How does the ECB classify deposits for its LCR?

Introduction and Background

One of the reasons for the EBA introducing the LCR into its framework on October 1, 2015 was that it allowed for the establishment of a common framework that harmonized supervisory and liquidity requirements throughout different jurisdictions.

Within the set of established guidelines, there are specific rules for which the regulatory body affords the entity a certain amount of leeway in their application. The EBA, in its role as supervisor, specifically mentions some elements that, owing to their materiality and the differences of results between jurisdictions, prevent uniformity in the calculation of the LCR. These elements are:

• The volume of wholesale deposits which benefit from a preferential exit because they are of an operational nature.
• The definition of ‘economic penalty’ in the context of retail deposits with a maturity of more than 30 days.
• The inclusion of inflows from maturing HQLA.
• Optionality and contingent inflows.
• Interbank swaps of retained covered bonds or ABS
• LCR time dimension.
• The notification process for certain items.

This article will focus on the EBA’s observations regarding the first two points, which refer specifically to to the categorization of deposits.

Operational wholesale deposits

The EBA focuses on the existing ambiguity in the classification of a deposit as operational, which part of a deposit should be considered as such and the distinction within operational deposits.

Regarding this classification, the regulation (in its article 27) originally establishes two types of operational deposits and the following criteria for their categorization:

• Type 1: Deposits effected to obtain clearing, custody, cash management or other comparable services in the context of an established working relationship
• Type 2: Deposits held by the depositor in the context of an established working relationship that differs from the above

In general, these two types of deposits must meet the following conditions:

• Deposits subject to significant legal or operational limitations that make a significant withdrawal unlikely within 30 calendar days.
• Only the part of the deposit required for operational purposes (clearing, custody etc) will be subject to preferential treatment, with any surplus being excluded.

The EBA has already recognized the fact that the previous classification does not contain sufficient detail – and that this may result in imprudent criteria and inconsistencies between different entities and countries subject to the regulation – hence it has sought to clarify the identification of these deposits . The details are as follows.

Operational deposits

This type of deposit (whether it be from a financial or non-financial depositor) must meet the following requirements:

1. Effected to obtain clearing, custody, cash management and other comparable services
2. The services provided by the entity must be carried out within a relationship considered established with the depositor, that is: the depositor has a minimum of two contracted products / services of the four mentioned in the previous point and, additionally, the depositor must have used one of these services in the last 3 months.
3. The services provided must be critical to the normal functioning of the depositor’s activity.
4. These deposits have legal or operational limitations that make their withdrawal unlikely in 30 calendar days. At least one of the following conditions must be met: the cancellation of the deposit must be notified at least 30 days in advance (or there is an unconditional cancellation date greater than 30 days) or it is technically impossible for the depositor to change service provider.

The following examples of deposits can be considered as candidates for belonging to this category:

• Separate accounts established by custodian banks for securities settlement only.
• Centralizing management accounts (cash pooling accounts) used in the context of project finance.
• Deposits created for the collection and payment of taxes on a recurrent basis.
• Bill remittances.
• Payment of wages.
• Payment of contributions to social security.
• Income from check remittances.

Other operational deposits

They must meet the following requirements:

1. The depositor must be a non-financial customer.
2. It should not be a term deposit, savings account, nor brokered deposit.
3. The deposit presents legal or operational limitations that make its withdrawal unlikely in 30 calendar days. At least one of the following conditions must be met: the cancellation of the deposit must be notified at least 30 days in advance (or there is an unconditional cancellation date greater than 30 days) or it is technically impossible for the depositor of change service provider.
4. The deposit rate does not present economic incentives for maintaining balances higher than those required for operational purposes. Remuneration must be 5 basis points below the rate of other comparable deposits (without requiring it to be negative in cases of comparable rates of 0.05%).
5. The deposit must be kept in specifically designated accounts.
6. Material recurring transactions must take place (at least monthly).
7. Additionally, they must meet one of the following criteria: that the relationship with the depositor has existed for at least 24 months or that the deposit is used, at least, for two types of current service, such as access to national or international payment services, security trading or depository services.

Regarding the detection of the operational balance part of a deposit, the EBA has suggested two types of methods that could be applied for this purpose.

Method 1. Based on deposit balance:

Under this method, account balances would be analysed during a series of trading cycles that would allow estimating the needs that are regularly covered with these deposits. It is usual to find an excess of balance that is not used during the cycles and that would suppose a balance or margin of safety and that is not used operationally, therefore, this part should not be considered as a deposit of this type.

Method 2. Based on operational payments:

This method analyses the history of daily payments made for payment of operational services, being able to use a moving average of these payments during different business cycles. The detection of this amount would suppose the amount to be assigned as an operational deposit.

Retail deposits excluded from the calculation of outflows

The exception of certain retail deposits in the calculation of outflows responds to legal and economic criteria. It is with the latter where the authority, in its exercise of supervision and monitoring, has detected divergences between the different credit institutions.

Regarding the legal criteria, those deposits where the depositor has legal impediments to withdraw the deposit in a period of less than 30 calendar days can be excluded

In the context of economic constraints, article 25 of the regulation instructs the following:

• The financial penalty must include, as a minimum, the loss of interest corresponding to the accrual from the withdrawal date to the maturity date.
• Additionally, there must be an economic penalty that does not necessarily have to be higher than the accrual of interest between the start date and the date of withdrawal of the deposit.

In order to provide greater clarity, the authority has provided as a guide, a series of aspects which need to taken into account to allow for the exclusion of deposits from outflows:

• The general principle should be the certainty of a non-withdrawal of the deposit over a period of 30 calendar days. This may be either due to legal conditions or material penalties on early withdrawal.
• It is important to analyse whether the early withdrawal penalty entails a material loss of the principal deposited. For these cases, this conditioning factor is sufficient to justify the non-withdrawal and exclusion of the outflows.
• Specifically, for those deposits where there is no material loss of principal (when it is only penalized with the interest accrued until the withdrawal date) or the loss is not material, additional factors would be required to reinforce the expectation of not early withdrawal. These factors can be high opportunity costs or transaction costs.