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Banking Essentials - Part I

This pathway will walk us through the basics of banks, starting with some of the different types and their main functions, then starting to look at the regulation faced by the banks, both before and after the Global Financial Crisis.

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Tackling the Cost of Living Crisis

In this video, Max discusses the cost-of-living crisis currently enveloping the UK. He examines its impact on households as well as the overall economy.

CSR and Sustainability in Financial Services

In the first video of this two-part video series, Elisa introduces us to sustainability. She begins by looking at the difference between sustainability and corporate social responsibility, two terms that can be easily confused.

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Principles of Bank Liquidity Risk Management

Principles of Bank Liquidity Risk Management

Moorad Choudhry

34 years: Banking and Capital Markets

Effective liquidity risk management is imperative for any bank that wishes to continue in business on a sustained basis. Here, Moorad introduces the concept of liquidity risk and the principles of sound liquidity management before considering more technical details and regulatory requirements.

Effective liquidity risk management is imperative for any bank that wishes to continue in business on a sustained basis. Here, Moorad introduces the concept of liquidity risk and the principles of sound liquidity management before considering more technical details and regulatory requirements.

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Principles of Bank Liquidity Risk Management

19 mins 44 secs

Key learning objectives:

  • Define liquidity risk management

  • Understand the elements of managing liquidity risk

  • Know the 9 principles of liquidity risk

Overview:

Liquidity risk management is the ability of a bank to meet obligations when they become due. Liquidity management is dictated from the highest level and it influences every aspect of the business strategy and operating model. The nine principles of liquidity risk are the general benchmarkers of banking liquidity risk management and include maintaining a liquidity buffer and diversifying funding sources to name a few.

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Summary

Why is Liquidity Risk Management Important?

The central tenet of the principles of banking is that of liquidity risk management; therefore by definition it should be part of the strategy of every bank to be able to survive a liquidity crisis. Liquidity management is the most important risk management function in banking, at the individual bank level and at the aggregate industry level.

What is Bank Liquidity Risk?

In banking, liquidity is the ability to meet obligations when they become due. In other words, maintenance of liquidity at all times is the paramount order of banking. Banks need to set in place an infrastructure and management ability to ensure that liquidity is always available, to cover for all times when market conditions deteriorate. Because banks are so important to the economy’s health, central banks operate as “lenders of last resort” to come to the aid of a bank that finds itself in liquidity difficulties.

What are the Elements of Liquidity Risk Management?

The importance of liquidity risk management is such that it must be addressed at the highest level of a bank’s management, which is the Board of Directors. Liquidity management is devised and dictated from the highest level, and influences every aspect of the bank’s business strategy and operating model.

Liquidity crises are endemic in banking and finance. That is why it is essential to maintain liquidity principles throughout the economic cycle, a discipline that may break down during a bull market or a period of cheap and plentiful cash availability. The majority of banks do adhere to sound principles of liquidity management during a bull market, when funds are readily available, but some do not. Sound liquidity management is to the benefit of the bank’s shareholders and all its stakeholders.

What are the Principles of Liquidity Risk Management?

The following represent basic essential management standards of banking. We consider these to be the most important principles of what should be taken to be the cornerstone of banking and liquidity risk management.

  1. Fund illiquid assets with core customer deposits
  2. Where core customer deposits are not available, use long-term wholesale funding sources
  3. No over-reliance on wholesale funding. Run a sensible term structure wherever wholesale funding is used
  4. Maintain “liquidity buffers” of instantly liquid assets, to cater for both firm-specific and market-wide stresses
  5. Establish a liquidity contingency plan
  6. Know what central bank facilities the bank can access and test access to them
  7. Be aware of all the bank’s exposures (here we are referring to the liability side, not the credit side)
  8. Liquidity risk is not a single metric. It is an array of metrics, and a bank must calculate them all in order to obtain the most accurate picture of liquidity. This is especially true for multinational banks and/or banks with multiple business lines
  9. The liquidity risk management framework is “owned” by the Board, i.e. the policy is centralised.

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Moorad Choudhry

Moorad Choudhry

Professor Moorad Choudhry is a non-executive director at two UK financial institutions, having worked in London since 1989. He has experience in wholesale capital markets, treasury, ALM, and balance sheet management. Moorad's most recent role was as divisional treasurer at the Royal Bank of Scotland. He has also worked with Europe Arab Bank, KBC Financial Products, and JP Morgan. He is the author of "The Principles of Banking," which is currently in its 2nd edition.

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