Liquidity risk management
by Richard Barfield and Shyam Venkat
The Journal • Global perspectives on challenges and opportunities
Director, Advisory, Financial Services
PricewaterhouseCoopers (UK) Tel: 44 20 7804 6658
Partner, Advisory, Financial Services
PricewaterhouseCoopers (US) Tel: 1 646 471 8296
It is not listed on any exchange. Nor is it a line item on any financial institution’s balance sheet. Nonetheless, confidence is the financial system’s and every financial institution’s most valuable asset. The financial markets cannot hope to recover until confidence is restored. Banks need to recover their faith in each other and rebuild their reputations across their stakeholder base. They must also regain the trust of the regulators. For that to happen, banks must achieve two things. First, they will have to show that they have learned lessons from the liquidity crunch. Second, they will have to demonstrate that they are putting those lessons to good use. Simply going through the motions will not suffice: banks will have to prove that they are genuinely effecting change. In our view, this should be done against a clear strategy for liquidity risk management. This requires taking a longer-term perspective, detached from the day-to-day firefighting and conference calls that are currently consuming the days of most treasurers.
made profits in the quarter before they disappeared. Both were well-capitalised businesses. And yet, as a result of their failure to deal with their liquidity risk issues, they were simply swept away. Of course, Northern Rock and Bear Stearns were not the only banks with their minds elsewhere. The fact is, no one talked much about liquidity risk until last year. Although the regulators may have monitored banks’ management of the issue, they rarely raised serious challenges. As a result, liquidity was largely an invisible risk for many firms. Risk is managed in silos in many institutions. It is typically split into categories – such as liquidity risk, credit risk, market risk and operational risk – each of which is seen as separate and distinct. Recent events have shown, however, that different types of risk can and do impact on each other. In fact, during times of financial crisis, risks have repeatedly shown a tendency to transform from one type to another with breathtaking speed. We have seen, for example, how mistrust of asset values due to credit default risk can generate liquidity risk. So, going forward, banks will need to place greater emphasis on developing an integrated view of risk across all the risk types.
Asset and Liability Committees (ALCOs) are set to play a pivotal role. Their challenge will be to build a comprehensive, joined-up perspective of their institutions’ asset and liability risk. To achieve this, ALCOs will need to ensure that fundamental challenges are addressed. Are relevant roles and responsibilities clearly defined and understood? Are management information systems functioning as they should be? In particular, are those systems operating on a ‘real time’ basis that enables up-to-date information to be provided at the right time? Are the interrelationships between market, credit and liquidity risk understood and monitored? As ever, quality rather than quantity is the critical factor, so Key Performance Indicators and Key Risk Indicators need to be in place to allow managers to cut through the mountains of data to the critical facts. Without these, early insight and timely action cannot be achieved.
Diversified funding sources
The nationalisation of Northern Rock underlined the need for banks to diversify their funding sources. A sizeable bank that was adequately capitalised, Northern Rock came unstuck as a result of its excessive reliance on the wholesale...