DRIVERS AND CHALLENGES OF ADVANCED LIQUIDITY RISK MANAGEMENT

R&C: To what extent has the COVID-19 pandemic highlighted the importance of a sound liquidity risk management (LRM) framework? In which areas is this most evident?

Chen: Agility in the sense of flexibility and timeliness is key to the value and importance of a sound liquidity risk management (LRM) framework. Liquidity risk can be triggered and morphed by many factors. The lack of a proper and timely response to liquidity risk can also quickly spill into other risks leading to an institutional or systematic crisis, as we have witnessed in recent years. The coronavirus (COVID-19) pandemic has illustrated how dynamic liquidity risk is. At the very beginning of the crisis, liquidity facilities incentivised borrowers to utilise their lines to the fullest extent. Loan balances jumped 15.4 percent, as many companies tapped credit lines. This coincided with forbearances and intensified capital market margin calls. A liquidity crunch looked unavoidable. Nevertheless, as markets panicked, the Federal Reserve responded quickly by committing adequate liquidity support, and, unexpectedly, bank deposits surged. This fast-changing situation, in just a few weeks, illustrates why financial institutions (FIs) must quickly assess and adjust their liquidity situation and contingency funding plans.

Heilemann: Although the COVID-19 pandemic has not directly threatened the liquidity profile of most banking institutions, it has highlighted the need for flexible real time liquidity reporting and management action. During the crisis, global regulators and internal executive management teams want to understand the impact or potential impact that market developments can have on the liquidity position. A critical pillar of a sound LRM framework includes daily and intraday standard reporting to clearly identify areas of stress or weakness. Reporting capabilities should also include the ability to forecast the position under a variety of future scenarios to provide comfort that if conditions worsen, firms can clearly identify where risk may lie.

Oct-Dec 2020 Issue

SAS

State Street Bank

Wells Fargo