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Liquidity management

The objective of KBNs liquidity management is to ensure sound and prudent liquidity management to guarantee sufficient liquidity to meet obligations upon maturity. KBN’s strategy is to maintain a liquidity reserve in highly creditworthy liquid securities, money market instruments and cash.

The liquidity portfolio’s size is determined by the objective of aiming for a liquidity reserve equivalent to approximately 12 months of expected outflows. This allows the bank to address a situation where funding markets are unavailable and/or KBN lacks access to new borrowings for a year (the “survival horizon”). Additionally, a minimum size for the liquidity reserve is relative to the number of months of expected outflows is defined. The liquidity portfolio should be sufficiently large to handle liquidity outflows equivalent to previously experienced crises.

At end of March 2024, the liquidity portfolio amounted to NOK 130bln with an average maturity of 2 years.

Counterparty credit rating distribution

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as of 30.04.2024

Counterparty risk weigh distribution

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as of 30.04.2024

Investment universe

KBN’s investment universe primarily consists of certificates and bonds issues by states, regions, financial institutions, state owned companies with guarantee domiciled in OECD countries, and selected multilateral institutions with supranational affiliation.

Liquidity management is carried out with the aim of optimizing alignment within the established frameworks and leveraging business opportunities that can contribute to increased returns. The liquidity management strategy places significant emphasis on ensuring that the securities possess the necessary liquidity characteristics. The return is largely determined by the requirements of the liquidity portfolios strategy.

The goal of the portfolio’s return is to achieve a positive margin, meaning that the returns from investments are higher than the costs of financing the portfolio. To limit the possibility of a return-driven investment strategy, an upper limit for the portfolio size relative to the bank’s total balance sheet has been established.

Counterparty geographical distribution

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as of 30.04.2024

Distribution by type of instrument

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as of 30.04.2024

Liquidity risk

Liquidity risk is the risk of not being able to meet ongoing obligations (without incurring significant additional costs) or failing to secure stable financing regardless of market conditions. It also includes the risk of not meeting regulatory requirements for liquidity (LCR) and stable funding (NSFR).

Liquidity risk arises due to:

  • Unforeseen cash needs. For example, the need for collateral due to market movements.
  • Maturity mismatches. The differences in maturity dates and contract amounts, especially related to borrowings and loans.
  • Insufficient access to new borrowings. This can occur due to market turbulence or company-specific factors.
  • Inability to transform the liquidity buffer into cash without incurring large losses.

Liquidity management aims to ensure sufficient financial strength and the ability to withstand critical situations, avoiding potential recovery scenarios. Liquidity management considers that the need for cash can arise, both in the short and long term, especially during prolonged periods of market turbulence when the bank lacks access to new funding.

Liquidity strategy for shorter time horizons

Hedging market risk, along with collateral exchange with counterparties, entails liquidity risk that is significant for the bank. Since the underlying market risk is uncertain and collateral exchanges typically settle within 1 to 2 days, this constitutes short-term liquidity risk. The extent of this risk primarily depends on the size of the balance sheet, the borrowing strategy, and the bank’s interest rate hedging strategy. The proportion of KBN’s borrowings denominated in foreign currency is the most significant contributor to short-term liquidity risk. Hedging currency risk, including collateral exchanges with counterparties, represents the bank’s most substantial short-term liquidity risk, especially where the USDNOK exchange rate is a significant risk driver. Currency hedging also entails market risk in the form of basis risk, which contributes to short-term liquidity risk. Additionally, interest rate hedging represents significant exposure to short-term liquidity risk.

KBN must always maintain sufficient liquidity to handle the liquidity needs arising from this risk. KBN’s internal liquidity framework sets requirements for available liquidity. The framework considers short-term liquidity horizons and is based on market risk shocks related to the underlying market risk factor, similar to previous financial crises.

Liquidity characteristics requirements for securities

Liquidity management aims to ensure that the bank holds an appropriate amount of liquid assets that can be converted into cash (with minimal or no loss of value) within a defined period. The liquidity reserve is categorized based on criteria that indicate the market liquidity of the securities. Market liquidity refers to the ease with which assets, such as securities, can be traded in a market without causing significant price changes. A market is considered liquid if large volumes can be traded within a short time without substantial price fluctuations.

To effectively manage liquidity risk the liquidity portfolio is divided into the following three sub-portfolios, based on the liquidity characteristics:

  • Very High Liquidity (VHL)
  • High Liquidity (HL)
  • Lower Liquidity (LL)

The criteria used for dividing the portfolio into these sub-portfolios are a combination of type of issuer, currency and issue size. Typically, the most liquid government bonds and some covered bonds with LCR1 classification will be categorized as VHL.

Sustainability requirements in liquidity management

The management of KBN’s liquidity reserve will be conducted in a sustainable manner by integrating environmental, social, and governance (ESG) factors into the assessment of counterparties.

Counterparties refer to issuers of securities in the liquidity portfolio. Considering ESG in the investment decisions and investing in issuers acknowledging their responsibility towards sustainability is believed to generate higher risk-adjusted return in the long-run and be in the best interest of our communities, society, and the environment. The inclusion of ESG in the assessment of counterparties is also anticipated to reduce the risk of KBN being affected by serious ESG violations by these counterparties.

Sustainability in liquidity management has been implemented through the following three dimensions:

  • Exclusion criteria
  • Norm-based screening (NBR)
  • ESG rating by external ESG rating provider

When evaluating new counterparties, an assessment will be made based on the three dimensions (where available). The counterparty’s ESG rating will be monitored continuously, and a contingency plan will be put in place in case of undesirable developments. KBN also aim to hold parts of the portfolio in thematic investments; green, social, and sustainable development bonds. Please read KBNs Sustainable Investment Policy for further information.