LIQUIDITY RISK MANAGEMENT
By Stalcup, Philip R | |
Proquest LLC |
Provide for adaptation to changing requirements
Four years ago, the
Regulators increasingly are scrutinizing the adequacy of institutions' liquidity risk management framework, leaving those institutions that haven't taken action facing regulatory criticisms and potential enforcement action.
Since 2010, the supervisory perspective on the adequacy of an institution's liquidity risk management framework has been influenced by related regulations covering capital stress testing, model risk management and enhanced liquidity standards required under the Dodd-Frank Act.
Accordingly, an institution's liquidity risk management framework should include a review of governance controls, control procedures and tools to make sure they are consistent with the size and sophistication of the institution as well as the nature and complexity of its activities.
New standards bring new expectations
In
The NPR LCR would for the first time create a standardized minimum liquidity requirement for large and internationally active banking organizations and systemically important nonbank financial companies designated by the
These institutions would be required to hold minimum amounts of high-quality liquid assets such as central bank reserves and government and corporate debt that can be converted easily and quickly into cash.
The proposed LCR requirements for the U.S. generally are consistent with the Basel III international standards and are scheduled to be implemented effective
Banks of all sizes currently are required to maintain a liquidity risk measurement framework consistent with the size, complexity and risk profile of their institution. Meeting this objective begins with financial institutions considering several strategic questions.
* Are the tools and data used for liquidity projections adequate and properly sourced?
* Are contingent liquidity risk events planned for properly?
* Is the stress-test reporting sufficient?
* Is the model risk management framework current and adequate?
Readying for the changes
In an effort to stay ahead of operational needs and manage contingent liquidity risks, institutions are assessing their operational liquidity risk in dynamic fashion through tools such as forecasting models. Operational cash flow forecast reports must be able to project daily cash flow gaps over a 30-day period.
These forecast reports are becoming increasingly granular and complex, and institutions for which the LCR requirements apply must be able to forecast the largest net cumulative outflow position during a 30-day stress period in order to capture the effect of maturity mismatches.
Significant challenges might exist in developing reporting that reliably can forecast liquidity in future periods. Liquidity forecast reporting requires the timely collection of reliable data across all lines of business. Poor data quality or management information system limitations can adversely affect the reliability of the information gathered.
For instance, if the data used in the liquidity forecast model resides throughout the institution on multiple IT platforms, data aggregation can be complex, and the risk of data error would increase. In addition, assumptions used in liquidity forecasting might be invalid and not accurately reflect customer or product characteristics of one or more of an institution's lines of business.
Institutions subject to LCR requirements should perform a detailed review of current management information systems, data and reporting capabilities to identify potential weaknesses that might adversely affect the institutions' ability to timely and effectively implement LCR reporting.
Contingency funding plan
Another important component of liquidity risk management is an institution's liquidity contingency funding plan (CFP), which should be current and provide for the identification and analysis of the institution's contingent liquidity risks through relevant stress scenario analysis.
CFP stress scenarios should be periodically updated and should consider potential liquidity events over short-, intermediateand long-term time horizons. Significant risks, sources and funds use, as well as assumptions encompassed in each stress scenario, should be well-documented and supported.
The assumptions used should be subject to effective challenge, as regulatory agencies have dramatically increased their scrutiny around assumptions about contingency funding sources. In addition, the planned risk mitigation measures for each stress scenario should be welldescribed.
Each institution's liquidity risk management framework must provide for the periodic assessment of contingent liquidity risk that is analyzed through the use of stress-test reporting that assesses the effectiveness and appropriateness of the risk mitigation measures for each stress scenario defined in the CFP. This is accomplished by comparing the institution's forecasted liquidity position under defined CFP stress scenarios with established liquidity risk tolerance limits, assuming the implementation of the risk mitigation measures specifically described in the CFP.
The analysis of stress-test reporting should be robust and allow management and the board to determine if the institution's balance sheet composition, diversity of off-balancesheet funding sources and liquid asset cushion provide for sufficient liquidity levels under alternative stress conditions that are aligned with the institution's risk tolerance levels.
Stress-test reporting results should allow management and the board to confirm the survivability of the institution under alternative liquidity stress scenarios. In the event that stress-test reporting identifies insufficient liquidity levels under a given stress scenario, a remediation plan should be determined, documented, communicated and approved in accordance with the institution's policies.
Stress-test reporting might also act as a tool to recalibrate or tune the institution's funding strategy where possible. This could include opportunities to increase yields on earning assets while maintaining an adequate liquid asset cushion.
The road to successful liquidity risk management
An institution's model risk management framework and control procedures play a significant role in its approach to liquidity risk management. Model risk management and control procedures governing the institution's liquidity forecast models should encompass the governance and control mechanisms described in the supervisory guidance on model risk management.
Consistent with the supervisory guidance, banks should perform periodic back testing and validation of liquidity forecast models and liquidity stress-test models to assess the adequacy of the model design and implementation, the integrity of data and the assumptions used in producing liquidity forecast reports.
Model design and implementation problems, data errors and invalid assumptions identified through the model back test and validation process should be documented, remediated and retested to verify the sufficiency of corrective actions.
An effective liquidity risk management framework requires ongoing investments in information systems, people and risk management systems. The regulatory and operating environments that affect liquidity risk management are continually evolving. Au institution's liquidity risk management framework should be designed to make certain that business planning provides for the adaptation to changing requirements. O
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Copyright: | (c) 2014 Texas Banker Association |
Wordcount: | 1225 |
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