An introduction to the Basel III Net Stable Funding Requirement (NSFR) for insomniacs or obsessives in the repo market

The NSFR measures a bank’s Available Stable Funding (ASF) relative to its Required Stable Funding (RSF). Banks will have to maintain their NSFRs at 100% or more.

NSFR= ASF/RSF

The NSFR is one of the key Basel III reforms to promote a more resilient banking sector through structural changes in the liquidity risk profiles of banks that will reduce the likelihood that disruptions to a bank’s regular sources of funding will erode its liquidity position in a way that would increase the risk of its failure and potentially lead to broader systemic stress. Specifically, the NSFR is intended to limit over-reliance by banks on short-term wholesale funding during times of buoyant market liquidity, by forcing banks away from short-term funding mismatches and towards longer-term funding of longer-term and less liquid assets and business activities.

The NSFR is designed to complement the Liquidity Coverage Ratio (LCR) and reinforce other supervisory efforts. Whereas the LCR focuses on cashflow behaviour under multiple general liquidity stresses (market liquidity risk) over a short term of 30 days, the NSFR looks at the resilience of the asset and liability structure of the balance sheet under firm-specific stresses (funding liquidity risk) over a medium-term timeframe of one year. Among other things, the NSFR is intended to offset incentives for bank to fund their stock of high-quality liquid assets (HQLAs) with short-term funds that mature just outside the 30-day horizon of the LCR.

The ASF of a bank is calculated by assigning different weightings (ASF factors) to each of a series of five categories of borrowing. The weightings depend upon the assumed stability of the category of funding to which they apply. The stability of funding is seen as being a function of its:

  • term to maturity (which can be open, less than six months, six to one year or over one year);
  • type of lender (who can be retail, SMEs, central banks, corporates, sovereigns, public sector entities (PSEs), or national or multilateral development banks);
  • type of asset (which can be capital, deposits, wholesale funding, short positions or net derivatives payables).

The RSF of a bank is calculated by assigning different weightings (RSF factors) to each of a series of seven categories of lending. These depend upon the assumed liquidity of the category of asset to which they apply. The liquidity of an asset is seen as being a function of its:

  • term to maturity (which can be open, less than six months, six to one year or over one year);
  • quality and liquidity (which depends on whether it is encumbered, ease of sale or use as collateral, LCR status and credit rating).
  • RSF factors also reflect:
  • an assumption that banks will roll over a proportion of their lending to preserve customer relationships;
  • the policy objective of ensuring continued lending to the real economy by requiring a minimum degree of stable funding for such lending.

The following table compares ASF and RSF factors.

Image

If a bank funds itself from a category in the ASF column and lends to a category in the RSF column with the same weighting, then the NSFR is 100%. However, if a bank funds itself from a category in the ASF column and lends to a category in the RSF column with a lower weighting (which will be in a lower row), then the NSFR would be less than 100% and there would be a net stable funding requirement, which the bank would need to cover by borrowing from a higher category.

Unsecured borrowing/lending and repo/reverse repos

No distinction is drawn by the NSFR between unsecured and secured lending. Both are assigned RSF factors on the basis of the type of counterparty and the term of lending.

However, because the collateral on the balance sheet of the seller is regarded as ‘encumbered’ (unless the repo is with a central bank), repos are subject to enhanced RSF factors, Where the encumbrance (the term of the repo) is for more than six months but less than one year, assets which otherwise would have RSF factors of 50% or less, are assigned RSF factors of 50%. Encumbrance of more than one year pushes the RSF factor to 100%.

A key target of the NSFR is interbank maturity transformation. This is penalised, unless it takes place within discrete bands: overnight to six months; over six months to one year; and over one year.

Thus, if a bank borrows (1) on an open basis or (2) for less than six months from another bank and lends for less than six months to a third bank, the ASF factor is 0% and the RSF factor is 0%. This means that, although the borrowing is regarded as completely unstable, the lending does not need any stable funding, so there is no net stable funding requirement. The NSFR therefore allows interbank maturity mismatches anywhere between overnight and six months.

Similarly, interbank maturity transformation is also allowed without penalty between six months and one year. If lending to banks for more than six months is funded by borrowing of more than six months from other banks or financials, there would be an ASF factor of 50% and a matching RSF factor of 50%.

And there is no NSFR penalty on lending to banks and other financials for more than one year, if it is funded by borrowing (from anyone) for more than one year or from capital. The ASF and RSF factors would then both be 100%.

If, in contrast, a bank borrows (1) on an open basis or (2) for less than six months from another bank and lends for more than six months to a third bank, the ASF factor is still 0% but the RSF factor rises to (1) 50% for loans of between six months and one year and (2) 100% for loans longer than a year. That means the borrowing is regarded as completely unstable, while the loan is deemed sufficiently illiquid to require 50% or 100% stable funding. There would therefore be a 50% or 100% net stable funding requirement. In other words, the NSFR penalises interbank maturity transformation of across the six-month horizon.
In the repo market, the estimated penalties for borrowing (1) on an open basis or (2) for less than six months from another bank and lending to a third bank for between six and 12 months is shown in the table.

Image

Maturity transformation by banks is tolerated, if fund