Liquidity Risk Measurement, Standards, and Monitoring: Ratios and Indicators

Liquidity Risk Measurement, Standards, and Monitoring: Ratios and Indicators

Copyright: © 2018 |Pages: 22
DOI: 10.4018/978-1-5225-4131-8.ch012


Liquidity ratios – as well as Basel III leverage ratios were not only consequence of the recent global financial crises – having been introduced under Basel III in 2010, but serve as complements, rather than substitutes, to a risk based capital adequacy framework whose deficiencies were brought to light during the recent financial crisis. This chapter considers and highlights the need for such vital complements – as well as challenges which may still necessitate further revisions to such ratios.
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The Basel Committee’s recent focus is reflected through its goals of not only intensifying the “resilience of internationally active banks to liquidity stresses”, but also intensifying international harmonisation of liquidity risk supervision. These efforts are aimed at consolidating recent work which culminated in the issue of the Principles for Sound Liquidity Risk Management and Supervision (BIS, 2009).

As part of measures aimed at facilitating “further consolidation and promotion of consistency in international liquidity risk supervision”, and in response to the “inaccurate and ineffective management of liquidity risk” – such ineffective management being a prominent feature of the financial crisis, the Basel Committee has developed a minimum set of monitoring tools to be used in the “ongoing monitoring of the liquidity risk exposures of cross border institutions and in communicating these exposures amongst home and host supervisors (BIS, 2009).

This chapter is structured in accordance with identified components which are considered to be essential to the successful implementation of the (two fold) topics of discussion of this chapter, namely, monitoring and liquidity risk measurements. The importance of successfully communicating results obtained from monitoring and measuring such risks, and the role of corporate governance in ensuring such effective communication, constitutes a recurring theme throughout this chapter. The identified components are as follows: (1) corporate governance, (2) internal controls, (3) disclosure, (4) management of risk, (5) substance over form, (6) transparency

Disclosure and transparency embody the same goals, whilst the effective management and measurement of risks, and liquidity risks in particular, are aims which the internal control function and management should strive to achieve. The theme “substance over form” draws attention to creative accounting practices and the need for greater emphasis on principles based regulation. Creative accounting and “window dressing” of figures in the financial statements are ever recurring issues arising from corporate collapses – as also recently highlighted by the recent crises which involved Lehman Brothers.

Whilst the danger of formalism lies in the exercise of “creative compliance,”1 inherent problems of anti formalism are considered to include (Beattie, Brandt & Fearnley, 2001):

  • The fact that citizens have the right to know exactly what is prohibited in advance of behavior rather than in retrospect.

  • That broad rules are imprecise and over inclusive.

  • That anti formalism could result in ineffective control – where it is impossible to implement.

Principles based regulation (PBR) is more advantageous than a rules-based approach – owing to the fact that off balance2 sheet debt could result from the direct application of rules – without being able to consider the substance of the transaction and because the implemented standards do not allow such consideration. As its secondary argument3, this chapter will seek to demonstrate that detailed rules could still operate within a system of principles based regulation – whilst enabling a consideration of the substance of the transactions which are involved.

Regulatory standards implemented by the Basel Committee in its recent document provide for “jurisdiction-specific conditions” – for example, the percentage of potential run-off of retail deposits which is partially dependent on the structure of a jurisdiction’s deposit insurance scheme” (BIS, 2009). Furthermore, the Committee highlights that “in these cases, the parameters should be transparent and clearly outlined in the regulations of each jurisdiction” (BIS, 2009). It also adds that this would provide clarity both within the jurisdiction as well as across borders concerning the precise parameters that the banks are capturing in these metrics, and that there was need for public disclosures in respect of regulatory standards (BIS, 2009).

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