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The BIS released a paper today entitled Liquidity Risk: Management and Supervisory Challenges. The paper outlines initial observations from the current financial turmoil, highlights financial market developments that affect liquidity risk management, and discusses national supervisory regimes and their components.
The market turmoil that began in mid-2007 has highlighted the crucial importance of market liquidity to the banking sector. The contraction of liquidity in certain structured product and interbank markets, as well as an increased probability of off-balance sheet commitments coming onto banks' balance sheets, led to severe funding liquidity strains for some banks and central bank intervention in some cases. In response to the market events, the original mandate was expanded and the Working Group made initial observations on the strengths and weaknesses of liquidity risk management in times of difficulty. These observations, together with those provided by the review of national liquidity regimes, formed the basis of the report, which was submitted to the Basel Committee in December 2007.
"The extreme liquidity conditions of last summer and resulting difficulties that persist today are vivid illustrations of the critical importance of market liquidity to the banking sector," stated Nout Wellink. "These events emphasised the links between market and funding liquidity, the interrelationship between funding liquidity risk and credit risk, and the fact that liquidity is a key determinant of banking sector soundness."
The Working Group is currently conducting a fundamental review of the Basel Committee's Sound practices for managing liquidity risk in banking organisations published in 2000. Drawing from recent and ongoing work on liquidity risk by the public and private sectors, the Basel Committee aims to enhance these sound practices to strengthen banks' liquidity risk management and improve global supervisory practices. The Basel Committee plans to issue the revised sound practices for public comment this summer.