ComplianceJanuary 09, 2017

NSFR implementation in Hong Kong: Practice makes perfect

As banks in Hong Kong gear up for the 2018 implementation of the Basel III net stable funding ratio (NSFR), the Hong Kong Monetary Authority (HKMA) has launched another study into its likely impacts that should both reassure the local financial sector and also serve as a reminder of the need for careful preparation.

The HKMA’s quantitative impact study (QIS) on the modified net stable funding ratio (MNSFR) is the third of its kind and part of a broader, multi-year consultation exercise on NSFR’s local implementation. While previous studies targeted so-called ‘category 1’ institutions -- generally larger, internationally active banks -- that will be subject to the full force of NSFR requirements, this study will gauge the ability of smaller category 2 banks to adhere to MNSFR, essentially a less stringent ‘NSFR lite.’

Not a level playing field

The HKMA is taking the view that there is a clear need for all institutions active in Hong Kong to be subject to core funding requirements of some kind, and the NSFR/MNSFR distinction represents the regulator’s attempt to implement the NSFR regime across all banks while acknowledging the operational constraints faced by smaller institutions.

NSFR definitions, calculations and reporting requirements have much in common with the Basel liquidity coverage ratio (LCR), which has already been implemented locally for category 1 banks -- while category 2 institutions are subject to a separate liquidity maintenance ratio, or LMR. Category 1 banks therefore have something of a ‘head start’ on NSFR, but as category 2 institutions report the LMR, it is operationally difficult for them to calculate the LCR required for NSFR reporting. In addition, there is less argument for subjecting category 2 foreign bank branches with a limited local deposit base to the 100% NSFR requirement.

The HKMA is therefore proposing the ‘lite’ version of NSFR, MNSFR, for category 2 institutions, which will be required to maintain a MNSFR of 75% on average for each calendar month. The sample reporting form used in the MNSFR QIS -- which targeted institutions have to complete using data from June 2016 -- is also substantially simpler than the form used for NSFR reporting, substituting LCR with similar LMR outputs. For example, in NSFR reporting marketable debt securities are classified into various high quality liquid asset (HQLA) and non-HQLA categories, whereas under MNSFR they fall under the same ‘marketable debt securities and prescribed instruments’ category recognized in LMR reporting.

Banks aren’t due to submit their sample reports until February 2017, and the results of the MNSFR and NSFR studies may alter the HKMA’s implementation approach somewhat. However in our view the HKMA’s forms and guidelines are broadly consistent with Basel recommendations and have no doubt already been subjected to comprehensive internal analysis, and may therefore be viewed as relatively complete.

Constant management challenge

Since most of the reporting output required under NSFR and MNSFR can be mapped to pre-existing LCR and LMR requirements, both category 1 and 2 institutions should be able to collect the necessary information from existing data, and the new standards should not present a massive burden from the compilation perspective. Neither are they likely to require massive investments in new systems.

That said, there will be a certain degree of complexity associated with the need to calculate and monitor ratios daily – this will create an extra burden for staff on top of the daily LCR / LMR monitoring.

The advent of NSFR will also present new challenges to funding management. Risk and treasury functions will have to be fully aware of the necessity of meeting new statutory requirements on a rolling basis, and banks may need to forecast NSFR to ensure treasury can meet these obligations. Banks will also need to revisit their balance sheet structures with an eye to prioritizing stable medium and long-term funding. Excessive reliance on short-term wholesale or interbank funding will be riskier in the emerging environment, and may see institutions struggle to consistently meet minimum ratios.

Arguably the best way to prepare for the NSFR shift is a trial run that tests the institution’s ability to manage funding or structure the balance sheet in a way that meets standards across a sustained time horizon. The HKMA’s impact studies represent one such opportunity, albeit on a limited scale. With the studies wrapping up early next year and the regulator determined to meet the Basel timeline, the HMKA’s exercises are also a timely reminder institutions need to be ready for new funding obligations.

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