Treasury: Basel/Cash flows/Credit Ratings/Collateralized Financing

Continuing from previous Treasury Article …….

1.4   Cash flows from Operating, Investing and Financial Activities

Traditional methods of cash flow analysis with emphasis on net earnings and net assets have little meaning to global banks except for identifying some macro trends within their businesses. These banks evaluate funding and liquidity positions and policies quite differently as already described above with emphasis on tracking loans from origin to maturity, along with portfolios of investment securities and other receivables.

 

1.5  Credit Ratings

Generally, such factors as earnings, market position, business mix, capitalization, ownership, financial strategies, policies and practices including risk management, future prospects for the financial industry as a whole and even the composition of the management team figure in arriving at a credit rating for a bank. Although a bank’s credit rating may not be severely affected by retail and private deposits, availability, finding, and the cost of obtaining unsecured external funding, certainly would.

 

A downgrading in credit rating could result in increase in funding costs, reduced access to capital markets, having to post additional collateral, or risk the termination of some contracts on collateralized financing and derivatives by relevant counter-parties. This would ultimately lead to reduction in liquidity and thus adversely affecting performance and financial status.

 

1.6  Capital Management Framework

Over the last several years of operations, the Global Trust Bank (GTB) has been adhering to BCBS issued Basel II framework of international standards for its capital management. GTB’s capital management framework ensures availability of sufficient capital for supporting its primary risks, while achieving the management’s regulatory objectives and maintaining the credit rating at an appropriate level, less, a maximum of two to three notch downgrading.

 

(a)    Basel II Standards

Measurement of eligible capital and RWAs in addition to shareholders’ equity and qualifying non-controlling interests are dealt under tier-1 capital, which together with RWAs are resolved under Basel II. A three pillar based mutually reinforcing framework defines the standards for measuring capital adequacy and minimum standards to be observed by supervisors.

 

• Pillar 1 – sets minimum levels of capital to be held by a bank to cover it’s operational and credit market risks.
• Pillar 2 – covers supervisors’ roles in ensuring the periodical assessment and maintenance of capital ratios above minimum levels.
• Pillar 3 – sets norms on disclosure requirements – especially for financial institutions seeking approval for their own models for ascertaining capital requirements.

 

(b)   Basel III Standards

Introduced by the BCBS in December 2010, two notable improvements over Basel II consist of the introduction of two ratios called the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR) which are so structured as to complement each other.

• LCR, which is expected to be operative only from 2015, is intended to make banks carry sufficient unsecured high quality liquid assets to meet liquidity requirements over a 30 day horizon even under stressful periods. Another aim is to make banks keep liquid assets at a minimum level of 100% over their net cash outflows.
• The NSFR) which is to be introduced in 2018, sets out criteria to base a minimum level of stable funding on the liquidity of a bank’s assets and activities over a sphere of one year. This establishes a standard for banks to deploy stable long term funds for funding illiquid assets. The intention again is to make banks maintain a minimum level of 100% in the ratio of available stable funding to the amount of required stable funding.

1.6 Collateralized Financing

Collateralized Financing is another strategy employed by GTB. This includes securities lending and repurchase agreements. Depending on prevailing levels of client needs (for higher liquid collateral like US and agency securities), balance sheets impacts, RWA limits (risk weighted asset limits), and market opportunities, the Bank does collateralized financing, which includes repurchase agreements on one side and security lending agreements on the other.

Along with collateralized financing, the bank also engages in matched book trading where securities are purchased under agreements (meant for immediate resale); and are almost immediately sold under agreements to repurchase with matched maturities. This gives the Bank the additional advantage of earning spreads that are comparatively risk free and client activity related.  Consolidated entities remain GTB’s main source of liquidity since funding through SPEs (non-consolidated special purpose entities) and asset securitization are of no significance.