Assessment of liquidity and funding risk management and control framework
To achieve a comprehensive understanding of the institution’s liquidity and funding risk profile and their interconnectedness, competent authorities should also review the governance and risk management framework underlying its liquidity and funding risk. To this end, competent authorities should assess:
the liquidity risk and funding strategy and liquidity and funding risk appetite;
the organisational framework, policies and procedures;
risk identification, measurement, management, monitoring and reporting;
the institution’s liquidity/funding-specific stress testing;
the internal control framework for liquidity risk and funding risk management;
the institution’s liquidity contingency plans and recovery plans;
the institution’s funding plans.
Liquidity and funding risk strategy and risk appetite
Competent authorities should assess whether the institution has a sound, clearly formulated, documented and communicated liquidity/funding risk strategy and appetite, approved by the management body. For this assessment, among other factors, competent authorities should take into account the role of the management body in setting, approving and reviewing the liquidity/funding risk strategy and appetite (including its major underlying assumptions), the proper implementation of this strategy by the management body as well as its appropriateness for the institution given its business model, overall risk tolerance, role in the financial system, financial condition and funding capacity.
Organisational framework, policies and procedures
Competent authorities should assess whether the institution has an appropriate organisational framework and governance arrangements for liquidity and funding risk management, including a robust ILAAP framework in line with paragraph 911 of Title 5 of these Guidelines. Further, they should assess whether the institution has implemented appropriate measurement and control functions, with sufficient human and technical resources to develop and implement these functions and to carry out the required monitoring tasks. The liquidity risk control and monitoring of systems and processes should be controlled by an independent function.
Competent authorities should assess whether the institution has appropriate policies and procedures for the management of liquidity and funding risk and whether these are consistent with the institution’s liquidity risk appetite. This includes assessment of whether the policies and procedures are properly defined, formalised and effectively communicated throughout the institution. The management body should approve and regularly review the policies and procedures, and these should be implemented by senior management.
Competent authorities should assess the adequacy of the institution’s approach to maintaining market access in its significant funding markets, including any testing of market access that has been undertaken, the institution’s approach to maintaining an ongoing presence in the markets (for specific small institutions or specialised business models, testing of access to markets may not be relevant), the institution’s approach to developing strong relationships with funding providers, and any evidence that the institution would continue to have ongoing market access in times of stress.
Risk identification, measurement, management, monitoring and reporting
Competent authorities should assess whether the institution has an appropriate framework and IT systems for identifying and measuring liquidity and funding risk, in line with the institution’s size, complexity, risk appetite and risk-taking capacity. They should take the following factors into account:
whether the institution has implemented appropriate methods for projecting its cash flows over an appropriate set of time horizons, assuming business-as-usual and stress situations, and comprehensively across material risk drivers;
whether the institution uses appropriate key assumptions and methodologies, which are regularly reviewed, recognising interaction between different risks (credit, market, IRRBB etc.) arising from both on- and off-balance sheet items;
whether the institution understands its ability to access financial instruments wherever they are held, having regard to any legal, regulatory and operating restrictions on their use, including, for example, the inaccessibility of assets due to encumbrance during different time horizons.
Competent authorities should assess whether institutions have an appropriate reporting framework for liquidity and funding risk that has been agreed by the senior management. They should take into account the quality of information systems and internal information flows used to generate reporting and whether the reporting is understandable for the target audience, accurate and usable (e.g. timely, not overly complex, within the correct scope). The reporting should be provided regularly to appropriate recipients (such as the management body, senior management or an asset-liability committee).
Competent authorities should assess the adequacy of the process of measuring intraday liquidity risk, especially for those institutions that participate in payment, settlement and clearing systems. They should take into account whether the institution adequately monitors and controls cash flows and liquid resources available to meet intraday requirements and forecasts when cash flows will occur during the day, and whether the institution carries out adequate specific stress testing for intraday operations, also considering business developments (e.g. possibility for instant payments).
Competent authorities should assess whether the institution has an adequate set of liquidity and funding indicators. They should take into account:
whether the indicators adequately reflect the institution’s liquidity risk profile including the degree of diversification of assets in the liquidity buffer and the consistency between the currency denomination of their liquid assets and the distribution by currency of their liquidity outflows;
whether the indicators adequately cover key liquidity risk aspects related to potential cliff risks such as the concentration of outflows maturities (considering also any potential early withdrawal of liabilities) and central bank support programmes;
whether the indicators permit identification of the institution’s structural funding vulnerabilities, including any concentrations in particular markets, currencies, counterparties, and maturities;
whether the indicators provide an insight into the ‘stickiness’ of the institutions’ funding (independent of what is assumed in the LCR or NSFR), including the breakdown into homogenous categories in accordance with their risk properties, and the proportion of deposits outside the scope of a guarantee/insurance scheme.
Institutions should be able to demonstrate that the indicators are adequately documented, periodically revised, used as inputs to define the risk appetite of the institution, part of management reporting and used for setting operating limits.