The topic of this thesis arose from an internship with Deloitte Germany. The internship took place in a bank preparing for new regulatory claims, especially liquidity. After consulting for a better understatement in the new regulatory needs and improving reporting frequency and quality the issue of the costs to meet the Liquidity Coverage Ratio (LCR) came up.
Thus in this thesis we will develop a framework on how to evaluate regulatory caused liquidity costs for the LCR. This framework is then implemented into a Visual Basic for Application (VBA) tool, which displays a “fair” internal transfer price. Hence the concept of Funds Transfer Pricing (FTP) is used. The thesis will also have a look on the current situation in banks, I will mention ideas on further extensions in the tool as well. In general the thesis stays in touch with practitioner’s needs and market developments.
Table of Contents
1 Introduction
1.1 Structure
1.2 Constructing the LCR
2 Quantitative Impact Study
3 Introduction to Funds Transfer Pricing
3.1 Liquidity Pricing
3.2 General Dependence of Liquidity Costs
4 Funds Transfer Pricing
4.1 Derivation of the Liquidity Costs
4.2 Liquidity costs of a product
5 A Model
5.1 Derivation of the Cash Equivalent
5.2 Overall Example
5.3 Sensitivity
6 Bank Management
6.1 Expired Situations of Non-Optimal fulfilment
6.2 Target Based Pricing
7 Data
8 Discussion and Limitations
8.1 Discussion
8.2 Limitations
9 Conclusion and Outlook
Research Objectives and Key Topics
The primary objective of this thesis is to develop a framework for quantifying regulatory-driven liquidity costs associated with the Liquidity Coverage Ratio (LCR), and to implement this framework into a VBA-based tool that calculates a fair internal transfer price using Funds Transfer Pricing (FTP) principles.
- Development of a methodology to measure liquidity costs for the LCR on a product level.
- Implementation of the LCR framework and FTP concepts into a functional VBA tool.
- Analysis of liquidity cost drivers and their impact on banking management and internal pricing strategies.
- Evaluation of regulatory incentives and their effect on interbank transactions and maturity structures.
Excerpt from the Book
4.1. Derivation of the Liquidity Costs
The following examples to determine liquidity costs are based on [15], in specific A. Leistenschneider. There are two remarks to be made. First as liquidity costs are driven by the funding side there are only liquidity acquiring bargains explained (e.g. REPO instead of Reverse REPO). Second not every bargain is convertible into the liquidity time structure, especially swaps, (e.g. Credit Default Swap (CDS)) as they do not bare liquidity. But as we will see later this makes them handsome to decompose more complex products in order to derive liquidity costs.
The next three products deliver the main devices to gain anchor points for marginal costs of funds. Any more complex, liquidity acquiring bargain can be decomposed into these three plain vanilla bargains (and a swap component). These are only examples representing any bargain with “simple one way” direction.
Floating Rate Note Figure 10a depicts the cash flow structure of a floating rate note. After a bank issues a floating rate note, investors buy that note which pays a floating rate. As you can see an initial liquidity amount is funded for the investor’s purchase. Here you can also see why liquidity costs depend on the institutions credit risk - as mentioned in section 3.2. The spread above the reference rate (LIBOR) determines the funding spread.
Summary of Chapters
1 Introduction: Provides the context of the LCR regulatory requirements and outlines the thesis structure for measuring liquidity costs.
2 Quantitative Impact Study: Analyzes the results of the BCBS regulatory monitoring survey regarding bank asset structures and LCR compliance.
3 Introduction to Funds Transfer Pricing: Explains the historical evolution of FTP and identifies key drivers of liquidity costs in banking.
4 Funds Transfer Pricing: Details the derivation of liquidity costs and calculation approaches, specifically the tranche and IRR methods.
5 A Model: Develops the core model for calculating the LCR-specific cash equivalent and product-level liquidity pricing.
6 Bank Management: Discusses how the developed VBA tool supports management in addressing non-optimal LCR situations and target-based pricing.
7 Data: Describes the data sources and the rationale behind the term structure used in the VBA model.
8 Discussion and Limitations: Reflects on the LCR implementation environment and discusses potential future model extensions and structural limitations.
9 Conclusion and Outlook: Summarizes the methodology’s findings and the importance of integrating FTP with LCR compliance.
Keywords
Liquidity Coverage Ratio, Funds Transfer Pricing, Basel III, Capital Requirements Directive, Liquidity Costs, Transfer Pricing, Bank Treasury, Maturity Mismatch, Regulatory Compliance, Stress Testing, Financial Risk Management
Frequently Asked Questions
What is the core focus of this thesis?
The thesis focuses on developing a quantitative framework to measure the liquidity costs imposed by new regulatory requirements, specifically the Liquidity Coverage Ratio (LCR), and integrating these costs into a bank's internal Funds Transfer Pricing (FTP) system.
What are the central themes of the work?
The central themes include the integration of Basel III LCR standards into internal banking management, the mechanics of liquidity cost derivation, the use of FTP for decentralized organization, and the practical implementation of these concepts via a VBA tool.
What is the primary research objective?
The primary objective is to create a model that evaluates regulatory-caused liquidity costs at the product level and displays a "fair" internal transfer price, enabling banks to set appropriate incentives to meet regulatory LCR targets.
Which scientific methods are applied?
The author employs a framework based on liquidity flow analysis and financial modeling, specifically using the "tranche approach" and "IRR approach" to decompose complex products and weight their liquidity costs, supported by VBA implementation.
What is covered in the main part of the thesis?
The main part covers the derivation of liquidity costs, the development of a model to translate complex bargain structures into cash equivalents for LCR purposes, and how this model supports bank management through target-based pricing.
Which keywords best characterize this research?
Key terms include Liquidity Coverage Ratio (LCR), Funds Transfer Pricing (FTP), Basel III, Bank Treasury, Liquidity Risk, Maturity Mismatch, and Regulatory Compliance.
How does the model handle the complexity of banking products?
The model uses a decomposition method, where complex products are stripped down into plain vanilla funding components, allowing for the calculation of liquidity costs even for sophisticated financial instruments.
Does the thesis consider the practical limitations of the proposed tool?
Yes, the thesis explicitly discusses limitations such as the need for robust data infrastructure, the requirement to include a wider range of products, and potential feedback effects like balance sheet contraction when shifting asset classes to meet LCR requirements.
- Quote paper
- Claus Bissinger (Author), 2012, Toolbased Liquidity Coverage Ratio Control , Munich, GRIN Verlag, https://www.hausarbeiten.de/document/207968
