An introduction to risk/ALM
Authored by: Synechron Business Consulting Group
Managing intraday liquidity risk is a key element of a bank’s overall liquidity risk management framework. By means of this opinion paper, we argue that managing this risk demands a higher priority. The rationale is that increased volatility in financial markets, combined with decreased levels of trust in the financial sector requires enhanced intraday monitoring tools and oversight. Managing intraday liquidity risk ensures that expected payments run smoothly and avoids negative signaling effects in the market. We advocate a combined approach which not only focuses on improving the insight into the flows but also enhances risk management capability.
There are four major reasons to rethink intraday liquidity management on a short notice:
Missing a (critical) payment may result in penalty and also reputational damage.
Payment behavior has a signaling effect and disturbed behavior may give a wrong impression to your clients.
Banks with international activities must adhere to the monitoring tools of the BIS paper.
Market infrastructure developments:
It offers opportunities to streamline your intraday collateral management.
There is a common notion in the market that improving intraday liquidity risk management predominantly requires a number of IT and operational changes. As such, projects aimed to improve data quality and payment flow controlling are regularly identified. Although these improvements are important, they are only a derivative of the actual necessity. Our recommendation is for a bank to start with reviewing its governance and operating model, to ensure and demonstrate that it is in control as control is an important requirement both internally and for regulators.
We advocate the organization of intraday liquidity risk management according to two design principles:
- Manage intraday liquidity risk within all three lines of defense
- Manage intraday liquidity risk by using the COSO II enterprise risk management model
These principles provide the structure to prove that the bank is in control, they help to determine the appropriate controls and prevent unnecessary IT & operational investments. Furthermore, following the COSO II model on a per entity basis, they will help to distinguish effectively between legal entities and remain in control. We recommend this approach as the setup and requirements for cash management differ from country to country.