Modern approaches to liquidity risk management

real time treasury
Pete McIntyre, the liquidity expert

Written by Pete McIntyre

February 5, 2024

Liquidity risk in the banking sector refers to the potential inability of an institution to meet its financial obligations as they come due without incurring unacceptable losses.

This type of risk arises from the mismatch between a bank’s liquid assets and its liabilities. Liquidity risk, in short, is the risk that a bank will not be able to convert its assets into cash quickly enough to satisfy its short-term obligations, such as customer withdrawals, interbank payments, or debt obligations.

The management of liquidity risk is critical for banks because they operate within a complex web of financial obligations, all of which run on different timelines, but all of which must be met promptly. Banks typically hold a portfolio of assets that range from highly liquid, such as cash and government securities, to less liquid, such as long-term loans and complex financial instruments. Different institutions hold different mixes of these assets, according to their risk profile and their overarching business goals.

At the same time, banks owe money to depositors and other creditors, often on demand. The challenge lies in ensuring that enough liquid assets are available at all times to meet these demands without having to sell other assets at a loss or seek expensive emergency funding.

Liquidity risk kills banks

When a bank fails to manage liquidity risk effectively, it can lead to severe consequences, not only for the institution itself but also for the broader financial system. A liquidity shortfall can quickly erode customer confidence, leading to a bank run where depositors rush to withdraw their funds, exacerbating the crisis. If the bank cannot halt the outflow of cash, it may be forced into emergency asset sales, borrowing from other banks or central banks, or even bankruptcy.

Recent examples of catastrophic liquidity crises abound. The most famous of the modern era, at least in the UK, is the 2007 failure of Northern Rock, an institution that had relied heavily on short-term funding from the wholesale money market to finance its mortgage lending. 

When the global financial crisis struck, the wholesale markets froze, and Northern Rock found itself unable to roll over its short-term loans. The resulting liquidity crisis led to the first bank run in the UK in over 150 years. Despite receiving emergency support from the Bank of England, Northern Rock was eventually nationalised.

More recently, liquidity crises have begun to spread again. Silicon Valley Bank was the partner of choice for much of the tech ecosystem. The bank collapsed in short order as a result of a liquidity crisis brought on by poor or non-existent risk management processes. Credit Suisse, meanwhile, ceased to exist in its historic form following a gradual erosion of trust in the institution that culminated in a major liquidity crunch.

Proactive, not reactive

Proactive risk management is crucial for all financial institutions because it allows them to identify potential liquidity issues before they become crises. Proactive measures include stress testing liquidity scenarios, setting internal liquidity limits, and maintaining a robust contingency funding plan.

Banks should maintain a buffer of liquid assets to cover unexpected outflows, optimise their asset-liability matching and portfolio mix, and ensure they have access to a suitably diverse range of funding sources. 

Of course, liquidity risk management is also crucial from a compliance perspective. Regulators have placed a sharp focus on liquidity since 2008, for example, the Basel III regulatory framework introduced global liquidity standards, including the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR). This requires banks to hold sufficient high-quality liquid assets and to maintain a stable funding profile.

“The capability to monitor today’s activity in real-time makes a decisive difference. What did we expect to happen, what has happened, how do we adjust for the rest of the day. After the recent events in the UK Gilts markets, and the banking disruptions in the US and Switzerland, we know that regulators will be focusing on intra-day liquidity and management capabilities. FIs can choose to sharpen those capabilities now!” – Olaf Ransome, Liquidity Futurologist, Planixs

Real-time liquidity management is no longer ‘nice to have’

With the regulators’ strategic shift real-time liquidity management is no longer ‘nice to have.’ If you want to mitigate risk and make your money work harder, you need easy-to-access, real-time data at your fingertips. It is essential for compliance and the cornerstone of successful strategic growth.

Acknowledged as the best-in-class solution for regulatory confidence, the Realiti platform is the only liquidity intelligence solution to deliver real-time, enterprise-wide 360° visibility of a firm’s liquidity landscape, control over treasury activities and value-creating insights, in one place. Realiti provides an invaluable liquidity lens, providing dynamic real-time insights across cash and securities.

A Planixs client at Scotiabank says: “Realiti is the only proven provider in this banking liquidity space. Additionally, the architecture of the solution made implementation remarkably nimble. A progression from deal signing to global go-live deployment was seen in just a few short months. Realiti aggressively fends off regulators and also drives a strong business value contribution–further enhancing the value for Scotiabank,” 

The outcomes for Planixs’ clients speak volumes – millions in savings on intraday liquidity buffer costs, ensuring compliance with the BCBS248 regulatory agenda, and fostering efficient and effective funding operations. 

Realiti’s staged rollout plan ensures that high-priority items, including regulatory compliance, are addressed first. This approach allows treasuries to experience immediate benefits while providing the flexibility to customise and expand functionality in subsequent stages.

Realiti is more than just a solution for your Treasury department; but a catalyst for transformation, offering a comprehensive suite of tools that actively contributes to your organisational advancement.

 You are warmly welcome to ask us any questions. Book a call to get expert advice from Planixs, we’d love to talk to you.

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