## _wp16200 - 1. Assumptions in the Extreme Scenario

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---

### I. Introduction and motivation
- Panama’s national banking system assets amounted to 189 percent of GDP at the end of 2015.
- Domestic credit-to-GDP (financial depth) is comparable to some advanced economies and much higher than the regional average.
- More than half of banks operating in Panama are foreign; banks tap external markets for funding and investments.
- Panama lacks a public financial safety net:
  - Panama is the only country in the region without a lender of last resort (LOLR) facility or a deposit insurance arrangement.
  - Ecuador and El Salvador, the other fully dollarized economies in Latin America, have maintained a financial safety net.
- Interbank market characteristics:
  - The interbank market is segmented, especially under stress: larger foreign banks tend to lend only to larger domestic banks.
  - The interbank market froze completely during the 2009 downturn.
- Regulatory liquidity metric:
  - The New Banking Law of 2008 and SBP Rule 4 of 2008 define the Legal Liquidity Index (LLI) with a 30 percent minimum requirement on liquid assets as a share of qualifying deposits.
  - The LLI of the whole banking system has fluctuated around 60 percent – twice the required level.
- Historical stability:
  - The only systemic banking crisis in the last 45 years was the crisis of 1988–89 (political in origin).
  - Panama’s modern banking history dates back to 1970; the 1988 episode included a 9-week bank holiday and resulted in three bank failures.
- Cross-country benchmarking:
  - Financial Soundness Indicators (FSI) show Panama’s aggregate ratios of liquid assets to total assets and liquid assets to short-term liabilities are relatively low in international comparison.
  - The LLI and FSI differences stem from definition and horizon discrepancies (e.g., LLI includes inflows within 186 days; FSI uses a 3-month horizon and more stringent liquid securities definitions).

### II. Objectives of the analysis
- Reconcile the SBP’s LLI-based view of high liquidity with FSI-based evidence of relatively low liquidity by examining measure construction and assumptions.
- Assess whether Panamanian banks have sufficient liquidity to meet substantial outflows of foreign funding triggered by loss of correspondent banks (de-risking).
- Two analytical angles:
  - Approximate the Basel III Liquidity Coverage Ratio (LCR) to analyze short-term resilience.
  - Conduct a conventional liquidity stress test to evaluate layers of liquidity over a prolonged hypothetical funding outflow.

### III. Short-term liquidity in light of the LCR
- LCR purpose and structure:
  - The LCR objective: ensure banks maintain adequate unencumbered high-quality liquid assets (HQLA) convertible to cash to meet liquidity needs for a 30 calendar day liquidity stress scenario.
  - LCR distinguishes HQLA into Level 1, Level 2a and Level 2b with different haircuts and caps (example: Level 2b corporate debt securities get a 50% haircut).
  - Outflow assumptions: retail deposits considered more stable than wholesale deposits from non-financial corporations; funding from other financial institutions assumed highly vulnerable.
  - Treatment of expected cash inflows varies by counterparty type.
- Data intensity:
  - LCR requires granular data on credit ratings, issuing entities, and counterparties, imposing a substantial reporting burden on banks and regulators.

### IV. Approximating the LCR (methodology and limitations)
- Data limitations and mapping:
  - SBP liquidity reports are insufficient to calculate the LCR directly.
  - The analysis constructs a mapping from the SBP template to LCR categories and augments SBP reports with essential breakdowns.
- Two complementary approaches to address missing data:
  - Derive bounds on bank-level LCR distribution using extreme scenarios (best-case and worst-case assumptions for missing data).
  - Calculate baseline results using SBP technical staff best estimates for missing breakdowns based on other data sources, including on-site supervisory inspections.
- Caveat:
  - The methodology is an adaptation of the LCR standard; results are indicative and should not be compared to other jurisdictions.
- Time-horizon and reporting mismatches:
  - LCR has a 30-day horizon; LLI lumps inflows and outflows within 186 days.
  - LCR uses a finer credit rating breakdown; LLI distinguishes only investment grade and below investment grade.
  - LCR requires differentiation of retail, non-financial wholesale and financial counterparties; LLI distinguishes only bank and non-bank funding.
  - LCR considers all sources of funding (including notes, bonds and other debt securities issued by the bank); LLI considers only certain types of deposits.

### V. Mapping issues and remedial steps (Box 1)
- Identified data gaps in SBP reports:
  - Maturity breakdowns needed for 30-day horizon calculations versus LLI’s 186-day aggregation.
  - Credit rating distributions of securities (LCR requires more granular ratings).
  - Sectoral composition of counterparties (sovereign, retail, nonfinancial, financial).
  - Inclusion of all funding sources (LCR) vs. certain deposits only (LLI).
- Remedial steps:
  - Constructed an augmented template with inserted breakdowns mapping SBP report lines to LCR categories.
  - SBP technical staff completed the augmented survey for each bank; some items derived from other reports (e.g., capital adequacy reports for security ratings, deposit breakdowns by maturity and counterparty).
  - Where direct data were not available, SBP staff used estimates (e.g., maturity and sectoral distribution of loan receivables).
- Example structural items captured in the template (as appearing in SBP reports):
  - PASIVOS: Depositos a la Vista No Bancarios (a. Minorista; b. Corporaciones no financieras, estados soberanos, etc.), Depositos a Plazo No Bancarios hasta 186 dias (breakdowns into hasta 30 dias and desde 31 hasta 186 dias with subcategories), Depósitos a Plazo de Bancos hasta 186 dias, etc.
  - ACTIVOS: Obligaciones con grado de inversion emitidas por Gobiernos Extranjeros (AAA to AA-, A+ to A-, BBB+ to BBB-), Obligaciones con grado de inversion emitidas por Org. Financieros Intern., Obligaciones con grado de inversion de empresas privadas nacionales, Depósitos a Plazo en Bancos en Panamá hasta 186 días (hasta 30 dias; desde 31 hasta 186 dias), Abonos de Obligaciones Pagaderas en Panama (Vcto.< 186 Días) with institutions and others, Balance de Situación PASIVOS (Obligaciones hasta 30 dias; Más de 30 dias; Otros pasivos hasta 30 dias; Más de 30 dias).

### VI. Extreme-scenario assumptions used to bound LCR outcomes
- Maturity distribution assumption:
  - Both optimistic and pessimistic extreme scenarios assume the maturity distribution of term deposits and loan receivables is uniform within the 6-month horizon of the official LLI.
- Credit rating and stability assumptions:
  - Optimistic scenario: all securities have the highest possible credit rating and all funding and inflows are the most stable within their respective categories.
  - Pessimistic scenario: all securities have the lowest possible credit rating and all funding and inflows are the least stable within their respective categories.
- Purpose:
  - These extreme scenarios allow derivation of bounds on the bank-level LCR distribution given the available SBP data.

### VII. Key findings (extreme-scenario LCR bounds)
- The range of possible LCR outcomes is wide under the extreme scenarios.
- Even the most optimistic scenario yields a number of banks failing the mark (i.e., not meeting the LCR threshold).
- The available data allow for very different LCR distributions depending on assumptions.
- Rank correlation between the official Legal Liquidity Index (LLI) and the LCR: 0.3, indicating a weak relationship and substantial re-ranking of banks under the two measures.
- Observed pattern among outliers:
  - Group 1 (low LCR, high LLI): tend to be foreign-owned, large share of parent bank and wholesale funding, little/no securities holdings. Local regulation excludes non-deposit wholesale funding and deposits from affiliated banks; LCR treats these liabilities as highly unstable.
  - Group 2 (high LCR, low/medium LLI): hold highly-rated securities, rely more on non-bank and retail funding with longer maturities; LCR rewards stable funding and high-quality securities.

### Short-term Liquidity Overview and LCR Findings (system-level estimates)
- Dataset: liquidity reports and balance sheets reported by 46 onshore banks as of end-October 2015.
- Baseline LCR estimates (incorporating bank-level SBP expert information):
  - Only 40 percent of banks could cover their net cash outflows through the use of HQLA.
  - Median bank LCR: 72.7 percent.
  - Asset-weighted average LCR for the banking system: 108.3 percent.
  - Current official threshold at the time: 70 percent.
- Extreme scenarios produced widely varying results, from almost no bank meeting the 100 percent LCR threshold to most banks passing the LCR test—motivating improved data reporting in line with international standards.
- International context:
  - LCR global rollout:
    - Effective internationally on January 1, 2015, with a 60 percent minimum requirement growing by 10 percentage points each year until reaching 100 percent by January 1, 2019.
    - Current threshold (at time of analysis): 70 percent.
  - Adoption status (as of November 2015 data referenced):
    - Almost all BCBS member jurisdictions have fully implemented the LCR.
    - More than 40 percent of 117 surveyed non-BCBS jurisdictions have fully implemented or published a draft law of the LCR; 22 countries indicated no plans for implementation.
    - Panama is among 44 non-BCBS countries planning to adopt the LCR but had not published proposed domestic regulations.

### Liquidity Stress Test for Loss of Foreign Funding — Assumptions and mechanics
- Purpose: supplement LCR calculations by simulating substantial loss of foreign funding (e.g., large-scale loss of correspondent banking relationships).
- Key departures from LCR:
  - Run-off of liquidity extends beyond the 30-day LCR horizon; maturity mismatches in longer buckets are factored in.
  - Severe 50 percent run-off rate for foreign retail deposits (LCR: up to 10 percent).
  - 100-percent run-off rate for foreign bank funding (same as LCR).
  - Some benign parameters reflecting local conditions: all local retail funding subject to uniform 10 percent run-off; bank bonds and local interbank funding assigned 50 percent rather than 100 percent; no run-off assumed for funding from headquarters and “other liabilities.”
- Funding run-off rate table (run-off rates by funding type and residual maturity, as used in the test):
  - Foreign retail funding: sight deposits — Unstable / 50% / 0%
  - Foreign retail funding: savings deposits — Unstable / 50% / 0%
  - Foreign retail funding: term deposits — 50% / 50% / 50%
  - Bank funding from parent bank — 0% / 0% / 0%
  - Bank funding from foreign banks — 100% / 100% / 100%
  - Bank funding from domestic banks — 50% / 50% / 50%
  - Local retail funding (sight, savings and term deposits) — 10% / 10% / 10%
  - Bank bonds — 50% / 50% / 50%
  - Other liabilities — 0% / 0% / 0%
- Overall run-off summary:
  - Average overall run-off: 33.6 percent of total liabilities.
  - Range of overall run-off rates: between 6.9 and 64.2 percent.
  - Rule-of-thumb from past crises: 20 percent of funding may be lost within 3 months and 30 percent within 6 months.
- Liquidity stress test methodology:
  - Gross perspective by maturity bucket: outflows in a bucket must be met by liquidity in the same bucket (no offset by longer-horizon liquidity).
  - Three sequential liquidity layers:
    1. Inflows from maturing investment and lending operations:
       - Roll-off rate for shorter-term securities maturing within 6 months: 100 percent.
       - Roll-off rate for maturing loans to the non-financial sector: 50 percent.
    2. Stocks of cash and interbank loans with a 100 percent roll-off rate.
    3. Sale of securities with residual maturities over 6 months, subject to a fire-sale haircut of 20 percent.
  - Remaining shortfall after third layer signals terminal illiquidity in absence of a lender of last resort.

### Stress Test Results — General License Banks (46 banks, data as of end-December 2015)
- Most funding outflows can be met using the first and second layers; shortfalls mainly in the two shorter maturity buckets (up to 6 months and 6–12 months).
- After using first layer (inflows from operations), many banks show considerable shortfalls; these generally disappear when using cash and maturing interbank loans.
- Persistence of shortfalls:
  - Shortfall after second layer persists in less than one-third of cases: 14 out of 46 general license banks (accounting for 30 percent of system assets).
  - Number of banks with terminal shortfall after exhausting third layer: 4 banks (accounting for 18 percent of system assets).
- Table 3 summary results (General License Banks) — (In percent):
  - Funding outflow in percent of total liabilities:
    - Average (mean): 33.6
    - Maximum: 64.2
    - Upper quartile: 42.3
    - Lower quartile: 23.9
  - Liquidity gap in percent of outflows after using 1st layer:
    - Average (mean): 37.1
    - Maximum: 82.2
    - Upper quartile: 51.4
    - Lower quartile: 21.3
  - Liquidity gap in percent of outflows after using 2nd layer:
    - Average (mean): 5.5
    - Maximum: 39.5
    - Upper quartile: 3.3
    - Lower quartile: 0.0
  - Final liquidity gap in percent of outflows after using 3rd layer:
    - Average (mean): 0.9
    - Maximum: 16.8
    - Upper quartile: 0.0
    - Lower quartile: 0.0
- Relationship with funding outflows:
  - Positive correlation between degree of funding outflows and liquidity shortfall after first layer (regression: y = 0.66x + 14.9; R² = 0.15).
  - Some banks have large gaps despite not being exposed to high funding outflows; others have large initial buffers.

### Liquidity versus Solvency under Stress
- Most banks with sizable liquidity shortfalls have robust solvency positions.
  - SBP solvency stress test system-level drop in CAR: 16.85 percent (about one-sixth of initial CAR).
  - Finding: no evident link between illiquidity and insolvency in the sample—most illiquid banks show below-average declines in CAR under severe solvency stress.
  - All banks but one failing the solvency test perform reasonably well in the liquidity stress test; none failing solvency had a liquidity shortfall after using the second layer.
- Caveat: liquidity shocks can spill over to solvency in the medium run (rising funding costs, falling fee income); perceived insolvency can precipitate funding outflows.

### Stress Test Results — International License Banks (offshore banks)
- Segment characteristics: prohibited from engaging with domestic clients; typically lack domestic retail funding base → higher overall funding run-off.
- Summary results (Text Table I) — International License Banks (in percent):
  - Funding outflow in percent of total liabilities:
    - Average (mean): 40.9
    - Maximum: 60.7
    - Upper quartile: 49.5
    - Lower quartile: 46.9
  - Liquidity gap in percent of outflows after using 1st layer:
    - Average (mean): 60.7
    - Maximum: 100.0
    - Upper quartile: 77.7
    - Lower quartile: 51.4
  - Liquidity gap in percent of outflows after using 2nd layer:
    - Average (mean): 10.6
    - Maximum: 60.5
    - Upper quartile: 17.7
    - Lower quartile: 0.0
  - Final liquidity gap in percent of outflows after using 3rd layer:
    - Average (mean): 5.0
    - Maximum: 39.7
    - Upper quartile: 0.0
    - Lower quartile: 0.0
- Findings:
  - Five out of 26 international license banks (about 40 percent of assets of this segment) show a final shortfall after all three buffers.
  - Around three-fourths of international license banks can cover funding shortfalls through cash and cash-like positions.
  - Banks with final liquidity gaps would need to adjust asset composition (larger share of short-term instruments) to pass the test.

### Conclusions and Policy Implications
- Vulnerabilities identified:
  - Several banks would not meet the 100 percent LCR requirement under current balance sheet compositions, owing to over-reliance on interbank placements and scheduled inflows instead of high-quality tradable securities.
  - Some banks would need to sell less liquid instruments to close liquidity gaps under a severe foreign funding outflow scenario; a few would remain with final liquidity shortfalls.
- Policy recommendations and options:
  - Strengthen data reporting requirements in line with international standards to improve LCR estimates and supervisory oversight.
  - Step up ongoing efforts to update Panamanian liquidity regulation and data collection.
  - Adopt the LCR and later the Net Stable Funding Ratio (NSFR) to improve the banking sector’s ability to absorb large and unexpected shocks and reduce risk of spillovers from the financial sector to the real economy.
- Timing consideration:
  - Given steady global progress in Basel III liquidity adoption, advancing domestic implementation is a worthwhile policy option.

*Source: _wp16200 - 1. Assumptions in the Extreme Scenario; Staff calculation based on SBP data.*

### 1. Assumptions in the Extreme Scenario .................................................................................

### _wp16200 - 1. Assumptions in the Extreme Scenario

### I. Introduction and motivation
- Panama’s national banking system assets amounted to 189 percent of GDP at the end of 2015.
- Domestic credit-to-GDP (financial depth) is comparable to some advanced economies and much higher than the regional average.
- More than half of banks operating in Panama are foreign; banks tap external markets for funding and investments.
- Panama lacks a public financial safety net:
  - Panama is the only country in the region without a lender of last resort (LOLR) facility or a deposit insurance arrangement.
  - Ecuador and El Salvador, the other fully dollarized economies in Latin America, have maintained a financial safety net.
- Interbank market characteristics:
  - The interbank market is segmented, especially under stress: larger foreign banks tend to lend only to larger domestic banks.
  - The interbank market froze completely during the 2009 downturn.
- Regulatory liquidity metric:
  - The New Banking Law of 2008 and SBP Rule 4 of 2008 define the Legal Liquidity Index (LLI) with a 30 percent minimum requirement on liquid assets as a share of qualifying deposits.
  - The LLI of the whole banking system has fluctuated around 60 percent – twice the required level.
- Historical stability:
  - The only systemic banking crisis in the last 45 years was the crisis of 1988–89 (political in origin).
  - Panama’s modern banking history dates back to 1970; the 1988 episode included a 9-week bank holiday and resulted in three bank failures.
- Cross-country benchmarking:
  - Financial Soundness Indicators (FSI) show Panama’s aggregate ratios of liquid assets to total assets and liquid assets to short-term liabilities are relatively low in international comparison.
  - The LLI and FSI differences stem from definition and horizon discrepancies (e.g., LLI includes inflows within 186 days; FSI uses a 3-month horizon and more stringent liquid securities definitions).

### II. Objectives of the analysis
- Reconcile the SBP’s LLI-based view of high liquidity with FSI-based evidence of relatively low liquidity by examining measure construction and assumptions.
- Assess whether Panamanian banks have sufficient liquidity to meet substantial outflows of foreign funding triggered by loss of correspondent banks (de-risking).
- Two analytical angles:
  - Approximate the Basel III Liquidity Coverage Ratio (LCR) to analyze short-term resilience.
  - Conduct a conventional liquidity stress test to evaluate layers of liquidity over a prolonged hypothetical funding outflow.

### III. Short-term liquidity in light of the LCR
- LCR purpose and structure:
  - The LCR objective: ensure banks maintain adequate unencumbered high-quality liquid assets (HQLA) convertible to cash to meet liquidity needs for a 30 calendar day liquidity stress scenario.
  - LCR distinguishes HQLA into Level 1, Level 2a and Level 2b with different haircuts and caps (example: Level 2b corporate debt securities get a 50% haircut).
  - Outflow assumptions: retail deposits considered more stable than wholesale deposits from non-financial corporations; funding from other financial institutions assumed highly vulnerable.
  - Treatment of expected cash inflows varies by counterparty type.
- Data intensity:
  - LCR requires granular data on credit ratings, issuing entities, and counterparties, imposing a substantial reporting burden on banks and regulators.

### IV. Approximating the LCR (methodology and limitations)
- Data limitations and mapping:
  - SBP liquidity reports are insufficient to calculate the LCR directly.
  - The analysis constructs a mapping from the SBP template to LCR categories and augments SBP reports with essential breakdowns.
- Two complementary approaches to address missing data:
  - Derive bounds on bank-level LCR distribution using extreme scenarios (best-case and worst-case assumptions for missing data).
  - Calculate baseline results using SBP technical staff best estimates for missing breakdowns based on other data sources, including on-site supervisory inspections.
- Caveat:
  - The methodology is an adaptation of the LCR standard; results are indicative and should not be compared to other jurisdictions.
- Time-horizon and reporting mismatches:
  - LCR has a 30-day horizon; LLI lumps inflows and outflows within 186 days.
  - LCR uses a finer credit rating breakdown; LLI distinguishes only investment grade and below investment grade.
  - LCR requires differentiation of retail, non-financial wholesale and financial counterparties; LLI distinguishes only bank and non-bank funding.
  - LCR considers all sources of funding (including notes, bonds and other debt securities issued by the bank); LLI considers only certain types of deposits.

### V. Box 1 – Mapping the SBP’s liquidity report to the LCR (key data issues and remedies)
- Identified data gaps in SBP reports:
  - Maturity breakdowns needed for 30-day horizon calculations versus LLI’s 186-day aggregation.
  - Credit rating distributions of securities (LCR requires more granular ratings).
  - Sectoral composition of counterparties (sovereign, retail, nonfinancial, financial).
  - Inclusion of all funding sources (LCR) vs. certain deposits only (LLI).
- Remedial steps:
  - Constructed an augmented template with inserted breakdowns mapping SBP report lines to LCR categories.
  - SBP technical staff completed the augmented survey for each bank; some items derived from other reports (e.g., capital adequacy reports for security ratings, deposit breakdowns by maturity and counterparty).
  - Where direct data were not available, SBP staff used estimates (e.g., maturity and sectoral distribution of loan receivables).
- Example structural items captured in the template (as appearing in SBP reports):
  - PASIVOS: Depositos a la Vista No Bancarios (a. Minorista; b. Corporaciones no financieras, estados soberanos, etc.), Depositos a Plazo No Bancarios hasta 186 dias (breakdowns into hasta 30 dias and desde 31 hasta 186 dias with subcategories), Depósitos a Plazo de Bancos hasta 186 dias, etc.
  - ACTIVOS: Obligaciones con grado de inversion emitidas por Gobiernos Extranjeros (AAA to AA-, A+ to A-, BBB+ to BBB-), Obligaciones con grado de inversion emitidas por Org. Financieros Intern., Obligaciones con grado de inversion de empresas privadas nacionales, Depósitos a Plazo en Bancos en Panamá hasta 186 días (hasta 30 dias; desde 31 hasta 186 dias), Abonos de Obligaciones Pagaderas en Panama (Vcto.< 186 Días) with institutions and others, Balance de Situación PASIVOS (Obligaciones hasta 30 dias; Más de 30 dias; Otros pasivos hasta 30 dias; Más de 30 dias).

### VI. Extreme-scenario assumptions used to bound LCR outcomes
- Maturity distribution assumption:
  - Both optimistic and pessimistic extreme scenarios assume the maturity distribution of term deposits and loan receivables is uniform within the 6-month horizon of the official LLI.
- Credit rating and stability assumptions:
  - Optimistic scenario: all securities have the highest possible credit rating and all funding and inflows are the most stable within their respective categories.
  - Pessimistic scenario: all securities have the lowest possible credit rating and all funding and inflows are the least stable within their respective categories.
- Purpose:
  - These extreme scenarios allow derivation of bounds on the bank-level LCR distribution given the available SBP data.

### VII. Key findings (as reported in the section)
- The range of possible LCR outcomes is wide under the extreme scenarios.
- Even the most optimistic scenario yields a number of banks failing the mark (i.e., not meeting the LCR threshold).
- The available data allow for very different LCR distributions depending on assumptions.

*Source: _wp16200 - 1. Assumptions in the Extreme Scenario*

### conclusions about the short-term liquidity position of the banking system, ranging from

### _wp16200 - conclusions about the short-term liquidity position of the banking system, ranging from

### Short-term Liquidity Overview and LCR Findings
- Dataset: liquidity reports and balance sheets reported by 46 onshore banks as of end-October 2015.
- Baseline LCR estimates (incorporating bank-level SBP expert information):
  - Only 40 percent of banks could cover their net cash outflows through the use of HQLA.
  - Median bank LCR: 72.7 percent.
  - Asset-weighted average LCR for the banking system: 108.3 percent.
  - Current official threshold at the time: 70 percent.
- Extreme scenarios produced widely varying results, from almost no bank meeting the 100 percent LCR threshold to most banks passing the LCR test—motivating improved data reporting in line with international standards.
- Rank correlation between the official Legal Liquidity Index (LLI) and the LCR: 0.3, indicating a weak relationship and substantial re-ranking of banks under the two measures.
- Observed pattern among outliers:
  - Group 1 (low LCR, high LLI): tend to be foreign-owned, large share of parent bank and wholesale funding, little/no securities holdings. Local regulation excludes non-deposit wholesale funding and deposits from affiliated banks; LCR treats these liabilities as highly unstable.
  - Group 2 (high LCR, low/medium LLI): hold highly-rated securities, rely more on non-bank and retail funding with longer maturities; LCR rewards stable funding and high-quality securities.

### International Context and Implementation Timeline
- LCR global rollout:
  - Effective internationally on January 1, 2015, with a 60 percent minimum requirement growing by 10 percentage points each year until reaching 100 percent by January 1, 2019.
  - Current threshold (at time of analysis): 70 percent (coincidentally near the median of baseline estimates).
- Adoption status (as of November 2015 data referenced):
  - Almost all BCBS member jurisdictions have fully implemented the LCR.
  - More than 40 percent of 117 surveyed non-BCBS jurisdictions have fully implemented or published a draft law of the LCR; 22 countries indicated no plans for implementation.
  - Panama is among 44 non-BCBS countries planning to adopt the LCR but had not published proposed domestic regulations.

### Liquidity Stress Test for Loss of Foreign Funding — Assumptions and Mechanics
- Purpose: supplement LCR calculations by simulating substantial loss of foreign funding (e.g., large-scale loss of correspondent banking relationships).
- Key departures from LCR:
  - Run-off of liquidity extends beyond the 30-day LCR horizon; maturity mismatches in longer buckets are factored in.
  - Severe 50 percent run-off rate for foreign retail deposits (LCR: up to 10 percent).
  - 100-percent run-off rate for foreign bank funding (same as LCR).
  - Some benign parameters reflecting local conditions: all local retail funding subject to uniform 10 percent run-off; bank bonds and local interbank funding assigned 50 percent rather than 100 percent; no run-off assumed for funding from headquarters and “other liabilities.”
- Funding run-off rate table (run-off rates by funding type and residual maturity, as used in the test):
  - Foreign retail funding: sight deposits — Unstable / 50% / 0%
  - Foreign retail funding: savings deposits — Unstable / 50% / 0%
  - Foreign retail funding: term deposits — 50% / 50% / 50%
  - Bank funding from parent bank — 0% / 0% / 0%
  - Bank funding from foreign banks — 100% / 100% / 100%
  - Bank funding from domestic banks — 50% / 50% / 50%
  - Local retail funding (sight, savings and term deposits) — 10% / 10% / 10%
  - Bank bonds — 50% / 50% / 50%
  - Other liabilities — 0% / 0% / 0%
- Overall run-off summary:
  - Average overall run-off: 33.6 percent of total liabilities.
  - Range of overall run-off rates: between 6.9 and 64.2 percent.
  - Rule-of-thumb from past crises: 20 percent of funding may be lost within 3 months and 30 percent within 6 months.
- Liquidity stress test methodology:
  - Gross perspective by maturity bucket: outflows in a bucket must be met by liquidity in the same bucket (no offset by longer-horizon liquidity).
  - Three sequential liquidity layers:
    1. Inflows from maturing investment and lending operations:
       - Roll-off rate for shorter-term securities maturing within 6 months: 100 percent.
       - Roll-off rate for maturing loans to the non-financial sector: 50 percent.
    2. Stocks of cash and interbank loans with a 100 percent roll-off rate.
    3. Sale of securities with residual maturities over 6 months, subject to a fire-sale haircut of 20 percent.
  - Remaining shortfall after third layer signals terminal illiquidity in absence of a lender of last resort.

### Stress Test Results — General License Banks (46 banks, data as of end-December 2015)
- Most funding outflows can be met using the first and second layers; shortfalls mainly in the two shorter maturity buckets (up to 6 months and 6–12 months).
- After using first layer (inflows from operations), many banks show considerable shortfalls; these generally disappear when using cash and maturing interbank loans.
- Persistence of shortfalls:
  - Shortfall after second layer persists in less than one-third of cases: 14 out of 46 general license banks (accounting for 30 percent of system assets).
  - Number of banks with terminal shortfall after exhausting third layer: 4 banks (accounting for 18 percent of system assets).
- Table 3 summary results (General License Banks) — (In percent):
  - Funding outflow in percent of total liabilities:
    - Average (mean): 33.6
    - Maximum: 64.2
    - Upper quartile: 42.3
    - Lower quartile: 23.9
  - Liquidity gap in percent of outflows after using 1st layer:
    - Average (mean): 37.1
    - Maximum: 82.2
    - Upper quartile: 51.4
    - Lower quartile: 21.3
  - Liquidity gap in percent of outflows after using 2nd layer:
    - Average (mean): 5.5
    - Maximum: 39.5
    - Upper quartile: 3.3
    - Lower quartile: 0.0
  - Final liquidity gap in percent of outflows after using 3rd layer:
    - Average (mean): 0.9
    - Maximum: 16.8
    - Upper quartile: 0.0
    - Lower quartile: 0.0
- Relationship with funding outflows:
  - Positive correlation between degree of funding outflows and liquidity shortfall after first layer (regression: y = 0.66x + 14.9; R² = 0.15).
  - Some banks have large gaps despite not being exposed to high funding outflows; others have large initial buffers.

### Liquidity vs Solvency under Stress
- Most banks with sizable liquidity shortfalls have robust solvency positions.
  - SBP solvency stress test system-level drop in CAR: 16.85 percent (about one-sixth of initial CAR).
  - Finding: no evident link between illiquidity and insolvency in the sample—most illiquid banks show below-average declines in CAR under severe solvency stress.
  - All banks but one failing the solvency test perform reasonably well in the liquidity stress test; none failing solvency had a liquidity shortfall after using the second layer.
- Caveat: liquidity shocks can spill over to solvency in the medium run (rising funding costs, falling fee income); perceived insolvency can precipitate funding outflows.

### Stress Test Results — International License Banks (offshore banks)
- Segment characteristics: prohibited from engaging with domestic clients; typically lack domestic retail funding base → higher overall funding run-off.
- Summary results (Text Table I) — International License Banks (in percent):
  - Funding outflow in percent of total liabilities:
    - Average (mean): 40.9
    - Maximum: 60.7
    - Upper quartile: 49.5
    - Lower quartile: 46.9
  - Liquidity gap in percent of outflows after using 1st layer:
    - Average (mean): 60.7
    - Maximum: 100.0
    - Upper quartile: 77.7
    - Lower quartile: 51.4
  - Liquidity gap in percent of outflows after using 2nd layer:
    - Average (mean): 10.6
    - Maximum: 60.5
    - Upper quartile: 17.7
    - Lower quartile: 0.0
  - Final liquidity gap in percent of outflows after using 3rd layer:
    - Average (mean): 5.0
    - Maximum: 39.7
    - Upper quartile: 0.0
    - Lower quartile: 0.0
- Findings:
  - Five out of 26 international license banks (about 40 percent of assets of this segment) show a final shortfall after all three buffers.
  - Around three-fourths of international license banks can cover funding shortfalls through cash and cash-like positions.
  - Banks with final liquidity gaps would need to adjust asset composition (larger share of short-term instruments) to pass the test.

### Conclusions and Policy Implications
- Vulnerabilities identified:
  - Several banks would not meet the 100 percent LCR requirement under current balance sheet compositions, owing to over-reliance on interbank placements and scheduled inflows instead of high-quality tradable securities.
  - Some banks would need to sell less liquid instruments to close liquidity gaps under a severe foreign funding outflow scenario; a few would remain with final liquidity shortfalls.
- Policy recommendations and options:
  - Strengthen data reporting requirements in line with international standards to improve LCR estimates and supervisory oversight.
  - Step up ongoing efforts to update Panamanian liquidity regulation and data collection.
  - Adopt the LCR and later the Net Stable Funding Ratio (NSFR) to improve the banking sector’s ability to absorb large and unexpected shocks and reduce risk of spillovers from the financial sector to the real economy.
- Timing consideration:
  - Given steady global progress in Basel III liquidity adoption, advancing domestic implementation is a worthwhile policy option.

*Source: Staff calculation based on SBP data.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2016/_wp16200.pdf_