BACKGROUND
The Office of the Superintendent of Financial Institutions ("OSFI") has released a final version of revised Guideline B-6 – Liquidity Principles ("Guideline"). The Guideline has been updated to incorporate the principles set out in the Basel Committee on Banking Supervision ("BCBS"), Principles for Sound Liquidity Risk Management and Supervision (2008) (BCBS "Principles").
In early 2009, OSFI had released an advisory stating its expectations concerning the adoption by banks and other deposit taking institutions' ("DTIs") of the updated BCBS Principles. At that time, OSFI noted its expectation that, in addition to meeting the minimum standards of the existing Guideline, DTIs should also comply with the BCBS principles.
OVERVIEW
The Guideline sets out prudential considerations relating to the liquidity risk management programs of DTIs and bank holding companies ("Institutions"). The Guideline lists 13 principles that build upon the principles articulated by BCBS. In addition, the Guideline provides the framework within which OSFI assesses the content and effectiveness of the liquidity risk management of Institutions.
SUMMARY
Principle 1 provides that an Institution is responsible for the sound management of liquidity risk and must establish a risk management framework that ensures it maintains adequate liquidity to withstand a range of stress events including those involving the loss or impairment of both unsecured and secured funding sources.
The requirements for governance, risk tolerance and liquidity policies are addressed in Principles 2, 3 and 4. An Institution is required to articulate a liquidity risk tolerance that reflects its business strategy and role in the financial system. Senior management is responsible for developing a strategy, policies and practices to manage liquidity risk in accordance with the risk tolerance and ensuring that the Institution maintains sufficient liquidity. The Institution's board of directors is required to review and approve the liquidity risk tolerance and strategy. In addition, an Institution is required to actively monitor and control liquidity risk exposures and funding within and across legal entities, business lines and currencies.
Principle 5 requires an Institution to have a sound process for identifying, measuring, monitoring and controlling liquidity risk. This process must include a robust framework for projecting cash flows arising from assets, liabilities and off-balance sheet items over an appropriate set of time horizons.
Stress testing is addressed in Principles 6, 7 and 8. An institution is required to conduct stress tests on a regular basis for a variety of short-term and protected institution-specific and market-wide stress scenarios to ensure that current exposures remain in accordance with an Institution's established liquidity risk tolerance. The outcomes of stress test exercises should be integrated into management decisions and impact the design of contingency funding plans. An Institution is required to maintain a cushion of unencumbered high quality liquid assets to be held as insurance against a range of liquidity stress scenarios. In addition, an Institution is required to actively manage its collateral positions, differentiating between encumbered and unencumbered assets, and monitor the legal entity and physical location where collateral is held and how it may be mobilized in a timely manner. OSFI has indicated that in addition to internal stress testing programs, it will require, on a targeted basis, the calculation of a common stress measure defined as net cumulative cash flow which is a survival stress measure that quantifies the length of time before the Institution's net cumulative cash flow turns negative.
Principle 9 requires an Institution to have a formal contingency funding plan that clearly sets out the strategies for addressing liquidity shortfalls in emergency situations.
Internal controls and incentives are addressed in Principle 10. OSFI requires an Institution to incorporate liquidity costs, benefits and risks in the internal pricing, performance measurement and new product approval process for all significant business activities thereby aligning the risk-taking incentives of individual business lines with the liquidity risk exposures their activities create for the Institution as a whole.
Principle 11 focuses on managing market access. An institution is required to establish a funding strategy that provides effective diversification in the sources and tenor of funding. OSFI expects an Institution to review this effort to maintain diversification of liability and establish relationships with funds providers in different funding markets to promote effective diversification.
Intraday liquidity risk is addressed in Principle 12. An institution is required to actively manage its intraday liquidity positions in order to meet payment and settlement obligations on a timely basis under both normal and stressed conditions.
Finally, Principle 13 speaks to public disclosure, requiring an Institution to disclose information on a regular basis that is sufficient for market participants to make an informed judgement about an Institution's liquidity risk management framework and the ability of an institution to meet its liquidity requirements.
OTHER COMMENTS
OSFI has indicated that the Guideline will also be complemented by a set of quantitative liquidity standards, metrics and disclosure requirements.
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