Page 83 - FINAL CFA II SLIDES JUNE 2019 DAY 5.2

NSFR relates the liquidity needs of a bank’s assets to the liquidity READING 17: ANALYSIS OF FINANCIAL INSTITUTIONS
provided by the bank’s liabilities (i.e., funding sources).
• Longer-dated liabilities are considered more stable and hence
would be suitable to fund assets with longer maturities (e.g., MODULE 17.4: LIQUIDITY POSITION AND SENSITIVITY TO MARKET RISK
long-term loans). Deposits from retail and small business clients
are considered more stable than deposits from corporate
clients. The standards recommend a minimum NSFR of 100%.

Other liquidity monitoring metrics recommended by Basel III include concentration of funding and maturity mismatch.
• Relatively concentrated funding indicates a bank’s reliance on relatively few funding sources. This lack of diversification may pose a problem
when the sources withdraw funding, heightening liquidity risk for the bank. Maturity mismatch occurs when the asset maturities differ from
maturity of the liabilities (funding sources). The higher the mismatch, the higher the liquidity risk. For example, sometimes banks try to maximize
the spread between lending and borrowing rates by borrowing at low, short-term rates and lending at higher, longer-term rates. This mismatch
in assets and liabilities may expose the bank to a liquidity crunch if it is unable to roll over its borrowings at reasonable rates.

Sensitivity to Market Risk
Bank earnings are affected by various market risks (e.g., volatility of security prices,
currency values, interest rates).
The most critical of these is interest rate risk - the result of differences in maturity,
rates, and repricing frequency between the bank’s assets and its liabilities. For
example, in a rising interest rate scenario, if the assets are repriced more frequently
than liabilities, the bank’s net interest income would increase.

Banks respond to opportunities presented in the market and alter their balance
sheets. For example, following the financial crisis of 2008, central banks around the
Answer: world reduced short-term interest rates, allowing banks to borrow at lower rates. To
benefit from this interest rate scenario, many banks increased their duration risk
(i.e., borrowed more short-term funds while lending long term).
LCR for 20X8 = (1,100/1,050) = 104.76%
Similarly, the impact of a change in the shape of the yield curve differs among
LCR for 20X9 = (1,250/1,300) = 96.15% banks, based on differences in the composition of their assets and liabilities. In the
MD&A section of their annual reports, banks often disclose exposure to a wide
For 20X9, the bank’s LCR has dropped from prior year, dropping variety of market and nonmarket risks. For example, a bank may disclose the impact
of a change in yield on its earnings.
even below the minimum requirement of 100%, indicating higher
liquidity risk. The impact of market risk can be captured by value at risk (VaR).