It goes without saying that liquidity management, particularly in the past five years, is important; it is fundamental to banking and keeps the financial system going. Since the financial crisis began in 2007, regulators have focused on reducing the time scales in liquidity management, moving away from previous requirements for monthly reporting to weekly and now daily. The next logical move is to intraday liquidity management.
If a liquidity problem occurs, it is likely to occur intraday and the regulators, the financial industry in general and financial institutions’ clients need to know that individual banks are aware of any problems. We learned from the collapse of Lehman Brothers in 2008 that if a bank was in trouble, it could go down very fast and contagion spread like wildfire. Stress testing for liquidity on a longer timeframe was similar to ensuring we had a fire extinguisher to put out the fire. The focus on intraday liquidity requires a smoke alarm; if a stress is happening it is a real-time event.
Regulators, such as the Financial Services Authority (FSA) in the UK, are requiring financial institutions to calibrate their liquid asset buffers by considering their need for intraday liquidity in normal and in stressed conditions. But there is concern that this may lead to financial institutions changing their behaviour and, in times of stress, paying out at the end of the day. A recent study by the Bank of England (BoE), based on one day’s business in the UK and on three banks, found that if two of the banks suspected there were problems at the third and delayed their payments to that bank for half an hour, the suspect bank’s liquidity requirements would go up by 40%, from £1.53bn to £2.15bn.
To date much of the regulatory activity has been confined to setting out general principles on intraday liquidity; we have been told that it is important to manage intraday liquidity, but not how that might work in the real world.
That is set to change with the publication in July of the Basel Committee on Banking Supervision’s (BCBS) consultative document on monitoring indicators for intraday liquidity management. The Committee is inviting responses to the document by a deadline of 14 September 2012.
Eight indicators have been proposed by the Committee to monitor banks’ intraday liquidity risk. They are designed to enable banking supervisors to monitor a bank’s intraday liquidity management and its ability to meet payment and settlement obligations on a timely basis. The proposed indicators are:
- Daily maximum liquidity requirement.
- Available intraday liquidity.
- Total payments.
- Time-specific and other critical obligations.
- Value of customer payments made on behalf of financial institution customers.
- Intraday credit lines extended to financial institution customers.
- Timing of intraday payments.
- Intraday throughput.
The Committee says over time the indicators will enable supervisors to gain a better understanding of payment and settlement behaviour and the management of intraday liquidity risk by banks. It is likely these indicators will be accepted and become regulation. They are all based on an understanding of what time of day payments come into and go out of a financial institution. By combining that cash flow data with how much collateral a bank needs, as well as its committed credit lines and reserve balances, a picture of intraday liquidity can be built.
Challenges and Solutions
Determining the time of day of payments is not as straightforward as it seems; a direct participant in a central bank settlement system, such as Target 2, may be able to determine its settlement time via a portal, although it is not always easy to integrate into a system. Furthermore, an indirect participant, using a nostro agent, may be able to pay for a SWIFT advisory message that will indicate the time the message was sent, but this is not necessarily the time the payment was settled.
There is a data gap here; we may recognise it is a good idea to monitor intraday liquidity but this is an operational issue and we need to know where to get the data from. This is a problem exacerbated by the silo approach in financial institutions. Typically cash, collateral, credit and asset liability management (ALM) systems, processes and staff are separate. But an effective liquidity management approach requires the collateral management system to feed data into the cash management system, credit lines to be factored in and the result used in ALM. The battleground has shifted, from long-term statistical analysis to intraday, real-time data. Financial institutions that take this holistic view will be able to control payments, allowing them to be made when liquidity is optimised and thus reducing the capital buffer required. This is not something that can be done on the back of an envelope or via spreadsheets.
Financial institutions must take a more real-time approach and better leverage their systems in order to effectively manage intraday liquidity. At its heart, banking is about transactions with customers. The financial institution needs to know the cash flows associated with each transaction – actual and potential, confirmed and projected – and that all of the stages of those cash flows have been carried out correctly and that the resulting data makes sense. Only with this level of tracking can liquidity be correctly assessed.
Liquidity management is about monitoring and controlling outflows. Once visibility is mastered, rules can be applied that act as a valve on the outflow of payments; if liquidity is low, then low-priority, non-time sensitive payments can be held back and released when payments come into the system. At the same time, such a system will ensure that requirements within various central bank liquidity stability mechanisms, such as Target2, are met. The ‘just-in-time’ process that has worked so well for years in the manufacturing industry is applicable when it comes to intraday liquidity management.
A financial institution that can manage its intraday liquidity effectively can do the same for its corporate clients, thus enabling them to offer those clients a lower capital buffer to manage throughout the day. This is particularly attractive to very large corporates that until now have had to create in-house banks (IHBs) for lack of this type of service.
A direct benefit for corporates is that if their bank has an effective intraday liquidity management process, the corporate’s liquidity will be better handled. The corporate will know that liquidity usage and any funds transfer pricing is accurate. However, with better control and visibility over liquidity, a financial institution can target both banks and corporate counterparties that are sub-optimal in their own approach to liquidity and charge accordingly.
The financial industry remains in the midst of a significant liquidity crisis that all players are trying to work through. Regulators have abandoned the ‘light touch’ approach to the financial industry and are prepared to stop at nothing in order to prevent a repeat of the 2007-08 crisis.
The BCBS’ approach to intraday liquidity monitoring will help, but as with all regulatory initiatives there are limitations. Yes, it may well prevent future collapses of the Lehman Brothers type, but you rarely get the same event twice. What regulators are trying to ensure is that if there are future collapses, they are contained and corporate and consumer clients are protected.
One thing has become clear: survival depends on managing liquidity. In order to meet increasingly onerous regulatory requirements and deliver competitive liquidity solutions to corporate clients, financial institutions must improve their liquidity management systems. Integrating collateral, credit and ALM systems on to a cash management platform will take financial institutions to the next level of liquidity management, away from spreadsheets and manual processes and into the real-time world.
Many banks around the world, large and small, continue to experience major security failures. Biometric systems such as pay-by-selfie, iris scanners and vein pattern authentication can help.
Despite all the automation and improvements that digital banking has the potential to achieve, customers and their needs still form the very core of the banking sector.
Banks might feel justified in victim blaming when fraud occurs, but it does little for customer confidence.
Politicians have united in urging the Reserve Bank of Australia to lend its backing to the digital currency by officially recognising it.