Debevoise & Plimpton publishes a guide to NSFR — providing some clarity to a confusing topic

Last month Debevoise & Plimpton published a nice guide to the Net Stable Funding Ratio (NSFR), “Client Update Basel Committee Adopts Net Stable Funding Ratio: How Much Liquidity Is Enough?”. The application of NSFR has been confusing (and especially so for securities financing) and this report does a excellent job to clarify it – although the news may not always be so welcome. It is absolutely worth a read.

To review, NSFR is a parallel to LCR — only it addresses longer term funding stability. Available Stable Funding (ASF) must be equal to or greater than Required Stable Funding (RSF). But the trick is how they are calculated: each component is multiplied by a factor. ASF consist of bank liabilities and capital. The more stable the funding source is, the higher the ASF factor. “…RSF is calculated by multiplying a banking organization’s assets by the factors assigned to them based on their maturity, quality and liquidity value, and then adding the weighted figures. Assets with lower RSF factors tend to have greater liquidity, be of better quality and/or have shorter maturities…”

Comparing LCR to NSFR:

“…While the LCR is designed to promote short-term liquidity resilience by ensuring that affected banking organizations maintain high quality liquid assets to fund their short term liquidity needs in times of stress, the NSFR aims to reduce funding risk over a longer horizon by requiring affected banking organizations to have available stable sources of funding for their assets and activities…”

The paper looks at how assets and liabilities might be matched so that RSF and ASF factors, in effect, cancel each other out. A 50% RSF asset should be funded with at least a 50% ASF liability, and so forth. The ideal is to have high ASF factors (since it is the numerator of the fraction) and low RSF factors. We aren’t so sure it is always possible to connect those asset and liability dots so precisely. Bottom up management in a complex business (much less an entire bank) comes at a cost. Banks will be challenged when managing NSFR.

There is a penalty when funding comes from a financial. It is assumed to be less stable (when compared to cash from a non-financial). This becomes an issue when funding a repo book since non-financial cash is atypical (although it may encourage dealers to push harder for corporates providing funding).

Two sections of the report bring this home:

“…What Happens when a Broker-Dealer Tries to Fund Customer Margin Loans with Overnight Repo Financing?

Margin loans extended to financial institutions typically would be assigned a 15% RSF while all other margin loans, including to retail and non-financial corporate clients, would be assigned a 50% RSF. A broker-dealer would be able to fund either of these activities with repo financing provided by non-financial corporate customers, which is assigned a 50% ASF. However, in the more likely event that the broker-dealer sought to rely on repo financing provided by financial institution counterparty, such financing is assigned a 0% ASF and the broker-dealer would need another source of ASF to balance out the ratio. For example, if a bank-affiliated broker-dealer lends $100 to a client, it will incur $15 of RSF if the client is a financial institution and $50 of RSF if the client is a non-financial corporate client. On the other hand, repo financing provided by financial institution counterparty would not provide the broker-dealer with a source of ASF. As a result, the broker-dealer will have to locate either $15 or $50 of ASF, respectively, to counterbalance the RSF charge…”

and

“…What Is the Treatment of Securities Lending Transactions under the NSFR?

In a typical securities lending transaction, a broker-dealer borrows securities from a lender (typically through an agent bank intermediary) and lends the securities to its borrower client. At the same time, the broker dealer takes collateral from its borrower client and posts this collateral to the lender (also generally via an agent bank intermediary). If the collateral received from the borrower client and posted to the lender is cash, then, prior to unwinding the securities loan, the broker-dealer will hold both cash receivable (from the lender) and cash payable (to the borrower) on its balance sheet. The cash receivable would generally incur a 15% RSF factor if the lender is a financial institution and a 50% RSF factor if the lender is a non-financial corporate client. The cash payable, on the other hand, would receive a 0% ASF factor if the borrower is a financial institution and a 50% ASF factor in the unlikely event the borrower is a non-financial corporate client. As a result, securities lending involving a financial institution borrower may need to be funded by other activities at the banking organization, because there will be an RSF charge that is not counterbalanced with ASF from the back-to-back transaction. On the other hand, securities lending involving a non-financial corporate borrower may be a source of funding for the banking organization; ASF will outweigh RSF when the lender is a financial organization and will be equivalent to RSF when the lender is a non-financial corporate entity. The treatment of back-to-back repo and reverse repo transactions would be the same….”

NSFR is going to change the way banks fund themselves – who they borrow from and for how long. The biggest impact may be on securities financing businesses where asymmetric NSFR treatment may upset traditional business models. While it will be a couple years before it kicks in (January, 2018), experience tells us that banks like to start early. It is hard to think it will be watered down given the regulators focus on funding risks. Will NSFR make LCR look like child’s play?

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