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In December 2010 the Basel Committee on Banking Supervision (BCBS) announced the introduction of the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR) to be put in place in 2015 and 2018, respectively. In the European Union (EU), the LCR became a binding requirement in October 2015, while for the NSFR there is currently no fixed implementation date. These requirements are important steps to improve banks’ resilience to liquidity shocks. However, they focus on individual banks, without taking into account liquidity risks and mitigation from a macroprudential perspective. Therefore, the Financial Stability Committee of the European Central Bank (ECB) agreed in 2016 that work on systemic liquidity would be carried out by a dedicated group.

The Task Force on Systemic Liquidity (TFSL) was set up to examine systemic liquidity risk and potential policy responses. Its objective was to develop a framework that measures systemic liquidity and helps to identify the need for macroprudential liquidity instruments from both a risk and a legal perspective. The TFSL focused on the macroprudential level to provide a broader view of liquidity developments and to facilitate the monitoring of potential build-ups of liquidity risks at system level. The European Central Bank (ECB) issued a first report providing the necessary foundation for assessing, measuring and monitoring systemic liquidity risk. The report is divided in five parts.

The first part establishes a concept of systemic liquidity and develops a case for considering macroprudential liquidity instruments. It builds upon the definition of systemic liquidity developed by the International Monetary Fund, explaining that systemic liquidity risk occurs when multiple financial institutions experience financial difficulties at the same time. Because of the possibility of public intervention (i.e. bailouts) in the event of a crisis, this concept is also strongly related to a collective moral hazard issue, as banks do not fully internalise the risks of a systemic event by holding more liquidity buffers.

The second part of the report discusses the microprudential liquidity tools available and the potential to use them for macroprudential objectives. Existing micro-prudential measures are not completely suitable for mitigating systemic liquidity risk. In particular, they ignore the importance of the cross-sectional dimension of systemic liquidity risk: interconnectedness and contagion effects.

The third part of this report analyses the legal basis for macroprudential liquidity requirements under current regulation. An examination of the legal basis of macroprudential liquidity tools is a key contribution of the report, which aims to provide clarity on the availability of macroprudential tools from a legal perspective.

The fourth part of this report develops a set of indicators for measuring system-wide liquidity risks. The focus is on the cyclical dimension of systemic liquidity to support policy discussions about potential countercyclical elements of existing liquidity measures or the need for new instruments. A total of 20 indicators were developed. Four criteria were used to analyse the indicators: (1) ability to capture systemic liquidity; (2) scope; (3) crisis signalling; (4) data availability. The dashboard of indicators focus on developments in systemic liquidity risk in the bank and non-bank financial system.

The fifth part of this report illustrates, via several case studies, the usability of the dashboard of indicators, and presents possible extensions to the indicators created. Since the dashboard shown is most useful when compared across time, long time series data showing the change in liquidity risk across different market conditions and different points in the business cycle are essential. Therefore, although the dashboard indicators are deemed useful at this stage, they are generally hampered by the lack of long time series and data granularity.

Taking into account the usability of the dashboard with its current limitations, the TFSL proposes using the dashboard as a reference tool for monitoring liquidity risk conditions and monitoring its effectiveness in the next two years. While a case for new macroprudential liquidity tools cannot yet be made from a risk perspective, primarily due to the lack of data availability and granularity, as well as the current highly accommodative monetary policy stance, the TFSL is of the opinion that the dashboard can be used to provide quantitative evidence of changes in the intensity of systemic liquidity risk conditions while improving the set of indicators.

Systemic liquidity concept, measurement and macroprudential instruments (PDF)

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