08 Jul Bank Liquidity in a COVID-19 Pandemic Scenario
By: Orlando Sampaio, Global Product Manager, AxiomSL LATAM
Banks have always been at the center of most systemic financial crises, starting, perhaps, with the Great Depression, which originated in the Wall Street crash of 1929, going through the Asian crisis of 1997 due to the overexpansion of credit and the excessive accumulation of debts in economies of the region, until the financial crisis of 2007 – 2008, originated in the housing bubble of the United States.
During the crisis that started in 2007, many banks, despite having adequate capital ratios, were in serious difficulty due to liquidity issues. As before the crisis, funding resources were available at low cost, banks did not care if they did not have resources readily available to cover their obligations, as it was enough to go to the market to obtain these resources. Trusting that, many banks did not bother to do a good liquidity management, thinking about crisis situations like the one that occurred.
For this reason, the Basel Committee published in 2008 the document Principles for Sound Liquidity Risk Management and Supervision and defined two minimum standards for financing liquidity, the LCR (Liquidity Coverage Ratio), which encourages the resilience of the profile of the bank’s short-term liquidity and the NSFR (Net Stable Funding Ratio), which allows a longer-term view of the financing sources of its activity.
Bank Liquidity during the pandemic
The COVID 19 crisis, despite having a financial face, did not originate in the markets, but was due to a public health problem. Solid companies had to stop their activities and quarantine their teams to slow the transmission of the virus. Many of these companies laid off a large number of employees because they did not have the resources to maintain their salaries during the crisis, which is not expected to end. This means, for banks, a scenario with an increase in defaults due to the lack of capacity of people and companies to fulfill their obligations and, at the same time, a decrease in the ability to finance through withdrawals from current accounts and investments.
For this reason, Central Banks had to adopt measures to stabilize the financial market, particularly in terms of liquidity. The United States Federal Reserve Board, for example, promoted the repurchase of Government Bonds and the federal government provided guarantees for mortgage bonds, as well as substantially increased repo operations.
Central Bank of Brazil also took action
The Central Bank released several regulatory requirements like:
- Reduction of provisions for losses through the classification of credit operations to risk levels before the COVID19 crisis.
- Decrease in compulsory deposits on time deposits, freeing up resources to increase liquidity in the financial system.
- Reduction in capital allocation for new loans granted to small and medium-sized enterprises (SME).
- Change in the Liquidity Coverage Ratio (LCR) calculation criteria, making the compulsory deposits held at the Central Bank eligible for the calculation in the High Quality Liquid Assets (HQLA) in the calculation of the LCR.
- Decrease in the Mattress for Capital Conservation of Required Capital according to Basel III rules, from 2.5% to 1.25%.
- Reduced capital requirements for small financial institutions.
The Role of Technology
The current turbulence took a form never seen before in recent times and even banks fully prepared for crises, with controls already fully established, suffered the impacts. In order to carry out an effective crisis management, the internal teams had to quickly understand the causes and consequences, both in the short and long term, and implement tactical solutions that can be maintained for a longer time.
AxiomSL’s liquidity solution offers financial institutions the ability to automatically generate their liquidity regulatory reports, while also allowing them to stress the positions and parameters of these calculations. The open architecture of the solution, together with the visual programming resources, considerably accelerate changes and adaptations to new internal or regulatory requirements, making our ideal tool for the constantly changing market.
If you want to know more information about AxiomSL’s Liquidity Regulatory Reports solution and how our clients comply with all their regulatory requirements, contact us here.