Deutsche Bank’s Christine Thomas talks to Joy Macknight about the increasing regulatory oversight of intraday credit and how market participants are responding to emerging regulations.

Christine Thomas

Despite the crucial role that intraday credit plays in enabling the smooth functioning of global payments, clearing and settlement systems (encompassing securities and derivatives), historically these flows were below the radar of regulatory supervision.

The main reason was because of the typically unadvised and uncommitted – and therefore unreported – nature of this category of credit. It does not appear on a bank’s balance sheet, as usually the liquidity underpinning these credit lines is released in the morning and squared off by the day’s end. But by virtue of being unadvised and uncommitted, these intraday credit lines between users and correspondent banking providers could theoretically be withdrawn any time, at the provider’s discretion.

The collapse of Lehman Brothers changed regulators’ perception of the systemic risk posed by financial institutions (FIs) being unable to cover their payment obligations. The global financial crisis exposed the vast (in terms of volume and value) credit lines extended daily between FIs to make payments. In a crisis, such credit lines, along with interbank money market lending lines, can evaporate within the business day, effectively bringing the global payment system to a grinding halt.

Under regulators’ scrutiny

While this scenario did not play out in full during the 2008 crisis, it did propel intraday liquidity and intraday credit into the regulators’ line of sight. As outlined in the Basel Committee on Banking Supervision’s set of monitoring tools for intraday liquidity management (BCBS 248), published in April 2013, internationally active banks are now being asked to measure usage and report their intraday commitments. The monitoring tools complement the Basel III framework and liquidity ratio requirements, which are currently being phased in.

As well as measuring and reporting during normal market conditions, regulators want to understand how these credit lines would perform in a crisis scenario. “The regulators are attempting to make the global system more stable by shining a spotlight onto this sphere,” says Christine Thomas, head of financial risk, institutional cash management, at Deutsche Bank.

While the general stress-testing being performed under Basel III to date has not been extended to intraday liquidity specifically, Ms Thomas believes this might change. “The regulators are requesting data around the usage of intraday credit lines and can be expected to analyse this data once it is fully available,” she says. “If a bank is extending intraday liquidity to certain clients that use it on a regular basis, then they may want to explore what that means under stressed market conditions.”

Currently, unadvised and uncommitted credit lines do not create risk-weighted assets (RWAs), and as such they do not absorb equity. However, if the regulators decide that there is a type of credit component in intraday liquidity that merits assets and equity to post against it, then the availability of unadvised and uncommitted intraday credit lines might decrease in the future, according to Ms Thomas.

“If regulators decide to use a blunt tool, such as requiring equity be put against these vast credit lines, then banks would have to charge for that, which in turn would drive up the costs of the entire system and potentially drive down availability,” she says. A coordinated approach is key to addressing this issue, she adds, in addition to assessing the impact with all stakeholders prior to changing the rules.

Impact of reporting requirements

In many jurisdictions, regulations governing how intraday credit lines and liquidity usage are to be reported have yet to be transposed into local law. The new reporting requirements were originally planned for introduction in January 2017, but deadlines have been pushed back.

Different jurisdictions are at differing stages of implementation. For example, the UK’s Prudential Regulation Authority published guidelines in August 2015 and updated them in March this year. Also in 2015, the Hong Kong Monetary Authority released locally reporting requirements on intraday liquidity positions in both payment and settlement systems, as well as with correspondent banks.

Swift, in association with the Liquidity Implementation Task Force, has also developed global market practice guidelines for intraday liquidity reporting messaging. The guidelines describe usage of intraday confirmations on a per transaction basis including a time stamp accurate to the minute, which is a key way to comply with reporting requirements, according to Ms Thomas.

“By having guidelines around the information being provided and received, it is possible for the monitoring bank to match information from different providers, which offers a real-time overview and is agnostic as to who is providing the payment information,” she says.

Complicating the issue

But with no globally binding regulations for reporting currently in force, many jurisdictions are implementing diverging rules, thus complicating compliance. However, the direction of travel is clear. Ms Thomas says: “While reporting requirements may differ country to country, regulators want to have oversight of the total credit lines and the highest usage threshold, to assess the worst-case scenario.”

Once reporting is widespread, it remains to be seen what the regulators do with the information – but most expect them to begin digging deeper into intraday credit risk during the supervisory review process.

Ms Thomas reports that one regulator has asked Deutsche Bank to provide credit not only based on the bank’s credit appetite but also on observed client usage, which is a significant shift in mind-set. “Effectively, that means we must monitor the usage of intraday credit lines and consider setting them at a different level, as well as potentially reducing them,” she says.

It is a balancing act. On the one hand, intraday credit lines are unadvised and uncommitted, so banks do not have a commitment; but on the other hand, the more that regulators focus on the intraday space, the less intraday liquidity may be available or the more costly it might become, especially in stressed market conditions.

“Regulators are indicating that, going forward, it will not be possible to rely on unadvised and uncommitted credit lines. Therefore, market participants need to have secure funding sources, which means either more committed credit or more liquidity sourced elsewhere – but both come at a price,” says Ms Thomas.

Systemic oversight

In order to address the potential systemic risk inherent in intraday credit, the regulators focused on central securities depositories (CSDs) and central counterparty clearing houses (CCPs), and then turned to internationally active banks. Whether other banks and FIs should be a focus of the regulation will be at the discretion of the national supervisors.

In 2015, the European Banking Authority (EBA) published regulatory technical standards for monitoring, measuring, reporting and public disclosure specifically for CSDs, as mandated by EU regulation 909/2014. “The EU regulators are focused on liquidity risk management,” says Ms Thomas. “The CSD, or banking service provider, has a risk on the liquidity side because of the unadvised and uncommitted nature of credit lines.”

The EU regulators require entities regulated under this directive to provide different solutions to make the system more stable. One such solution is to put in place committed credit lines or similar agreements. For example, a CSD or CCP might be requested to move a certain portion of its existing intraday credit lines from an unadvised and uncommitted position to a committed intraday credit facility.

New product development

According to Ms Thomas, Deutsche Bank has developed a new type of intraday credit product specifically to address this requirement: a committed daylight overdraft limit. “At this stage, it will be predominantly for those clients that fall under this legislation, mainly because moving to committed credit, whether a loan or overdraft facility, comes at a cost,” she says. “We have also met client needs by putting committed repo and committed foreign exchange solutions in place.”

In addition, the bank is looking at developing variations on the committed intraday product, according to Ms Thomas. “Basically, any variation will be a commitment to support cash clearing, but there will be different versions driven by client type, their credit standing and the bank’s risk appetite,” she says. “Additionally, it will come down to a question of cost – because both uncollateralised and collateralised credit has implications on pricing.”

As the regulation emerges, Deutsche Bank remains in close dialogue with clients, regulators and the industry to develop solutions that match client interest, regulatory requirements and its own credit perspective. “We are developing several different product sets and tools, but all will be closely related to the committed intraday product – predominantly intraday, but possibly overnight,” says Ms Thomas.

The bank is also exploring a better way to measure a portfolio’s risk-return profile. Conventionally, most banks use the return over RWA methodology. However, as previously indicated, unadvised and uncommitted intraday credit lines do not create RWAs because the funds are normally repaid at the end of the day. Therefore, it is not possible to measure these substantial portfolios in classic metrics.

To address this, Deutsche Bank has developed an intraday-specific methodology to correlate credit quality, risk appetite and revenue for an individual client or counterparty, called return over risk-weighted daylight overdraft limit.

“This is a big change for us. It means we can better evaluate and direct our portfolios, effectively putting our credit fire power towards preferred clients that can generate a decent risk-return,” says Ms Thomas. “It allows us to adjust quickly to changes in certain markets or in risk perception and/or risk appetite.”

Efficient use of liquidity

Ultimately, better liquidity management is the best way to minimise the cost of liquidity, according to Ms Thomas. For example, in order to cover its intraday payments, a bank must either make its own funds available by prefunding the account or having a credit line in place, which incurs cost. Additionally, the more collateral a bank can put against credit, the lower the cost of that credit is – but collateral also comes at a cost.

“Purely from a cost perspective, it depends on whether the individual entity can better manage its liquidity. Credit comes with an associated cost but it might be less expensive than sourcing cash elsewhere. Banks should also optimise their payment behaviour so that throughout the day, or a specific time period, their outgoing flows match incoming flow, and, as a result, it will need less intraday liquidity,” she says.

The onus is on banks to optimise their intraday liquidity management and many are rising to the challenge. “In the past, intraday liquidity hasn’t been free, but intraday credit has been perceived as a free resource,” says Ms Thomas. “But now that it has been brought into the spotlight, banks are beginning to think about how to better manage this resource.”

Some optimisation of liquidity flows is already happening through CCPs. But, as Ms Thomas points out, this in turn makes CCPs more systemically important. “That is the reason the EBA has targeted CCPs in the first regulation. They can’t fail – they are that important to the system. If a large bank fails, that would be a big issue, but if a CCP were to fail then the system would be in deep trouble,” she says.

For the greater good

Uncertainty remains about the end state of the emerging intraday liquidity regulation, together with general global regulatory uncertainty regarding Basel III’s progression and the future of the Dodd-Frank act. However, overall the regulators are moving in a positive direction. Globally, their overarching aim has been to establish safety nets and increase equity in banks.

Regulators want banks to be safe because they are at the heart of the economy. “Increasing transparency in the system, making the industry focus on things that have been taken for granted in the past and putting commitment in place – these all have the potential to increase the stability of the global payments systems and cash clearing,” says Ms Thomas.

Regulation will not take all the risk out of the financial system – it cannot and, most would argue, should not – but it can make the entire system more secure for market participants and, by definition, for society as a whole.

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter