Risk Management & Analytics: Liquidity model validation: A critical component of liquidity risk management

Liquidity model validation: A critical component of liquidity risk management

So many decisions and transactions affect liquidity, which is why financial institutions are taking extra steps to implement a robust liquidity risk-management framework to help identify, monitor, measure, and control the institution’s day-to-day liquidity management and ensure they are adequately prepared for any unforeseen liquidity demands.

The primary purposes of liquidity risk management are to assess the need for funds to meet obligations and ensure the availability of cash or collateral to fulfill those needs at the appropriate time by coordinating the available sources of funds under both normal and stressed conditions.

A critical component of liquidity risk management is the liquidity model, which is used to demonstrate an institution’s ability to fund its balance sheet during the normal course of business and when unexpected events cause stress on liquidity. Since financial institutions heavily rely upon the liquidity model, it is critical to validate the model regularly. A robust model validation will:

  • Review the conceptual framework of your general approach to monitoring and managing your liquidity position;
  • Assess the effectiveness of measurement metrics employed for current and future liquidity positions;
  • Confirm methodologies for projecting and assessing expected liquidity needs;
  • Affirm your liquidity policy appropriately documents and communicates your liquidity risk management philosophy and your framework for liquidity risk measurements, monitoring, management, limits and controls;
  • Assess the adequacy of your contingency funding plan (CFP) with respect to your business needs, regulatory mandates and stress testing;
  • Ensure the model adheres to key regulations, including Supervisory Guidance on Model Risk Management (SR 11-7) and 2010 Interagency Policy Statement on Funding and Liquidity Risk Management.

To learn more about key elements to liquidity risk management, watch the webinar by MountainView Financial Solutions, a Situs company, “Measuring and Managing Liquidity Risk,” by clicking here.

America’s Libor alternative is gaining traction on Wall Street

After some early struggles, America’s Libor alternative appears to be finding its footing.

Since the debut of the Secured Overnight Financing Rate (SOFR) almost six months ago, futures have launched in Chicago, swaps are being cleared in London and about half-a-dozen issuers have sold debt linked to the nascent benchmark. Measured against the Alternative Reference Rates Committee’s transition plan, efforts to develop SOFR as a viable replacement for the scandal-tainted London interbank offered rate appear to be proceeding ahead of schedule.

That’s not to say it doesn’t have a long way to go. Volumes and open interest in derivatives products indicate the market is still highly illiquid. And firms remain hesitant to commit resources to SOFR when there’s a chance Libor’s administrator and the panel banks that determine its setting could keep it alive past 2021, when global regulators intend to sound its death knell. Yet it’s a far cry from April, when two weeks after SOFR’s introduction the Federal Reserve Bank of New York disclosed it had made errors calculating the rate, an inauspicious start for a benchmark racing against time to gain traction.

Read more: Bloomberg

Loose leveraged lending is storing up economic trouble, BIS says

One of the world’s senior financial regulators is sounding the alarm about surging high-risk lending.

The Bank for International Settlements (BIS) warned that likely distress among indebted borrowers may spread into the wider economy as central banks raise interest rates. It’s not just the total debt, but the fact that investors seem less and less concerned about protecting themselves against losses, the BIS said.

The total of leveraged loans and high-yield bonds outstanding in Europe and the US has doubled to about $2.65 trillion since the financial crisis, according to the Basel, Switzerland-based BIS, known as the central bank for central banks. While high-yield bonds still account for more than half the tally, growth in lending to risky companies has outpaced sales of those securities, and leveraged loans now account for almost 45 percent of the market.

Distress among indebted borrowers “may affect not only investors holding these loans, but also the broader economy,” economist Tirupam Goel wrote in the BIS’s Quarterly Report.

Read more: Bloomberg

Small banks falling behind in the deposit war

Banks with less than $10 billion of assets are losing the deposit war, even as many continue to raise rates on savings accounts and certificates of deposit to try to keep pace with their larger rivals.

New data from the Federal Deposit Insurance Corp. shows that deposits at banks that have less than $10 billion of assets fell 3% in the 12-month period that ended June 30, to $2.37 trillion. That’s a reversal from the prior 12-month period, when deposits for this group of banks increased by 0.8%.

Meanwhile, deposits at banks with more than $10 billion of assets climbed 6% during the most recent 12-month period, to $9.9 trillion.

The data suggests that smaller banks may need to raise to rates even more aggressively if they hope to reverse these trends, according to industry analysts. Without a pressing reason to switch banks, many consumers so far have decided to stick with regional and large banks, even though many are paying comparatively paltry rates.

Read more: American Banker

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