The Principles of Banking

Chapter 12

Principles of Bank Liquidity Management

The banking system in both the US and Western Europe was on the brink of collapse in September and October 2008, in the wake of the Lehman bankruptcy. Government intervention using taxpayer funds, which in many countries extended to a blanket guarantee of banks' complete liabilities, prevented this collapse from taking place. In the aftermath of the crisis, national regulators and the BIS circulated consultative papers and recommendations that addressed new requirements on bank capital, liquidity and risk management. The UK FSA was perhaps most demanding; its Policy Statement 09/16, which was issued in October 2009, outlined measures on capital treatment, liquidity requirements and stress testing that implied a fundamental change in the bank business model going forward.¹ Many of the elements of this change in regulatory requirements were not new, however, but rather a turning of the clock back to earlier times, when conservative principles in liquidity management were actually quite common practice. The crisis of 2007 and 2008 was as much a crisis of bank liquidity as it was of capital erosion, and the events of that period restated the importance of efficient liquidity management in banking.

In this and the next three chapters we discuss the “water of life” of banking: liquidity management. The recommended practices described in this chapter should not be followed because they are required by the national regulator or by the ...