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Important issues in managing liquidity
risk
Basic principle for supervision and
management of liquidity risk – In case
of liquidity risk management, the
responsibility for managing liquidity
risk is squarely placed on banks. There
are several actions that need to be
taken by banks in order to manage
liquidity risk, such as making sure that
a goof framework for risk management is
in place. Moreover, the banks need to be
obligated to check if it maintains the
right liquidity level such that the
trading requirements are met.
The governance of managing liquidity
risk – The governance consists of 3
principles. All the three principles
relate to the liquidity risk level that
a financial institute is prepared to
handle. This involves setting the
required liquidity level so that the
business strategies are met,
establishing suitable management
structure in order to manage liquidity
risk and the responsibility of the board
of directors of a bank for reviewing and
approving issues related to liquidity at
least once every year. The 3rd
principle is the requirement of the
costs of liquidity, the risks and the
benefits to be included for product
pricing.
Management and measurement of liquidity
risk – Management and measurement of
liquidity risk consists of 8 individual
principles. These are as follows –
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Banks need to have a good process
in place for identifying, measuring,
monitoring and controlling the liquidity
risk.
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It is necessary that banks take
the entire view of active liquidity.
This indicates that these banks need to
manage exposures as well as funding
across all the lines of business, legal
entities and currencies simultaneously.
They also have to allow regulatory,
practical and regulatory limits so that
the liquidity can be moved between
businesses.
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Banks need to diversify their
funding sources and should also test
regularly their ability for raising
ample funds from the funding sources at
small notice periods.
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Intraday liquidity should be
managed actively so that the obligations
of the banks could be met if and when
they arise. Moreover, this needs to be
planned by a bank under normal as well
as strained conditions.
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Collateral needs to be managed
actively and care must be taken for
separating assets that are free and
those that are tied-up already.
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The bank needs to have a formal
plan for emergency liquidity. This plan
also needs to indicate clear
responsibility lines as well as
escalation procedures. The plan in place
should also be tested at regular
intervals.
Role of supervisors – Firstly, it is
necessary that supervisors carry out
regular checks of the structure of risk
management of a bank. Checks pertaining
to the bank’s liquidity position should
also be carried out. The supervisors
also should get extra information such
as current market details and internal
reports. If supervisors encounter
problems then it is their duty to
address such issues promptly. Moreover,
supervisors need to establish a
communication with other public
authorities and supervisors such as
central banks, across and within
national borders. During stressful
times, these communications need to
amplify appropriately.
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