Until recently, most banks seemed to believe that, in relation to the disclosure of liquidity risk, less disclosure was 'more prudent' and more knowledge was a dangerous thing. Since 2008, not only has liquidity risk become a stakeholder issue but it has also absorbed many more stakeholders. Traditionally, the stakeholders who had a direct interest in liquidity risk were the asset and liability committee and the local regulator. Stakeholders now include holders of senior and subordinated debt, wholesale and retail depositors and shareholders. More significantly, shareholders not only include private investors but also sovereign states.
In short, a wide variety of economic agents are interested in the liquidity risk profiles of banks, the impact of these profiles on share values and the banks' survival. Intense scrutiny is being undertaken by these agents on banks' balance sheets. However, to what extent do banks consider these stakeholders in the scope and frequency of their publication of liquidity risk data? It is generally the case that the frequency and scope of a bank's liquidity risk disclosure is supervised by a disclosure committee. This is fed by the requirements of the regulatory reporting department and the enthusiasm of the treasurer for explaining his or her controls, procedures and data. Rarely do these internal bodies ask what external investors might want to know. Disclosure is driven by what individuals in institutions are comfortable to disclose.
The dangers of this approach are manifold. Investors may continue to shun the banking sector on the basis that it is too opaque, or they may start to form their own, possibly ill-informed, analysis and make investment decisions accordingly. Even if investors are content to invest in the banking sector they will avoid institutions that are relatively opaque. All three of these events will affect the cost of capital to the institutions concerned and reduce their economic return.
Proactive decision
Given the dangers of this approach, we believe that increasing the level of disclosure must be a proactive decision, taking into account what investors and other external stakeholders want to know. Banks should be conscious of the level of disclosure provided by peer institutions. Although this might seem an obvious statement, regularly practiced in relation to capital or executive compensation, it does not seem to be the case in relation to liquidity.
How does one remove subjectivity in analysing liquidity risk disclosure? Liquidatum carries out liquidity analysis on more than 90 major banks, which we believe provides a unique insight into both the current level of disclosure made by the world's major banks and the optimal level of information required to make banks' liquidity risk profiles more genuinely transparent.
To remove subjectivity about the level of disclosure, we have created the Liquidatum Transparency Index. This enables us to quantify and compare the levels of disclosure for each institution. We score each institution on 16 questions that we believe are necessary to helping investors understand an institution's liquidity risk profile. This approach enables an institution to analyse its score by question, compare itself to its peers, understand their respective trends over time and review best practice by topic across the whole sample.
The result of this analysis and benchmarking is that disclosure will become proactive rather than reactive. Decisions on disclosure can be taken in the full know-ledge of what investors may want to know as well as what they may be receiving from other institutions.
An institution then has more chance to avoid investor antipathy or ill-informed decisions made as a result of lack of attention to disclosure on its part. We consider our Transparency Index, or equivalent measures, key to the establishment of disclosure best practice, and a critical tool in breaking the deadlock of investor indifference towards various types of bank risk. At the very least, we think it will facilitate a more constructive approach to investor engagement with liquidity risk, in a similar way to how banks have worked with investors and other external stakeholders on other risk areas.
What is striking from the outputs is that there are very different levels of disclosure across jurisdictions, with European and Australian institutions disclosing far more information than those in North America or Japan. The US, in particular, is relatively opaque about the maturity profile of its assets and liabilities. However, even within jurisdictions, it is noticeable some institutions (for example, in Europe) provide little more than the regulatory minimum, wheareas others go to great efforts to communicate their liquidity risk policies, structures and profiles. We believe that those who are proactive in analysing their liquidity disclosure and gauging investment requirements will reap the benefits. Those that ignore this do so at their peril.
David Vander is a director and co-founder of Liquidatum, a specialist data and advisory services company focusing on bank liquidity risk
