9Liquidity Risk Management and Reporting
The Financial Crisis raised fundamental questions regarding liquidity risk, with financial firms across the global financial system experiencing an urgent demand for cash from counterparties, short‐term creditors and borrowers. It was the banks' credit that was hit hardest by liquidity pressures. Many solvent banks were denied access to short‐term interbank lending (which many had in fact built their business models on). Emergency central bank lending programmes assisted some banks, although others went into liquidation. It is against this backdrop that the Bank of International Settlements enhanced the Basel II framework, in particular putting liquidity management front and centre of the Basel III framework, which this chapter details. In particular, the chapter explains the impact of credit rating downgrade clauses (for example, see Appendix A) that had been in many trading agreements, causing somewhat unexpected outflows of cash during the Financial Crisis due to the manner in which it unfolded.
Bank Liquidity
Given the central role banks play in financial markets, their stability and perception of being ‘safe’ is critical. This is mainly derived from solvency, whereby assets are worth significantly more than liabilities (i.e. having a ‘capital buffer’). However, having a liquidity buffer is also key in order to be able to cover ‘unexpected outflows’ (such as a ‘bank run’) or a sudden inability to access the debt markets for funding. ...