The Office of the Superintendent of Financial Institutions (OSFI) recently issued for comment a draft Liquidity Adequacy Requirements (LAR) Guideline (the Draft Guideline) applicable to banks, bank holding companies and federal trust and loan companies. The Draft Guideline sets out the metrics OSFI will use to assess the adequacy of an institution’s liquidity and is part of the ongoing rollout of Basel III in Canada. The Draft Guideline is to be read together with OSFI Guideline B-6: Liquidity Principles and the Principles for Sound Liquidity Risk Management and Supervision issued by the Basel Committee on Banking Supervision (BCBS) in 2008.

Comments on the Draft Guideline are to be provided by January 24, 2014.

The Draft Guideline states that OSFI will conduct detailed supervisory assessments of quantitative and qualitative aspects of an institution’s liquidity risk in light of the Liquidity Adequacy Requirements (LAR) Guideline and Guideline B-6. Deputy Superintendent Andrew Kriegler stated in a presentation at the Autorité des marchés financiers “Adapting to a New Reality” conference on November 18, 2013 that OSFI will review liquidity risk management and liquidity transfer pricing across the six Canadian domestic systemically important banks (D-SIBs) in 2014.

Overview of the Draft Guideline

The Draft Guideline addresses the following:

  • Liquidity Coverage Ratio (LCR) - a standard that promotes the short-term resilience of an institution’s liquidity risk profile by ensuring it has sufficient high-quality liquid assets (HQLA) to survive a significant stress scenario lasting 30 days. The minimum LCR requirement for Canadian institutions will be set at 100%, meaning that the stock of HQLA should be at least equal to total net cash outflows during a 30 day period. It is recognized that LCR may fall below 100% during periods of financial stress.
  • Net Stable Funding Ratio (NSFR) - a standard that establishes a minimum acceptable amount of stable funding based on the liquidity characteristics of an institution’s assets and activities over a one year horizon. NSFR is subject to change based on the BCBS’s scheduled review of the NSFR standard in 2013-2014.
  • Net Cumulative Cash Flow (NCCF) - a measurement of an institution’s net cumulative cash flows, on a contractual basis, after the application of assumptions around the functioning of assets and modified liabilities. NCCF helps identify gaps between contractual inflows and outflows for various time bands over and up to a 12 month time horizon and, accordingly, helps identify potential cash flow shortfalls. Whereas LCR and NSFR are BCBS standards, NCFF is a Canadian monitoring tool that OSFI has used for a number of years.
  • Liquidity monitoring tools - a suite of metrics (in addition to the LCR, NSFR and NCFF) that are to be used to capture information relating to cash flows, balance sheet structure, available unencumbered collateral and certain market indicators.
  • Intraday liquidity monitoring tools - a suite of tools to enable OSFI and the Bank of Canada to monitor an institution’s management of intraday liquidity risk and its ability to meet payment and settlement obligations.

In the November 18, 2013 presentation referred to above, Andrew Kriegler discussed “outside” and “inside” rules in a manner that provides insight into OSFI’s expectations regarding liquidity risk management. As explained by Mr. Kriegler, outside rules are quantitative, measureable and objective and inside rules focus on how institutions are managing themselves and on the behaviours and attitudes of institutions. In his view, LCR and NSFR are both outside rules and NCCF is an inside rule. As part of the review of liquidity risk management and liquidity transfer pricing for the D-SIBs that is scheduled to occur in 2014, OSFI will look at how each institution is meeting not only the outside rules of LCR and the draft NSFR, but also at how it is living the inside rules of the prudential liquidity risk principles in OSFI’s guidance and the risk management methodologies implied by NCCF.

While the liquidity adequacy requirements generally apply on a consolidated basis (except with respect to insurance subsidiaries), institutions are expected to monitor and control liquidity risk exposures and funding needs at the level of individual legal entities, foreign branches and subsidiaries, and the group as a whole, taking into account limitations on the transferability of liquidity.

The implementation date of the LCR standard is January 1, 2015; there will be no phase-in period for the 100% LCR requirement. The implementation date for electronic filing of data supporting the other liquidity monitoring tools, including the NCCF supervisory tool, is also set for January 2015. Implementation of the intraday liquidity monitoring tools and NSFR will follow the Basel implementation timelines.