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Intraday Liquidity now baked into Europe’s Liquidity regulations

Bake


The European Central Bank (ECB) has updated its approach to regulation and intraday is now firmly part of its liquidity regime. In this article I’ll give the background, explain what’s new and suggest what might happen next. This is important to anyone interested in Eurozone banks, it will inevitably spill over into other European countries and there is also learning for other territories around the world. Spoiler Alert: Intraday has now hit the Eurozone, so get ready to react. When I use the phrase ‘bank’ please treat this as shorthand for any firm that is a financial institution and subject to liquidity regulation.

What’s all this about?

In a nutshell, this is about what one of the biggest regulators in the world looks for when testing if a bank can cope in a liquidity crisis. To hugely simplify the story:

  • Regulators blamed the financial crashes of a decade ago on a lack of liquidity at the banks;
  • In response Basel III was introduced as the global policy ensuring banks hold much higher liquidity buffers;
  • In the EU, Basel III was enabled by CRD IV and banking regulators in each EU country have to make sure each of their banks comply;
  • Up until now, apart from in the UK, the European regulators had been pretty quiet on intraday liquidity risks i.e. checking to see if the bank has enough cash during the day to cope in a crisis. After all, it’s no good having the ability to get hold of cash over a multi-day stress, if you can’t survive Day 1 when all your credit lines are withdrawn in a hurry (Lehman Brothers anyone?);
  • The UK has some very well thought through approaches to testing intraday capability (see Pillar 2 SOP). When the PRA comes calling, you had better be able to understand your intraday activity and have the right systems/processes/governance to manage intraday, every day;
  • Now the ECB has started to catch up with the UK. Along with the relevant local regulator, the ECB jointly supervises the largest banks in the Eurozone (about 120 banks plus a long list of their subsidiaries). Here is some unavoidable jargon I’m afraid. These firms have to carry out an internal liquidity adequacy assessment process (ILAAP), effectively a self-assessment of how the bank manages and reports on its liquidity. This ILAAP is picked up by the regulators in their annual reviews, which is known as the Supervisory Review and Evaluation Process (SREP);
  • The new ILAAP approach, valid from 2019 onwards, has just been published (see ECB Guide to ILAAP). Finally intraday matters have been addressed.

So what is new about intraday?

It’s useful to think about what’s in the new ILAAP and also what isn’t mentioned. The ECB has squeezed in the phrase “including intraday” into a number of key areas. In essence, they are baking in the concept of intraday risk into the existing liquidity risk regime:

ensure that institutions have robust strategies, policies, processes and systems for the…management and monitoring of liquidity risk… including intraday…to ensure that institutions maintain adequate levels of liquidity buffers

There are three key takeaways:

  1. They confirm intraday must be included in the scope of all the bank’s liquidity management and monitoring processes. Senior management have to understand intraday now;
  2. Banks must carry out stress modelling on intraday risks, to make sure their liquidity buffers are big enough and include specific intraday provisions;
  3. Banks have to consider how intraday liquidity will be hit when they think through all the risks that could hit the business (the Risk Inventory).

It’s also worth pondering on what the ILAAP guidance doesn’t say, particularly compared to previous iterations:

  1. There is no mention of how they will review the bank. So expect some confusion, but if a European firm wants some clues about what good looks like then take a look at the UK PRA’s guidance (see Pillar 2 SOP). The UK PRA was the prime regulator pushing for an intraday global regime and having been evolving their regime for some time
  2. There is no mention at all of the BCBS248 intraday monitoring regime (see BCBS248), which was effectively Basel III for Intraday Liquidity. The ECB seems to have followed regulators like the UK PRA and the Federal Reserve here by downplaying the 248 regime. BCBS248 only makes a bank look back and spot historic uses of intraday liquidity. This is elementary grade capability when what’s actually needed is to understand liquidity in real-time, not weeks after the event when it is too late to act.

What might happen now?

A few predictions for how this agenda will develop:

  • Many banks will produce their ILAAPs as they have always done and only start to feel the intraday pressure when their SREP reviews take place during 2019. 2019 will be a year to improve as the pressure ramps up;
  • The Regulators will (eventually) issue some more prescriptive guidance, when they realise the variance between the good and the bad banks in terms of intraday;
  • European countries outside the Eurozone will be dragged along. This ECB guidance only covers the 19 Eurozone countries but other regulators (e.g. in Denmark, Sweden) will likely follow the same principles. Also, many banks headquartered in these non-Eurozone countries have subsidiaries that are covered by the new regime (e.g. Nordic banks with activity in the Baltic states) and will start to set a sensible policy at HQ to encompass all their activity cross-territory.

Final thoughts

It’s taken some time, but we are now seeing a major part of the global economy embracing the importance of intraday liquidity. There are $millions of savings from getting intraday right – it’s not rocket science to think that knowing where all your cash is in real-time can bring huge benefits.

This move to tighten regulations should be very helpful in forcing budget committees to approve investment in this space. When challenged to justify improvements in intraday systems and processes, Treasurers can now say “the regulator demands it”

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