Finance

How Net Stable Fund Ratio (NFSR) is managed by bank?

How Net Stable Fund Ratio (NFSR) is Managed by Bank?

The key role of banks in society is to attract savings from families, businesses, and other stakeholders and then lend it to others. A bank borrows short-term loans (deposits) and lends long-term loans. The management of this timing mismatch creates an advantage, but also involves a number of risks. One of the largest is to keep the liquidity deemed necessary to meet the cash needs of those who have lent the bank their money.

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To mitigate this risk, the LCR and NSFR have been created, which are part of the Basel III agreements approved in January 2013 and October 2014, respectively. Two distinct but complementary objectives are pursued by both ratios: the objective of the LCR is to promote the short-term resilience of banks’ liquidity risk profile; while the objective of the NSFR is to reduce the risk of financing over a wider time horizon.

Net Stable Fund Ratio (NFSR):

  • In relation to their off-balance-sheet assets and activities, the NSFR requires banks to maintain a stable funding profile. The objective is to decrease the likelihood that shocks affecting the usual funding sources of a bank may erode its liquidity position, increasing its risk of bankruptcy. The NSFR standard aims to diversify banks’ sources of funding and reduce their dependence on short-term wholesale markets.
  • The NSFR is defined as the ratio between the amount of stable funding available and the amount of stable funding required. Available stable funding means the proportion of own and third-party resources that are expected to be reliable over the one-year horizon (includes customer deposits and long-term wholesale financing).
  • Basel III requires the NSFR to be equal to at least 100% on an ongoing basis. In other words, the amounts of available stable funding and required stable funding must be equal.

The requirement for Managing NSFR:

  • The Net Stable Funding Ratio seeks to calculate the proportion of Available Stable Funding for assets through liabilities over Required Stable Funding.
  • Sources of Available Stable funding includes client deposits, long-term wholesale financing (from the interbank lending market), and equity.
  • Stable funding excludes short-term wholesale funding (also from the interbank lending market).
  • Structural term assets
  • 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;
  • 20% of government and corporate bonds.
  • Off-balance sheet categories

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How the bank manages NSFR:

  • NSFR is managed by using the off-balance-sheet elements. In simple term bank use liabilities and assets as tools to manage appropriate NSFR. Below the list of entities used by the bank to manage NSFR.
Liability Category Increase/Decrease NSFR Impact
Own  Fund

Source of stable funding
Deposits: Individuals, SME

Stable funding
Deposits: Other

Less stable funding than other deposits
Capital markets: Long term

Stable funding
Derivatives

Not considered as stable funding

 

Asset Category Increase/Decrease NSFR Impact

Mortgage loan

Requires relatively less stable funding than unsecured
Short term loans

Requires less stable funding than long term
Long term loans

Requires more stable funding than short term
Derivatives

Requires more stable funding

 

 Author: Pruthviraj Sondani

About the Author: One day I will find the right words, and they will be simple.

Related:

What is LIBOR?

Three pillars of the Basel II Capital Accord

Liquidity funding risk

 

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