Building Resilience to Financial Turbulence Through a Robust Intraday Liquidity Risk-Management Solution

By Manoj Reddy, Head of BFSI (Banking, Financial Services and Insurance) Risk, Finance and Treasury Consulting & Advisory Practice, TATA Consultancy Services (TCS)

Liquidity is the lifeblood of any organization, and this is particularly true for financial institutions that are at the forefront of mobilizing funds to foster economic activity and ensure the financial system’s smooth operation. Intraday liquidity risk is the most volatile and demanding form of liquidity risk; it can emerge innocuously during a business day but cause significant operational impacts due to mismatches between large payment inflows and outflows, margin calls on derivative positions and collateral pledges for funding purposes. Although the Basel Committee on Banking Supervision (BCBS) published intraday liquidity risk guidelines (BCBS 248) more than a decade ago in 2013, intraday liquidity has largely been viewed as a regulatory issue for large global banks rather than a core business capability of financial institutions. If designed effectively, an intraday liquidity risk framework can potentially mitigate catastrophic financial and reputational losses while ensuring financial stability and increasing market credibility.

What drivers are propelling the adoption of intraday liquidity risk management?

• Advancements in APIfication and open banking. Due to advancements in technology through APIfication and open-banking initiatives, financial institutions can now obtain real-time views of cash balances across their nostro accounts at correspondent banks, custody accounts and balances with other financial institutions and central banks. Obtaining real-time views of cash and collateral balances through an API call is no longer an aspiration but a practical utility.

• Market reforms in securities settlements and payments. Reduced settlement cycle times for securities, such as the T+1 settlement in the United States, have increased the need for close-to-real-time intraday views of securities, which has strongly impacted the intraday liquidity and funding derived through these securities. Additionally, with the increasing macro adoption of real-time payments globally, there is a need to monitor cash flows throughout the day, as opposed to the legacy payments-through-batch mode, whereby the end-of-day liquidity position was just adequate to manage the bank’s liquidity.

• Higher funding costs due to increased interest rates. To combat inflationary pressures since the pandemic—owing to increases in the money supply, rising energy costs and supply-chain disruptions—central banks globally have had to increase interest rates. This has directly impacted funding costs in both retail-funding and wholesale-funding channels, and the foci and priorities of businesses have shifted from excess-liquidity buffering in settlement accounts (nostro and custody) to determining the most real-time, or near-real-time, views of account balances to achieve optimal fund utilization.

• The 2023 banking crisis elevating the regulatory focus. Although the lack of a holistic intraday liquidity risk-management framework may not have been the primary driver of the 2023 banking crisis, if it had been in place, it would have, to a certain extent, mitigated the devastating impacts of the bank runs we witnessed. The autopsy of the crisis, in addition to elevating regulatory attention to address vulnerabilities in financial institutions’ interest-rate risk and liquidity risk management, has pushed Tier 2 banks, regional banks and even insurance firms to assess their own vulnerabilities to these risks and potentially build resiliency by fortifying their overall liquidity positions—specifically, their intraday liquidity- funding and contingency-funding plans.

What are the key considerations for a holistic intraday liquidity risk-management framework?

• Going beyond regulatory metrics to reflect idiosyncratic risks. To ensure a robust intraday liquidity risk-management capability, banks will need to analyze their business lines, portfolios and operating models to determine their idiosyncratic-risk profiles while augmenting regulatory metrics with additional liquidity measures. It is extremely critical to identify the key drivers and sources of intraday liquidity risk specific to the institution—including analyses of time-sensitive obligations—and establish monitoring capabilities to ensure that the most critical risks are being addressed, beyond tactical compliance to broader regulatory metrics.

• Objective assessments of potential candidate solutions as opposed to extending existing payment or treasury management systems (TMSs). Intraday liquidity management, as a function, brings its own complexity and criticality to a business and its operations. While building an in-house intraday liquidity solution is always an option for larger banks—which have the regulatory experience, depth of expertise and resources—Tier 2 and regional banks are more likely to explore the buy option with the required enhancements and customizations to meet their specific needs. Regardless of the choice to buy or to build, it is essential to conduct detailed, objective assessments of potential solutions to determine their alignment with core business needs and integration with payment-processing engines and TMS solutions, rather than merely extending these solutions to meet intraday liquidity requirements.

• Enterprise collateral-management capabilities. Most banks will have a collateral-management group in place, largely part of their capital-markets line of business, that caters to the needs of margin calls on derivatives and posting collateral for secured funding transactions (SFTs). However, banks should establish enterprise collateral-management frameworks that are accessible to both capital markets and liquidity-and-funding teams to gather real-time or near-real-time views and statuses of securities. This will enable the optimal utilization of securities—not only by the capital markets team but also by the liquidity-and-funding team, especially to secure central-bank funding for intraday liquidity and funding needs. A real-time view of collateral is as critical a component of liquidity as cash is.

• Integrated data platforms to enable holistic views. Technically, an intraday liquidity-monitoring engine can be integrated in a siloed fashion with central-bank payments and settlement account feeds; it can also, through APIfication, gather real-time balances from nostro and custody accounts. However, it is important to ensure that the data strategy and data architecture factor in and reflect access to payment information throughout the day, enabling the reconciliation of balances to underlying transactions to explain movements, as well as client and other collateral data across business lines that impact overall liquidity at the enterprise level. Having a central data platform integrated into the intraday liquidity solution ensures not only the aggregation of multiple datasets and optimization of integration layers but also the buildup of historical data for forecasting and stress testing. Downstream reporting to senior management could also be enabled intraday or to regulators if the need arose during an economic downturn or stressed market conditions.

• Limit monitoring and breach management enabled through inbuilt workflows. It is essential to consider integrating limit-management capabilities into the intraday liquidity management solution to ensure that there is no lag in identifying potential risks. Although computed exposure data in real-time could be provisioned to an enterprise limit-management system, having this capability built within the intraday liquidity solution is highly recommended. Additionally, any breach of the policy-defined limits or monitoring thresholds should be managed through workflows built within the intraday liquidity risk solution, not through offline calls for action to the funding desk or any other funding measure, to enable a faster response to a liquidity situation and ensure a greater level of transparency and auditability of funding actions.

• Stress testing and data-driven advanced forecasting capabilities. An intraday liquidity management solution requires a robust stress-testing infrastructure to simulate stressed cash-flow scenarios, an elevated number of margin calls and operational events delaying payments. Stress testing should not be viewed or built as an academic or regulatory activity to determine the liquidity buffer periodically; instead, it must be regarded as a capability to dynamically review the liquidity position and its impacts in order to build resilience to potential threats from a stressed market or economic environment. Additionally, forecasting intraday liquidity should not be restricted to the visibility of contractual payments but rather extended to forecasting non-contractual cash flows, which can be harnessed through deep machine learning and statistical models with historical data on intraday balances and payments.

• Payment throttling and prioritization. Payment throttling and prioritization are among the most effective techniques available for mitigating intraday liquidity risks. Although payment throttling is implemented through a payment engine, the intraday liquidity solution should be configured with the required thresholds and workflows that can invoke payment throttling as needed when a limit or threshold is breached and trigger the workflow for payment throttling through the payment engine.

• Early-warning triggers that are integrated into the contingency funding framework (CFF). Having robust early-warning signals to augment the overall limit-management framework is a critical component of designing an intraday liquidity management system. This ensures the early identification of potential liquidity risk events, even before a limit breach occurs, providing sufficient time for corrective action. In addition to having an early-warning framework in place, it is essential to ensure that the risks identified through early warnings limit breaches and are integrated into the contingency funding framework. Additionally, each specific contingency-funding communication, escalation and action should reflect intraday-funding needs and not end-of-contingency-funding actions.

Conclusion

Intraday liquidity risk management should not be viewed as merely a regulatory reporting mandate for large banks. It holds enormous significance and is a business necessity in the current scenario of volatile markets and uncertain interest-rate environments. It is a complex solution, so multidimensional data and analytics capabilities must be built or integrated into it. Due consideration must also be given to solutions and data strategies to future-proof it. Banks should not only view the optimal fund utilization that is enabled through effective intraday liquidity management by way of real-time views of cash and liquidity balances as a cost-saving measure but also recognize the funds freed from excess buffering as additional funds to offer newer intraday credit lines or overdraft facilities to further their business footprints and increase revenues.