What is an appropriate DLC level?
Published: 9 May 2022
There are many benefits of having a positive cumulative net cash flow for all time buckets; that is, a constant DLC level above zero. If a crisis emerges in which a bank cannot obtain new liquidity, the bank is in a better position to fulfil its outflows with its cumulative inflows provided that it does not sustain a bank run. A bank which is below zero at any point in time cannot however manage on its own but is forced to seek assistance from the central bank, if new liquidity cannot be obtained from the market.
Let us say that there is a requirement for a bank to have a DLC value over zero; that is, maintaining a positive cumulative net cash flow. Sometimes the bank will lose some part of its deposits even in the absence of any stress – unstable deposits, for example – and in that case the bank must cover this with liquid assets, which usually consist of central bank reserves today. This causes the entire graph showing the cumulative net cash flow to decline to the same extent as the outflow of deposits. Here, the bank must thus have a certain margin down to zero, and this requires a good understanding of stability in the bank’s deposits. A bank with a large proportion of unstable deposits therefore needs to have a greater margin down to zero. If a bank knows that the supervisory authority and central banks use this metric to monitor liquidity risks, the bank must thus itself define unstable deposits – rather than a regulator doing so generally for all banks. That is way, it serves as a good complement to LCR and NSFR, in which the definition of unstable deposits is harmonised.
Near-term liquidity risks arising can, in many cases, pose a greater danger than longer-term liquidity risks. This is because both the bank and the authorities have less time to implement measures in the near term. For this reason, it might be relevant for a bank to have a slightly larger margin down to zero in its cumulative net cash flows on the short component of the metric, for instance in the first 30 days.