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 –

-       Banks need to have a good process in place for identifying, measuring, monitoring and controlling the liquidity risk.

-       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.

-       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.

-       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.

-       Collateral needs to be managed actively and care must be taken for separating assets that are free and those that are tied-up already.

-       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. Contact one of our helpful account representatives to assist you in the setup of a high risk merchant account or offshore merchant account for a high risk merchant.