Risk Management & Analytics: A decade after the crisis, we are still learning key lessons about liquidity risk

In observance of Columbus Day, Newswatch will not be distributed on Tuesday, October 9, 2018. Circulation will resume Friday, October 12, 2018.

A decade after the crisis, we are still learning key lessons about liquidity risk

“Wow, I can’t believe I can say that the financial crisis was a decade ago,” said Chris Mills, Managing Director of Model Validation Services for MountainView, a Situs company, during Wednesday’s liquidity risk webinar. “It doesn’t feel like a decade.”

Time flies when you are trying to emerge from a global financial crisis. Post-crisis, regulators identified ineffective liquidity risk management as a key contributor to the crisis.  Now, 10 years later, financial industry executives are assessing whether their financial risk management strategies are effective enough to enable them to meet ongoing cash and collateral obligations if another crisis, or liquidity event, occurs.

Mills, a seasoned executive banker and balance sheet strategist, made it clear in the webinar that predicting the next downturn is not nearly as important as preparing your institution for the next downturn. “The industry was ill-prepared for an extreme systemic crisis,” said Mills. “We just didn’t have the proper plans in place, and stress testing was not a mainstream.”

Reflecting on the crisis, Mills further explained that many institutions had a siloed approach to risk management. Key risk red flags from one area of the institution were managed separately from other areas, without knowing how interdependent these risks were. Now, said Mills, we’ve spent a full decade trying to fix these problems.

With that in mind, Mills discussed the industry’s migration to enterprise risk management and the key components necessary for an effective liquidity risk management framework. That said, Mills noted some of the deficiencies that still linger, possibly limiting the effectiveness of liquidity risk management and stress testing. Financial institutions need to keep an eye on the following key areas:

(1) Are Holdings of Liquid Assets Sufficient?

Financial institutions need to determine the amount of on-balance sheet liquidity that is appropriate to cover the day-to-day funding needs as well as short-term fluctuations of unexpected behaviors.

(2) Have You Defined Appropriate Measures and Metrics?

Liquidity measures should be a combination of current position static measures and dynamic forward-looking measures such as Basic Surplus, LCR type coverage ratios and liquidity gap forecasts.

(3) Are Your Modeling Assumptions Dynamic? Do They Consider Economic Factors?

Stress tests should include assumptions that are reasonable based on the economic environment of the scenario, including regulatory constraints.  For example, institutions should consider asset growth assumptions as well as loss of funding.  Institutions need to periodically review scenarios to encompass both escalating liquidity threat and specific events such as market disruption or economic recovery.

(4) Are Your Policies and Governance Comprehensive?

The institution needs both a comprehensive liquidity policy that establishes a sufficient liquidity risk management framework, including intra-day processes, and a full-scope contingency funding plan (CFP).

(5) Do You Have Adequate Early Warning Systems?

Create dashboards that are monitored and reported frequently, and include both idiosyncratic and systemic measures that will alert the institution to potential funding issues or possible liquidity events.

What strategies, processes, systems, measurements and tools should institutions have in place today?

Watch the webinar on-demand, download the slides, or contact MountainView to find out whether your institution has put in place appropriate liquidity risk management strategies.

This webinar is now available for on-demand viewing.


Cybersecurity spending’s way up. Is it overkill, or not enough?

Bank executives already know what their investors don’t want to hear: Spending on cybersecurity is climbing, and there’s little way around it.

The cost of fighting cybercrime at banks rose 9% over a recent 12-month period, according to a new LexisNexis Risk Solutions survey of 175 executives from bank and nonbank financial services firms.

Those firms spent an average of $2.92 for every dollar of fraud or theft stemming from a digital attack in the 12 months ending in April — an increase of 25 cents from a year earlier. So, say a breach resulted in $10 million of theft or unauthorized charges, a bank could spend nearly $30 million to find the cause of the problem, fix it, reimburse customers and cover other related costs.

Commercial banks with $50 billion of assets or more spent an average of $2.97 for every dollar, which was a 30-cent increase, the survey found.

Read more: American Banker


Hollowing out the Volcker Rule

This past May, the five financial regulators tasked with implementing the Volcker Rule issued a proposal that would severely undermine its safeguards and protections. The Volcker Rule — Section 619 of the Dodd-Frank Act — was finalized by regulators in 2013 and took effect in 2015; it is one of the most important elements of the federal government’s response to the 2007–2008 financial crisis.

The provision bans banks and their affiliates from engaging in proprietary trading — highly risky speculative trading for their own profit — and severely restricts their ability to own, invest, or sponsor hedge funds and private equity funds. It also targets conflicts of interest and places restrictions regarding these highly risky activities on certain nonbank financial institutions, which are designated as systemically important by the Financial Stability Oversight Council. The Volcker Rule essentially ensures that banks with access to the federal safety net — namely the Federal Reserve’s discount window and federal deposit insurance — are oriented toward client-focused activities that bolster the real economy, which actually produces goods and services.

The financial crisis demonstrated that highly risky trading activities and hedge fund and private equity investments can cause rapid and large-scale losses at banks, thereby threatening financial stability. These activities also lent themselves to significant conflicts of interest between banks and their customers. The 2013 final rule implementing the Volcker Rule statute, while not perfect, took meaningful steps to ensure that banks and their affiliates no longer engaged in these highly risky activities.

The proposed rewrite would strip away many important protections included in the original 2013 final rule. US Securities and Exchange Commission (SEC) Commissioner Kara Stein appropriately summed up the impact of the changes included in the proposed rule: “[T]his proposal cleverly and carefully euthanizes the Volcker Rule.” The changes are not tweaks. Under the guise of streamlining the rule, the rewrite drives large and irreparable holes in the limits established by statute. By expanding exemptions, watering down definitions, eliminating certain compliance requirements, and transferring some oversight to the banks themselves, regulators are inviting more risk into the banking system.

Read more: Center for American Progress


Credit unions fire back at Elizabeth Warren’s CRA plan

Credit unions are fighting back against Sen. Elizabeth Warren’s proposal to subject them to the Community Reinvestment Act.

While it’s not expected to make waves in the remainder of the current Congressional session, the plan could gain momentum if Democrats take the Senate in the midterm elections.

The bill, known as the American Housing and Economic Mobility Act, would upend current reform efforts around CRA. Currently CRA only applies to banks insured by the Federal Deposit Insurance Corp. but Warren’s proposal, which was introduced on Tuesday, would extend the requirements to credit unions and nonbank mortgage originators. CUs with a low-income designation – which account for approximately half of the nation’s credit unions – would be exempt from the regulation.

Read more: Credit Union Journal


U.S. mortgage rates jump to highest levels in 7 years

According to Freddie Mac’s most recent Primary Mortgage Market Survey for late September 2018, US mortgage rates in the past week surged to their highest level in over seven years.

Sam Khater, Freddie Mac’s chief economist, says the 30-year fixed-rate mortgage rose for the fifth consecutive week to 4.72 percent – a high not seen since April 28, 2011 (4.78 percent).  “The robust economy, rising Treasury yields and the anticipation of more short-term rate hikes caused mortgage rates to move up,” he said. “Even with these higher borrowing costs, it’s encouraging to see that prospective buyers appear to be having a little more success. With inventory constraints and home prices starting to ease, purchase applications have now trended higher on an annual basis for six straight weeks.”

Khater further commented, “Consumer confidence is at an 18-year high, and job gains are holding steady. These two factors should keep demand up in coming months, but at the same time, home shoppers will likely deal with even higher mortgage rates.”

Read more: World Property Journal


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