1. HKMA’s Regulatory
Requirements on LRM
Mr. Fai Y. LAM
MSc in Financial Engineering
CFA, CAIA, FRM,
PRM, MCSE, MCNE
PRMIA Award of Merit 2005
Tuesday 16
October 2012
11:00 pm to 12:30 pm
2
Outline
Supervisory framework on LRM
Banks’ LRM implementation
Survival tips
Sound practices of LRM
3
Supervisory framework
Laws and statutory guidelines
Circulars
LRM profiling
Prudential survey
Offsite review
Onsite examination
Control self-assessment
Tripartite meeting
4
Laws and statutory guidelines
Banking Ordinance
Liquidity ratio 25%
To be revised under the new Liquidity (Banking)
Rules
Follow Basel III’s LCR and NSFR
Statutory supervisory policy manuals
LM-1 Liquidity Risk Management
LM-2 Sound Systems and Controls for Liquidity
Risk Management

2. 5
Circulars
6
LRM profiling
A long questionnaire consisting 30 to 40 questions
LRM officer
Composition of LRM committee
IT systems for LRM in place
Major MIS reports
Contingency funding plan
No. of liquidity shortage incidents during the last three years
Latest audit findings
To capture static information about a bank’s LRM program
To be completed within two to three months, renew on annual
basis
Regulator to build a centralized database
7
Prudential survey
A short questionnaire to collect some ad-hoc
information during the year
European debt crisis
Quantitative easing
RMB liquidity
Driven by contemporary political, economic,
regulatory and/or media focus
Issued on ad-hoc basis
To be completed within one to four weeks
8
Off-site review
Revised and updated policies and procedures
Independent audit reports on an bank’s LRM
program
LCR implementation plan
Action plans to rectify audit findings
Progress report on rectification actions
Major incident reports
Follow up by meetings

3. 9
Onsite examination
Comprehensive examination
Two/three-people group, around two to three months
Covering major topics of an bank's LRM program
To assess the quality of an bank's LRM program
Thematic examination
One man band, around one month
Covering one to three hot LRM topics
Aim at identifying sound practices and common issues of
contemporary LRM topics
10
Control-self assessment (“CSA”)
A comprehensive audit check list
To be completed by an FI herself
Covering critical policy areas
For each control procedure
Compliance status – fully, partially or not
compliant
Explanations of compliance
Mitigation plan and tentative completion date
11
CSA summary
12
CSA summary by institution

4. 13
CSA summary by control procedure
14
CSA summary by institution and
control procedure
15
Compliance projection
16
Tripartite meeting
Three-party senior meeting among
Financial institution
Auditor
Regulator
To assess the major and critical areas for
improvement and/or development

5. 17
Challenges facing banks
External
Regulatory requirements keep on changing and tightening
Lacking implementation references
Lacking comprehensive academic theory
Internal
LRM is a cost centre
Limited budget
Lack of manpower
LRM impacts the cost and revenue directly
18
Outline
Supervisory framework on LRM
Banks’ LRM implementation
Survival tips
Sound practices of LRM
19
LRM structure
Management oversight
Board of directors – to listen and approve
Senior management – to propose and action
Liquidity risk management framework
Identification
Measurement
Monitoring
Control
Regulatory returns
Public disclosure
20
Liquidity risk identification
Assets vs liabilities
Off balance items
Funding sources
Contingent liabilities
Foreign currency

6. 21
Liquidity risk measurement
Cash flow approach
Accounting based
Advantages
+, -, x, /
Easy to understand
Simple to implement
Disadvantages
Cannot capture diversification
Fail to handle off-balance sheet items
Rely on subjective assumptions
22
Contractual maturity mismatch
23
Liquidity risk measurement
Liquidity stock approach
Liquefiable assets = Sum of Assets x (1 – haircut)
Liquidity ratio = Liquefiable assets / Liabilities
Minimum 25%, the higher the better
Advantages
Simple
Disadvantages
Totally useless
24
Liquidity risk monitoring
Bank liquidity monitoring
Maturity profile
Contractually cash inflows vs outflows
Behavioral assumptions
To ascertain that liquidity stock 0
Liquidity ratio
Liquefiable assets / Liabilities
Market monitoring
Counterparty monitoring

7. 25
Market-related monitoring tools
Market-wide information
Equity market indices, interest rates, currency rates,
commodity prices, volatility indices and CDS indices
Information (news) on the financial sector
To track whether the financial sector as a whole is
mirroring broader market movements or is experiencing
difficulties
Bank-specific information
The confidence of market in a particular institution or has
identified risks at an institution, e.g. stock prices,
volatilities, credit spreads and credit ratings
26
Scenario analysis and stress-testing
Bank specific
Failure of major counterparties
Failure of parent companies
Credit downgrade
Bank run
Market wide
Market crisis
Liquidity flowing outside Hong Kong
Standard results
Overall – no major
Specific immaterial items – room for enhancements
Major issues
Internal historical data insufficient
External historical data not transparency
Using academic theories
27
Liquidity risk control
Liquidity cushion
Regulatory liquidity – LCR and NSFR
Economic liquidity
Liquidity volatility
A missed item
Diversification
Wholesale funding
Retail funding
Market access
Question: How to measure diversification?
28
Liquidity risk control (***)
Intragroup liquidity
Intraday liquidity
Collateral management
Contingency funding flan

8. 29
Regulatory returns
Liquidity position
Liquidity ratio 25%
Maturity profile
Liquidity stock 0 in short to medium terms
Return on selected data for liquidity stress-testing
A hypothetical bank-run situation
Not used by anybody
30
Outline
Supervisory framework on LRM
Banks’ LRM implementation
Survival tips
Sound practices of LRM
31
Banks’ survival tips
With strong confidence
You know more than the HKMA and BCBS
Think in the shoes of the HKMA
Exception, regulatory and media focus
Demonstrate
No major issues in short to medium terms
Continuous improvements through assessments, plans and actions
Regular update to regulator
Meetings and short reports
Reserve immaterial rooms for suggestions
No major issues
Certain minor areas for enhancements
32
Management oversight
LRM committee
Likely to be same members from the ALM
committee
Terms of reference
Regular meetings, at least quarterly
To listen and approve/disapprove
To dedicate actions to the LRM working group
Agendas and meeting minutes

9. 33
LRM working group
To work on action items
To review draft policies
To approve procedures
To identify, measure, monitor and control
To source service providers
To request for budgets
To satisfy regulator
34
LRM policies
Prepared by the LRM project teams
Reviewed by the LRM working group
Approved by the LRM committee
Taking into accounting LM-1, LM-2 and LBR
Policy structure largely following LM-1, LM-2 and LBR
No of pages = LM-1 + LM-2 + LBR
To be reviewed on on-going basis
At least annually
Material changes to regulatory requirements
Substantial changes to business conditions
35
LRM implementations
LRM working group meetings
Procedures for focus topics, e.g. contingency
funding plan
Monthly MIS reports
Exception report
Trend analysis
Peer analysis
Review and sign off
IT system to produce reports
36
Contractual maturity mismatch
To identify the gaps between the contractual inflows
and outflows of liquidity for defined time bands
To indicate how much liquidity a bank would
potentially need to raise in each of these time bands
if all outflows occurred at the earliest possible date
To provide insight into the extent to which the bank
relies on maturity transformation under its current
contracts

10. 37
Concentration of funding
To identify those sources of wholesale funding that
are of such significance that withdrawal of this
funding could trigger liquidity problems
To encourage the diversification of funding sources
Thresholds
Significant counterparties 1%
Significant instruments / products 1%
Significant currencies 5%
38
Concentration of funding
.
'
/
.
'
.
Funding liabilities sourced from each significant counterparty
a
The bank s balance sheet total
Funding liabilities sourced from each significant product instrument
b
The bank s balance sheet total
ing liabilities sourced by each significant currency
Fund
c
The bank '
s balance sheet total
39
Available unencumbered assets
The assets that have the potential to be used as
collateral to raise additional secured funding in
secondary markets and/or are eligible at central
banks and as such may potentially be additional
sources of liquidity for the bank
A list of quantity of available unencumbered assets
that are marketable as collateral in secondary
markets and/or eligible for central banks’ standing
facilities by denominating currency, location and
other major characteristics
40
LCR by significant currency
To evaluate banks’ ability to raise funds in foreign currency
markets and the ability to transfer a liquidity surplus from one
currency to another and across jurisdictions and legal entities
Higher currency LCR expected for currencies in which a
bank has limited ability to raise funds in foreign currency
markets and/or the ability to transfer a liquidity surplus from
one currency to another and across jurisdictions and legal
entities
Amount of total net foreign exchange cash outflows to be net
of foreign exchange hedges
30
Foreign currency LCR
Stock of high quality liquid assets in each significant currency
Total net cash outflows over the next calendar days in each significant currency
=

11. 41
Preparation of MIS reports
Start from the minimum set
Same set of MIS reports for regulatory reporting and
internal LRM purposes when ever possible
To reduce recognition effort
Add at most two per quarter
Automation by IT systems
Microsoft Excel and Access
Algorithmics, Oracle, SAS, etc.
Never dress a big suit if you are small
42
Market monitoring
Major currencies
Major interest rates
Major equity market
indices
Price and volatility
indices
Major commodity
prices
Gold, old
Major credit indices
Large exposures
Credit rating
CDS spread
Credit spread
Action plans
Crisis management
team and meeting
Keep on monitoring
43
Monitoring by weekly percentage
changes
80%=4 year
44
Snapshot analysis

12. 45
Snapshot summary
46
Trend analysis
47
LRM outsourcing
Global market monitoring
Training and awareness
Compliance
Procedure review
Control-self assessment
Thematic review on fashion topics
Annual independent assessment
48
Training and awareness programs
General training
For all bank staff
Special topic training
Tailored for certain staff, e.g. treasury department
Regular update training
New comer training
Attendancy record
After training assessment

13. 49
Outline
Supervisory framework on LRM
Banks’ LRM implementation
Survival tips
Sound practices of LRM
50
Governance
The Board of Directors determines and
articulates the “liquidity risk tolerance” for
the AI both qualitatively and quantitatively.
Liquidity costs are allocated to business lines
according to their respective risk taking
activities so that business incentives are
aligned with the AI’s liquidity risk tolerance.
51
Risk identification, measurement,
monitoring and control
Net cash-flow mismatches along different
time horizons are measured: day-by-day for
the near term to ensure management has a
clear picture of the most imminent funding
needs, and by time buckets for the medium to
long term.
Cash-flows are monitored by individual
currency when AIs’ exposures to FX liquidity
risk in respect of that currency are significant.
52
Risk identification, measurement,
monitoring and control
The behavioural and contractual assumptions applied
in cash-flow projections to each applicable asset,
liability and off-balance sheet item are properly
documented.
Effective management information systems are put
in place to enable the timely generation of accurate
cash-flow analysis and other liquidity risk
management reports, both on a regular basis and
upon the request of users
Regular basic qualitative review of the AI’s
resilience to liquidity squeezes isconducted,

14. 53
Intraday liquidity risk management
Review is undertaken of intra-day liquidity
reports generated at various predefined times
throughout the day to assess cash-flows needs
and the adequacy of the AI’s intraday
liquidity resources
The respective levels of intra-day liquidity
needs, during both normal and stressed
market conditions, are regularly reassessed
54
Stress-testing and scenario analysis
The impact of significant cash outflows under
market-wide and institution specific stress scenarios
is analyzed
Reasonable assumptions are applied with respect to
key parameters based on relevant market and/or
institutional experience
The cash inflows expected to be generated from the
sale of liquid assets are fairly incorporated by
applying prudent assumptions
Regular reporting of stress-testing results to the
senior management is required
55
Sound practices or wish list
Maintenance of liquidity cushion
A reasonable amount of liquidity cushion is maintained by
setting floor limits on the holding of very high quality
liquid assets
Contingency funding plan
Detailed and prescriptive policies and procedures on a
contingency funding plan (CFP) are maintained and
comprehensive assessment on the feasibility of the CFP
conducted, drawing on experiences in respect of stresses
on markets and/or institutional liquidity during past
financial crises.