The 2012 guide to Liquidity Management: Standard Chartered - Managing the risks

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Corporate treasurers and their bank counterparts are starting to employ similar strategies in dealing with liquidity risk. Both have learned valuable lessons over the past few years, and now it’s time to put them to good use. by Martijn Stoker, Director, Global Head Liquidity Management, Transaction Banking, at Standard Chartered Bank.

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Liquidity risk management can be seen as two sides of the same coin. Increasingly, the needs of both banks and corporates are converging as liquidity is the life blood for the survival of both. Developing an effective risk governance structure involves measuring your organization’s risk appetite, defining strategies to limit these risks and testing the efficacy of your oversight measures. All of this will need to be supported by the right systems and procedures.

Liquidity management risk 
Source: Standard Chartered 

Corporate treasury is rapidly evolving from a task-based department into the financial ‘nerve’ centre of the organization. At the same time, treasurers at corporates and banks are becoming more and more aligned in terms of risk management practices, as both need to be fully aware of the impact of liquidity risks on their business activities.

Invisible risk

The collapses of Northern Rock and Bear Stearns prove that profitability and capital are no defence against liquidity risk. Both made profits in the quarter before they defaulted and both were well-capitalized businesses. And yet, as a result of their failure to deal with their liquidity risk issues, they vanished. The fact is, no one talked much about liquidity risk and as a result, liquidity was largely an invisible risk for many firms.

Corporate treasurers and their bank counterparts are starting to employ similar strategies in dealing with liquidity risk. Both have learned valuable lessons over the past few years, and now it’s time to put them to good use. We see that ‘best in class’ treasury organizations are outpacing their peers by addressing the following items in a structured manner:

1. Cash management fundamentals

  • Cash visibility;
  • Cash management;
  • Liquidity management tools;
  • Cash deployment.

2. Liquidity risk analytics

  • Cash forecasting;
  • Liquidity stress-testing.

3. Liquidity risk management

  • Benchmarking your liquidity risk;
  • Execution to limit liquidity risk.

Cash management fundamentals

Cash visibility

Effective cash management has been a key priority for the corporate treasury over the past few years and this obviously starts with full visibility on the organization’s worldwide cash positions. This requires access to a system that provides you with timely and accurate information on all your cash positions, preferably on a real-time basis. It includes insights into balance levels, transactions within the clearing cycle and capital trapped in your supply chain. If you can see it you, can manage it.

Cash management

This is basically about gaining full control over your cash flows. The payments and collection processes are like the arteries through which the blood (liquidity) of the company flows, so ensuring ‘best of class’ practices are used in each country is critical. Full control to move funds (internally and externally) also requires a clear access authorization process – without it you might have visibility but you are still unable to manage the cash effectively. With this control in place the organization is able to take a well-founded short-term funding or investment decisions.

Liquidity management tools

A key part of the fundamentals are the various tools that help free up internal liquidity. Besides the basic ‘leading and lagging’ of their collections and payments there are also others tools such as;

  • Supply chain finance solutions – such as receivable services, bill discounting, vendor pre-payment services and an efficient collateral management service – will free up internal liquidity that would otherwise be stuck in a company’s supply chain.
  • Physical sweeping and notional pooling are tools that allow a company to automatically concentrate and utilize operating cash positions across different entities and locations. This can be either in a domestic or cross-border structure within a single currency or in multiple currencies.

Cash deployment

Treasuries that have complete global visibility of their cash positions, effective control mechanisms in place and utilize the right liquidity tools are in a better position to deploy their cash where and when it’s needed. Intercompany lending provided to operating companies, either directly or indirectly via multi-entity physical sweeping structures, limits the need for external funding.

Based on the lessons learned in the financial crisis, cash will be even more valuable in the future. These changes also bring opportunities for corporate treasurers. With upcoming regulatory changes around Basel III, balances linked to operating business may provide a valuable alternative to other short-term investments as banks will start to provide more incentives in order to hold on to operating account balances.

Liquidity risk analytics

Over the past year many banks have been reviewing their liquidity policy statements and contingency funding plans and are challenging the assumptions made that underpin their behavioural modelling and funding mismatch guidelines. These items should also be a vital part of any corporate liquidity risk analytics toolkit and could be linked to the company’s cash flow forecasting and liquidity stress testing.