Lab Test: Liquidity risk and funding · RiskAtoms Academy

How it works

Eight problems from the people who keep a bank able to pay: the treasurer, liquidity risk, regulatory reporting, ALM, payments and funds transfer pricing, and, outside the bank, a pension scheme and a fund. They follow one new bank, Fenmarsh Bank plc, from its funding mix to its stress test and its plan, and most need more than one lesson. Answer each part (the unit is shown beside the box; £, %, commas, a minus sign and an x after a multiple are fine), press Check, then step through the worked solution. Numeric answers are marked right within a small tolerance, so round sensibly as you go. Keep a calculator handy.

Illustrative dataFenmarsh Bank plc, a new bank for the Lab Test

The lessons use RiskAtoms Bank's £67bn liquidity book. These problems apply the same methods, rates and factors to a new, smaller bank: Fenmarsh Bank plc, with a £5,000m balance sheet, its staff pension scheme and the Fenmarsh Property Income Fund, all invented. The calculations are hand-sized: a 30-day stress summed by source, one day of eight payments, one waterfall. All figures are made up, in £ millions, principal only (no interest flows).

Problem 1Who funds Fenmarsh

L3.5.02 · L3.5.08

Treasurer, Fenmarsh Bank plc

Fenmarsh Bank plc (invented) is a UK retail and small-business bank with a £5,000m balance sheet, about a thirteenth the size of RiskAtoms Bank. Its balance sheet, used in every problem below:

Assets, £m. The buffer is held as a stock; the other lines show what falls due within 30 days on contract.
Asset	Amount	Due in 30 days
Cash and central bank reservesLevel 1	200	–
GiltsLevel 1, £100m pledged in repo	400	–
Covered bondsLevel 2A	200	–
BBB corporate bondsLevel 2B	300	–
Placements with banks	100	100
Residential mortgages	2,700	30
Loans to small businesses	900	30
Other assets	200	–
Total assets	5,000

Funding, £m. Deposits with no fixed term fall due overnight on contract.
Liability or equity	Amount	Due within 30 days
Stable retail deposits (insured current accounts)	1,600	1,600
Less stable retail deposits (instant-access savings)	1,000	1,000
Retail fixed-term deposits	600	60
Operational corporate deposits	200	200
Other corporate deposits	400	300
Deposits from banks and other financial institutions	300	200
Repo secured on gilts	100	100
Senior bonds (over a year)	400	0
Equity	400	–
Total funding	5,000

Off the balance sheet: £500m of undrawn committed credit facilities to companies, and £30m of extra derivative collateral the bank would have to post after a three-notch downgrade.

To make its funding stickier, the treasurer replaces £200m of the other corporate deposits falling due within 30 days (paying 3.50%, LCR outflow rate 40%) with two-year retail fixed-term bonds paying 4.10%, which have no outflow within 30 days.

Fenmarsh's wholesale funding, its deposits from banks and other financial institutions and its repo, comes from six providers (£m):

Provider	Deposits	Repo	Total
Provider A (bank)	70	50	120
Provider B (money market fund)	90	0	90
Provider C (bank)	20	50	70
Provider D (pension scheme)	55	0	55
Provider E (insurer)	35	0	35
Provider F (company)	30	0	30
Total	300	100	400

As in L3.5.08: Funding concentration, a counterparty is significant if it provides more than 1% of the total balance sheet.

Lessons: L3.5.02: How banks fund themselves · L3.5.08: Funding concentration

(a)What is Fenmarsh's loan-to-deposit ratio (customer loans over customer deposits)? Answer in %.
%
(b)What does the switch cost in extra interest a year for each £1 of 30-day stressed outflow it removes? Answer in % a year.
%
(c)What is the HHI of the wholesale funding by provider, on the 0 to 10,000 scale?
(d)How many of the six providers are significant counterparties?

Problem 2A month of forced sales

L3.5.01

Liquidity risk manager

In a market-wide stress Fenmarsh must find £600m over a month, before any collateral calls. Its unencumbered buffer at face value, and the forced-sale discounts in the module's market-wide stress:

Asset	Face, £m	Discount at m = 1
Cash and reserves	200	0%
Gilts not pledged	300	2%
Covered bonds (Level 2A)	200	10%
BBB corporate bonds (Level 2B)	300	30%
Total	1,000

As in L3.5.01: Funding liquidity and market liquidity, market stress $m$ scales every discount ( $m = 1$ is the module's market-wide stress, $m = 2$ twice as severe) and brings collateral calls of £20m × $m$ on top of the £600m. Fenmarsh pays from cash first, then sells gilts, then covered bonds, then BBB bonds.

Lessons: L3.5.01: Funding liquidity and market liquidity

(a)What is the counterbalancing capacity at m = 1? Answer in £m.
£m
(b)At m = 1, what face value of covered bonds must Fenmarsh sell to pay the month's bill, calls included? Answer in £m.
£m
(c)At what level of market stress m does the headroom reach zero?

Problem 3The buffer and the two ratios

L3.5.06 · L3.5.07

Regulatory reporting, treasury

From the balance sheet in Problem 1: the £100m of gilts pledged in repo is encumbered and does not count. The LCR haircuts are 0% (Level 1), 15% (Level 2A) and 50% (Level 2B); after haircuts, Level 2 may be at most 40% of the stock and Level 2B at most 15%, with the excess deducted. The LCR's 30-day outflows and inflows (inflows are capped at 75% of outflows):

LCR line	Base, £m	Rate
Stable retail deposits	1,600	5%
Less stable retail deposits	1,000	10%
Retail term deposits due in 30 days	60	10%
Operational corporate deposits	200	25%
Other corporate deposits due in 30 days	300	40%
Bank and financial deposits due in 30 days	200	100%
Repo on gilts (Level 1)	100	0%
Undrawn committed facilities to companies	500	10%
Collateral after a three-notch downgrade	30	100%
Inflow: placements with banks due in 30 days	100	100%
Inflow: loan repayments due in 30 days	60	50%

The NSFR's available and required stable funding factors (all mortgages qualify for 65%):

Available stable funding	£m	Factor
Stable retail deposits	1,600	95%
Less stable retail deposits	1,000	90%
Retail term deposits, under a year	300	90%
Retail term deposits, a year or more	300	100%
Operational corporate deposits	200	50%
Other corporate deposits (all under a year)	400	50%
Bank and financial deposits (all under 6 months)	300	0%
Repo (under 6 months)	100	0%
Senior bonds (over a year)	400	100%
Equity	400	100%

Required stable funding	£m	Factor
Cash and reserves	200	0%
Gilts (including the £100m in repo)	400	5%
Covered bonds	200	15%
BBB corporate bonds	300	50%
Placements with banks (under 6 months)	100	15%
Residential mortgages	2,700	65%
Small business loans, under a year	330	50%
Small business loans, a year or more	570	85%
Other assets	200	100%
Undrawn committed facilities	500	5%

Lessons: L3.5.06: The liquidity buffer · L3.5.07: LCR and NSFR in practice

(a)What is the buffer, the stock of HQLA after haircuts and caps? Answer in £m.
£m
(b)What is Fenmarsh's LCR? Answer in %.
%
(c)What is its NSFR? Answer in %.
%
(d)A portfolio manager proposes spending £100m of reserves on more BBB bonds for the yield. What would the buffer be? Answer in £m.
£m
(e)Instead, treasury replaces £100m of bank deposits due within 30 days with a two-year senior bond. What would the LCR be? Answer in %.
%

Problem 4The ladder, on contract and in behaviour

L3.5.04

ALM analyst, treasury

Fenmarsh's contractual cash flow ladder for the first year, £m. Principal only; the buffer is held as a stock, not in the flows; deposits with no fixed term fall due overnight on contract.

Bucket	Inflows	Outflows	of which demand deposits
Overnight	40	3,150	3,000
2–7 days	40	150	–
8–30 days	80	160	–
1–3 months	120	190	–
3–6 months	170	170	–
6–12 months	340	80	–

The £3,000m of demand deposits are the retail current accounts and savings, the operational deposits and the £200m of other corporate deposits due overnight. In the behavioural view they leave 1%, 1%, 3%, 4%, 4%, 8% of the balance in the six buckets in normal times; the rest stays beyond a year. Every other line keeps its contractual dates. The position adds the buffer from Problem 3, £788.2m, as cash on day one.

Lessons: L3.5.04: Cash flow ladders and maturity gaps

(a)What is the contractual cumulative gap at 30 days? Answer in £m, negative for a shortfall.
£m
(b)In the behavioural view, what is the position at 30 days (cumulative gap plus the buffer)? Answer in £m.
£m
(c)In the behavioural view, what is the lowest position in the first year? Answer in £m.
£m

Problem 5A combined stress, and the plan

L3.5.03 · L3.5.05 · L3.5.10

Head of liquidity risk

Fenmarsh's combined stress: a three-notch downgrade during a market-wide freeze. The assumptions for the first 30 days:

Line	Assumption
Stable retail deposits	6% withdrawn
Instant-access savings	20% withdrawn
Operational corporate deposits	25% withdrawn
Other corporate deposits due in 30 days	50% renewed
Retail term deposits due in 30 days	50% renewed
Bank and financial deposits due in 30 days	none rolled
Repo on gilts	rolls (secured on Level 1)
Undrawn committed facilities	10% drawn
Downgrade collateral	£30m called on day 1
Placements with banks due in 30 days	not renewed: cash comes in
Loans due in 30 days	50% renewed, the rest repaid

The counterbalancing capacity is the buffer at the forced-sale values of Problem 2 at $m = 1$ , £884m. The cumulative net outflow rises every day of the first month and stays below capacity. From day 31 the run slows to a steady net outflow of £9m a day. The bank survives while its headroom (capacity less cumulative net outflow) is not negative.

Lessons: L3.5.03: What drains liquidity · L3.5.05: Liquidity stress tests and survival horizons · L3.5.10: Contingency funding plans

(a)What is the cumulative net outflow over the first 30 days? Answer in £m.
£m
(b)How many days does Fenmarsh survive?
days
(c)The board wants Fenmarsh to survive 90 days. The contingency funding plan lists four actions. Which one, on its own, gets it there?
AIssue a £400m two-year senior bond, cash on day 10: in normal times the cheapest term money.BBorrow from the central bank against £500m of pre-positioned mortgages at a 30% haircut, cash from day 2, at 0.5% a year over the market rate.CSell £400m of small business loans at an 8% discount, cash on day 60.DPay 1 percentage point more on instant-access savings from day 2: £40m less leaves in the first month, and the steady outflow falls to £6m a day.
(d)With that action, what is Fenmarsh's headroom on day 90? Answer in £m.
£m

Problem 6A day on the payment system

L3.5.09

Payments liquidity manager

Fenmarsh settles its sterling payments over its account at the central bank's real-time gross settlement system. One day's payments, in time order:

Time	Direction	£m
07:00CLS pay-in, time-specific	Out	120
08:30	In	80
09:15	Out	150
10:00	In	60
11:30	Out	90
12:45From the largest counterparty	In	200
14:00	Out	70
16:30	In	110

It starts the day with £120m of reserves. Beyond that it borrows intraday from the central bank against gilts, at a 5% haircut.

Lessons: L3.5.09: Intraday liquidity

(a)What is the day's largest intraday liquidity usage? Answer in £m.
£m
(b)The largest counterparty's £200m never arrives (a counterparty stress). What is the largest usage now? Answer in £m.
£m
(c)On the stressed day, what face value of gilts must Fenmarsh pledge for intraday credit to cover the usage beyond its reserves? Answer in £m.
£m

Problem 7What liquidity costs

L3.5.11

Funds transfer pricing, treasury

Fenmarsh's funds transfer pricing curve, continuously compounded: a flat base rate of 3.90% plus a liquidity premium

\text{LP}(T) = 1.50\% \times \big(1 - e^{-T/2}\big), \qquad T \text{ in years.}

A relationship manager offers a small business a 3-year loan at a floating rate reset every three months: base plus 1.80%.

The buffer is funded for one year at the FTP rate. At market value it holds £500m of Level 1 (cash and unpledged gilts), £200m of Level 2A and £300m of Level 2B, which earn the base rate plus 0.00%, 0.25% and 0.40%. Its cost is shared in proportion to the LCR's gross outflows (Problem 3); corporate banking owns the operational and other corporate deposits and the undrawn facilities.

Lessons: L3.5.11: Pricing liquidity

(a)What liquidity premium should the loan be charged? Answer in bp.
bp
(b)What net margin does the loan earn after the base rate and the liquidity premium? Answer in bp.
bp
(c)What does it cost Fenmarsh a year to hold its buffer? Answer in £m.
£m
(d)How much of that cost is charged to corporate banking? Answer in £m.
£m

Problem 8Beyond the bank: a pension scheme and a fund

L3.5.12

Risk manager, pensions and funds

Fenmarsh's staff pension scheme hedges its liabilities with LDI: swaps and gilt repo with a PV01 of £0.6m per basis point. Gilt yields rise 150bp in three days. The trustees' liquidity waterfall:

Source	£m	Ready by day	Sale cost
Collateral buffer in the LDI fund	40	0	–
Scheme cash	15	1	–
Fenmarsh's liquidity facility to the scheme	20	2	–
Corporate bonds	60	3	3%
Equities	80	4	2%

The Fenmarsh Property Income Fund (also invented) deals daily. Its net asset value is £200m: 200 million units at 100p. One day investors redeem £15m net, paid from cash. The fund then sells enough property to replace the cash it paid, and selling property costs 6% of its value.

Lessons: L3.5.12: Liquidity beyond banks

(a)What collateral does the hedge call for? Answer in £m.
£m
(b)If the cash is needed by the end of day 2, how much short is the scheme? Answer in £m.
£m
(c)How large a yield rise can the scheme meet within three days? Answer in bp.
bp
(d)Without swing pricing, by how much does the value of a unit fall for the investors who stay? Answer in pence.
p
(e)What does swing pricing do for the fund?
AIt stops the fund from ever having to suspend dealing.BIt makes redeemers bear the cost of the sales they cause, so those who stay are not diluted; it does not make property sell any faster.CIt pays redeemers more than the mid price, to compensate them for the wait.DIt removes the need for a notice period, because a swung price slows redemptions to the pace of property sales.

Score 0 / 310 of 8 problems checked

Back · L3.5.12

Liquidity beyond banks

Next module · L3.6.01 · coming soon

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