The IAIS plans to consult on metrics for liquidity monitoring in 2020 and 2021. Holistic liquidity metrics. These metrics, together with the LCR and NSFR standard, provide the cornerstone of information that aid supervisors in assessing the liquidity risk of a bank. Figure 1 summarizes our market risk taxonomy. New York, NY 10168. Liquidity Risk Measurement and Management Creating a state-of-the-art liquidity risk management framework in a dynamic market context Liquidity is the ability of a financial institution to fund increases in assets and meet obligations as they come due, without incurring unacceptable losses. Liquidity risk is the risk that an institution’s financial condition or overall safety and soundness is adversely affected by an inability (or perceived inability) to meet its obligations. Because of its tendency to compound other risks, it is difficult or impossible to isolate liquidity risk. An integrated liquidity risk management framework and the development of a robust and operational CFP enables the strategic forecast and optimization of liquidity risk management. In addition, supervisors may need to supplement this framework by using additional tools and metrics tailored to help capture elements of liquidity risk specific to their jurisdictions. Providing intraday liquidity risk oversight for various legal entities maintaining active dialogue with trading desks, Corporate Treasury, Operations, Risk Management colleagues, and other support groups regarding business activities generating intraday liquidity risk exposures, risk representation, as well as adherence to limits and Key Risk Indicators (KRIs) Get The Principles of Banking now with O’Reilly online learning. The holistic liquidity metrics are used to provide more context to market conditions than traditional liquidity metrics. Liquidity means fluidity: the firm has funds ready to flow for immediate spending needs. The contingency funding plans (CFPs) of many firms should be linked to stress test results, but often fail to consider the potential closure of some funding sources. 12 Interagency Policy Statement on Funding and Liquidity Risk Management, March 17, 2010 Summary The point of calculating and reporting liquidity risk metrics is to enable senior management to have the most accurate, and up‐to‐date, estimation of the liquidity exposure of the bank at any time. © 2020, O’Reilly Media, Inc. All trademarks and registered trademarks appearing on oreilly.com are the property of their respective owners. These liquidity metrics will serve as a tool for the IAIS to assess insurers’ liquidity exposures. Thus banks can only add to the range of metrics they use, because a benchmark minimum is required under Basel III. Liquidity Risk Management and Supervision, liquidity is “the ability of a bank to fund increases in assets and meet obligations as they come due, without incurring unacceptable losses.” 8. Funding liquidity risk refers to the risk that a company will not be able to meet its short-term financial obligations when due. Technology Innovation for Financial Markets. We utilize a holistic and comprehensive framework that includes the measurement of business activities and design of stress scenarios to the strategic management of liquidity risk, creation of a corporate governance framework and validating processes that have been implemented. The ICE Liquidity Indicators service provides an independent, near-term view of relative liquidity. The ability to exit a position at or near the current value, to help support risk management in connection with a variety of regulatory obligations. Background Liquidity metrics such as Working capital and Current ratio measure the firm's ability to produce cash flow and meet short term needs. The below figure outlines the tests and metrics typically used internal liquidity risk management. IAIS issued a consultation on systemic risk that included a more detailed liquidity risk management framework.2 In addition, in March 2019, the Prudential Regulation Authority (PRA) in the UK issued a consultation paper (CP) on liquidity risk management for insurers.3 insurer liquidity risk, exploring sources of that risk and providing This reflects the fact that the business of liquidity risk, like the wider field of asset–liability management, is as much art as science. They will not be a binding requirement, but rather a monitoring tool, and will help identify trends in insurer and insurance-sector liquidity. Only 39% of delegates, mostly from risk management desks, said in an online poll that they had formalised measures of liquidity and 85% said they needed better liquidity risk metrics. uncertainty due to liquidity risk. Funding or cash flow liquidity risk is the chief concern of a corporate treasurer who asks whether the firm can fund its liabilities. Firms that implement liquidity risk metrics should ensure that conservative and appropriately difficult assumptions are used in designing the risk measurement and management systems. Accordingly, liquidity risk has to be managed in addition to market, credit and other risks. Liquidity risk stress testing is very different than that of market risk as the latter tends to be tied to systematic drivers over time such as declining GDP, or overvalued markets. Severe and prolonged liquidity disruptions are plausible, and stress tests that factor in the possibility of market wide strain or the severity or duration of disruptions should be conducted. The ICE Liquidity Indicators service provides an independent, near-term view of relative liquidity. Conventional VaR approaches such as JP Morgan’s (1996) RiskMetrics focus on capturing risk due to uncertainty in asset returns but ignore uncertainty due to liquidity risk. Banks must appropriately measure liquidity risks posed by individual products and business lines, and incentives at the business level must be aligned with the overall risk tolerance of the bank. One of the principles of bank liquidity management we introduced in the last chapter stated that liquidity risk cannot be represented by a single metric, but rather by an array of metrics. Buy-side risk managers polled at Risk Hedge Europe's annual conference disclosed they had little faith in their own liquidity metrics. In other words, funding liquidity risk is the risk that a company will not be able to settle its current outstanding bills. This would result in the collapse of the entire economy or reduction in the value of the currency and various other domino effects would take place. In the wake of the 2008 crisis, national regulators and the BCBS proposed a consistent set of monitoring metrics for all firms. Failure to do so could well cause the risk management framework to fail in a real liquidity crisis. Liquidity refers to the amount of market interest (the number of active traders and the overall volume of trading) present in a particular market at any given time. Many of the liquidity stressed events that we’ve directly observed in recent years have their roots in a single day and event that triggered them. Hence, it is deemed necessary that liquidity risk management in banks should be appropriately done. FHFA expects the Enterprises to use liquidity metrics that are commensurate with their funds management strategies and provide a comprehensive view of their liquidity risk to ensure that sufficient funds are available at a reasonable cost to meet potential demands. In some instances banks will not have a choice with regard to the liquidity metrics they report. These listed shows that the impact of liquidity risk on banks is very high. This was so as to assist supervisors across jurisdictions in looking at the liquidity risk in global banks, and to create a common language for MI, reducing the risk of misinterpretation of information by bank boards and regulators. Together with liquidity cash flow metrics, the liquidity position of an institution can be gleaned by banks funding costs and the components of its funding by product. The metrics highlighted in Basel III documents were supposedly already captured in some form by banks for their risk management purposes; however, they were not reported to supervisory bodies. In January 2013, 2 the Basel Committee therefore published its "Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools" (LCR and Tools). The LCR is a risk-sensitive liquidity metric that is used to assess whether a credit union has an adequate stock of HQLA to survive a 30-day stress scenario. The financial crisis exposed that many banks did not have an adequate liquidity risk management framework. Effective enterprise-wide liquidity stress testing that incorporates the methodological approaches of Basel III’s LCR and NSFR stress testing metrics with CLAR and Contingent Liquidity concepts will present a unique challenge when integrating across risk. Understanding Liquidity. 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