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CEBS Consultation Paper on Liquidity Buffers & Survival Periods Summary

Core Content

This Consultation Paper by the Committee of European Banking Supervisors (CEBS) outlines guidelines for the appropriate size and composition of liquidity buffers that credit institutions should maintain to withstand liquidity stress for at least one month without changing their business models. It serves as a follow-up to CEBS’s previous recommendations on liquidity risk management (September 2008), particularly Recommendation 16, which emphasizes the importance of liquidity buffers in times of financial stress.

The paper focuses on the internal risk management processes of credit institutions, though it also acknowledges the potential utility for supervisory review. CEBS proposes enhancements to existing liquidity buffer approaches, emphasizing that they should be tailored to the institution’s liquidity management strategy, business model, complexity, and risk tolerance.

Main Points

• Definition of Liquidity Buffer and Survival Period:
  A liquidity buffer is the short end of the counterbalancing capacity under a "planned stress" view. It is liquidity available outright for a defined short period (the survival period), which is at least one month. Within this period, a one-week time horizon is also considered to ensure higher confidence in short-term liquidity needs.

• Stress Scenarios:
  Institutions should apply three types of stress scenarios:

  • Idiosyncratic stress: Assumes no rollover of unsecured wholesale funding and some outflows of retail deposits.
  • Market-specific stress: Assumes a decline in the liquidity value of some assets and deterioration in funding market conditions.
  • Combined stress: A mix of the above, reflecting a more comprehensive view of liquidity risk.

• Composition of the Buffer:
  The liquidity buffer should primarily consist of cash and core assets that are both central bank eligible and highly liquid in private markets (e.g., high-quality government bonds, covered bonds). For the longer end of the buffer (at least one month), a broader range of liquid assets may be included, provided the bank can demonstrate the ability to generate liquidity from them under stress.

• Avoiding Concentration Risks:
  Banks should avoid holding large concentrations of particular assets to prevent potential market instability and fire sales during liquidity stress. This is important to avoid further market deterioration.

• Proportionality and Risk-Based Approach:
  CEBS guidelines are principles-based and subject to the overarching principle of proportionality. They aim to reflect the specific liquidity risk of each institution, with higher risk institutions requiring larger buffers.

• Economic Impact Considerations:
  CEBS acknowledges the potential economic impact of its proposals, including possible restrictions on lending capacity and increased financing costs. It also recognizes that a more restrictive definition of eligible assets could lead to sub-optimal macroeconomic outcomes and wrong incentives. Therefore, it encourages stakeholder input during the consultation period.

Key Information

• Liquidity Buffer: Represents available liquidity to cover additional needs during stress. It should be composed of assets that can be liquidated quickly and predictably.
• Survival Period: Defined as at least one month, with a one-week sub-period to ensure short-term liquidity resilience.
• Stress Testing: Stress scenarios should be consistent with other bank-wide tests, and the buffer size should be derived from these scenarios.
• Central Bank Eligibility: Central bank eligibility is a key criterion for determining which assets can be included in liquidity buffers. It is important to understand the terms and conditions of central bank facilities during stress.
• Market Liquidity Risk: Credit institutions remain responsible for the market liquidity risk associated with the assets they hold in their liquidity buffer.

Consultation and Feedback

CEBS seeks detailed feedback from market participants, particularly on the following issues:

1. Eligible Assets: Whether restricting liquidity buffers to assets that are both highly liquid in private markets and central bank eligible would lead to shortages, increased concentration, or cost implications.
2. Liquidity Value Consistency: Potential pressure points due to inconsistencies in the definition of liquidity value for eligible collateral and other assets.
3. Macro-Economic Implications: Whether a too narrow definition of eligible assets could lead to sub-optimal allocation of resources or wrong incentives.
4. Central Bank Eligibility: Views on the reference to central bank eligibility in determining eligible assets for liquidity buffers.

CEBS also invites feedback on the general economic impact of the proposed guidelines, including the effect on return on equity (ROE), lending capacity, and funding costs.

Conclusion

The paper aims to provide a flexible and principles-based approach to liquidity buffer management, while encouraging institutions to develop their own counterbalancing frameworks aligned with their risk policies. It stresses the importance of maintaining a sufficient liquidity buffer to ensure resilience during stress periods, and it emphasizes the need for ongoing dialogue between institutions and supervisors to implement the guidelines effectively. The consultation period runs until 31 October 2009, with a public hearing scheduled on 22 September 2009.