The 2023 banking turmoil highlighted a number of lessons learnt in the context of liquidity risk management. Some of these lessons relate to the management of intraday liquidity risk – traditionally a less scrutinized area that could be viewed as financial plumbing. This article from researchers at the European Central Bank (ECB) takes a look at intraday liquidity risk in the light of a thematic review carried out by ECB Banking Supervision.
Intraday liquidity risk arises in situations where a bank fails to manage its intraday liquidity effectively. It is the risk that a bank is unable to meet a payment obligation, including collateral, at the time expected, thereby affecting its own liquidity position and those of other parties. Traditional liquidity risk indicators do not capture intraday liquidity risk, as changes in a bank’s liquidity positions between the start and end of the day are typically limited. In other words, banks normally send and receive about the same amount of money on any given day, implying that there is no liquidity need. However, there are timing mismatches (within a currency and across currencies) between outgoing and incoming payments during the day that give rise to intraday liquidity needs – and therefore intraday liquidity risk.
While incoming payments are not under the bank’s control, it is expected to process outgoing payments in a timely manner, especially time-specific obligations, such as margin calls. In addition to using their liquidity reserves to meet such obligations, banks throttle (i.e. delay) payments to optimize the matching of intraday inflows and outflows and/or use counterparty credit lines to process the payments and settlements. Intraday liquidity risk is created through the processing of payments via real-time gross settlement systems and correspondent banking, as well as through securities settlement activities, foreign exchange settlement and activities related to central counterparties (e.g. clearing of derivatives).
Intraday liquidity was a relevant factor in the failure of Credit Suisse (CS) in 2023. This is highlighted in a recent report by the Basel Committee on Banking Supervision (BCBS), which mentions the increase in intraday requirements as a significant driver of CS’s liquidity needs: during the stress period, incoming payments were delayed due to changes in the payment behavior of counterparties, but CS wanted to maintain normal outgoing payments to avoid negative signaling.
Other stress episodes in recent years have also highlighted the growing need for supervisors to assess banks’ intraday liquidity risk management, including the COVID-19 pandemic in 2020, the 2022 UK gilt market turmoil and the 2022 energy crisis, with fast-moving margins on cleared transactions. The risk is becoming even more relevant with emerging technological developments, including the growing importance of instant payments, faster settlement cycles, and algorithmic trading driven by artificial intelligence technology (e.g. by principal trading firms). These events and trends have prompted many supervisors and standard-setters globally to prioritize their efforts in the area of intraday liquidity.
Intraday liquidity risk management in banks under European banking supervision
Against this backdrop, ECB Banking Supervision conducted a thematic review to analyze existing intraday liquidity risk management practices among a sample of the most complex global systemically important banks (G-SIBs). The review covered the following dimensions of intraday liquidity risk management:
- Risk management framework: the definitions of intraday liquidity, liquidity risk drivers, formalization of internal procedures (e.g. internal bank policies), coverage of intraday liquidity in the risk appetite framework, and soundness of HR/IT resources. Intraday liquidity risk requires appropriate involvement of the second line of defense and, in the case of unfavorable developments, of the bank’s board. Therefore, where intraday liquidity risk is material, it is expected to be part of the institution’s risk appetite framework.
- Governance: the existence and functioning of dedicated committees, escalation procedures, including the coverage of the risk by the contingency funding plans, the internal reporting set-up, compliance with BCBS standard 248 on monitoring tools, and whether and how the three lines of defense consider intraday liquidity risk. With regard to reporting, it was observed that some banks apply alternative monitoring tools instead of the ones defined by the BCBS.
- Forecasting and monitoring: the projection of liquidity needs throughout the day (amount and timing), as well as banks’ real-time intraday monitoring capabilities and the existence of automated alerts.
- Managing outflows: the ability of banks to prioritize and actively manage outflows, including the set-up for managing time-specific obligations. Beyond the euro, direct access to real-time gross settlement systems varied across institutions, with an impact on the ability to monitor and steer payment activities. Relying on correspondent banking is a widely followed market practice, especially for currencies other than the euro and for host institutions.
- Sources of liquidity: the identification of funding sources (per currency), including the distinction between business-as-usual and contingency resources, as well as practices regarding maintaining collateral at central banks, correspondent banks and financial market infrastructures. Diversification and regular testing of liquidity capabilities is relevant not only for managing structural liquidity but also for managing intraday liquidity.
- Stress testing: the stress-testing practices and methodologies for the quantification of intraday liquidity buffers. The distinction between business-as-usual and stress intraday liquidity buffers can provide an additional safety layer to ensure appropriate internal escalation. While historical stress flows and events can serve as a starting point for stress testing, a forward-looking approach, stressing the liquidity drivers, can offer an additional perspective for the bank.
As a general observation, the sampled banks have functioning practices for managing intraday liquidity risk, although the maturity of these frameworks differs across banks. Some institutions appear to be more advanced in areas such as real-time monitoring and forecasting of intraday liquidity flows, while others adopt a more conservative approach to internal stress-testing of intraday liquidity risk.
Sound practices identified
As a result of the thematic review, a number of sound practices for managing intraday liquidity risk have been identified. These practices help banks to meet intraday stress outflows, which may differ significantly from those encountered during regular business operations. This requires a robust stress-testing framework and related assumptions, appropriate governance structures and an appropriate risk management framework, as well as granular monitoring capabilities, timely forecasting, active management of outflows, and sufficient liquidity across currencies and entities.
The sound practices identified will be used for future follow-up with banks (taking into account the principle of proportionality) and will serve as a foundation for ECB Banking Supervision to harmonize and further strengthen existing industry practices.