Following the Credit Crisis that rocked global financial markets during 2007 – 2010, and continued problems within the Eurozone, there has been an increased focus on the management of Liquidity Risk and in particular a focus by Regulators on firms having an adequate liquid asset buffer.
Liquidity risk can be defined as:
“The risk that a firm, although solvent, either does not have available sufficient financial resources to enable it to meet its obligations as they fall due, or can secure such resources only at excessive cost.”
As part of the increased focus on the management of Liquidity Risk, Regulators are requesting firms to conduct Stress Testing to determine potential liquidity shortfalls “Gaps” under various scenarios and the calculation of survival periods. The output of the Stress Testing should feed into a Firms Contingency Funding Plan (CFP).
Firms are asked to looks at Firm-Specific, Market Wide and Combination Stresses with a focus on well thought out and documented assumptions. The following are prescribed stress types typically requested by Regulators:
- wholesale funding risk
- retail funding risk
- intra-day liquidity risk
- intra-group liquidity risk
- cross-currency liquidity risk
- off-balance sheet liquidity risk
- franchise-viability risk
- marketable assets risk
- non-marketable assets risk
- asset diversification risk
Basel III introduces a further enhanced liquidity regime through the Net Stable Funding Ratio (NSFR) and Liquidity Coverage Ratio (LCR).
The Liquidity Coverage Ratio (LCR) addresses the sufficiency of a stock of high quality liquid assets to meet short-term liquidity needs under a specified acute stress scenario.
Under the new Basel III proposals firms must hold a stock of unencumbered, high quality liquid assets which is clearly sufficient to cover cumulative net cash outflows over a 30-day period under the prescribed stress scenario.
Firms are expected to be able to meet their liquidity needs in each currency and maintain high quality liquid assets consistent with the distribution of their liquidity needs by currency.
The complementary standard, the Net Stable Funding Ratio (NSFR) addresses longer-term structural liquidity mismatches. The net stable funding (NSF) ratio measures the amount of longer-term, stable sources of funding employed by an institution relative to the liquidity profiles of the assets funded and the potential for contingent calls on funding liquidity arising from off-balance sheet commitments and obligations.
The NSF standard is defined as a ratio of available amount of stable funding to a required amount of stable funding.
AxiomSL provides a solution for the Liquidity Regulatory Reporting requirements and the monitoring of Liquidity Risk through the use of Risk Monitor and ControllerView® to calculate the various Liquidity Ratios and perform Stress Testing by allowing firms to version and adjust input data, change parameters at the calculation stage or stress report data.