Liquidity and governance issues for banks


Meeting banks’ liquidity requirements will require major operational, financial and structural changes and a shift from short-term wholesale funding to a longer-term funding strategy.

Mr Kafi Khan / Corporate Secretary, City Bank Limited

September 27, 2021, 12:45 p.m.

Last modification: September 27, 2021, 12:50

Kafi Khan

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Kafi Khan

The crisis arises when banks are unable to renew short-term funding, which lowers investor confidence, leading to liquidity congestion within financial institutions.

Liquidity coverage ratios aim to strengthen banks against adverse shocks by eliminating structural asymmetries between assets and liabilities, encouraging more stable sources of funding – medium and long term options rather than short term.

Meeting liquidity requirements has proven to be an even greater challenge than that of capital. For many banks, these requirements are “the iceberg under water”.

Additional standards will require operational, financial and structural changes and a shift from short-term wholesale funding to a longer-term funding strategy.

It is evident from the observations that any bank will find this difficult, especially in terms of reduced profitability. It will be costly for banks to adjust their balance sheets by holding more quality liquid assets with relatively low yields; raise more expensive retail deposits as well as medium and long term wholesale financing. At the same time, they will also have to cut back on long term loans.

Illustration: SCT

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Illustration: SCT

Illustration: SCT

These challenges will be compounded as many banks will seek to make similar adjustments at the same time as the market moves against them. With varying severity, depending on the type and size of the bank, they will all need to act at the same time to ensure compliance.

Many banks will also face significant costs in meeting other aspects of the new liquidity requirements, such as: collecting and reporting the necessary data, performing a wide range of stress tests and scenarios , the modeling of cash flows, the monitoring and evaluation of their maturity mismatches, the verification of funding concentrations and the availability of unencumbered assets.

Holding additional liquidity to meet “pillar 2” requirements and putting in place more robust recovery plans to cover both capital and liquidity will also be a challenge. For many banks, these costs combined with the impact of other regulatory changes will lead to changes in their business models and organizational structures.

Banks aren’t the only ones feeling the heat. Liquidity requirements, in addition to those of the whole of Basel and other regulations, will have a ripple effect on other parts of the financial sector, for example, asset managers, insurers and the industry. financial as a whole. Infrastructure and mortgages will come under pressure from reduced funding and a general lack of liquidity.

To meet specified corporate governance requirements, management will be required to assess the Company’s liquidity risk tolerance at least annually. At the same time, they will have to approve liquidity risk management strategies and supervise the execution of these strategies.

To meet specified corporate governance requirements, management will be required to assess the Company’s liquidity risk tolerance at least annually. At the same time, they will have to approve liquidity risk management strategies and supervise the execution of these strategies.

To project cash flow requirements over various time horizons, short-term cash flow projections should be updated daily while long-term cash flows should be updated at least monthly. Cash flows should be complete and provide sufficient detail to reflect the capital structure, risk profile, complexity, activities and size of the business.

To perform regular stress testing, cash flow projections should be stress tested at least monthly to measure liquidity needs at 30-day, 90-day, and 1-year intervals during periods of time. instability of the financial market.

Stress tests should incorporate a range of stress scenarios to account for bank-specific strains, market strains, and a combination of the two. The results of stress tests should be used to determine the size of the liquidity buffer and to contribute to the quantitative component of the emergency financing plan.

To set internal limits on certain liquidity measures, specific limits should be placed on the funding concentration, the number of specified liabilities that mature in different time periods. Similar limits should be imposed on balance sheet exposures and other exposures that could create funding needs in the event of a liquidity crisis.

Banks are required to maintain an emergency funding plan that identifies potential sources of liquidity strain and alternative sources of funding when usual sources of liquidity are not available. The plan should have four components: quantitative assessment, event management, monitoring and testing.

To fully achieve articulation, banks will need to ensure that they are able to measure their liquidity risk. The lack of relevant risk data is an obstacle not only for banks but also for many financial services companies to achieve better liquidity and risk management.

Banks need to change their methods to balance their liquidity risk and their role as providers of liquidity by restructuring liquidity management. Liquidity risk exposes banks to financial difficulties. Banks should attempt to control liquidity risk factors by balancing cash inflows and outflows and even by holding liquidity buffers for strategic purposes.

When a crisis hits, banks limit their exposure to related companies and those companies, including other banks, will fare less well. Being exposed to too high a liquidity risk can lead banks to deal with runaway investors, withdrawals of deposits, downgrades and more difficult funding.

Banks therefore tend to provide liquidity in a counter-cyclical fashion: too much when the economy is hot and too little when the economy is at its worst. Banks should revert to more conservative policies and aim to improve cracks in their systems, including improving information systems and more accurate models with more realistic assumptions.

Banks must find a way to prevent the countercyclical trend and ensure that the actions of the banks, intended to guarantee their own liquidity, do not make the situation worse for all parties. With policy changes, it will be necessary to evaluate these strategies before a crisis hits, in order to try to prevent or limit the intensity of the damage.

Liquidity analysis requires bank management not only to measure the bank’s liquidity position on an ongoing basis, but also to consider how funding requirements are likely to evolve under various scenarios, including conditions. unfavorable.

Above all, according to the permanent approach based on internal and external construction, banks should develop a structure for liquidity management, measurement and monitoring of net financing needs, management of market access, development contingency plan, foreign currency liquidity management planning, establishment of internal controls for liquidity risk management, ensure timely public disclosure to improve liquidity, analyze the use of liquidity in a variety of “what if” scenarios.

Many banks envision and implement the “quick wins” and relatively easy fixes that would allow them to meet (or progress towards meeting) requirements. However, some banks may need to take more drastic steps to change their business models and restructure their balance sheets, either to meet liquidity requirements or in response to a combination of those requirements and broader regulatory reform.


Mr Kafi Khan is the secretary of City Bank Limited.


Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions and views of The Business Standard.


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