Global liquidity regulation, supervision and risk management
As prepared for delivery
Introduction
Good afternoon. It is my great pleasure to be with you in Amsterdam today at the DNB's seminar on "Liquidity risk management - the LCR and beyond". Let me begin by acknowledging that this seminar is being held as part of the DNB's 200th anniversary celebrations - a milestone to be very proud of. Of course, coming from Sveriges Riksbank, which was founded 346 years ago, I can't help but note you are still a young organisation in comparison.
The global financial crisis reminded us of the need for sound liquidity risk management. It is unfortunate, I have to admit, that we needed a reminder about the importance of an issue that is at the very heart of banking. Banks' fundamental role in the maturity transformation of short-term deposits into long-term loans makes them inherently vulnerable to liquidity risk. But it is clear that banks and regulators were, at the very least, complacent about liquidity risks in the pre-crisis period. Liquidity was abundant and, as is the nature of good times in financial markets, there was a tendency to think that the good times would roll on.
In reality, the crisis showed that many banks had failed to take account of a number of basic principles of liquidity risk management. At the core of the matter, the banking industry underestimated the probability that we could experience the sorts of severe and prolonged liquidity shocks that we encountered. And this lack of preparedness in many ways exacerbated the shocks. Many of the most exposed banks did not have an adequate framework that appropriately accounted for the liquidity risks posed by individual products and business lines, many of which had substantial contingent obligations that were not always immediately visible or understood. Contingency funding plans were often based on overly optimistic assumptions, including that any liquidity problems encountered would largely be idiosyncratic, and so normally deep and liquid markets would be open and available when needed. And, of course, regulatory constraints on excessive levels of liquidity risk were not rigorous enough, in many cases relying on only slightly less optimistic assumptions than the banks themselves had used.
Dealing with the shortcomings brought to light by the crisis requires changes by both banks and supervisors. I will be using much of my time this afternoon to talk about the global regulatory response developed by the Basel Committee. But I don't want to take away from what you discussed this morning on the practical side of liquidity risk management. Indeed, I will conclude with a reminder that regulators don't run banks, and ultimately it is for the banking industry to learn from recent experience to ensure it better measures, manages and prices liquidity risk in the future.