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Liquidity Risk Governance

Steve Turner, Managing Director, Novantas provides insights in to why liquidity risk governance is an important topic for discussion and how this can improve efficiency and effectiveness, how incorporating liquidity into funds transfer pricing assist key decision metrics as part of the balance sheet optimization process and more.

Why is liquidity risk governance an important topic for discussion and how can this improve efficiency and effectiveness?

Liquidity often is the final event which causes a financial institution to fail, not insufficient capital, making it a critical area of management focus. Additionally, setting liquidity limits has challenges which are not mirrored in capital management. That is, in capital management the risks are baked into the balance sheet and there is little management can do to change the outcome once a credit or other capita-impacting event occurs.  Conversely, liquidity events evolve and often are influenced by management actions after the event begins.  Regarding efficiency and effectiveness, the range of information and analytics that banks must have in place today requires thoughtful development and common usage of data, analytics, and applications.  Liquidity measurements require large amounts of use-specific data that are shared with ALM, financial planning and analysis, capital stress testing, and other applications.  Efficiency and effectiveness come from liquidity measurements using the same source data and baseline analytics (e.g., behavioral decay functions for deposits) as other applications while avoiding conflicts that often occur when this discipline is not part of the development process.

Can you provide some examples of liquidity measurement challenges, and why is triangulation needed to project liquidity in stable and stressed environments?

Liquidity, unlike other risks, does not lend itself to direct measurement. For example, when measuring credit risk it is possible to develop correlations of credit risk to changes in macroeconomic factors, like unemployment, housing prices, and CRE vacancy rates.

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