BOJ introduces new liquidity standards for banking sector
The Bank of Jamaica (BOJ) has imposed new liquidity standards for the island’s banking sector, which will be phased in over a one-year period beginning this month.
The standard aims to ensure that a financial institution has an adequate stock of unencumbered high-quality liquid assets (HQLAs), consisting of cash or assets that can be converted into cash at little or no loss of value in private markets to meet its liquidity needs for a 30-calendar day liquidity stress scenario.
The new standards require that banks and other deposit-taking institutions have a 100 per cent Liquidity Coverage Ratio (LCR), which has the primary objective of supporting and improving the short-term resilience of the liquidity profile of financial institutions.
This is attained by ensuring that these institutions have sufficient HQLAs to survive a significant stricture to funding sources lasting 30 calendar days. Ultimately, the LCR is designed to improve the deposit-taking sector’s ability to survive the shocks arising from financial and economic stress, thereby reducing spill-over risks from the financial sector to the real economy.
PHASED IMPLEMENTATION
This standard aims to ensure that financial institutions have an adequate stock of unencumbered HQLAs. Taking into consideration the varying states of readiness of licensees for compliance with the full LCR requirement, the BOJ will phase it in over a one-year period beginning this month end.
The minimum requirement will first be set at 75 per cent in October 2019 and be increased to 100 per cent as at the end of October 2020.
For the purposes of the LCR, the stress scenario reflects a financial institution’s total net cash outflows (ie the difference between cash outflows and inflows) that arise over a period of 30 calendar days.
At a minimum, the stock of unencumbered HQLAs should enable the financial institution to survive until day 30 of the stress scenario.
The BOJ anticipates that “by this time it is assumed that management would have taken appropriate corrective actions and the supervisor would have implemented appropriate intervention measures to address the root cause of any liquidity problem. Furthermore, given the uncertain timing of outflows and inflows, financial institutions are also expected to be aware of any potential mismatches within the 30-day period and ensure that sufficient HQLAs are available to meet any cash flow gaps throughout the period.”
STANDARDS REQUIREMENT
The central bank says “the standard requires that, absent a situation of financial stress, the value of the ratio be no lower than 100 per cent (ie the stock of HQLAs should at least equal total net cash outflows) on an ongoing basis because the stock of unencumbered HQLAs is intended to serve as a defence against the potential onset of liquidity stress.
In this new regime, banks in the interim will be required to submit a detailed plan indicating the steps they will take to be fully compliant with the LCR when the minimum LCR requirement of 100 per cent becomes fully effective.
“Any banks that reports LCR below the minimum requirement will be required to provide the supervisor with an assessment of its liquidity position, including factors that contributed to its LCR falling below the minimum requirement, the actions that have been and will be taken to remedy the breach and the length of time required to implement such measures,” the BOJ states.
In instances where a licensee reports LCR below the minimum requirement, the supervisor, as is deemed appropriate, will have the authority under the LCR regime to require a licensee to execute one or more, of the following: (i) reduce its liquidity risk exposure; (ii) strengthen its overall liquidity risk management; and (iii) improve its contingency funding plan.
Recent policy measures aimed at fiscal consolidation have materially changed the operating environment for liquidity risk management in Jamaica. According to the BOJ, “This ongoing reform programme provides an opportunity for the modernisation of Jamaica’s prudential framework to be better aligned with international sound practice.”
The LCR provides the supervisor with the authority to make determinations, on a case-by-case basis, in terms of members of financial groups that should be included or excluded from the scope of consolidation for the purposes of the LCR. Notably, the scope of the LCR does not include liquidity risks stemming from insurance business conducted within financial groups.