Robust Intraday Liquidity Management Tim Neijs* and Martijn Wycisk** Zanders Treasury and Finance Solutions

August 2015

Zanders Treasury and Finance Solutions is an independent and leading advisory firm specialized in treasury management, risk management and corporate finance. With offices in The Netherlands, United Kingdom, Belgium and Switzerland, Zanders aims to build long-term client relationships with financial institutions, corporate clients and public sector organizations.

[*] Tim Neijs has a Master’s degree in Risk Management from Duisenberg School of Finance (Amsterdam) and is a consultant at Zanders located in The Netherlands. Zanders Nederland, Brinklaan 134, 1404 GV Bussum, The Netherlands, Tel. +31 35 692 89 89. [**] Martijn Wycisk is an executive consultant at Zanders located in Switzerland. He has a Master’s degree in Economics from Erasmus University (Rotterdam) as well as an Executive MBA degree from Rotterdam School of Management (RSM). Zanders Switzerland, Gessnerallee 36, 8001 Zurich, Switzerland, Tel. +41 44 577 70 10.

Table of Contents

1

Introduction ...........................................................................................................3

2

Intraday liquidity management (ILM) ........................................................................3

2.1

Intraday liquidity risk principles .............................................................................3

2.2

Why manage intraday liquidity risk? .......................................................................4

2.3

Divergence between regulators on intraday liquidity risk ...........................................4

3

Drivers of intraday liquidity ......................................................................................5

4

Measuring intraday liquidity risk ...............................................................................6

4.1

BCBS intraday liquidity risk monitoring tools ...........................................................6

4.2

Definition of intraday stress scenarios ....................................................................8

4.3

Developing a contingency plan (synopsis) ...............................................................9

5

Implementing an ILM framework ............................................................................ 10

5.1

Robust intraday liquidity management .................................................................. 11

5.2

System and organizational challenges .................................................................. 11

6

Benefits of managing intraday liquidity risk .............................................................. 13

7

Conclusion and next steps ..................................................................................... 14

References................................................................................................................ 15

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1

Introduction

Management of intraday liquidity risk is an important element of a bank’s overall liquidity risk management framework. Since the Basel Committee on Banking Supervision (BCBS) published its “Principles for Sound Liquidity Risk Management and Supervision” in 2008 and the “International Framework for Liquidity Risk Measurement, Standards and Monitoring” in 2010, banks have made considerable progress in improving their liquidity risk management framework. Besides the short-term LCR and long-term NSFR risk measures, intraday liquidity risk management is the next hurdle for banks 1. This paper explains what intraday liquidity is and discusses the drivers of its risks. Furthermore, this paper describes how BCBS encourages banks to measure and report intraday liquidity risk under normal and stressed conditions. The significant challenges banks face in implementing a robust intraday liquidity risk management framework as well as the benefits associated are outlined. This paper concludes with some insights into what is next for intraday liquidity risk.

2

Intraday liquidity management (ILM)

Intraday liquidity risk is an issue that applies to all banks. In recent years, banks raised their capital and liquidity reserves closer to the levels required by regulators. Although just as essential, intraday liquidity risk management has so far received less attention from banks.

2.1 Intraday liquidity risk principles BCBS (2008) states in principle 8 that “banks should actively manage their intraday liquidity positions and risks to meet payment and settlement obligations on a timely basis under both normal and stressed conditions and contribute to the smooth functioning of payment and settlement systems.” The following six operational elements for managing intraday liquidity have been identified: 

Measure expected daily gross liquidity in- and outflows, anticipate the intraday timing of these flows and forecast the range of potential net liquidity shortfalls during the day;



Monitor intraday liquidity positions against expected activities and available resources (balances, remaining intraday credit capacity, available collateral);



Arrange to acquire sufficient intraday liquidity to meet intraday objectives;



Manage and mobilize collateral as necessary to obtain intraday liquidity;



Manage timing of liquidity outflows in line with intraday objectives;



Be prepared to deal with unexpected disruptions in intraday liquidity flows.

1 LCR stress scenario does not cover expected or unexpected intraday liquidity needs. See BCBS (2013), “Basel III: The Liquidity Coverage Ratio (LCR) and liquidity risk monitoring tools”, paragraph 41, BIS Jan 2013.

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BCBS asks internationally active banks to report intraday liquidity risk on group as well as legal entity level (across all currencies) to local regulators on a monthly basis.

2.2 Why manage intraday liquidity risk? A bank’s failure to meet intraday payments in a timely manner negatively impacts its own liquidity position (signalling). The rest of the financial payment system could be negatively impacted as well due to the high degree of interdependency between payment systems. Failure to settle payments also causes counterparties to be unexpectedly short of liquidity (contagion). Disruptions are likely to spill over to other financial institutions and money markets. Banks should therefore have an intraday liquidity risk management framework in place. The objective is that banks comply with liquidity regulation on an intraday basis and are able to make intraday liquidity risk more transparent. As soon as local regulators adopt the BCBS recommendations, banks will need to comply with regulation on intraday liquidity risk. Regulation will require banks to actively manage, measure and report intraday cash flows under normal conditions. Banks must also develop a contingency plan based on stress scenario calculations and prove their resilience under stressed conditions. Enhanced transparency allows for active management of intraday liquidity risk. Complexity of the intraday liquidity structure differs across banks in terms of the number of relevant currencies and legal entities. Banks often operate on a system-by-system basis in various currencies. A bank can be a direct participant in a large-value payment system (LVPS) in one particular currency, but can simultaneously rely on correspondent banking services in other currencies. Complexity increases when a bank operates in multiple jurisdictions. These banks are confronted with different regulatory requirements that pose impediments on transferring intraday liquidity between legal entities. For cross-border banking groups, transparency on intraday liquidity for each legal entity is key.

2.3 Divergence between regulators on intraday liquidity risk BCBS (2013) recommended reporting intraday liquidity risk as of January 1 st 2015. Some local regulators – including those in the UK and the Netherlands – have already adopted BCBS’s guidelines and translated the recommendations into detailed reporting requirements. In these two countries, the local regulator included the capability of managing intraday liquidity within the bank’s individual liquidity adequacy assessments process (ILAAP). Starting from October 1st 2015, Dutch banks not only have a 100% LCR requirement, but they also need to demonstrate how intraday liquidity is managed. Other local regulators, such as FINMA in Switzerland, confirmed their support for the BCBS guidelines but have not yet provided detailed reporting requirements on intraday liquidity. These regulators extended the implementation timeline until 2017. As a consequence, there is a risk that the BCBS recommendations will not be applied unilaterally across jurisdictions.

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3

Drivers of intraday liquidity

Intraday liquidity refers to funds that can be accessed during a business day to enable banks to make (unexpected) payments in real time. Differentiation is needed between the sources and uses of intraday liquidity. Table 1 provides an insight into the main constituents of the bank’s sources and uses of intraday liquidity under both normal and (market or idiosyncratic) stressed conditions. Aspects

Scope

# S1 S2

Own sources

S3

Sources (S) S4 S5 3rd party

S6

U1

Uses (U)

Own uses

U2

U3

Description Reserve (cash) balances at central banks. Collateral pledged with central banks that can be freely converted into intraday liquidity (cash). Unencumbered assets on bank’s balance sheet that can be freely converted into intraday liquidity via money market. Secured and unsecured funding sources available intraday from other banks (committed or uncommitted credit lines). Balances with other banks available for intraday settlement. Payments received from LVPS participants, other payment systems or through correspondent banking services. Payments made to other LVPS participants, other payment systems or through correspondent banking services. Secured and unsecured funding made available intraday to other banks (committed or uncommitted credit lines). Contingent payments related to payment and settlement system’s failures (when emergency liquidity provider).

Normal Scenario

Stress Scenario

Available

Available

Available

Eligibility / Asset Quality

Available

Stressed HCs / CP risk2

Available

Reduced / Unavailable

Available

Minimized

Available

Delayed

Obliged

Obliged / Prefund

Available

Reduced / Withdrawn

Not Relevant

Contingent (Obliged)

Table 1: Sources and uses of intraday liquidity It is important to realize that not all sources and uses are equally relevant to all banks as intraday liquidity profiles differ between banks. Exposure depends on whether banks access LVPSs and settlement systems directly or indirectly. Banks also provide or use correspondent banking services to or from other banks. A bank can also be a direct participant in one payment system while using correspondent banking services in other payment systems3. The bank will need to manage its intraday liquidity positions during both normal and stressed conditions. In case of stressed liquidity, the bank cannot rely on all sources of intraday

2 HC: haircut; CP: counterparty. 3 A direct participant in a large-value payment system (LVPS) is a participant that can settle transactions without using an intermediary. If not a direct participant, a participant will need to use the services of a direct participant (correspondent bank) to perform payments and settlements on its behalf. A correspondent bank services transactions (on behalf of the domestic bank) that originate in a foreign country which the domestic bank cannot serve directly without opening a branch in that foreign country.

5

liquidity to the same extent as in normal conditions. For example, availability of secured funding might be reduced by means of higher haircuts or higher perceived counterparty risk. Counterparty banks may withdraw unsecured funding, making it unavailable as a liquidity source (e.g. uncommitted credit facilities). Banks delaying payments during stress periods elevate liquidity stress within the payment system even further. Item

Intraday liquidity stress

Contingent actions

1

A lack of available intraday liquidity at the beginning of the day to cover the expected time-critical obligations during the day reduces the bank’s flexibility to deal with unexpected intraday outflows.

Increase portion of unencumbered assets on the bank’s balance sheet.

2

A bank will struggle to settle intraday payments when the amount of intraday liquidity available at the beginning of the day is small relative to the potential impact of a stressed intraday liquidity event.

Convert collateral pledged at central banks into intraday liquidity (cash) in case of a stressed liquidity event.

3

The bank bears a risk of failing to make intraday payments when the amount of available intraday liquidity sources at the beginning of the day is consistently lower than the expected intraday liquidity usage.

Increase portion of unencumbered assets on the bank’s balance sheet.

4

Correspondent banks become vulnerable to liquidity stress themselves when other banks are mostly relying on correspondent banking services for their payment activities.

Local regulator needs to understand how correspondent banks mitigate intraday liquidity risk.

Banks that consistently delay intraday payments directly or indirectly cause intraday liquidity stress to other participants in the LVPS.

Local regulator must identify behavioral changes in how banks manage intraday liquidity risk.

5

Table 2: Causes of intraday liquidity risk Table 2 illustrates possible causes of intraday liquidity risk and corresponding mitigating actions. In some cases, actions are needed from bank’s senior management. In other cases, corrective measures by the local regulator are required. The next section explains BCBS’s view on how intraday liquidity risk can be measured and monitored.

4

Measuring intraday liquidity risk

BCBS (2013) recommends that banks include a time stamp on all intraday cash flows in and out, such that at the end of the month (retrospectively) an intraday liquidity report can be provided to the local regulator. The intraday liquidity risk monitoring tools presented in BCBS (2013) provide regulatory supervisors insight into a bank’s intraday liquidity position under normal conditions. In order to understand how stress scenarios impact intraday liquidity, BCBS (2013) also defined four stressed scenario conditions. This section provides insight into both the monitoring tools and intraday liquidity stress scenarios defined by BCBS (2013).

4.1 BCBS intraday liquidity risk monitoring tools BCBS (2013) translated the sound principles of intraday liquidity risk management into a number of intraday liquidity risk monitoring tools. Since no single monitoring tool provides a sufficient overview on the bank’s liquidity risk, seven monitoring tools have been identified for reporting purposes to the local regulator. These intraday liquidity risk monitoring tools 6

have been split into three categories, i.e. monitoring tools applicable to (A) all reporting banks, (B) reporting banks providing correspondent banking services to other banks and (C) reporting banks that are direct participants. For each category, the corresponding monitoring tools are explained below. See Table 3 for more details. Monitoring Tools

Description

Requirements

A1

Daily maximum intraday liquidity usage

Report the 3 largest net (positive and negative) cumulative balances between payments made and received under normal conditions as well as the average during the reporting period.

Monitor all cash flows in and out at various points in time during the day5. Minimum amount of intraday liquidity must be at least equal to the largest net negative balance.

A2

Available intraday liquidity at start of business day

Report the 3 lowest values of intraday liquidity available at the start of the business day (by constituent) as well as the average during the reporting period.

Need for enhanced transparency on intraday liquidity sources. Breakdown intraday liquidity sources into its constituent elements (See Section 2).

A3

Total payments

Report the 3 largest daily values of gross payments sent and received as well as the average during the reporting period.

Measure the overall size of the bank’s payment activities each day.

A4

Time-specific and critical obligations6

Report the 3 largest cumulative values of the time-specific and critical obligations intraday as well as the average over the reporting period.

Monitor and cumulate the timespecific and critical obligations during the day that should not be failed.

B1

Value of payments made on behalf of correspondent banking customers

Report the 3 largest daily gross values of intraday payments made on behalf of customers that use the bank’s correspondent banking services as well as the average during the reporting period.

Enhance understanding and calculate the total daily gross value of payments the bank makes on behalf of all its customers that use correspondent banking services.

B2

Intraday credit lines extended to customers

Report the 3 largest total amounts of intraday credit extended to customers (of which secured, committed and peak usage).

Monitor the total amount of intraday credit extended to customers each day.

C1

Intraday throughput

Report the daily average of the percentage throughput that settles each hour during the day.

Monitor the percentage of outgoing payments (relative to total payments) that settles on specific times during the day.

Cat.4

Table 3: BCBS intraday liquidity risk monitoring tools Retrospectively measuring and reporting the monitoring tools to the regulator does not prevent banks from running the risk of negative net liquidity positions at certain points during the day. In these instances, banks need access to its intraday liquidity sources. By

4 Category A (all reporting banks), Category B (correspondent banks) and C (direct participants). 5 For direct participants, the net position is the change in its opening balance with the central bank. For banks that rely on one or more correspondent banks, the net position represents the change in opening balance on the account with the correspondent bank during the day. 6 Time-critical obligations are: (1) obligations for which there is a time-specific intraday deadline, (2) obligations required to settle positions in other payment and settlement systems, (3) obligations related to market activities (e.g. margin requirements) and (4) other payments critical to the bank’s reputation.

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having an amount of

intraday liquidity available that is at least equivalent to the largest

negative net intraday liquidity position measured over time, unnecessary reliance on additional intraday liquidity sources can be reduced (also lowering accompanying costs). Another consideration is that collateral located in other jurisdictions may only be included in the computations of the monitoring tools when the bank can prove that the collateral can be freely transferred intraday to where it is needed. This is especially relevant for banks that rely on multiple payment systems for multiple currencies in various jurisdictions. The monitoring tools for correspondent banks (i.e. total value of payments on behalf of correspondent banking customers and the total amount of intraday credit extended to customers) provide local regulators insight into the degree to which correspondent banks are exposed to intraday liquidity risk. Using intraday throughput, regulators can monitor any behavioral changes in how direct participants manage their intraday liquidity over time and the probability of spill-over effects to other banks.

4.2 Definition of intraday stress scenarios The BCBS monitoring tools provide insight and transparency into a bank’s intraday liquidity profile under normal conditions. Since normal conditions do not always prevail, intraday liquidity sources and uses can substantially change during times of stress. BCBS (2013) defined the following four stress scenarios (behavioral assumptions) in Table 4. Scenarios

Scenario description

Financial stress

The bank suffers or is perceived to be suffering from a stress event which causes counterparties to defer payments and/or withdraw intraday credit lines. In such an event, a direct participant must fund more of its payments from its own sources of intraday liquidity in order to avoid deferring its payments. Banks using correspondent banking services must either pre-fund payments or collateralize intraday credit lines.

Counterparty stress

A counterparty suffers from a stress event when it is not able to make its payments on time. In this case, both direct participants and banks that use correspondent banking services cannot (fully) rely on incoming payments from the stressed counterparty. This is expected to increase uncertainty because the bank’s available amount of intraday liquidity is lower than expected.

Customer bank’s stress

In this event, a correspondent bank's customer bank suffers liquidity stress. This will cause other banks to defer payments to the customer bank, making the correspondent bank more vulnerable to intraday liquidity stress as well.

Market-wide (credit or liquidity) stress

Market-wide (credit/liquidity) stress could negatively impact the value of liquid assets the bank holds to meet its intraday liquidity obligations. In case credit ratings of unencumbered liquid assets deteriorate (i.e. haircuts increase), the ability to raise intraday liquidity from the central bank or correspondent banks will be constrained. In the worst case, certain assets end up not being eligible for central bank’s liquidity facilities. Banks that rely heavily on cross-currency basis swaps to manage intraday liquidity face considerable intraday liquidity risk in case the currency swap market becomes distorted. Money markets could be negatively impacted as well.

Table 4: BCBS intraday liquidity stress scenarios Banks are asked to determine the impact of stress on their intraday liquidity position. For this purpose, banks are recommended to use their core systems and tools as much as possible, when estimating the impact of stress. The above stress scenarios will be used by 8

the regulator to estimate how resilient the bank’s intraday liquidity position is under stressed conditions. Stressed outcomes will also be used by the regulator to judge the quality of the bank’s contingency plan.

4.3 Developing a contingency plan (synopsis) Banks do not need to report the impact of stress scenarios on the monitoring tools to the regulator. They should use the outcomes of the stressed scenarios to understand how their intraday liquidity profile changes under stressed conditions and define a proper contingency action plan. Aspects Stress

Category

Assess impact on monitoring tools7

Contingent action plan8

Assessment of the bank’s resilience to intraday liquidity stress Own financial stress

Counterparty stress

All reporting banks

All reporting banks

Direct Corresparticipondent pants banks A1 A1 A2 A2 A3 A3 A4 A4 C1 ---Convert collateral and unencumbered assets into cash in case of negative net intraday liquidity (S2, S3).

Direct Corresparticipondent pants banks A1 A1 A2 A2 A3 A3 A4 A4 C1 ---Restrict secured and unsecured funding (credit lines) made available to stressed counterparty (U2).

Prioritize timecritical obligations; limiting reputational damage and spillover effects (U1).

Contribute to smooth functioning of payment systems and prevent reputational damage and spill-over risk (U1).

Monitor intraday throughput to identify changes in direct participant’s payment and settlement behaviour.

Reduce own balances on accounts with stressed counterparty to a minimum (S5).

Customer bank’s stress

General market stress All reporting banks

Correspondent banks only A1 A2 A3 A4 B1 B2 Restrict secured and unsecured funding available to stressed counterparty (U2). Continue to smooth functioning of payment systems; prevent reputational damage and spillover risk (U1).

Direct Corresparticipondent pants banks A1 A1 A2 A2 A3 A3 A4 A4 C1 ---Monitor all intraday liquidity sources impacted by general market stress (S2, S3, S4, S5, S6). Monitor and restrict secured and unsecured funding (credit lines) made available to perceived stressed counterparties (U2). Continue to smooth functioning of payment systems; prevent damage of reputation and spillover risk (U1).

Monitor secured and unsecured funding and payments received from stressed counterparty (S4, S6).

Table 5: Intraday liquidity contingent action plan

7 See Table 3 for categorization and numbering of BCBS (2013) monitoring tools. 8 Numbering of aspects according to intraday liquidity sources (S) and used (U) as shown in Table 1.

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Table 5 explains which monitoring tools can be used to assess the impact of various stress scenarios and what contingent actions are potentially available. This table also provides a good basis for understanding which banking (transaction or service) activities are the main contributors to intraday liquidity risk during stressed conditions as well as discussing with the regulators the resilience (breadth and depth) of the contingency plan.

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Implementing an ILM framework

In order to ensure that (1) payments and settlements run smoothly throughout the day (even during stressed times) and (2) the bank is compliant with regulatory requirements (i.e. reporting monitoring tools), the bank’s intraday liquidity risk management framework needs to be improved. Most banks are expected to face considerable challenges when implementing a robust ILM framework. Goals

Aspects

Requirements  Obtain a holistic overview on the intraday liquidity position by

currency, payment system and jurisdiction (e.g. beginning balance, cumulative net cash flows in and out during the day and the end-of-day liquidity position);

 Prioritize and plan time-critical intraday obligations in advance

(i.e. at the beginning of the day);

 Limit occurrences of excessive negative net intraday liquidity

Intraday liquidity dashboard

Active management

positions by actively managing the mismatch between outgoing payments made and incoming payments received. This is expected to reduce a bank’s intraday liquidity risk and (unexpected) need to access intraday liquidity sources;9

 Make changes in intraday liquidity sources and uses transparent;  Enhance insight into businesses’ intraday liquidity usage and

associated costs;

 Reflect intraday liquidity risk into pricing of banking transactions

and services.

 Exercise proper governance and control over intraday liquidity

Internal oversight

Governance and control

risk by defining the three layers of defense (e.g. defining and monitoring intraday liquidity risk limits);

 Define responsibilities, escalation process and actions in case of

an intraday limit breach.

 Comply with regulatory requirement by (retrospectively)

Regulatory compliance

Reporting monitoring tools

calculating and reporting the BCBS intraday liquidity monitoring tools at the end of each month;

 Define and evaluate the impact of stress scenario conditions on

intraday liquidity to support discussions with regulators on the resilience of the developed contingency plans.

Table 6: Robust intraday liquidity requirements 9 Especially for large banks offering correspondent bank services across multiple jurisdictions, settlement systems and currencies, it is crucial to plan large value payments (of which some of those are time-critical) as much as possible aiming to minimize intraday liquidity usage and to prevent unnecessary utilization of liquid assets on the balance sheet (e.g. unencumbered assets becoming encumbered). Banks that use correspondent banking services often have access to intraday credit facilities from the correspondent bank in case they don’t have sufficient cash on the account with the correspondent bank.

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5.1 Robust intraday liquidity management A robust intraday liquidity risk framework is more than just the ability to report the monitoring tools to the regulator. The monitoring tools do not require banks to manage intraday liquidity risk in a real-time manner, but only ask banks to report intraday liquidity positions retrospectively. A robust framework goes one step further and enables banks to effectively measure, monitor and actively manage the bank’s intraday liquidity position in real-time. Table 6 explains the requirements of a robust ILM framework. Implementation of a robust risk framework that satisfies these requirements will be timeconsuming and resource-intensive exercise for banks. Complexity increases when the bank provides correspondent banking services to others or when the bank operates in multiple jurisdictions, currencies and across various payment and settlement systems.

5.2 System and organizational challenges These days most banks manage intraday liquidity risk in a rather fragmented and often inefficient manner. Regulatory compliance will confront banks with a number of challenges related to multi-functional data issues and system requirements. These challenges can widely differ across banks depending on their size and structure, whether they are direct participants or not and to the degree they rely on or provide correspondent banking services. Following an in-depth assessment with financial institutions, SWIFT (2014) concluded that a large number of banks have only a small portion of their payments tagged with an intraday time stamp (timed information). Also, a small portion of the correspondent banking payments exchanged are currently confirmed intraday. The challenges banks face when implementing a robust intraday liquidity risk framework relate to (1) data sourcing, (2) data centralization and consolidation, (3) regulatory reporting, (4) building an intraday liquidity dashboard and (5) governance. See Table 7 for more information. Not many correspondent banks are able to provide customer banks with intraday transaction data and balances let alone providing the data with a proper time stamp or in a sufficient degree of granularity. Most correspondent banks currently provide end-of-day settlement statements only. For correspondent banks it will be costly to continue serving other banks with corresponding banking services while providing them with the required timed information. Besides data availability, data quality is also an issue. Any output from a system which is not able to provide data with an intraday time stamp is basically useless for intraday liquidity monitoring and reporting purposes. Systems that overwrite a prior balance with the most actual cash balance won’t be able to store intraday variations. This makes it impossible to comply with regulatory requirements. Dovetail (2014) also refers to a shift in risk managers’ mindset from ‘end-of-day thinking’ to ‘real-time thinking’. Manual business processes that used to take one day were suitable for end-of-month reporting cycles. However, these types of business processes cannot be used when it needs to be refreshed almost real-time. This could expose a bank’s structural problems, deeply nested in its operations, to the local regulator.

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Compliance with regulatory requirements and the implementation of a robust intraday risk management framework force banks to cope with the above challenges. This coincides with significant expenditures in systems, automatization as well as management attention. In today’s banking environment, where margins are under pressure, banks might not be willing to make these expenses. They focus on incremental improvements to their existing systems first. On the other side, the question remains: “What is the risk and accompanying cost of non-compliance with regulatory requirements?” Challenges

Scope

Description  Defining internal data requirements for regulatory compliance and

define additional internal data requirements for implementing an intraday liquidity dashboard;

 Obtaining timed information (transactions and balances) from

multiple functions within the organization (e.g. treasury, payments & settlements, collateral management etc.);

Internal

 Locating and sourcing internal data that is fragmented over a

number of internal systems;  Aligning granularity and format of internal data to the requirements

implied by regulatory compliance (reporting) and liquidity dashboard;

Sourcing

 Amending and automating internal data gathering processes (where

possible).

 Defining external data requirements for regulatory compliance;  Obtaining intraday transaction data and balances from one (or

External

more) correspondent banks and handle information in proprietary data formats from correspondent banks;

 Deciding on common granularity, format and automated processing

of external data.

 Centralizing and storing internal (multi-functional) data and external

data into one (or more) data bases each day (reflecting agreed granularity and format);

Centralization and consolidation

 Consolidating timed information across all operations, currencies

Internal

and jurisdictions serving purpose of reporting BCBS’s intraday monitoring tools each month to local regulator;

 Centralized database(s) also provides basis for building an intraday

liquidity dashboard;

 Automating data processing as much as possible.  Defining the monthly regulatory reporting process (including

Regulatory reporting

Internal

responsibilities) and build a tool that calculates the intraday liquidity monitoring tools at month-end (see Table 3);

 Deriving and agreeing on a contingency plan from stressed scenario

outcomes (see Table 4).

Liquidity dashboard

 Constructing a dashboard that provides an holistic overview and

Internal

allows for active management of the bank’s intraday liquidity position (see requirements in Table 6).

 Monitoring the net intraday liquidity positions versus limit(s);

Governance

Internal

 Defining and building internal management report on intraday

liquidity risk (MIS).

Table 7: Challenges implementing a robust ILM framework

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6

Benefits of managing intraday liquidity risk

Being able to actively manage the bank’s intraday liquidity position is a costly exercise as explained above. Banks can also reap significant benefits. The following potential benefits exist from an improved intraday liquidity risk management framework. Funds transfer pricing: Funds transfer pricing ensures risk is properly reflected in pricing of products or services. All efforts directed to improving transparency help to identify which businesses or clients are consuming the bank’s intraday liquidity. Banks should apply a clear cost-by-cause principle 10 . Transparency on the usage of intraday liquidity provides an informed basis for pricing and allocating intraday liquidity costs to their activities (businesses) and clients. Businesses and clients that need access to significant amounts of intraday liquidity should also bear most of the costs associated with it. Transferring the appropriate amount of intraday liquidity costs to a business enhances insight in the true economic value performance of a business. Properly reflecting intraday liquidity costs into pricing of products (e.g. committed or uncommitted intraday credit lines), also provides banks the opportunity to (dis)incentivize products depending on their actual intraday liquidity position. Collateral optimization: Collateral optimization reduces operational costs. Assets and collateral reserved for payment and settlement activities can be substantial, but cash and collateral held for these purposes come at a cost. These assets yield minimal returns. In recent years, banks have increased their focus on and became smarter in managing their collateral pool of assets. Active management of intraday liquidity risk further contributes to managing the collateral pool of assets in a more optimal and efficient manner. This is expected to reduce costs. A better understanding and accurate projection of intraday liquidity throughout the day also allows for a more accurate view of how much collateral is really needed for intraday liquidity purposes. Excess collateral can now be used more economically elsewhere within the firm, be it to support activities internally or externally in the money market. Competitive advantage: Correspondent banks that have insight as well as the capability to actively manage their own intraday liquidity position can also do so for other customers by providing them with real-time information on their intraday positions. Improved visibility over all intraday cash in- and outflows has substantial value to banks that rely on correspondent banking services, because they can also comply more easily with regulatory requirements on intraday liquidity. Correspondent banks can help customers understand and explain their intraday net cash balances as well as advise them on how they can alter their payment profile in order to reduce their reliance on additional intraday liquidity sources and usage of collateral. For correspondent banks, this can potentially result in a commercial advantage or even a competitive advantage in the marketplace. As a result, both correspondent banks and their customers can potentially find a mutual benefit. 10 Regulation on liquidity requires that banks properly manage and price liquidity risk in all of their products, services and trading activities. This also includes intraday liquidity costs.

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7

Conclusion and next steps

Intraday liquidity risk is the least managed part of liquidity risk management within banks. Regulation on intraday liquidity risk management is another example of regulation making banking more costly. Significantly more spending – both in terms of time and money – is needed to comply with regulatory requirements. Banks will be confronted with various internal and external data sourcing and system problems before they can report the monitoring tools to the regulator and have an intraday liquidity dashboard in place. This liquidity dashboard improves transparency, provides an holistic view on intraday liquidity risk and enables the bank to actively manage its intraday liquidity position. The (immediate) cost for implementing a robust intraday liquidity risk management framework must be balanced against the benefits in the long-term. Due to improved transparency, a bank is able to accurately reflect risk in pricing of products and services as well as identify which business should absorb most of the costs associated with intraday liquidity risk. This allows for some degree of business incentivization. Actively managing intraday liquidity risk also reduces costs, because it enables the bank to manage the pool of collateral assets in a better and more efficient manner. Collateral assets can be put to use elsewhere in the organization or in the money markets, thus enhancing returns. In this context, banks need to realize what the cost of non-compliance will be when balancing short-term costs against the longer-term benefits. The consequence of inaction or inadequate action by a bank can either result in penalties (direct costs), higher capital requirements (indirect costs) or in the worst case longer-term opportunity losses due to erosion of its competitive advantage. Banks need to ensure that they focus on and comply with regulatory requirements first. Tackling data sourcing and system problems will consume a significant amount of time. Afterwards, banks can decide to shift attention to building an intraday liquidity dashboard that allows for active management of the bank’s intraday liquidity position.

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References Banking Technology (2014), “The challenge of intraday liquidity reporting”, 5th Jun 2014 Basel Committee on Banking Supervision (2008), “Principles for sound liquidity risk management and supervision”, BIS Sep 2008 Basel Committee on Banking Supervision (2013), “Basel III: The liquidity coverage ratio and liquidity risk monitoring tools”, BIS Jan 2013 Basel Committee on Banking Supervision (2013), “Monitoring tools for intraday liquidity management”, BIS Apr 2013 Baringa (2013), “Intraday liquidity management – The final liquidity frontier (Viewpoint)”, 2013 Dovetail (2012), “Intraday liquidity management – Compliance requirement or competitive opportunity (White Paper)”, 2012 Dovetail (2014), “Demystifying intraday liquidity monitoring and BCBS 248 – Common misconceptions and their remedies (White Paper)”, 2012 European Banking Authority (2013), “Draft methodology for assessment of liquidity and funding risk under SREP (Discussion Paper)”, EBA Dec 2013 Hartig,

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Considerations on content and implementation of the Basel reporting requirements (White Paper), Targit 2013 Neef de, P.L., Baneke, P.J.J., Wijck van, J.F. (2012), “Uitgangspunten voor het internal liquidity adequacy assessment process (ILAAP) – Toezichthouderhandleiding”, DNB Jul 2012 Olieslager, E., Koppens, L., Davidson, J., (2014), “Management der Innertagesliquiditaet”, Risikomanager 20 2014, p. 25 – 29 SWIFT (2011), “Managing liquidity risk – Collaborative solutions to improve position management and analytics (White Paper)”, Jun 2011 SWIFT (2013), “Intraday liquidity reporting – Tools from SWIFT to support compliance with BCBS monitoring requirements (Information Paper)”, Dec 2013 SWIFT (2014), “Intraday liquidity reporting – The case for a pragmatic industry solution (White Paper)”, Jul 2014

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