Watching intraday liquidity will lead to better banks

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Banks and businesses are being forced to transform how they report liquidity – regulators want them to understand their balances on an intraday basis instead of using end-of-day forecasts. This requires fundamental change but the insight it provides will enable banks to increase controls, decrease operational risk, reduce buffer requirements and offer better services.

Ludy Limburg, senior product manager, RBS

There is a clear need for banks and businesses to provide enough liquidity at the right time and place, under both normal and stressed conditions. Risks previously considered theoretical when liquidity was always available suddenly became very real after the financial crisis.

Recent regulation like Basel III first focused on strengthening the existing capital requirements and introducing new rules around short and long-term liquidity and funding.

The Bank for International Settlements (BIS) then issued a report on intraday liquidity management last month outlining the reporting requirements local supervisors need to introduce before January 2015.

These requirements broadly reflect the approach several regulators have already taken in the last few years.

The BIS report includes rules on the use of intraday liquidity on nostro accounts – accounts held with other financial institutions.

In the past, large intraday lines were granted to make sure payments could be executed during the day. Large intraday overdrafts were therefore not considered a liquidity risk by the nostro account holder.

This approach is no longer enough. If a large overdraft is not adequately funded by the expected level of incoming payments, the account holder will have to look for other ways to fund the position. This might be particularly difficult in a stressed market – hence the regulator’s call for sufficient liquidity buffers.

Banks must understand their intraday liquidity risk on all their accounts and be able to report against all appropriate liquidity indicators. They will need to demonstrate complete control of their own flows and those of their clients.

As a result, banks need to overhaul their processes because the financial industry has worked around end-of-day reporting for decades. The information required on nostro accounts is currently unavailable as it is not included in today’s reporting regime. Banks will have to look into solutions and offer services to their clients to bridge the gap.

Long term, it should be worth it. Banks will be able to use the detailed data they must gather to gain greater insight into their intraday liquidity flows. Analysing this data will enable them to mitigate risks and improve liquidity efficiency, which in turn will lead to lower buffer requirements and better services.

To meet the new requirements as efficiently as possible, banks will have to consider intraday liquidity when making choices in their network set-up.

For example, further concentration of cash flows over a smaller number of nostro accounts will most likely improve intraday liquidity efficiency.

A service provider’s ability to deliver detailed reporting on intraday liquidity will also be central to a bank’s decision on who to work with. Building a complete picture of liquidity use throughout the day is extremely challenging because different service providers will collate the information in different ways using varying standards.

The focus on intraday liquidity could have a negative effect on payment behaviour. Some businesses might actually start charging for intraday liquidity use. This could have a very bad impact on the overall industry.

Charging could lead to participants delaying their payments to create a positive effect on their liquidity position in the short term.

Needless to say, if all market players did this, the liquidity problem would return — only with higher spikes. Risks would increase as payments backed up, there would be less time to solve problems and the likelihood of a stress event would increase.

We need to ensure as an industry that we create a market where we increase liquidity efficiency and lower intraday liquidity risks.

It is now more important than ever that businesses stay on top of their liquidity positions at all times throughout the day. Achieving that presents a number of challenges, but those that get it right won’t just be meeting regulators’ rules. They will benefit from less risk, lower buffer requirements and decreased costs.

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