With an increasing number of banks, accounts, suppliers, customers, ERP systems, subsidiaries, employees, processes, and excels, it becomes challenging to manage liquidity. It means that you need to trust everyone to contribute with their timely and error-free data input to be able to analyze liquidity accurately. Finance and treasury teams can save time and resources, and prevent errors, by centralizing all data into a centralized liquidity management system. https://www.xcritical.com/ Accurate liquidity management can make a big difference in the success of your business. When done right, it provides insights into your cash position in the past, present, and future, and how it will be affected by cash outflows or short-term liabilities, thus giving you a good outlook on the financial health of a business. While liquidity management is an involved science, it is also part art, in the way a bank can structure and design requisite systems.
Risk identification is the process of identifying and understanding the distinct risks facing the firm. This process is important because firms that are not aware of the scope and nature of their risks may allow less visible issues to grow unchecked. Incorporating an exhaustive list of liquidity risk drivers is an important first step in establishing processes for risk measurement, monitoring and mitigation.
Operational risks
Integrated interest rate and liquidity risk management can help banks to optimize their interest income and reduce interest expenses, while simultaneously ensuring liquidity with reduced cost of funding for any given time band. However, due to firms’ siloed organizational structures, data may be inconsistent across lines of business and asset classes, which may use different and specialized solutions. Firms often put in place a data warehouse to address the difficulty in collecting and integrating group-wide data.
Yet, the challenge for medium or larger-sized companies is that it is difficult to get real-time and accurate financial information on where they stand at any point in time. In turn, this often slows down the whole company in the long term https://www.xcritical.com/blog/xcritical-your-technological-partner-for-liquidity-management/ due to longer strategic decision-making processes. Therefore, it is extremely important for companies to have a proper liquidity management strategy in place to mitigate any liquidity risks and to make the company financially agile.
Reducing Liquidity Risk With Conscious Cash Flow Management
A rigid step-by-step plan may not be able to cope with the variety of these risks, but having a series of different scenario responses prepared can allow management to decide on an appropriate response. An effective governance process should feature daily internal price variance checks and reviews of exception reports. On a less frequent basis—say, every five days—those price reviews should be cross-checked with external vendors. And monthly, the governance team should analyze and discuss the pricing and liquidity data with the portfolio-management team. As part of these reviews, managers should evaluate portfolio liquidity against stress tests using different scenarios.
Greater transparency would help provide the appropriate incentives for businesses to better self-manage activities that drive liquidity usage and charges they incur. Business-level attribution and charging for liquidity buffers has also come into sharper focus as liquidity buffers have become commonplace and grown significantly in size. Liquidity buffers are a drag on income as they are required to be invested in low yielding, high quality assets. Accordingly, the cost of maintaining contingent liquidity reserves should be charged to businesses driving the need for reserves and ultimately should factor into product pricing and comparison of fully- loaded returns across businesses. Our observation is that internal transfer pricing frameworks are in varying stages of development across the industry, with widely varying practices across firms, and many still relying on legacy approaches. Treasury, LRM and LTRA maintain a Liquidity policy landscape which articulates the overarching guiding principles for the robust and rigorous management of the Bank’s liquidity.
Areas of focus and opportunities for Treasury leaders
Lockdowns created an unexpected economic disruption, and many businesses saw sales dwindle to a catastrophically low level and liquidity risk drastically increase. The higher rates have had various impacts on bank balance sheets, including spoiling the cheap liquidity. Banks are facing liquidity risk management challenges in today’s interest rate environment. Banks got comfortable with abundant and cheap liquidity over the past several years.
To weather the liquidity storm posed by Covid-19, banks need to take proactive measures. They need to institute steps to identify potential gaps in their liquidity requirements and formulate plans on how to address them, as well as ensure their cash-flow management processes and calculations are robust. Stress testing is conducted at a global level and for defined material legal entities covering an eight-week stress horizon. In addition to the consolidated currency stress test, stress tests for material currencies (EUR, USD and GBP) are performed. Ad-hoc analysis may be conducted to reflect the impact of potential downside events that could affect the Bank’s liquidity for instance the COVID-19 pandemic and Brexit.
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