Page 39 - Monocle Quarterly Journal Vol 1 Issue 1 Q4

lIquIdIty At RISK: A meASuRemeNt AppRoAch wIthIN BANKING INStItutIoNS
a particular con dence level. e goal? A stable, robust metric for the measurement of a liquidity gap, which includes the impact of credit, market, and interest rate risk.
Why LaR Measurement is Crucial
When wholesale funding markets seized up, existing liquidity models failed. Why? Because they were predominantly based on point estimates, rather than LaR distributions. Point estimates cannot accommodate the scenario tests and stress testing necessary to assess a bank’s liquidity position under market extremes, except in an overly simpli ed manner. e result was that many organisations didn’t fully understand the speed and severity with which their liquidity position would deteriorate in these extreme markets. And banks were not prepared for deleveraging debt markets, in which there were more sellers of debt securities than buyers. e desperate need for liquidity forced many banks to issue debt at previously unthinkable spreads, and liquidate assets at previously unthinkable prices. But if they’d been able to anticipate or predict liquidity strains in the markets – and the contingent funding requirements – that desperation could have been halted.
A contingent funding requirement measure needs to look at the inter- relatedness between di erent risk types, and give a response on funding requirements with di erent levels of con dence. Of course, banks are not only funded via wholesale markets, but also by deposits; re ected in the bank’s overall loan-to-deposit ratio.
LaR is a more distribution-based approach to the measurement of liquidity risk, under a range of di erent market rate scenarios. It looks at the e ect that these scenarios may have, not only on the wholesale funding markets, but also on the behavioural aspects of the overnight core to non-core deposit base, and gives banks substantially greater insight.
Who will particularly bene t from this approach? Banks that, in the past, relied too heavily on wholesale market funding, rather than retail and commercial deposit funding. Rapid liquidity deterioration was particularly severe at these organisations, with high loan-to-deposit ratios.
ese banks will be able to focus on creating deposit products that have longer periods of limited redemptions, by analysing the di erential
“A contingent funding requirement measure needs to look at the inter- relatedness between di erent risk types, and give a response on funding requirements with di erent levels of con dence.”
37