Intraday liquidity risk management is set to become an increasingly high-profile component of banks’ overall liquidity risk mitigation strategies. Deutsche Bank’s Christian Goerlach, director, cash management FI product, looks at the impact this will have on banks, and the industry at large. 

The management of intraday liquidity – defined by the Committee on Payment and Settlement Systems (CPSS) as “funds that can be assessed during the business day, usually to enable financial institutions to make payments in real time” – is now in the spotlight. Sources of this type of liquidity include central bank reserve balances, liquid assets on the balance sheet, payments received and balances with other banks that could be used for same-day settlement. The newly intensified focus on the management of such funds heralds a shift from banks’ historical focus on end-of-day liquidity positions, and comes as result of two key factors.

First, the fact that advances in banking technology – in going a long way to mitigate counterparty and settlement risks – have inadvertently shifted hazards that would have once come under these umbrellas into intraday liquidity management.

Managing intraday funds requires the capacity to measure expected daily gross liquidity inflows and outflows and balance them with expected activities and available resources. The risk in this process accrues because banks are obliged to settle certain payments at specific times during the day – as opposed to on a specific value day – and it must be mitigated if banks are to ensure the timely meeting of payment and settlement obligations under both normal and stressed conditions.

The second key factor is the combined effects of technology development and regulatory change. Over the past 10 to 15 years, the mitigation of counterparty and settlement risk has been significantly improved across all asset classes as a result of upgrades to core real-time payment systems as well as, more recently, to ancillary capabilities such as net payments and security settlement structures. This trend is accelerated by regulation (such as Dodd-Frank and European Market Infrastructure Regulation) pushing further business into clearing systems in an attempt to increase transparency and mitigate counterparty risks, but at the same time increasing the intraday liquidity risks resulting from timed payment requirements for cash settlements and margining.

Intraday liquidity concerns, however, cannot be adequately addressed merely by enhancing visibility over cash and payments processing efficiency – which is ultimately what automation offers. Given this, intraday liquidity may be thought of as the 'final frontier' in terms of addressing banks’ overall liquidity profiles – and goes some way to explaining why it is now coming under increasing regulatory scrutiny.

Indeed, the second factor behind the new focus is the recent publication by the Bank for International Settlement (BIS) of ‘Monitoring Tools for Intraday Liquidity Management’ – a document that outlines a new set of metrics for mitigating intraday liquidity risk and meeting payment and settlement obligations. This comes as a result of the Basel Committee’s broader aims – announced in 2008, in the aftermath of the global financial crisis – to improve the strength and stability of the international banking system.

The data challenge

Developed in consultation with the CPSS, the monitoring tools detailed in the BIS report are designed to give banking supervisors a deeper insight into banks’ payment and settlement behaviour, as well as greater oversight of their liquidity risk management. At present, it is suggested that only banks that operate internationally are required to implement the seven stipulated tools, which include the calculation of daily maximum intraday liquidity usage, and the availability of intraday liquidity at the start of the business day and time-specific obligations.

As global players already have systems in place to track intraday liquidity, the implementation of additional tools does not necessarily pose too much of a concern. What is a worry, however, is the requirement to collect and report intraday data.

The BIS framework suggests monthly reporting by banks starting from January 1, 2015 – the timing of which coincides with the implementation of a number of new bank regulatory requirements, such as the Basel III Liquidity Coverage Ratio – to encourage planning for various stress scenarios. Such set-ups range from banks’ own financial stress to market-wide credit constraints. Though well intentioned, data collection is a concern for banks on two fronts.

From a practical perspective, data collation is a significant undertaking for banks. This is true at the best of times, let alone in the current environment in which the majority of banks – to varying degrees – are challenged by a combination of cost pressures, compliance requirements and an increased reporting/administration burden. The latter, in particular, will not be helped by the obligation to produce additional monthly reports. And from a strategic viewpoint, uncertainties over exactly how the collected data will be used are cause for concern for individual banks – and, indeed, the finance industry as a whole.

Transaction-related data and information can be a solid indicator of a financial institution’s strength and stability. But intraday liquidity data only offers a momentary snapshot. Any intraday liquidity report would show a drop in liquidity following the execution of payments – traditionally done first thing to inject liquidity into the banking system – and banks are understandably worried as to how such dips may be perceived. Should concerns in this respect escalate, some banks may deem it in their best interest to hold back payments, as doing so would strengthen their own intraday liquidity positions on paper. Though this is a somewhat short-sighted view, as it would ultimately work to the detriment of all industry players, it is a real possibility.

Behavioural changes

In addition to the potential of inadvertently changing banks’ behaviour – as discussed in greater depth by Morten L Bech, a senior economist at the Federal Reserve Bank of New York, in the article entitled 'Intraday Liquidity Management: A Tale of Games Banks Play' – there are also question marks over the true value of intraday liquidity data and reporting. Risk mitigation is, by nature, a forward-looking exercise. This means that any pressure points that had remained undiscovered until the analysis of intraday liquidity data would be a case of 'too little too late'.

Not only this but, given the fluctuations in liquidity positions that inevitably occur as payments are issued and received, intraday data becomes historical – rather than current – the moment it is reported. As banks cannot plan ahead (as risk mitigation requires) on the sole basis of historical data (which offers a past perspective that does not necessarily correlate to future market changes and resulting business needs), how can intraday liquidity reports be put to practical use?  

While reports holding historical data could be part of an overall risk management framework, the framework should first be discussed and outlined prior to great efforts and resources being ploughed into vast data collection exercises, which only appear to address parts of the overall topic.

Unanswered questions

As a result of major efforts in recent years to improve overall liquidity risk mitigation, global players have largely addressed the issue of intraday liquidity risk management (Deutsche Bank, for example, has had a dedicated intraday liquidity management desk since 2002), and so may struggle to extract any significant value from the data. And local banks, for their part, may fail to see why they need it.

Though only globally active banks are obliged to implement the tools at present, it will be up to national supervisors to determine the extent to which the tools apply to non-internationally active banks within their jurisdictions. Whatever the outcome of such decisions may be, securing buy-in from domestic banks is likely to be a challenge. This is because many smaller players fail to see how their more limited operational scope warrants liquidity risk-management on this scale, and such scepticism – though perhaps understandable – could lead to an absence of co-operation. As greater industry alignment is needed now more than ever, the possibility of a lack of cohesion must be taken seriously.

That said, banks’ questions and concerns are justified – especially seeing as there is the chance that regulating intraday liquidity on a standalone basis will result in further complexity and inefficiency. For example, complex interconnectivities between the myriad regulations already in play mean a single exposure could be collateralised numerous times according to different regimes, which can present challenges for both asset allocation and liquidity diversification.

A further problem is that intraday liquidity data is – in theory – designed to give an immediate indication of a bank’s liquidity position. In practice, however, intraday liquidity is not necessarily immediate. A prime example of this is that mobilising a bond and pledging it at a counterparty or clearing system can take two days or so, and means, where liquidity is concerned, now does not always mean 'now'.

Finding a clear way forward

Such issues render intraday liquidity management – as both a necessity and an industry talking point – an issue for the global specialists. As one such institution, we at Deutsche Bank believe that finding a resolution will ultimately depend on greater dialogue between banks and regulators, and banks of all sizes working in closer alignment.

At present, many banks are not sure if the reporting of intraday liquidity positions is an exercise in data collation or a genuine risk-mitigation effort. Increased bank-regulator interaction could provide some much-needed clarification, as well as bring to light important, relevant points that have yet to be raised.

For example, clearing systems have centralised databases that hold complete, consistent data, and using them as a data source could be far more straightforward than having banks report on an individual basis.

Closer local-global bank alignment is also vital. While this is primarily an issue for international players, it is not one that smaller banks can disregard entirely. Working together – with the global banks leading the way – can ensure it is something that banks get right for their own benefit, and for the benefit of the financial system as a whole.

Christian Goerlach is a director, cash management FI product, at Deutsche Bank.

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