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Regulation & PolicySeptember 1 2014

Putting the stress on intraday liquidity

Until now, banks have managed their payment and settlement obligations based upon end-of-day forecasts, but from January 2015 the Basel Committee on Banking Supervision wants to see banks monitoring their balances intraday. Frances Faulds reports on how the industry is adapting to this fundamental change to reduce operational risk.
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Putting the stress on intraday liquidity

In the past, as a matter of course, large intraday credit lines were granted by banks to correspondent banks and businesses to make sure payments could be executed during the day. Until last year, these large intraday overdrafts were not considered a liquidity risk by nostro account holders but rather part of the payment and settlement flows, provided everything was squared up at the end of the business day. This approach is no longer enough. If a large overdraft is not adequately funded by the expected level of incoming payments, positions will have to be funded in other ways.

While this in itself represents a fundamental change in the way banks and businesses fulfil their payment and settlement obligations, it is also having a significant effect on payment system infrastructures that have been built around end-of-day settlement. The demands for data on liquidity flows, rather than balance sheets, will require significant changes to banks’ existing data models and processes.

The focus is on the set of quantitative monitoring tools published by the Basel Committee on Banking Supervision (BCBS) in collaboration with the Committee on Payment and Settlement Systems in April 2013 to help supervisors monitor how well banks manage intraday liquidity risk.

Seven indicators

The Basel Committee believes no single indicator can provide supervisors with sufficient information on intraday liquidity risks or on how well such risks are managed. In all there are seven indicators to liquidity management, ranging from a daily maximum liquidity requirement and available intraday liquidity to the value of customer payments made on behalf of financial institution customers and the intraday credit lines extended to those customers.

Although the indicators will apply specifically to internationally active banks, they have been designed equally to apply to all banks, including those that access payment and settlement systems indirectly via the services of a correspondent bank. The monitoring tools require banks to assemble the necessary data to ensure effective monitoring of intraday liquidity risk, and their ability to meet payment and settlement obligations on a timely basis in normal and stressed conditions.

The BCBS would like banks to start using the monitoring tools for reporting in January 2015, with full implementation by January 2017. Implementation depends upon the regulatory mandate at the national level. While no national supervisor has yet issued specific rules or guidelines, banks must still start collecting the data they will need to build a central intraday liquidity transaction database.

The BCBS monitoring tools require a retrospective view of aggregated data points using credit/debit confirmations from servicing institutions and payments settlement systems. A recent white paper published by the Society for Worldwide Interbank Financial Telecommunication (Swift), entitled Intraday Liquidity Reporting – The Case for a Pragmatic Approach, reveals that based on analysis of Swift data, only 20% of total correspondent banking payment instructions on Swift are confirmed with a credit/debit confirmation message. This indicates that even though the BCBS requires banks to report intraday liquidity retrospectively, they will need to build the intraday position for each of their accounts in real time to be able to provide the level of detail required in the monthly reports.

In its paper, Swift outlines how data could be easily managed with a messaging copy mechanism that enables the group liquidity or treasury service to obtain the missing flows and suggests that the new requirements will lead the way towards a more collaborative and standardised approach across the industry. 

Beating the deadline

Intraday liquidity management continues to grow in importance for banks, says Amit Agarwal, head of liquidity management services for Europe, the Middle East and Africa at Citi. Similar to the approach to Basel III rules around end-of-day liquidity with which banks are responding to the key requirements issued by the Bank of International Settlements (BIS), Mr Agarwal says that Citi is communicating with national supervisors on both sides of the Atlantic about new requirements for intraday liquidity management.

“It is very much an area of focus for us and we hope to be compliant ahead of any deadlines," he says. "We have looked at the principles that have come out of BIS papers, such as the requirement that banks should actively manage intraday liquidity positions and risks to meet payment and settlement obligations on a timely basis under normal and stressed positions." He adds that banks should have the capacity to measure daily gross liquidity inflows and outflows, anticipate timing of those flows where possible and forecast potential shortfalls.

While there are requirements for monthly reports, Mr Agarwal says that for banks to be able to properly manage liquidity, they need to monitor it on an intraday basis. “As an industry, I don’t think we are quite there yet. But from Citi’s perspective, this is the direction we are heading. Everything we are working on – our policies, our procedures and our systems – are geared around this.

“Citi’s pre-eminent position as one of the largest settlement banks globally makes intraday liquidity management a critical goal for us to ensure that we are not only serving our clients efficiently around the world but also ensuring system-wide risks are mitigated.”

Mr Agarwal adds that Citi is developing an effective monitoring mechanism that allows it to calculate the right amounts of collateral required intraday to fund all payment and settlement activities. “We are investing in new systems, which will allow us to do more robust stress testing for our euro and sterling intraday liquidity," he says.

Employment of collateral

As part of Citi’s frequent stress testing, the bank monitors the peaks in payments activity on an intraday basis to determine the level of collateral the bank will need, while also stress testing its systems to operate against an artificially low collateral level.

“Bearing in mind the large volumes, this is still a manual and resource-intensive work," says Mr Agarwal. "Data is at the heart of intraday liquidity risk management, and while we have to apply ‘brute force’, using extra people and resources to create and generate the data to get a baseline starting point, the systems and technology that we are investing in will get us to the stage where we will be able to do this on a near real-time basis with automated decision management tools."

While Mr Agarwal thinks it is unlikely that Citi’s collateral requirements will be reduced as a result of better liquidity management, he does believe that collateral may need to be employed in a more intelligent manner and that the bank will need to be able to optimise it across the various market infrastructures that hold that collateral. “There may be certain times when we need to hold more collateral and there may be times when we need to hold less," he says. "We need to concentrate on optimisation of collateral, and re-deploying it from one market to the other, without necessarily looking to lower it.”

According to Mike Winn, head of cash at Royal Bank of Scotland, it is too early to predict whether the bank will be able to use the improved understanding and operational capabilities around intraday liquidity to discuss lowering capital buffer levels because there is so much uncertainty about national implementation and so much work to be done before a bank is managing intraday positions with the level of sophistication needed. “Given the increasing focus from the regulators on ensuring the stability of banking systems, it might be a little premature to prioritise this,” he says.

The guidelines published by BIS require only monthly, historic reporting for banks and correspondent banks, however. The detail of the possible national interpretations is still unknown. While it is unlikely that the local regulator rules will be implemented by January 2015, which was a target date given by the BIS rather than a mandatory go-live date, Mr Winn says there are a number of changes the banking industry is going to have to make to become more sophisticated at managing its intraday liquidity positions and to manage the risks and opportunities that arise throughout the day.

Fragmentated data

The industry as a whole is fairly unsophisticated when it comes to intraday liquidity. At present, Mr Winn says the management of intraday liquidity is only really put into practice regularly in the direct clearing connections, as some of these are monitored in real time, but the flows between correspondent banks are still managed on an end-of-day position basis, relying upon intraday overdraft facilities.

“What is underpinning the regulation is both the ability to report, but also the active management of intra-day positions," he says. "The expectation is that the payment activity will be funded more proactively and therefore with less reliance upon intraday overdraft facilities. It should not be underestimated how significant a transition, and development, this is for banks, both in terms of operations and collateral."

Mr Winn argues that in the long run, there is value for banks in doing this but first they have to overcome fragmented data, fragmented systems and lack of data, particularly information that is time-stamped.

“Data needs to be time-stamped in order to be able to understand positions on an intraday basis, but the number of clearing systems, and the lack of homogeneity, and how the different correspondents and other providers account for themselves, mean that to get to the point where you can look at this information in a single place, with a single intraday position, creates a significant operational challenge," he says. "It highlights the complexity of some of the larger banks, and the complexity of the architecture that sits beneath operations.”

The right incentives

However, Mr Winn says the collateral part of the outcome, and the potential to reduce liquidity buffers, gives banks the incentive to get this right.

“Beyond regulatory compliance, the opportunity here is being able to track intraday activity and to be able to manage it much more effectively," he says. "For RBS, this will drive how we manage our collateral, our costs, and our liquidity as a whole, and not just intraday. It will also generate changes in the way we position ourselves as a service model. If we understand our intraday flows then we should equally understand intraday flows of all our clients and work with them to give them more insight into their intraday efficiency and processes.

“This is all about how we pull the information together in an accurate, homogenous manner in order to report to regulators, historically, what our intraday positions have been and what lessons, controls and process we put in place as a result of having this information. At the same time we are being asked to hold higher quality collateral and to fund outpayments activity by relying less on overdraft facilities. Smart liquidity and collateral management are going to become really important in terms of making sure the business remains as viable as it is today.”

Sharing information

While in recent years much of the focus, and investment, has been on the regulatory payments framework, RBS has developed an intraday liquidity management framework bringing together the informational architectures across operations and currencies, and building the information exchange between liquidity systems and payment systems and data platforms. “This dashboard, or portal, enables us to monitor our cash positions, collateral positions and payment queues, and how these break down by client," says Mr Winn. "This can then be extended for deeper analysis as well as just reporting on it. As we develop the roadmap further, we are able to offer an intraday liquidity reporting tool to our clients as well.”

While he believes the banking industry is becoming more proactive about working with trade bodies in supporting the process of implementation, Mr Winn adds that the global transaction business, as defined by the scope of the BIS, is necessarily an industry that is operating internationally. But the rules are being implemented on a jurisdiction-by-jurisdiction basis, and this is bound to have complications. While he is positive about these moves, Mr Winn is concerned that the longer it takes for national regulators to confirm their specific implementation of the guidelines and the bigger the differences between their interpretations, the greater the risk of confusion and delay in how the industry responds.

As with any regulatory change, there can be pitfalls and unintended consequences. For example, if banks start charging for intraday liquidity it is quite possible that participants might start thinking about how and when they submit their payments in order to manage those charges, which could end up creating higher payment spikes, with less time to resolve them, and potentially increase the likelihood of liquidity squeezes. Mr Winn says: “The value we bring is to avoid this consequence.”

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