Liquidity Coverage Shortfall After a Peer Failure
Ravensworth Bank has EUR 52 billion of assets, EUR 34 billion of loans and EUR 38 billion of deposits, 34% of which are uninsured. After a mid-sized peer failed, Ravensworth lost 9% of deposits in six days, mostly uninsured balances. Its high-quality liquid assets are EUR 4.4 billion of Level 1 and EUR 1.3 billion of Level 2A after haircuts; modelled 30-day net cash outflows are EUR 6.9 billion. CET1 capital is 10.1% against a 4.5% minimum, a 2.5% conservation buffer and a 1.0% systemic buffer, so the maximum distributable amount threshold is 8.0% plus buffers. Collateral already pledged to the central bank is EUR 7.2 billion, with EUR 2.1 billion still undrawn; 60% of loans are already pledged elsewhere. Unsecured interbank quotes are 210 bp over OIS and the bank's CDS spread has tripled. Management proposes selling EUR 3 billion of held-to-maturity securities carrying a 6% unrealised loss.
1. Calculate the liquidity coverage ratio, identify the shortfall, and evaluate the proposed securities sale against the central bank facility.
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LCR. HQLA = 4.4 + 1.3 = EUR 5.7bn. LCR = 5.7/6.9 = 82.6%, a shortfall of 17.4 points, or 0.174 × 6.9 = EUR 1.2bn of HQLA needed to reach 100%. Composition tests: Level 1 is 4.4/5.7 = 77%, above the 60% floor; Level 2 is 23%, below the 40% cap, so no Level 2 haircut applies beyond the stated one. The binding constraint is total HQLA, not composition.
Securities sale. Selling 3.0bn at a 6% loss yields about 2.82bn of cash; HQLA rises to roughly 8.5bn and LCR to about 123%. But the loss crystallises EUR 180m against CET1, cutting the ratio by roughly 35 bp to about 9.75%, still above the 8.0% threshold but eroding the buffer that absorbs further deposit flight. A fire sale of HTM securities also signals distress and can force mark-to-market recognition across the remaining book.
Central bank facility. Drawing the undrawn 2.1bn against pledged collateral raises cash HQLA to 7.8bn and LCR to about 113%, without realising a loss, at a penalty rate. It is the cheaper option on capital and preserves the securities as a future liquidity source. The trade-off is stigma and the signal sent to uninsured depositors. On balance: draw the facility first, sell only the most liquid unpledged securities if outflows continue, and keep the HTM sale as a contingency rather than a first move.
2. Assess solvency versus illiquidity, and the moral-hazard and supervisory issues raised by lender-of-last-resort support.
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Solvency assessment. CET1 at 10.1% is above the 8.0% maximum-distributable-amount threshold, so the bank is not in breach, but the buffer is thin and the HTM loss is not yet in capital. Loans are 65% of assets and 60% are already pledged, so unencumbered assets are limited: of 34bn loans, about 13.6bn are unpledged, plus the securities book. The bank looks illiquid but probably solvent on a hold-to-maturity basis, which is exactly the case lender-of-last-resort lending is designed for: lend freely against good collateral, at a penalty rate, to a solvent institution.
Moral hazard. Support must not subsidise the business model that created the mismatch - 34% uninsured deposits funding long-dated loans. Conditions should include: a penalty rate above the market, overcollateralisation, restrictions on dividends and buybacks while the facility is outstanding, a credible plan to term out uninsured funding, and a supervisory review of the liquidity risk appetite. Without these, the facility teaches the bank and its peers that duration mismatch is privately profitable and publicly insured.
Supervisory issues. Deposit insurance coverage matters: extending guarantees to all uninsured deposits would stop the run but widen the safety net and require explicit fiscal authority. The supervisor should also coordinate disclosure - a sudden announcement of facility use can accelerate outflows - and require a recovery plan. If a capital shortfall emerges after marking the HTM book, the correct instrument is resolution or recapitalisation, not liquidity support.
3. Recommend a 30-day action plan and the communication strategy.
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Days 1-3. Pre-position collateral and confirm the 2.1bn facility is operational; draw it and hold the proceeds as HQLA rather than lending them out. Activate the contingency funding plan: contact the largest uninsured depositors, offer term deposits at market rates, and secure committed corporate lines. Suspend the dividend and buyback under the buffer framework. Brief the board and supervisor jointly.
Days 4-10. Build a daily 30-day cash-flow forecast by depositor segment, not a single aggregate. Identify 3.0-5.0bn of unpledged, saleable assets and obtain indicative prices, keeping the HTM sale as a contingency. Approach two or three institutional funders for a secured, collateralised facility as a bridge. Prepare a recovery plan with triggers - for example, if outflows exceed 15% of deposits, move to asset sales and a capital raise.
Days 11-30. If outflows stabilise, begin a capital raise or a portfolio sale of unpledged loans to restore the buffer to 10.5% or above. If they do not, prepare a resolution submission in parallel rather than waiting until the LCR breaches.
Communication. Be precise and factual: confirm the LCR, the collateral available and the actions taken, without predicting a return to normal. Avoid the word "stigma" and avoid disclosing facility use unless required; disclose to the market if there is a listing obligation. Internally, tell staff and branch managers what to say, because deposit rumours spread through branches. Coordinate with the supervisor so public statements do not conflict, and prepare a holding statement for the peer-failure fallout.