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SectionsOctober 1 2012

Banks wake up to intraday liquidity management challenge

Market reforms are flooding the financial sector and banks are facing the challenge of managing their liquidity more efficiently. But the industry remains divided on best practice approaches to intraday liquidity management.
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Banks wake up to intraday liquidity management challenge

The global liquidity crisis has exposed the obvious but often disregarded significance of intraday liquidity for banks if they are to survive and remain efficient in unpredictable market conditions.

Although various pending regulations will put banks under pressure to manage their liquidity more efficiently, there is no common global guidance or regulation on how to measure and monitor intraday liquidity yet, and approaches to best practice in intraday liquidity vary from region to region, and often even from bank to bank. 

New regulations are tackling liquidity issues both in markets and in individual banks. In some cases, reform of market practices, such as the centralisation of derivatives clearing under Dodd-Frank in the US and the European Market Infrastructure Regulation, creates more liquidity but requires banks to both reform their business flows and to post more high-quality collateral.

The Basel bet

In addition to this, there is the demand for liquid assets under Basel III. Experts say that nowadays many banks pledge their liquid assets that are eligible as a buffer under Basel III on an intraday basis – although neither the Liquidity Coverage Ratio nor the Net Stable Funding Ratio under Basel cover intraday liquidity.

David Renz, director of SunGard's risk advisory practice, says there is a risk that banks gamble with their Basel III buffers to meet daily settlement obligations. This is a risk because the amounts cleared and settled per day far exceed the cash that banks have – as most systems work on real-time gross settlement, such as Chaps in the UK and Fedwire in the US, says Mr Renz.

This means that at present, a single view of an institution’s total liquidity position in real-time is as far away as ever for many banks. Although some industry leaders claim to be making progress in this direction, another issue to solve is what to do with the data even when it is in the possession of those that require it.

A set of proposals put forward in July by the Committee on Payment and Settlement Systems (CPSS), the standards-setting body of the Bank for International Settlements, aims to lay down suitable metrics for intraday liquidity. Whether these proposals turn into full-scale regulation such as Basel III, or whether individual regulators introduce standards based on these indicators – and what impact either consequence will have – is so far unclear.

At the moment, there are local variations of regulatory guidelines. In the US, for example, Fedwire charges overdraft fees every 15 minutes to encourage the flow of funds throughout the day. In the UK, the Financial Services Authority, with the backing of the Bank of England, set a precedent in Europe when it narrowed the definition of liquid assets, mandated frequent reporting and improved system controls through stress-tests in its system Chaps.

What is clear is that the industry remains divided on best practice approaches to intraday liquidity management. Some call for a global standard, others argue that controls are more important than metrics when a bank finds itself in a stressed situation.

Either way, the renewed emphasis on liquidity that has developed since the financial crisis is unlikely to ease, and banks will have to overhaul their systems to comply with different regulations and manage their liquidity well enough throughout the day.

A CPSS solution

In its consultation paper, the CPSS argues that banks should monitor and report their average, maximum and minimum liquidity requirements per month based on a list of eight indicators. The CPSS proposes that banks report this monthly data for each payment and settlement system they participate in, and for each currency they deal in, and for each legal entity that is part of the group. The eight indicators are:

  • the daily maximum liquidity requirements, which should be calculated based on monthly data;
  • available intraday liquidity, which would be based on a bank’s reserve balances at the central bank, and collateral pledges made to its central bank and also other lines of credit that are easily accessible for intraday settlements;
  • total payments settled and received on a gross basis;
  • time-specific and other critical obligations (for example, payments that have to be settled at certain times of the day);
  • the value of customer payments made on behalf of financial institution (FI) customers (correspondent banks). This should be based on gross daily values for all of a bank’s FI customers as well as a separate screening of the value of payments and settlements made on behalf of its five largest FI clients;
  • intraday credit lines extended to financial institution customers;
  • timing of intraday inflows and outflows, which would help identify trends in payment flows and assess potential stress scenarios; and
  • liquidity reporting throughout the day, so the bank can track what proportion of its outgoing payments are settled at what time.

In addition, the CPSS also argues that banks should test against stress scenarios that could be caused internally (which would delay payments to counterparties and cut credit lines), by counterparties (if the bank does not receive a payment at all or on time), and by its own customers (in which case other banks would delay payments to the customer).

RBS’s managing director for intraday liquidity and markets, Peter Lightfoot, believes that this paper may be used to drive consistent reporting requirements and get a wider level of understanding of the issues globally. But he has one criticism: “A focus on controls is the key area that this paper understates the importance of. The paper focuses on metrics. In my view – as someone who has run a bank when there was a stress scenario – controls can be more important than metrics. Metrics are important, but controls are key to handling what happens minute by minute and in a stress scenario.”

The challenge banks have now is how to achieve this control and single view. 

Global accounts, single view?

A single oversight of a bank’s payment flows is not easily achieved. This is due to two reasons, experts say. First, the number of bank accounts a bank holds in a foreign country with a local bank and in the local currency, so-called nostro accounts, means a bank’s liquidity is split into different currencies in different legislations, which makes oversight not only cumbersome, but also creates liquidity risk. Second, many banks still have different business units in silos, where cash management priorities differ.

Banks move money and bits of relevant information from A to B. So whether it is a card payment, mobile or online, we don’t care

Mark Buitenhek

“A large multinational bank needs to settle payments not only in its home country currency, but also in other currencies, depending on the trade flows of its customers and its methods of clearing payments in those currencies. For low volumes of payments, this is typically done through correspondent banks, but there is a threshold above which it makes economic sense for a bank to join the national clearing directly,” says Leo Lipis, associate analyst at Lipis & Lipis and also associate consultant at the Single European Payments Area (SEPA) Consultancy.

Even the international multi-currency clearing and settlement system CLS, which operates on a payment-on-payment basis to reduce foreign exchange risk, can prove impractical, says Ashley Dowson, chairman of the SEPA Consultancy and a former chief operating officer and managing director of Barclays Group Treasury.

“If you are a UK bank, for instance, and you get a debit via CLS for sterling contribution to a settlement, that funding won’t be available for managing other [sterling] obligations of the sending bank in other systems. So a lack of coordinated rules and guidelines can create disturbances between the cashflow that goes in one direction (into CLS) and the cashflow that has gone into another direction (out of another system),” he says.

According to Mr Lipis, central banks and regulators are now increasingly worried about the risk to the correspondent when large volumes and values of payments are concentrated in a few direct clearers, and therefore ask high-value correspondents to become direct participants, so as to reduce the risk concentration.

Establishing a habit of detailed reporting, as suggested by the CPSS and individual banks, could solve these risks, Mr Dowson says. “But the risk is that you end up with a complex dashboard that tries to bring together in one place at one time the various cash liquidity and collateral positions, payment queues and obligations.” Due to the lack of common global liquidity standards, such a dashboard would be like comparing apples with pears and oranges, he says.

Internal fragmentation

The second challenge in achieving a single view of intraday liquidity is that the majority of banks still operate business divisions in silos, so achieving sophisticated overview and forecasting on group level may prove difficult.

“The less communication between the treasury operation, the payments division and the middle office, which deals with information flows through the front and back office, the greater the risk of not being well positioned enough at the end of the day when large payment flows have already taken place,” says Mr Dowson.

He tested this siloed approach among banks and concluded that the payments division usually prioritises the smooth running of payments volume processing, whereas the treasury division is more concerned with the management of payment flows. “Consequently, the two areas may not see the same motivation in liquidity management, leading to liquidity troughs and peaks, depending on which unit is primarily responsible for realising payments from an organisation,” he says.

The de-siloisation has started now, according to some industry experts, but the trend has not spread fast through the industry yet. One of the banks that has a single payments and cash management operation is ING. For Mark Buitenhek, the banking group's global head of payments and cash management, a payment is a payment and the data is just bits and bytes floating through the system. “Banks move money and bits of relevant information from A to B. So whether it is a card payment, mobile or online, we don’t care. Managing liquidity is a key challenge for banks now and combining all cash management and payments under one roof was a logical step for ING,” he says.

Having these levels of transparency is key to successful intraday liquidity management – and knowing how to automate information needed to make the right decisions at certain times of the day, says Linda McLaughlin-Moore, head of transaction services for JPMorgan Treasury Services in Europe, the Middle East and Africa. “Cashflow forecasting in most businesses is a very manual process and far from a science. In addition, market practices demand early action. Worse than the risk of idle balances is the risk that an overly ambitious investment action leaves the account overdrawn or inaccurate cashflow forecasting results in short-term liquidity shortages that incur costs far in excess of the investment return,” she says.

According to Lipis calculations, borrowing money in the short-term markets typically cost 15 to 20 basis points in ‘normal’ times, but can cost up to 200 to 250 or more basis points in distress scenarios. “It is therefore important that the bank knows when the largest accumulation of payments will be to make sure it has sufficient collateral to cover its obligations,” one CPSS member says.

Data management

Information technology is very much at the heart of the matter, but as one banker remarks: “Some of the software providers sell cash management systems that focus on nostro reporting and nostro balances. But that is not the same as an intraday liquidity system. They are trying to squeeze what they do into liquidity systems. I don’t think that is a good way to do it.”

An analysis by Lipis produced similar findings. While IT providers for payments focus on monitoring and predicting cash flows that are settled, IT providers with a traditional risk management background prioritise asset and balance sheet management as the solution to solving the intraday liquidity management problem. Lipis argues, however, that a combination of these two approaches would create the single view needed.

Assuming banks do achieve a single global view, what will they do with the data, and how? And how will regulators use and interpret this data? Will this data reveal unexpected results, results that could lead to further stringent regulation, such as, for example, Basel III?

The CPSS argues that by tracking the timing of payment inflows and outflows, banks and their regulators could use the aggregated data to identify trends in payment flows and so assess stress scenarios. 

To identify changes, the CPSS also proposes that banks know at what time payments are settled, so that they are aware of what percentage of a day’s payment obligations are met at a certain time. Consequently, this would also reveal the times at which a bank may be “particularly vulnerable to liquidity and operational difficulties”, the CPSS claims.

Ultimately, experts agree that the benefits of a holistic view will be extensive and improve a bank’s flows, data management and investment decisions. It will also help banks identify opportunities to charge clients for services and products, Mr Dowson says. “If a bank receives an overcharge from the central bank and systems it works with, it is easier to justify charges to its clients. But if the bank operates in a country with low or free liquidity, such as the Netherlands, you have less justification to charge for payments and liquidity.” 

Bad timing

This is still years off, however. Even if a sophisticated and comprehensive liquidity view of intraday was possible already, “with such little trust in banks and recent scandals, this is not the right time to start charging for payment and liquidity services”, says Mr Dowson. 

Mr Renz at SunGard is one of the experts who believes the eight indicators could become regulation, but Mr Dowson doubts it. He thinks that best practice should be monitored and the regulator step in if it recognises a gridlock in the system.

“We will always rely on guidelines and recommendations, which to some extent will be policed by the local payment system and regulator. But if you legislate for it, you take away all the commercial opportunity,” says Mr Dowson.

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