Liquidity Stress Testing

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1 Liquidity Stress Testing Scenario modelling in a globally operating bank APRA Liquidity Risk Management Conference Sydney, 3-4 May 2007 Andrew Martin Head of Funding & Liquidity Risk Management, Asia/Pacific Treasury & Capital Management

2 Agenda External requirements for liquidity risk management Integrated liquidity risk management process Stress testing: risk drivers and scenarios APRA Liquidity Risk Management Conference page 2

3 Increasing focus on Liquidity Risk Management Basel Committee: Sound Practices (issued in Feb 2000) Liquidity is crucial to the ongoing viability of any banking organisation The importance of liquidity transcends the individual bank since a liquidity shortfall at a single organisation can have systemic repercussions. Joint Forum: Management of liquidity risk in financial groups (May 2006) Survey on best practices across banking, securities and insurances groups IIF Paper: Principles of Liquidity Risk Management (March 2007) No one-size-fits-all formula for liquidity risk management Recommends individual risk management practices and systems to suit the institution, rather than prescriptive, quantitative requirements Greater harmonisation of standards and practices among regulators Developments in the financial markets: Declining ability to rely on core deposits and increased reliance on wholesale funding Technological and financial innovations provided banks with new ways of funding their activities and managing their liquidity APRA Liquidity Risk Management Conference page 3

4 Liquidity ratios are still common practice Liquid assets / Liquid liabilities >= 1 3 mths assets >= 3 mths liabilities Liquid assets >= 6% of deposit & borrowing Liquid assets >= 3-15% of 1wk-3mth deposits (cash flow based) Total current assets / Total current liabilities >= 25% Liquid assets >= 30% of liabilities in Foreign currency deposit unit (FCDU) APRA Liquidity Risk Management Conference page 4

5 however, regulators are increasingly moving towards processes Hong Kong Monetary Authority: New liquidity risk management framework (June 2005) Monetary Authority of Singapore: Liquidity Supervision Framework (July 2001 / 2007) Bangko Sentral ng Pilipinas: Guideline on Liquidity Risk Management (September 2006) Australian Prudential Regulation Authority: APS 210 Liquidity (September 2000) Bundesanstalt fuer Finanzdienstleistungsaufsicht: Opening clause for internal bank models under discussion APRA Liquidity Risk Management Conference page 5

6 Rating agencies place increasing emphasis on comprehensive liquidity risk management For the measurement of banks liquidity risk, Moody s does not rely solely on any numeric indicator and insists on stress-tests demonstrating the capacity of the bank to continue operating over a one year horizon under very difficult market conditions. Moody s Methodology for Risk Management Assessments of Diversified Global Banking Groups, March 2005 the solid liquidity profile and management capabilities are a key determinant of, as much as a crucial prerequisite for, Deutsche Bank s credit quality. We expect the group to retain a prudent approach to its liquidity and funding. Moody s on Deutsche Bank, August 2006 APRA Liquidity Risk Management Conference page 6

7 Agenda External requirements for liquidity risk management Integrated liquidity risk management process Stress testing: risk drivers and scenarios APRA Liquidity Risk Management Conference page 7

8 Liquidity Risk Management framework at DB Dimension Operational Liquidity Tactical Liquidity Objectives Safeguard solvency Intra-day liquidity Management Maintenance of collateral Access to Central Banks Daily cash flow projections Access to Wholesale funding - unsecured - secured Access to liquid assets on the balance sheet DB-Toolbox Central Liquidity Pool Maximum Cash Outflow (MCO) Analysis including limit setting Asset Liquidity Analysis Stress Testing Analysis including contingent liquidity risk Unsecured Funding Limits Strategic Liquidity Balanced liquidity profile of the balance sheet Access to Capital Markets Funding diversification Support the bank s credit curve Funding Matrix (Liquidity profile of assets & liabilities) Funding Plan & Issuance Strategy APRA Liquidity Risk Management Conference page 8

9 Integrated Liquidity Risk Management process Reporting Liquidity Risk Management Liquidity Projection Stress Testing Risk Mitigation Adjustments Liquidity Projection Maximum Cash Outflow (MCO) Asset Liquidity Stress Testing Various stress scenarios Including Contingent Liabilities Risk Mitigation Contingency Planning Integrated concept for limit calculation Adjustments of Parameters Review of limit setting and Stress Testing Assumptions on Asset Liquidity analysis Reporting Daily reports (working level) Liquidity Score Card (senior management) APRA Liquidity Risk Management Conference page 9

10 Guiding Principle Liquidity Management is Local Our global liquidity profile is the sum of local analysis Local Liquidity Management Global Liquidity Management Local Liquidity Managers Local regulatory framework Local Liquidity Policies Local stress parameters Local cash flow profiles Local limit allocations Application of methodology Consolidation of local analysis Global Liquidity Managers Global Liquidity Policy Development of methodology Enhancement of toolbox Risk appetite Limit determination APRA Liquidity Risk Management Conference page 10

11 Cash flows projections for forward looking liquidity management 8 week horizon 18 month horizon Cash inflows Net cash flow profile Cash outflows APRA Liquidity Risk Management Conference page 11 Cumulative cash flow profile Daily cash flow projections with 18 month horizon, cash outflow limits are set for the first 8 weeks, recalibrated at least quarterly Central modelling tool for short-term cash flow modelling High granularity by product, business line, location and currency Limit incorporates stress testing through haircut on funding capacity and inclusion of contingent funding requirements

12 Local analysis determines global asset liquidity Unencumbered Assets Determine unencumbered assets Singapore London Sydney Determine asset classes RTGS / Statutory Portfolios CB eligible MBS Other Determine haircut Haircut Haircut Haircut Haircut Determine liquidation profile Encumbered Asset e.g. secured, short coverage Total Haircut defines illiquid portion of the unencumbered assets 5 Liquidation profile of all unencumbered assets APRA Liquidity Risk Management Conference page 12

13 Agenda External requirements for liquidity risk management Integrated liquidity risk management process Stress testing: risk drivers and scenarios APRA Liquidity Risk Management Conference page 13

14 Things may seem fine APRA Liquidity Risk Management Conference page 14

15 but are they really? APRA Liquidity Risk Management Conference page 15

16 Overview of Stress Scenario Application Main Objective: Quantify potential liquidity gaps in specified stress scenarios and identify means of closing those gaps Liquidity Gaps are created by: Loss of Funding Capacity (e.g. reduction in deposits, CP and CD rollover) Demand for Liquidity (e.g. funding contingent liabilities) These Gaps are closed by: Secured funding or liquidation of unencumbered assets Reduction of external placements Analysis of Stress Testing Results If liquidity gap cannot be closed, action must be taken: Raise term-funding or tap alternative funding sources Change business structure: e.g. reduce exposure to contingent liabilities APRA Liquidity Risk Management Conference page 16

17 Stress drivers and scenarios Liquidity Risk Driver Committed Facilities & Asset Backed Conduits Additional collateral requirements Evaporation of wholesale funding capacity Withdrawal of retail deposits Erosion in value of liquid assets Stress Scenarios Emerging Markets Crisis Systemic Shock (London / New York) Market Risk Operational Risk Rating Downgrade (1 / 2+1 Notch) External scenarios Internal scenarios E.g. Pandemic Ad hoc scenarios Scenarios were defined top-down in co-operation with other risk areas and the Bank s business divisions Several represent real events that have occurred in the market e.g. 1 notch downgrade and emerging markets crisis Not one size fits all! APRA Liquidity Risk Management Conference page 17

18 Development of DB s stress testing approach Phase one: Global stress testing using globally applied stress assumptions Monthly analysis on the entire balance sheet of the Bank Phase two: Local assumptions developed and applied to: Monthly global stress tests Local stress tests, using global or ad hoc local scenarios Frequency of local stress tests: in some cases bilaterally agreed with regulators, in others performed as required e.g. when prospective or real changes in local environment demands it Local assumptions incorporated into quarterly local limit setting process Underlying assumptions Changes have been made over time as we ve learned from experience APRA Liquidity Risk Management Conference page 18

19 Application of stress testing Step one - Based on expected cash flow profile of each LRD and the respective scenario assumptions it is determined how fast the liquidity gap opens over time: Roll-over ratio of maturing wholesale funding Impact on the stability of modelled liabilities Additional liquidity requirement from contingent liabilities Roll-over assumption on assets (i.e. no change of business model) Step two - Assess counterbalancing capacity from LRD which provide inflows under the respective scenario Determine liquidity value of trading assets Quantify inflows from loans which are not rolled under stress (e.g. O/N inter-bank) APRA Liquidity Risk Management Conference page 19

20 Stress testing results 80, ,000 Liquidity Risk Driver 1 40,000 20,000 Liquidity Risk Driver 2 Net Position Inflows - Liquidity Risk Driver 3-20,000-40,000 Liquidity Risk Driver 4 : : : : : : Liquidity Risk Driver XY Outflows -60,000 APRA Liquidity Risk Management Conference page 20

21 Stress testing output Matrix of drivers and scenarios Liquidity Risk Drivers Outflows Stress Scenarios Downgrade Systemic Emerging Operational Downgrade Market to A A2 Shock Markets Risk to A1 Risk Wholesale funding (excl. O/N funding) Overnight funding ABCP conduit liquidity facilities Clearing balances Fiduciary deposits Collateral requirements from derivative contracts Calls on structured notes Committed facilities Retail funding Small Mid-Cap Deposits TOTAL Inflows Debt Asset Liquidity Equity Asset Liquidity Maturing Loans TOTAL Net Liquidity Position APRA Liquidity Risk Management Conference page 21

22 Contingency Plans Definition of contingency levels: no check-list approach, but assessment based on combination of factors DB specific or market-wide (currency fluctuations, investment outflow) Contingency plans incorporate: different scenarios liquidity management tools sources of contingent assets and liabilities measures to increase liquidity of assets and stability of liabilities Clear assignment of responsibilities and authorities is required APRA Liquidity Risk Management Conference page 22

23 Cautionary statement regarding forward-looking statements and non-u.s. GAAP financial measures This presentation contains forward-looking statements. Forward-looking statements are statements that are not historical facts; they include statements about our beliefs and expectations. Any statement in this presentation that states our intentions, beliefs, expectations or predictions (and the assumptions underlying them) is a forward-looking statement. These statements are based on plans, estimates and projections as they are currently available to the management of Deutsche Bank. Forward-looking statements therefore speak only as of the date they are made, and we undertake no obligation to update publicly any of them in light of new information or future events. By their very nature, forward-looking statements involve risks and uncertainties. A number of important factors could therefore cause actual results to differ materially from those contained in any forward-looking statement. Such factors include the conditions in the financial markets in Germany, in Europe, in the United States and elsewhere from which we derive a substantial portion of our trading revenues, potential defaults of borrowers or trading counterparties, the implementation of our management agenda, the reliability of our risk management policies, procedures and methods, and other risks referenced in our filings with the U.S. Securities and Exchange Commission. Such factors are described in detail in our SEC Form 20-F of 27 March 2007 under the heading "Risk Factors." Copies of this document are available upon request or can be downloaded from This presentation contains non-u.s. GAAP financial measures. For a reconciliation to directly comparable figures reported under U.S. GAAP refer to the 4Q2006 Financial Data Supplement, which is accompanying this presentation and available on our Investor Relations website at APRA Liquidity Risk Management Conference page 23

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