Article written with guest author: Sridhar Aiyangar* / Group Head, Balance Sheet and Liquidity Management, Bank ABC
Think of your bank as a high-performance engine, built for speed and endurance. However, even the most powerful engine can’t deliver optimal performance if it’s not finely tuned. Overlook the balance of its components, and you risk breakdowns just when you need to accelerate or get around a nasty obstacle. The same is true for your bank’s balance sheet—it is an intricate machine.
And strategic liquidity management is about more than just keeping the engine running; it’s about optimising funding costs, improving funding diversification to achieve greater funding stability, and bolstering your ability to withstand stress.
“The better you understand your balance sheet structure, the more effectively you can define your liquidity buffers and free up assets for higher-performing opportunities.” —Sridhar Aiyangar, Group Head, Balance Sheet and Liquidity Management, Bank ABC
Sridhar Aiyangar is a senior banker and executive leader with expertise in key facets of banking visualisation, treasury, finance, and risk management within large multinational commercial banks. He is known as the “balance sheet doctor” for his ability to enhance decision-making through real-time data analysis. Sridhar, along with Planixs liquidity expert Nick Applebee, discussed how understanding and managing your bank’s balance sheet can be pivotal in enhancing a bank’s strategic liquidity position. They also touched upon structured solutions for liquidity risk management.
Why the focus on balance sheet optimisation?
We are seeing a heightened focus on liquidity management and balance sheet optimisation, in no small part because of changing regulatory environment, faster settlement, and changing interest rates expectations.
This emphasis prompts important considerations: Is your liquidity position where it needs to be? Should steps be taken to free up or acquire additional liquid assets?
Having the right information is essential for managing liquidity effectively and in real time. This approach is intricately linked to fostering a stronger culture of risk awareness. This contrasts with the criticism from some quarters that some banks look to prioritise short-term benefits over long-term stability.
As Sridhar says:
“Real-time data bridges the gap between theory and practice, providing senior management (and regulators) with deeper insights on the funding structure which fosters greater confidence. It allows them to accurately identify and monitor areas of stability and vulnerabilities, ensuring that the organisation remains in a safe and sound position at all times by putting into effect appropriate early warning indicators.”
Balance sheet management involves strategically managing assets and liabilities to maximise returns while minimising risk. It’s crucial for maintaining capital adequacy, allocating capital efficiently, ensuring that the bank has enough capital to support projected business growth – as well as to absorb unforeseen losses and continue operations during economic downturns. However, we are focussing on strategic liquidity management in this article.
Many CFOs and treasurers admit they have not been able to apply these disciplines to the fullest extent due to the lack of availability of granular cash flow data that is tagged to respective client segments and industry segments to assess potential vulnerabilities in a given stress scenario. This lack of granular analysis can lead to banks maintaining higher levels of liquidity buffers for potential stress events or from unexpected market shifts.
4 step framework for effective liquidity management
Sridhar observes that robust analysis of a bank’s balance sheet is at the core of effective liquidity management. In consulting with banks around the world, he emphasises the importance of a detailed evaluation of assets and liabilities, particularly amidst changing economic conditions and heightened risk factors. Sridhar proposes a four-stage approach:
ONE: In-depth analysis
Balance sheet structure evaluation
- Assess Asset and Liability maturity mismatch on both a contractual and behavioural basis (using historical observations and statistical analysis).
- Scrutinise funding sources and balances at granular levels, considering factors such as liquidity characteristics, client segments, depositor concentration & stickiness, and industry segments of deposits.
- Assess the liquidity characteristics of assets and identify portfolios that can be converted to cash within a reasonable timeframe, if needed.
- Understand the impact of various products/asset classes, client segments, external ratings, and tenor profiles on liquidity metrics, as these factors affect different regulatory liquidity metrics differently (for e.g., Retail deposits have a 90%/95% Available Stable Funding (ASF) factor while Corporate deposits have ASF of 50% only. Similarly credit rating, industry segment and tenor have differential Required Stable Funding (RSF) factors for NSFR.
Understanding Vulnerabilities
- Implement scenario modelling and stress testing to identify vulnerabilities in the asset portfolio and funding position.
- Tag cash flows by industry segment, client segment, product type to gain deeper insights into vulnerabilities of cash flow and potential impact on metrics under different stress scenarios
TWO: Setting risk appetite
- Utilise insights from the above analyses to establish appropriate liquidity risk appetite limits for key metrics (Liquidity Survival Horizon, LCR, NSFR, Loans to Deposits Ratio, Depositor concentration limits, and liquidity mismatch limits)
- Use stress testing results to determine suitable levels for liquid asset buffers to withstand potential stress events (both idiosyncratic and systemic).
- Develop relevant early warning indicators based on these analyses.
Sridhar says,
“For an effective plan and the ability to navigate stress events, it is important to get granular data that can inform the extent of a potential stress impact. For example, a Covid type stress would impact cashflows from manufacturing, transportation, hospitability and leisure sector while pharma and IT sectors remains resilient and will perform better. Understanding data at a granular level will help to navigate the stress more confidently, effectively and with efficiency.”
THREE: Contingency funding plan
- Develop a well-defined contingency funding plan that includes:
- A set of contingency funding actions for stress scenarios.
- A crisis committee governance structure.
- An escalation process.
- Clearly defined roles and responsibilities for key management personnel/functions.
- A communication plan covering both internal and external stakeholders.
- Run stress tests to simulate macroeconomic and entity-specific stress events (e.g., reputational risks like cyber-attacks or regulatory issues).
- Conduct liquidity fire-drills to ensure the effectiveness of the contingency plan and the ability to execute planned actions during stress.
- Establish Repo funding lines with Central Banks and market counterparties for immediate liquidity support. Periodically test these lines to ensure operational effectiveness.
- Preposition eligible assets for funding from Central Banks as an important crisis funding avenue.
FOUR: Integrated risk management
- Transition from siloed risk approaches to an integrated enterprise risk management framework.
- This holistic strategy provides a comprehensive view of liquidity, operational, and compliance risks, enhancing decision-making and governance.
Advice around emerging risks
Discussions about risk have evolved significantly. Sridhar notes that following the global financial crisis, there has been an increased focus on risk appetite, governance frameworks, and early warning systems. A bank’s risk management framework must now encompass a broader spectrum of risks beyond mere compliance or liquidity risk management. It should lead to more informed decision making that can lower the risks as well as costs.
Complexities like emerging geopolitical instability, the rise of shadow banking, and the increasing role of cryptocurrencies require treasury and finance functions to stay informed and agile. Sridhar offers this practical advice:
Geopolitical Factors: Economic disruptions can arise from geopolitical tensions which can impact global liquidity. Banks should implement strategies to mitigate these risks, such as diversifying portfolios, stress testing and ensure adequate levels of liquidity buffers and availability of credible contingency funding actions.
Technological Innovations: The fintech revolution brings both opportunities and threats. Banks must be proactive in understanding how innovation in payments, cryptocurrencies, and digital banking could affect their traditional liquidity operations.
Regulatory Changes: With regulation constantly shifting, financial institutions must ensure compliance while remaining competitive. A thorough understanding of regulations is necessary for strong risk management frameworks that can provide a competitive edge.
“If your institution struggles with inadequate tracking of real-time balances, you will also struggle with accurate liquidity forecasting. A lack of effective tracking systems can result in a foggy understanding of available liquidity, causing difficulties in predicting cash flow needs. This leads to higher costs as banks attempt to correct imbalances and ensure compliance with regulatory requirements.” —Barry Lewis, Associate Partner, Elixirr
Sridhar’s experience further highlights the crucial role that banks with robust balance sheets can play during financial crises. When a bank has a well-structured balance sheet, it not only secures its own financial position but also opens avenues for collaboration and support within the broader banking ecosystem. By leveraging their strengths, such banks can provide much-needed solutions to weaker counterparts, thereby contributing to the overall stability of the financial system while improving its profitability.
Advanced strategies for strengthening your balance sheet
Building upon the four foundational steps of balance sheet optimisation, liquidity experts at Planixs have helped banks further enhance their financial resilience through the following advanced strategies:
Capital Optimisation: After securing capital adequacy, the next step is to develop innovative solutions that optimise capital usage.
Enhanced Liquidity Management: With a solid understanding of liquidity needs, banks can adopt practices that refine cash flow forecasts and liquidity positioning. This involves closely monitoring the maturity profiles of assets and liabilities to ensure liquidity is unlocked and maintained.
Data-Driven Insights: Leveraging advanced analytics and scenario modelling can further refine decision-making processes. By continuously evaluating how different scenarios could impact liquidity and capital structures, banks can remain agile in the face of economic shifts.
These advanced strategies build on the initial steps of balance sheet optimisation, offering banks a roadmap to not only fortify their position but also to thrive amid economic challenges.
Transform how you see and use data
Planixs collaborated with clients to develop the Realiti platform, a best-in-class real-time ILM tool used by leading financial institutions such as Barclays, National Bank of Canada, Scotia Bank and many others. While the largest banks invest $millions in creating in-house systems, Realiti can also offer smaller banks similar capabilities at a lower cost and fast.
“Believing in the data does not necessarily make it true. The accuracy and reliability of data depend on its source, the methods used to collect it, and the context in which it is analysed.” —Lindita Blakaj, Money Market and Investments Manager, Raiffeisen Bank of Kosovo
Realiti’s suite of tools put real-time visibility and intelligent liquidity management practices in the hands of every financial institution. The transformation in their operations can be remarkable.
What leading banks say
These three quotes are from partners of ours, banks like Santander, AIB, and Lloyds, demonstrating how implementing Realiti capabilities can generate value exceeding $100 million per annum:
1. According to one partner, “Companies not using Realiti are limiting their treasuries from tapping into this powerful source of real-time liquidity data, and therefore, they’re at a massive disadvantage. Choosing to manage liquidity the ‘old-fashioned way’ or manually when Realiti exists doesn’t make any sense.”
2. Another partner highlights that, “If you’re paying your treasury staff to manually manage liquidity data, essentially, you’ll be paying skilled professionals to do basic administrative tasks.”
3. Describing the platform’s benefits, a partner notes, “The platform’s additional features open up new opportunities by offering real-time visibility into counterparties, optimising fund transfers, and identifying spare liquidity for new products.”
We are seeing a paradigm shift in how financial institutions manage liquidity and navigate the complexities of modern-day transactions. Realiti has proven its value to financial institutions (FIs) repeatedly. The insight and analytics available from this data are transformational across all business units of the bank including Treasury, Operations, Risk, Front Office and Office of the CFO.
In short – don’t guess, know.
*Views expressed are personal.
