The regulated financial services sector is familiar with liquidity management and planning under normal and stressed environments, but for most other corporate treasury functions it is not an area that often merits any structure or guidance.
We have seen a fundamental shift in the liquidity markets over past couple of weeks and while the change has been sudden, it will have long lasting implications for how corporate treasuries think about their liquidity strategy. During these extraordinary times, it is helpful to consider some of the approaches adopted by those working in banks, insurers and asset managers.
Banks have to manage to minimum liquidity requirements, as detailed in Basel frameworks, and provide regular reporting on these metrics to their regulators. The Liquidity Coverage Ratio (“LCR”) is one of the two key metrics (the other being the Net Stable Funding Ratio). It is designed to ensure that banks hold a sufficient liquidity buffer – defined as a reserve of high-quality liquid assets (“HQLA”) to allow them to survive a period of significant liquidity stress lasting 30 days. The period is selected as the minimum period for corrective action to be taken by management.
The LCR liquidity stress scenario is prescriptive and based on assuming:
Banks also undertake reverse stress testing which looks at the various scenarios that would need to arise for the firm to cease to be able to pay out on its obligations. This may include sale of assets at distressed prices, accelerated outflows and delays in liquidating certain assets.
Adopting a structured approach in developing a forward-looking liquidity risk view is key. There are three key focus areas which will input into the model:
There are several models that one can adopt to determine liquidity requirements, but the following three-step approach may be effective across a range of businesses and circumstances.
Estimate Liquidity Requirements
Undertake scenario analysis
Explore all your funding options
Thanks to Nick Burge and Harsh Gambani from Standard Chartered Bank for their assistance with this article.
Naresh Aggarwal
Associate Director – Policy and Technical
ACT
The VDT launched the working group in June to deals with the adaptation of internal and external processes to the digital treasury world. They share some of their findings so far.
ReadCOVID-19 has certainly impacted the way we communicate from a technical or logistical perspective – I think we’d all agree with that! It has also perhaps raised our awareness around the importance of communications, on a number of different levels.
Read12 months ago, Central Bank Digital Currencies (CBDCs) were the topic of think tanks and obscure magazines. These days, not a month goes by without a new headline in the more popular press.
ReadFrom March to May 2020 the VDT conducted a survey on Payment Factories. The trigger for the survey were the numerous regulatory changes that have had a strong impact on the processing and optimization opportunities in payment processes.
ReadThe health crisis linked to the coronavirus epidemic has plunged all countries worldwide into the unknown. Paralyzing a large portion of the population and of companies, the health crisis subsequently gives way to a major economic crisis. Against this backdrop, companies first focused on liquidity. Indeed, with a sudden drop in sales, the cash flow generation slows down or even stops as companies are unable to slow down their cash outflows.
Read