Global bank supervisors endorse strengthened sound practice standards for liquidity risk management and supervision

Bank supervisors from central banks and supervisory agencies endorsed the Basel Committee's Principles for Sound Liquidity Risk Management and Supervision. Supervisors were meeting at the International Conference of Banking Supervisors hosted by the Belgian Banking, Finance and Insurance Commission and the National Bank of Belgium on 24-25 September 2008 in Brussels.

The principles underscore the importance of establishing a robust liquidity risk management framework that is well integrated into the bank-wide risk management process. Key elements of a bank's governance of its liquidity risk management are also emphasised. The document also sets out the principles to strengthen the measurement and management of their liquidity risk. Among other things, a bank should:

• conduct regular stress tests for a variety of short-term and protracted institution-specific and market-wide stress scenarios and use the outcomes to develop robust and operational contingency funding plans;
• ensure the alignment of risk-taking incentives of individual business lines with the liquidity risk exposures the activities create;
• actively manage its intraday liquidity positions and risks to meet payment and settlement obligations on a timely basis under both normal and stressed conditions, and thus contribute to the smooth functioning of payment and settlement systems; and
• maintain a cushion of unencumbered, high quality liquid assets as insurance against a range of stress scenarios.

Nout Wellink, Chairman of the Basel Committee on Banking Supervision and President of the Netherlands Bank, stated that "the new liquidity principles should help promote better risk management in this key area. This will only be achieved, however, if there is robust and timely implementation by banks and supervisors. The Committee will coordinate rigorous follow up by supervisors to ensure banks adhere to these fundamental principles." The principles support one of the key recommendations for strengthening prudential oversight set out in the Report of the Financial Stability Forum on Enhancing Market and Institutional Resilience, which was presented to G7 Finance Ministers and Central Bank Governors in April 2008.

The principles discuss the key role of regular public disclosure that enables market participants to make an informed judgement about the soundness of a bank's liquidity risk management framework and liquidity position. The role of supervisors is also highlighted, including the responsibility to intervene to require effective and timely remedial action by a bank to address liquidity risk management deficiencies. The principles also stress the need for regular communication with other supervisors and public authorities, both within and across national borders.

The guidance focuses on liquidity risk management at medium and large complex banks, but the sound principles have broad applicability to all types of bank. The document notes that implementation of the sound principles by both banks and supervisors should be tailored to the size, nature of business and complexity of a bank's activities. Other factors that a bank and its supervisors should consider include the bank's role and systemic importance in the financial sectors of the jurisdictions in which it operates.

The principles deliver a significant enhancement to the Basel Committee's liquidity guidance that was published in 2000. Draft principles were published for public consultation on 17 June 2008. Comments received were largely supportive. Commentors provided a number of useful clarifications and suggestions, which have been adopted in the final version of the principles.

The Committee has also begun a review of ways to promote more consistency in the implementation of global liquidity supervision for cross border banks as a way to enhance resiliency to financial market stress.