New LCR and NSFR regulations will strengthen banks` resilience to  short and long term liquidity shocks

ArmInfo. The risks of an outflow of funds against the background of the crisis, associated with the uncertainty of the timing of overcoming the coronavirus pandemic, and domestic and foreign policy shocks, predetermined the steps of the  Central Bank of Armenia to take early proactive measures to  neutralize short-term and long-term shocks of liquidity of the  financial system.  As part of these measures, the Central Bank of  Armenia is introducing new prudential liquidity ratios recommended by  Basel III - short-term (LCR - Liquidity Coverage Ratio) and long-term  (NSFR - Net Stable Funding Ratio). Corresponding additions have  already been made to Regulation 2 of the Central Bank of the Republic  of Armenia "On regulation of banking activities and applied economic  standards". 

These measures, along with increasing capital requirements, were  proposed for introduction long before 2020 and were periodically  postponed. However, the outbreak of the coronavirus pandemic and the  second Karabakh war negatively affected the economy and the level of  real incomes of the population, leading to a deterioration in the  quality of the total loan portfolio of banks and a drop in profits.   Against this background, the Central Bank of Armenia considered it  expedient to start introducing new Basel standards earlier than the  stipulated time, according to which the deadlines for introducing  changes to the Basel III reform package adopted in December 2017 were  postponed by one year - until January 1, 2023. Thus, from August  2020, one of the three capital adequacy buffers - a countercyclical  capital buffer - was set at that time at 0% and is still maintained  at this level for all banks (subject to a phased increase to 2.5%).  And the introduction of two other ones- to maintain capital adequacy  (0.5% with a phased increase to 2.5%) and for systemically important  banks (0.5% with an annual increase to 1.5%) - has been postponed for  the time being. Now, new liquidity ratios have been introduced -  short-term and long-term (with a gradual increase in the threshold),  along with which the ratios of total and current liquidity will  continue to operate (at the minimum specified level: N21 - 15% and  N22 - 60%).

The liquidity coverage ratio (LCR - N23) shows the proportion of the  bank's liquid assets of the amount required to cover within 30 days  the increased outflow of funds that occurs in the banking system in  crisis conditions. It reflects the bank's level of resilience to  short-term liquidity shocks - a phenomenon typical of crisis periods  when there is a significant outflow of customer funds.

Net Stable Funding Ratio (NSFR - N24) determines the minimum level of  the bank's liquidity over the horizon of one year and is calculated  as the ratio of the amount of available stable funding to the amount  of required stable funding. The main goal of NSFR is to help mitigate  one of the systemic risks to financial stability associated with  short-term funding of banks, balance the assets and liabilities of  banks by maturity, create incentives for banks to attract long-term  deposits and reduce dependence on short-term financing.  Both  standards will be gradually increased. Thus, the minimum LCR (the  ratio of highly liquid assets to net cash outflow) is set at 60% with  the effect of this level until June 30, 2021, then from July 1 to  December 31, 2021, the level will be increased to 80%, and from  January 1, 2022 at the 100% level. In the same time frame and at the  same levels, the NSFR standard (the ratio of stable funds available  to the bank to the required stable funds of financing) will change.

According to AmRating experts, the package of regulatory requirements  recommended by Basel III is a transition from regulation of the  current economic situation to preventive regulation, containment, and  mitigation of the impact of new crisis waves. In other words, it is a  model that protects the banking sector from the emergence of crisis  shocks. A feature of this package is the tightening of requirements  for the structure and elements of capital, the level of its adequacy,  the formation of additional capital buffers, as well as new  approaches to assessing liquidity.

Undoubtedly, experts believe that the measures taken have a positive  meaning and, above all, contribute to:  an increase in the coverage  of risk by bank capital; improving the quality of capital; smoothing  the cyclical development of the banking sector; strengthening the  liquidity of banks.

In general, in the experts' opinion, the regulatory measures taken  are aimed at implementing the basic functions of banking capital (its  protective and operational functions), increasing the liquidity of  the banking sector, strengthening supervision and transparency of  banking activities, and improving risk management in the monetary  field. Experts believe that against the backdrop of the coronavirus  crisis, with the ensuing serious socio-economic consequences, the  measures of containment taken by the regulator turned out to be very  useful in order to neutralize short-term and long-term liquidity  shocks and maintain the stability of the financial sector at the  proper level.

To note, in the same Regulation 2 of the Central Bank of the Republic  of Armenia, regarding the requirements for banks on compulsory  reserves in the Central Bank from attracted dram and foreign currency  funds, it is indicated that at least 4% is reserved for dram  borrowings, and for foreign currency - at least 18% (this also  applies to funds on unallocated metal accounts). But in relation to  the funds attracted from the placement of bonds, the compulsory  reserve requirements are different: for AMD borrowings - at least 0%,  for foreign currency - at least 10%.

According to the Financial Rating of Banks of Armenia as of December  31, 2020, prepared by ArmInfo IC, the level of total capital adequacy  in 2016-2020 decreased from 38.76% to 24.21%, total liquidity - from  37.55% to 29.46%, the current liquidity - from 253.83% to 145.57%,  with the required minimum regulatory levels of 12%, 15% and 60%,  respectively. The total capital of the banking system slowed down  during this period the annual growth from 32% to 6.2%, amounting to $  1.7 billion. Assets in the context of five years slowed down the  annual growth from 24% to 15%, amounting to $ 12.7 billion, and loan  investments - from 24% to 17%, amounting to $ 8.4 billion. Net  profit, after slowing growth in 2019 from 62% to 34%, in 2020 went  into recession by 20%- to $ 115.7 million. As a result, efficiency  ratios also decreased in 2020: return on equity (ROE) - from 9.4% to  6.8% and return on assets (ROA) - from 1.4% to 0.9%.  Time deposits  with a 14% growth in 2019 turned towards a 1% decline in 2020,  amounting to $ 4 billion, and demand liabilities significantly slowed  down growth from 35% to 8%, amounting to $ 2.9 billion.  Moreover,  deposits of individuals (urgent and additional claims taken in total)  slowed down growth in 2020 already to a stagnant 1%, amounting to $  3.8 billion.

In the structure of assets, the highly liquid component has shown the  following dynamics over the past three years: cash - from 31% growth  turned towards 11% decline, the same reversal was observed in funds  on correspondent accounts (nostro) in banks - from 44% growth by 16%  decline, while in an accelerated upward trend the balance of funds in  unallocated metal accounts remained - from 6% to 70% and investments  in government bonds - from 5% to 37%, the volumes of which amounted  to $ 320.4 million, respectively, $ 207.7 million, $ 4.4 million and  $ 1.6 billion.