Principles for Sound Liquidity Risk Management and Supervision

The Basel Committee on Banking Supervision today issued for public comment enhanced global Principles for Sound Liquidity Risk Management and Supervision.

"The Basel Committee's goal in developing these global standards is to significantly raise the bar for the management and supervision of liquidity risk at banks" stated Nout Wellink, Chairman of the Basel Committee and President of the Netherlands Bank. "The Committee fully expects banks and supervisors to implement the enhanced principles promptly and thoroughly. We will vigorously assess the degree to which the principles are implemented." 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 draft principles represent a substantial revision of the Committee's liquidity guidance that was published in 2000 and reflect the lessons of the financial market turmoil. 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 are based on the fundamental premise that a bank's liquidity risk framework should ensure it maintains sufficient liquidity to withstand a range of stress events, including those that affect secured and unsecured funding" noted Nigel Jenkinson, co-chairman of the Basel Committee's Working Group on Liquidity and Executive Director of the Bank of England. Arthur Angulo, the other co-chairman of the Working Group and Senior Vice President of the Federal Reserve Bank of New York, added that "supervisors, for their part, should assess the adequacy of both a bank's liquidity risk management framework and its liquidity position. In order to protect depositors and to limit potential damage to the financial system, supervisors should take prompt action if a bank is deficient in either area."

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 are invited by 29 July 2008. All comments will be published on the Bank for International Settlements' website unless a commenter specifically requests anonymity.

Comments may be sent 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