Liquidity Management: An Introduction

Good liquidity management helps ensures the availability of funds to meet all cash outflow commitments for day-to-day operations and deploys cash in an optimal manner. It implies managing cash on a global level for the purpose of minimising idle cash, reducing external debt and optimising returns on excess cash by grasping better investment opportunities. This article focuses on the benefits of having a sound liquidity management system in place for financial institutions with worldwide operations and managing liquidity for their corporate clients.
 

Having worldwide operations throws open myriad challenges in the form of timing the flow of funds, handling multiple currencies, regulations, and the difference in liquidity management strategies being followed, etc. The core premise of liquidity management is to have a centralised global view of the cash for a conglomerate. This centralised view of the cash is achieved by creating a global liquidity management structure. A global liquidity management structure consists of accounts of different entities operating at various locations (within a country or across different countries) linked together and pooling the funds into a single location for either re-allocation or investment. Liquidity management has always been a core function of corporate treasuries and banks have catered to this need by providing liquidity management solutions as part of their cash management services suite.
 

Liquidity Management: The Business Context

The need for a global liquidity management structure arises for the following reasons:
 

  • Ensuring access to liquidity – in the right amount, in the right place, at the right time’ that in turn reduces high levels of global surplus cash.
     
  • Uncertain credit conditions – Uncertainty about future availability of credit drives many global corporations to become more prudent in tapping internal sources of liquidity. The recent credit crunch in US and European markets has given more strength to this particular factor. The goal is to consolidate cash more effectively to take advantage of market opportunities. This could mean putting it back into the working capital of the company, retiring debt, or maximising returns through short-term investment until the right opportunity comes along.
     
  • Regulatory developments – Regulatory developments are facilitating a more co-ordinated approach to liquidity management, as well as demanding more control and transparency.
     
  • Before designing a liquidity management application for a bank, a functional understanding of the overall liquidity management process is a prerequisite. The liquidity management function involves managing the overall liquidity for a bank. To ensure this, an application designed to manage liquidity should be able to:
    • Interact with various other systems present in the bank’s IT infrastructure to collect information about the various sources and uses of liquidity.
       
    • Provide a user interface to create/delete/modify liquidity structures and assign rules, to view and track transactions and customised reports.
       
    • Identify rules associated with liquidity as specified and perform the processing accordingly.
       
    • Create user profiles and define access levels to sensitive information. It should also provide audit logging for critical processes to ensure recovery in case of failure scenarios.
       
    • Connectivity with downstream interfaces – internal legacy systems using the liquidity data and external networks such as SWIFT, Faster Payments to route payments.
       
    • Calculation of the amount to be moved and the interest accrued on the movements as per the rules.
       
    • Posting of the fund movements and the interest earned on the general ledger systems.
       
    • Predict the liquidity positions for a particular client and currency.
       

     

The process of liquidity management involves the following steps:

Figure 1: Liquidity Management Process

Source: Infosys
 

Assessing potential sources and uses of liquidity – The first step towards designing a liquidity management solution is to identify the potential sources and uses of liquidity and the rotation cycle of the funds, i.e. how frequently the cash is churned. It identifies potential areas of liquidity risk, decision about the strategies to mitigate the risk can be decided upon which eventually will lead to creation of the liquidity structures.

Creation of the liquidity structures

After the potential sources or uses of liquidity are identified, the user can create a liquidity structure as per available documentation. A liquidity structure is an arrangement of different accounts in which fund movement takes place. The structure can have multiple levels and can span across various countries, banks, currencies and entities. One account acts as a source account i.e. account providing funds and another account acts as header account i.e. account receiving funds. The account in which all the money is concentrated and pooled is called a final concentration account.
 

Figure 2: A Multi-currency Liquidity Structure

Source: Infosys
 

In addition to creation, user can also delete or modify an existing structure. The available documentation will have the details about the accounts participating in the structure, frequency at which funds need to be moved and other necessary details.
 

Identification of rules

The movement of funds across the liquidity structure will be subjected to various rules. These rules can be classified as:
 

  1. Client-specific rules.
     
  2. Bank’s policy-related rules.
     
  3. Regulatory rules.
     
  4. Business-specific rules.
     

These rules are customisable according to the business requirements and will be applied as per the direction.
 

Fund movement and interest calculation

After a liquidity structure has been created and rules are set, the account balances of the participating accounts are obtained from the general ledger systems and the net funds to be moved is calculated as per the rules and the interest calculated.
 

Transaction generation and posting

Once the amounts to be swept are ascertained, the transactions effecting the sweeps are generated by the liquidity management and the respective transactions are posted on to the respective accounting systems.
 

Reporting

Reports are generated on the basis of the transaction done during the day and also on demand for interested parties. The frequency and the criteria of various reports are decided. In certain geographic regions there are certain mandatory central bank reporting to be done.
 

Recovery and audit logging

In case of failure scenarios, the transactions need to be recovered and the process needs to be re-run. It is therefore vital for all critical processes to be audit logged. This reduces the time to recover the system and correct account balances.
 

Data security

Last but not least, as part of the liquidity management solution user profiles should be created and the levels of access should be defined. As the information is highly sensitive, only authorised users should have access to it.
 

Liquidity management solution

A typical liquidity management solution (see figure 1) pools the data spread across disparate systems inside a bank’s IT infrastructure and delivers value by putting cash to its optimum use as well as forecasting liquidity needs.

Figure 3: A Model Liquidity Management System

Source: Infosys
 

Figure 3 depicts a model liquidity management system. The model comprises various components and requires connecting with others of the bank’s legacy systems. The process of liquidity management begins with operators capturing the client data and liquidity requirements through the user interface built for the system. This user interface is, in turn, supported by the data warehouse for the static information and also the different modules present in the proposed liquidity engine. The liquidity engine forms the core of the liquidity management product, as it enables creation of liquidity structures, setting up processing rules and storing them, calculating the funds to be moved, creating the transactions and posting it to the general ledger systems of the bank and finally reporting the transaction and interest related information to the interested parties. There are other systems in the bank that will use the liquidity information to formulate their strategies accordingly, such as trading systems, foreign exchange (FX) settlement systems etc. For cross border payments and transfers, connectivity with the payment gateways like SWIFT, real-time gross settlement (RTGS) has to be established. Advanced liquidity management will have the capability to forecast the liquidity needs of global corporations on the basis of the analysis done on past liquidity data and current business trends.
 

Liquidity Management Solution – Case Study

Client profile

The client is a major international banks with a worldwide presence. In addition to its banking services, the client also has a considerable presence in insurance, credit card and investment products.
 

Problem statement

The client approached Infosys for an integrated liquidity management system. The client was maintaining multiple systems for liquidity management. Different applications were maintained for end-of-day, intraday, pooling structures, interest calculation, real time balances etc. The main objective of the assignment was to centralise the entire liquidity management process worldwide through one single application. One of the other major concerns of the client was to ensure that the liquidity management application has a flexible architecture, keeping in view the ever-changing regulations and business needs of the client. The project also involved migration of the data from current liquidity systems to the new systems. The newly built application replaced the multiple liquidity applications, which will be decommissioned in a phased manner.
 

Business drivers

Major business drivers for the client to move to an integrated liquidity platform were:
• Reducing the time to market of liquidity management products.
• Single window for managing end to end liquidity management needs.
• Ensuring cost efficiency by reducing maintenance costs on managing multiple applications.
• Tracking transactions arising out of the liquidity management process seamlessly.
• Effective recovery management process.
 

Challenges faced

The major challenges faced by Infosys during this assignment fall into three categories:

  1. Implementation challenges. This was a highly complex project that involved implementing the domain requirements across different time zones. There were different scenarios to be managed and foreseen before implementation.
     
  2. Technical challenges. Involvement and integration of multiple technologies was a daunting task. Interfacing with the multiple downstream and upstream systems, each with its own unique set of specification and files to be sent was another challenge faced by the team. Time-specific performance requirements also added their bit to the technical challenges.
     
  3. Domain challenges. The assignment involved lot of in-depth knowledge about the liquidity management process in general and also about the payment systems, SWIFT, accounting, value dating etc. In addition to this, the main task was to come up with different potential scenarios and how to handle them. Infosys also had to take into account regulations affecting the flow of payments, the information to be sent as part of the payments and also the central bank reporting required. The regulatory aspect added to the requirements definition of the core engine, as well as reporting facilities provided by the system.
     

Conclusion

Liquidity management remains to be one of corporate treasurers’ key concerns. JPMorgan’s Global Cash Management Survey for 2008 also reaffirms the fact, with 53% of participant treasurers (up from 45% in 2007) saying that cash management was their top priority. The recent credit crisis has contributed towards this renewed importance and focus. In these challenging times, a conscious effort is needed from technology vendors stay abreast of the ever-changing liquidity management space in order to understand and assist their banking clients to serve their clients in a more proactive manner.

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