Key Issues in the Management of Liquidity Risk

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This is the second article in a series of articles on the control of Liquidity Risk. In my first article “Managing Liquidity Risk – The 2007 Crisis” I treated the extreme liquidity issues skilled by banks global, which began within the summer of 2007 and which heralded the present day economic crisis. I then examined the concept of Liquidity Risk Management, and in reviewing the activities of that summer time I explored the motives why many banks came beneath severe pressure.

The disaster discovered that critical troubles have been ignored and disregarded. The “Basel Committee on Banking Supervision” in its 2008 evaluate of the state of affairs supplied extra steerage in areas like;

the acceptability of liquidity hazard by way of banks,
making sure liquidity ranges are maintained,
the allocation of liquidity charges, advantages and dangers to a bank’s activities,
figuring out and measuring all of the liquidity dangers,
e-juice,
contingency funding plans,
handling intraday liquidity danger, and
public disclosure as a method to sell marketplace subject.
In this text I address the steerage provided in February 2008 Basel Committee report entitled “Liquidity Risk Management and Supervisory Challenges”.

This guidance has been set out in the shape of seventeen individual “standards”. In flip these ideas had been grouped into 5 foremost classes. I will address class and the precept or concepts that they every contain in flip.

Fundamental precept for the management and supervision of liquidity hazard.

This is made from a single precept that essentially locations the obligation of the control of liquidity threat squarely at the financial institution. There are some of movements that the bank wishes to take to try this, which includes ensuring that a sturdy danger management framework exists and that a bank is obligated to see that it continues the perfect level of liquidity to fulfill its trading necessities. Within the same principle Bank Supervisors are enjoined to ensure the adequacy of the man or woman banks liquidity threat control framework.

Governance of liquidity hazard management

This segment accommodates three ideas. All relate to the extent of liquidity risk that a bank is prepared to take. This includes setting a stage of required liquidity to satisfy the character banks business method, the establishment of the correct control structure to manipulate this risk and the obligation of the financial institution’s board of directors to study and approve all problems regarding liquidity at least yearly. The 0.33 principle in this phase offers with the need for liquidity prices, blessings and risks to be integrated in product pricing and for the want for all new merchandise to be accepted as a way to understanding the effect they have got on and how they are suffering from the financial institution’s liquidity position.

Measurement and management of liquidity risk

This is the “meat” of the concept. It is made of eight man or woman standards. I will address each of these precept in flip.

Banks have to have a sound procedure to pick out, measure, reveal and manage their personal liquidity chance.
Banks must take a complete energetic liquidity view. This way that they have to manage their exposures and their investment throughout all their commercial enterprise strains, currencies and legal entities on the identical time. And they also need to allow for criminal, regulatory and practical limits to transferring liquidity between business the various entities that make up their commercial enterprise.
Banks must diversify their sources of investment and that they need to often take a look at their capability to raise adequate funds from those resources at short be aware.
Intraday (as opposed to overnight) liquidity need to be actively controlled in order that it is able to meet the financial institution’s obligations as they get up. Furthermore a financial institution needs to devise to do that below each everyday and strained conditions.
Collateral must also be actively managed and care must be taken to separate property which can be already tied-up and those that are free.
Regular pressure exams have to be undertaken, using extraordinary situations. This is essential because it will assist determine if the financial institution can maintain its liquidity necessities and usage inside the formerly set limits.
The bank need to have a proper emergency liquidity plan. This ought to also encompass clean lines of duty and escalation methods. This plan have to additionally be tested often.
Banks are also required to hold a buffer of unencumbered, high satisfactory liquid belongings to satisfy emergency conditions. These property should also be freed from any limitations to their use.
Public disclosure
There is a unmarried principle here – that a financial institution need to disclose statistics frequently that will permit market contributors to form their own opinion as to the bank’s liquidity and its liquidity risk management shape.

The role of supervisors

The final four ideas cope with the position of the financial institution manager. Firstly supervisors want to do a ordinary take a look at of the financial institution’s danger control shape and its liquidity function. On pinnacle of this they should be getting additional records like inner reviews and present day market statistics. If supervisors locate troubles they ought to additionally intrude to make certain that these issues are addressed right away.

There is also a requirement for supervisors to communicate with other supervisors and public government, like valuable banks, each inside and throughout national borders. This is to make sure that there is powerful cooperation regarding the supervision of liquidity hazard control. This verbal exchange needs to take place often in the course of normal times. In instances of strain this sharing of information wishes to boom appropriately.

This steering changed into published for preliminary consolation and comment. In a subsequent article I will address some of the “hows”, “whys” and “what to search for” in making use of some of these ideas.

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