The Principles of Banking

Part III

Bank Liquidity Risk Management

As we emphasised in the Preface, the art of banking is essentially the art of liquidity management. It is the key principle of banking. Part III of the book is dedicated exclusively to liquidity management, liquidity reporting, liquidity risk management and liquidity stress testing.

In Chapter 12 we consider the basic liquidity principles, which form the cornerstone of a sustainable bank business model. We emphasise sustainable here – as the experience of the financial crisis of 2007–2009 illustrated, it is easy for senior management to forget the importance of liquidity management during an extended period of plentiful and cheap liquidity. It is also easy for business line heads to think that any crisis is a rare one-off and unlikely to appear again (at least in their careers), especially when it comes to assumptions on liquidity. However, the importance of banks to the wellbeing of the economy means that it is important for them to follow a strategy, and liquidity principles, that remain successful in the long term, and continuously over the business cycle. There is no long-term viable alternative to the principles described in the next four chapters.

Chapter 13 looks at the main liquidity metrics essential for effective governance, while Chapter 14 covers liquidity risk reporting and stress testing.

Internal funds pricing in a bank, also known as funds transfer pricing (FTP) or simply transfer pricing, is an important part of the liquidity ...