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CEBS Technical Advice on Liquidity Risk Management: Summary

Core Content and Objectives

The CEBS report, part of the European Commission’s Call for Advice on Liquidity Risk Management (2007), provides an updated survey of the regulatory frameworks for liquidity risk management in the European Economic Area (EEA). The primary objective is to assess how national regulators and supervisors approach liquidity risk, with a focus on the supervision of credit institutions and investment firms, and to identify any gaps or inconsistencies in the current framework.

The report is structured into three parts:

• Part 1: Key themes and messages from the responses.
• Part 2: Summary of responses from EEA countries.
• Part 3: Detailed country-specific responses.

Main Regulatory Frameworks

Capital Requirements Directive (CRD)

• Introduced in Annex V, point 10 of Directive 2006/48/EC, requiring credit institutions to have:
  • Policies and procedures for liquidity risk management.
  • Contingency plans for liquidity crises.
• The CRD does not provide detailed guidance on liquidity risk, except for EEA branches.
• Most national authorities refer to the Basel "Sound Practices for Liquidity Risk Management" (2000) as an authoritative source.

Regulatory Aims

• Micro-level aim: Ensuring institutions can meet payment obligations at any time at reasonable cost.
• Macro-level aim: Maintaining financial stability by ensuring credit institutions do not pose systemic risks due to poor liquidity management.
• Some regimes aim to address market failures, such as:
  • Preventing solvent banks from being unable to attract sufficient funds.
  • Mitigating market frictions.
• However, most responses imply addressing market failures through other mechanisms like stress testing and contingency plans.

National Regulatory Requirements

Introduction and Recent Changes

• Regulatory frameworks have been in place for varying periods, with the earliest from 1979 and the latest updated in 2007.
• Only five countries have implemented significant changes to their liquidity regimes:
  • Allowing internal measurement and management approaches.
  • Introducing explicit quantitative (liquidity ratios) and qualitative requirements.
  • Standardized reporting and mandatory liquidity limits.
  • Updated qualitative requirements and consolidated reporting options.
  • Standardized reporting and minimum liquidity limits.

Scope of Application

• Most countries apply the same supervisory requirements to all credit institutions, regardless of size or type, but with attention to proportionality.
• Some countries differentiate between:
  • Large and small institutions.
  • Mortgage lenders and other credit institutions.
  • Local banks and overseas branches.
• A few countries allow host supervisors to allocate liquidity supervision to home authorities through "global concessions" if the home and host regimes are considered equivalent.

Consolidation vs. Solo Supervision

• Consolidated supervision: One country supervises solely at the consolidated level, while more than two-thirds of regimes apply consolidated supervision either generally or on a case-by-case basis.
• Solo supervision: The majority of countries apply liquidity requirements at the solo level only.
• Reasons for consolidated supervision:
  • Enhancing transparency.
  • Identifying group-wide liquidity risks.
  • Aligning with the philosophy of Pillar 2.
  • Article 69 of Directive 2006/48/EC allows for waiving solo requirements if group-level compliance is ensured.
• Reasons for solo supervision:
  • Preference for local management.
  • Business strategy and market-specific knowledge.
  • Local funding utilisation.
  • Autonomous liquidity risk management in subsidiaries.

Centralised vs. Decentralised Management

• Centralised management is common, especially in cross-border banking groups, and is typically applied to:
  • Risk principles, policies, limits, and contingency plans.
  • Central monitoring of liquidity exposure.
  • Securing long-term funding for the group.
• Decentralised management is often used for:
  • Day-to-day liquidity management.
  • Local decision-making based on market-specific conditions.
• Rationales for centralised management:
  • Efficient use of group liquid assets.
  • Better funding terms.
  • Consistency and coordination in crisis.
  • Combining central expertise with local knowledge.
  • Transparency for investors and rating agencies.
  • Counterparty risk management.
• Rationales for decentralised management:
  • Local market understanding.
  • Increased responsibility of local managers.
  • Local funding utilisation.
  • Self-sufficiency in crisis.
  • Reduced vulnerability to operational risks.
  • Restrictions on cross-border collateral pooling and fund transfers.

Liquidity Ratios and Eligible Assets

• Quantitative approaches include:
  • Mismatch limits (11 countries).
  • Stock ratios (4 countries).
  • Combined mismatch/stock (5 countries).
  • Separate approaches based on institution type (1 country).
• Qualitative requirements include:
  • Documented liquidity policies.
  • Internal controls and contingency planning.
  • Stress testing and scenario analysis.
• Eligible assets:
  • Cash and freely convertible foreign currency are universally accepted.
  • Other assets vary by country, with some requiring specific liquidity criteria.
  • Assets are typically valued at market or nominal value, with or without haircuts.

Stress Testing and Scenario Analysis

• All countries require stress testing as part of liquidity risk management.
• Most do not set obligatory scenarios but expect institutions to use scenarios appropriate to their risk profile.
• There is a general expectation that institutions apply both bank-specific and market-wide scenarios.

Liquidity Reporting

• Almost all countries have liquidity reporting requirements for credit institutions.
• Reporting frequency is typically monthly or quarterly, with some extending to semi-annual or daily.
• Some countries allow internal management information to be used instead of standardized reporting.
• Only a limited number of countries require liquidity reporting from investment firms.
• Reporting schemes are generally similar but vary in detail, definitions, and aggregation levels.

Key Observations

• The EU has expanded significantly since 2000, highlighting challenges with cross-border banking groups.
• While most countries apply qualitative requirements, some have introduced quantitative limits.
• There is a continuum between quantitative and qualitative approaches, with internal models playing an increasing role.
• Differences exist in the treatment of foreign currencies and liquidity sources.
• Consolidated and solo supervision coexist, with varying justifications.
• The report sets the stage for a deeper analysis of liquidity risk management, particularly in relation to internal models, stress testing, and the interaction between funding and market liquidity risks.