SKS LiqRisk Maturity Matrix

Since the sub-prime crisis, at the very latest (starting in Spring 2007), we have known that it was not only the volume of payment defaults that were insufficiently monitored and controlled, but also the extent of the losses in market value (adjustments to the capital buffer). Also, in crisis situations, it was by no means always possible to realise (in the short-term) receivables exposures, or for banks to secure relatively stable refinancing.
The requirement to continue, across different scenarios, to comply with mandatory regulatory ratios (LCR, NSFR), which have been introduced and to take adequate account of the cost of liquidity is not only the subject matter of the Basel III framework. This also forms part of the "Principles for Sound Liquidity Risk Management and Supervision“ that have to be implemented in Germany in accordance with BaFin's "Minimum Requirements for Risk Management" (MaRisk). Nevertheless, this is by no means a replacement for the instrument that has traditionally been used, namely, a funding matrix (liquidity gap analysis) based on internal models (incl. scenarios). This merely complements it.

Exact quantification of liquidity through methodical and process-oriented liquidity risk management. 

Besides the challenge of quantifying liquidity and the liquidity risk as precisely as possible, there is, therefore, also the further challenge of connecting liquidity risk management to bank-wide risk management. In the sense also of aligning the way that liquidity risk is treated in relation to credit or market risks.
If the quantification of the liquidity risk is imprecise, or not comprehensive then the bank will be in danger of managing its risks on the basis of false information. Then again, if the quantification of the liquidity is exact, but liquidity risk management has not been integrated, or not thoroughly into the bank-wide risk management, then signals that are important for risk control would be ignored. If a financial institution were to ignore one of the stipulated variables, which should be viewed as one of its core competencies, then the minimisation as well as the effective control of liquidity risk would no longer be possible. 
Embedding control indicators (that are as precise as possible) - possibly for Liquidity@Risk - into the overall process flows has to be pursued methodically and in a process-oriented manner. In the current market environment this constitutes a competitive advantage from both an auditing and an economic perspective.  

In this way it is possible to compare actual values with future target values. 

The SKS LiqRisk Maturity Matrix juxtaposes two components – the quantification of the liquidity risk (i) and the integration of liquidity risk management (ii) into bank-wide risk management. The matrix thus illustrates, on two distinctly separate levels as well as on a superordinate level, the quality of the liquidity risk management that is currently being "practised" by the company (= actual situation). Furthermore, the SKS LiqRisk Maturity Matrix shows the development potentials in the area of quantification and connection to bank-wide risk management (= target situation). Moreover, the matrix simplifies the classification of regulatory requirements as well as the associated need for action as regards the quantitative and qualitative aspects.

The SKS LiqRisk Maturity Matrix can be divided into four quadrants:

 

  • Quadrant 1 – LiqRisk as a mandatory regulatory task
    Insufficient use is made of both the connection to the bank-wide risk management system as well as the quantitative capabilities. Liquidity risk management is essentially being conducted solely within the scope of regulatory requirements.
  • Quadrant 2 – Knowledge that is not being used
    Even though the quantitative methods in the LiqRisk are well developed and are being used, the integration of this knowledge into the bank-wide risk management system is lacking.
  • Quadrant 3 – Risk management not based on knowledge
    Even though liquidity risk control is connected to the bank-wide risk management system, the quantitative capabilities in the LiqRisk area lag behind the standards in the area of credit and market risks. Effective control is not possible.
  • Quadrant 4 – LiqRisk constitutes competitive advantage
    As LiqRisk is deemed to be as important as credit risk or market risk it is fully reflected in the overall risk assessment; optimisation potential, if any, is very marginal.

Here, the path from Q1 (minimum) to Q4 (maximum, or better: optimum) shows a steadily increasing share of inter-departmental activity and a targeted and achievable benefit at the level of the bank as a whole. In this way, it is possible to shift away from purely operational measurement towards strategically integrative management.
Furthermore, the clear presentation and the ease of use make it possible to conduct benchmarking. As a consulting firm, we have been managing this for the financial industry and for selected clients since 2010. The following depiction, which uses anonymised data, illustrates both the principle behind the SKS LiqRisk Maturity Matrix as well as the result and, thus, the benefits associated with it.