Regulation on Minimum Requirements for Liquidity Risk Management of Commercial Banks of the Kyrgyz Republic

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Creation Date: 2023-02-03

Appendix to the Resolution of the Board of the National Bank of the Kyrgyz Republic of March 29, 2019 No. 2019-P-12/17-3-(NPA)

REGULATION

on minimum requirements for liquidity risk management of commercial banks of the Kyrgyz Republic

(As amended by Resolutions of the Board of the National Bank of the KR of December 27, 2019 No. 2019-P-12/68-2, December 28, 2022 No. 2022-P-12/83-7)

Chapter 1. General Provisions

1. This Regulation establishes mandatory minimum requirements for liquidity risk management to be observed by commercial banks of the Kyrgyz Republic (hereinafter - commercial banks).

This Regulation applies to all commercial banks, including commercial banks conducting operations in accordance with Islamic principles of banking and financing, including banks having an "Islamic window," taking into account the special terminology applied by them in carrying out banking operations (hereinafter - banks).

2. The following definitions are used in this Regulation:

Liquidity Indicator is an indicator that quantitatively determines one or several characteristic levels of a bank's liquidity risk.

Balance sheet liquidity risk is the probability of bank losses associated with the bank's inability to meet its obligations due to a lack of liquid assets or cash because the bank is unable to effectively meet current and/or future cash inflow needs, without damaging the bank's daily operations or its financial condition, i.e., current or expected income and capital. Balance sheet liquidity risk is associated with a decrease in the ability to finance accepted transaction obligations when their maturity dates arrive, to cover counterparties' claims, as well as collateral requirements. Balance sheet liquidity risk is the main type of liquidity risk.

Market liquidity risk is the risk that a bank cannot quickly sell an asset at market price due to insufficient market depth and/or due to deterioration in market conditions.

Chapter 2. Duties of the Board of Directors and the Management Board of the Bank in Liquidity Risk Management

§ 1. Aggregate Risk Acceptance Level (Risk Appetite)

3. The bank's Board of Directors must determine an acceptable level of liquidity risk for the bank and ensure clear definition and compliance by the bank's Management Board, as well as by relevant bank departments/employees involved in liquidity risk management, with legislative requirements and internal procedures for identifying, assessing, monitoring, and controlling liquidity risk.

4. The bank's Board of Directors determines the bank's aggregate risk acceptance level (risk appetite) taking into account the following factors:

• clear definition of the level of balance sheet liquidity risk that the bank can accept under normal conditions and in a stress situation, taking into account its business strategy, financial position, and potential financing. The bank's aggregate risk acceptance level (risk appetite) must correspond to the bank's systemic significance. Bank departments/employees involved in liquidity risk management must clearly understand and comply with the acceptable level of liquidity risk for the bank, as well as monitor it;

• the bank's obligation to manage its liquidity prudently under normal conditions, as well as to be able to withstand a prolonged period of stress, for one month or more;

• the aggregate risk acceptance level (risk appetite) must reflect an assessment of liquidity risk sources, taking into account the interconnection between possible risks and profit.

5. The aggregate risk acceptance level (risk appetite) must be documented and formulated, using qualitative and quantitative indicators for the subsequent control of various aspects of liquidity risk.

6. The National Bank has the right to assess the justification of the bank's aggregate risk acceptance level (risk appetite) regarding liquidity risk (and any subsequent changes in the acceptability of such risk). In the event that the bank's aggregate risk acceptance level (risk appetite), in the opinion of the National Bank, is assessed as higher than established (higher than acceptable for the bank), then at the request of the National Bank, the bank must revise and establish an acceptable aggregate risk acceptance level (risk appetite) for the bank.

7. The bank's Board of Directors bears full responsibility for the level of liquidity risk accepted by the bank and for liquidity risk management.

§ 2. Powers and Duties of the Board of Directors of the Bank in Liquidity Risk Management

8. The bank's Board of Directors is responsible for organizing the liquidity risk management system, defining a liquidity risk structure corresponding to the bank's activities, its scale, complexity, and size.

9. The bank's Board of Directors conducts an analysis of the risks of the existing liquidity risk management system/structure, including when it is changed, including cases of changes in the bank's activities affecting liquidity risk.

10. The bank's Board of Directors, for the purpose of timely liquidity risk management, may delegate some powers to the Asset and Liability Management Committee (hereinafter - ALM Committee) of the bank or other similar committees. However, the delegation of powers does not relieve the Board of Directors and its members of their duties to organize an adequate internal control system ensuring the integrity of the liquidity risk management process, as well as for the work of all committees performing their assigned duties.

11. For the effective performance of functions related to liquidity risk management, the ALM Committee must include employees from the treasury, risk management (with advisory voting rights), and other key departments of the bank and/or their supervising members of the Bank's Management Board who determine the bank's liquidity risk. The ALM Committee is also based on information from the risk management service, which is directly responsible for assessing liquidity risk and managing this risk.

In this regard, a risk management employee must be included in the composition of the ALM Committee with advisory voting rights.

(As amended by Resolution of the Board of the National Bank of the KR of December 28, 2022 No. 2022-P-12/83-7)

12. The bank's Board of Directors must appoint competent management responsible for measuring, monitoring, and controlling liquidity risk, having sufficient experience and knowledge of systems and resources for effective liquidity risk management.

13. The bank's Board of Directors reviews and approves the bank's general strategy, which also includes issues of liquidity management, as well as the liquidity risk management policy in accordance with the established aggregate risk acceptance level (risk appetite) for the purpose of maintaining the established level of sufficient liquidity.

14. The bank's liquidity risk management policy must correspond to the bank's activities, its liquidity needs under both normal conditions and in a stress situation.

The bank's liquidity risk management policy must reflect, at a minimum, the following main aspects:

a) liquidity risk acceptance level;

b) goals and objectives, according to the bank's main strategy on:

• the level of diversification and stability of funding sources necessary to maintain an acceptable level of bank liquidity;
• the approach to liquidity management in various areas of activity;
• the approach to liquidity management during the working day;
• the permissible minimum level (limit) of liquidity;
• daily measurement and monitoring of cash inflows and outflows, as well as weekly monitoring of maturity gaps of the bank's assets and liabilities to control daily liquidity needs and ensure the fulfillment of obligations;
• forecasting of required liquidity;
• the structure and assessment of the stability of the deposit base and other borrowed funds by the Bank's Management Board;
• the ability to borrow in the money market;
• requirements for asset quality;
• the execution of off-balance sheet obligations;
• planning for liquidity crisis scenarios;
• liquidity management in foreign currencies;
• internal control over liquidity risk management;
• necessary management reporting;

c) duties for liquidity risk management with clearly defined division of powers and reporting structure;

d) liquidity risk management systems - the use of systems and tools for measuring, monitoring, controlling, and reporting on liquidity risk, including:

• establishment of various liquidity limits and coefficients (for example, target liquidity coefficients, maturity mismatch limits, loan-to-deposit ratio, etc.);
• bases for forecasting cash flows and liquidity stress testing, including used methods, scenarios, and assumptions;
• a management reporting system for liquidity risk;

e) a contingency funding plan, which must contain approaches and strategies for possible stress situations.

15. The bank's Board of Directors reviews the approved general strategy of the bank regarding liquidity management in accordance with economic, financial, and operational standards and conditions.

For the purpose of ensuring effective and adequate liquidity risk management, the bank's Board of Directors regularly reviews the bank's strategy and policy, but no less than once a year, making appropriate adjustments as necessary.

16. The bank's Board of Directors is responsible for organizing an adequate internal control system ensuring the integrity of the liquidity risk management process. For these purposes, the bank's Board of Directors creates an internal control system ensuring the implementation of control functions over liquidity risk management processes and their effectiveness.

The bank's Board of Directors ensures the independence and competence of the conducted internal control and the separation of their functions from the bank's operational activities.

§ 3. Powers and Duties of the Bank's Management Board in Liquidity Risk Management

17. The bank's Management Board is responsible for implementing the bank's general strategy, as well as the bank's liquidity risk management policy.

18. The bank's Management Board should establish the level of authority and responsibility of individual structural subdivisions, whose functions will include compiling and providing timely and adequate reporting on the bank's liquidity status.

19. The bank's Management Board must timely and on a continuous basis possess information about new and potential problems, and changes in conditions in external markets, which could potentially lead to future difficulties.

20. The bank's Management Board must timely and on a continuous basis inform the bank's Board of Directors about new and potential problems, such as:

• increase in the cost of financing (established threshold levels);
• increase in the size of financing at various maturity dates;
• concentration of funding sources;
• negative changes in markets from which a significant part of financing is received;
• alternative sources of financing;
• significant or prolonged exceedance of established limits;
• significant change/decrease in the reserve of unencumbered, highly liquid assets;
• increase in additional collateral requirements due to a potential decrease in the market price of assets acting as collateral or for other reasons;
• changes in conditions in external markets, which could potentially lead to future difficulties.

§ 4. Independent Assessment and Audit of Liquidity Risk Management

21. Periodic assessment of liquidity risk management processes must be conducted in the bank to ensure the integrity, reliability, and justification of the activities carried out. The assessment must be conducted by employees/experts independent of operational activities, internal or external auditors, possessing the necessary skills and knowledge.

The bank's Management Board must timely and on a continuous basis inform the bank's Board of Directors about the results of the conducted assessment.

22. The assessment of liquidity risk management processes must include, at a minimum:

• adequacy of internal systems and procedures for identifying, measuring, monitoring, and reducing liquidity risk;
• justification of various internal limits on liquidity parameters allowing control of liquidity risk;
• constructiveness of applied scenarios and assumptions for cash flow analysis;
• integrity and sufficiency of provided management information on liquidity risk;
• execution of rules and procedures established for maintaining liquidity.

The Board of Directors and the Management Board of the bank must timely and effectively eliminate any deficiencies or problems identified in the process of assessing liquidity risk management processes.

Internal audit must regularly check the sufficiency and effectiveness of the internal control system for liquidity risk management.

Chapter 3. Identification, Measurement, Monitoring, and Control of Liquidity Risk

§ 1. Parameters and Tools for Measuring Liquidity Risk

23. The liquidity risk management process in the bank includes the following elements:

a) use of a set of adapted (operational) tools and parameters, relative to which the bank establishes internal limits for measuring, monitoring, and controlling levels of liquidity risk;

b) development and implementation of early warning indicators to identify potential vulnerabilities of liquidity positions and risks;

c) creation of a system for reporting to the Board of Directors on existing and potential liquidity problems and other liquidity information on a timely and effective basis.

24. For measuring and analyzing its liquidity risk, the bank must use various parameters that allow the bank's management to understand operational liquidity positions and structural liquidity mismatches, as well as determine the bank's resilience in stress conditions.

Liquidity parameters must be aimed at:

• forecasting future cash flows of the bank and identifying potential funding mismatches, both in current normal operations and in stress conditions, as well as in various time intervals (cash flow forecasts must be based on reasonable and justified assumptions, which are properly documented, periodically reviewed, and approved);
• assessment of potential liquidity risks inherent in the balance sheet and off-balance sheet structure and commercial activities of the bank, including emerging risks of a rarer nature, including contingent liabilities;
• assessment of the bank's ability to attract financing, as well as its vulnerability or concentration on any of the main funding sources;
• identification of the bank's liquidity risk to exchange rate changes.

25. The bank must use parameters and tools corresponding to the structure, complexity, and characteristics of risk in its activities. The following liquidity parameters may be used for risk measurement:

• information on the level of concentration of funds attracted from major counterparties (including funds attracted from individuals and legal entities, regardless of volume) or main funding instruments (for example, by issuing various types of securities);
• analysis of maturity mismatches based on contractual terms, as well as assumptions about the dynamics of cash inflows and outflows;
• information on the size, structure, and characteristics of the bank's liquidity reserve to assess its ability to attract additional liquidity in conditions of economic stress;
• other coefficients and indicators (loan-to-deposit ratio), intra-group open positions and borrowings, swap coefficient (to measure the bank's dependence on foreign currency to finance liquidity needs in national currency), contractual and non-contractual mechanisms and obligations corresponding to the bank's commercial activities.

26. The bank must regularly analyze information or trends, such as a sustained decrease in the volume of stable deposits, as indicated by liquidity parameters, to identify significant potential liquidity problems.

§ 2. Limits for Controlling Liquidity Risk Management

27. The bank establishes limits on liquidity parameters that will be used to monitor and control levels of liquidity risk. The set of limits must correspond to the bank's commercial activities and its level of accepted liquidity risk.

28. Established limits on liquidity risk parameters must be used to manage current liquidity, and must be set at a level that ensures the bank's ability to continue functioning in conditions of economic stress.

29. The bank must ensure compliance with established limits on liquidity risk parameters and establish a procedure for preparing and reporting on exceptions or violations, which may serve as early indicators of excessive risk and/or inadequate liquidity risk management. Established limits on liquidity risk parameters, and corresponding procedures for the procedure for preparing and reporting, must be reviewed at least once a year, or as necessary during the year.

§ 3. Early Warning Indicators of Excessive Liquidity Risk

30. The bank must develop indicators that allow early identification of increasing risks and indicate rising risks in various liquidity risk positions and/or potential funding needs (hereinafter - early warning indicators).

Early warning indicators must ensure the identification and assessment of any negative trends in liquidity to take appropriate measures by the bank's management and reduce the impact of emerging risks on the bank.

Both internal data and system-wide data may be used as early warning indicators of excessive liquidity risk.

31. Early warning indicators of excessive risk may be qualitative or quantitative, and must include at least the following:

• growth of assets financed by potentially volatile liabilities/obligations;
• concentration of assets or liabilities (obligations), as well as funding sources;
• growth of currency mismatches;
• increase in the cost of financing;
• deterioration of cash flow or structural liquidity indicators indicating an increase in negative maturity gaps, especially in the short-term interval up to 1 month, etc.;
• reduction of the weighted average maturity of obligations;
• cases of approaching the values of regulatory indicators to internal or established in the Regulation on Economic Indicators and Requirements Mandatory for Compliance by Commercial Banks of the Kyrgyz Republic limits or exceeding established limits;
• negative trends or increased risk, such as an increase in cases of default, increase in non-performing loans, or loss-making activity associated with a specific enterprise, business type, product, or banking activity;
• significant deterioration in profit indicators, asset quality, and the overall financial condition of the bank;
• negative information about the bank in the media and the Internet;
• downgrade of credit rating, if available;
• counterparties' demands for additional collateral for loans or refusal to conclude new transactions for providing financing without collateral, or for longer terms;
• reduction of available credit lines from correspondent banks;
• intensifying trends of withdrawal of demand deposits;
• increasing early withdrawal of term deposits;
• difficulties with access to longer-term financing.

32. The bank must establish additional indicators that allow identifying an increase in risks for off-balance sheet operations and contingent liabilities of the bank, which may cause asset repurchase, additional liquidity support for financial products, increased collateral requirements, or a demand for an increase in margin in cash form, or may significantly reveal changes in liquidity.

§ 4. Information Systems

33. A reliable information system must function in the bank, aimed at ensuring timely and accurate provision to the Board of Directors, the Bank's Management Board, and other responsible employees of relevant information on the bank's liquidity status.

Information systems must assist the Board of Directors and bank management in identifying emerging liquidity problems, as well as controlling the situation during a liquidity crisis, including during non-compliance with National Bank requirements.

34. Information systems must, at a minimum, allow the bank to:

• monitor liquidity, both by currency types and on an aggregated basis;
• present concentration levels of funding sources from various aspects, such as maturity date, source type, counterparty, etc.;
• reflect all sources of liquidity risk, including possible new requirements for contingent liabilities and off-balance sheet operations;
• calculate liquidity positions during the day, during the month, for more distant time periods, and between periods;
• calculate and forecast various liquidity-related constraints and coefficients, including requirements of banking legislation and regulatory acts of the National Bank, for the purpose of internal risk management;
• monitor the bank's liquidity risk. The Bank's Management Board must define reporting parameters, including the procedure and frequency of reporting for various recipients, as well as responsible persons for report preparation.

Note of the IT Center "Toktom": The number of paragraphs in paragraph 34 of this Regulation does not correspond to the number of paragraphs in the text in the state language.

35. Reports for assessing liquidity risk management, measuring the required level of liquidity needs, and controlling liquidity risk must contain accurate data.

Reports must reflect current liquidity positions with established limits, both for internal liquidity risk management and for the purpose of compliance with regulatory requirements, in order to allow identifying emerging problems and contributing to the limitation of limit violations.

In case of exceeding liquidity risk limits, it is necessary to inform senior management depending on the competence of management bodies in order to make decisions on corrective measures to comply with established limits, justified revision of threshold values, and reporting.

§ 5. Cash Flow-Based Liquidity Risk Management

36. The bank must manage liquidity risk based on cash flows. Quantitative measurement and analysis of liquidity risk must be sufficient and include cash flows generated by assets, liabilities, as well as balance sheet and off-balance sheet positions within daily, weekly, monthly, annual, and other time horizons, which must be used for:

• monitoring net funding needs under normal operating conditions on a daily basis;
• conducting regular cash flow analysis based on a whole spectrum of stress scenarios.

37. Cash flow-based liquidity measurement must include an assessment of the bank's cash inflows relative to its outflows, arising balance sheet and off-balance sheet assets and liabilities, as well as an assessment of the liquid value of e