The Challenges of Real-time Intraday Liquidity Risk Management

The 2007 – 2009 financial crisis has had damning implications across the financial services industry, creating a wave of new regulation and placing increasing pressure on banks to put in place the necessary measures to avoid a repeat crisis. Among the various regulatory directives hitting the banks, the new liquidity regime imposed by the UK’s Financial Services Authority (FSA), coupled with global rules on capital and liquidity from the Basel Committee on Banking Supervision, is being felt the keenest. Under Basel III, financial institutions are required not only increase the amount of capital reserves they hold, but also demonstrate their liquidity risk position on a daily basis. As we enter the latter part of 2010, financial institutions are turning their attention to the issue of intraday liquidity risk management in a bid to meet these policies and better understand their risk position.

Traditionally, banks have managed their cash and liquidity in-house and it has often been retrospective exercise based on historic information. While some of the larger institutions have been quite good at this and had a general understanding of the liquidity flows within the bank, new regulation now requires banks to demonstrate their liquidity risk position and not just understand it. Risk managers are therefore seeking a holistic view across all their portfolios and also want this information in real-time, giving rise to the need for intraday liquidity risk management.

Reporting Intraday Liquidity

Comparative to the US, where intraday liquidity risk reporting is well versed and a regulatory framework is already defined, the UK is only now determining such measures. The need for better liquidity risk management was highlighted by research published by Swift earlier this year, which surveyed 255 treasury, liquidity and liquidity risk managers in the UK. The findings revealed that 90% of respondents wanted more intraday liquidity reports, and 87% wanted better insight into trend and pattern analysis. This level of detail is currently out of reach for most institutions, since the report also revealed that less than 25% of transactions are reported on the same business day.

So what are the benefits of real-time intraday liquidity risk management? By giving banks a complete picture of their risk exposure, it not only reduces third party credit risk, but also ensures risk and compliance policies are fully met. In addition, liquidity data can be passed back to the regulators faster if it is captured in real-time. In the past, this process took weeks, which was not only a drain on time but the data was also outdated and therefore didn’t represent a true and real picture of the bank’s current risk position.

Intraday liquidity management also improves operational efficiency by optimising the amount of cash coming in and going out of the bank and enables comparisons to be drawn between its real-time and forecasted position. This not only enhances a banks’ ability to predict for the future, but also better react to client behaviour changes. In addition, banks can set up alerts which will flag any discrepancy in positions and thereby negate the risk of fraud.

With the case for intraday liquidity clear, it poses the question of why are banks and financial institutions still grappling with the task? For many banks, the job of building a real-time picture of liquidity risk is seen as daunting. A perceived drawback of the new rules is the sheer increase in volume of data, where not only is there more, but the nature of the data is also different for liquidity. Due to its fluid character, there are also a far greater number of payment transactions taking place than the actual number of payments being made.

Challenges for Financial Institutions

This problem, however, is by no means a new issue for banks, and one can draw a comparison and look at what has happened with market risk and apply this learning to liquidity risk management. Here, with the right technology solutions aggregating high volumes of data from multiple streams to produce both snapshots and the ability to drill down into the data in real-time is now possible. Whilst technology is by no means the panacea to solving all the issues associated with risk management and indeed liquidity risk, if implemented and deployed appropriately, it can provide detailed analysis and ensure that decisions that need to be made quickly are not only well informed but also support the business.

At a time when money is being chased to repair damaged balance sheets, implementing a liquidity regime is made harder due to the damaging effect on a bank’s bottom line. Many have put forward suggestions for a pricing model, with some proposing that corporates should pay for their intraday liquidity to satisfy the associated expense to the bank. However, so far, the FSA has not outlined a model and this is by no means an easy feat. Whereas the US has a properly established relationship between the banks and central banks, the UK and Europe have yet to achieve this. Implementing a pricing model is made difficult due to numerous considerations and requirements that need to be accounted for. For example, will the process happen at the beginning of the day, or at the end? Therefore, while it is likely to happen, a definitive model is still some time away. Nevertheless, it will be interesting to see how the pricing picture unravels, especially as banks customers and large corporates put increasing pressure on banks to help them with their risk management. To this end, it is likely that it will be a ‘wait and see’ approach for corporates while banks and regulators make sense of it.

Conclusion

There is no doubt that the banking industry is undergoing rapid change and liquidity risk is at the heart of it. Banks are the responsible party for risk management and faced with external challenges from Basel III and the FSA, having access to accurate information in real time is going to be key. With the tools available, financial institutions now need to take a firm hold and demonstrate their intraday liquidity risk positions and potential exposures in the context of the overall risk picture. The quicker this can be done, the better banks’ overall market competitiveness and confidence will be.

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