International framework for liquidity risk measurement, standards and monitoring

The Basel Committee on Banking Supervision has issued for consultation a package of proposals to strengthen global capital and liquidity regulations with the goal of promoting a more resilient banking sector.

The Committee welcomes comments on all aspects of this consultative document by 16 April 2010. Comments should be submitted by post (Secretariat of the Basel Committee on Banking Supervision, Bank for International Settlements, CH-4002 Basel, Switzerland) or email (baselcommittee@bis.org). All comments will be published on the Bank for International Settlements' website unless a commenter specifically requests anonymity.

Introduction

Throughout the global financial crisis which began in mid-2007, many banks struggled to maintain adequate liquidity. Unprecedented levels of liquidity support were required from central banks in order to sustain the financial system and even with such extensive support a number of banks failed, were forced into mergers or required resolution. These circumstances and events were preceded by several years of ample liquidity in the financial system, during which liquidity risk and its management did not receive the same level of scrutiny and priority as other risk areas. The crisis illustrated how quickly and severely liquidity risks can crystallise and certain sources of funding can evaporate, compounding concerns related to the valuation of assets and capital adequacy.

A key characteristic of the financial crisis was the inaccurate and ineffective management of liquidity risk. In recognition of the need for banks to improve their liquidity risk management and control their liquidity risk exposures, the Basel Committee on Banking Supervision ("the Committee") issued Principles for Sound Liquidity Risk Management and Supervision in September 2008. These sound principles provide consistent supervisory expectations on the key elements of a robust framework for liquidity risk management at banking organisations. Such elements include:

• board and senior management oversight;
• the establishment of policies and risk tolerance;
• the use of liquidity risk management tools such as comprehensive cash flow
  forecasting, limits and liquidity scenario stress testing;
• the development of robust and multifaceted contingency funding plans; and
• the maintenance of a sufficient cushion of high quality liquid assets to meet
  contingent liquidity needs.

Supervisors, for their part, are expected to assess both the adequacy of a bank's liquidity risk management framework and its liquidity risk exposure. Supervisors are also expected to take prompt action to address the bank's risk management deficiencies or excess exposure in order to protect depositors and enhance the overall stability of the financial system.

To reinforce these supervisory objectives and efforts, the Committee has recently focused on further elevating the resilience of internationally active banks to liquidity stresses across the globe, as well as increasing international harmonisation of liquidity risk supervision. The Committee has developed two internationally consistent regulatory standards for liquidity risk supervision as a cornerstone of a global framework to strengthen liquidity risk management and supervision. The standards also respond to recommendations of the G20 that called for the Committee to "....enhance tools, metrics and benchmarks that supervisors can use to assess the resilience of banks' liquidity cushions and constrain any weakening in liquidity maturity profiles, diversity of funding sources, and stress testing practices". Furthermore, the G20 recommended that "...the BCBS and national authorities should develop and agree by 2010 a global framework for promoting stronger liquidity buffers at financial institutions, including cross-border institutions."

It should be stressed that the standards establish minimum levels of liquidity for internationally active banks. Banks are expected to meet these standards as well as adhere to all the principles set out in the September 2008 Sound Principles document mentioned above. As under the Basel Accord (for capital adequacy), national authorities are free to adopt arrangements that set higher levels of minimum liquidity.

To further strengthen and promote consistency in international liquidity risk supervision, the Committee has also developed a minimum set of monitoring tools to be used in the ongoing monitoring of the liquidity risk exposures of cross-border institutions and in communicating these exposures among home and host supervisors.

This document is organised as follows:

• Section II discusses the two measures of liquidity risk exposure developed to be
  formally-adopted standards for internationally active banking organisations.
• Section III presents a set of common monitoring tools to be used by supervisors in
  their monitoring of liquidity risks at individual institutions.
• Section IV discusses application issues for the standards and monitoring tools.