Liquidity risk management: beyond Basel requirements

What it is about

Jorge L. García, director of Financial Stability at Banco de México, explained at the Second Annual Risk Conference (September 27, 2024) how to manage and monitor liquidity risk beyond Basel requirements. The opinions are the author's and do not necessarily reflect those of Banco de México.

The 31 slides cover the introduction (definition of liquidity, lessons from the 2007-2008 crisis and the March 2023 banking episodes), Basel III liquidity regulation, the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR), and ask whether those two ratios are enough, with the authority's own monitoring tools and additional reflections.

Objectives

• Explain what the LCR and the NSFR measure and how they complement each other.
• Show what other monitoring tools an authority uses to see risks that those ratios do not capture.
• Offer reflections on access to central bank facilities, the use of liquid assets and the speed of runs in the digital era.

Key takeaways

1. The LCR (30-day horizon, under stress) seeks to ensure the bank has high-quality liquid assets to cover its net outflows; the NSFR (one-year horizon) promotes a stable funding profile consistent with the asset structure.
2. Funding concentration is a significant vulnerability even with adequate LCR and NSFR, so it is monitored through analysis of the main creditors and withdrawal stress tests.
3. Additional tools include the obligation coverage horizon, contractual cash flow analysis, LCR at risk and stress tests under different scenarios, including climate ones.
4. Banks tend to be reluctant to use their stock of liquid assets in times of stress, which can increase the probability that they will need central bank support.
5. Digital banks and social media news make withdrawals happen faster and with more contagion; the possible "cliff effect" of the LCR from the concentration of outflows at the end of the 30-day window is also noted.