Liquidity and compliance for FIs – why real-time is the only answer

regulations and compliance cog wheels turning
Pete McIntyre, the liquidity expert

Written by Pete McIntyre

January 8, 2024

Liquidity is the watchword in a post-GFC world. Following the 2008 crash, one of the overarching priorities for regulators has been to ensure that banks and other institutions are sufficiently well managed to absorb unexpected systemic shocks while ensuring they retain the freedom required to finance economic growth.

Today we face risks and uncertainty on a scale that could yet outstrip 2008. While great efforts have been made to bolster the stability of the global banking system, liquidity remains a primary concern and a potential Achilles’ heel.

Where are we now?

In the EU, liquidity management is governed by a series of mandates made by the European Banking Authority (EBA). In particular, liquidity coverage ratios (LCR) and net stable funding ratios (NSFR) are set out in a series of binding technical standards established and implemented by the EBA.

These stem ultimately from Basel III, the set of rules agreed upon in 2010 as a direct response to the 2008 crash. The focus of Basel III was explicitly on the restoration of strong liquidity controls and on ensuring that institutions were sufficiently well-capitalised to absorb another so-called ‘Black Swan’. Basel III introduced new Leverage Ratio regimes, requiring institutions to adhere to certain limits regarding their debt obligations as a proportion of their total capital position. These rules were introduced into law by local lawmakers, and are implemented by regulators. In the UK, for example, the Bank of England sets rules on LCRs, and implements them through a strict reporting and disclosure regime. These fall within the overarching ‘prudential regulation’ remit assumed by the Bank.

It’s been common for LCR, NSFR, and other such metrics to be reported on a monthly basis. Therefore, the data is already out of date by the time it reaches regulators. Far more timely data is required if institutions are to properly understand their liquidity positions.

Compliance requires data

It should go without saying that compliance is now the most important priority for any financial institution, especially as we enter a period of acute uncertainty. Over the last decade regulators and policymakers have rapidly tightened the regimes under which banks and other FIs operate and, while domestic politics still has some bearing on the strictness with which those regimes are enforced, every person in a senior position at an FI should be well aware of the organisational and personal risks associated with non-compliance. For a stark reminder of this, we need look no further than the custodial sentences handed to those blamed for the LIBOR scandal.

Institutions cannot ensure compliance with their liquidity requirements unless they have complete visibility of their current and projected position. Generally speaking, FIs are getting better at gathering and interpreting the range of signals and metrics that form their liquidity KPIs. But, as Planixs discovered at a recent summit of Nordic banks, capabilities of managing liquidity in real time are still far behind where they should be, both on an organisational and personal level.

Basel is the bare minimum

The reporting and regulatory requirements set out in Basel III are the absolute core of institutional liquidity risk management. Again, the specific ways in which those requirements are executed may vary depending on territory, but the principle is the same: all regulated entities must demonstrate that they can meet their capital and liquidity requirements at all times.

But Basel III is the bare minimum required of institutions, and already the reporting regimes associated with it are beginning to look outdated. Consider, for example, the liquidity coverage reporting obligations of a regulated entity in the UK. As set out in the PRA Rulebook, institutions are required to report every month – but in a global economy increasingly defined by near-instant transactions, how can this be considered sufficient from either the regulator’s perspective or that of a responsible institution?

The limitations of month-end reporting can be starkly seen in the collapse of Credit Suisse, which in fact had perfectly healthy ratios when judged against their regulatory requirements – but these did not mean that the institution itself was stable.

As Nick Nicholls recently pointed out, liquidity management solutions and processes have barely evolved since the publication of the BCBS’s ‘Sound Principles’ document in 2011. But today, in an economy defined by ever-faster transactions and ever-larger cash outflows, real-time data is an absolute necessity. In Nicholls’ equation, “Sound Principles + real-time = liquid confidence.”

Real-time transactions require real-time data

To properly understand their liquidity position, modern financial institutions need access to true real-time data. As the sector moves towards standard T+1 settlement, and as transactions of almost every kind can now be carried out on a near-instant basis, it is an absolute necessity for FIs to have access to data as it is being recorded.

Olaf Ransome, Liquidity Futurologist at Planixs, sums up the current position. “Today, liquidity management is typically focussed on periodic mandatory reporting: LCR, NSFR and any intraday obligations. I believe that focus should be extended to ensure robust capabilities for real-time intraday liquidity management capabilities. There should be a real-time view of what was expected to happen vs. what has happened and the current collateral availability.”

Cash and liquidity crises are almost always defined by speed. In a conventional bank-run situation, the crisis materialises when the institution cannot honour withdrawals at the speed at which they are requested. Variations on this template can be seen in almost every institutional collapse, including both SVB and Credit Suisse in this year alone. SVB lost 85% of its deposits over just two days.

To ensure resilience in a real-time economy, institutions need to be able to see and understand their real-time position. This is both a strategic benefit and an existential necessity; real-time liquidity management is the only way institutions can remain both fully compliant and sufficiently agile to negotiate an economy ruled by speed.

You may also like…

Real-time Liquidity Management

Real-time Liquidity Management

Contents Introducing real-time liquidity management Why do real-time liquidity insights matter? Using technology to...