Mr Stefan Ingves said: "The global financial crisis reminded us of the need for sound liquidity risk management. It is unfortunate, I have to admit, that we needed a reminder about the importance of an issue that is at the very heart of banking. Banks' fundamental role in the maturity transformation of short-term deposits into long-term loans makes them inherently vulnerable to liquidity risk. But it is clear that banks and regulators were, at the very least, complacent about liquidity risks in the pre-crisis period. Liquidity was abundant and, as is the nature of good times in financial markets, there was a tendency to think that the good times would roll on."
In reality, the crisis showed that many banks had failed to take account of a number of basic principles of liquidity risk management. At the core of the matter, the banking industry underestimated the probability that there could be experience the sorts of severe and prolonged liquidity shocks that are encountered. And this lack of preparedness in many ways exacerbated the shocks. Many of the most exposed banks did not have an adequate framework that appropriately accounted for the liquidity risks posed by individual products and business lines, many of which had substantial contingent obligations that were not always immediately visible or understood. Contingency funding plans were often based on overly optimistic assumptions, including that any liquidity problems encountered would largely be idiosyncratic, and so normally deep and liquid markets would be open and available when needed. And, of course, regulatory constraints on excessive levels of liquidity risk were not rigorous enough, in many cases relying on only slightly less optimistic assumptions than the banks themselves had used.
Mr Stefan Ingves concluded: "There is no doubt that liquidity risk management is a very complex area for both banks and supervisors. Indeed, the subject has challenged the Basel Committee since its inception. We expect that our comfort level will only increase as we learn from each other’s implementation experiences and expand RCAP monitoring to cover liquidity standards."
He continued: "But liquidity risk is inherent in banking, and banks and supervisors cannot allow themselves to be complacent about the issue. In response to the crisis, the Committee has developed two new metrics to help benchmark bank liquidity profiles. These should help supervisors make a more consistent assessment of liquidity risks, and provide market participants with a benchmark against which they can judge banks’ relative liquidity positions. But we must never assume these will be enough to avert all liquidity problems in future."
The first line of defence against the impact of future liquidity shocks on the banking system is stronger risk management by banks themselves. Here, he encourages the banking industry to devote as much time, if not more, to assessing their implementation of the Principles as they do to measuring and managing their position against the LCR and NSFR. Strong liquidity risk management – in both its quantitative and qualitative dimensions – is undoubtedly critical to long-run success in banking.
Full speech
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