The Net Stable Funding Ratio (NSFR) is a key component of the Basel III liquidity risk management framework, designed to promote long-term funding stability in banks. It complements the Liquidity Coverage Ratio (LCR) by addressing structural liquidity risk over a one-year horizon, thereby reducing banks’ reliance on volatile short-term funding.
Purpose of the NSFR
The NSFR ensures that banks maintain a stable funding profile in relation to the composition of their assets and off-balance sheet exposures. It aims to:
- Limit excessive maturity transformation (i.e., funding long-term assets with short-term liabilities).
- Enhance resilience to funding shocks.
- Support financial stability during periods of stress.
Key Aspects of the NSFR Framework
1. Focus on Long-Term Stability
Unlike the LCR, which addresses short-term liquidity needs over a 30-day stress period, the NSFR focuses on the sufficiency of stable funding over a one-year time horizon. This ensures a more sustainable and resilient funding structure.
2. Available Stable Funding (ASF)
ASF refers to the portion of a bank’s funding that is considered reliable over the one-year horizon. Sources include:
- Regulatory capital (Tier 1 and Tier 2 capital).
- Preferred stock with maturity or call options beyond one year.
- Long-term liabilities (e.g., term deposits, bonds) with residual maturities greater than one year.
- A portion of stable retail and wholesale funding, assigned ASF factors based on their stability.
3. Required Stable Funding (RSF)
RSF measures the amount of stable funding required to support a bank’s assets and certain off-balance sheet exposures. Factors include:
- Long-term loans and investments (e.g., mortgages, corporate loans).
- Non-performing assets.
- Off-balance sheet items such as undrawn credit lines and derivatives.
- Each asset/exposure is assigned an RSF factor depending on its liquidity and maturity characteristics.
4. NSFR Calculation Formula
NSFR= [Available Stable Funding (ASF)] ÷ [Required Stable Funding (RSF)]
5. Minimum NSFR Requirement
Basel III stipulates a minimum NSFR of 100%, indicating that a bank’s ASF must be at least equal to its RSF. This ensures that long-term and illiquid assets are funded with equally stable funding sources.
6. Reducing Maturity Transformation Risk
The NSFR discourages banks from relying on short-term wholesale funding to finance long-term, illiquid assets. This reduces the risk of liquidity shortages during periods of stress and curbs systemic risk.
7. Supervisory Tool
Regulatory authorities use the NSFR as a supervisory and monitoring tool to assess the structural liquidity risk profile of banks. It aids in the early identification of vulnerabilities and informs regulatory interventions where necessary.
Regulatory Implementation and Impact
- The Reserve Bank of India (RBI), in line with Basel III, has adopted the NSFR requirement for Indian banks, with full implementation effective from October 1, 2021.
- The NSFR has influenced bank strategies regarding liability management, promoting longer-term funding instruments and adjustments in asset-liability compositions.
- Compliance with NSFR also encourages prudence in balance sheet management, contributing to greater resilience in the banking sector.
In summary, the NSFR complements short-term liquidity tools like the LCR by ensuring that banks maintain a sound and stable funding base to support their business activities in both normal and stressed market conditions.
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