Liquidity Coverage Ratio (LCR)

BASEL III Overview

Kevin Grabowski– Global Product Manager
Ph. 704-715-7444
Kevin.Grabowski@wellsfargo.com
Cathy Bader- Treasury Product Consulting Mgr.
Ph. 336-732-6561
Cathy.Bader@wellsfargo.com

March 16th, 2016

© 2016 Wells Fargo Bank, N.A. All rights reserved. For public use.
 BASEL III /Liquidity Coverage Ratio
BASEL III is a comprehensive set of
reform measures designed to improve
the regulation, supervision and risk
management within the banking sector
 Internationally agreed upon measures will
strengthen risk weighted capital
requirements Limit
systematic
 Introduced two new standards; Leverage risk
Ratio and LCR
 Designed to ensure banks have adequate
capital and stable sources of funding to
withstand a crisis

The regulations will have an impact on banks and their clients

 Customers can expect:
– A push for deeper relationships from their bank including a mix of products and
services

– The market adapting to provide new and different banking services

– Competition for LCR ‘friendly’ deposits

Source: Basel Committee on Banking Supervision, Bank of International Settlements, BOAML
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 BASEL III /Liquidity Coverage Ratio
The LCR is a component of the Basel III liquidity standards.
 It is a measure requiring banks to hold High Quality Liquid
Assets (HQLA) at least equal to projected net cash outflows
over a 30 day macro stress scenario
 The objective of the new capital rules and specifically the
LCR is:
– To improve institutions ability to withstand periods of economic
stress and function as financial intermediaries during those
periods
– Better reflect an institutions risk profile

Net cash outflows include HQLA includes

 Deposit run-off
 Funding of undrawn credit /
liquidity facilities
 Funding of contingent liabilities
Source: OCC, Federal Reserve Board, FDIC
 Cash & cash equivalents
 Agency securities
 IG corporate bonds
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 How is the Liquidity Coverage Ratio calculated?
The intent of the LCR is to ensure that banks remain liquid in a period of stress
by requiring banks to hold HQLA against customer deposits

High Quality Projected Liquidity

Liquid Assets Net Cash Outflows Coverage Ratio
$90B* $100B* 90%*
Numerator Denominator 100% by Jan 2017

The bank should have enough high quality liquid Different types of deposits have different
assets to cover projected net cash outflows. run-off assumptions.

High Quality Liquid Assets Projected Net Cash Outflows

Level 1 Assets Retail

Cash & Treasuries $60B* Consumer & Business customer $60B*
(<=$1.5MM in balances)

Level 2A Assets Wholesale

Agency Mortgage Backed Securities $20B* Business customer $40B*
(can be no more that 40% of total) (>$1.5MM in balances)

Level 2B Assets
Investment Grade Corporate Bonds $10B*
& Select Common Stock

*Numbers are for illustration purpose only

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 Operational versus non-operational deposits
 All depository institutions will evaluate their portfolio to determine
whether a deposit is deemed Operational or Non-Operational
 Operational deposits provide added value to the overall organization
– Defined as “fully transactional; sticky money”
– Used to fund customers key operating activities

 Non-operational deposits require banks to hold more HQLA

– Higher runoff factors than operational balances; greater likelihood of
being drawn down in a period of financial crisis

 Deposits must pass a series of tests in order to be deemed

Operational*
– Switching cost test: ease of which to exit cash management services in
30-days
– Market rate test: alignment of customer rates with the “market”
– Operational services test: number of cash management products tied to
a deposit

*All FI’s have created their own tests based on the regulation; there is no one size fits all
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 Deposit Outflow Factors
Expected cash outflow is determined by multiplying balances levels by the
outflow factor. Customer type or Counterparty determines the rate applied.

Operational Non-Operational
Insured Uninsured Insured Uninsured
Non-Financial Corporate 5% 25% 20% 40%
Mortgage Escrow N/A 25% N/A N/A
Public Sector Entity 5% 25% 20% 40%
US GSE 5% 25% 20% 40%
Sovereign Entity 5% 25% 20% 40%
Multilateral Development Bank 5% 25% 20% 40%
Non-Bank Regulated Financial Company 5% 25% N/A 100%
Pension Fund 5% 25% N/A 100%
Investment Advisor N/A 25% N/A 100%
Investment Company N/A 25% N/A 100%
Non-Regulated Fund N/A 25% N/A 100%
Bank 5% 25% N/A 100%
Special Purpose Entity 5% 25% N/A 100%
Other Legal Entity 5% 25% N/A 100%

Source: OCC, Federal Reserve Board, FDIC

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Unfunded commitments attract an LCR outflow
(and cost)
What credit products are currently in scope?
 Unfunded credit facilities:
– Availability under general working capital facilities (e.g., revolving credit lines)

 Liquidity facilities:
– Commercial paper (CP) backup facilities – Assumes CP issuers lose access to short-
term CP funds and have to turn to Bank liquidity facilities

– Variable rate demand obligations (VRDOs)

• Standby bond purchase agreements - Put feature allows the investor to put the obligation back
to the issuer/financial intermediary

• Direct Pay LCs – liquidity facility that can be drawn on to pay bondholders if the underlying
issuer is unable to fulfill its obligation

 Facilities not currently receiving a run-off %:

– Standby Performance & Financial LCs

– Trade LCs

– Fully funded loans

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LCR – Customer impacts

 Media reports on the impacts of LCR to the banking industry

have fully caught the attention of our customers.
– Introduction of new deposit or TM fees to keep account open
– Shedding 100% runoff deposits altogether
– Some banks are still offering bids or rates well above (below)
competitor price points
 Customers are getting conflicting and confusing
messages/proposals all for the same piece of business.
– Due to ambiguity of the rules; interpretation
– Looking for insight and guidance from their bank – impacts new
and existing customers

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LCR – What can customers expect?
Started our conversation today with the following:

 Push for deeper relationships from their bank including a mix of

products and services
– Deepening client relationships make it more difficult for customers to
take their cash management business and related deposits to a
competitor; retaining/expanding these relationships is a key to
maximizing operational deposits

 The market adapting to provide new and different banking services

– New deposit products are being developed to minimize the HQLA banks
need to hold especially for 100% runoff counterparty types

 Competition for LCR ‘friendly’ deposits

– Each bank is looking at their balance sheet mix and the types of clients
they do business with. For those looking to recalibrate with more LCR
favorable deposits, there will be institutions who are very aggressive with
rates and prices offered to particular customer types

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Appendix

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Appendix – U.S. Operational Deposit Definition
 Definition – Unsecured wholesale funding that is required for the bank to provide
operational services as an independent third-party intermediary to a wholesale
customer

 In order for deposits to be considered “operational” they must:

1. Be held pursuant to a legally binding written agreement, the termination of which

is subject to a minimum 30-day notice period or significant termination costs are
borne by the customer

2. Not have significant volatility in the average balance of the deposit

3. Be held in an account designated as an operational account

4. Be maintained at a bank for the primary purpose of obtaining operational services

5. Not be designed to create an economic incentive for the customer to maintain

excess funds therein through increased revenue, reduction in fees, or other offered
economic incentives

6. Demonstrate the deposit is empirically linked to operational services and there is a

methodology for any excess amounts (excess amounts need to be excluded)

7. Not be provided in connection with the bank’s provision of operational services to

an investment company, non-regulated fund, or investment adviser

8. Not be for correspondent banking arrangements pursuant to which the bank

(as correspondent) holds deposits owned by another depository institution bank
(as respondent)
Source: OCC, Federal Reserve Board, FDIC
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 Appendix – Wholesale Counterparty Types
 Mortgage Escrow – Not technically a counterparty type; 25% prescribed outflow. No
need to determine operational vs. non-operational

 Public Sector Entity – A state, local authority, or other governmental subdivision

below the sovereign entity level

 US GSE – An entity established or chartered by the Federal government to serve

public purposes specified by the United States Congress, but whose debt obligations
are not explicitly guaranteed by the full faith and credit of the United States
government. For example, FHLMC, FNMA, FHLBs, Farm Credit

 Sovereign Entity – Central Government, Agency, Department, Ministry, or Central

Bank of a Central Government. Includes GNMA and other Government Guaranteed
Entities

 Multilateral Development Bank – 15 named institutions plus any other entity that
provides financing for national or regional development in which the U.S. government
is a shareholder or contributing member

 Bank – Bank, Credit Union, Foreign Bank, Depository Institution, Industrial Bank, Bank
Holding Company, Covered Depository Institution Holding Company, Depository
Institution Holding Company, Saving and Loan Holding Company, Industrial Loan
Company

 Non-Bank Financial Institution – Insurance Company, Securities Holding Company,

Broker or Dealer, Futures Commission Merchant, Swap Dealer, Security-based Swap
Dealer, Designated Financial Market Utility
Source: OCC, Federal Reserve Board, FDIC
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 Appendix – Wholesale Counterparty Types
 Pension Fund – Employee benefit plan as defined in paragraphs (3) and (32) of
section 3 of the Employee Retirement Income and Security Act of 1974 (29 U.S.C.
1001 et seq.), a “governmental plan” (as defined in 29 U.S.C. 1002(32)) that complies
with the tax deferral qualification requirements provided in the Internal Revenue Code,
or any similar employee benefit plan established under the laws of a foreign jurisdiction

 Investment Adviser – A company registered with the SEC as an investment adviser

under the Investment Advisers Act of 1940 (15 U.S.C. 80b-1 et seq.), or foreign
equivalents of such company

 Investment Company – A company registered with the SEC under the Investment
Company Act of 1940 (15 U.S.C. 80a-1 et seq.) or foreign equivalents of such
company (Money Market Funds and Mutual Funds.)

 Non-Regulated Fund – Any hedge fund or private equity fund whose investment
adviser is required to file SEC Form PF (Reporting Form for Investment Advisers to
Private Funds and Certain Commodity Pool Operators and Commodity Trading
Advisors), and any consolidated subsidiary of such fund, other than a small business
investment company as defined in section 102 of the Small Business Investment Act of
1958 (15 U.S.C. 661 et seq.)

 Special Purpose Entity – A company organized for a specific purpose, the activities
of which are significantly limited to those appropriate to accomplish a specific purpose,
and the structure of which is intended to isolate the credit risk of the special purpose
entity

 Non-Financial Corporate – All other entities

Source: OCC, Federal Reserve Board, FDIC
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