## EXECUTIVE SUMMARY (1wauea2022005)

## Source details

**Canonical URL:** [EXECUTIVE SUMMARY (1wauea2022005)](https://www.imf.org/-/media/files/publications/cr/2022/english/1wauea2022005.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/cr/2022/english/1wauea2022005.pdf.md)
- [Structured JSON version](/-/media/files/publications/cr/2022/english/1wauea2022005.pdf.json)

---

### Introduction
- Since the 2008 FSAP:
  - Bank deposit base increased from 18 percent to 30 percent of gross domestic product (GDP).
  - Government securities market buoyancy benefited from the interruption of public deficit financing by the Central Bank of West African States (BCEAO).
- Systemic liquidity analysis objectives:
  - Assess liquidity risk, including stress testing.
  - Focus on measures to internalize liquidity risk (microprudential and macroprudential).
  - Enumerate central bank instruments for residual liquidity risk, including Emergency Liquidity Assistance (ELA).
  - Assess measures to manage risks that the central bank takes onto its balance sheet.

### Liquidity Risks — Liquid Assets and Market Structure
- Definition and composition of liquid assets:
  - Central bank money (vault cash and banks’ reserves at the central bank) represents 21 percent of liquid assets in the WAEMU.
  - Government securities account for more than 31 percent of bank assets and currently represent 72 percent of liquid assets.
  - The sum of potentially liquid assets averages 37 percent of the total assets, with significant disparities among banks.
- Market structure and vulnerabilities:
  - Capital markets are shallow; universe of potentially liquid assets beyond central bank money and government securities is limited.
  - Insufficient secondary market liquidity and prevalence of unsecured intragroup transactions (60 percent of the total) in the interbank market increase risk and potential losses during liquidity distress.
- Policy-relevant observation on reserves:
  - Current WAEMU practice: only excess reserves are factored into the denominator of liquidity ratios.
  - Mission assessment: required reserve should be included in liquid assets in the same manner as excess reserves because:
    - Required reserve is available at any time in its entirety and a priori at no cost to meet a one-time liquidity need (constituted on an average basis in the WAEMU).
    - Maintenance period is one month (from the 16th of the month to the 15th of the following month), aligning with withdrawal period recommended by Basel principles.
  - Possible limitation: using required reserve can be costly if it leads to a shortfall at period end and a financial penalty.

### Systemic Liquidity Management and BCEAO Role
- Exchange rate and monetary policy context:
  - CFA franc pegged since 1948; since 1999 to the euro at a fixed exchange rate.
  - BCEAO uses capital controls and developed an inflation targeting system in the 2000s based on an interest rate operational target.
  - Legal obligation: minimum coverage of currency issuance by foreign exchange reserves of 20 percent (Article 76 of the statutes).
- BCEAO refinancing practices and consequences:
  - Full allotment of refinancing demand to seven- and 28-day BCEAO operations introduced in 2020.
  - Full allotment removed uncertainty about access to refinancing and reduced the liquidity premium.
  - BCEAO currently accepts all government securities and private debt under the same conditions regardless of different risk profiles, which:
    - Helped absorb systemic and idiosyncratic liquidity shocks.
    - Encouraged risk-taking and dependence of some banks on BCEAO.
    - Resulted in accumulation of risk on the BCEAO balance sheet.
  - BCEAO limits refinancing proportional to bank assets and capital, but these limits are procyclical and may prevent refinancing for banks with additional needs.

### Measures to Internalize Liquidity Risks and Market Development
- Regulatory and internal risk management:
  - Regulator must choose objective and verifiable liquidity indicators to determine assets eligible for Level 1 of the liquidity coverage ratio (LCR) numerator and corresponding haircuts, including for government securities.
  - If differentiated haircuts for sovereign issuers are not used, at minimum apply a uniform non-zero haircut to account for limited market liquidity.
  - Ultimately, LCR should reflect different bank risk profiles based on time series of deposits per bank under Pillar II of Basel III.
- Market development priorities and actions:
  - Improve secondary market liquidity to reduce liquidity risk and support repo operations.
  - Include secondary market development as an objective in states’ medium-term debt management strategies.
  - Resolve market segmentation linked to syndication procedures (for example, by unifying the legal depository).
  - Review privileges and obligations of treasury securities dealers (TSDs).
  - Strengthen cooperation between WAMU Securities Agency (WSA) and CREPMF to promote transparency, supervision, and fungibility of securities.

### Funding Plans and Collateral Framework
- Funding plans to reduce BCEAO dependence:
  - Definition: projection of a bank’s balance sheet over a predetermined period (for example, three years) showing changes in funding needs.
  - Banks exceeding a predetermined threshold of dependence on the central bank must prepare a funding plan reviewed and monitored by the supervisor.
  - Under a plan banks must reduce funding requirement below the threshold by:
    - Asset sales and recapitalizations.
    - Reducing growth in assets.
    - Actively raising funding from customers or the market.
  - Trigger threshold in funding plans should be lower than current quantitative limits; subject to diligent execution, banks meeting funding plan requirements would retain access to BCEAO operations.
- Collateral framework enhancements:
  - Introduce additional haircuts based on risk types to maintain diversified collateral while achieving risk equivalence after haircuts.
  - Haircuts should reflect credit risk and liquidity risk for both government securities and private debt.
  - For government securities, credit risk haircut should be based on international ratings, with larger haircut for unrated sovereign debt.
  - Introduce concentration limits to ensure diversity of collateral provided.

### Emergency Liquidity Assistance (ELA) — Framework and Principles
- Recommendation to introduce an ELA framework:
  - ELA allows central bank to provide liquidity to viable banks facing persistent liquidity shortages that have exhausted collateral eligible for monetary policy operations.
  - ELA can be based on expanded collateral, but additional central bank risk must be offset by strict conditionality and monitoring of repayment plans.
  - ELA is a BCEAO responsibility but requires coordination with the supervisor to assess viability and impose conditionality.
  - Prepare a framework agreement for ELA counterparties defining ELA conditions and align funding plans with ELA repayment obligations.
  - Establish procedures for information sharing and coordination between BCEAO and the Banking Commission in ELA context.
- ELA conditions and operational parameters:
  - ELA is last resort for temporary liquidity squeeze; central bank must verify exhaustion of alternative funding sources (including interbank market).
  - Pricing: ELA interest rate must be higher than the BCEAO’s marginal lending facility rate; suggested range: 100 to 300 basis points above the marginal lending rate.
  - Tenor and renewals: grant up to two weeks, renewable every two weeks; renewals accompanied by recalibration of ELA envelope.
  - Legal/technical architecture required:
    - Public circular defining main conditions and parameters of ELA.
    - Internal procedures at BCEAO and Banking Commission detailing technical parameters.
    - Framework agreements between BCEAO and Banking Commission, BCEAO and WAEMU member states, and model agreements with ELA recipients.
    - Model funding plan.
  - IMF Technical assistance available from the Monetary and Capital Markets Department.

### Liquidity Stress Tests — Scope, Methodology, and Results
- Coverage and scenarios:
  - Tests covered 94 banks representing about 81 percent of the banking system’s assets.
  - Six scenarios: three moderate and three extreme; run-off rates under extreme scenarios are twice those of moderate scenarios.
  - Overall effective withdrawal rates under extreme scenarios are 25 percent to 27 percent.
  - Historical context: 25 percent to 27 percent extreme withdrawal rates are higher than the 95th percentile of the highest withdrawals experienced by 90 percent of banks over 2000–20.
- HQLA definition and haircuts:
  - HQLA = cash on hand + deposits and reserves at central bank + available government securities after haircut.
  - Haircut assumptions:
    - Moderate scenario: 10 percent haircut on available government securities.
    - Extreme scenario: 30 percent haircut on government securities.
  - Mission’s survey: average range of haircuts applicable to collateral commonly used for interbank transactions is about 23 percent of face value.
- Results (aggregate and scenario-specific):
  - Aggregate HQLA shortfalls range from 0.3 percent to 2.1 percent of GDP, depending on scenario severity.
  - Scenario results:
    - Scenario 2A: HQLA shortfall CFAF 1,819 billion (1.7 percent of GDP) for 53 banks.
    - Scenario 2B: HQLA shortfall CFAF 2,142 billion (2.1 percent of GDP) for 58 banks.
    - Scenario 4A: HQLA shortfall CFAF 1,896 billion (1.8 percent of GDP) for 52 banks.
    - Scenario 4B: HQLA shortfall CFAF 2,183 billion (2.1 percent of GDP) for 58 banks.
    - Scenario 6A: HQLA shortfall CFAF 914 billion (0.9 percent of GDP) for 33 banks.
    - Scenario 6B: HQLA shortfall CFAF 1,052 billion (1.0 percent of GDP) for 36 banks.
  - In a severe crisis—with run-off rates of up to 40 percent for large deposits and haircuts of 30 percent on public securities—58 banks (out of 91) would be unable to handle deposit withdrawals.
  - System-wide liquidity gap: CFAF 2.2 trillion over three months under severe conditions.
  - Vulnerability concentrated among smaller banks and banks in some member countries, particularly Benin and Burkina Faso.
  - Majority of banks would have an LCR of less than 100 percent under adverse scenarios.
- Calibration and recommendations:
  - Proposal: adjust run-off rates of each bank according to historical volatility of its deposits; use 5th or 10th percentile of monthly or quarterly changes in deposits where feasible.
  - Transition: gradual increase in liquidity requirement to 100 percent by 2028 considered appropriate.
  - Including required reserve and excess reserves in numerator of liquidity ratio should partially offset increase in haircuts.

### Secondary Market Liquidity, Turnover, and Primary Dealers (TSDs)
- Secondary market indicators and structure:
  - Number of transactions limited to 3.4 per day on average since January 2019.
  - Out of 132 banks, 32 participated in the secondary securities market.
  - There are 43 TSDs, which should maintain a minimum market share of 2 percent of transactions in the secondary market.
  - Market participants traded an average of only 0.5 percent of their securities portfolio.
  - Of 149 banks and financial institutions reporting trading portfolios, only 18 report non-zero portfolios, with a median of no more than 3 percent of total assets.
- Turnover measurement recommendation:
  - Turnover = number of transactions per security in the secondary market as a percentage of the amount issued.
  - Exclude intragroup carry trades; monitor attempts to artificially improve liquidity status.
- TSD system weaknesses and reforms:
  - Few institutions have TSD status (23 out of 127 survey responses); large institutions do not participate.
  - Requirements for participation not met (nor requirement to purchase 5 percent of amounts issued).
  - Privileges granted to TSDs viewed as not commensurate with obligations.
  - Recommended TSD obligations:
    - Minimum participation in issues at “5/n” percent where (n) is number of states in which TSD commits.
    - Publish quotation range and firm minimum amount; resell a fixed minimum percentage (e.g., 10 percent) of securities acquired.
  - Strengthen TSD privileges conditionally: exclusive access to auctions in committed states, exclusive access to securities lending, and intermediation fee paid by issuing states.

### Repo Market, Interbank Activity, and Funding Stability
- Market funding and central bank reliance:
  - At end-2020, market funding represented on average less than 4 percent of total deposits.
  - Refinancing obtained from the central bank reached 20 percent in June 2020.
- Interbank market characteristics:
  - Interbank financing largely involves intragroup transactions, mostly unsecured within regional groups.
  - Stigma associated with nongroup interbank market: banks using nongroup market often borrow at high rates, signaling distress.
- Repo market and collateralization:
  - Repo market operates below potential; collateralization could help overcome stigma and expand transaction network.
  - Limitations: absence of active secondary market with observable benchmark prices makes haircuts, valuation, margin calls, and liquidation difficult.
  - Need coordination and dialogue among banks to develop standardized practices and possibly a dedicated platform for exchanging information; platform access rights could be managed by the BCEAO.

### MMCG (Monetary Market Contact Group) — Proposal and Design
- Purpose:
  - MMCG to serve as a regular forum for discussion between BCEAO and leading banks on money market functioning.
- Proposed features:
  - Meeting frequency: quarterly, with BCEAO convening ad hoc meetings as needed.
  - Composition: between 12 and 15 banks represented by CFOs or treasurers (one participant per bank); one representative per banking group.
  - Chairmanship and secretariat provided by BCEAO; WAMU Securities Agency invited as observer when relevant.
  - Selection criteria: size of banking group; regional presence; diversity of nationalities; competence of CFOs/treasurers.
  - Annual rotation: remove two or three members and replace with equivalent number to maintain representativeness.
  - Meeting format: two to three hour sessions with thematic presentations and open discussion; one physical meeting in Dakar per cycle and others virtual.
  - Equitable treatment: detailed minutes prepared and published no later than one month after meeting to ensure transparency and avoid preferential treatment.

### BCEAO Quantitative Limits, Funding Plans, and Collateral Haircuts
- Current quantitative limits on refinancing:
  - Limit of 35 percent of bank assets on total central bank refinancing of each counterparty.
  - Additional limit of two times the bank’s capital for marginal lending facility and special refinancing facility.
  - Limit of 35 percent of the tax revenues of each WAEMU member state on total amount of its financing backed by government securities of that member state and securities it holds in its own account.
- Assessment and proposed replacement:
  - Current limits are historically justified but suboptimal and can be problematic without a lender-of-last-resort framework.
  - Recommendation: gradually replace quantitative limits with a funding plan mechanism.
- Funding plans — key parameters (textual summary):
  - Projection horizon: typically 1 to 3 years; quarterly projection points.
  - Trigger point examples: 5% (Portugal 2012), 10% (BEAC 2019), 20% (proposal for BCEAO 2021).
  - Recommendation: trigger point of 20 percent of each bank’s total assets for funding plans.
  - Current statistic: 26 BCEAO counterparties have dependence on BCEAO refinancing exceeding 20 percent of total assets; four counterparties are over the 30 percent threshold.
  - Trigger point should be reassessed regularly and treated as a macroprudential parameter.
- Collateral framework issues and haircut proposals:
  - Current uniform haircut: 10 percent applied to all assets eligible as collateral.
  - Problems: uniform haircut may expose BCEAO to significant losses and creates adverse selection and concentration risk.
  - Proposed differentiated haircuts for public instruments:
    - Maturity risk: 0 percent (residual maturity < two years) to 5 percent (residual maturity > five years).
    - Liquidity risk: 0 percent (secondary market turnover > 15 percent past calendar year) to 5 percent (no secondary market transactions).
    - Credit risk: 5 percent for highest quality sovereign bonds to 20 percent for lowest quality sovereign bonds; 50 percent for bonds whose latest rating is more than two years old.
    - Securities characteristics: additional 5 to 15 percent for risks such as existence of a grace period.
    - Government guarantee: additional 0 percent or 10 percent depending on explicit guarantee.
  - Sovereign credit risk assessment: rely on external ratings; highest haircut to unrated member states.
  - Incorporate market values into collateral framework gradually (initial monthly then weekly aggregation) using issuance conditions, recent transactions, and centralized market maker quotations.
- Private securities and bank loans:
  - Private securities eligible for refinancing could be differentiated with additional haircuts for maturity, liquidity, and credit risks.
  - Current 10 percent haircut on bank loans "greatly underestimates the liquidity risk" and is much lower than haircuts applied by other central banks.
  - Proposed haircut components for bank loans:
    - Maturity risk: 0 percent to 5 percent.
    - Liquidity risk: about twice the maximum haircut used for liquidity risk on government securities (i.e., 10 percent).
    - Credit risk: suggested additional haircut range 10 percent to 30 percent.
    - Collateral availability from borrower: 0 percent to 20 percent.
  - Exclude related-party loans from the rating agreement system.
  - Concentration limits (gradual implementation):
    - Listed credits: 20 percent limit of collateral pledged by each counterparty.
    - All bank loans pledged through rating agreements: initial 75 percent, ultimately 50 percent of collateral pledged by each counterparty.
    - Government securities from a single WAEMU member state: 75 percent limit of collateral pledged by each counterparty.
  - Transition measures:
    - Detailed impact assessment and phased implementation.
    - Banks constrained by stricter rules may use rating agreement framework pre-emptively before new rules take effect.
    - Establish safety nets including an ELA framework with broader eligible collateral.

*Source: WEST AFRICAN ECONOMIC AND MONETARY UNION — INTERNATIONAL MONETARY FUND (content unit 1wauea2022005).*

### EXECUTIVE SUMMARY __________________________________________________________________________ 5

### EXECUTIVE SUMMARY

### Introduction
- Since the previous Financial Sector Assessment Program (FSAP) in 2008:
  - Bank deposit base increased from 18 percent to 30 percent of gross domestic product (GDP).
  - Government securities market buoyancy benefited from the interruption of public deficit financing by the Central Bank of West African States (BCEAO).
- The systemic liquidity analysis is a cross-cutting exercise covering stability, supervision, and crisis management. It:
  - Assesses liquidity risk, including stress testing.
  - Focuses on measures to internalize liquidity risk (microprudential and macroprudential).
  - Enumerates central bank instruments for residual liquidity risk, including Emergency Liquidity Assistance (ELA).
  - Assesses measures to manage risks that the central bank takes onto its balance sheet.

### Liquidity Risks — Liquid Assets
- Definition and composition:
  - Liquid assets are those convertible into central bank money with little or no loss in value and without excessive costs.
  - Central bank money (vault cash and banks’ reserves at the central bank) represents 21 percent of liquid assets in the WAEMU.
  - Government securities account for more than 31 percent of bank assets and currently represent 72 percent of liquid assets.
  - The sum of potentially liquid assets averages 37 percent of the total assets, with significant disparities among banks.
- Market structure and vulnerabilities:
  - The capital markets are shallow; the universe of potentially liquid assets beyond central bank money and government securities is limited.
  - Insufficient secondary market liquidity and the prevalence of unsecured intragroup transactions (60 percent of the total) in the interbank market increase the risk and extent of potential losses during liquidity distress.
- Policy-relevant observation on reserves:
  - Current WAEMU practice: only excess reserves are factored into the denominator of liquidity ratios.
  - Basel Committee guidance allows inclusion of required reserves in Level 1 assets if available in stress.
  - The mission’s assessment:
    - Required reserve should be included in liquid assets in the same manner as excess reserves because:
      - The required reserve is available at any time in its entirety and a priori at no cost to meet a one-time liquidity need, being constituted on an average basis in the WAEMU.
      - The maintenance period is one month (from the 16th of the month to the 15th of the following month), aligning with the withdrawal period recommended by Basel principles.
    - Excluding required reserves would strain banks’ balance sheets and cause disproportionate demand for excess reserves.
  - A possible limitation: using required reserve can be costly if it leads to a shortfall at period end and a financial penalty.

### Systemic Liquidity Management and BCEAO Role
- Exchange rate regime and monetary policy:
  - The CFA franc (CFAF) has been pegged since 1948, first to the French franc and since 1999 to the euro, at a fixed exchange rate.
  - The BCEAO uses capital controls to retain autonomy for monetary policy and systemic liquidity management and developed an inflation targeting system in the 2000s based on an interest rate operational target.
  - A legal obligation requires a minimum coverage of currency issuance by foreign exchange reserves of 20 percent (Article 76 of the statutes).
- BCEAO refinancing practices and consequences:
  - Full allotment of refinancing demand to seven- and 28-day BCEAO operations was introduced in 2020.
  - Full allotment removed uncertainty about access to refinancing and reduced the liquidity premium in the market.
  - The stability of system liquidity relies on BCEAO refinancing.
  - BCEAO currently accepts all government securities and private debt under the same conditions regardless of different risk profiles, which:
    - Helped absorb systemic and idiosyncratic liquidity shocks.
    - Encouraged risk-taking through reliance on BCEAO support.
    - Resulted in dependence of some banks on BCEAO and accumulation of risk on the BCEAO balance sheet.
  - BCEAO applied limits on refinancing proportional to bank assets and capital, but these limits are procyclical and risk preventing refinancing for banks with additional needs.

### Measures to Internalize Liquidity Risks and Market Development
- Internal risk management and regulation:
  - Regulator must choose objective and verifiable liquidity indicators to determine assets eligible for Level 1 of the liquidity coverage ratio (LCR) numerator and corresponding haircuts, including for government securities.
  - If differentiated haircuts for sovereign issuers are not used, at minimum a uniform non-zero haircut should be applied to account for limited market liquidity.
  - Ultimately, the LCR should reflect different bank risk profiles based on time series of deposits per bank under Pillar II of Basel III.
- Market development priorities:
  - Improved secondary market liquidity reduces liquidity risk and supports development of repo operations, which are more resilient to confidence shocks than unsecured lending.
  - The secondary government securities market is the cornerstone for broader market development. Recommended actions:
    - Include development of the secondary market as an objective in states’ medium-term debt management strategies.
    - Resolve market segmentation linked to syndication procedures (for example, by unifying the legal depository).
    - Review privileges and obligations of treasury securities dealers (TSDs).
  - Strengthen institutional cooperation between the WAMU Securities Agency (WSA) and the Public Savings and Financial Markets Regional Board (CREPMF) to promote transparency and supervision and to contribute to fungibility of securities.

### Funding Plans and Collateral Framework
- Funding plans to reduce BCEAO dependence:
  - A funding plan is a projection of a bank’s balance sheet over a predetermined period (for example, three years) that shows changes in funding needs.
  - Banks exceeding a predetermined threshold of dependence on the central bank must prepare a funding plan reviewed and monitored by the supervisor.
  - Under a plan, the bank must reduce funding requirement below the threshold through:
    - Asset sales and recapitalizations.
    - Reducing growth in assets.
    - Actively raising funding from customers or the market.
  - The trigger threshold in funding plans should be lower than the quantitative limits currently imposed.
  - Subject to diligent execution, banks meeting funding plan requirements would retain access to BCEAO operations.
- Collateral framework enhancements:
  - Introduce additional haircuts based on risk types to maintain diversified collateral while achieving risk equivalence after haircuts.
  - Haircuts should reflect credit risk and liquidity risk for both government securities and private debt.
  - For government securities, credit risk haircut should be based on international ratings, with larger haircut for unrated sovereign debt.
  - Introduce concentration limits to ensure diversity of collateral provided.

### Emergency Liquidity Assistance (ELA)
- Recommendation to introduce an ELA framework:
  - ELA allows central bank to provide liquidity to viable banks facing persistent liquidity shortages that have exhausted collateral eligible for monetary policy operations.
  - ELA can be based on expanded collateral, but the additional central bank risk must be offset by strict conditionality and monitoring of repayment plans.
  - ELA is a BCEAO responsibility but requires close coordination with the supervisor to:
    - Assess viability of counterparties.
    - Impose conditionality.
  - Prepare a framework agreement for ELA counterparties defining ELA conditions and align funding plans with ELA repayment obligations.
  - Establish procedures for information sharing and coordination between BCEAO and the Banking Commission in ELA context.

### Table of Key Recommendations (selected items and mandates)
- Ex Ante Risk Control Measures:
  - Introduce Basel-type liquidity ratios to improve liquidity risk management and strengthen resilience to liquidity shocks. — Authority: BCEAO — Priority: ST
  - Include the reserve requirement in Level 1 liquid assets. — Authority: BCEAO — Priority: ST
  - Use turnover per security to determine LCR haircuts; if not introducing differentiated haircuts, at least apply a uniform non-zero haircut. — Authority: BCEAO — Priority: MT
  - Require banks to provide detailed information on maturities and interest rates of assets and liabilities to monitor maturity mismatches and interest rate risk. — Authority: Banking Commission — Priority: MT
  - Consider stability of each bank’s funding estimated on a time series basis to impose higher LCR requirements on banks with higher liquidity risk profiles under Pillar II of Basel III. — Authority: BCEAO — Priority: MT
- Local Market Development Measures:
  - Prepare a regional strategy for development of the public debt market. — Authority: BCEAO, WSA — Priority: MT
  - Consolidate the central securities depository for auction and syndication issues at the BCEAO or within an independent infrastructure to increase fungibility of securities. — Authority: BCEAO — Priority: CT
  - Strengthen cooperation between WSA and CREPMF to establish common transparency and market supervision standards and to increase competition in syndication. — Authority: BCEAO, WSA, CREPMF — Priority: MT
  - Enhance privileges of TSDs: reserve access to issues, reserve securities lending, and pay commission. — Authority: BCEAO, WSA — Priority: MT
  - Create a Money Market Contact Group (MMCG) as a regular forum for interbank market key players. — Authority: BCEAO, WSA — Priority: MT
- Monetary Policy Operations and Collateral:
  - Introduce funding plans to replace quantitative limits on BCEAO refinancing over time. — Authority: BCEAO — Priority: MT
  - Introduce additional haircuts and concentration limits on public and private collateral for BCEAO refinancing. — Authority: BCEAO — Priority: MT
- Emergency Liquidity Assistance (ELA):
  - Determine ELA collateral universe and related risk management measures. — Authority: BCEAO — Priority: MT
  - Prepare a framework agreement for ELA counterparties defining ELA conditions. — Authority: BCEAO — Priority: MT
  - Align funding plans with ELA repayment for ELA recipients and establish BCEAO–Banking Commission coordination procedures. — Authority: BCEAO — Priority: MT

Note: ST = short term (between one and two years); MT = medium term (between three and five years).

*Source: EXECUTIVE SUMMARY (1wauea2022005).*

### 7. The main buyers of government securities are banks. In the absence of stable demand for

### 7. The main buyers of government securities are banks. In the absence of stable demand for

### Secondary market liquidity and market structure
- Banks buy securities with relatively long maturities and generally hold them to maturity, explaining maturity mismatches and transformation risk given the short-term nature of bank funding.
- The market is segmented between different issuance methods (auction or syndication).
- Liquidity indicators suggest a shallow secondary market:
  - The number of transactions has been limited to 3.4 per day on average since January 2019.
  - Out of 132 banks, 32 participated in the secondary securities market.
  - There are 43 TSDs, which should maintain a minimum market share of 2 percent of transactions in the secondary market.
  - Market participants traded an average of only 0.5 percent of their securities portfolio.
  - Of 149 banks and financial institutions reporting their trading portfolios to the banking supervisor, only 18 report non-zero portfolios, with a median of no more than 3 percent of total assets.
- The secondary market’s lack of dynamism partly reflects the passive investment strategy adopted by many banks.
- Some securities generate significant interest:
  - Côte d’Ivoire securities have the highest liquidity in terms of number of transactions, amounts traded, and number of securities available on the market.
  - The Ivoirian Treasury issues securities with a maturity of less than two years more regularly to develop a yield curve.

### Turnover measurement and market monitoring (mission recommendation)
- Calculate the turnover of securities to determine liquidity:
  - Turnover = number of transactions per security in the secondary market as a percentage of the amount issued.
  - Transactions should reflect genuine secondary market transactions (exclude intragroup carry trades).
  - Regulator should monitor attempts to trade in a security to artificially improve its liquidity status.
- Based on available data, the mission calculated turnover of each sovereign issue.
- Once the secondary market has developed, consider a range of liquidity indicators.

### Benefits of a liquid secondary market
- A liquid secondary market:
  - Increases resilience to liquidity shocks because more of banks’ assets are liquid.
  - Increases demand for securities issuance.
  - Facilitates development of the repo market by enabling regular valuation and liquidation of collateral.
  - Makes repo use less damaging than unsecured transactions for the LCR and less impactful on capital consumption.

### Reducing market segmentation: auctions vs. syndication (recommendations)
- Syndication accounts for 20 percent of securities issues, targets same investor group as auctions (banks), minimizes placement uncertainty but is problematic for pricing transparency and has higher funding costs than auctions.
- Two important changes recommended:
  - Merge the central depositories into a single infrastructure to ensure fungibility of issues; management could be entrusted to the BCEAO or to an independent market infrastructure.
  - Strengthen cooperation between the auction supervisor (WSA) and the syndication regulator (CREPMF) to promote transparency in primary and secondary segments and improve fungibility. Cooperation could extend to organizing mixed issues (opened by syndication and completed by auction or vice versa) for large issues.

### Debt management and market development strategy (recommendations)
- Debt management strategies should include a market development objective in addition to cost and risk objectives.
- The WSA is ideally positioned to coordinate issues and ensure market transparency across eight issuers.
- The WSA could promote a regional strategy including:
  - Agreement on benchmark issues to be placed in the market.
  - Timing of those issues.
  - Securities that TSDs should target for listing in the secondary market.
- Development of a medium-term debt management strategy and its communication to WAMU-Securities by each treasury should be a prerequisite for issues in the regional market.
- Diversification of the investor base should be part of the market development strategy.

### Primary dealers (TSDs): current status and recommended reforms
- Current TSD system weaknesses:
  - Few institutions (23 out of 127 survey responses) have TSD status; large institutions do not participate.
  - Requirements for participation in the secondary market are not met (nor is the requirement to purchase 5 percent of amounts issued in the primary market).
  - Privileges granted to TSDs (restricted access to ad hoc issues, noncompetitive allocation, privileged access to treasury information) are viewed as not commensurate with obligations.
  - Transparency of syndicated issues and the secondary market is seen as insufficient compared with WSA auction information.
- Recommended changes to TSD obligations:
  - Set minimum participation in issues at “5/n” percent, where (n) is the number of states in which a given bank accepts TSD obligations, to promote cross-state TSD adoption and reduce domestic bias.
  - For the secondary market, TSDs should:
    - Publish a quotation range.
    - Quote a firm minimum amount for other market makers.
    - Resell a fixed minimum percentage of the securities acquired.
- Recommended strengthening of TSD privileges, conditional on strict compliance verified by the WSA:
  - TSDs generally expected to place primary issues with other investors; access generally exclusive for TSDs for securities issues and a fee is paid as compensation for intermediation.
  - TSDs required to facilitate the secondary market; treasury or central bank provides liquidity support by refinancing securities or loaning securities.
  - The WSA could act as securities lender based on securitization of part of the BCEAO’s residual claim on governments and in coordination with national treasuries. The BCEAO would continue to refinance the securities.

### Primary dealer obligations and privileges (table summary)
- Obligations:
  - Participate in primary issues for at least "5/n" percent of the issue, where "n" represents the number of states in which the TSD commits to participate in issues.
  - Publish a range of quotations with a maximum spread on a known IT platform and on a continuous basis.
  - Quote a firm minimum amount for all other market makers on a continuous basis.
  - Resell a minimum percentage (e.g., 10 percent) of securities purchased on its own account.
  - Inform the WSA of the rates and amounts traded.
- Privileges:
  - Exclusive access to auctions in states in which the TSD has committed to participate at "5/n."
  - Exclusive access to a securities lending facility by the BCEAO, WAMU Securities Agency, and/or treasuries.
  - Intermediation fee paid by the issuing states in proportion to the turnover in the primary and secondary markets.

### Stability of funding: deposit structure and monitoring
- Bank funding mainly from customers in the form of deposits, mostly demand deposits or savings accounts withdrawable at depositors’ discretion; time deposits with notice/penalties account for a limited share.
- It is difficult for the regulator to assess deposit stability because funding sources have no maturity; regulator should analyze distribution of withdrawals based on granular breakdown of deposits (by type of depositor, size of deposits, and other features), ideally at individual bank level.
- The mission’s indicators indicate customer funding is not predominantly stable in the WAEMU:
  - Banks are exposed to withdrawal of their largest depositors; relatively large corporate deposits dominate.
  - Wide disparity in composition of customer funding across banks implies some institutions may face significant liquidity pressures.
- Customer funding stability indicators (description):
  - Distribution of deposits by size: smaller deposits more transactional and more stable.
  - Nature of depositors: households and institutional investors hold savings and may provide stable funding; businesses use deposits for operational purposes.
  - Determination of stable versus nonstable deposits based on historical time series.
  - Concentration of deposits: high concentration exposes bank to withdrawal by major depositors.
- Time series studies and run-off rates:
  - Volume of demand deposits is slightly higher than that of time deposits (55/45).
  - The run-off rate in the 5th percentile of the demand deposit distribution is higher than that of time deposits in most cases.
  - The spread of run-off rates across banks is high, especially for time deposits.

### Maturity mismatches, interest rate risk, and disclosure (recommendations)
- Monitor and strengthen oversight of maturity mismatches and interest rate risk due to creation of portfolios with relatively long maturities compared to bank resources and limited hedging options.
- Supervisor should require banks to disclose in detail:
  - Maturities of assets and liabilities.
  - Variable or fixed nature of interest rates applying to balance sheet items.
- A more granular view of maturity mismatches is needed to introduce a long-term structural ratio.

### Market funding, interbank activity, and central bank reliance
- Market funding plays a minor role in bank funding:
  - At end-2020, market funding represented on average less than 4 percent of total deposits.
  - Refinancing obtained from the central bank reached 20 percent in June 2020.
- Banks and financial corporations rarely issue bonds and certificates of deposit.
- Interbank financing largely involves intragroup transactions, mostly unsecured within regional groups redistributing liquidity to subsidiaries.
- Presence of regional groups reduces national market fragmentation because intragroup transactions are cross-border.
- Network of interbank transactions has grown with more banks participating and more transactions; COVID-19 crisis increased risk aversion and affected the transaction network in 2020.
- There is a stigma associated with the nongroup interbank market:
  - Banks using nongroup interbank market often have reached maximum refinancing at the central bank or did not obtain BCEAO refinancing before the introduction of full allocation in 2020.
  - These banks borrow in the market at high rates, possibly above the credit facility, which signals distress.

### Repo market, collateralization, and standardization (recommendations)
- Repo market operates below potential; collateralization could help overcome stigma and expand the transaction network.
- Limitations due to absence of active secondary market with observable benchmark prices:
  - Difficulty calculating haircuts for repurchase agreements.
  - Difficulty regularly valuing collateral and implementing margin calls.
  - Difficulty liquidating collateral without significant losses on default.
- Disparate bank practices for interbank repo agreements impede widespread use:
  - Banks adapt BCEAO master agreement to their own risk management constraints and maximum maturities.
  - Need for coordination and dialogue among banks to develop good practices and standardization to facilitate bilateral repo lines and reduce money market fragmentation.
- Exchanges of information between banks sometimes do not flow smoothly:
  - Disparate practices on compliance requirements prior to establishing interbank lines of credit.
  - A more structured dialogue among local banks, coordinated by the banking association or organized by the BCEAO, would identify and promote best practices for local agreement formalization.
  - Establishing a dedicated platform for exchanging information could be studied to facilitate uniform practices and denser network of interbank lines of credit; platform access rights could be managed by the BCEAO according to bank requests.

*Source: WEST AFRICAN ECONOMIC AND MONETARY UNION — INTERNATIONAL MONETARY FUND (extracted content).*

### 28. The BCEAO should establish an MMCG at the level of the monetary zone. Currently, the

### The BCEAO should establish an MMCG at the level of the monetary zone

### Recommendation: MMCG (Monetary Market Consultative Group)
- The dialogue between the BCEAO and banks regarding development of the money market is currently taking place mainly at the level of the national directorates.
- Since 2019, the BCEAO has organized an annual seminar for treasurers at the regional level that serves as a discussion forum and provides training; this seminar should be maintained as a useful complement to a possible MMCG.
- The BCEAO conducts surveys of its counterparts at the regional level; these exchanges allow information from all the banks in the system to be sent to BCEAO headquarters and should be continued.
- A national mechanism should be complemented by a forum for regular exchanges at the level of the monetary zone, with participation by the leading banks in the region.
- Appendix I provides suggestions for the composition and operation of this MMCG.

### Liquidity Stress Tests — scope and methodology
- Tests assessed the ability of banks to withstand sudden deposit outflows, across the region and by country, based on cash flows and the Basel III LCR framework.
- Coverage: 94 banks, representing about 81 percent of the banking system’s assets.
- Scenarios: three moderate and three extreme scenarios. Run-off rates under extreme scenarios are twice those of the moderate scenarios.
- Overall effective withdrawal rates under the extreme scenarios are 25 percent to 27 percent.
- Historical context: the 25 percent to 27 percent extreme withdrawal rates are higher than the 95th percentile of the highest withdrawals experienced by 90 percent of banks over 2000–20.
- Comparison with banks’ own stress tests: banks applied on average 24 percent for individuals and non-financial corporations.
- International comparisons: FSAP stress tests applied run-off rates of 10 percent to 50 percent in examples of liquidity crises.

### Calibration and potential refinement of run-off rates
- Proposal: adjust run-off rates of each bank according to the historical volatility of its deposits, differentiating between idiosyncratic and systemic stress scenarios.
- Suggested calibration approach: use the 5th or 10th percentile of monthly or quarterly changes in deposits over a given observation period, although technical difficulties may arise given the increasing number of banks and rapid financial system changes.

### Definition and haircuts for High-Quality Liquid Assets (HQLA)
- For the stress test, HQLA defined as the sum of:
  - cash on hand,
  - deposits and reserves at the central bank, and
  - the value of available government securities after a haircut.
- Haircut assumptions:
  - Moderate scenario: 10 percent haircut on available government securities (same as applied by the BCEAO for its refinancing and higher than the 95th percentile of haircuts in the secondary market over 2019–21).
  - Extreme scenario: 30 percent haircut on government securities (corresponds to haircuts considered by banks in their stress tests and theoretical price calculations).
- Comparators:
  - Under the LCR, a haircut of 15 percent is applied for government securities rated A+ to BB-.
  - Literature reference: haircuts up to 10 percent for investment-grade government securities, but up to 30 percent for lower-quality securities (Schmieder et al. 2012).
  - Mission’s survey: average range of haircuts applicable to collateral most commonly used as security for interbank transactions is about 23 percent of face value of eligible assets.

### Results of the liquidity stress tests
- Aggregate HQLA shortfalls range from 0.3 percent to 2.1 percent of GDP, depending on scenario severity.
- Scenario-specific results (Figure 9):
  - Scenario 2A: HQLA shortfall of CFAF 1,819 billion (1.7 percent of GDP) for 53 banks.
  - Scenario 2B: HQLA shortfall of CFAF 2,142 billion (2.1 percent of GDP) for 58 banks.
  - Scenario 4A: HQLA shortfall of CFAF 1,896 billion (1.8 percent of GDP) for 52 banks.
  - Scenario 4B: HQLA shortfall of CFAF 2,183 billion (2.1 percent of GDP) for 58 banks.
  - Scenario 6A: HQLA shortfall of CFAF 914 billion (0.9 percent of GDP) for 33 banks.
  - Scenario 6B: HQLA shortfall of CFAF 1,052 billion (1.0 percent of GDP) for 36 banks.
- In a severe crisis—with run-off rates of up to 40 percent for large deposits and haircuts of 30 percent on public securities—58 banks (out of 91) would be unable to handle deposit withdrawals.
- System-wide liquidity gap: CFAF 2.2 trillion over three months under severe conditions.
- Vulnerability concentrated among smaller banks and banks in some member countries, particularly Benin and Burkina Faso.
- Majority of banks in the region would have a liquidity coverage ratio of less than 100 percent under adverse scenarios, requiring careful contingency planning and broader adoption of liquidity stress testing.

### Correlation with BCEAO refinancing
- Vulnerability to liquidity shocks appears to have little correlation with the level of refinancing from the central bank.
- Implication: stress tests, the introduction of the LCR, and implementation of funding plans for banks most dependent on BCEAO refinancing have complementary roles in managing liquidity risk.

### Measures to internalize liquidity risk — regulatory tools
- Two regulatory measures BCEAO can use to reduce exposure to liquidity risk:
  - Reserve requirement: influences the share of central bank reserves in bank assets and provides macroprudential benefits (internalization of aggregate liquidity risk; smoothing of liquidity shocks via averaging and maintenance period).
  - Prudential liquidity regulation: includes a liquidity ratio and a transformation ratio.
- Planned regulatory changes:
  - Introduction of short-term liquidity ratios and a structural ratio to allow more accurate monitoring and targeting of risk.
- Liquidity ratio definition and target:
  - Ratio = available assets realizable or mobilizable in the short term (three months maximum) divided by liabilities due in the short term or commitments by signature that could be fulfilled at any moment.
  - The standard to be met is a minimum of 75 percent.
  - Coverage ratio for medium- and long-term assets requires at least 50 percent of fixed assets be covered by stable resources.

### Haircuts and LCR calibration recommendations
- Haircuts for government securities used in liquidity ratios should reflect market liquidity; calibrate haircuts according to actual liquidity indicators.
- If regulator opts not to apply different haircuts across sovereign issuers, at minimum apply a uniform haircut commensurate with overall market liquidity risk.
- Allow differences in deposit stability to influence LCR requirements as part of Basel III Pillar II considerations.
- Given data limitations, use Basel III illustrative benchmarks for withdrawal rates and apply a uniform liquidity requirement initially; later impose higher Pillar II requirements on banks with historically larger withdrawals.

### Transition to new liquidity standards
- Support for gradual approach: transition to new liquidity standards expected to require an effort by a number of institutions.
- Gradual increase in the requirement to 100 percent by 2028 is considered appropriate.
- Including required reserve and excess reserves in the numerator of the liquidity ratio (instead of just excess reserves) should partially offset the increase in haircuts applied to government securities recommended by the mission.

### Central bank liquidity interventions — operational context
- Fixed exchange rate regime constraints: BCEAO buys and sells CFA francs for euros at a fixed rate at the request of operators to finance current transactions; impact on banks’ reserves at the BCEAO is difficult to predict and manage.
- Structural position of banks at the BCEAO is volatile; since 2004 it moved from a surplus to a relatively large deficit due to the end of direct financing of public deficits by the BCEAO.
- During the COVID-19 crisis, BCEAO introduced a fixed-rate, full allotment method that reduced the liquidity premium and uncertainty about access to BCEAO refinancing.

### Emergency Liquidity Assistance (ELA) and counterparty eligibility
- Absence of an ELA framework undermines the BCEAO’s operational framework for monetary policy.
- ELA defined as provision of liquidity, as a last resort, to a solvent, viable bank facing temporary liquidity stress to preserve financial stability.
- Two reasons for ELA need: (i) exhaustion of collateral eligible for regular central bank refinancing; (ii) loss of eligibility as a central bank counterparty.
- Without a dedicated ELA framework, suspension of a systemically important bank from monetary policy operations could jeopardize financial stability and create moral hazard.
- Counterparty eligibility reform recommendations:
  - Apply the same eligibility rules to all monetary policy operations (tenders and marginal lending facility).
  - Define eligibility criteria more clearly (for example, prudential solvency ratio), while retaining possibility for BCEAO to suspend a counterparty on the basis of a "prudence principle."
- Grace period for suspension:
  - Violation of an eligibility criterion (for example, solvency ratio) should lead to suspension only after a grace period (typically three to six months) if the BCEAO considers the bank can re-establish satisfactory position within that timeframe.
  - Purpose: balance compliance with prudential ratios and reduction of risks to financial stability.

*Source: WEST AFRICAN ECONOMIC AND MONETARY UNION — INTERNATIONAL MONETARY FUND (content unit 1wauea2022005).*

### 47. ELA should be considered only as a last resort, to address a temporary liquidity

### 47. ELA should be considered only as a last resort, to address a temporary liquidity

### ELA: conditions and guiding principles
- ELA is a financial stability measure and should be considered only as a last resort to address a temporary liquidity squeeze.
- Central bank verification is required that the bank requesting ELA has exhausted all alternative sources of funding, including the interbank market (a mere increase in the cost of interbank refinancing is not a sufficient reason to receive ELA).
- Banks should make full use of the repo mechanism to optimize access to interbank refinancing.
- Liquidity need must be temporary; if liquidity problems are structural, ELA is inappropriate and a resolution scenario should be envisaged, with, if necessary, liquidity support from the central bank subject to:
  - a clear timetable allowing for a short-term exit (less than six months), and
  - provision of government guarantees protecting the central bank against any risk of loss.

### Institutional arrangements and collaboration
- ELA primary responsibility: BCEAO.
- Banking Commission provides crucial input; collaboration should be formalized in a framework agreement.
- Framework agreement should define:
  - detailed exchange of information between BCEAO and the Banking Commission,
  - technical inputs expected from the Banking Commission (including assessment of solvency and viability of the bank requesting ELA, assessment of its funding plan, and possibly data on loans provided as collateral),
  - mutual commitment to inform each other promptly if indications suggest a bank may soon request ELA.
- Rationale: avoid duplication of supervisory assessments at the central bank and allow rapid decision-making given tight deadlines.

### Pricing, uniformity, and moral hazard
- ELA interest rate must be higher than the BCEAO’s marginal lending facility rate.
- A high ELA rate reduces moral hazard and incentivizes prompt repayment.
- Suggested range: 100 to 300 basis points above the marginal lending rate.
- ELA rate should be applied uniformly to all counterparties to avoid reputational, legal, and financial stability risks arising from differential rates.

### ELA tenor and renewal
- ELA should be granted for a period of up to two weeks, with the possibility to renew every two weeks.
- Renewals should be accompanied by recalibration of the ELA envelope if necessary.
- Rationale:
  - Short maturity reduces central bank risk and allows fine-tuning of the ELA envelope.
  - Two-week liquidity projection period helps estimate needs and calibrate the envelope.
  - Regular (every two weeks) reassessment reduces moral hazard and tracks progress on measures to restore sustainable liquidity.

### Legal and technical architecture required
The BCEAO should implement:
- (i) a public circular defining main conditions and parameters of ELA;
- (ii) internal procedures at the BCEAO and the Banking Commission detailing technical parameters (e.g., risk control measures for collateral);
- (iii) a framework agreement between the BCEAO and the Banking Commission defining collaboration arrangements for ELA;
- (iv) a model framework agreement between the BCEAO and a bank receiving ELA defining conditionality;
- (v) a model funding plan;
- (vi) a framework agreement between the BCEAO and WAEMU member states defining procedures for exchanging information on ELA and conditions requiring government guarantees (examples: ongoing resolution, uncertainty about solvency, lack of collateral).
- Technical assistance from the IMF’s Monetary and Capital Markets Department is available to support implementation, as needed.

### BCEAO risk control measures — A. Funding plans: current quantitative limits
- Current BCEAO quantitative limits applied to refinancing of counterparties:
  - A limit of 35 percent of bank assets applies to the total central bank refinancing (through all instruments) of each counterparty.
  - An additional limit of two times the bank’s capital applies for each counterparty on its financing through marginal lending facilities and the special refinancing facility.
  - A limit of 35 percent of the tax revenues of each WAEMU member state on the total amount of its financing backed by the government securities of that member state and the government securities it holds in its own account.

### Assessment of current limits and proposed replacement
- Current limits are historically justified but suboptimal and can be problematic, particularly without a lender-of-last-resort framework.
- Example risk: a shock reducing bank asset quality can reduce capital and therefore (because of the additional limit of two times capital) the bank’s access to BCEAO refinancing, undermining countercyclical smoothing and potentially jeopardizing financial stability.
- The limit of 35 percent of bank assets introduces bias disadvantaging banks with large nonbank assets (e.g., fixed assets, intragroup holdings).
- Current limits do not allow adequate support for banks overly dependent on BCEAO refinancing; there is no individualized close monitoring in absence of an ELA framework.
- Recommendation: gradually replace quantitative limits with a funding plan mechanism.

### Funding plans: design and parameters
- Definition: a funding plan is a projection of a bank’s balance sheet (in analytical form), typically with a horizon of 1 to 3 years and quarterly projection points, allowing projection of central bank refinancing needs over the medium term.
- Funding plans are prepared by each bank overly dependent on central bank refinancing, at the central bank’s request, and evaluated by the banking supervisor and the central bank.
- Table 6 — Key parameters (textual summary):
  - Projection horizon: Typically, 1 to 3 years. If the liquidity problem is "benign," the bank must return to a sustainable situation in the near future (e.g., 3 to 6 months). If more serious, adjustment horizon can be extended, but not too far, to avoid moral hazard.
  - Frequency of projection points: Typically, quarterly. Monthly points may be considered for close short-term monitoring but increase complexity.
  - Trigger point: Typically defined as a percentage of each bank’s total assets: 5% (Portugal 2012), 10% (Bank of Central African States 2019), 20% (proposal for BCEAO 2021).
  - Target for refinancing from the central bank: Typically, identical to the trigger point for funding plans. The central bank determines the deadline by which the bank must meet this target.
  - Frequency of updates: Typically, quarterly. Monthly frequency is excessive.
  - Validation: Iterative process after preliminary submission by the bank to achieve an acceptable-quality funding plan.
  - Assessment: Banking supervisor assesses whether the plan (i) is based on reasonable assumptions and measures; (ii) reflects the bank’s best effort to achieve the target as soon as possible; and (iii) whether deviations are due to exogenous or endogenous factors.

### Trigger point, current statistics, and macroprudential calibration
- Recommendation: trigger point of 20 percent of each bank’s total assets for funding plans.
- Current statistic: 26 BCEAO counterparties have dependence on BCEAO refinancing exceeding 20 percent of total assets; four counterparties are over the 30 percent threshold.
- Rationale: after prudent risk control measures and full collateralization, these banks may have high-quality assets largely pledged to the BCEAO and unavailable to other creditors, creating perilous liquidity situations.
- The 20 percent trigger is lower than the current strict limit of 35 percent but higher than triggers adopted by other central banks.
- Funding plans aim to reduce systemic liquidity risk and stimulate the interbank market by encouraging repurchase agreements and interbank refinancing.
- The trigger point should be adjusted according to the macroeconomic and monetary environment:
  - Reassess regularly (for example, every two years) and on an ad hoc basis after significant macro deterioration.
  - Gradual reductions in normal times possible (for example, to 15 percent of total assets, then to 10 percent).
  - Treat the trigger point as a parameter of BCEAO macroprudential policy.

### BCEAO risk control measures — B. Collateral framework: current issues
- Current uniform haircut: 10 percent applied to all assets eligible as collateral.
- Problems:
  - Uniform 10 percent haircut may expose BCEAO to significant financial losses in a counterparty default due to low and heterogeneous liquidity of eligible assets (government securities and bank loans).
  - The haircut should be calibrated based on a collateral liquidation approach with a short-term horizon.
  - Uniform haircut violates the principle of risk equivalence and creates incentives for banks to present the riskiest eligible assets to the central bank, leading to adverse selection and concentration risk.

### Evidence of asset selection behavior
- Some banks actively offer bank loans (rather than government instruments) pre-emptively through the rating agreement mechanism—particularly loans to large companies and to individuals.
- Other banks prioritize illiquid sovereign securities to retain the most liquid securities for portfolios or interbank repo collateral.

### Proposed differentiated haircuts for public instruments
- Introduce "haircut add-ons" reflecting different risk sources:
  - Maturity risk: additional haircut ranging from 0 percent for securities with residual maturity of less than two years to 5 percent for securities with residual maturity of more than five years.
  - Liquidity risk: additional haircut ranging from 0 percent for securities with secondary market turnover in excess of 15 percent during the past calendar year to 5 percent for securities with no secondary market transactions.
  - Credit risk: additional haircut ranging from 5 percent for the highest quality sovereign bonds to 20 percent for the lowest quality sovereign bonds, for WAEMU member states. A 50 percent haircut will be applied to bonds whose latest rating is more than two years old.
  - Securities characteristics: an additional haircut of 5 to 15 percent to reflect risks such as the existence of a grace period (adjustable by length of the grace period).
  - Government guarantee: an additional haircut of 0 percent or 10 percent to securities issued by entities of WAEMU member states, depending on whether they benefit from an explicit government guarantee.

### Sovereign credit risk assessment
- Credit risk assessment for sovereign issuers should rely on objective external evaluations.
- Preferred approach: rating agencies, with BCEAO actions to:
  - define a limited list of recognized rating agencies (possibly including WAEMU-based agencies whose methodology aligns with international best practices),
  - apply the best available rating to encourage member states to obtain multiple ratings and reward transparency,
  - set deadlines allowing unrated member states time to obtain ratings.
- States whose debt has not been rated will have the highest haircut applied.

### Incorporating market values into the collateral framework
- Recommendation: BCEAO should gradually apply haircuts to market values (even if estimated) rather than face values.
- Proposed process to estimate market values (initial monthly, then weekly aggregation) using:
  - conditions of issuance in the primary market (for new issues),
  - transactions observed in the secondary market over the past month (then past week),
  - quotations of market makers centralized on a single electronic platform.

*Source: IMF — WEST AFRICAN ECONOMIC AND MONETARY UNION (excerpt).*

### 65. The haircuts on private securities eligible for refinancing by the BCEAO could be

### 65. The haircuts on private securities eligible for refinancing by the BCEAO could be

### Haircuts on private securities and overall objective
- Private securities eligible for refinancing by the BCEAO could be differentiated according to the same principles as those for government securities.
- A system of additional haircuts (for maturity, liquidity, and credit risks) could be applied to private securities without imposing excessive haircuts, to encourage issuance and investment by a wide range of companies and thus develop the WAEMU private securities market.

### Haircuts on bank loans — rationale and need for increase
- Bank loans (pledged through rating agreements) are naturally illiquid and difficult for a central bank to manage on a long-term basis.
- The current 10 percent haircut applied by the BCEAO to eligible bank loans:
  - "greatly underestimates the liquidity risk on these assets,"
  - "appears to be much lower than the haircuts applied to this type of asset by other central banks."
- A significant increase in haircuts on bank loans is recommended to reflect liquidation risk and comparators with other central banks.

### Proposed differentiated haircut framework for bank loans
- Introduce a system of additional haircuts reflecting distinct risks:
  - Maturity risk:
    - Additional haircut of 0 percent to 5 percent, depending on residual maturity.
  - Liquidity risk:
    - Haircut equal to about twice the maximum haircut used for liquidity risk on government securities, that is, 10 percent.
  - Credit risk:
    - Assessment based on historical PD and LGD in the WAEMU; in their absence, comparisons with other central banks could guide levels.
    - Additional haircut for credit risk should be significantly higher than for sovereign issuers.
    - Suggested additional haircut range: 10 percent to 30 percent.
  - Collateral availability from borrower:
    - Additional haircut ranging from 0 percent to 20 percent, reflecting existence/availability of assets pledged by the borrower (0 percent if fully secured up to 20 percent for unsecured bank loans).

### Related-party loans
- Loans to related parties present correlation risk and should be excluded from the rating agreement system.
- Rationale:
  - Eligible assets must be as uncorrelated as possible with the default risk of the pledging counterparty.
  - Exclusion would strengthen prudential safeguards and encourage banks to strictly limit related-party lending and adopt sounder lending policies.

### Concentration limits to ensure collateral diversification
- The BCEAO should consider concentration limits (aggregate and individual levels) and implement them gradually:
  - Listed credits (loans to individuals pledged via listings through rating agreements):
    - 20 percent limit as a proportion of the collateral pledged by each counterparty.
  - All bank loans pledged through rating agreements:
    - Initial limit at 75 percent and ultimately at 50 percent as a proportion of the collateral pledged by each counterparty.
  - Government securities issued by a single WAEMU member state:
    - 75 percent limit as a proportion of the collateral pledged by each counterparty.
- Objectives:
  - Protect BCEAO from liquidity and liquidation-value uncertainty on bank loans.
  - Ensure diversification of sovereign risk and encourage cross-market securities holdings.

### Measures to develop private instruments and transition
- Continue BCEAO efforts to make private instruments more attractive.
- Ex ante listing option for nonfinancial corporations by the BCEAO:
  - Under this arrangement, loans to companies rated A and B (subject to a sovereign guarantee) can be pledged as refinancing support.
- Proposed measures for government securities (better-reflecting haircuts, market-value consideration, concentration limits) should encourage diversification and support private securities market development.
- BCEAO should conduct a detailed impact assessment (aggregate and individual) to define timing of reforms:
  - Allow banks to prepare for phased implementation of new eligibility, valuation, and risk-control rules.
  - Banks constrained by stricter rules should be able to use the rating agreement framework pre-emptively before new rules take effect.
  - Establish appropriate safety nets, notably an emergency liquidity assistance (ELA) framework with broader eligible collateral.

### Emergency Liquidity Assistance (ELA) — solvency, viability, and framework
- Solvency verification:
  - ELA requires supervisor verification that the bank is solvent going forward.
  - A bank is considered solvent for ELA if the supervisor considers it has a credible prospect of maintaining or restoring its solvency ratio above the prudential minimum within a short-term horizon (typically six months).
  - The prospect must be credible and supported by factual, objective considerations (asset sales, recapitalization, other measures).
- Supervisor assessment can be qualified using a "traffic light" system for ELA context:
  - "Red light": no credible prospect of restoring solvency within six months → ELA must be refused (except in ongoing resolution).
  - "Green light": positive prospect → central bank may consider ELA (not bound by supervisor’s assessment).
  - "Yellow light": risk regarding return to solvency within six months → central bank may accept or reject ELA; if accepted, strict measures (e.g., government guarantees) must be taken if supervisor considers risk significant.
- Viability requirement:
  - ELA should be reserved for viable banks (business model and tools to achieve minimum profitability without repeated recapitalizations).
  - Forward-looking supervisor assessment needed, supported by past profitability and competitive-position evidence.

### ELA collateral framework and haircuts
- BCEAO can leverage its rating agreement mechanism to quickly implement an ELA collateral framework.
  - Banks under liquidity stress eligible for monetary policy operations can use eligible instruments (mainly government securities and high-quality loans pledged via rating agreements) before requesting ELA.
  - Once eligible collateral is exhausted, ELA must be fully collateralized with remaining assets (mainly bank loans not pledgeable under monetary policy).
  - BCEAO could apply the rating agreement framework to lower-quality loans for ELA with adjustments.
- Haircut calibration for ELA:
  - Haircuts for bank loans used as ELA collateral should be higher than the highest haircuts applied for monetary policy operations.
  - They should be calculated as the sum of additional haircuts covering maturity, liquidity, credit, and collateral-availability risks (as proposed for monetary policy).
  - No upper limit on ELA haircuts; haircuts of 90 percent or more may possibly be justified for low-quality bank loans.
- Collateral selection and documentation:
  - For ELA the central bank exercises discretion in selecting assets from the bank’s balance sheet.
  - The bank must provide complete, up-to-date information and all documentation on assets the central bank wishes to use as collateral.

### ELA conditionality and funding plans
- ELA must be accompanied by strict conditionality to limit moral hazard and help the bank restore soundness.
  - Conditionality should be defined in a legally binding ELA framework agreement signed by the beneficiary and the BCEAO before any ELA operation.
  - Obligations may include enhanced reporting, limits on lending and investments, operating-cost measures, suspension of dividends, prohibition on investing ELA funds in the interbank market, and cessation of loans to related parties.
  - Conditionality can be tailored to each counterparty based on the framework agreement.
- Funding plans:
  - Each ELA beneficiary must submit regularly (typically quarterly) a funding plan with quantitative steps to repay ELA per the central bank schedule.
  - Funding plans are balance-sheet projections (typically quarterly projection points).
  - Preparation should be iterative with the supervisor to ensure credibility.
  - The supervisor evaluates the plan and it is submitted to the central bank; central bank adjusts ELA decisions based on credibility and deviations (exogenous vs. management choices).

### Appendix I — Considerations for the Establishment of an MMCG
- Objective:
  - Serve as a regular forum for discussion between the BCEAO and leading banks in the region on money market functioning.
- Meeting frequency and practical details:
  - MMCG could meet quarterly, with BCEAO able to convene ad hoc meetings when needed.
  - To reduce costs, one physical meeting at BCEAO headquarters in Dakar per cycle and other meetings held virtually.
- Composition and representation:
  - Chairmanship and secretariat provided by the BCEAO.
  - Between 12 and 15 banks as members, represented by CFOs or treasurers (one participant per bank); one representative per banking group.
  - WAMU Securities Agency could be invited as an observer when securities market discussions occur.
- Criteria for initial composition (in order):
  - (i) size of the banking group;
  - (ii) regional nature of the banking group (number of WAEMU countries with significant presence, defined by a minimum market share);
  - (iii) diversity of nationalities (each WAEMU member state should be represented by at least one bank);
  - (iv) personal competence of CFOs/treasurers including communication ability with the BCEAO.
  - Assessment details remain confidential; BCEAO may disclose selection criteria used.
- Annual rotation:
  - Every year (or every two years), BCEAO would rotate membership to a limited extent (e.g., remove two or three members and replace with an equivalent number) to maintain representativeness and stability.
  - Main rotation criterion: active participation in MMCG discussions.
- Typical meeting agenda and format:
  - Agenda prepared by MMCG Secretariat after member discussion.
  - Meetings could last two to three hours with two or three thematic presentations followed by open discussion.
- Possible topics for discussion:
  - Interbank repo agreements, compliance requirements for interbank lines of credit, liquidity and transparency of WAEMU securities market, liquidity management by BCEAO, and other money market functioning topics.
- Topics to avoid:
  - Specific situations of individual banks or sharing confidential information.
  - MMCG should not serve as a preferred channel for BCEAO monetary policy communication; BCEAO communications should reach all banks and the public simultaneously.
- Equitable treatment:
  - To ensure equitable treatment of monetary policy counterparties, MMCG secretariat should prepare detailed minutes of each meeting and publish them on a dedicated BCEAO website page no later than one month after an MMCG meeting.

*Source: IMF staff report content unit 1wauea2022005.*

---


_Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1wauea2022005.pdf_