Refinements to the Stable Funding Requirement

Our Ref: B9/152C
28 November 2014
The Chief Executive
All Authorized Institutions
Dear Sir/Madam,
Stable Funding Requirement
The Hong Kong Monetary Authority (HKMA) introduced Stable Funding Requirement (SFR) in October 2013 requiring authorized institutions (AIs) with significant loan growth to ensure adequate stable funding to support their lending business from 2014 onwards. To streamline SFR’s operation and alleviate AIs’ reporting burden, the HKMA has conducted a review and has sought industry associations’ input on the refinements. Taking into consideration the views of members of industry associations who generally appreciate the refinements and do not envisage major operational difficulties, the HKMA will implement several refinements to the SFR with effect from January 2015. These refinements include, among other things, the following:

• AIs1 with total loans of HK$10 billion or more and annualised average loan growth in
  the latest 8 quarters exceeding 15% will be required to observe the SFR;
• Frequency of review and report submission will be changed to quarterly;
• The SFR ratio applicable to an AI, subject to a cap of 100%, for calculating the stable
  funding to be obtained will be based on AI’s quarterly loan growth rate; and
• Subject to certain caps and conditions, additional flexibility will be allowed for
  exempting loans and accepting Head Office’s irrevocable committed liquidity facility as stable funding. A comparison between the existing and refined SFR regime is summarised at Annex 1. Illustrations of SFR calculation based on the refined regime are at Annex 2. Implementation Similar to the existing arrangement, AIs that fall within the thresholds set out above will be given two months after each quarter end to achieve compliance if they are required to obtain additional stable funding. Thereafter, the applicability of SFR to AIs, including those AIs not yet falling within the thresholds, would be reviewed on a quarterly basis. While the SFR is and will continue to be only applicable to AIs meeting certain loan portfolio and credit growth thresholds, the HKMA may, on a case by case basis, require an 1 AIs engaging solely in private banking business are not subject to the SFR.

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AI to maintain a higher level of SFR ratio or require an AI outside of the scope of the SFR to observe the SFR if the HKMA is not satisfied with the quality of its liquidity risk management or is concerned with its arrangements which, in the HKMA’s view, are for the purpose of limiting the HKMA’s supervisory reach by circumventing the SFR. For the avoidance of doubt, alternative arrangements previously agreed with individual AIs under the existing SFR regime will lapse upon the implementation of the refinements on 1 January 2015. AIs should approach the HKMA if it encounters difficulty in setting aside sufficient stable funding to comply with the SFR before a deadline. AIs are also reminded to directly communicate with the HKMA to resolve their difficulties and discuss any alternative arrangements. The HKMA will give due consideration to the justification. Further review of SFR The HKMA will review the parameters for SFR calculation from time to time, taking into account relevant factors such as credit, liquidity and capital conditions of the banking sector as well as the macroeconomic environment. The SFR is expected to remain in force until the full implementation of relevant international Basel standards (e.g. Net Stable Funding Ratio) designed to enhance banks’ resilience against liquidity risk. Reporting requirement Starting from end-December 2014 position, every AI meeting the revised thresholds should submit quarterly report in the format set out at Annex 3 to the HKMA’s private website within 14 calendar days after each quarter end. The first reporting deadline will be 14 January 2015. AIs will be informed of the arrangements and may download an electronic file of the reporting template from the HKMA’s private website in due course. In case you have further questions relating to the SFR refinements, please write to sfr_team@hkma.iclnet.hk or contact Mr Dennis Lau at 2878 8288 / Mr Samuel Kan at 2878 1163. Yours sincerely, Henry Cheng Executive Director (Banking Supervision) Encl. c.c. The Chairman, The Hong Kong Association of Banks The Chairman, The DTC Association FSTB (Attn: Mr Jackie Lui)

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Annex 1
Version: 28 November 2014
Comparison between the existing SFR regime and the refined SFR regime Criteria Existing Regime Refined Regime 1 Loan filter Banks whose loan book exceeds HK$5 billion and its annualised year-to-date loan growth exceeds 20%. (excluding banks that engaged in solely private banking business) Authorized institutions (“AIs”) with total loans of HK$10 billion or more and annualised average loan growth in the latest 8 quarters exceeding 15%. (excluding AIs that engaged in solely private banking business) 2 SFR ratio for calculating stable funding to be obtained A progressive scale with four tiers (40%, 60%, 80% and 100%) according to individual bank’s annualised year-to-date loan growth. Based on individual AI’s quarterly loan growth rate, subject to a cap of 100%. 3 Review and report submission frequency Monthly Quarterly 4 Loans exempted On a case by case basis taking into account funding arrangement and balance sheet structure of individual banks. Loans with remaining maturity of 6 months or less and supported by matched-term funds from its Head Office or overseas offices on a back-to-back basis, subject to a cap of 25% of total loans. 5 Other funding support from Head Office recognised as stable funding Head Office’s irrevocable committed liquidity facility, subject to the HKMA’s consent and a cap of 25% of total loans in any case for SFR calculation purpose. Negotiable debt instruments (“NDIs”) held by Head Office placed at Central Moneymarkets Unit, subject to the HKMA’s consent. The NDIs should be free from any encumbrances and should be no legal or regulatory barriers that would prevent from converting the NDIs into liquidity support.

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Calculation formula
(i)
(ii)
Note 1
Note 2
Illustrative examples
2012
31-Dec 30-Sep 30-Jun 31-Mar 31-Dec 30-Sep 30-Jun 31-Mar 31-Dec Total loans 25 24 18 18 22 21 20 18 20 Quarter-on-quarter (%) 4.2% 33.3% 0.0% -18.2% 4.8% 5.0% 11.1% -10.0% 25% Average of latest 8 quarters (%) (Annualised) 15.1% 0.25512 Total loans 23 24 18 21 23 22 21 15 20 Quarter-on-quarter (%) -4.2% 33.3% -14.3% -8.7% 4.5% 4.8% 40.0% -25.0% 25% Average of latest 8 quarters (%) (Annualised) 15.2% 0.2983 Total loans 23 22 18 21 23 22 21 15 20 Quarter-on-quarter (%) 4.5% 22.2% -14.3% -8.7% 4.5% 4.8% 40.0% -25.0% 25% Average of latest 8 quarters (%) (Annualised) 14.0% 0.24274 (1) (a) of which IPO loans (b) (2) (a) of which IPO loans (3) (4) (a) (b) (5) (6) (a) (b) (i) (ii) (iii) (iv) (c) (i) (ii) (7) (8) Version: 201412.2 0 Total loans as at 31 Dec 2014 Sample Bank C (HKD'mn) 0 23,000 24,000 10,000 Loans with remaining maturity of ≦6 months and supported by matched-term funds from its HO or overseas offices on a back-to-back basis, subject to a cap of 25% of total loans Total loans excluding IPO loans (previous quarter end) x (SFR ratio Note 1) - (Loans supported by matched-term funds Note 2) (current quarter end) - Available stable funding If [(70% of customer deposits) (current quarter end) - (Total loans excluding IPO loans) (current quarter end)] > 0, the formula is:
Total loans excluding IPO loans (previous quarter end) x (SFR ratio) - (Loans supported by matched-term funds) (current quarter end) - [(70% of customer deposits) (current quarter end) - (Total loans excluding IPO loans) (current quarter end)] - Available stable funding 0 0 Total loans as at 30 Sep 2014 0 of which loans with remaining maturity of ≦6 months and supported by matched￾term funds from its HO or overseas offices on a back-to-back basis, subject to a cap of 25% of total loans 0 0 Total customer deposits as at 31 Dec 2014 0 0 Deadline to obtain the stable funding Net due to / (from) Head Office, overseas offices and related banks repayable later than 6 months Capital base (less interests in land and buildings and fixed assets) 50% of net due to other banks with remaining maturities over 6 months 50% of term funding ( e.g. NDIs issued) with remaining maturities over 6 months Stable funding to be obtained [ (5) - 6(a) - 6(b) - 6(c) ] Other stable funding:
Other funding support from Head Office
(subject to the HKMA's consent)
Head Office's irrevocable committed liquidity facility (subject to a cap of 25% of total loans) NDIs held by Head Office placed at Central Moneymarkets Unit Loan growth as at 31 Dec 2014 quarter-on-quarter excluding IPO loans (equivalent to applicable SFR ratio, subject to a cap of 100%) [ ( (1)-(1)(a) / (2)-(2)(a) ) -1 ] x 100% average of latest 8 quarters (annualised and based on actual total loans) Total stable funding required = [ (2) - (2)(a) ] x (4)(a) - (1)(b) If [(3) x70% - (1)+(1)(a)] is positive, then the formula for calculating total stable funding required is [ (2) - (2)(a) ] x (4)(a) - (1)(b) - [(3) x70% - (1) + (1)(a)] Available stable funding Others (subject to the HKMA's consent) Stable funding to be obtained = (HKD' bn) 2014 2013 Sample Bank A Applicable SFR ratio is equivalent to individual authorized institution's latest quarter-on-quarter loan growth rate, subject to a cap of 100%. Sample Bank B Not applicable 4.2% 15.1% 1,000 -4.2% 15.2% Not required since QoQ % change is zero or negative Not applicable 4,000 28 Feb 2015 0 Not required 0 Not required 1,000 2,000 1,000 2,000 3,000 23,000 22,000 10,000 4.5% 14.0% Not required since average loan growth in latest 8 quarters ≦15% 25,000 24,000 10,000 (6,000) 6,000 0 3,000
Annex 2
Illustration of calculation of stable funding requirement ("SFR") Sample Bank A Sample Bank B Sample Bank C (6,000)

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(HKD'000)
(1) Total loans as at end of (current quarter end) (a) (b) (2) Total loans as at end of (previous quarter end) (a) of which IPO loans (3) (4) Loan growth as at (current quarter end) (a) (b) (5) (6) Available stable funding (a) (b) (i) (ii) (iii) (iv) (c) (i) (ii) (7) (8) Version: 201412.2 Other stable funding:
Capital base (less interests in land and buildings and fixed assets) 50% of net due to other banks with remaining maturities over 6 months 50% of term funding (e.g. NDIs issued) with remaining maturities over 6 months Others (subject to the HKMA's consent) Other funding support from Head Office (subject to the HKMA's consent) For the quarter ended (mmm/yyyy):
Total customer deposits as at
Total stable funding required = [ (2) - (2)(a) ] x (4)(a) - (1)(b) If [(3) x70% - (1)+(1)(a)] is positive, then the formula for calculating total stable funding required is [ (2) - (2)(a) ] x (4)(a) - (1)(b) - [(3) x70% - (1) + (1)(a)] average of latest 8 quarters (annualised and based on actual total loans) Report on Stable Funding Requirement ("SFR") quarter-on-quarter excluding IPO loans (equivalent to applicable SFR ratio, subject to a cap of 100%) [ ( (1)-(1)(a) / (2)-(2)(a) ) -1 ] x 100% of which loans with remaining maturity of ≦6 months and supported by matched-term funds from its Head Office or overseas offices on a back-to-back basis (subject to a cap of 25% of total loans) of which IPO loans Name of reporting institution:
Head Office's irrevocable committed liquidity facility (subject to a cap of 25% of total loans) NDIs held by Head Office placed at Central Moneymarkets Unit The report should be submitted to the HKMA within 14 calendar days after each quarter end. Stable funding to be obtained [ (5) - 6(a) - 6(b) - 6(c) ] Deadline to obtain the stable funding Net due to / (from) Head Office, overseas offices and related banks repayable later than 6 months

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Reference Note
Stable Funding Requirement (SFR)
Background
Introduction to the SFR
1. In October 2013, the HKMA wrote to certain banks with significant loan
growth to inform them that they would be required to maintain longer term stable funds to support their lending business from 2014 onwards if their loan growth in 2013 exceeds the banking sector’s average.
2. The stable funding ratio in respect of the SFR is determined based on the
pace of banks’ loan growth. The higher the pace of loan growth, the higher the required ratio. The HKMA will regularly review the parameters in SFR calculation to take into account market conditions.
3. In calculating the stable funding requirement, consideration is given to
available stable funding sources of banks including total customer deposits and capital base. Other term funds including net borrowing from Head Office / overseas offices, net inter-bank borrowings and negotiable debt instruments issued with remaining maturity over 6 months are also considered. Reason for introducing the measure
1. An objective of the HKMA’s policies is to maintain the stability of the
banking system. Therefore, the HKMA has been closely monitoring the developments in local and overseas financial markets and has been paying attention to banks’ business plans, their funding strategies and how they manage their liquidity risk. The HKMA also requires banks to adopt prudential measures to ensure that they have sufficient capacity to address

2 potential risks arising from possible significant fund outflows from Hong Kong.
2. While the overall liquidity of Hong Kong’s banking system remains stable,
the HKMA believes that it is necessary to take precautionary steps to reduce the impact of potential financial market instability on the banking system, the credit market and the local economy. The SFR measure requires banks to hold a certain proportion of stable funds so that these funds can support banks’ lending businesses even if market liquidity should come under significant stress as a result of fund outflows.

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Q&A
Q1. Other than an increase in loan growth, is this a precautionary measure in response to future US Fed tapering plan which may trigger possible significant fund outflows from Hong Kong? Has the HKMA noticed fund outflows? Does the introduction of this measure reflect an increase in credit risk or serious liquidity problem in Hong Kong banking sector? A1. The HKMA has been closely monitoring the developments in local and overseas financial markets. So far we have not identified any irregularities in the local banking sector or individual banks that might be caused by recent volatility in emerging markets. Statistical data indicate that the overall liquidity of Hong Kong’s banking system remains stable and loan-to-deposit ratio still stands at an acceptable level. The measure introduced by the HKMA aims at ensuring that banks have sufficient capacity to address potential risks arising from possible significant fund outflows from Hong Kong so as to reduce the impact of financial market instability on the banking system, the credit market and the local economy. Q2. Can you tell us the names of the banks which the HKMA has written to and what was the selection criteria? Whether local banks, Mainland banks, or foreign banks are mostly affected? A2. Up to the end of March 2014, 69 banks with relatively rapid loan growth were notified of the SFR measure. Banks with relatively narrow local customer deposit base but rapid loan growth are mostly affected.

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Q3. According to the HKMA’s assessment, how much stable funding should the industry reserve to fulfill the new requirements? A3. While banks have always maintained sufficient funds to support their lending businesses, the SFR measure requires affected banks to enhance the stability of their funds. Therefore, it is inevitable that the market demand for long-term funds will increase. When considering the introduction of this supervisory requirement, the HKMA has been cautious and conscious of the need to avoid unnecessary impact on the interest rate market. For example, we scheduled the SFR measure to be implemented from 2014 onwards so that affected banks would have sufficient time to make appropriate arrangements for their lending businesses and stable funds. Q4. Is the SFR measure too strict? Has the measure overly interfered with banks’ business operations? A4. An objective of the HKMA’s policies is to maintain the stability of the banking system. The SFR measure aims at ensuring that banks have sufficient capacity to address potential risks arising from possible significant fund outflows from Hong Kong so as to reduce the impact of financial market instability on the banking system, the credit market and the local economy. Affected banks had been given sufficient time to make appropriate arrangements for their lending businesses and stable funds. Q5. Is the SFR an on-going supervisory measure or an ad hoc requirement created to address the current market environment? To what level should credit growth decrease before the HKMA considers easing this measure? Is the measure different from the tenor matching requirement observed by certain foreign bank branches?

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A5. The SFR can be perceived as an on-going supervisory measure. The HKMA will regularly assess the market conditions and adjust the measure when necessary. Relevant considerations include credit growth rate of the banking system, structure of banks’ funding source, interest rate market environment, and the risk of possible significant fund outflows from Hong Kong.

In the second half of 2011, the HKMA gradually required the Hong Kong branches of certain foreign banks to observe the tenor matching requirement to ensure that they have sufficient liquid funds. The SFR is a continuation of the tenor matching requirement to further enhance banks’ liquidity risk management. Hong Kong Monetary Authority April 2014

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Reference Note
Stable Funding Requirement (“SFR”)
Background
Reason for introducing the SFR
1. An objective of the HKMA’s policies is to maintain the stability of the banking
system. Therefore, the HKMA has been closely monitoring the developments in local and overseas financial markets and has been paying attention to banks’ business plans, their funding strategies and how they manage their liquidity risk. The HKMA also requires banks to adopt prudential measures to ensure that they have sufficient capacity to address potential risks arising from possible significant fund outflows from Hong Kong.
2. While the overall liquidity of Hong Kong’s banking system remains stable, the
HKMA believes that it is necessary to take precautionary steps to reduce the impact of potential financial market instability on the banking system, the credit market and the local economy. The SFR measure requires banks to hold a certain proportion of stable funding so that these funds can support banks’ lending business even if market liquidity should come under significant stress as a result of fund outflows.
3. Against this background, the HKMA wrote to certain banks with significant loan
growth in October 2013 requiring them to maintain longer term stable funding to support their lending business from 2014 onwards if their loan growth in 2013 exceeds the banking sector’s average. Since the implementation of the SFR measure in the beginning of 2014, affected banks have obtained sufficient medium to long term funds to support their lending business. Reason for the refinements
1. The SFR measure has been in place for nearly a year. The letters to certain banks in

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October 2013 have indicated that the HKMA will regularly review the parameters and the SFR calculation to take into account relevant factors, such as credit, liquidity and capital conditions of the banking sector and macroeconomic environment. The HKMA also considers that the SFR should continue until international standard under Basel III designed to enhance banks’ resilience against liquidity risk (e.g. Net Stable Funding Ratio) to be implemented in 2018.
2. In light of the above, the HKMA conducted a review on the SFR in October 2014 with a
view to streamline its operation and alleviate reporting burden of authorized institutions (“AIs”). The review has given due consideration to industry feedback as well as our implementation experience. Based on the review results, the HKMA believes that it is an opportune time to refine the existing SFR measure. Refinements

1. The refinements are mainly change in the calculation of the SFR and the policy
   objective of the measure remains the same. The HKMA believes that with the refined SFR, the sensitivity of banks’ risk management will be further increased. The impact of the refined SFR measure on banks will vary, depending on the loan growth trend and the balance sheet structure of individual banks.
2. The HKMA issued letters to industry associations on 3 November 2014 requesting them
   to collect their members’ views on the refinements to the SFR. In general, their members appreciated the refinements and did not envisage major operational difficulties in implementing the refinements. To formalise the implementation of the refined SFR, a circular letter was issued on 28 November 2014. The following refinements to the SFR are prepared to be implemented with effective from 1 January 2015:
   (i) AIs with total loans of HK$10 billion or more and annualised average loan growth in the latest 8 quarters exceeding 15% will be required to observe the SFR; (ii) frequency of review and report submission will be changed from monthly to quarterly;

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(iii) the SFR ratio applicable to an AI, subject to a cap of 100%, for calculating the stable funding to be obtained will be based on AI’s quarterly loan growth rate, instead of the existing specified SFR ratio; and (iv) subject to certain caps and conditions, additional flexibility will be allowed for exempting certain loans and accepting Head Office’s irrevocable committed liquidity facility as stable funding.

3. Details of refinements and the relevant operations could be found in HKMA’s
   circular issued on 28 November 2014.
   (http://www.hkma.gov.hk/eng/key-information/guidelines-and-circulars/circulars/2014/)
4. Currently, for the calculation of the SFR, consideration is given to available
   stable funding sources of AIs including total customer deposits and capital base. Other term funds including net borrowing from Head Office / overseas offices, net inter-bank borrowings and issued negotiable debt instruments (“NDIs”) with remaining maturity over 6 months are also considered. Under the refined SFR measure, the following flexibilities, subject to certain caps and conditions, will be allowed:
   (i) to exempt loans, subject to cap of 25% of total loans, with remaining maturity of 6 months or less and supported by matched-term funds from its Head Office or overseas offices on a back-to-back basis from total loans; (ii) to include Head Office’s irrevocable committed liquidity facility, subject to a cap of 25% of total loans, as stable funding for SFR calculation purpose; and (iii) to accept NDIs held by Head Office and placed in the Central Moneymarkets Unit as stable funding for SFR calculation purpose. The NDIs should be free from any encumbrances and there should be no legal or regulatory barriers that would prevent from converting the NDIs into funding support. Hong Kong Monetary Authority November 2014