, subject to higher haircuts and a limit
Corporate debt securities rated A+ to BBB with a 50% haircut
Certain unencumbered equities subject to a 50% haircut
Certain residential mortgage-backed securities rated AA or higher with a 25% haircut

Aggregate of Level 2B assets, after haircuts, subject to a limit of 15% of total HQLA
Rating requirement on qualifying Level 2 assets
Use of local rating scales and inclusion of qualifying commercial paper

Usability of the liquidity pool

Incorporate language related to the expectation that banks will use their pool of HQLA during

periods of stress
Operational requirements
Refine and clarify the operational requirements for HQLA

Source : BIS press release Jan 2013

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Recent changes contd

High Quality Liquid Assets (HQLA)
Operation of the cap on Level 2 HQLA
Revise and improve the operation of the cap on Level 2 assets

Alternative liquid asset (ALA) framework

Development of the alternative treatments, and include a fourth option for Shariah-compliant banks

Central bank reserves

Clarify language to confirm that supervisors have national discretion to include or exclude required

central bank reserves (as well as overnight and certain term deposits) as HQLA as they consider
appropriate

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Recent changes contd

Inflows & Outflows
Insured deposits
Reduce outflow on certain types of fully insured retail deposits from 5% to 3%
Reduce outflow on fully insured non-operational deposits from non-financial Corporates,

sovereigns, central banks and public sector entities (PSEs) from 40% to 20%
Non-financial corporate deposits
Reduce the outflow rate for non-operational deposits provided by non-financial Corporates,

sovereigns, central banks and PSEs from 75% to 40%

Committed liquidity facilities to non-financial Corporates
Clarify the definition of liquidity facilities and reduce the drawdown rate on the unused portion of

committed liquidity facilities to non-financial Corporates, sovereigns, central banks and PSEs from
100% to 30%
Committed but unfunded inter-financial liquidity and credit facilities
Distinguish between interbank and inter-financial credit and liquidity facilities and reduce the

outflow rate on the former from 100% to 40%

Source : BIS press release Jan 2013

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Recent changes contd

Inflows & Outflows
Derivatives
Additional derivatives risks included in the LCR with a 100% outflow (relates to collateral

substitution, and excess collateral that the bank is contractually obligated to return/provide if
required by a counterparty)
Introduce a standardised approach for liquidity risk related to market value changes in derivatives

positions
Assume net outflow of 0% for derivatives (and commitments) that are contractually

secured/collateralised by HQLA
Trade finance
Include guidance to indicate that a low outflow rate (05%) is expected to apply

Equivalence of central bank operations

Reduce the outflow rate on maturing secured funding transactions with central banks from 25% to

0%
Client servicing brokerage
Clarify the treatment of activities related to client servicing brokerage (which generally lead to an

increase in net outflows)

Source : BIS press release Jan 2013

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Liquidity Coverage Ratio as specified by BCBS- January

2013
LCR =

The formula for the calculation of the stock of HQLA is as follows:

Stock of HQLA = Level 1 + Level 2A + Level 2B Adjustment for 15% cap Adjustment for 40%

cap
Where:
Adjustment for 15% cap = Max (Adjusted Level 2B 15/85*(Adjusted Level 1 + Adjusted Level

2A), Adjusted Level 2B - 15/60*Adjusted Level 1, 0)

Adjustment for 40% cap = Max ((Adjusted Level 2A + Adjusted Level 2B Adjustment for 15% cap)

- 2/3*Adjusted Level 1 assets, 0)

Alternatively, the formula can be expressed as:
Stock of HQLA = Level 1 + Level 2A + Level 2B Max ((Adjusted Level 2A+Adjusted Level 2B)

2/3*Adjusted Level 1, Adjusted Level 2B 15/85*(Adjusted Level 1 + Adjusted Level 2A), 0)

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Liquidity Coverage Ratio for Foreign denominated high

quality assets - as specified by BCBS in January 2013
Foreign Currency LCR =

(Note: Amount of total net foreign exchange cash outflows should be net of foreign exchange hedges)

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LCR Buffer Composition

Level 2 Assets
(Max)

Level 1 Assets
(Min)

Level 1 Assets (Min)

Factor

Coins and bank notes

Qualifying marketable securities from
sovereigns, central banks, PSEs, and multilateral
development banks
Qualifying central bank reserves
Domestic sovereign or central bank debt for non0% risk-weighted sovereigns

100%

Level 2A Assets (Max)

Sovereign, central bank and PSE assets qualifying
for 20% risk weighting
Qualifying corporate bonds rated AA- or higher

85%

Qualifying covered bonds rated AA- or higher

Level 2B (Max)

Qualifying RMBS
Qualifying corporate debt securities rated
between A+ and BBB Qualifying common equity shares

75%
50%
50%

Application of Regulatory Haircuts

The arrow indicates that the maximum amount of Level 2 assets is calculated by applying 40% cap of HQ liquid assets and
Aggregate of Level 2B assets, after haircuts, subject to a limit of 15% of total HQLA
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Liquidity Coverage Ratio

High Quality Liquid Assets

Stressed net cash outflow over a 30 day

period
Run off factor

Haircut
Retail deposits

Level one assets

Cash

0%

Wholesale deposits

Central bank reserves

0%

SME

Government bonds with 0%

risk weights

0%

Level 2 A assets

25%

Non Financial

75%

Financial

100%

15%

Secured funding by assets not

included in a stock of liquid assets

Corporate Bonds AA rating

15%

Undrawn credit commitment

Eligible RMBS
Corporate debt securities
rated A+ to BBB

25%

5% to 10%

Custody and Clearing

Government bonds with 20%

risk weights

Level 2 B assets

3% to 10%

0% - 100%

Retail and SME

5%

Non Financial Corporates

10%

Financial Sector

100%

50%
Source : BASEL IIII : The Liquidity Coverage Ratio and Liquidity Risk Monitoring tools January 2013

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Inflow and outflow in stressed window of 30 days

The stressed net cash outflow over a 30-day time horizon is measured net of cash inflows,

however, only to a maximum extent of 75% of cash outflows.

The outflows are defined by allocating run-off factors to different types of liquidity adhering to a

stress scenario
Inflows from different sources are weighted with a specific inflow-factor.

Credit facilities, liquidity facilities and other contingent facilities that the bank holds to the benefit of

the bank itself are assigned a 0% inflow factor

NSFR as a structural medium to long term component of liquidity requirements shall lead to a

maturity congruent funding of the bank's assets

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Net Stable Funding Ratio (NSFR) as specified by BCBS

NSFR =

Available Stable Funding / Required Stable Funding >= 100%

The NSFR numerator available stable funding (ASF) and denominator required stable funding

(RSF) are assessed by classifying capital items, assets and liabilities according to their
characteristics (e.g. product type and maturity) and type of customer/issuer.
The numerator includes capital, preferred shares, liabilities with effective maturity greater than one

year, stable deposits and wholesale funding provided by non-financial institutions, using
appropriate ASF weighting factors. The denominator includes assets and off-balance sheet
exposures using appropriate RSF weighting factors.

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Net Stable funding ratio

The NSFR, demands that banks establish a minimum level of stable funding in relation to the liquidity
characteristics of the bank's assets over a one year time horizon

Available Stable funding

Required stable funding

Factor

Factor

Capital

100%

Cash, securities, FI loans < 1 year

Liabilities 1 year maturity

100%

Unencumbered securities

Stable deposits & unsecured

wholesale funding < 1 year

90%

Retail client loans

85%

All other assets

100%

Less stable deposits &

unsecured wholesale funding <
1year

80%

Undrawn commitments
Other contingent obligations

Unsecured wholesale funding

1 year provided by non financials

50%

All other assets

0%

0%
5% - 50%

5%
To be
decided

The portion of required stable funding is the weighted sum of

the bank's assets excluding assets not convertible into cash
Source :BCBS Papers

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Emerging Trends in Balance

Sheet Management in APAC
Region

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GDP Performance of Investment Grade APAC Countries

Most of the A investment grade countries are performing between 5% to 10% range; where
as B investment grade countries are performing between 8% to 15% YoY in 2012
25

35

'A' Investment Grade Countries Nominal GDP

30

Nominal GDP (% change, local currency)

Nominal GDP (% change, local currency)

20

15

10

-5

-10

'B' Investment Grade Countries Nominal GDP

25

20

15

10

-5

Australia Aaa

HongKong Aa1

Japan Aa3

NewZealand Aaa

Singapore Aaa

Korea Aa3

Malaysia A3

India Baa3

Indonesia Baa3

Thailand Baa1

China Aa3

Bangladesh Ba3

Philippines Ba1

Cambodia B2

Taiwan Aa3

SriLanka B1

Vietnam B2
Source : Moodys Investor Services Countries Stat booklet 2012

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Key Trends
In a study conducted by Moodys Economic and Consumer Credit Analytics (www.economy.com) in

2012, it was observed that GDP and liquidity move in tandem. GDP is one measure of estimating
the level of liquidity in place in any economic system
However, liquidity can be fully measured after taking inflation into account

High inflation estimates require a focused approach to manage liquidity

High growth economies may need extra levels of liquidity, however, this may increase the cost of

funds at a regional level

Continued inflationary pressure may require central banks intervention to tame inflation; therefore

use of a temporary liquidity squeeze may be required to prevent hampering growth and demand
Liquidity risk has now become the paramount concern among practitioners, regulators and the

business community. The real GDP in the next slide tells the story why managing liquidity has
become important where global economic drivers like China and India are seeing significant drop in
growth estimates.
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Inflation levels in APAC Countries

A economies are expected to have inflation under 5% where as in high growth B economies the inflation
is expected to hover around 5% to 12% in the next two years

Inflation among 'A' investment grade APAC

Countries

90

35

80

30

70
(CPI, % change Dec/Dec)

(CPI, % change Dec/Dec)

40

25

20

15

10

Inflation among B' investment grade APAC

Countries

60
50
40
30
20

10

Vietnam B2

SriLanka B1

Cambodia B2

Singapore Aaa

Philippines Ba1

Bangladesh Ba3

Thailand Baa1

HongKong Aa1

Indonesia Baa3

India Baa3

Taiwan Aa3

Malaysia A3

Macao Aa3

Korea Aa3

China Aa3

NewZealand Aaa

Japan Aa3

Australia Aaa
Source : Moodys Investor Services Countries Stat booklet 2012

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Real GDP Performance of Investment Grade APAC

Countries
In real terms, most of the A economies are expected to grow under 5% whereas high growth B
economies are expected to grow around 4% to 8% . This is a significant drop as most of the high growth
economies were growing above 7% level over the last 10 years
30

'A' Investment Grade Countries Real GDP

16

'B' Investment Grade Countries Real GDP

14
25
12
10
Real GDP (% change)

Real GDP (% change)

20

15

10

8
6
4
2

0
-2

-5

-4
-10

Australia Aaa

HongKong Aa1

Japan Aa3

India Baa3

Indonesia Baa3

Thailand Baa1

NewZealand Aaa

Singapore Aaa

China Aa3

Bangladesh Ba3

Philippines Ba1

Cambodia B2

Korea Aa3

Macao Aa3

Malaysia A3

SriLanka B1

Vietnam B2

Taiwan Aa3

Source : Moodys Investor Services Countries Stat booklet 2012

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Unemployment in Leading APAC countries

10

Unemployment Rate (%) in 'A' grade countries

environment and job generation. Money supply,

disposable income levels are optimistic; it pushes
the demand upward.

8
Unemployment Rate (%)

Lower unemployment signaling promising business

Great opportunities for growth and sustainability

Unemployment rate in most of the advanced

economies may remain slightly higher than their

national average of 10 years
4

Where prospects of job in China and India are

bright, other APAC countries are likely to see

increase in unemployment levels.

In 2012, Indias unemployment rate was 3.8%

compared to 9.8% in 2010; where their national

average of 10 years is around 8%. (significant skew)

While in China, the unemployment rate stood at

Australia Aaa

HongKong Aa1

NewZealand Aaa

Singapore Aaa

Japan Aa3

4.10% in 2012, closer to their national average of 10

years i.e. 4.15%

Source : Moodys Investor Services Countries Stat booklet 2012

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Liquidity ratio in APAC region

Indias 4 fold high growth in short term deposits is significant in terms of liquidity, money supply; although
this puts alot of pressure on cost of funds, pricing and RoE. Inflationary pressure is also significant. Rest of
the participants in the region maintain healthy liquidity ratio; Korea and Vietnam are experiencing a liquidity
squeeze
450
300

Liabilities to BIS Banks Falling Due Within One

Year/Total Assets Held in BIS Banks

400

250

350
Liquidity Ratio %

Liquidity Ratio %

Liabilities to BIS Banks Falling Due Within One

Year/Total Assets Held in BIS Banks

200

150

100

300
250
200
150
100

50
50
0

0
2002

2003

2004

2005

2006

2007

China Aa3

Korea Aa3

Malaysia A3

Taiwan Aa3

2008

2009

2010

2011

Macao Aa3

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

India Baa3

Indonesia Baa3

Thailand Baa1

Bangladesh Ba3

Philippines Ba1

Cambodia B2

SriLanka B1

Vietnam B2

Source : Moodys Investor Services Countries Stat booklet 2012

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Moodys Analytics

Credit levels and money supply in China region

Domestic Credit/GDP (%)

The ratio of domestic credit to GDP is a useful indicator of the depth of financial intermediation reached in
the evolution of the financial system and also of the degree to which the provision of credit is dominated by
banks
A closer look at the credit levels in the
Chinese region is quite important as China is
180
Domestic Credit to GDP
a leading economy in APAC.
160

Taiwan Aa3

140

China Aa3

120

Malaysia A3

100

Chinas high credit levels reflect the demand

for liquidity to maintain a higher growth

momentum

Korea Aa3

80

Neighbours like Taiwan, Macao and Hong

60
Macao Aa3
40

Kong are helping mainland China to keep up

the pace

20

This appetite for growth is creating a catalyst

0
2002

2003

2004

2005

2006

2007

China Aa3

Korea Aa3

Malaysia A3

Taiwan Aa3

Source : Moodys Investor Services Countries Stat booklet 2012

2008

2009

2010

2011

Macao Aa3

for the other countries like Malaysia

The growing first tier financial systems are

generating an economic value and demand

for growth in second tier financial systems
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Credit levels and money supply in other parts of APAC

160

Domestic Credit to GDP

Trends are not as similar as seen across the

other high growth regions like India and

Indonesia

140

Domestic Credit/GDP (%)

120

Thailand and Vietnam have seen an increase

100

in appetite for liquidity. Their financial

systems are able to satisfy the need for credit
and growth. At the same time this is putting
stress on the overall liquidity position in these
countries

80

60

40

India and Indonesia, unlike their neighbours,

20

are trying to maintain balance between

growth, demand for liquidity and credit risk.

0
2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

India Baa3

Indonesia Baa3

Thailand Baa1

Bangladesh Ba3

Philippines Ba1

Cambodia B2

SriLanka B1

Vietnam B2

With stringent regulatory frameworks and

vigilant supervision, their central banks are

able to tame the unwarranted situations like
high inflation and higher cost of funds.
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Moodys Analytics

Emerging APAC: continued growth, though slower and

more volatile
Emerging Asian banks have maintained sound capital and stability ratios and will account for more

than 39 percent of global revenue growth.

Average ROE may drop by 3 to 4 percentage points from the current 17 percent because of increased

regulatory demands in some markets, as well as declines in asset quality and shifts in consumer
dynamics. Asian banks in the past year lifted Tier 1 ratios by 0.2 percentage points to 10 percent
(slightly below the global average).
Asian banks estimated to require more than US$1 trillion in new capital through the coming decade.

With downward pressure on ROE and over 75 percent government ownership (and governments likely
to limit capital Injections in this environment), attracting private capital will become a priority within two
to three years.
This could necessitate another round of business model innovation to bolster ROEs and policy

action in some markets.

China faces some specific challenges. Increased bad loans (mainly to local Governments and SME)

and slower economic growth expectations of about 8 percent give rise to concerns. In addition, China
needs to manage the smooth transition from a heavily directed growth model to a more market driven
Economy.
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Quantitative Easing, Liquidity

and Exchange rates

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Impact of quantitative easing, liquidity and exchange rates

Dollars, Euro, Yen and Pounds pumped into

the global economy by major central banks in

recent years has yet to pay off in the form of
job creation, investment and stronger
economic growth.
It has kept banks afloat, let corporations build

large cash reserves and restructure debt and,

arguably, staved off a worldwide depression
Gross Domestic Product in the 17-nation euro

zone declining 0.6 percent in the last three

months of 2012, compared with the prior
period. Growth in Britain was zero percent,
while Japans economy contracted 0.4 percent
at the end of the year.
This stagnation follows a historic run in which

$5.5 trillion has flowed into the global economy

from central banks in the United States, Japan,
Britain and the euro zone
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Interest parity and liquidity

Artificial

lower interest
unwarranted liquidity

Money
pumped
by Central
Banks

Foreign
Exchange

rates

creating

For better returns, money flows from low

yielding economies
economies
Excess
Liquidity

to

high

growth

This creates short term currency pressures

from outflow country to inflow country and

unnecessary volatility in exchange market
Similarly this affects the interest rates at

domestic levels on both sides

Credit vs.
Inflation

Artificial
Interbank
Interest
rates

This artificial control defies the Interest rate

parity
In Feb 2013, G-20 nations emphasised to

avoid any artificial movements in FX and

focus on competitiveness
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Funding Trends in APAC

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APAC is leading the global economy

Earlier focus was on short term funding now on long term funding
APAC banks generally have high levels of core capital and they have enhanced core capital

through retained earnings or common stock issuance

APAC Banks can be classified in three groups
High growth system such as China, India, Indonesia
Mature and low margin markets such as Japan and Taiwan
Sufficiently liquid markets like Korea, Singapore, Hong Kong, Australia and Malaysia
High growth and mature markets need to enhance their CET1 capital ratios, exception to China

which holds sufficient capital

These capital reforms would eventually increase the cost of funding it is up to the banks how

much they pass on this cost to their borrowers

Risk adjusted capital may hover around 7% to 8% in APAC
Asia has high saving tendencies ; Saving to GDP is more than 30% / Australia has 4%
This is changing a funding model of bank across APAC and re-balancing the source of

funding between retail and wholesale

Retail banking is focused on attracting customers and building relationship
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APAC Deposit Guarantee Schemes

Recent banking institution failures have the potential to
Deposit Insurance Threshold

trigger economic recessions, policy makers maintain

deposit insurance schemes to protect depositors and to
give them comfort that their funds are not at risk

Country
Hong Kong

Insured Amount
500,000

Currency
HKD

Singapore

50,000

SGD

Japan

10,000,000

YEN

Having a bank deposit insurance scheme guarantees that

Australia

250,000

AUD

a nation state will more likely have a higher rate of passive

foreign investment within the margin of insurable amount.

China

Expected to launch in early Dec 2012

India

100,000

INR

Malaysia

250,000

RGT

Philippines

500,000

PHP

Taiwan

3,000,000

NTD

Thailand

50,000,000

BHAT

Passive foreign investment in a nation states finance

system allows for more lending to be made when global

finance system conditions constrict the amount of lendable
money.
There has been substantial research done over the years

on the impact on foreign investment of bank deposit

insurance schemes.
Deposit insurance enables banks to increase the money

supply, without it underfunded banks might suffer a bank

run which is prevented by the insurance
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Moodys Analytics

Funding trends in China (in Yuans)

China is seeing alot of liquidity fluctuations 2012 was a relatively difficult year compared to the

previous years
The People's Bank of China (PBOC), the central bank, added more cash into banks through open

market operations during Jan 2013 after seeing actual liquidity drain during Dec 2012.

Thousands

Chinese Deposits Profile in 100 mm Yuan

350

An additional 11 billion Yuan (1.77 billion

U.S. dollars) of capital has flowed in the

market during Jan 2013.

300
250
200

Since June, the central bank has resorted

to reverse repos, a more cautious, targeted

and short-term tool than lowering banks'
reserve requirement by buying securities
held by commercial banks to improve the
cash flow in the money market.

150
100
50
0
2007.12

Source PBC

2008.12

2009.12

2010.12

Demand & Time Deposits of Enterprises

Savings Deposits
Designated Deposits
Other Deposits
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Moodys Analytics

Funding trends in Hong Kong (in HK Dollars)

HK retail banking focus increasing as a source of liquidity; Salary accounts offering better rate on
retail and wholesale savings
Better rates intended to increase core deposit portion for longer terms accounts
Condition of minimum run-off of 10% on Current Accounts and Saving Accounts becoming less
motivational on behavioral modeling/ statistical modeling to try to estimate how stable, or sticky
deposits will be;
Banks are now looking to model reasons of competitiveness in a more comprehensive approach

Thousands

5,000
Thousands

Customer deposits of all AIs in HK

4,200

Customer deposits of all AI in HK

4,100
4,000

4,000
3,900
3,800
3,700

3,000

3,600
HKD

Other Currencies

2,000

HKD

3,500

Other Currencies

Dec-12

Nov-12

Oct-12

Sep-12

Aug-12

Jul-12

Jun-12

May-12

Apr-12

Mar-12

Feb-12

2012

Jan-12

2011

Dec-11

2010

Nov-11

2009

Oct-11

3,400
2008

Source HKMA

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Moodys Analytics

Funding trends in Singapore (in Singapore Dollars)

Thousands

Retail Deposits of other residents in Singapore - TOTAL

$400.00
$350.00

High deposits in both retail and wholesale

$300.00

market is making Singapore a safe

destination. There are excess deposits
over funding and this excess pool is
keeping the interest rate at the lowest

$250.00
$200.00
$150.00
$100.00
$50.00

Deposits of other residents in Singapore TOTAL

$2007 2007 2007 2008 2008 2009 2009 2009 2010 2010 2011 2011 2012 2012 2012
Jan Jun Nov Apr Sep Feb Jul Dec May Oct Mar Aug Jan Jun Nov

Cost of funds in Singapore is cheaper

Thousands

compared to countries in the APAC region

$80.00
$70.00

Wholesale Deposits in Singapore

$60.00
$50.00
$40.00
$30.00
$20.00
$10.00
$2007 2007 2007 2008 2008 2009 2009 2009 2010 2010 2011 2011 2012 2012 2012
Jan Jun Nov Apr Sep Feb Jul Dec May Oct Mar Aug Jan Jun Nov
SINGAPORE GOVERNMENT AND STATUTORY BOARDS - TOTAL

"With more vibrant secondary market

activity, this will naturally invite issuers to
come and issue in this market because
pricing will be more accurate and more
transparent. Typically, you do not need to
pay a liquidity premium if trading liquidity of
the corporate bond market is high. Standard Chartered Bank's head of
research for South-east Asia, Edward Lee

DEPOSITS OF RESIDENTS OUTSIDE SINGAPORE - TOTAL

DEPOSITS OF NON-BANK FINANCIAL INSTITUTIONS - TOTAL

Source MAS

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Funding trends in Australia

With respect to funding, deposits continue

to represent the most sought after source

by the banks, particularly term and retail
deposits.
And with domestic deposit growth (circa

10%) currently a touch over 2x domestic

credit growth (circa 5%), the improvements
seen in bank funding profiles in recent
years look set to continue for a while yet.

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Moodys Analytics

Funding trends in Australia contd

Continuing to build up their term and retail deposit

books will be particularly important for the

Australian banks to comply with the Basel III
Liquidity Coverage Ratio (LCR) requirements
(comes into effect in January 2015).
They will also be attempting to reduce their reliance

on the RBAs Committed Liquidity Facility (CLF) so

as to minimise the impact of the facilitys 15bps fee.
Building term and retail deposit books will benefit

LCR compliance by minimising the 30 day cash

outflow denominator in the LCR ; raise the
available amount of stable funding which is the
numerator in the Net Stable Funding Ratio.

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Moodys Analytics

Funding trends in Australia contd

Saving tendency is less i.e. 4% on GDP

No more reliance on wholesale funding solely. Need

to re-balance between retail and wholesale funding

Internet banking non-sticky ; 30% run-off now

focus on Physical banking and building customer

relationship; Now penalty on early withdrawal from
savings

New Prescription of 10% minimum run-off in

Current Accounts / Savings Accounts

Loan to Total Deposit was 130% in Jan 2009 and in

June 2011 it was116%.

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Moodys Analytics

Funding trends in Australia contd

New metric introduced - 31 day B/E cost to Term

deposits.
Re-defining term of contract on CDs from 30

days to 90 days or even 180 days in some cases

2013 Wholesale funding volumes will be lower

than 2012 and could end up being similar to

2011, but with covered bonds now in the funding
mix
A growing area of research relates returns more

directly to the information in firms balance

sheets, such as the growth rate in total assets, or
in components such as working capital, net
operating assets or fixed assets - Louis K. C. Chan,
Jason Karceski, Josef Lakonishok, and Theodore Sougiannis, May
2008

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Moodys Analytics

Australian wholesale debt market

The major 4 banks reported a combined AUD118bn
AUD Billions

FY11

FY12

FY13(e)

$ Chg

% Chg

ANZ

18

25.8

22.5

-3.3

-13%

CBA

25

29

25

-4

-14%

NAB

31.6

31.3

28

-3.3

-11%

WBC

25

32

25.5

-6.5

-20%

In term debt issuance, the Big 4 have a combined

Total

99.6

118.1

101

-17.1

-14%

estimate in their FY13 periods that reverts back to

a FY11 level of AUD100bn

of long term debt issued in their respective FY12

financial years, up from $100m in their respective
FY11 years.

These expectations are more based off addressing

the known FY13 and FY14 debt maturities rather

than financing the harder to predict new asset
growth.
The Big 4 having AUD84bn equivalent of long term

debt maturing in calendar 2013 and AUD89bn in

2014.The Big 4 are likely to issue AUD100bn long
term debt in 2013 depending on current deposit
growth out pacing credit growth, the actual number
could well be closer to $95bn
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41

Covered bond market development in APAC

Covered bonds are an attractive way for issuers to fund as the savings from issuing versus senior

unsecured debt can be significant. Australia and New Zealand already have established markets;
where as Singapore, South Korea, India are introducing new frameworks for such bonds. Hong
Kong and Japan are debating on types of instruments to introduce
On average, depending on jurisdiction and ratings uplift over senior unsecured, issuers would

save 4050bp in terms of issuance spread on covered bonds versus senior unsecured bonds, Mark Lindon, head of the capital solutions group, Asia at Deutsche Bank in Singapore.
Basel III requires banks as part of their LCR requirement must have enough high quality assets

to survive a month-long stress scenario. This causes problems for countries like Australia, Hong
Kong and Singapore where there is a relative scarcity of government securities. The market has
been given an extra boost by regulation which requires the type of high quality liquid assets
Basel III allows up to 40% of the high quality liquid assets (HQLA) to comprise corporate bonds

and covered bonds rated AA or above. Therefore, covered bonds rated at least AA will be
available to satisfy this element of the LCR, which makes them a very attractive asset in Asia.

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42

Australian covered bond market

In 2012 , the 4 Australian majors issued an AUD $42.7bn across 62 transactions. By currency,

issuance was dominated by EUR, AUD and USD.

CBA was the biggest issuer of covered bonds in 2012 with AUD $14bn issued. Next was WBC with

AUD $9.7bn issued, ANZ AUD $9bn and NAB AUD $7.8bn. Suncorp also issued 3 soft bullet deals
into the domestic market for a total amount of AUD $2.2bn.

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43

Residential Mortgage Backed Securities (RMBS)

There are two dominant forms of financing home loans in the bond markets. One is covered bonds where

banks pledge mortgage assets as extra security to investors. The other is the RMBS in which a pool of home
loans are split into a separate trust which then issues various grades of debt. If 2012 was the year of the
covered bond, 2013 is looking like the year of RMBS.
Covered bonds favour Australias highly rated major banks, while RMBS are considered the great equaliser,

smaller lenders will have more of a fighting chance this year. Issuance is off to a strong start as almost $6
billion worth of RMBS have been sold in 2013 in Australia.
The major banks, regional lenders and non-banks are taking advantage of a sharp contraction in funding

costs as investors turn to structured products because yield is increasing difficult to find.
Moody's Investors Service expects a stable outlook in 2013 for the Australian RMBS, Asset-Backed

Securities (ABS) and Covered Bond (CB) markets. According to a just-released Moody's report titled,
"Australian RMBS, ABS and Covered Bonds: 2013 Outlook," the market for RMBS and ABS will be stable
because Moody's expects a low level of delinquencies and losses, underpinned by an expected GDP growth
rate of 2.5%-3.5%, a continued low interest rate environment, and a steady unemployment rate of 4.5%5.5%. Losses in the RMBS market will be limited because of the amount of equity buffers available for
mitigating losses in the event of obligor defaults. Buffers are expected to be supported by stable housing
prices in 2013, loan seasoning, the long-term trend in house-price appreciation, and continued deleveraging.
For RMBS, the continuation of Australia's low interest rate environment will be the main reason for stable

delinquencies. Moody's expects RMBS 30 days past due delinquencies in 2013 to stay at around the current
levels. As at December 2012, 30 days past due delinquencies were 1.44%.
In the ABS sector, losses are likely to increase only marginally, and will remain low overall, as recovery rates

stay just below their long-term average range of 50%-55%. The expected slight drop in recovery rates is
based on the expectation of continued strength in new car sales in 2013.
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Moodys Analytics

Credit spreads study for 4 major banks in Australia

Spreads for the Big 4 were significantly wider in

offshore markets in the first half of the year.

Domestic secondary spreads were comparatively
well insulated from the pain seen elsewhere.
The CBAs and WBCs inaugural AUD 5yr covered

bond deals which priced at Swap +175bps and

165bps respectively, resulted in wider spreads;
compared to the banks senior unsecured paper.
But this was a short lived blip and order was

restored in March when WBC came back to the

market to price a $2bn domestic 5yr senior
unsecured bond at 165bps exactly the same
level as its earlier covered bond.
The spreads were representing the phase

of

unease due to liquidity squeeze

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Moodys Analytics

Credit spreads study for 4 major banks in Australia

A re-ignition of the European sovereign debt

crisis pushed financial institution spreads

dramatically wider in the 2Q period
The turning point was the agreements made

on bailing out the Spanish banks in early

and mid June in 2012, followed by further
Euro-zone support measures and a gradual
improvement in the US economic situation
(not withstanding fiscal cliff possibilities)
gaining market support thereafter.
Since global macro tail risks have been

slowly receding for a while now, coupled

with a view that the underlying credit
features of the Big 4 are unlikely to change
too much in 2013, the expectation during
the first half of 2013 is to be more of a
period of consolidation at or around current
levels rather than looking for further material
improvement.
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Fund Transfer Pricing (FTP)

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Moodys Analytics

Target Balance Sheet Management Model

Governance / Board Oversight/ Senior Management Oversight
ALM Committee
Measurement of risk areas and possibility of
liquidity crunch

Cash Flow

Hedging

Prepayment

Haircuts

Behavior ( Demand/
and Revolving
facilities)

Maturity mismatch

Pricing
Strategy
Funds
Transfer
Pricing
Model

Internal Audit

Tactical vs. Long term

Market Liquidity

Funding Liquidity

Banking Book

Pricing

Monitoring
Early Warning Indicators

Risk Tolerance

Key Risk Indicators

Scenario Design
Stress Testing

Data and Systems

Governance

Models

Stress Testing

Reporting

Data and Systems

The above framework also meets the requirements of Sound Principles issued by the Basel Committee and requirements from Basel III- International framework
for liquidity risk measurement
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Moodys Analytics

Funding Liquidity Costs as Funds Transfer Pricing (FTP):

Overview
Practitioners use several different methodologies to assign a
transfer rate to a stream of cash flows. There should be an
economic approach to the calculation of transfer prices, which
sheds light upon the financial risks inherent in an instrument, and
associates appropriate premia to each component.

Funds Transfer Price

Commercial Margin
Credit Spread
Option Spread
Funding Liquidity
Spread
Contingent Liquidity
Spread

Figure shows a typical example of the different components

comprising a FTP for a balance sheet asset. In practice, different
variations on the composition of a transfer price may be used,
mixing economic criteria and commercial criteria

The expected cost of funds required to

support the exposure to its remaining life

The cost of maintaining a sufficient cushion of

high quality liquid assets to meet sudden or
unexpected obligations

Reference Rate
Best practices allow for the decomposition of the contribution
margin into its constituent components, i.e. option risk, liquidity
risk, (both contingent liquidity risk and funding liquidity spread),
and credit risk
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49

Common FTP Methodologies

Pooled Approaches: Funds are assigned to one or more pools created under a pre-defined set of criteria.
Criteria for pool classification may be based on type, term, repricing term, origination, or other fund
attributes.
The transfer rate assigned to individual pools is derived either internally, based on actual rates earned or
paid, or alternatively, by market-derived interest rates.
Single Pool
Multiple Pool
Contemporary market rates
Historical market rates at time of transaction origination

Co-Terminus Funds Transfer Pricing: Matched-term methods assign unique transfer rates to each source
and use of funds at the time of origination. But rather than use a discrete series of pools, matched-term
methods derive transfer rates from continuous term structure pricing curves that represent prevailing rates
for wholesale investment/borrowing alternatives available to the institution.
Other FTP methods are :
Strip Funding Method
Stochastic Strip Funding Method
Funding Index Method
Duration Method
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Moodys Analytics

Best Practices in Funds Transfer Pricing

All assets and liabilities must be transfer priced, including the trading book. Reporting units cannot simply
transfer price net positions.
A consistent approach should be applied to interest rate risk measurement, risk adjusted performance
measurement, and customer product pricing
Transfer rates should be based on arms length cash market interest rates
Banks large enough to have a cost of funds curve that is quoted on a daily basis have a source for

cash market rates

Approximately 70% of banks use the LIBOR curve adjusted for term liquidity to reflect cash market

versus derivative market interest rates.

Other banks may use wholesale funding rates or the CD curve.

Funds transfer rates should be applied to individual transactions based on each maturity, repricing, and
vintage assumption; FTP assignments should be until final maturity
Many institutions inappropriately assign short term cost of funds to floating rate products, i.e. 5 year

three month repricing loan gets 3-month LIBOR cost of funds.

The best practice is to develop a floating rate transfer pricing curve(s)
Floating rate loans also need to be adjusted for term liquidity

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Moodys Analytics

Best Practices in Funds Transfer Pricing contd

All instruments should receive a locked in spread for each new transaction; the rate assigned should
remove basis risk
When instruments have embedded options, an option cost/credit should be included in the assigned rate
A central mismatch unit should be used to monitor and manage interest rate risk
Firms that have a broad mix of assets and liabilities sometimes use multiple FTP curves
An unsecured borrowing curve for assets that cannot be pledged as collateral and deposits. The

unsecured FTP curve should be adjusted for standby liquidity and term liquidity.
A secured borrowing curve for pledgable assets i.e. agency MBS and secured borrowings i.e. FHLB

advances. The secured borrowing curve should be adjusted for term liquidity and standby liquidity
costs
Best practices allow for the decomposition of the contribution margin into its constituent components i.e.
option risk, liquidity risk, and credit risk.

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Moodys Analytics

Case Studies

Advisory Services

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6i

Case Study : Liquidity Transfer

Restrictions

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54

Outline of liquidity transfer restriction scenario

XYZ is a large financial institution with a presence across the globe. Several entities operate under

the parent institution umbrella.

Businesses are segregated in USA, UK, Americas and EMEA as one consolidated unit. China and

ASEAN are also consolidated as one unit and Australia, New Zealand as a separate unit.
During normal business conditions, the inter group funding can be transferred across geographical

units while in compliance with regional capital and liquidity requirements.

Under a stressed scenario, some units face a liquidity crunch and are restricted to seeking financial

assistance from the other geographical units which are sufficiently liquid.
Every geographic unit of the bank with global operations must maintain the local liquidity requirement

and can not fund the other units from liquid units; where funds are locked due to regulatory
requirements

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Moodys Analytics

Liquidity Transfer Restrictions Scenario

Reg.
Authority

USA

UK

CHINA

ASEAN

AUS

CCAR & DFA

ILAAP/ FSA

CBRC

HKMA / MAS

APRA

Minimum Liquidity Requirement

Normal
Conditions

Bank with
Global
Operations

US $145 bn
Optimum
LCR

Optimum
LCR

Optimum
LCR

Funds flow

US $ 120 bn

US $105 bn
Optimum
LCR

Funds flow

Optimum
LCR

Intra Group Liquidity Pool = US $570 bn

Minimum Liquidity Requirement

Under Stress

US $45 bn
Liquidity
Situation

US $ 100 bn

US $ 100 bn

Poor LCR

US $ 10 bn

US $ 100 bn
Optimum
LCR

Poor LCR

US $105 bn
Optimum
LCR

US $ 100 bn
Marginal
LCR

Intra Group Liquidity Pool = US $360 bn

Green = Good

Orange = Mild Stress

Red = Severe Stress

Easy fund flow

Restricted flow of funds

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6ii

Case Study : Liquidity Stress Testing

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Moodys Analytics

Link between Solvency and Liquidity

The link between solvency and funding costs comprises two dimensions: (i) an increase of the price to be
paid for funding as suchwholesale funding is particularly sensitive to changes in solvency, but recent
competition for retail deposits is an indication that retail deposits are also becoming more price-sensitive
going forward; (ii) an increase of collateral needs for secured funding sources (margin calls).
Implied Capitalization
(from IRB models etc.)

Time series of Implied Funding

Cost

Time Series of PDs

(from Moodys Analytics)

Historical Link
(linear/nonlinear)

Implied ratings

Portion passed
on to customers

Increase of
funding cost
(benchmark, used for stress
test)

Source : IMF

Light Blue : Inputs

Dark Blue : Outputs

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Moodys Analytics

General Liquidity Stress Testing Framework

Behavior
models

Assumptions

Parameter Variables Setup

Results
(including
cash flows)

Economic
and
Banking
data

Types of Test

Description

Outcome

Implied Cash Flow Analysis

Maturity Mismatch /
Rollover Stress Test

Integrated Liquidity
and Solvency Test

Assesses banks counterbalancing capacity

The
in case of bank run type scenario,
liquidity
gap
simulation
Simulating a gradual outflow of funding for a identifies liquidity gaps for each
maturity bucket. The test is available
time frame
Simulates the impact of
Scenarios account for market liquidity of (i) as a simplified version with
changes of solvency and
assets.
limited data requirements and
concentration
risk
on
The gradual test is usually run as a reverse (ii) as a full fledged cash flow test.
liquidity conditions and vice
test.
versa
LCR, which assesses the counterbalancing
NSFR assesses the stability of
capacity of banks for the next 30 days;
banks funding sources in more
The regulatory weights can be changed to
structural terms.
assess sensitivities
Which banks fail the test?
liquid up to which specific maturity
Which portion of banks remains liquid under
bucket?
Which portion of banks
a specific scenario?
How much is liquidity shortfall, if remains liquid/solvent under
How much liquidity shortfall occurs at the
applicable?
the specific assumptions?
bank and system level, if applicable?
Which portion of banks meets regulatory Which portion of banks meets
How much liquidity/capital
requirements?
regulatory requirements?
shortfall, if applicable?
How much liquidity shortfall occurs, if How much liquidity shortfall occurs,
applicable?
if applicable?

Results
Summary

Contingency
Funding Plan
Source : IMF

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Moodys Analytics

Case Study a Hong Kong based bank seeking

compliance with LM-2 liquidity stress test requirements
Introduction
XYZ International Bank (the Bank) is based in Hong Kong and has a material capital base and

exposure to interest rates, FX rates and other business risks in the industry.
The bank was in the process of establishing a sound and structured contingency funding plan in

order to meet their liquidity requirements, as required by HKMA

Moodys assisted the bank to complete a study of the banks liquidity profile and sustainability

under stress

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60

Regulatory requirement from Hong Kong Monetary

Authority (HKMA)
Hong Kong Monetary Authority (HKMA) required all the banks operating in Hong Kong to comply

with LM-2.
LM-2 outlines the variables a bank should consider and the metrics a bank should follow in order to

establish sound contingency funding plan and best practices in the industry to meet any liquidity
situation arise during a crisis.
The primary objective of this exercise was to stress their liquidity profile by constraining deposits

and loans in such a way that it projects variability in liquidity under different scenarios.
The primary goal of LM-2 is to promote awareness in the Hong Kong banking industry regarding

liquidity situations by conducting health checkups on a regular basis.

Credit downgrade and cost of funding during a crisis are the major metrics a bank should focus on

while revamping their contingency funding plan.

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Moodys Analytics

Scenario Design Principles

Designing Stress Testing Scenario

Liquidity risk and other inherent risks (e.g. credit,

market, interest rate, operational, reputation and

strategic) faced by AIs are not mutually exclusive and

Identify bank specific vulnerabilities

Short term
Long term

Interest
Rate Risk

should not be considered in isolation.

The

Short term
Long term

scenarios

should

cover,

at

minimum,

institution-specific and market-wide stress scenarios

(individually and in combination).
The scenarios should also cater for short-term and

Operational
Risk

Liquidity
Risk

Market
Risk

protracted liquidity stresses. (HKMA LM-2, 5.1.2)

Potential sources of demand for liquidity arising from

off-balance sheet commitments and other contingent

Short term
Long term

Short term
Long term

liabilities should also be addressed.

Credit Risk

These tests should consider the implications of the

stress scenarios across different time horizons,

including on an intraday basis. (HKMA LM-2, 5.2.1)

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62

Banks business profile and requirement

The bank has a material exposure to several currencies including Chinese Yuan, US Dollar, Aussie

Dollar, Euro and British Pound.

The bank is concentrated around Hong Kong local market.

The bank required a structured approach to achieve regulatory compliance and define a

contingency funding plans to derive liquidity support from either the Central bank or funding from
another geographical locations.

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63

View on market environment

Liquidity and Interest rates
After a detailed analysis of Hong Kong economy with a global perspective, MA concluded that

there could be a prolonged liquidity stress due to the Euro-zone crisis, slower recovery of US
economy and downward trends in GDP growth among major economies in Asia, including China
and Japan.
It was expected that the interbank interest rates will remain at lower levels until US, Euro and

Japanese economies recover from their crisis.

This may impact the overall liquidity in the market because higher interest rates during the time of

crisis have not been seen over the last 5 years or so;

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Moodys Analytics

Key Consideration - Interest Rates

Overnight Rates - Global Trend

25

Rates in %

20
15
10

There is a linkage between liquidity and

SGD O/N
HIHDO/N Index

AUS O/N
US00O/N Index

01/01/2011

01/01/2009

01/01/2007

01/01/2005

01/01/2003

01/01/2001

01/01/1999

01/01/1997

SHIFO/N Index

From the observations of monthly data for

LIBOR 3M - Global Trend

major currencies since 1997, there is an

observed inflation in interest rate to re-price
the impending risk.

30
25
20
15
10

01/01/2011

01/01/2009

01/01/2007

01/01/2005

01/01/2003

01/01/2001

01/01/1999

5
01/01/1997

Rates in %

interest rate risk which affects the funding

costs and higher cash outflows as result of
increased funding costs

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Moodys Analytics

Interest rates in todays economic scenario

LIBOR 1M - Global Trend

35
30
Rates in %

25
20

However, if the crisis tends to prolong for

15

a usually observable period for example,

more than 6 months, then a clear linkage
can be established between interest rate
risk and liquidity.

10

USD1M

HKD1M

CNY1M

01/01/2011

01/01/2009

01/01/2007

01/01/2005

01/01/2003

01/01/2001

01/01/1997

01/01/1999

SGD1M

AUD1M

funding costs tend to rise on an overall

balance sheet level for the Bank causing
strain on cash inflow.

LIBOR 6M - Global Trend

30

As a result of higher interest rate, the

25

Also, visibly

all currencies move in

tandem (visible from the charts) causing
higher than usual cash outflow if the Bank
operates in different currencies.

15
10

01/01/2011

01/01/2009

01/01/2007

01/01/2005

01/01/2003

01/01/2001

01/01/1999

01/01/1997

Rates in %

20

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Moodys Analytics

Interest Rates cont

Hence, the overall process of interest rate

risk movements operates as a cycle where

after higher interest rates, market tends to
ease the liquidity situation to push down the
interest rates so as to reach a lower
equilibrium.

LIBOR 9M - Global Trend

30

20
15
10

The cascading effect should be included

01/01/2012

01/01/2011

01/01/2010

01/01/2009

01/01/2008

01/01/2007

01/01/2006

01/01/2005

01/01/2004

01/01/2003

01/01/2002

01/01/2001

01/01/2000

01/01/1999

01/01/1998

5
01/01/1997

Rates in %

25

Dates
AUD9M

SGD9M

CNY9M

HKD9M

USD9M

and affected in the balance sheet across

different geographic regions as interbank
rates across different currencies / regions
have shown a similar behavior
Interest rate movements will play a central

role in our scenarios through extensive

sensitivity analysis

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Moodys Analytics

As seen from the crisis, GDP is an indicator of volume of

liquidity
World Economies - Real GDP YoY % Change
YoY Percentage Change each quarter

50
40
30
20
10
0
-10
-20
US.GDP BEA Index YOY% change

HK.GDP HKST Index YOY% change

SGDPYOY Index YOY% change

AUSGDP YoY%

CN.GDP CNST Index YOY% change

Dates

Over the years since 1997, different geographic regions experienced different types of economic crises in

the global context.

In 1997/98, the Asia Financial Crisis was limited to Asian markets. In 2007/08, the US Credit Crunch/ US

subprime mortgage crisis had a worldwide adverse effect on global economy.

The impact resulting from the current Euro zone debt crisis has yet to be felt in Asian context, particularly in

liquidity. The protracted Euro debt crisis has started to cause a strain in global economy evident in countries
like China and Hong Kong, where economic growth has started to stall and liquidity concerns are rising.
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Moodys Analytics

Behavior modelling for liquidity assessment and

compliance
Complex customer behavior and current economic environment requires a bank to model their

deposits and loans portfolio according to industry practices.

Prepayment of loans, run-offs in deposits, core and non-core portion of total deposits, usage of

undrawn facility etc. are also some major areas a bank should focus on and consider them as
liquidity variables.
The bank modelled 80% of their balance sheet covering all of their loans and deposit portfolios

in retail and wholesale banking.

This approach helped the bank to devise a more comprehensive strategic funding plan under

stress. This was also required by HKMA LM 2 guidelines.

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Moodys Analytics

Results of Stress testing - Net Cash-flow and Cumulative Gap

Banks fund requirement was deep from 3 months to 9 years;
without considering prepayments and core run-off. Behavioral
consideration was an major part of conducting stress testing

The bank was sufficiently liquid to meet its fund obligations; AFS
securities were sufficient enough after 3 notch credit downgrade to fill the
gap in funding; core deposit run-off peaked during the stress situation
while prepayment became stagnant

HKD Liquidity Gap Report (Before)

HKD Liquidity Gap Report (After)

15,000

70,000
10,000

9,480

60,000

8,009

6,335

53,878

50,000

49,262

5,100
5,000

44,137
40,000

4,802
3,207

3,598

3,171
2,256

2 TO 7
DAYS

(174)
1 TO 3

8 DAYS
3 TO 6 6 TO 12 1 TO 2
TO 1
MONTHS MONTHS MONTHS YEARS
(137)
MONTH

2 TO 3
YEARS

3 TO 4
YEARS

4 TO 5

(348) YEARS
(589)

5 TO 7
YEARS

7 TO 10 10 TO 15 15 TO 20 MORE
YEARS YEARS YEARS THAN 20
(1,534)
YEARS

(3,280)

34,284
24,647

10,000

(10,000)
(6,634)

(7,099)(7,447)
(8,037)
(10,000)

31,227

12,910
12,910

22,547
17,802 11,738
4,745

7,209 7,768

4,616

2,433 1,669

55

(2,457)
(5,000)

46,686

41,494

30,000
20,000

NEXT
DAY OR
LESS

1,471

1,403

2,256 2,283
27

56,311 57,979 58,035 58,035 58,035

NEXT
2 TO 7
DAY OR DAYS
LESS

8 DAYS 1 TO 3 3 TO 6 6 TO 12 1 TO 2 2 TO 3 3 TO 4 4 TO 5 5 TO 7 7 TO 10 10 TO 15 15 TO 20 MORE
TO 1 MONTHS MONTHS MONTHS YEARS YEARS YEARS YEARS YEARS YEARS YEARS YEARS THAN 20
MONTH
YEARS

(6,845)

(11,348)

(20,000)
(19,489)
(30,000)

(10,450)
(10,276)

(10,560)
(10,697)

(13,731)
(15,000)

Stressed Net Cash Flow Gap CCS

Net Cash Flow Gap Original

Net MCO Gap Original

Stressed Net MCO Gap CCS

Net MCO Gap Re-Profiled

Conclusion
This study enabled the bank to assess their soundness in terms of liquidity and gave them a perspective about the extreme market
conditions where they can strategically plan their funding requirements and stay creditworthy during the time of crisis. The risk return
balance and cost of funding under stress situation were the other aspects, the bank analyzed in detail.
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Shareholder Value Consideration

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Shareholder Value
Shareholder value has become the pre-eminent performance measure in many industrial

companies and it has significantly affected how some banks have tried to optimize their business.
The objective of the study by S Gross in 2006 and Koller, Goedhart & Wessels 2010 was to find the

metrics that are able to quantify the story behind shareholder value and to understand the
fundamental drivers of value.
Intrinsic value

Financial indicators

Operational value drivers

Income/Equity

EVA or
Residual
Income

Residual
income
on Equity

Return on
Equity
(After tax)

Cost/Equity
Loan Loss
Provision/Equity
Taxes/Equity

Economic
equity

Cost of Equity

Business mix:
Diversification of
income
Risk capabilities:
LLP/Interest income
Branch structure:
Customers/Branch
Cost efficiency:
Total cost/Employees

Gross, S. 2006, Banks and shareholder value - An overview of banks valuation and empirical evidence on shareholder value for banks
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Value Drivers
1

Interest
rate
liabilities
Interest
rate
assets

Net
interest
income
3

Interest rates on products

Volumes: Book values of assets

and liabilities outstanding

Cost-to-income ratio: Operating

costs of business relative to net
interest income

Capital ratio: Equity requirements

for assets outstanding

COE: Cost of equity based on

asset liability mix

Growth: Growth of assets and

liabilities

Liabilities

Cost / income

Operating
expenses

Assets

Additions
to loan loss
provisions

Return
on
equity
5

Value
creation

Cost of
equity
Growth

Equity
6

Capital ratio

Loan losses: Expected future

losses on loans outstanding

Source: (Koller, Goedhart & Wessels 2010)

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Cost to Income ratio vs. Loan to Deposit ratio in APAC

A recent study by McKinseys in 2011 examined the relationship between loan to deposit ratio and cost to
income by country:

1.2

80.00%
Malaysia A3

Thailand Baa1
Vietnam B2
Taiwan Aa3
1

Australia Aaa
Korea Aa3

60.00%

Cost to Income ratio

Australia Aaa China Aa3

50.00%

Indonesia Baa3

Philippines Ba1

Indonesia Baa3

Singapore Aaa

India Baa3
India Baa3
China Aa3

40.00%

Japan Aa3

Malaysia A3
Korea Aa3
Hong Kong Aa1

0.8

Taiwan Aa3
Thailand Baa1

Singapore Aaa
0.6

Japan Aa3
Philippines Ba1

Vietnam B2

30.00%

Loan to Deposit ratio

70.00%

0.4
20.00%

Hong Kong Aa1

0.2

10.00%

0.00%

Countries Position in 2011

Cost-to income ratio

Loan-to-deposit ratio
Data Source : McKinsey & Company : Annual Review of Banking Industry 2011

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Revenue margin vs. Loan to Deposit ratio in APAC countries

Revenue margins with respect to loan to deposit ratio reflect business strategies and portfolio composition.
Australia, an A investment grade country, has a good loan to deposit ratio, however revenue margins are
somewhat restricted. Hong Kong with a similar grade, also has lower margins but the loan to deposit ratio is
also lower
1.2

4.00%
Thailand Baa1
Indonesia Baa3
Malaysia A3

Vietnam B2
Vietnam B2
1

Australia Aaa
Korea Aa3

Revenue Margin

3.00%

2.50%

2.00%

Indonesia Baa3
Thailand Baa1
Taiwan Aa3
Singapore Aaa

India Baa3
China Aa3
China Aa3
India Baa3
Japan Aa3Korea Aa3

Philippines Ba1

0.6

Philippines Ba1
Malaysia A3

1.50%

0.4

Australia Aaa
1.00%

0.8

Loan to Deposit ratio

3.50%

Japan Aa3

Hong Kong Aa1

Hong Kong Aa1

Taiwan Aa3
Singapore Aaa
0.2

0.50%

0.00%

Country Position in 2011

Loan-to-deposit ratio

Revenue margin
Data Source : McKinsey & Company : Annual Review of Banking Industry 2011

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Risk to cost ratio vs. Loan to deposit ratio

Risk to cost ratio i.e. loan loss provisions/total retail and wholesale loan volumes (at average of period);
where higher risk to cost with higher loan to deposit ratio impose a greater risk in terms of liquidity. This
requires lot of attention in managing business portfolio leading to higher cost of funds. Significant
comparison can be drawn between A & B grade countries. High growth countries like China and India
have a lower risk ratio compared to loan to deposit.
Risk to cost ratio vs. Loan to deposit ratio
2.50%

1.2

Thailand Baa1
Malaysia A3

Vietnam B2
Vietnam B2

Australia Aaa

Korea Aa3
2.00%

1.50%

0.8

Taiwan Aa3
Singapore Aaa

India Baa3
China Aa3
Malaysia A3

Philippines Ba1

0.6

Japan Aa3
1.00%

Indonesia Baa3

Philippines Ba1
Thailand Baa1

Korea Aa3
China Aa3
Australia Aaa

India Baa3

0.50%

Japan Aa3

0.00%

Singapore Aaa
0.2

Countries Position 2011

Risk-to cost ratio

0.4

Taiwan Aa3

Hong Kong Aa1

Hong Kong Aa1

Loan to Deposit ratio

Risk to Cost ratio

Indonesia Baa3

Loan-to-deposit ratio
Data Source : McKinsey & Company : Annual Review of Banking Industry 2011

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Relationship between Credit Origination and Liquidity

and FTP Process - An Illustration
Data
Feed
Financial
Spreading

FTP
RWA
Econ.
Cap.

Rating

Pricing
EAD/LGD

Fac.
Rating

CVA/PFE Netting

Option
Spread

Liquidity
Spread

Contingent
Liquidity
Spread

Capital
Charge

Funding
Liquidity
Spread

LCP

Correlations
Pipeline

EL

Liquidity
Buffer

Liquidity
Gap (C/F)

Migration related
Econ. Cap.

Limits

Risk Systems

Waterfall
rec.

RAROC
EVA

RoRWA, RoLIquidity Cost

Business Unit Level Profitability

P/E

Long Term average ||Stock Price Vol. compared to 25 peers

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Shareholder Value: Building Blocks

BUSINESS WACC

EVA/EP

Shareholder Value

BUSINESS UNIT Performance

RAROC

RoRWA,
RoLIQUIDITY COST

LIQUIDITY/
CAPITAL
CHARGES

LIQUIDITY & CAPITAL MANAGEMENT

Liquidity Gap

Liquidity
Spread

Capital
Charge

Liquidity
Buffer

Capital
Buffer

RAROC = Risk Adjusted Return on Capital

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Conclusion
After decades of consistent success, global banking is facing a period of historic change.

Many of the profitable mechanisms developed in the years leading up to the financial crisis are now

obsolete and unlikely to be revived anytime soon.

The banking business model is under pressure from a combination of regulation, technological change,

and macro volatility.

While banks have strengthened their balance sheets in the recent period, there has been little progress

towards sustainable growth, with revenues still below pre crisis levels.
Capital and costs must be better managed and the trust of investors, regulators, and wider society

regained.

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Questions?

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