Draft Guidance Notes on Behavioural Adjustments to Banks Liquidity Positions

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1 Draft Guidance Notes on Behavioural Adjustments to Banks Liquidity Positions November 2005

2 Contents Page No. 1 Rationale for Behavioural Adjustments 3 2 Overview of the Commission s Approach to 4 Behavioural Adjustments 3 Measurement and Methodology 5 4 Procedures and Systems 5 Page 2 of 2

3 1 Rationale for Behavioural Adjustments 1.1. The behaviour of a bank s deposits is central to their liquidity management policy. It has long been accepted that actual cash flows from a bank s deposit liabilities bear little resemblance to their contractual maturity. In particular, only a small percentage of demand deposits are likely to be withdrawn on any one day, and fixed term deposits are often renewed automatically on each maturity date. This behaviour reflects customers desire to keep their savings readily available in case of any emergency or unforeseen event, rather than an intention to withdraw their funds The Isle of Man Financial Supervision Commission ( FSC ) have recognised this situation, and in the past have agreed liquidity mismatch limits that made allowance for the perceived stickiness of some deposits The proposed changes to the Banking Code include a measure to impose maximum liquidity mismatch limits in the sight to 8 days and sight to 1 month maturity bands (normally 0% and 5% of total deposit liabilities respectively), but, in order to offset this, the FSC is offering licenceholders the opportunity to apply to report its cash flows on a behaviourally adjusted basis, thereby formalising the previous arrangements The levels of behavioural adjustments will be agreed with licenceholders on a case by case basis, taking into account a number of factors outlined in section 2 below It should also be noted that the Commission analyses licenceholders liquidity on an ongoing basis and that they may not always consider it appropriate for behavioural adjustments to be granted to a bank. Furthermore, the Commission will also be assessing Licenceholders for any potential requirement for independent liquidity, and, in some instances, the Commission will issue Directions requiring a bank to maintain a stock of liquidity with, or issued by, third party banks. Page 3 of 3

4 2. Overview of the Commission s Approach to Behavioural Adjustments 2.1 The FSC requires a banking institution to have a prudent liquidity policy and appropriate systems in place to measure and monitor liquidity, and to ensure that the policy is adhered to. The policy should reflect FSC requirements and may take into account any level of behavioural adjustments agreed between the FSC and the licenceholder. 2.2 When establishing what is a prudent level of behavioural adjustments, it is important to take into account the fact that liquidity limits exist to ensure that a licenceholder has a sufficient pool of available funds or liquid assets to enable it to meet its obligations in times of liquidity stress or disruption. As banks business and risk profiles differ enormously, it is necessary to examine a number of different issues as they may relate to individual licenceholders and their depositors during a period of liquidity distress before agreeing a prudential level of behavioural adjustment. 2.3 The Commission will consider a number of issues when reviewing an application for behavioural adjustments. These include, but are not limited to: a) A high level overview of the licenceholder. b) An overview of different types of products. c) An overview of different types of deposits, including their stickiness High level review of licenceholder This will include a review of a range of areas including, but not limited to: Standing of parent and parental support. Regulatory oversight of parent. Group Funding position. Independent Liquidity Overview of products This will include a review of a range of areas including, but not limited to: The licenceholder s product profile. Pricing strategy. Distribution strategy Overview of deposits The Commission classifies deposits into three broad groups: Wholesale Incorporating deposits from banks and building societies (including noncommitted funding from the parent company), commercial deposits from corporate entities such as international life companies, and national governments and their agencies. Big ticket deposits via intermediaries should also be included in this category. Money market interest rates are likely to be paid on these deposits, and they are likely to be the first to be subject to repayment in the event of liquidity disruption. The FSC will not entertain behavioural adjustments on wholesale deposits. Page 4 of 4

5 Corporate Including deposits from, or introduced by, trust companies, corporate services advisors, collective investment schemes, investment managers, accountants and lawyers etc. This represents the large grey area between wholesale and retail deposits. Typically, these deposits will be substantially stickier and less price sensitive than wholesale, but as the business is directed through a fiduciary intermediary, the deposits should not be regarded as stable as retail deposits. It is recognised that some banks enjoy long standing relationships with some clients, and the relationship extends to accounts with the bank in corporate names, either on a direct basis or via a fiduciary manager. In such cases, it may be appropriate for the Commission to consider slighter higher adjustments on eligible corporate deposits to reflect the loyalty factor. Retail Deposits placed by individuals in their own name. Deposits from investment companies and other incorporated bodies that have been established as an SPV should normally be regarded as Corporate deposits. Retail deposits tend to be exceptionally stable and therefore attract the highest behavioural adjustment. Page 5 of 5

6 3 Methodology 3.1 Licenceholders wishing to apply for behavioural adjustments should carry out an in depth analysis of their deposit books in order to provide supporting evidence to the Commission. In particular, the following areas should be examined and details presented: a) Deposit Profile What is the deposit mix retail/corporate/wholesale? (See above for definitions). Identify any deposit concentration by sector, industry, or geographic classification. b) Product Profile Identify the bank s core products and their contractual liquidity profile. c) Deposit analysis The analysis should show: i) The stickiness of deposits by product. ii) iii) Numbers and values of new and closed accounts. Breakdown of the actual cash flows over a selected period. 3.2 The Commission will then meet with the licenceholder to discuss the requested levels of behavioural adjustments. Following the meeting, a recommendation will be made to a Validation Panel for approval A Direction will then be issued to the Licenceholder detailing the levels of behavioural adjustments that may be applied The agreed levels will represent the percentage of deposits classified as Corporate and Retail maturing in the sight to seven days, and eight days to one month maturity bands that may be factored out of the contractual maturity bands, and be placed in the one to three month maturity band. It should be noted that, in most circumstances, different levels of adjustment would be allocated to Retail and Corporate deposits Licenceholder have the right of appeal against the Direction through the normal channels. 3.3 In certain circumstances, e.g. during a period of liquidity disruption, the Commission maintains the right to vary the levels of behavioural adjustments previously agreed. Page 6 of 6

7 4 Procedures and Systems 4.1 The levels of behavioural adjustments agreed with the FSC should be reflected in the licenceholder s Liquidity Management Policy. 4.2 The licenceholder should maintain ongoing analysis of the deposit base to support their case for behavioural adjustments. Such analysis, should, on request, be made available to the FSC on request. 4.3 The licenceholder may, at any time, apply to the FSC to consider an amendment to the levels of behavioural adjustments previously agreed. Any request for an increase in the levels should be supported by empirical evidence. 4.2 Liquidity mismatch positions should be reported on Form SR-3A on a contractual basis, and then allowance made for behavioural adjustments. Please refer to Form SR3-A Liquidity Risk - Notes to Assist Completion for full details. Page 7 of 7

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