Principles for Sound Liquidity Risk Management and Supervision

The Basel Committee has published for public comment Principles for Sound Liquidity Risk Management and Supervision.

The enhanced global standards reflect the lessons of the financial market turmoil and represent a substantial revision of the Committee's Sound Practices for Managing Liquidity in Banking Organisations that were published in 2000. The work was drawn from recent and ongoing work on liquidity risk by the public and private sectors and is intended to strengthen banks' liquidity risk management and improve global supervisory practices. The principles support one of the key recommendations for strengthening prudential oversight set out in the Report of the Financial Stability Forum on Enhancing Market and Institutional Resilience, which was presented to G7 Finance Ministers and Central Bank Governors in April 2008.

The principles underscore the importance of establishing a robust liquidity risk management framework that is well integrated into the bank-wide risk management process. The primary objective of this guidance is to raise banks' resilience to liquidity stress. Among other things, the principles seek to raise standards in the following areas:

• Governance and the articulation of a firm-wide liquidity risk tolerance;
• Liquidity risk measurement, including the capture of off-balance sheet exposures, securitisation activities, and other contingent liquidity risks that were not well managed during the financial market turmoil;
• Aligning the risk-taking incentives of individual business units with the liquidity risk exposures their activities create for the bank;
• Stress tests that cover a variety of institution-specific and market-wide scenarios, with a link to the development of effective contingency funding plans;
• Strong management of intraday liquidity risks and collateral positions;
• Maintenance of a robust cushion of unencumbered, high quality liquid assets to be in a position to survive protracted periods of liquidity stress; and
• Regular public disclosures, both quantitative and qualitative, of a bank's liquidity risk profile and management.

The principles also strengthen expectations about the role of supervisors, including the need to intervene in a timely manner to address deficiencies and the importance of communication with other supervisors and public authorities, both within and across national borders.

The proposed guidance focuses on liquidity risk management at medium and large complex banks, but the sound principles have broad applicability to all types of banks. The document notes that implementation of the sound principles by both banks and supervisors should be tailored to the size, nature of business and complexity of a bank's activities. Other factors that a bank and its supervisors should consider include the bank's role and systemic importance in the financial sectors of the jurisdictions in which it operates.

Comments on the consultative document are welcome. They may be submitted by no later than 29 July 2008 via e-mail to baselcommittee@bis.org. Alternatively, comments may be addressed to:

Basel Committee on Banking Supervision,
Bank for International Settlements,
Centralbahnplatz 2,
CH-4002 Basel, Switzerland.

All comments will be published on the Bank for International Settlements' website unless a commenter specifically requests anonymity.