# **SECTION 3: LIQUIDITY RISK MANAGEMENT**

53. Liquidity risk management<sup>51</sup> refers to the internal policies and procedures put in place by an institution/bank to measure, manage and monitor its liquidity. The design of the liquidity risk management should be tailored to the size, degree of internationalization, and the strategy and complexity of the institution’s business model. Financial institutions should be aware that liquidity risk management is and should remain a cost center – but a vital one for the bank’s operation and continuity as an ongoing concern.

54. The ongoing liquidity management objectives of a bank should be: the maintenance of an appropriate amount of liquid assets under normal and stressed conditions, the measurement and projection of funding requirements under various scenarios, and the management of access to contingency funding sources (according to the bank’s, up to date, contingency funding plan).

55. A bank’s liquidity risk management plan should start by defining a clear liquidity strategy that should be communicated to and understood by all in the organization. The strategy must be approved by the bank’s Board of Directors (see discussion on governance above). Senior management should be responsible for clearly defining the liquidity risk management policy and the procedures for its implementation, measuring all costs of alternative liquidity strategies, controlling the liquidity risks across the banking group on an ongoing basis, and monitoring trends and developments that may affect the liquidity strategy.

56. The liquidity risk management structure should be reviewed, as needed, to reflect changing business and financial market conditions, and all business units should be aware of any change in the liquidity strategy.

57. Bank management must manage not only the bank’s assets, liabilities and off balance sheet cashflows, but also the release of financial information to the public. Communications at times of distress are absolutely critical—as many balance-sheet solvent but failed banks can corroborate. The public’s perception about the soundness of a bank can change quickly. Customer reaction is difficult to predict but it really affects the liquidity needs of the bank, often abruptly, precipitating the need for access to contingency sources. Therefore, it is very crucial that bank management have effective processes in place to monitor and react to any contractions in deposits and other funding<sup>52</sup> . Thus, it is not only important to have a strategy but also, critically, a mechanism for implementing it.

# **2.1  Liquidity Principles**<sup>53</sup>

58. In the aftermath of the 2007-2008 “credit crunch”, the Basel Committee, , updated in June 2008 the principles for the assessment of liquidity management in order to reinforce the importance of sound liquidity risk management by the banking system (see Annex IV).

> 51 CEBS, page 7

> 52 OCC, _An Examiner’s Guide to Problem Bank Identification, Rehabilitation and Resolution_ , Chapter III: ‘Resolving Liquidity Problems’, January 2001, page 48

> 53 Basel Committee on Banking Supervision, ‘Principles for Sound Liquidity Risk Management and Supervision’, June 2008