Management of liquidity risk
Triodos Bank does not have a complex business model as it only lends to and invests in sustainable enterprises in the real economy. Triodos Bank is not dependent on funding from the wholesale market. Funds are attracted from depositors and shareholders.
Following the same philosophy, Triodos Bank does not invest in complex financial instruments. It has been this approach that enabled Triodos Bank to remain solid and stable in a time of market crisis but also to continue to grow steadily. The key factor to achieve this is to maintain healthy levels of liquidity. Triodos Bank has a large, good quality liquidity buffer resulting in sufficient liquidity and funding ratios. Triodos Bank does not act as securities custodian or correspondent bank which minimises liquidity needs during the day.
The following funding principles apply:
- Balanced growth in funds entrusted is a prerequisite for growth in loans
- No dependency on cross-currency funding
- No dependency on central bank contingency funding
The daily liquidity management is currently executed at branch level as it is the business strategy of Triodos Bank to have this process close to the end-customer to provide detailed cash forecasts. On aggregated level, Group Treasury monitors the liquidity buffer versus the internal limits daily.
The management of the liquidity position under ‘normal’ conditions is described in the Liquidity Risk Management Policy. Triodos Bank manages the liquidity position to withstand a liquidity crisis without damaging the on-going viability of its business. The potential but unlikely event of an upcoming liquidity crisis requires a set of early warning indicators and triggers, a set of potential early warning and recovery measures, and a dedicated organisation including a communication strategy to handle such a crisis. A list of potential early warning and recovery measures are included in the Recovery Plan. The other aspects mentioned are described in the Liquidity Contingency Plan.
The liquidity portfolio increased only slightly during 2018 and Triodos Bank’s liquidity position remained strong. Its policy is to hold a sound liquidity buffer and invest liquidities in highly liquid assets and/or inflow generating assets in the countries where it has branches. Due to the ongoing expansionary monetary policy by the ECB and specifically the asset purchase program, yields of government bonds and other high rated counterparties stayed often below levels of –0.40%. Hence, the profile of the liquidity buffer changed during 2018. The bonds portfolio decreased by almost 14%, due to maturing bonds being placed mostly at the central bank.
Liquidity monitoring and reporting
Triodos Bank monitors and reports its liquidity position at different levels and frequencies. Firstly, the total liquidity position is monitored by Group Treasury and the individual branches on a daily basis. Secondly, the detailed liquidity position, both in total and at branch level, is reported to the Chief Financial Officer on a weekly basis. Finally, every month the liquidity ratios are reported to the Asset and Liability Committee. The main liquidity ratios are part of the quarterly ERM report.
In addition, Triodos Bank conducts short and long-term liquidity stress tests.
Mitigation of liquidity risk
The liquidity buffer is the source of funds in case of liquidity needs. It consists of liquid investments with other banks and liquid investments in deposits and bonds. The bond investments are divided into different liquidity classes. The optimal size and composition of the liquidity buffer is determined considering the risk appetite, balance sheet composition and expected development, strategic plans and funding needs.
The Liquidity Risk Management Policy describes the actions to manage the liquidity position of Triodos Bank.
The Internal Liquidity Adequacy Assessment Process (ILAAP) assesses Triodos Bank’s liquidity adequacy and liquidity management during normal business activities and in times of stress. This process is performed at least once a year and the results are submitted to the Dutch Central Bank as part of the Supervisory Review and Evaluation Process (SREP). The ILAAP Report is an internal document. The goal of this report is to properly evaluate the liquidity and funding risks and Triodos Bank’s corresponding liquidity levels and the quality of the liquidity management.
The Liquidity Contingency Plan and the Recovery Plan describe the main items that should be considered in managing the liquidity risk position of Triodos Bank in a ‘stressed situation’. This includes liquidity stress indicators and trigger levels for management actions.
Concentration of funding
All Triodos Bank’s funding comes from two sources, i.e. funds entrusted and depository receipts (DRs), while the bank does not make use of wholesale funding.
For its funding Triodos Bank mainly depends on retail funds entrusted, consisting of current accounts, saving accounts and fixed term accounts.
The total amount of funds entrusted is EUR 9,558 million of which 79% are deposits insured by the Deposit Guarantee Scheme.
With regard to the distribution of capital, depository receipts belong to institutional investors, private persons and family offices. 7.3% of the total share capital is owned by larger institutional investors with a participating interest of 1% or more.
The impact of potential collateral requirements is increasing at Triodos Bank. The amount pledged with central and commercial banks, for payment system purposes, increased in 2018 and is expected to increase with the further growth of Triodos Bank. The collateral needs stemming from FX forwards is decreasing, as Triodos Bank will no longer perform these deals with the Group’s investment funds, as from 2018.
Interest Rate Swaps which are centrally cleared, increased the potential collateral needs as well during the year. At the end of 2018 total net amount of EUR 7.1 million cash collateral was posted.
The liquidity risk appetite as determined by the Executive Board (EB) and Enterprise Risk Committee (ERC) is reviewed and approved by the Supervisory Board and Group Asset and Liability Committee (ALCo). With this governance structure in place, the risk appetite regarding liquidity is well anchored within the senior management team of the bank. The adequate organisational structure with three lines of defence ensures that a clear division of tasks, power and responsibility is in place together with an independent control, compliance, audit and risk management function.
A robust framework is in place at Triodos Bank to identify, measure and manage liquidity risk in line with BCBS/ EBA principles. An integrated overview of the group cash position and liquidity metrics is available on a daily and weekly basis.
In the last two years, the liquidity contingency plan has been tested and reviewed thoroughly to achieve a solid crisis management structure in case a liquidity crisis at Triodos Bank emerges.
A limit structure is in place to manage the inherent funding mismatch other than in exceptional circumstances. Triodos Bank follows the BSBC/EBA principles considering its sustainable profile, the very strong relationship with its customers, the granularity of the Funds Entrusted and its conservative and robust liquidity management framework that is integrated in the business processes.
As a mid-sized European bank with total Funds Entrusted of EUR 9,558 million per the end of December 2018, liquidity risk is an important risk for Triodos Bank. The Bank has intensively worked on the development of a solid liquidity framework to have always sufficient funds to meet sudden and (un)expected short-term liquidity needs. The high cash liquidity buffer in combination with a high-quality investment portfolio, reflects the low risk appetite for liquidity risk.
Triodos Bank has a large, good quality liquidity buffer resulting in high Liquidity Coverage Ratios and Net Stable Funding Ratios. In all liquidity stress test scenarios Triodos Bank has sufficient liquidity to survive the total stress period.
The remaining low interest rate climate influences liquidity risk management at Triodos Bank. Triodos Bank needs to manage its liquidity buffer at an ever-increasing cost-of-carry. The trade-off between having sufficient liquidity versus the relative high costs of holding that liquidity is becoming more important.