The liquidity buffers have been introduced to allow the banking sector to absorb shocks caused by financial and economic stress, thus reducing the risk of spill-over from the financial sector to the real economy. In the current pandemic, the cause and effect were reversed: it was the closure of the real economy that was a potential threat to the stability of the financial sector. In this sense, the pandemic gives no particular indication of the potential effectivity of liquidity buffers in their intended purpose.
Nevertheless, some banks have withstood short-lived pressure on their liquidity positions. Others perhaps operated securely in knowledge that they have sufficient buffers of high-quality liquid assets. At the climax of the pandemic, banks were experiencing downward pressure on their liquidity positions with their clients drawing on their credit lines to raise cash. In some cases, the drawdowns surpassed the prescribed LCR outflow rates. However, often, this pressure on LCR was mitigated by an increase in high-quality liquid assets as corporate entities have re-deposited the proceeds.
In the third quarter, there was an increasing pressure to buy back debt originating from disruption in financial markets as investors shifted away from investment vehicles that invest in bank liabilities. These vehicles were thus less willing to roll-over the short-term investments, which had a negative impact on bank funding. Moreover, these vehicles were unprepared to meet the surge in redemptions and turned to bank issuers to repurchase their debt. Although under no obligation to do so banks often met those requests to preserve the relationship.
Two-thirds of jurisdictions noted that the deposit inflows, due to the “flight to quality,” have counteracted some of the liquidity outflows. Another significant mitigant were the actions taken by the central banks such as asset purchases, lending facilities and the reduction in reserve requirements.
The extent to which the institutions felt the downward pressure was dependent on banks’ funding models, exposures to stress factors, and the extent to which they were positioned to benefit from mitigating factors. The banks that relied on unsecured wholesale money markets to fund corporate loan portfolios could experience notable pressure, whilst the banks that had a large deposit franchise (particularly if in the same currency as their loan portfolio) were not affected. After the central banks have engaged in liquidity measures, the liquidity pressure gradually subsided.
Banks proved reluctant to draw on their liquidity buffers, especially if it would lead to a drop in the LCR below 100%. Their response to the relatively minor liquidity pressure was not entirely proportional: the banks were observing their own internal liquidity targets that were part of their liquidity risk management frameworks and were significantly stricter than those required by the regulator. This overreaction however did not appear to have a significant adverse effect. Most commonly, they borrowed extra money from the central banks via standing or extraordinary facilities. The wholesale or retail sources still performed their function for albeit at higher rates. Some of these actions, such as restrictions in credit supply or spreading the concern in the interbank market could have been potentially harmful, nevertheless, they had little effect on bank’s ability to address the dash for cash.