Net Stable Funding Ratio

During the 2007 banking crisis, banks such as Northern Rock in the UK, and US investment banks such as Bear Stearns and Lehman Brothers suffered a bank run and/or collapsed, due to their over-reliance on short term wholesale funding from the Interbank lending market and lack of capital.

As a result the G20 has launched an overhaul of banking regulation. This led to the Dodd–Frank Wall Street Reform and Consumer Protection Act in the US, to new EU directives, and to Capital and Liquidity Requirements. Most of the media attention focused on the Capital Requirements proposed within Basel III. But Basel III also contains entirely new liquidity requirements: the Net Stable Funding ratio (NSFR or NSF ratio) and the Liquidity Coverage Ratio (LCR). Both ratios are landmark requirements: it is planned that they will apply to all banks worldwide if they are engaged in international banking activities.

Net Stable Funding ratio (NSFR or NSF ratio)

The Net Stable Funding Ratio has been proposed within Basel III, the new set of capital requirements for banks, which will over time replace Basel II.^[1] Basel III has been prepared within the Basel Committee on Banking Supervision of the Bank for International Settlements.^[2] Basel III is not yet implemented. This funding ratio seeks to calculate the proportion of long term assets which are funded by long term, stable funding.

• Stable Funding includes: customer deposits, long-term wholesale funding (from the Interbank lending market), and Equity.
• "Stable Funding" excludes short-term wholesale funding (also from the Interbank lending market).

These components of Stable Funding are not equally weighted: see page 21 and 22 of the Consultative Document dated December 2009 ^[3] for the detailed weights.

Long term assets or "Structural Term Assets" means:

• 100% of loans longer than one year;
• 85% of loans to retail clients with a remaining life shorter than one year;
• 50% of loans to corporate clients with a remaining life shorter than one year;
• and 20% of Government and corporate bonds.
• Off-balance Sheet Categories are also weighted.

See page 23 of the Consultative Document dated December 2009 ^[4] for the detailed weights. This Consultative Document will be amended.^[5]

The Standard (or Metric)

Stable Funding/weighted Long Term Assets must be > 100%
See page 20 of the Consultative Document dated December 2009 ^[6]

Planned implementation

Together with the Liquidity Coverage Ratio (LCR), the Net Stable Funding ratios (NSF ratios) are part of the new proposed DEVELOPMENT OF INTERNATIONAL LIQUIDITY STANDARDS.

Banks have until 2015 to meet the LCR standard and until 2018 to meet the NSFR standard. Over time this Net stable funding ratio will be reviewed as proposals are developed and industry standards implemented.^[7]

Off-balance Sheet Categories

As mentioned above, Off-balance Sheet Categories are also weighted: they will contribute to the Long Term Assets. This is best explained by the potential for contingent calls on funding liquidity (revocable and irrevocable line of credit and liquidity facilities to clients). As a consequence, once the standard is in place, off-balance sheet commitments will need to be funded, within the Stable Funding.
See page 24 of the Consultative Document dated December 2009 ^[8] for the detailed weights.
This may help prevent the excessive use of the Shadow banking system, including Special purpose entity and Structured investment vehicle, as these conduits often benefit from liquidity facilities (so-called back-stop facilities) granted by the bank which created them.

References

1. ^ Basel III :"Basel III" December 2010
2. ^ Bank for International Settlements: http://www.bis.org/
3. ^ International framework for liquidity risk measurement, standards and monitoring http://www.bis.org/publ/bcbs165.pdf
4. ^ International framework for liquidity risk measurement, standards and monitoring http://www.bis.org/publ/bcbs165.pdf
5. ^ The Group of Governors and Heads of Supervision reach broad agreement on Basel Committee capital and liquidity reform package 26 July 2010 http://www.bis.org/press/p100726/annex.pdf
6. ^ International framework for liquidity risk measurement, standards and monitoring http://www.bis.org/publ/bcbs165.pdf
7. ^ *"Basel III: International framework for liquidity risk measurement, standards and monitoring" December 2010
8. ^ International framework for liquidity risk measurement, standards and monitoring http://www.bis.org/publ/bcbs165.pdf

• "FSA and the Net Stable Funding Ratio" 17 March 2010