Deposit Loss Capacity
Published: 9 May 2022
A new, alternative liquidity metric devised by the Riksbank is Deposit Loss Capacity (DLC). It is based on the points in time when a bank’s assets and liabilities will contractually fall due for payment and generate cash inflows and cash outflows. It has been possible to calculate this in a harmonised way for all banks in the EU since March 2018, thanks to the maturity ladder report which, since that time, has been included in the reporting requirements of the European Capital Requirements Regulation The report must be submitted once a month, with the last day of each month as the record date, see EU (2017). , see Figure 1 in the Appendix.
Diagrams 1, 2 and 3 illustrate the basis for calculating DLC. The graphs are typical examples showing what a hypothetical large Swedish bank’s cash flows might be in SEK billion. Diagram 1 illustrates how the bank’s assets mature and hence generate cash inflows over time. For instance, when the maturity for the loans issued by the bank expires or is paid off and the bank receives a cash inflow. Assets that are contractually always available, such as central bank reserves, generate inflows already in the first time bucket. In the same way, the liability side generates cash outflows, see
If the cash flows from assets and liabilities are totalled, a graph is formed that shows the bank’s cumulative net cash flows, see Diagram 3. If cumulative inflows are greater than cumulative outflows for a given time bucket, the graph rises, and vice versa.
As a point of departure for the metric, all assets and liabilities mature contractually; this is also the case for instance for the assets in a bank’s liquidity reserve. There is however one exception, which is that deposits from the public are excluded and hence do not generate any outflows in Diagrams 2 and 3. This is because deposits largely do not have any maturity-defined contractual cash outflows. Taking as a starting point the bank’s lowest liquidity position based on the cumulative net cash flows, the volume of deposits a bank could theoretically cope with losing is calculated instead. The lowest point in the graph in Diagram 3 emerges at five to six months, where the distance down to zero is SEK 150 billion. Note that cumulative inflows are greater than cumulative outflows for all points on the graph that are above zero (x axis). This sum is then related to deposits from the public to calculate DLC. Deposits from the public are generated in the maturity ladder report through all deposits (row 260) excluding deposits from credit institutions (row 300), irrespective of the time bucket in which the deposits are reported. Term deposits from the public are thus not distinguished from on demand deposits in the DLC calculation. If we assume that deposits are 1,000, the formula is as follows:
Formula 1. Deposit Loss Capacity
The lowest cumulative net cash flow is identified only on maturities of up to one year in the metric. Although it is also important to measure liquidity risks on long maturities, the maturity ladder report does not have a sufficient number of time buckets to enable measuring net cash flows meaningfully after one year.
Note that the DLC metric is not a scenario, unlike stress tests Stress tests are also an important way of measuring liquidity risks. The Riksbank stress-tests the banks, using the maturity ladder report for that too, see Danielsson and Manfredini (2019). . Instead, it measures the underlying maturity structure of a bank’s balance sheet. The DLC metric thus provides an indication of how large an outflow of deposits from the public the bank could manage without a supply of new liquidity, such as from the market or central bank.
It is important to bear in mind that the risk of a bank being subjected to a bank run is a contingent risk; that is, it depends on some other, adverse, event or fear of an adverse event transpiring. This is one reason why a bank should take small risks, for instance in terms of credit risks and business risks. In the same way, it could be argued that the bank’s maturity risk, of which DLC is a measure, is also correlated with the risk of a bank run. A bank that has higher cumulative net cash flows is therefore at a lower risk of a bank run than one with lower cumulative net cash flows, all else equal.
The DLC metric thus differs from the liquidity risk in two different elements of the balance sheet – the maturity-defined items and deposits. The latter is correlated with the former, and merging these might thus be problematic when it comes to measuring liquidity risk. The international liquidity metrics, see section 2.2, and the stress test performed by banks and supervisory authorities do exactly that (that is, merge these two types of liquidity risks), without taking account of the correlation between them. DLC is thus a new method for calculating liquidity risk in banks.