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Liquidity Risk Management

Category: Corporate Governance

Effective liquidity risk management requires an informed Council, capable management, and appropriate staffing. The Supervisory Council and senior management are responsible for understanding the nature and level of liquidity risk assumed by the bank and the tools used to manage that risk. The Supervisory Council and senior management should also ensure that the bank’s funding strategy and its implementation are consistent with their expressed risk tolerance.

The Supervisory Council’s primary duties are establishing and guiding the bank’s strategic direction and tolerance for liquidity risks electing senior managers who will have the authority and responsibility to manage liquidity risk; monitoring the bank’s performance and overall liquidity risk profile, and ensuring that liquidity risk is identified, measured, monitored, and controlled. The following reports should assist members of Council in assessing the bank’s liquidity risk:

Liquidity risk report — shows the level and trend of the bank liquidity risk by a variety of appropriate measures. Report should indicate how much liquidity risk the bank is assuming, whether management is complying with risk limits, and whether management’s strategies are consistent with the Council’s expressed risk tolerance.

Funds provider report — lists large funds providers and identifies funding concentrations. These reports should include consolidated information from all commonly owned banks.

Funds flow analysis — reflects trends of balance sheet line items, in money terms, which have a significant impact on liquidity. Changes over time can be useful in developing a «source and use analysis » to more clearly show where money is coming into and going out of the bank.

Cash flow or funding gap report — shows future time frames when funds may be needed to pay for deposit withdrawals, or other decreases in liabilities, or increases in assets. The funding gap is a shortfall (or excess) of funds that is caused at certain points in time by a funding mismatch.

Contingency Funding Plan (CFP) — may incorporate the funding gap report or be considered an outgrowth of it. The plan forecasts funding needs and funding sources (and therefore gap) under varying market scenarios resulting in rapid liability erosion (usually due to increasing customer concerns about the asset quality of the bank), or excessive asset growth.

Liquidity Risk Red Flags:

Liquidity risk that exceeds risk limits established by the Supervisory Council.

A negative trend or significantly increased risk in any area or product line, particularly a decline in indicators of asset quality, or a decline in earnings performance or projections.

Concentrations in either assets or liabilities indicating undue reliance.

Rapid asset growth funded by wholesale, volatile liabilities. This may indicate poor credit underwriting standards.

Increased funding costs due to customer or counterparty concerns about increasing risk.

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