Page 38 - Monocle Quarterly Journal Vol 1 Issue 1 Q4

BANKING
“Each simulation o ers a picture
of how the balance sheet and, ultimately, the cash in ows and out ows, may evolve under di erent scenarios. Ultimately, it assists banks in anticipating strains, and managing liquidity risk.”
For Monocle, that means a comprehensive measurement and manage- ment approach for deeper understanding of liquidity risk and its potential interaction with other risks. It’s an integrated way to treat Liquidity-at- Risk (LaR). e process enables stress and scenario testing under market crises, leading to quanti cation of levels of contingent funding. It also helps to nd more optimal loan-to-deposit ratios by investigating reliance on the wholesale funding markets.
LaR is a framework that includes simulation of a large number of future cash ow pro les, by replicating the entire cash ow process under each circumstance of contractual cash ows, behavioural cash ows, growth in asset and liability sizes, and interest rate re-pricing of each position. Each simulation o ers a picture of how the balance sheet and, ultimately, the cash in ows and out ows, may evolve under di erent scenarios. Ultimately, it assists banks in anticipating strains, and managing liquidity risk.
Liquidity Risk
When we talk Liquidity Risk, we talk, simply, about “the ability to fund increases in assets and meet obligations as they come due, without incurring unacceptable losses”. When we drill down, liquidity risk encompasses both market liquidity risk; the risk that a position cannot be o set or eliminated without economic loss – and funding liquidity risk; the risk that cash ow and collateral needs cannot be met in the normal course of business.
Conventionally, liquidity risk has been managed and measured within the Asset and Liability Management (ALM) function. But then the strains in the wholesale funding markets in August 2007 and September 2008 highlighted the interrelationships between funding and market liquidity risk, funding liquidity risk and credit risks, funding concentration and liquidity risk, and the e ects of reputation on liquidity risk. We now know that liquidity risk is consequential – and cannot be viewed in isolation. So, today, banks veer towards an integrated risk management approach, in which all risk types are measured inclusively.
Monocle’s LaR model quanti es credit, market, liquidity, and interest rate risk using a single set of underlying risk factors, allowing a bank to view various ‘future states of the world’ from an integrated risk perspective. It also allows the risk management function in a bank to isolate the impact of these risk types on the liquidity shortfall for a particular tenor, with
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