The evolving challenges in the banking sector demand a more rigorous approach to asset-liability and liquidity management, said Patrick Montagner, member of the Supervisory Board of the European Central Bank (ECB), in a recent speech.
Rising interest rates and quantitative tightening have succeeded a decade of low interest rates and ample liquidity. These changes bring both challenges and opportunities for banks, particularly in the critical area of asset liability management (ALM).
Banks’ liquidity buffers are moving away from central bank deposits and towards collateral. As well as adding interest rate risk and credit spread risk, this also means that assets held in the liquidity buffer are no longer immediately available to meet payment needs – collateral first needs to be monetized, either in repo markets or with central banks. However, after years of very high excess liquidity, ECB reviews have shown that not all banks are operationally ready to make this adjustment.
“Banks must have the technical and procedural capacity to participate in central bank operations, including ensuring access to sufficient levels of eligible collateral, maintaining the necessary infrastructure and governance for transactions, and always meeting the central bank’s operational requirements,” he said.
Room for improvement
Some institutions are overly optimistic about the time required to monetize collateral. To avoid missteps, banks must assume realistic but conservative timelines. Internally, this means “streamlining workflows and empowering teams to act swiftly” when monetizing collateral. Banks must also understand that central banks need time to assess collateral eligibility.
In addition, banks need to review their balance sheets systematically. Some banks already identify unencumbered, non-liquid assets – such as residential mortgages – that can be securitised to raise new funding. This practice should become standard, supported by robust monitoring indicators embedded in the bank’s risk appetite framework.
“Strong governance, a refined strategy, robust planning, and enhanced risk identification and stress testing are the foundations of resilience,” said Montagner. “Banks must also make their use of central bank liquidity facilities more routine and ensure they are operationally ready to use these tools at any time.”