Draft Basel III provisions cushion liquidity shocks

To help banks tide over liquidity shocks, the RBI today came out with draft Basel III guidelines under which lenders will have to maintain a minimum amount of assets that can be encashed fast, and set up mechanisms to monitor risks.

"Banks will have to ensure that they maintain the required Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) at all times starting from January 2015 and January 2018, respectively," the Reserve Bank said in the draft guidelines.

"While the LCR and NSFR standards would become binding only from January 2015 and 2018, respectively, the supervisory reporting under the Basel III framework is expected from 2012," it further said.

The central bank has invited comments and feedbacks from banks and other institutions by March 21 on draft guidelines. Banks are expected to submit the liquidity returns under the Basel III framework to the Reserve Bank from the month or quarter ending June 2012, the RBI said.

The LCR promotes short-term resilience of banks to potential liquidity disruptions by ensuring that they have sufficient high quality liquid assets to survive an acute stress scenario lasting for 30 days.

The NSFR promotes resilience over longer-term time horizons by creating additional incentives for banks to fund their activities with more stable sources of funding on an ongoing structural basis.

The draft guidelines said that a bank should have appropriate internal controls, systems and procedures to ensure adherence to liquidity risk  management policies and procedure as also adequacy of liquidity risk management functioning.

"Management should ensure that an independent party regularly reviews and evaluates the various components of the bank's liquidity risk management process. These reviews should assess the extent to which the bank's liquidity risk management complies with the regulatory/supervisory instructions as well as its own policy," it said.

For a robust liquidity risk management framework, the board of directors of a bank should be responsible for sound management of liquidity risk, it said, adding that the board should articulate the liquidity risk tolerance appropriate for its business strategy and its role in the financial system.

The draft said the board of directors should also develop a strategy, policies and practices to manage liquidity risk.

"Top management/asset liability committee (ALCO) should continuously review information on bank's liquidity developments and report to the board on a regular basis," it said.

It further said that a bank should have a sound process for identifying, measuring, monitoring and controlling liquidity risk, including a robust framework for comprehensively projecting cash flows arising from assets, liabilities and off-balance sheet items over an appropriate time horizon.

"A bank should incorporate liquidity costs, benefits and risks in internal pricing, performance measurement and new product approval process for all significant business activities.

"A bank should actively monitor and manage liquidity risk exposure and funding needs within and across legal entities, business lines and currencies, taking into account legal, regulatory and operational limitations to transferability of liquidity," the draft said.

Besides, it said that a bank should conduct stress tests on a regular basis for short-term and market-wide stress scenarios and use their outcomes to adjust its liquidity risk.