Bâle III: Short-Term Funding Requirements

Bâle III, a comprehensive set of reform measures developed by the Basel Committee on Banking Supervision (BCBS), addresses weaknesses in bank regulation, supervision, and risk management exposed during the 2008 financial crisis. While often associated with capital adequacy, Bâle III also places significant emphasis on liquidity risk, particularly short-term funding, to prevent future crises.

The primary concern addressed by Bâle III concerning short-term funding is the excessive reliance of banks on unstable sources of funding. Prior to the crisis, many banks relied heavily on wholesale funding, such as commercial paper and interbank loans, to finance their assets. These funding sources proved highly volatile during times of stress, as investors quickly withdrew their funds, leading to liquidity crunches and, in some cases, bank failures.

To mitigate these risks, Bâle III introduces two key liquidity standards:

Liquidity Coverage Ratio (LCR)

The LCR requires banks to hold sufficient high-quality liquid assets (HQLA) to cover their net cash outflows over a 30-day stress scenario. HQLA are assets that can be easily and quickly converted into cash with little or no loss of value. These typically include cash, central bank reserves, and highly rated government securities. The LCR is expressed as a ratio: HQLA divided by total net cash outflow over 30 days must be at least 100%.

The “net cash outflow” calculation accounts for both expected cash inflows and outflows. However, outflow rates are typically higher than inflow rates, reflecting the potential for funding runs during stressed conditions. For example, deposits from retail customers are assigned a lower outflow rate than deposits from corporate clients, recognizing the stickier nature of retail deposits.

Net Stable Funding Ratio (NSFR)

The NSFR focuses on long-term funding stability. It requires banks to maintain a stable funding profile in relation to the composition of their assets and off-balance sheet exposures over a one-year horizon. The NSFR is also expressed as a ratio: available stable funding (ASF) divided by required stable funding (RSF) must be at least 100%.

ASF represents the portion of an institution’s capital and liabilities expected to be reliable over a one-year period. This includes items like capital, long-term debt, and stable deposits. RSF represents the amount of stable funding needed to support the bank’s assets, based on their liquidity characteristics. Less liquid assets, such as long-term loans, require a higher level of stable funding.

Impact of Bâle III on Short-Term Funding:

• Reduced Reliance on Wholesale Funding: The LCR discourages banks from relying excessively on short-term wholesale funding, as it typically has a high outflow rate in the LCR calculation.
• Incentivized Stable Funding: The NSFR encourages banks to rely on more stable funding sources, such as long-term deposits and equity.
• Increased Liquidity Buffers: The LCR requires banks to hold a significant amount of HQLA, providing a buffer to absorb liquidity shocks.
• Enhanced Risk Management: Both the LCR and NSFR promote a more rigorous and forward-looking approach to liquidity risk management within banks.

While Bâle III has increased the cost of funding for some banks, particularly those that relied heavily on short-term wholesale funding, it has also significantly strengthened the stability and resilience of the banking system. By addressing the vulnerabilities associated with short-term funding, Bâle III has helped to reduce the likelihood of future liquidity crises and promote a more stable financial system.