Net Stable Funding Ratio: Avoiding A Northern Rock Scenario

More bite size banking insights today. In my last article we looked at the Liquidity Coverage Ratio, this time we will consider the Net Stable Funding Ratio (NSFR), also known as the Northern Rock rule. You may remember that Northern Rock ran into trouble in September 2007 (maturing money market borrowings could not be replaced). They needed emergency funding and the Bank of England, perhaps unwisely, decided upon a high interest rate, to send a message to other banks that excessive risk taking would not result in a bail out.

By February 2008 the emergency borrowing had reached £25bn and Northern Rock was nationalised. As was often stated at the time, this was a liquidity issue and not a solvency problem, not that that stopped customers queuing outside branches to withdraw their savings.

Therefore, the objective of the net stable funding ratio is to promote medium and long term funding. And this is achieved by establishing a minimum amount of liquidity based on the liquidity characteristics of assets and activities, over the course of a one year period of a specific stress scenario (essentially a liquidity shock). The thinking behind this is that the mismatch between assets and liabilities on the balance sheet is, as far as possible, reduced. This should then ensure a Northern Rock scenario is avoided. The formula is:

NSFR = (Available Stable Funding (ASF) / Required Stable Funding (RSF)) >= 100%

Sign up for our FREE newsletter
and receive our best trading ideas and research

Further detail can be found here: BIS – NSFR

In the link above, there is a template which illustrates the components of the Net Stable Funding Ratio formula. As a quick introduction, the ASF is largely regulatory capital, deposits and funds with a maturity of greater than one year. The RSF takes a slightly different approach and assigns a grading to assets according to the percentage of stable funding which is necessary to support them. For example, net derivative trades, loans to other banks or financial institutions require matched ASF. By contrast, residential mortgages would require stable funding in the order of 65%. Off Balance Sheet commitments also require stable funding.

In my next article we will look at the Core Tier 1 Ratio. Thanks for reading.

   Follow Allan on Twitter:  @MillarAllan

Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.