About liquidity risk
For a corporate entity, liquidity risk is the risk that it cannot meet its financial obligations as they fall due. This can lead to a sudden loss of confidence in the entity and, potentially, immediate default.
Banks are particularly vulnerable to liquidity risk as a result of the ‘maturity transformation' role they play in the financial system. Retail banks take in short-term or on-call deposits, while a major part of their lending out is in long-term residential mortgages.
Main components of policy
Our liquidity policy has three main parts:
- minimum ratio requirements calculated from banks' financial data
- rules and guidance on the risk management processes banks should have in place to manage liquidity risk
- requirements for banks to regularly report to us on their liquidity risk.
Our liquidity policy is primarily contained in two banking prudential requirements documents: 'Liquidity policy' (BS13) and 'Liquidity policy annex – liquid assets' (BS13A), which apply to locally incorporated registered banks under their conditions of registration. Reporting requirements are imposed under section 93 of the Banking (Prudential Supervision) Act 1989, and we provide quantitative information to the public about bank liquidity using our Banking Dashboard on our website.
Go to the liquidity policy documents on the banking prudential requirements page
Mismatch ratios
Locally incorporated registered banks are normally subject to minimum one-week or one-month mismatch ratios. These ratios aim to reduce the risk that an individual bank is brought down by a short-term loss of confidence.
The one-week mismatch ratio models what a bank's expected cash inflows and outflows might be over the first week after a serious loss of confidence in the bank. To meet the minimum ratio requirement, a bank needs to hold a sufficient stock of liquid assets to be able to fill the projected mismatch between cash inflows and outflows. Liquid assets include securities that can be sold quickly and at a reliable price, such as New Zealand government debt.
The one-month mismatch ratio is defined similarly, but over a one-month stress period.
Core funding ratio
Locally incorporated registered banks are also subject to a minimum core funding ratio (CFR). Put simply, this is a comparison between an estimate of a bank's funding that is stable and can be assumed to stay in place for at least one year (‘core funding'), and the bank's core lending business that needs to be funded on a continuing basis.
Requiring banks to maintain a minimum CFR reduces the vulnerability of the banking sector in a period of general market disruption.
Adjustments to the CFR
We brought the CFR in at 65% (a level banks could comply with initially) and progressively raised it to the steady state setting of 75%.
The CFR is one of the instruments that makes up our macroprudential toolkit.
Go to our macroprudential tools page
We reduced the minimum CFR requirement from 75% to 50% in April 2020 to support banks’ lending to the economy during the period of economic uncertainty resulting from the COVID-19 pandemic. The limit was returned to 75% on 1 January 2022 after consultation with regulated entities.
Liquidity risk management
A standard condition of bank registration in New Zealand requires locally incorporated banks to have an internal framework for liquidity risk management that covers certain essential aspects. For example, the framework must consider the significant sources of stress the bank might face and prepare it to manage stress through a contingency funding plan.
Our liquidity policy supplements this standard condition with guidelines on the details of a bank's liquidity risk management framework.
Reporting to us
Banks must submit monthly reports on liquidity risk to us. Reporting uses a standard template that covers:
- compliance with the minimum ratios
- a breakdown of liquid assets held
- comprehensive data on cash inflows and outflows broken down by maturity
- details of new funding raised over the latest month and the cost of that funding.
Further discussion of the policy and its rationale is covered in the 2009 Bulletin article, The Reserve Bank's new liquidity policy for banks.
Qualifying Crown Agents
In October 2018, we amended Annex 1 of 'Liquidity policy annex — liquid assets' (BS13A) by adding a new category, 'Qualifying Crown Agents', to the list of primary liquid assets.
This category is restricted to the following list which we may change from time to time at our discretion (that is, we may add to the list of Qualifying Crown Agents or remove agents from the list as appropriate).