The Liquidity Coverage Ratio (LCR) was introduced with the implementation of Basel III, and is designed to ensure that financial institutions have the necessary assets on hand to ride out short-term liquidity disruptions. Two important elements of the LCR that are especially relevant to South African banks are:
1. The LCR in South Africa was implemented on 1 January 2015. From that date:
a. undrawn commitments under swing-line, backstop or standby liquidity facilities that are made to non-financial corporates, and that mature or are capable of maturing within 30 days from then (a Standby Facility); or
b. undrawn commitments on any loan facilities to banks, insurance companies and other financial institutions (a Financial Institution Loan),
will be required to be 60% backed (increasing in 10% annual increments to reach 100% by 1 January 2019) with high quality liquid assets, to the extent those commitments are available for drawing within 30 days;
2. When calculating net cash outflows for the purposes of LCR, banks will have to assume that 30% of the undrawn portion of a Standby Facility or a Financial Institution Loan has been fully drawn (the assumed drawdown), and as such, the 60% required backing will be calculated against the assumed drawdown.
Therefore, as from 1 January 2015, banks will have to back any Standby Facility or a Financial Institution Loan with high liquid quality assets to the value of 18% of the full value of the relevant loan.
As high quality liquid assets are low yield, there will be an increase in the opportunity costs of bank funding should a Standby Facility or a Financial Institution Loan have existed on 1 January 2015.
Banks can avoid or mitigate this risk of increased costs in any of the seven ways described below:
- Make this funding uncommitted. This eliminates the risk entirely. However, if negotiations do not permit that, then banks will need to mitigate the effect of Standby Facility or a Financial Institution Loan in any of the other ways set out below.
- Avoid unnecessary labels – if a loan facility is not properly intended as a Standby Facility, do not call it by that name in the purpose clause.
- If only part of the loan facility is to be Standby Facility and part is for working capital, clearly specify the limited extent to which that loan facility might be used as a Standby Facility.
- Where there are multiple borrowers, some being financial institutions and some not, specify the limited extent to which the loan facility can be drawn by any financial institution borrower.
- Restrict the ability of financial institutions to accede to the loan facility as a borrower.
- Restrict the borrower from engaging in activities that could result in its classification as a financial institution.
- Draft clauses to the loan facility that will lawfully allow the commitment to be toggled on and then to be toggled off, so as to fall outside of the 30 day period.