Basel III and the Net Stable Funding Ratio

We validate the new Basel liquidity standards as encapsulated by the net stable funding ratio in a quantitative manner. In this regard, we consider the dynamics of inverse net stable funding ratio as a measure to quantify the bank’s prospects for a stable funding over a period of a year. In essence, this justifies how Basel III liquidity standards can be effectively implemented in mitigating liquidity problems. We also discuss various classes of available stable funding and required stable funding. Furthermore, we discuss an optimal control problem for a continuous-time inverse net stable funding ratio. In particular, we make optimal choices for the inverse net stable funding targets in order to formulate its cost. This is normally done by obtaining analytic solution of the value function. Finally, we provide a numerical example for the dynamics of the inverse net stable funding ratio to identify trends in which banks behavior convey forward looking information on long-term market liquidity developments. 1. Introduction The episode of financial market turbulence in 2007–2009 has depicted the importance of liquidity for normal functioning of the financial system. It is because of this background that we are contributing to the procedures for the regulation and supervision of sound liquidity risk management for banks. Some of the well-documented materials to this regard are the notable papers by [1–4]. The Basel Committee on Banking Supervision (BCBS) outlines certain measures to strengthen global capital and liquidity regulations. The objective for these measures is to improve the banking sector's ability to ensure that risk does not spillover to the real economy. The measures are formulated in a form of a principle for sound liquidity risk management and supervision comprising quantitative and qualitative management instruments (see, e.g., [1]). In essence, the response provides guidance on risk management and supervision for funding liquidity risk and promotes a better risk management in that critical area of financial segment. As such, the committee will coordinate rigorous followup by supervisors to ensure that banks adhere to these fundamentals principles (see [3] for more details). The global economic crisis which recently attack the financial system occurs due to liquidity constraints. We define liquidity constraint as an arbitrary limit on the amount an individual can borrow or an arbitrary alteration in the interest rate they pay. In some instances banks exchange assets in the form of collateral in order to have access to finances. In essence,