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CEBS Technical Advice on Liquidity Risk Management: Summary

Core Content

The Royal Bank of Scotland (RBS) responds to the CEBS (Committee of European Banking Supervisors) technical advice on liquidity risk management, published in June 2008. RBS broadly supports the recommendations and emphasizes the importance of a robust liquidity risk management framework that aligns with both the institution's risk appetite and profitability goals. The advice outlines a structured approach for managing liquidity risk, involving the identification of liquidity positions, stress testing, cost-benefit analysis, and contingency planning.

Main Recommendations and Key Points

1. Liquidity Risk Strategy and Policies

• The Board should define a liquidity risk strategy and set management policies based on the institution's liquidity risk, role in the financial system, and risk tolerance.
• The strategy should consider both normal and stressed conditions and be regularly reviewed.
• Management must implement these strategies effectively.

2. Internal Liquidity Cost/Benefit Allocation

• Institutions should have mechanisms to allocate liquidity costs and benefits across different business activities.
• Internal charging mechanisms should encourage appropriate behavior and not lead to cost avoidance.
• The potential cost of liquidity stress events should be considered, with challenges in equitable allocation.
• Cross-border liquidity charges must be recognized by tax authorities.

3. Organisational Structure and Staffing

• The organisational structure should ensure segregation of duties and independent internal control.
• Adequate staffing, resources, and coordination are essential for effective liquidity risk management.

4. Strategic Liquidity Risk Awareness

• Institutions must understand liquidity positions and flows within the group, considering all market, regulatory, and financial constraints.
• There may be a conflict between local regulatory requirements and global liquidity management needs.
• For less freely traded currencies, self-sustainability is more prudent than relying on central group resources.

5. IT Systems and Liquidity Management

• IT systems must support liquidity risk measurement, internal management, and regulatory reporting.
• Regulators should demonstrate the cost-benefit of additional data requirements and allow time for IT development.

6. Collateral and Liquidity Management

• Collateral should be managed as a key liquidity tool, with policies to identify and estimate collateral needs.
• Collateral must be available at all times to address unexpected funding needs.
• Collateral is used in various contexts, including settlement, repo, and as a buffer.

7. Intraday Liquidity Monitoring

• Intraday liquidity should be managed on a gross basis to ensure accurate monitoring.
• Collateral in settlement systems supports intraday exposures and should be tracked closely.
• Banks should have limits to control exposure to individual counterparties.

8. Liquidity Stress Testing

• Stress tests should evaluate the impact of extreme but plausible scenarios on liquidity positions.
• Normal assumptions form the basis of stress testing, which should be regularly reviewed.
• Stress testing helps design contingency plans and assess the bank's ability to withstand liquidity shocks.

9. Contingency Planning

• Institutions should have contingency plans for liquidity crises and test them regularly.
• Care must be taken to avoid sending negative market signals during testing.
• Central banks may coordinate contingency rehearsals to ensure preparedness.

10. Liquidity Buffers

• Liquidity buffers are essential during stress events to meet urgent funding needs.
• The value of liquidity buffers must account for potential market declines in asset values.
• Assets eligible as collateral by central banks play a crucial role in buffer composition.

11. Funding Diversification

• Institutions should monitor funding sources to avoid concentration risks.
• Funding should be diversified across providers, types, and markets.
• A bank's reliance on wholesale funding and maturity transformation should be assessed.

12. Disclosure and Transparency

• Institutions should disclose timely and adequate information on liquidity risk management.
• There is a balance between transparency and confidentiality to avoid misinterpretation of liquidity buffer usage.

13. Supervisory Framework

• Supervisors should have methodologies to assess liquidity risk and management.
• Supervision should be proportionate based on the institution's risk profile and systemic risk.
• Special attention should be given to the identification of all liquidity risks and the robustness of internal methodologies.

14. Cross-Border Coordination

• Supervisors of cross-border groups should coordinate to better understand liquidity risk profiles.
• Collaboration within "colleges of regulators" is encouraged to develop consistent approaches to regulating global banks.

15. Proportionality and Internal Methodologies

• Supervisors should consider the proportionality principle when regulating less sophisticated institutions.
• Internal methodologies can supplement or replace quantitative supervisory requirements if adequately assessed.

Conclusion

RBS supports the CEBS recommendations and believes they will help maintain robust liquidity policies across the financial sector. The bank emphasizes the importance of a clear liquidity strategy, effective stress testing, and well-managed contingency plans. It also highlights the need for regulatory alignment and the development of appropriate IT systems to support liquidity risk management. Overall, the advice provides a comprehensive framework for managing liquidity risk, both in normal and stressed conditions, and encourages a proactive and transparent approach.