With a focus on Asian regions, Mahidhara Davangere V, Deputy Chair of the IFoA’s Finance and Investment Board, highlights the sources of liquidity risk during the global coronavirus crisis.
Due to the financial effects of the Covid-19 outbreak, Asian Regulators have become increasingly concerned about insurers’ and banks’ ability to manage liquidity risk.
The liquidity risk exposure comprises the characteristics of an organization’s assets and liabilities, its internal structure, and market behavioral factors. While an organization should assess their own sources of liquidity risk individually, below are highlights of the sources of liquidity risk across the insurance industry & banking industry to be considered in the liquidity risk assessments.
There are eight sources of liquidity risk across the insurance sector namely, liability risk, asset risk, concentration risk, off-balance sheet risk, funding risk, cross-currency risk, intra-day risk, and franchise risk and ten sources of liquidity risk across the banking sector namely, wholesale funding risk, retail funding risk, intraday liquidity risk, intragroup liquidity risk, off‐balance sheet liquidity risk, cross‐currency liquidity risk, funding cost risk, asset risk, funding concentration risk, and correlation and contagion risk.
Specific areas of liquidity risk exposure that need to be considered in depth:
- Group-specific risks: liquid assets may not always be freely transferable around groups to meet liquidity needs, particularly in times of stress, and firms also need to consider the liquidity impact of intra-group transactions;
- Collateral upgrade transactions – repo-style arrangements to swap high quality liquid assets in exchange for higher yielding, but less-liquid assets, could lead to liquidity problems in a stress;
- Fungibility considerations – particularly where Matching Adjustment portfolios for life insurers have been established, assets will effectively become encumbered and not able to be used to meet other liabilities; and
- Unit-linked business – risks arise particularly in relation to operational costs, such as charges and processes associated with unit redemptions
Current scenario of Liquidity Risk Management in Asian regions
1) East Asia
Hong Kong: In the midst of the current market volatility in Hong Kong, tumbling oil prices and recent U.S. stock market turbulence, and as the impacts of the COVID-19 pandemic on the global economy are surfacing, liquidity risks are increasingly prevalent. Hong Kong’s prudential regulator has adopted measures to ensure that banks are properly prepared for such risks. At the same time, fund managers are also reminded of their obligations to manage the liquidity of funds given the present volatility of the local and international markets.
In the Banking Sector to be adequately prepared for market turmoil and capability to manage risks, including liquidity risk, the banks in Hong Kong are expected to integrate stress-testing into their risk governance & management processes, and conduct stress tests on a regular basis. These tests are designed to provide a forward-looking assessment of a bank’s vulnerability (e.g., with regards to its profitability, liquidity and capital adequacy) in “stressed” scenarios such as during liquidity crisis. The Hong Kong Monetary Authority (“HKMA”) plays a supervisory role in assessing the stress-testing practices of banks and whether they are appropriate and effective. In addition to monitoring internal stress-testing practices, the HKMA also conducts its own stress tests on banks’ liquidity positions.
China: China’s banks are set to receive a boost as the country’s banking and insurance regulator has published final rules on liquidity risk management with clearer guidelines expected to keep lenders in line with various regulatory requirements.
Banks with assets of more than $31.22b (RMB200b) will be subject to a minimum liquidity coverage ratio (LCR), NSFR, liquidity ratio and liquidity matching ratio requirements. As the LCR and NSFR requirements are largely in line with the guidelines in the Basel regulatory frameworks, the gradual phase-in periods will allow banks to meet the requirements without causing massive shocks to system-wide liquidity conditions.
2) South Asia
India: Regulator in India has given an official statement: With the national lockdown impacting business and the economy, insurance regulator IRDAI has asked insurers to ensure that they have sufficient capital and liquidity to service the requirements of policyholders. “Indian insurers need to prepare strategies and action plans for business continuity to ensure enhanced protection to the policyholders,” the Insurance Regulatory and Development Authority of India said in a circular. It further said that due to the stress experienced by the economy, sufficiency of capital and liquidity position of the insurers may be adversely impacted and all the insurers need to guard against it. “Boards of insurers are advised to critically examine their capital availability and solvency margin as required in the current financial year 2020-21 and devise strategies to ensure that they have adequate capital and resources available with them,” it added.
3) Southeast Asia
Indonesia: For banks and other financial institutions to maintain liquidity, especially in the case of small and not so well-managed banks and other financial institutions, following steps are urgently needed:
First, an in-depth review of banks or other financial institutions on the liquidity front. This is particularly important following the introduction of the OJK’s policy to allow the postponement of payments on loans for borrowers have been adversely affected by COVID-19. The impacts of this policy will be far reaching. If the above review finds that a bank or other financial institution is suffering from liquidity problems but has good financial performance and management, provision of liquidity assistance should be considered, as happened through the BI liquidity support (BLBI) program during the 1998 crisis. Liquidity assistance will be essential to allow such banks to continue lending.
In the case of a bank or other financial institution identified as suffering liquidity problems due to evident mismanagement (such as lending to its own group companies through nominees, failing to address NPLs resulting in real cash flow, etc.), then policies will be required to force them to immediately consolidate or accept rescue.
Liquidity flow to the market needs to be maintained through the top 10 banks by providing them with liquidity assistance so that they can continue lending, albeit at lower interest rates (both loan and deposit interest rates).
Thailand: Thailand on Sunday introduced measures, including a liquidity support fund worth 70 billion to 100 billion baht ($2.14 billion to $3.06 billion) to reduce risk in the debt market amid the spread of the coronavirus outbreak.
Thai financial institutions are still strong with high liquidity and authorities will ensure sufficient liquidity and the functioning of the debt market. The Thai parliament on May 31 has approved three executive decrees, allowing the government to borrow one trillion baht to repair the financial system and restore the country's economy that has been hit hard by the pandemic
Singapore: For liquidity risk management during COVID-19, banks in Singapore have been forced to better understand their liquidity and capital positions and any associated weakness in their funding sources. The COVID-19 response by banks has uncovered the crucial need of banks to have an accurate view of their risk exposures amid the quickly shifting trends in 2020. For handling such a situation, Crisis Analytics is essentially the best-response analytics that brings together several capabilities that may already be in place in banks but will need tuning for current adverse conditions. These capabilities include predictive analytics, use of new data, enterprise-wide data management, and model risk management.
Malaysia: The effects and aftermath of the COVID-19 pandemic will be felt for a long while, even after the dull period ends. Malaysia’s central bank is working on techniques, through whose combined measures will release approximately 30-billion-ringgit worth of liquidity into the banking system.
4) Western Asia / Middle East
Kuwait: The COVID-19 pandemic is expected to have a significant negative impact on the global and Kuwaiti economy due to the stoppage of many economic activities. Insurers’ revenues are also affected by the fall in oil prices and the decline in global and local stock markets, which will lead to a decreased liquidity for the latter and affect their cash flows. This in turn will affect the ability of insurers to continue to pay compensation and benefits.
The insurance sector in Kuwait is expected to be one of the main sectors hit by the pandemic, which is aggravating conditions in the industry that was already suffering from problems before the emergence of COVID-19, it is also one of the weakest sectors because it does not enjoy any significant support from the government.