Liquidity Coverage Ratio Management : Analyzing Norwegian Market Dynamics and Optimizing Liquidity Portfolios

Abstract

This thesis aims to present an in-depth exploration of the Liquidity Coverage Ratio (LCR), and further analyze the optimum allocation of High-Quality Liquid Assets (HQLA) for Norwegian banks. Additionally, we compare our simulated portfolios to our reference portfolios to explore if today's LCR management can improve. To answer the question at hand, we analyze a unique dataset spanning from 2016 to 2023, based on credit margins and realized excess returns for HQLA, which in turn, comprises relevant assets for Norwegian banks liquidity portfolio. The analysis is separated into two parts, where the first part focuses on data inspection. Here, we utilize correlation-, standard deviation- and variance ratio calculations on credit margins and realized excess return to elucidate the behavior of HQLA under varying financial situations. The second part introduces our simulation analysis where we illustrate our findings for several optimum HQLA portfolio compositions, taking varying constraints into consideration. Through our research, we find strong tendencies for mean reversion in our dataset. Our calculations indicate that credit margins for HQLA revert to the mean for 52-week horizons. This discovery provides valuable insights for liquidity portfolio managers, as this detail is currently neglected in today's practice. Furthermore, we see that our optimum solutions deviate from our reference portfolios. Consequently, by implementing similar optimization techniques, banks have the potential to enhance their performance in terms of risk and return. In conclusion, our findings suggest that Norwegian banks can improve the management of their liquidity portfolio. However, it is important to recognize that liquidity portfolio management does not constitute the primary function of banks overall activities. Moreover, although there is clear potential for enhancement in LCR management, it is crucial to adopt a comprehensive approach that considers the wider goals of the LCR requirements. Effective liquidity portfolio management involves not only optimizing returns but also adhering to regulatory requirements and maintaining stability across various market conditions.