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6.3.2 Components of High-Quality Liquid Assets (HQLA)

C 33/2015 STA Effective from 3/1/2022
  1. a.The HQLA are defined as assets unencumbered by liens and other restrictions on transfer which can be converted into cash easily and immediately, with little or no loss of value, including under the stress scenario.
  2. b.HQLA are to be determined on the basis of the eligibility criteria for different categories of HQLA and must be subject to the limits applicable to each category. These eligibility criteria for HQLA and composition limits are intended to ensure that an IB’s HQLA stock provides it with the ability to generate liquidity in fairly short order, through sale or secured funding in a stress scenario. The assets are required to meet fundamental and market-related characteristics, particularly in terms of low risk, ease and certainty of valuation, and low volatility. HQLA is also eligible for intraday and overnight liquidity facilities offered by the Central Bank.
  3. c.To be considered as HQLA, an asset must also have a low correlation with risky assets, an active and sizeable market, and low volatility. This requirement has to be fulfilled at all times, including during an underlying stress scenario. These factors assist the Central Bank to determine which assets qualify as HQLA. The Central Bank also will consider risk components of HQLA, such as liquidity risk, market risk, credit risk, and operational risk. For Shari’ah-compliant assets, the risk of Shari’ah non-compliance and associated reputational problems could significantly limit liquidity for these assets – both sale and interbank trading – in the secondary market.
  4. d.HQLA (except Level 2B assets, as defined below) is eligible for use as collateral when seeking short- to medium-term liquidity facilities from the Central Bank.
  5. e.To meet HQLA requirements, the assets must possess the following characteristics:

    i.Fundamental characteristics:
    The assets must be low risk, as reflected in the high credit rating of the issuer or the instruments. The assets must be easy to value, have a homogeneous and relatively simple structure, and not be subject to wrong-way (highly correlated) risk. Shari’ah compliance of the structure and contracts underlying the liquid assets is another critical criterion of HQLA for IBs. Ideally, the asset must be listed on a national, regional or international stock exchange to ensure that sufficient information on pricing and trading is available to the public.

    ii.Market-related characteristics
    The assets are expected to be liquefiable at any time. Thus, as far as possible, there must be historical evidence of market breadth and depth. This could be demonstrated by low bid–ask spreads, high trading volumes, and a large and diverse number of market participants. Availability of market-makers is another factor for consideration. The asset prices are expected to have remained relatively stable and be less prone to sharp price declines over time, including during stress conditions.
    Assets must be tested through sale or Shari’ah-compliant alternatives of repurchase (repo) transactions to ascertain whether the liquid assets meet the criteria of “high quality” and fulfil the fundamental and market-related characteristics mentioned above. It is required that the liquidity-generating capacity of HQLA remains unchanged in periods of severe idiosyncratic and market stress. Lower-quality assets typically fail to meet that test. It must be noted that, in severe market conditions, if IBs attempt to raise liquidity from lower-quality assets, this will lead to significantly discounted prices. This may not only worsen the market’s confidence in the Islamic Banks but also may generate mark-to-market losses for its similar assets and put pressure on its liquidity position. In these conditions, market liquidity for lower-quality assets is likely to disappear quickly.