Banks came into the COVID-19 pandemic much stronger than they went into the Global Financial Crisis (GFC). Given the regulatory push post GFC, banks now have more resilient liquidity and capital buffers. However, can banks take comfort in their capital and liquidity buffers, and expect to successfully tide over this pandemic unscathed. We cannot be sure, as the crisis is still unfolding and the full impact is yet to be ascertained. This is the second part of our Liquidity Management during the Pandemic series that strives to bring to the fore the relevant and best practices for liquidity management during the current crisis. You can view our previous write-up Liquidity Management during the Pandemic on our website at https://www.aptivaa.com/blog/. This piece focusses on cash flow forecasting and behavioural modelling aspects which banks should consider in their day to day cash flow management, and how these are to be adjusted during the current crisis to obtain a more realistic view of customer behaviour.
Banks mitigate the funding liquidity risk and market liquidity risk in two ways. First, they ensure maximisation of stable sources of funding that are less likely to run-off in the event of stressed market conditions, such as retail demand and time deposits. And second, banks hold a buffer of high quality liquid assets (HQLA) or cash, which can be drawn down when their liabilities fall due. This buffer is particularly important if a bank is unable to roll-over (renew) its existing sources of funding, or if other assets are not easy to liquidate.
Behavioralization and Forecasting of Cash Flows
The current Covid-19 crisis has upended the normal understanding of how severe a stress scenario can be. The annual stress tests recommended by regulators so far assume a decline in global GDP by 5 to 7 percent which were seen as extremely remote. However, in the current crisis, China, US, Euro Area have all experienced negative quarter-on-quarter GDP growth of -9.8 percent, -4.8 percent and-3.8 percent respectively. ( Source: www.tradingeconomics.com accessed on 13th May 2020 )
Below are some factors which the management should consider in preparing their cash flow statements during this crisis period:
1. Impact of loan moratorium on loan repayment
Central banks around the world have announced a moratorium facility for retail/corporate or both borrowers for a period ranging from 3 to 6 months. This will shift the expected behaviouralized cash inflows in the up to 6 months buckets to farther buckets (assuming there is no default or delay in the payment beyond the moratorium period, which seems unlikely).
2. Impact of Lowe roll-over of deposits/run-down of CASA deposits
Another effect of the pandemic is delay in payments/salaries of the customers, which in turn will lead to a lower roll-over rate of maturing deposits and a gradual reduction in customer balances. This will effectively lead to a higher outflow as estimated earlier through behaviouralized pattern. A corona overlay on balance decay rates needs to be assumed in the rage of 5-10 percent for retail and 20-30 percent for wholesale deposit balances.
3. Lower market liquidity of securities
In a cash flow statement, the HQLA securities are bucketed as per the maturity of the underlying customer liabilities (governed by the cash reserve requirements) and the excess is bucketed as an inflow either equally in the short-term buckets based on management judgement or through a defeasance study by considering the market volume of the securities traded and the individual banks holding portfolio. In the current crisis situation it would not be conservative if the actual market liquidity of the security is assumed to be reduced.
4. Increased online transactions
We at Aptivaa have developed a range of advisory, analytical and IT solutions for implementing stress testing frameworks at several financial institutions. We look forward to hearing back from you on this subject, the challenges faced by you or any suggestions that you may have. Please feel free to contact us at
Director & Practice Head - ALM, FTP & Market Risk
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