Michael S Barr: The importance of effective liquidity risk management

Speech by Mr Michael S Barr, Vice Chair for Supervision of the Board of Governors of the Federal Reserve System, at the 5th European Central Bank Forum on Banking Supervision "Europe: banking on resilience", Frankfurt am Main, 1 December 2023.

The views expressed in this speech are those of the speaker and not the view of the BIS.

Thank you for the opportunity to speak today. I'm delighted to be here to celebrate the retirement of Andrea Enria, my dear friend and colleague, who has done so much to strengthen the supervision and regulation of European banks throughout his career. In my remarks, I would like to provide perspective on some of the lessons learned from the banking stress experienced in the United States last spring for both banks and their supervisors. In particular, I will focus on how banks manage liquidity risk, the role of the central bank's discount window lending in this process, and the importance of robust liquidity planning for good times and bad.

Last March, several large U.S. banks faced acute liquidity pressures when uninsured depositors looked at the banks' balance sheets and judged that the banks would be insolvent if they needed to liquidate their securities portfolios to meet potential outflows. The banks' poor interest rate and liquidity risk management triggered a crisis of confidence in their uninsured depositors, resulting in liquidity crises at these banks. In short, they faced old-fashioned bank runs, the speed of which was anything but old fashioned. Despite their compliance with our capital rules, these banks lacked enough capital to reassure uninsured depositors that they had sufficient resources to weather this liquidity storm.

In addition to our domestic strains, Credit Suisse came under renewed pressure in March 2023 after a long period of liquidity pressures that had been acute since the fall of 2022. Of course, Credit Suisse had been a troubled bank for some time, with doubts about its future viability after the Archegos and Greensill scandals had tarnished its reputation. These concerns became reality when the firm was forced to announce that its internal controls over financial reporting were ineffective and had been for several years. Credit Suisse was acquired by UBS in a deal that involved triggering of Credit Suisse's contingent convertible capital instruments, a severe dilution of shareholders, and the removal of senior bank management, as well as emergency liquidity support and extraordinary loss sharing from the Swiss government.

While there is more that regulators and supervisors can do to help to ensure banks' interest rate risk management and capital bases are sufficiently calibrated to the risks of their business models, today I will focus most of my comments on liquidity risk management and operational readiness for firms in the United States to utilize the Federal Reserve's discount window. This is not a new topic, as I have spoken about lessons from March and the importance of bank's preparedness to tap Fed facilities previously. Today I will revisit those themes and provide some additional observations about the March stress events, including the importance of discount window preparedness relative to some specific liquidity risk factors such as uninsured deposits.