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Can banks manage new liquidity requirements?

Banks’ risk management capabilities are under the spotlight following the events of the past two years.  The issue of liquidity used to sit firmly with the treasury department, but the advent of RTGS (real time gross settlement) has broadened its scope and the current scarcity and cost of liquidity means that this problem now affects the flows in commercial and retail payments departments.

Managing liquidity is however becoming more complicated due to two main developments: new payment systems which are affecting liquidity in ways not experienced in the past, and increased regulation in the area. Until the introduction of the UK’s Faster Payments Scheme in May last year, banks conducted their settlement overnight. However, now the real time payment mechanism for person-to-person transactions means that those banks offering the service must conduct settlement up to three times a day, which can have an important effect on liquidity.

Further regulation is on the horizon but the Basel Committee Report of September 2008 has already specified 17 clear liquidity principles which it expects banks to implement “promptly and thoroughly” in areas such as the identification and management of the full range of liquidity risks.

Banks are also increasingly realising that many payment services do not bear the real cost of the liquidity they consume. This is an issue since it could affect the customer proposition.  Can these costs be passed on in today’s challenging market conditions where customers are very sensitive to their own costs?

While all banks currently have some way of measuring liquidity, the systems responsible have typically grown organically over the years and numerous changes have been made as rules and payment types have evolved. These old legacy systems are naturally complex and difficult to maintain. The question remains whether they can rise to the challenge of more sophisticated liquidity management requirements, particularly in a siloed environment?

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Comments: (1)

Elizabeth Lumley
Elizabeth Lumley - Girl, Disrupted - Crayford 29 September, 2009, 13:22Be the first to give this comment the thumbs up 0 likes

Prior to the impact of the credit crunch many banks failed to perform any liquidity related scenario analyses, simply because they did not anticipate that the liquidity inherent in the market would dry up.

Now, all anyone in the risk world can talk about is liquidity risk management. However, isn't this a bit liking taking a birth control pill in the third trimester?

The purpose of liquidity risk management is to identify potential future funding problems. To do that a bank must have a firm understanding of its net cash flows and the fungibility of its assets.

Reporting and communication should also be considered. Many banks still rely on email for quarterly risk reports. A more robust MIS system should be part of any bank's enhancement to their risk platforms.

Stress tests should be conducted regularly for several firm-specific and market-wide stress scenarios with the goal of identifying sources of potential liquidity strain. The results of stress tests should also play a key role in shaping the bank's contingency funding plan.