The European Central Bank (ECB) has published the Eurosystem’s response to the European Commission's (EC’s) consultation on further considerations for implementing the net stable funding ratio (NSFR) in the EU. The Eurosystem constitutes the ECB and the national central banks of member states in the Eurozone.

The consultation paper

The EC is consulting on the implications of implementation of the NSFR under the Capital Requirements Regulation (Regulation 575/2013) (CRR) in May 2016. The Basel Committee on Banking Supervision (BCBS) introduced the NSFR in October 2014 as a new liquidity requirement.

Eurosystem's comments

Eurosystem stated that the financial crisis demonstrated that regulatory capital requirements alone are insufficient to ensure the resilience of the banking system, and that excessive maturity mismatch and funding risks from on and off-balance-sheet activities made banks vulnerable to shocks which also affected their solvency. NSFR is being implemented to contribute to financial stability by making the banking sector more resilient through an improvement in banks’ funding profiles. Eurosystem also made the following specific remarks regarding the implementation of NSFR:

Overall impact on banks

Eurosystem believe that the available evidence for European banks does not suggest an excessive impact of the NSFR for the majority of banks, however a significant NSFR shortfall is concentrated in a few large banks, where, in some cases, significant and difficult adjustments could be expected.

Methodological deficiencies in the treatment of collateral received

Collateral received is currently treated consistently with the overall design of the NSFR, and aims to ensure consistency between the leverage ratio and the NSFR, so limiting the operational burden of calculating NSFR. However, Eurosystem suggests assessing whether, considering the different purposes of the leverage ratio and the NSFR, the treatment of Level 1 assets used as variation margin should be fully aligned in the two bodies of legislation.

Methodological deficiencies in the treatment of gross derivative liabilities

Gross derivative liabilities represent the replacement cost of the contract, i.e. its negative mark-to-market value, however the future counterparty credit risk depends on factors other than the mark-to-market value of the contract, such as the notional amount, maturity, type and volatility of the asset underlying the derivative contract. Currently, the rules assume that the 20% factor applied to gross derivative liabilities is an estimation of the future market and counterparty exposure, however this may underestimate potential future exposure, and so there may be an advantage in introducing of a more sensitive NSFR measure of exposure. However, as this represents a material deviation from the Basel Committee agreement and may increase available funding sources, especially for banks with large derivative books, the ECB calls for further analysis to assess the impact of such a switch.

The final BCBS NSFR October 2014 standards introduced asymmetry in the treatment of short-term secured financing transactions

This treatment was designed to prevent institutions from over-relying on short-term wholesale funding to meet their funding needs, as this type of funding can be extremely volatile and quickly disappear in times of market or idiosyncratic stress. To prevent excessive reliance on short-term wholesale funding, NSFR introduces a stable funding requirement for short-dated securities financing transactions (SFTs). The ECB raises the issue of a loophole regarding the treatment of re-used collateral under the NSFR: while own assets used as collateral are considered as encumbered under the current NSFR rules and are therefore subject to a stable funding requirement according to the maturity of the encumbrance, collateral received and re-used as collateral, and which does not appear on the institution’s balance sheet, would not be subject to any encumbrance, i.e. would not receive an RSF (required stable funding) factor. This allows institutions to improve the NSFR without adequately addressing short-term funding risks, and so the ECB suggested the EC consider how to close this loophole and to assess any unintended consequences of the closing of this loophole for the smooth functioning of the securities financing markets.

There is no clear correlation between the size of institutions and their level of compliance with the NSFR

The ECB observed that the level of compliance with NSFR is already generally high and, in most cases, well above the minimum 100% level for most smaller institutions. Therefore, the case for a different requirement for smaller institutions based on the size of their balance sheet was not supported on the basis of the available evidence. However, the ECB also acknowledges the need for a proportionate approach of regulation and supervision, and so stable funding reporting requirements should reflect this, and be implemented in a differentiated manner across institutions, for example as regards frequency and granularity.

Next Steps

Banks need to be aware of their regulatory capital requirements, and to consider how the meet these in a way which minimises the regulatory burden on the firm as a whole. Our specialist team of capital adequacy advisers can help you take a practical approach meet these requirements.