The regulated financial services sector is familiar with liquidity management and planning under normal and stressed environments, but for most other corporate treasury functions it is not an area that often merits any structure or guidance.
We have seen a fundamental shift in the liquidity markets over past couple of weeks and while the change has been sudden, it will have long lasting implications for how corporate treasuries think about their liquidity strategy. During these extraordinary times, it is helpful to consider some of the approaches adopted by those working in banks, insurers and asset managers.
Banks have to manage to minimum liquidity requirements, as detailed in Basel frameworks, and provide regular reporting on these metrics to their regulators. The Liquidity Coverage Ratio (“LCR”) is one of the two key metrics (the other being the Net Stable Funding Ratio). It is designed to ensure that banks hold a sufficient liquidity buffer – defined as a reserve of high-quality liquid assets (“HQLA”) to allow them to survive a period of significant liquidity stress lasting 30 days. The period is selected as the minimum period for corrective action to be taken by management.
The LCR liquidity stress scenario is prescriptive and based on assuming:
Banks also undertake reverse stress testing which looks at the various scenarios that would need to arise for the firm to cease to be able to pay out on its obligations. This may include sale of assets at distressed prices, accelerated outflows and delays in liquidating certain assets.
Adopting a structured approach in developing a forward-looking liquidity risk view is key. There are three key focus areas which will input into the model:
There are several models that one can adopt to determine liquidity requirements, but the following three-step approach may be effective across a range of businesses and circumstances.
Estimate Liquidity Requirements
Undertake scenario analysis
Explore all your funding options
Thanks to Nick Burge and Harsh Gambani from Standard Chartered Bank for their assistance with this article.
Associate Director – Policy and Technical
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