Active net stable funding ratio

Active Net Stable Funding Ratio

The Active Net Stable Funding Ratio (ANSFR), commonly known as the Net Stable Funding Ratio (NSFR), is a crucial regulatory metric within the realm of financial risk management. It is designed to ensure that banks maintain a stable funding profile in relation to the composition of their assets and off-balance sheet activities over a one-year horizon. The objective of the Active Net Stable Funding Ratio is to reduce the likelihood that disruptions to a banking organization's regular sources of funding will compromise its liquidity position and potentially lead to broader systemic stress.

History and Origin

The concept of a stable funding requirement gained significant prominence in the aftermath of the 2007–2009 global financial crisis. During this period, many financial institutions, despite meeting existing capital requirements, faced severe liquidity difficulties due to an over-reliance on short-term wholesale funding and significant maturity transformation. This crisis highlighted the critical importance of robust liquidity risk management and inspired a comprehensive overhaul of banking regulation. Basel III, an international regulatory framework developed by the Basel Committee on Banking Supervision (BCBS), introduced two new quantitative liquidity standards: the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR). The NSFR was initially proposed in 2010 and finalized in October 2014 by the BCBS. In the United States, federal bank regulatory agencies, including the Federal Reserve Board, the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC), subsequently issued a final rule implementing the NSFR in October 2020, with an effective date of July 1, 2021, for certain large banking organizations. T¹⁸he goal was to promote a more resilient banking sector globally.

¹⁷## Key Takeaways

• The Active Net Stable Funding Ratio (ANSFR) is a long-term liquidity standard ensuring banks have sufficient stable funding for their assets and activities over a one-year horizon.
• It is a core component of the Basel III regulatory framework, designed to enhance financial stability and reduce reliance on volatile short-term funding.
• The ratio compares a bank's Available Stable Funding (ASF) to its Required Stable Funding (RSF).
• A higher Active Net Stable Funding Ratio indicates greater funding stability and resilience to liquidity shocks.
• Compliance with the ANSFR helps banks sustain financial intermediation, such as lending to households and businesses, even during adverse economic conditions.

¹⁶## Formula and Calculation

The Active Net Stable Funding Ratio is calculated as the ratio of a bank's Available Stable Funding (ASF) to its Required Stable Funding (RSF). Banks are generally required to maintain an ANSFR of at least 100 percent.

¹⁵The formula is expressed as:

Where:

• Available Stable Funding (ASF): Represents the portion of a bank's regulatory capital and liabilities that is considered stable over a one-year time horizon. Different categories of liabilities and equity are assigned specific ASF factors (weights) based on their perceived stability. For example, regulatory capital typically receives a 100% ASF weight, while stable retail deposits might receive a 95% weight.,
  ¹⁴*¹³ Required Stable Funding (RSF): Represents the amount of stable funding a bank is required to hold based on the liquidity characteristics and residual maturities of its assets and off-balance sheet exposures over a one-year horizon. Assets are assigned RSF factors (weights) based on their illiquidity. For instance, less liquid assets or longer-term loans will require more stable funding (higher RSF factor), while highly liquid assets like cash may require no stable funding (0% RSF factor).,
  ^{12
  11}## Interpreting the Active Net Stable Funding Ratio

Interpreting the Active Net Stable Funding Ratio involves understanding its purpose: to measure the sustainability of a bank's funding structure. A ratio of 1.0 or greater signifies that a bank has at least enough stable funding to cover its long-term assets and activities. This indicates a robust balance sheet that is less susceptible to sudden shifts in funding availability.

Conversely, an Active Net Stable Funding Ratio below 1.0 suggests a potential funding mismatch, where the bank relies too heavily on short-term funding to finance its longer-term, less liquid assets. Such a scenario could expose the bank to significant liquidity risk, especially during periods of market stress when access to short-term funding may become constrained or more expensive. Regulators monitor this ratio closely to ensure banks can maintain their operations as a going concern for at least one year under firm-specific funding stress.

¹⁰## Hypothetical Example

Consider a hypothetical bank, "Evergreen Trust," preparing its Active Net Stable Funding Ratio calculation.

1. Available Stable Funding (ASF) Calculation:

   • Evergreen Trust has $100 million in common equity, which receives a 100% ASF factor. Stable funding from equity = $100M * 1.00 = $100M.
   • It has $200 million in retail deposits with a stable characteristic (e.g., insured, long-term relationships), receiving a 95% ASF factor. Stable funding from deposits = $200M * 0.95 = $190M.
   • It has $50 million in long-term wholesale funding (maturity > 1 year), receiving a 100% ASF factor. Stable funding from wholesale funding = $50M * 1.00 = $50M.
   • Total ASF = $100M + $190M + $50M = $340 million.

2. Required Stable Funding (RSF) Calculation:

   • Evergreen Trust holds $150 million in residential mortgages (long-term loans), receiving a 65% RSF factor. Required funding for mortgages = $150M * 0.65 = $97.5M.
   • It has $80 million in high-quality liquid assets (e.g., government bonds), receiving a 5% RSF factor. Required funding for liquid assets = $80M * 0.05 = $4M.
   • It has $110 million in corporate loans with a remaining maturity of greater than one year, receiving an 85% RSF factor. Required funding for corporate loans = $110M * 0.85 = $93.5M.
   • Total RSF = $97.5M + $4M + $93.5M = $195 million.

3. Active Net Stable Funding Ratio Calculation:

   • ANSFR = ASF / RSF = $340M / $195M (\approx) 1.74

In this example, Evergreen Trust's Active Net Stable Funding Ratio of approximately 1.74 (or 174%) exceeds the minimum 1.0 (100%) requirement, indicating a strong and stable funding structure. This demonstrates the bank's ability to finance its long-term activities with reliable sources of funding.

Practical Applications

The Active Net Stable Funding Ratio is primarily applied in the banking sector as a prudential regulatory tool. Its practical applications include:

• Bank Regulation and Supervision: Regulatory bodies globally, following the Basel III framework, mandate the ANSFR for large, internationally active banks and other significant financial institutions. This standard helps supervisors assess and monitor the structural liquidity risk within the banking system, ensuring that banks are not overly reliant on potentially volatile liabilities. The U.S. federal banking agencies adopted the final NSFR rule to strengthen the resilience of large banks, requiring them to maintain a minimum level of stable funding.
  *⁹ Risk Management Frameworks: Banks integrate the Active Net Stable Funding Ratio into their internal risk management frameworks to guide strategic decisions regarding asset and liability management. It encourages a shift towards more stable funding sources and discourages excessive maturity transformation.
• Financial Planning and Strategy: The ANSFR influences a bank's financial planning, affecting decisions on the composition of its funding mix, the types of assets it acquires, and its overall growth strategy. Banks may adjust their business models to optimize their ratio and comply with regulatory expectations.
• Investor and Analyst Scrutiny: While primarily a regulatory metric, the Active Net Stable Funding Ratio is also a point of interest for investors and financial analysts. A strong ANSFR can signal a bank's financial health and resilience, contributing to investor confidence.
• Macroprudential Policy: Beyond individual institutions, the ANSFR contributes to broader macroprudential policy goals by limiting systemic liquidity risk and promoting overall financial stability across the market. The International Monetary Fund (IMF) has studied the potential impact of the NSFR, noting its role in limiting excess maturity transformation risk in the banking sector.

⁸## Limitations and Criticisms

Despite its aim to foster financial stability, the Active Net Stable Funding Ratio has faced certain limitations and criticisms:

• Potential for Unintended Consequences: Some critics argue that the NSFR can have unintended consequences, such as discouraging certain types of market-making activities, particularly those involving highly liquid assets like Treasury securities and repurchase agreements (repos). This could potentially reduce market liquidity in critical funding markets.
  *⁷ Rigidity and "One-Size-Fits-All" Approach: The standardized nature of the NSFR's weighting factors (ASF and RSF factors) has been criticized for not fully accounting for the diverse business models and specific risk profiles of different banking organizations or national market characteristics. T⁶his can lead to inefficiencies or disproportionate impacts on certain banks or regions.
• Interactions with Other Regulations: The Active Net Stable Funding Ratio complements other liquidity requirements, such as the Liquidity Coverage Ratio (LCR), but the interaction between these rules can sometimes lead to overlapping or conflicting incentives, adding complexity to regulatory compliance.
  *⁵ Impact on Lending: There have been concerns that the NSFR, by requiring more stable and potentially costlier funding for long-term assets, could disincentivize banks from providing long-term funding and lending, potentially impacting economic growth.

⁴## Active Net Stable Funding Ratio vs. Liquidity Coverage Ratio

The Active Net Stable Funding Ratio (ANSFR) and the Liquidity Coverage Ratio (LCR) are both crucial liquidity requirements under Basel III, but they address different time horizons and aspects of liquidity risk.

While the LCR focuses on a bank's ability to survive a short-term, acute liquidity stress event, the Active Net Stable Funding Ratio ensures that a bank maintains a sustainable funding profile over a longer horizon. They are designed to be complementary, providing a comprehensive framework for managing a bank's liquidity risk.

FAQs

What is the primary goal of the Active Net Stable Funding Ratio?

The primary goal of the Active Net Stable Funding Ratio is to reduce structural funding risk in banks by requiring them to fund their longer-term assets and activities with stable sources of funding over a one-year horizon. This helps prevent liquidity crises caused by maturity mismatches.

Which financial institutions are typically subject to the Active Net Stable Funding Ratio?

Generally, large and complex banking organizations, including U.S. depository institution holding companies, depository institutions, and U.S. intermediate holding companies of foreign banking organizations with total consolidated assets of $100 billion or more, are subject to the Active Net Stable Funding Ratio.

³### How does the Active Net Stable Funding Ratio relate to capital requirements?
While distinct, the Active Net Stable Funding Ratio complements capital requirements by addressing liquidity risk, whereas capital requirements primarily focus on solvency. Both are critical components of the broader regulatory framework aimed at strengthening bank resilience. Stable components of regulatory capital are included in the Available Stable Funding calculation, demonstrating their role in providing long-term stability.

Does the Active Net Stable Funding Ratio impact consumers?

Indirectly, the Active Net Stable Funding Ratio can impact consumers by influencing banks' lending practices. By promoting stable funding, it supports the ability of banks to lend to households and businesses under both normal and adverse economic conditions. H²owever, some critics argue it might make long-term lending more expensive or less available if banks face higher funding costs due to the regulation.

Is the Active Net Stable Funding Ratio the same globally?

The Active Net Stable Funding Ratio is part of the international Basel III framework, which aims for consistent implementation across jurisdictions. However, national regulators may introduce specific modifications to the Basel standard to account for unique characteristics of local markets and domestic policy objectives.¹