• LM-2 LM-2 Liquidity Risk Identification, Measurement, Monitoring and Control

    • LM-2.1 LM-2.1 Liquidity Metrics and Measurement Tools

      • LM-2.1.1

        A bank should have a sound process for identifying, measuring, monitoring and controlling liquidity risk. This process should include a robust framework for comprehensively projecting cash flows arising from assets, liabilities and off-balance sheet items over an appropriate set of time horizons.

        August 2018

      • LM-2.1.2

        Banks must use a range of liquidity metrics for identifying, measuring and analysing liquidity risk. These metrics must enable the management to understand its day-to-day liquidity positions and structural liquidity mismatches, as well as its resilience under stressed conditions. In particular, these metrics must perform the functions of:

        (a) Ensuring compliance with statutory liquidity requirements;
        (b) Projecting the bank's future cash flows and identifying potential funding gaps and mismatches under both normal and stressed conditions over different time horizons;
        (c) Evaluating potential liquidity risks inherent in the bank's balance sheet structure and business activities, including the liquidity risks that may arise from any embedded options and other contingent exposures or events;
        (d) Assessing the bank's capability to generate funding, as well as its vulnerability to, or concentration on, any major source of funding;
        (e) Identifying the bank's vulnerabilities to foreign currency movements; and
        (f) Identifying market related information.
        August 2018

      • LM-2.1.3

        The above must take into account all assets, liabilities, off—balance sheet ('OBS') positions and activities of the bank, across business lines, legal entities and overseas operations in a timely and effective manner.

        August 2018

      • LM-2.1.4

        Banks must use metrics and tools that are appropriate for their business mix, complexity and risk profile. In addition to liquidity coverage ratio ('LCR') and net stable funding ratio ('NSFR'), the following liquidity indicators must be monitored:

        (a) Maturity mismatch analysis, based on contractual maturities, as well as behavioural assumptions of cash inflows and outflows. Such metrics provide insight into the extent to which a bank engages in maturity transformation and identify potential funding needs that may need to be bridged;
        (b) Information on the level of concentration of funding from major counterparties (including retail and wholesale fund providers);
        (c) Major funding instruments (e.g. by issuing various types of securities);
        (d) Information on the size, composition and characteristics of unencumbered assets included in a bank's liquidity cushion for assessing the bank's potential capacity to obtain liquidity, through sale or secured borrowing, at short notice from private markets or CBB in times of stress; and
        (e) LCR in individual currencies.
        August 2018

      • LM-2.1.5

        In addition to the above, banks should adopt other metrics, as considered prudent or necessary to supplement their liquidity risk management, such as:

        (a) Medium-term funding ratio3, stable or core deposit ratio, or any similar ratio that reflects the stability of a bank's funding;
        (b) Financing-to-deposit ratio, or any similar ratio that reflects the extent to which a major category of asset is funded by a major category of funding4; and
        (c) Metrics tracking intragroup lending and borrowing.

        3 A medium-term funding ratio is a ratio of liabilities to assets, both with a contractual maturity of, say, more than 1 year. This ratio focuses on the medium-term liquidity profile of a bank and is intended to highlight the extent to which medium-term assets are being financed by the roll-over of short-term liabilities.

        4 A bank, depending on its business profile, may decide to adopt different breakdowns of the financing-to-deposit ratio such as, by way of example: financing to retail customers / retail customer deposits; financing to corporate customers / corporate customer deposits; financing / retail (or corporate) customer deposits. To complement the analysis provided by these indicators, the bank may consider assessing other funding risk indicators such as customer deposits / total liabilities or deposits from credit institutions / total liabilities to provide a notion of the bank's funding profile and take a closer look at the share of wholesale funding. Depending on its foreign activities and the related relevance, the bank may decide to assess the share of deposits in non-domestic markets.

        August 2018

      • LM-2.1.6

        Banks must regularly analyse information or trends revealed from liquidity metrics (e.g. a persistent decline in stable deposits) to identify any material liquidity concerns.

        August 2018

    • LM-2.2 LM-2.2 Risk Control Limits

      • LM-2.2.1

        Banks must, where appropriate, set limits for the liquidity metrics they employ in monitoring and controlling their liquidity risk exposures. The limits set must be relevant to a bank's business activities and consistent with its liquidity risk tolerance.

        August 2018

      • LM-2.2.2

        The limits must be used for managing day-to-day liquidity within and across business lines and entities. A typical example is the setting of maturity mismatch limits over different time horizons in order to ensure that a bank can continue to operate in a period of market stress.

        August 2018

      • LM-2.2.3

        Banks must ensure compliance with the established limits, and define the procedures for escalation and reporting of exceptions or breaches which can be early indicators of excessive risk or inadequate liquidity risk management. The limits set, and the corresponding escalation and reporting procedures, must be regularly reviewed.

        August 2018

      • LM-2.2.4

        Banks must consider setting stricter internal limits on intrabank funding denominated in foreign currencies where the convertibility and transferability of such funding is not certain, particularly in stressed situations.

        August 2018

    • LM-2.3 LM-2.3 Early Warning Indicators

      • LM-2.3.1

        To complement liquidity metrics, banks must adopt a set of indicators that are more readily available, either internally or from the market, to help in identifying at an early stage emerging risks in their liquidity risk positions or potential funding needs, so that management review and where necessary, mitigating measures can be undertaken promptly.

        August 2018

      • LM-2.3.2

        Such early warning indicators can be qualitative or quantitative in nature and may include, but are not limited to, the following:

        (a) Rapid asset growth, especially when funded with potentially volatile liabilities;
        (b) Growing concentrations on certain assets or liabilities or funding sources;
        (c) Increasing currency mismatches;
        (d) Increasing overall funding costs;
        (e) Worsening cash-flow or structural liquidity positions as evidenced by widening negative maturity mismatches, especially in the short-term time bands (e.g. up to 1 month);
        (f) A decrease in weighted average maturity of liabilities;
        (g) Repeated incidents of positions approaching or breaching internal or regulatory limits;
        (h) Negative trends or heightened risk, such as rising delinquencies or losses, associated with a particular business, product or activity;
        (i) Significant deterioration in earnings, asset quality, and overall financial condition;
        (j) Negative publicity;
        (k) A credit rating downgrade;
        (l) Stock price declines;
        (m) Widening spreads on credit default Shari'a compliant hedging instrument or senior and subordinated Sukuk;
        (n) Counterparties beginning to request additional collateral for credit exposures or to resist entering into new transactions to provide unsecured or longer dated funding;
        (o) Reduction in available credit lines from correspondent banks;
        (p) Increasing trends of retail deposit withdrawals;
        (q) Increasing redemptions of certificates of deposit before maturity; and
        (r) Difficulty in accessing longer-term funding or placing short-term liabilities (e.g. Murabaha Sukuk).
        August 2018

    • LM-2.4 LM-2.4 Management Information Systems

      • LM-2.4.1

        A bank must have reliable management information systems ('MIS') that provide the Board, senior management and other appropriate personnel with timely and forward-looking information on its liquidity positions. The MIS must be appropriate for the purpose of supporting the bank's day-to-day liquidity risk management and continuous monitoring of compliance with established policies, procedures and limits. The MIS reports must be capable of supporting the Board and senior management in identifying emerging concerns on liquidity, as well as in managing liquidity stress events.

        August 2018

      • LM-2.4.2

        A bank's MIS must encompass information in respect of the bank's liquidity cushion, major sources of funding and all significant sources of liquidity risk, including contingent risks and the related triggers and those arising from new activities. Moreover, a bank's MIS must have the ability to calculate risk measures to monitor liquidity positions:

        (a) In all currencies, both individually and on an aggregate basis;
        (b) Under normal business conditions and during stress events, with the ability to deliver more granular and time-sensitive information for the latter;
        (c) For different time horizons (e.g. on an intraday basis, on a day-to-day basis for shorter time horizons (of, say, 5 to 7 days ahead), and over a series of more distant time periods thereafter); and
        (d) At appropriate intervals (in times of stress, the MIS reports must be capable of being produced at more frequent intervals such as daily, or even intraday if necessary).
        August 2018

      • LM-2.4.3

        To facilitate liquidity risk monitoring, there must be reporting criteria specifying the scope, manner and frequency of reporting liquidity information for various recipients (e.g. daily/weekly & monthly for those responsible for managing liquidity risk, and at each meeting convened by the Board or its relevant delegated committee(s) during normal times, with increased reporting frequency in times of stress) and the parties responsible for preparing the reports.

        August 2018

      • LM-2.4.4

        In particular, the reporting must compare current liquidity exposures to established limits (both for internal liquidity risk management and statutory compliance purposes) to identify any limit breaches. Breaches in liquidity risk limits must be reported to the appropriate level of management. Thresholds and reporting guidelines must be specified for escalation of the reporting of breaches to higher levels of management and the Board.

        August 2018

    • LM-2.5 LM-2.5 Cash-flow Approach to Managing Liquidity Risk

      • LM-2.5.1

        Banks must adopt a cash-flow approach to managing liquidity risk, under which they must have in place a robust framework for projecting comprehensively future cash flows arising from assets, liabilities and OBS items over an appropriate set of time horizons. The framework must be used for:

        (a) monitoring on a daily basis their net funding gaps under normal business conditions; and
        (b) Conducting regular cash-flow analysis based on a range of stress scenarios.
        August 2018

      • LM-2.5.2

        Unless otherwise specified, the cash-flow management requirements in this chapter apply generally to banks under both normal and stressed situations.

        August 2018

      • Scope, Coverage and Frequency of Cash-flow Projection

        • LM-2.5.3

          Cash-flow projections involve the estimation of a bank's cash inflows against its outflows and the liquidity value of its assets to identify the potential for future net funding shortfalls. The projections must be forward-looking and based on reasonable assumptions and techniques, covering liquidity risks stemming from:

          (a) On-balance sheet assets and liabilities;
          (b) OBS positions and Shari'a-compliant hedging transactions (including sources of contingent liquidity demand and related triggering events associated with such positions);
          (c) Special Purpose Vehicles; a bank must have a detailed understanding of its contingent liquidity risk exposure and event triggers arising from any contractual and non-contractual relationships with special purpose vehicles; and
          (d) Core business lines and activities (for example, correspondent, custodian and settlement activities).
          August 2018

        • LM-2.5.4

          Cash-flow projections must address a variety of factors over different time horizons, including:

          (a) Vulnerabilities to changes in liquidity needs and funding capacity on an intraday basis;
          (b) Day-to-day liquidity needs in, say, 5 to 7 days ahead;
          (c) Funding capacity over short and medium-term horizons (e.g. 14 day, 1, 2, 3, 6 and 9 months) of up to 1 year;
          (d) Longer-term liquidity needs over 1, 2, 3, 4 and beyond 5 years; and
          (e) Vulnerabilities to events, activities and strategies that can put a significant strain on a bank's capacity for generating liquidity.
          August 2018

        • LM-2.5.5

          Cash-flow projections must cover positions in Bahraini Dinar (BHD/USD), where appropriate and in all significant currencies in aggregate. Separate cash-flow projections must also be performed for individual foreign currencies in which a bank has significant positions. Please refer to LM-3: Foreign currency liquidity management for the identification of significant positions in other currencies.

          August 2018

      • Net Funding Gaps

        • LM-2.5.6

          In order to meet their obligations as they fall due and thereby stay in business, banks need to ensure:

          (a) Positive cash-flow position is maintained; or
          (b) Sufficient cash can be generated from their assets; or
          (c) Adequate funding sources to cover their funding gaps promptly.
          August 2018

        • LM-2.5.7

          Net funding gaps can be assessed through the construction of a maturity profile, supplemented where relevant with additional analysis of the funding capacity of specific on- or off-balance sheet items.

          August 2018

        • LM-2.5.8

          A bank's maturity profile should encompass adequate time bands so that the bank can monitor its liquidity needs for various time horizons. It is generally expected to have daily time bands in the very short term (say for a period of 5 to 7 days ahead), which may be followed by wider and less granular time bands for other periods;

          August 2018

        • LM-2.5.9

          Banks must set internal limits to control the size of their cumulative net mismatch positions (i.e. where cumulative cash inflows are exceeded by cumulative cash outflows), at least for the shorter-term time bands (e.g. next day, 5 to 7 days ahead, 14 days, 1, 2, 3, 6 and 9 months). Such limits must be in line with the established liquidity risk tolerance, and must take into account the potential impact of adverse market conditions on the bank's funding capacity. Maturity mismatch limits must also be imposed for individual foreign currencies in which a bank has significant positions.

          August 2018

        • LM-2.5.10

          The maturity mismatch limits must be properly documented in the Liquidity Risk Management Policy statement. Banks must regularly review the suitability of such limits.

          August 2018

      • Cash Flow Projection Assumptions and Techniques

        • LM-2.5.11

          While certain cash flows can be projected based on contractual maturities, some may need to be estimated based on certain assumptions. In these circumstances, banks should make realistic assumptions (with a reasonable degree of prudence) to reflect the characteristics of their businesses and products, as well as economic and market conditions. For example, banks may take into account the following factors in setting the assumptions for cash flow projection:

          (a) Expected future growth or contractions in the balance sheet;
          (b) The proportion of maturing assets and liabilities that banks reasonably expect to roll-over or renew;
          (c) The quality and proportion of liquid assets or other marketable sukuk that can be used as collateral to obtain secured funding;
          (d) The behaviour of assets and liabilities with no clearly specified maturity dates, such as repayment of overdrafts and demand deposits as well as sticky deposits;
          (e) The potential cash flows arising from off-balance sheet activities, e.g., drawdown under financing commitments and contingent liabilities (including all potential draws from contractual or non-contractual commitments);
          (f) The behaviour of cash flows under different service delivery channels (e.g. branches vs e-banking channels);
          (g) The convertibility of foreign currencies;
          (h) The lead time required for the monetization of marketable sukuk; and
          (i) Access to wholesale markets, standby facilities and intragroup funding.
          August 2018

        • LM-2.5.12

          Techniques employed by banks for designing cash flow assumptions must be commensurate with the nature and complexity of their business activities.

          August 2018

        • LM-2.5.13

          In deriving behavioural cash flow assumptions, banks may analyse historical observations on cash flow patterns. While there is no standard methodology for making such assumptions, it is important that the assumptions used are consistent and reasonable and they should be supported by sufficient historical or empirical evidence.

          August 2018

        • LM-2.5.14

          Banks must document in their liquidity risk management policy statement, the underlying assumptions used for estimating cash flow projections and the rationale behind them. The assumptions and their justifications must be approved, and subject to regular review, by the ALCO to take account of available statistical evidence and changing business environment.

          August 2018