Six questions about the Net Stable Funding Ratio (NSFR) requirement

Six questions about the Net Stable Funding Ratio (NSFR) requirement

Six questions about the Net Stable Funding Ratio (NSFR) requirement

Yesterday, the Basel Committee on Banking Supervision (BCBS) “reiterated their expectation of full, timely and consistent” implementation of the Basel III standards for internationally active banks.”  The last outstanding element of the original Basel III standards is the NFSR, which has been proposed in the United States but not yet finalized.  The NSFR is intended to ensure that banks have a robust funding profile over a one-year horizon and to complement the liquidity coverage ratio (LCR) requirement, which focuses on ensuring that banks have sufficient high-quality liquid assets (HQLA) to cover expected net cash outflows under severe stress at a thirty-day time horizon. The NSFR was the last of the major post-crisis regulatory reforms released by the Basel Committee and, because it was developed and completed on a rushed basis, the final version features several significant and serious flaws.  (For BPI analysis on the NSFR see this note and the nine additional reports cited therein.)

As a general matter, the NSFR is intended to ensure that a bank’s sources of funding are sufficiently stable to support its assets and activities over the course of the coming year.  To that end, the NSFR is defined as the ratio of “available stable funding” (ASF) to “required stable funding” (RSF), and, under the proposal, banks with more than $250 billion in assets would be required to maintain an NSFR ratio of at least 100 percent.  Banks with between $50 billion and $250 billion in assets would be required to maintain an NSFR of at least 70 percent.  ASF is determined by taking each bank liability and element of regulatory capital, multiplying it by an “ASF factor,” and then adding up all the resulting, weighted numbers.  The ASF factors, which vary between 0 and 100 percent, are meant to measure the stickiness of each liability – the less likely a liability is to need to be replaced or repaid, the higher the assigned ASF factor should be.  For example, large, brokered deposits have an ASF of 50 percent and insured retail deposits have an ASF of 95 percent.  RSF is similarly determined by summing bank assets weighted by “RSF factors.”  The RSF factors are meant to measure the difficulty of liquidating an asset and, like ASF factors, they also vary from 0 to 100 percent.  For example, an overnight reverse Treasury repo has an RSF of 10 percent and a non-qualifying 30-year mortgage have an RSF of 85 percent.

There are six important questions that we think policymakers should be asking their staff about the NSFR before deciding to finalize it.

Question 1: How, exactly, were the ASF and RSF factors determined and calibrated?

While the NSFR proposal lists the characteristics that determined relative levels of the ASF and RSF factors (eg. “…the proposed rule would generally require less stable funding for shorter-term assets compared to longer-term assets) the proposal includes no explanation of what the absolute levels of the factors are intended to mean.  Perhaps not surprisingly given that the proposal doesn’t provide the intended meaning of the factors, the proposal also does not explain how regulators/authors/draftsmen/Fed staff came up with the proposed calibration.  On what empirical basis did they pick the specific ASF and RSF factors?

Question 2: Why are the ASF and RSF factors that define the NSFR inconsistent with the LCR?

For example, why does the LCR assume a bank can liquidate all its Treasury securities within 30 days, but the NSFR assume a bank can only liquidate 95 percent after a year?  Why does the LCR assume that all of a banks’ unsecured short-term lending is repaid within 30 days while the NSFR assume that only 85 percent is repaid within a year?

Question 3: How was the proposed requirement that banks with between $50 billion and $250 billion in assets maintain an NSFR of at least 70 percent derived?

We suspect that the answer is related to the reason why these banks are required to maintain an LCR of at least 70 percent rather than 100 percent. The regulation implementing  the LCR explains that the 70 percent requirement is intended to approximate ensuring that the banks have sufficient liquidity for 21 days of stress (versus the 30 day horizon for larger banks).   Is the 70 percent NSFR requirement intended to reflect roughly a 3-quarter horizon rather than a one-year horizon? If so, then the specification is incorrect; the designer need to check their math (see note).i

Question 4:  Is the NSFR necessary?

The regulatory agencies require banks to conduct monthly stress tests across at least overnight, 30-day, 90-day, and one-year horizons, and these and other internal liquidity management processes are subject to substantial, ongoing supervisory scrutiny and review, including through horizontal examinations such as the Comprehensive Liquidity Assessment and Review (CLAR).  Indeed, liquidity risk management is a linchpin of the Fed’s upcoming LFI rating system for bank holding companies.  What funding risk has been left unaddressed by existing regulation, and thus left for the NSFR?

Question 5:  Does the NSFR pass a cost-benefit test?

The only cost-benefit analysis the agencies cite in the NSFR proposal is a 2010 paper by the Basel Committee on Bank Supervision (BCBS), which found positive net benefits from the NSFR.  But as BPI pointed out last year, that conclusion assumed banks have pre-crisis levels of capital.  The same paper finds large negative net benefits when calculated at banks’ current capital levels.  Are there any analyses that find that the NSFR proposal’s benefits exceed its costs?

Question 6:  Does the U.S. have to implement the NSFR just because the Basel Committee adopted it?

There is no treaty obligating the United States to comply with Basel standards.  Given that the BCBS’s own analysis finds that the NSFR will cost Americans more than it will benefit them, why must we adopt it?  If the reason is to maintain U.S. support for international standards, couldn’t that be done by supporting an effort to improve the NSFR?


Disclaimer: The views expressed in this post are those of the author(s) and do not necessarily reflect the position of the Bank Policy Institute or its membership, and are not intended to be, and should not be construed as, legal advice of any kind.

i The correct way to adjust the RSFs and ASFs to reflect a 3-quarter horizon is RSF* = 1-.7(1-RSF), and ASF* = 1 – .7(1-ASF).  Highly liquid assets, however, can be sold or repoed in significantly less than 3 quarters and therefore their RSFs would likely not need adjustment.