Occasional Paper Series

Occasional Paper Series

Raschid Amamou, Andreas Baumann, Dimitrios Chalamandaris, Laura Parisi,

P?r Torstensson

Liquidity in resolution: estimating possible liquidity gaps for specific banks in resolution and in a systemic crisis

No 250 / November 2020

Disclaimer: This paper should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB.

Contents

Abstract

3

Non-technical summary

4

1 Observations and lessons from past crises

7

1.1 Liquidity aid in the financial crisis and selected past cases

7

1.2 Deposit outflows in past cases

9

1.3 Key takeaways from past cases

12

2 Methodology and data

13

2.1 Description of the model

14

Box 1 Methodology used for approximating post-FOLTF LCR values

17

2.2 Scenario design

19

Box 2 Comparison of pre-FOLTF run-off rates with run-off rates used in

LiST 2019

23

2.3 Systemic crisis model

24

2.4 Main methodological features and their impact on the results

26

2.5 Data and sample of banks

28

3 Possible liquidity gaps in resolution of individual banks

30

3.1 Estimated liquidity gaps

30

4 Possible liquidity gaps in a systemic crisis

35

4.1 Magnitude of the simulated crisis

35

4.2 Liquidity gaps in a systemic crisis

37

4.3 Estimated liquidity gaps when two G-SIBs are resolved

38

5 Conclusion

40

Annex

42

A.1 Detailed results in idiosyncratic resolution

42

A.2 Detailed results in the systemic crisis

44

A.3 Robustness checks ? random sampling

50

ECB Occasional Paper Series No 250 / November 2020

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A.4 Sensitivity analysis

51

A.5 Summary of past bank failures studied

54

References

58

ECB Occasional Paper Series No 250 / November 2020

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Abstract

This paper contributes to the debate on liquidity in resolution by providing a quantitative assessment of liquidity gaps of banks in resolution in the euro area. It estimates possible ranges of liquidity gaps for significant banks under different assumptions and scenarios. The findings suggest that, while the average liquidity gaps in resolution are limited, the averages hide significant outliers. The paper thus shows that, under adverse circumstances, the instruments currently available to provide liquidity support to financial institutions in the euro area would be insufficient.

Keywords: Liquidity, resolution, bank runs, systemic crisis, contagion, Monte Carlo simulations

JEL codes: G01; G21; G28, G33, C63

ECB Occasional Paper Series No 250 / November 2020

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Non-technical summary

Liquidity in resolution was identified by the Financial Stability Board (FSB) at the end of 2014 as an outstanding issue that needed to be addressed to complete the reform agenda.1 This was confirmed by the results of the first resolvability assessment process (RAP) for global systemically important banks (G-SIBs), which concluded that there "was need for more analysis and understanding of funding, liquidity needs and availability of unencumbered collateral in resolution"2. In particular, it was noted that "Insufficient liquidity to maintain critical operations and meet increased margin requirements, the risk of termination or inability to roll over short-term borrowing or the loss of access to alternative sources of credit all have the potential to hinder the execution of the preferred resolution strategy"3. To address these impediments to resolution, the FSB published guiding principles on the temporary funding needed to support the orderly resolution of a G-SIB4 and funding strategy elements of an implementable resolution plan5.

In recent years, some jurisdictions, such as the United States6 and the United Kingdom7, have addressed the need to ensure liquidity in resolution by setting up frameworks for this purpose. In the EU, the issue has been discussed in the context of completing the banking union, but the discussions are still ongoing.

This paper aims to contribute to the debate by providing analysis of liquidity gaps of banks in resolution in the euro area. A liquidity gap in resolution implies that the bank, although recapitalised by the application of resolution measures, still faces a shortage of liquidity owing to a combination of two factors. First, there are net liquidity outflows (e.g. from deposit outflows and/or when creditors are not willing to roll over maturing debt) and the bank has insufficient liquidity buffers after resolution to meet regulatory requirements. Second, the bank cannot currently obtain sufficient funding in the market or in regular monetary policy operations to meet its liquidity needs (e.g. because it lacks unencumbered assets and eligible collateral). In order for resolution to be successful, such liquidity gaps need to be addressed.

The paper estimates possible ranges of liquidity gaps for significant banks in resolution, including in a systemic crisis, assuming different scenarios and severity levels. As such, it contributes to the debate in two ways. First, it is ? to the best of our knowledge ? the first publication of a methodology developed to measure and estimate possible liquidity gaps in resolution. Second, by providing approximate estimates of the possible liquidity gaps, it can facilitate ongoing discussions in the EU on the design and calibration of policy choices to address liquidity gaps in resolution.

1 See Financial Stability Board (2014). 2 See Financial Stability Board (2015). 3 Ibid. 4 See Financial Stability Board (2016). 5 See Financial Stability Board (2018). 6 See Deslandes and Magnus (2019). 7 See Bank of England (2017).

ECB Occasional Paper Series No 250 / November 2020

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