Key matters in examining Liquidity Risk Management at Large Complex Financial Groups(1) Governance of liquidity risk management
Senior management of a large complex financial group (hereinafter referred to as “afinancial group”) should ensure the following points in order to maintain effective
governance of liquidity risk management:(a) A liquidity risk management framework appropriate for the business profile of thefinancial group is maintained;(b) Leveraging the lessons learned through studying cases with liquidity pressure in both
Japan and overseas, the financial group has been developing the liquidity risk
management in consideration of possible factors which may bring about vulnerabilities
in liquidity risk management (e.g. reliance on short-term sources of funds and parentalloans) so that materialization of liquidity risk is prevented;(c) Adequate consideration is made for ensuring a proper balance between consistency inliquidity risk management at the group-wide level and appropriate differentiation inliquidity risk management at the level of individual entities (i.e. subsidiaries and/or
branches) and/or type-of-business level so that entity and/or type-of-business levelliquidity risk management is appropriate for the business profile at the level which may
differ among entities and/or types of business;(d) Liquidity risk appetite in normal conditions is articulated in advance with properconsideration of latent liquidity risk. In addition, an adequate framework is maintained
so that a financial group is operated in accordance with the articulated liquidity risk
appetite; and(e) A plan-do-check-act (PDCA) cycle is established in order to enhance the liquidity risk
management framework in light of the results of self-assessments of relevant
departments and internal audit reviews.
To ensure achievement of the above points, examination should be conducted by focusing
on the items set out below. However, when examining the essential functions of the risk
limit established in connection with liquidity risk management, supervisors should keep inmind that the risk limit may be used for different purposes, thus it is important tounderstand the specific purposes of the risk limit set by the financial group under
examination.
For example, exceeding the risk limit would have different implications in the following
two cases: (i) the risk limit is used to prohibit risk taking beyond such threshold, and is thus

1

set at a level somewhat higher than normal utilization; and (ii) the risk limit is set aroundthe normal utilization level, assuming the occasional breach which will trigger reporting torelevant parties and promote discussion on, or lead to a common understanding as tobusiness conditions. Examination of the functions of the risk limit should be conductedcarefully, by taking into account the difference as described above. The matters to befocused on during the examination are as follows:(i)

Roles and responsibilities of bodies, such as the board of directors and related
divisions including the finance and risk management divisions, are articulated in
the liquidity risk management;(ii)

Systematic establishment and maintenance of policies and procedures for liquidity
risk management in major entities is ensured in accordance with their businessprofiles. In addition, systematic establishment and maintenance of group-wide
rules of liquidity risk management is ensured in light of the nature of key
businesses of the group, along with the clarification on the roles and cooperation of
headquarters and entities so that consistency among the group-wide level and theheadquarters and major-entities level is maintained in their rules;(iii)

Regular review on the structure of delegated and/or shared authority, coordination
within the group and consistency among the internal rules noted in (ii) above ismade. In addition, revision of internal rules and reinforcement of the liquidity risk
management framework is made based on the results of such review;(iv)

Review of the appropriateness of regular and ad-hoc liquidity risk reports is madeat least annually;(v)

An adequate framework that ensures the operation of each business is establishedin accordance with the liquidity risk appetite at least quarterly, through analysis of
the status of business operations, estimated future cash flow, and other relevant
matters;(vi)

An examination process is established to review the liquidity risk management
framework, annually and as needed, including liquidity risk limits, stress scenariosand stress testing;(vii)

A PDCA cycle is established to facilitate ceaseless improvements to the liquidity
risk management framework, including the examination process noted in (vi)above. The PDCA cycle is implemented with appropriate consideration on liquidity
regulations such as the Basel III Liquidity Coverage Ratio (LCR), and the resultsof comparisons with international research and guidance such as the BaselCommittee on Banking Supervision’s “Principles for Sound Liquidity Risk
Management and Supervision” published in September 2008; and2

(viii)Self-assessment of liquidity risk management divisions and internal audit are
performed at an appropriate frequency and an appropriate manner from theviewpoint of effective operation of the PDCA cycle. The status of improvements tothe liquidity risk management framework is checked by executive officers incharge based on the result of the self-assessment and internal audit.

(2) Setting and complying with the liquidity risk appetite
In setting and complying with the liquidity risk appetite at a financial group, it is importantto (1) establish a business management structure to ensure that the business profile is inaccordance with the liquidity risk appetite which is determined through an integrated
approach on a group-wide basis; and (2) conduct a periodic review regarding the liquidity
risk appetite based on analysis of the liquidity risk embedded in each business. Therefore,
examination should be conducted by focusing on the items set out below:(i)A liquidity risk appetite is articulated for major divisions of financial groups, suchas entities and business units, based on an analysis of commonalities/differences in
the liquidity risk embedded in each business;(ii)

The divisional liquidity risk appetite articulated in (i), for major dimensions suchas entities and business units, is consistent with the group-wide liquidity risk
appetite; and(iii)

Review of the liquidity risk appetite is conducted at least annually, in light ofmulti-faceted analysis (e.g. stress testing) on size and profile of the financial groupand liquidity risk embedded in each business.

(3) Comprehensive measurement of liquidity risk
In measuring liquidity risk at a financial group, it is important to capture potential liquidity
risk comprehensively by projecting cash flows in times of stress and other methods. To
ensure this point, examination should be conducted by focusing on items set out below:(i)Systems and processes are established to be capable of delivering time sensitive
information, such as cash flow projections and the rate of utilization of the liquidity
risk limit;(ii)

Projection of the cash flow is updated daily for a period within 30 days, and at least
monthly for a period of more than 30 days; and(iii)

Cash flow is projected based on analysis of the following:(a) Latent factors (i.e. future refinancing needs, change in behavior of customers)
associated with projecting cash flow for the duration of the relevant exposures;

3(b) Reasonableness of the forecasts in relation to assets, liabilities and off-balance
sheet exposures. In particular, the conservativeness of the forecasts based on
the factors, such as market liquidity categorized by assets and currencies, andbusiness profiles; and(c) Validity of cash flow mismatches between outflow and inflow calculated on
both a point-in-time basis and a cumulative basis.
(4) Utilization of liquidity stress testing results
At a financial group, it is important to implement liquidity stress testing in a timely mannerby reflecting not only the viewpoint of regulatory compliance such as Basel III LCR, butalso the senior management’s awareness and business profile. Additionally, the results ofsuch stress testing should facilitate the senior management’s decision-making. To ensure
this point, examination should be conducted by focusing on the items set out below:(i)Stress tests on the adequacy of the excess liquidity buffer are performed by thegroup on a whole and individual-entity basis at an appropriate frequency, and any
liquidity issues are examined using the results of such stress tests;(ii)

A framework to ascertain the appropriateness of liquidity stress testing scenarios,
such as institution-specific and market-wide stress for managerial purposes, isestablished based on the results of comparison with international research andguidance, such as the Basel Committee on Banking Supervision’s “Principles forSound Liquidity Risk Management and Supervision” published in September
2008; and(iii)

An analysis is conducted on gaps between the results of liquidity stress testing for
regulatory compliance purposes, such as the Basel III LCR requirements, and thosefor managerial purposes. In addition, an implementation framework for liquidity
risk management is considered by taking into account the two different testing
approaches above, and liquidity risk management policies and methodologies foraddressing the difference between the regulatory stress testing and managerial
stress testing are articulated in internal rules.

(5) Holdings of sufficient excess liquidity buffer
To enable the excess liquidity buffer to sufficiently cover potential liquidity outflow underliquidity stress conditions at a financial group, it is important to make sure that the financial
instruments comprising the excess liquid asset portfolio are feasibly converted into cash4under liquidity stress conditions. To ensure this point, examination should be conducted byfocusing on the item set out below:(i)

An implementation process is articulated for cash conversion of the excess
liquidity buffer through an analysis of feasibility (authority for cash conversion,
capacity to convert) on both a group-wide basis and individual-entity basis.

(6) Collateral management by classification
In considering actions to address the cases where liquidity pressure materializes at afinancial group, it is necessary to capture the value of the excess liquidity buffer in a timely
manner. Specifically, the value of the excess liquidity buffer should be captured at an
appropriate time based on the frequency of change in the amount of excess liquidity buffer
due to collateral movements and other factors. To ensure this point, examination should be
conducted by focusing on the item set out below:(i)

A frameworkisestablishedtodistinguishcollateralized

assetsfrom

uncollateralized ones and monitor the amount of excess liquidity buffer at least
weekly as well as potential restrictions on the transfer of such assets, based on
major classifications such as by the entities, countries and currencies.
(7) Management methodology for liquidity risk
In establishing methodologies for liquidity risk management at a financial group, it isimportant to develop a framework that will facilitate an effective liquidity risk control, suchas measures upon breach of a liquidity risk limit, with appropriate consideration of the sizeand profile of its business. To ensure this point, examination should be conducted byfocusing on the items set out below:(i)Targets of liquidity risk management are set appropriately and communicatedthroughout relevant departments in light of the following points;(a) Comprehensiveness of fund management (i.e. whether the entire
secured/unsecured borrowings are managed or not);(b) Respective roles and responsibilities shared between onshore and offshore,
between main office/headquarters and overseas operations, and other relevant
units; and(c) Currencies subject to currency basis management.

(ii)

A management framework is established for managing the excess liquidity buffer
based on business units, entities, and other relevant classifications, in addition to5the framework of the group as a whole;(iii)

A framework is in place to manage the adequacy of the excess liquidity buffer heldby overseas subsidiaries and subsidiaries operating different types of business inlight of legal/regulatory and supervisory restrictions, and other relevant factors;(iv)

The scope, management methodology, durable period (period during which
liquidity is expected to be resilient under a stress event such as a foreign exchange
market failure) of the targets of liquidity risk management, and the degree of
reliance on investments using the home currency resources for funding foreign
currencies are consistent with the liquidity risk appetite by currency; and(v)

A management framework is established for liquidity risk management to analyze
the potential need to fund currencies held in relatively small amounts. In addition
the framework is maintained so that a financial group will be able to take actions
such as establishing liquidity risk limits on those currencies in a manner consistent
with the results of the analysis.

(8) Establishment of a structure to incentivize reduction of liquidity risk in each business unit
For enabling liquidity risk management to function effectively at a financial group, it isimportant to build a structure where each business unit is incentivized to reduce liquidity
risk. To ensure this point, examination should be conducted by focusing on the items set
out below:(i)

In the process to establish a structure that will incentivize business units tovoluntarily contribute to maintaining the group-wide liquidity risk at an appropriate
level by recognizing the increase in liquidity risk as costs when evaluating theperformance of such business units (fund transfer pricing or FTP), consideration is
given to the ways for maintaining consistency with the profile of each business andthe liquidity risk appetite in relation to the purposes of adopting suchmethodologies to give incentives; and(ii)

A process is in place for reviewing the liquidity risk profile in the new productapproval process.

(9) Development and implementation of plans for funding and investing in view of liquidity
risk
In developing plans for funding and investing with appropriate consideration of liquidity
risk, and in operating businesses in line with such plans at a financial group, it is important6

to set out a specific assessment standard and evaluate the existing conditions at an
appropriate time. To ensure this point, examination should be conducted by focusing on theitems set out below:
However, when examining the functions of risk limits in liquidity risk management, it
should be kept in mind that the risk limit has various functions, and thus it is important forsupervisors to take into account the specific purposes of each risk limit set by a financialgroup.
(i)

A methodology is established for investing in assets (e.g. trading assets,internal/external loans, assets for long-term holding, Bank of Japan current deposit
account) in accordance with the liquidity risk appetite;(ii)

An adequate framework is in place to share an awareness of the current conditions
and future direction of liquidity risk in an appropriate manner between the senior
management and the supervisory authority by establishing liquidity risk limits
systematically, and aligning such risk limits with the liquidity risk appetite set byconsidering the following points; and(a) Concentration risk associated with funding sources by financial instruments,
fundingproviders,bysector/categoryoffundingproviders,bysecured/unsecured lending;(b) Concentration risk associated with the amount of redemption of debt by tenor;
and(c) Liquidity risk associated with off-balance transactions and other exposures that
may increase the necessary liquidity under liquidity stress conditions.
(iii)

An adequate infrastructure is established to capture changes in financing activities.
In addition, such changes are analyzed to identify potential causes, including themarket environment and business incentives.

(10) Contingency funding plan (CFP)(i)

At a financial group, its CFP is developed based on discussion and analysis on thefollowing points:(a) Identification of stress events that may have a material impact on the liquidityof the group as a whole and each entity;(b) Evaluation of the impact of identified stress events on the liquidity of the groupas a whole and each entity;(c) Identification of triggering conditions that will execute a CFP, including a7

breach of the acceptable level of liquidity risk;(d) Identification of available fund providers under the conditions specified in (c)above, and calculation of the amount of available funds and liquidity needed;(e) Identification of alternative funding providers under specified stress events;(f) Leveraging the information acquired through liquidity stress tests for both
regulatory and managerial purposes;(g) Consistency between the CFP trigger conditions and established Early Warning
Indicators; and(h) Ensuring the feasibility of the CFP execution plan, of internal and external
communication management (e.g. relevant authority, key funds providers), andof liquidity risk management in accordance with the seriousness of liquidity
pressure.
(ii)

A process is in place to examine and review the following CFP-related issues atleast annually:(a) Articulation of the policies and action plans to address liquidity stress;(b) Articulation of the roles and responsibilities in executing a plan to addressliquidity stress;(c) Articulation of the decision-making process under the stressed event; and(d) Development of a framework to improve the effectiveness of the CFP through a
PDCA cycle such as training for executing CFP.

(11) Liquidity risk management in light of the perspective of ensuring the resilience of thefinancial system(i) A liquidity risk appetite and liquidity risk management framework at a financialgroup is appropriate for ensuring the stability of the entire financial system;
for example, critical functions in the financial system such as settlement offunds and securities are maintained under the stressed environment.

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