Managing increased intraday liquidity challenges as liquidity reduces post pandemic

Charlie Peng, SVP and Head of Market Risk, Bank of China USA

Below is an insight into what can be expected from Charlie’s session at Treasury & ALM USA 2023.

The views and opinions expressed in this article are those of the thought leader as an individual, and are not attributed to CeFPro or any particular organization.

How can banks look to improve their intraday liquidity management even with less total liquidity?

Banks can improve their intraday liquidity management with less total liquidity from the two ways we observe.

  • System Automation- Banks should leverage system automation mechanism to reduce manual inputs in addition to the email and offline communication, and also set up notification emails or alert to related stakeholders. System should enable banking supervisors to real-timely monitor a bank’s intraday liquidity risk management and its ability to meet payment and application. Meanwhile, the cross system data analysing could be a more accurate and comprehensive measure for real-time liquidity needs and risk exposure of the bank, which provide a much clearer picture of current liquidity situation with consistency.
  • Planning & Projections-Banks could report large positions of certain date before head and leverage early warning framework so that if the position is over the warning line, there will be sufficient time for decision making and actions. Also, banks could organize and arrange internal funding positions based on the projection in advance and implement internal sharing of important information regarding large positions.
What implications will the reduction in liquidity reserves have on intraday stress?
  • Banks should stay more vigilant and prepare for more frequent contingency actions. By establishing Contingency funding plans, banks should further strengthen liquidity management through regular and meticulous contingency testing and simulation under various scenarios. While maintaining existing funding channels, banks need to consider expanding and diversifying funding resources to gain faster and cheaper access to funds in stressed conditions.
  • The tighten liquidity will make banks more cautious about any investment, resulting in a reduction or even withdrawal of funding availability. And this will further impact the market expectation and slow down the growth of funding availability s which will also make it even worse. This reserve decrease will shrink the dollar supply of the entire economy thereby tightening the liquidity. The decrease of reserves also impact the market. The historical long-time loose policy made the market liquidity dependent, which in turn, may made the entire financial system more sensitive to liquidity tightening than originally expected. Also, the minimum reserve balance that the market can accept is uncertain which create more uncertainty of the market.
What benefits could a real time intraday liquidity system have on banks?

The benefits include banks could use the system to capture, control and optimise the banks’ intraday liquidity position, collateral or other unexpected cash flows in real-time. Another benefit is that a bank could obtain the exact time point at which a given cash flow occurs during the day, the bank could arrange funding and match inflows and outflows which greatly reduces liquidity risk. By doing this, banks needs to have integrated intraday liquidity management capacities that could monitor liquidity needs and also react to the liquidity needs in real time. In addition, the intraday liquidity systems could provide instant visibility picture to all the internal users. Also, it can deliver both intraday control and regulatory compliance to banks and provide a clearer audit trail to internal or external examiners.

How has the pandemic increased liquidity stress challenges?

Pandemic significantly increased uncertainty to the market and liquidity management. The injection of massive liquidity from the Fed and global bank have been unprecedented and subsequently the tightening period can be suffering with great uncertainty and challenge to test the liquidity management capability. Some specific challenges are

  • More scenarios should be considered. After pandemic, the behaviour of customers and investors may change, compounding by the central bank’s monetary policy changes and geo-political events.
  • Banks models, parameters and benchmarks to test different liquidity needs derive from past years of historical data and experiences. Currently the bank industry have past 3 years of historical data. However, there are still doubts whether these data are sufficient and granular enough for the post-pandemic situation.
Why is intraday payment sequence so important?

Intraday payment sequence would help bank to prioritize the time-specific and other critical obligations. Banks tends to make payments until sufficient funds flow in, which could decrease the banks total demand for intraday liquidity.

  • Payment sequence is beneficial to avoid system or platform over capacity. Non-critical payments may be delayed if very high data volumes were processing during the day. Banks payment systems were designed and architected with limited capacity which should make sure the most critical payment should be processed first.
  • Payment sequence could help bank balance out cost and benefits. Liquidity buffer contribute the least to the bank’s net profit margin because it usually provides very low returns. The trade-off between reducing liquidity risk and maintaining a high rate of return is the core of liquidity management. It is difficult for banks to minimize the loss of profits caused by maintaining liquidity while maintaining sufficient liquidity to avoid crisis. The more accurate the bank’s forecast of expected inflows and outflows, the better the bank can arrange payment sequence, and the less excess liquidity it will hold and also, the lower capital it will occupy.