Liquidity Risk: Management and Supervisory Challenges

In December 2006, the Basel Committee on Banking Supervision established the Working Group on Liquidity to review liquidity supervision practices in member countries. The Working Group's mandate was to take stock of liquidity supervision across member countries. This included an evaluation of the type of approaches and tools used by supervisors to evaluate liquidity risk and banks' management of liquidity risks arising from financial market developments.

The market turmoil that began in mid-2007 has highlighted the crucial importance of market liquidity to the banking sector. The contraction of liquidity in certain structured product and interbank markets, as well as an increased probability of off-balance sheet commitments coming onto banks' balance sheets, led to severe funding liquidity strains for some banks and central bank intervention in some cases. In response to the market events, the original mandate was expanded and the Working Group made initial observations on the strengths and weaknesses of liquidity risk management in times of difficulty. These observations, together with those provided by the review of national liquidity regimes, formed the basis of the report, which was submitted to the Basel Committee in December 2007.

In view of the relevance and timeliness of the report, the Basel Committee is publishing this summary of the key findings. This document highlights financial market developments that affect liquidity risk management, discusses national supervisory regimes and their components, and then outlines initial observations from the current period of stress and potential future work related to liquidity risk management and supervision.

The Working Group is currently conducting a fundamental review of the Basel Committee's publication Sound practices for managing liquidity risk in banking organisations published in 2000. While the guidance remains relevant, the Working Group identified areas that warrant updating and strengthening. The Basel Committee plans to issue the enhanced sound practices for public comment in the summer of 2008.