Liquidity and stable funding
In accordance with the authorisation found in Article 12 of the Act on the Central Bank of Iceland, no. 36/2001, with subsequent amendments, the Central Bank has issued the Rules on Liquidity Ratio, no. 266/2017, and the Rules on Funding Ratios in Foreign Currencies, no. 1032/2014.
The Rules on Liquidity Ratio, no. 266/2017, took effect on 31 March 2017 and are issued in accordance with Article 12 of the Act on the Central Bank of Iceland, no. 36/2001, with subsequent amendments, which authorises the Central Bank to set rules on credit undertakings’ minimum or average liquidity. The rules replaced the previous Rules on Liquidity Ratio.
As before, the aim of the liquidity rules is to mitigate credit institutions’ liquidity risk by ensuring that they always have sufficient liquid assets to fulfil their obligations under stressed conditions over a specified period of time.
The liquidity rules are based on the Basel Liquidity Coverage Ratio (LCR) requirements, as were the Bank’s previous rules, which date from 2013. The new rules will not have a significant impact on the liquidity requirements made of banks. However, they aim at implementing the definitions and presentation requirements that have taken effect in the European Union, and they are the same as the EU rules in most respects. However, the Central Bank’s new rules still make specific requirements concerning minimum LCR ratio in foreign currencies that are not found in the EU liquidity rules.
The rules apply to parent companies and to the group for which a credit institution acts as the parent company. Credit institutions are obliged to send the Central Bank monthly reports providing information underlying the calculation of their liquidity ratios. Parent company reports and group-level reports shall be submitted to the Central Bank by the fiftheenth (15th) day of each month. The Central Bank is authorised to levy per diem fines for negligence in reporting. The liquidity requirements according to the rules apply to 30-day liquidity ratios and developments of the ratio shall be monitored. If a credit institution should fall below the minimum specified in the rules, or if it is foreseeable that it will fall below the minimum within the next six months, the institutions shall immediately send the Central Bank a written report outlining the reasons for the deviation. The institutions shall also present a dated schedule of who it intends to restore its liquidity ratio to the regulatory minimum. In addition to the liquidity reports, credit institutions shall submit deposit summaries and additional monitoring metrics reports (AMM) for informational purposes. Institutions shall also provide any and all information the Central Bank deems necessary to assess the liquidity position of the institution concerned more accurately or to conduct stress tests. The LCR reports are delivered to the Central Bank of Iceland on XBRL form.
Rules and templates
The Rules on Funding Ratios in Foreign Currencies, no. 1032/2014, took effect on 1 December 2014. The funding ratio is intended to ensure a minimum level of stable one-year funding in foreign currencies and therefore restrict the degree to which the commercial banks can rely on unstable short-term funding to finance long-term foreign-denominated lending. The rules on funding ratios limit maturity mismatches and the extent to which the banks can depend on unstable short-term funding to finance long-term assets that could prove difficult to sell.
Maturity transformation between assets and liabilities is an important contribution made by the banks to the economy, but it is also risky. By transmitting liquidity to the banking system and acting as a lender of last resort, central banks can mitigate the systemic risk that accompanies this maturity transformation. A central bank’s ability to grant foreign-denominated last-resort loans is limited, however. As a result, it is undesirable that the banks should take risks based on the assumption that the Central Bank will be able to extend foreign-denominated loans to them under duress. During the prelude to the 2008 financial crisis, the large commercial banks’ maturity mismatches escalated markedly. The banks relied increasingly on short-term foreign funding, including collateralised short-term loans and foreign deposit collection, which led to rising foreign refinancing risk. Rules on stable funding should impede adverse developments such as those taking place during the run-up to the financial crisis.
In view of experience, the Central Bank considers it important to reduce the risk that could result from excessive maturity mismatches between the commercial banks’ assets and liabilities by explicitly limiting maturity mismatches in foreign currency. This is particularly important during the prelude to capital account liberalisation. The funding ratio in foreign currencies that the Bank has adopted is based on the Basel Committee’s rules concerning net stable funding ratios (NSFR).