Liquidity Risk Management

Since the financial crises in the banking sector took place, one thing became clear: not only equity has inadequately been monitored and managed, but also liquidity. In times of stress and crisis, cash and cash equivalents (i.e. the short-term realizability of assets) must be on sufficiently available to cover extra outflows and maturities must be sufficiently matched (assets v/s liabilities).

The new regulatory ratios (LCR, NSFR, ALMM) introduced in the course of CRR have since stipulated a minimum level of liquidity reserves and refinancing structure. However, these ratios do not replace the traditional instrument for achieving this aim, namely internally modeled liquidity maturity statements (including scenarios).


In addition to the minimum requirements under Pillar 1, which follow strict regulatory guidelines, supervisory authorities are also increasingly interfering in internal bank models (Pillar 2) and setting ever-stricter frameworks. Apart from the Internal Liquidity Adequacy Approach (ILAAP), the extended disclosure requirements have increased documentation requirements enormously.


Ongoing audits and stress tests conducted by the supervisory bodies continue to tie up personnel internally, making it difficult for banks to devote the resources required to develop the new automation measures that are so urgently needed. And, of course, these measures are precisely those that supervisory bodies (i.c.w. BCBS 239) have recently named a key priority.


The challenge posed by liquidity risk management today lies in the availability and reconcilability of data.


The exact quantification of liquidity reserves and the modeling of liquidity gap balances remain a key component of ongoing liquidity management. In particular, the modelling of prepayments for fixed rate loans as well as drawdowns for sight and savings deposits and/or credit facilities leave room for further optimization when it comes to strengthening banks’ liquidity profiles.


However, the relatively static analyses and representations of the liquidity situation that have been prevalent to date are being overshadowed by the new challenge of being able to react quickly or “ad-hoc” to inquiries from the supervisory authorities and the stress scenarios contained therein in the future. For example, the ECB recently asked banks to present their liquidity situation from a variety of viewpoints on five consecutive days and to present stress scenarios in the standardized form of the maturity ladders. This new way of auditing banks is primarily aimed at internal management processes and the willingness of banks to make evaluations available in a wide variety of formats, placing the data landscape at the heart of future efforts to further improve liquidity risk management.


The "Principles for Sound Liquidity Risk Management and Supervision" established by the CEBS (followed-up by EBA = European Banking Authority) were largely adopted by the EU in the course of CRD IV and form the basis of the supervisory authority's demands for more governance in liquidity risk management. Together with the ILAAP, this has resulted in a comprehensive framework that must be fulfilled. On the one hand, the common thread in the setup within liquidity risk management plays a central role, and on the other hand the ECB is placing ever more importance on consistency in other areas (ICAAP, accounting, management).


So in addition to the challenge of quantifying liquidity and liquidity risk as precisely as possible, there is also the added challenge of linking liquidity risk management to total bank steering - also in the sense of harmonizing the treatment of liquidity risk in relation to credit and/or market risk.


In principle there are two approaches to meeting this challenge:

  1. Reducing complexity
  2. Overcoming complexity


Reducing the number of data interfaces between and within the systems falls under the first point, as each interface automatically requires reconciliation and maintenance. However, the number of interfaces also results from the organizational structure of the Bank and its functional separation into risk, accounting and regulatory reporting. In this instance, process-related integration of related business areas should be considered (e.g. liquidity management, risk and reg. reporting) to reap the benefits of the synergies that result.


Establishing processes that enable efficient and effective workflows within the organization falls under the second approach. This includes both the organizational processes within and across all departments as well as all data processes, which continue to feature a large number of redundancies in most banks. Moreover, the field of data governance is becoming the focus of efforts for preparing for ongoing digitization in the banking industry. Together with comprehensive reporting, the course is currently being set for the future of banking.


As the focus at most banks is currently set on meeting new regulatory requirements, little time remains to work towards making sustainable improvements to liquidity risk management. However, those banks that do manage to turn these new regulatory challenges into economic opportunities—in the sense of improved risk management and increased efficiency overall—will enjoy clear advantages over their competitors in the future. SKS is happy to help.