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5 free takeaways from a regulator’s latest squeeze on Intraday Liquidity risk

In my last post I described the latest state of BCBS248 rollout by regulators across the globe. I said that my next post would pick out what we can learn from some of the regulators’ public utterings, so today I will focus on analysing the UK PRA’s latest thoughts on intraday liquidity.

Why should I care about the UK PRA?

The UK PRA is worth keeping a close eye on wherever you are in the world, because they have always been at the forefront of assessing intraday liquidity risk. Much of the original BCBS248 push in 2012/13 came from their efforts, along with colleagues in the Dutch PRA.

The UK PRA has just gone out to consultation on its planned next wave of regulation, all intended to build upon, and beef up, their approach to Liquidity risk. Have a look at their latest paper on Pillar 2 liquidity, published on May 12th 2016.

Amongst other things, this new regime is gunning for intraday liquidity.

Intraday liquidity is consulted on …as it is a significant risk which is not captured in the Pillar 1 standard

It is really insightful to dig into the consultation and pick out what we can learn from the regulator’s thinking. Here are five key takeaways.

1. It’s not really about BCBS248 and after-the-event analysis

One of my major gripes with the BCBS248 regime is that it is very backward looking. It asks a firm to look historically and report what its intraday usage was. Now that has its place, but Northern Rock, Lehman Brothers etc were no longer around to calculate their intraday peaks and troughs six weeks after they went bust….

Other than a few references and some builds on stress scenarios, this latest consultation doesn’t really mention BCBS248 much. Instead, it links back to earlier approaches such as Basel’s ‘Principles for Sound Liquidity Risk Management and Supervision’ and wants to ensure that firms have a much better handle on their risk positions than simple backward‑looking reporting would give them.

It also gives a clue to some future requirements on firms. There is an interesting comment explaining how the regulator expects a firm to know its future outflows & inflows, which has some parallels with the Fed in the US wanting firms to show they have a really good grip on planned and actual activity as business settles throughout the day.

2. It links LCR to intraday liquidity

intraday liquidity shortfall

The regulator is quite specific in saying that the LCR could be inadequate in assessing a firm’s ability to reach the iconic “30-day” horizon. It makes the point that “The PRA is concerned about the risk that firms may on paper meet the LCR, but fail the stress scenario embedded in the metric if the requirement were computed using more granular, daily cash flows” and provides a lovely graphic to illustrate the problem.

3. We have a new metric – maximum net debits

The most useful, and hardest, part of BCBS248 is measuring your peak use of

maximum net debits intraday liquidity

intraday liquidity historically. The idea is that this metric can be compared to your intraday liquidity buffer to see if the buffer is big enough.

The consultation paper takes a subtly different approach, and wants a firm to look at the ‘maximum net debit position’ (which is effectively each day’s peak usage of liquidity when you ignore any start of day credit balances). This is to test if the actual roll-out of the ‘LCR plan’ could come unstuck, as illustrated in the previous diagram.

It then wants you to pick out the average of these positions (to ignore extreme events that a firm typically is prepared for and adequately buffered against).

Again, they provide a helpful illustration to drive the point home, 1400 and 1445 look like dangerous times.

4. Stress scenarios become really important

The consultation paper is very explicit that it wants to use stress modelling to assess the intraday risks of the firm. The BCBS248 stress scenarios are referenced and beefed-up a little, as they want you to look at your maximum net debits then consider what stress could do to your world.

The regulator appears to be removing some of the mystery around setting intraday liquidity buffers. They want it to become much more explicit – your buffer needs to be big enough to support your maximum net debits, and then there will be a ‘stress uplift’ that is designed to ensure the buffer can cope in times of stress.


5. You need to get really good at managing intraday

The regulator has been careful to point out that they will still apply judgement to the final decisions on stress buffers, and your best chance of a ‘good’ answer is to prove that you are on top of your intraday game. I quote (my emphasis)

“Factors taken into account will include, but are not limited to, the sophistication of the firm’s intraday liquidity management systems, how the firm connects to the respective payment and securities settlement systems it uses, and the business model of the firm.”

So what does all this mean?

To boil all this down to the essential takeaways:

  • LCR is not subtle enough, a firm could go under within the 30-day period because of a really tough day
  • So a firm also needs a big enough intraday liquidity buffer
  • The intraday difference between credits and debits will show your ‘worst-case’ use of liquidity and this will drive your buffer requirement
  • This buffer will need then to be increased to make sure it can cope in stress scenarios
  • The regulator will increase that buffer even further if they deem you aren’t on top of the intraday challenge
  • And remember, that buffer is costing you real money today! Every $100m you can shave off your buffer will save you about $1m of cost each and every year.

Keep checking back for new posts as I do want to dig into a bit more detail around the best help I have seen from regulators on understanding and delivering BCBS248.

In the meantime, please give your thoughts below and share any insights into anything else you might have picked up from other regulators’ thinking on intraday liquidity risk.

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