Financial institutions must hold substantial buffers of liquid assets such as cash to enable them to get through a period of at least one month of liquidity stress, according to new guidelines published by the Committee of European Banking Supervisors (Cebs).
In September 2008, Cebs published its advice to the European Commission on sound liquidity risk management, including 30 recommendations. The latest paper, Consultation Paper on Liquidity Buffers & Survival Periods, follows up on recommendation 16, which called on banks to build up buffers of cash and other liquid assets to enable them to survive future stresses without having to adjust their business models.
The paper suggests banks should apply three types of stress scenarios to determine the size of the buffer: idiosyncratic, assuming a loss of confidence in a bank equivalent to a multi-notch downgrade; market-specific, assuming the simultaneous unavailability of several funding markets with concern about the decline in the value of financial assets; and a combination of the two.
Banks are also urged to ensure the buffer is composed of sufficiently liquid assets that will be immediately available in times of stress. "The buffer should be composed mainly of cash and the most reliably liquid assets, even in stressed circumstances, which banks can sell or repo regardless of their own condition (short of a complete loss of confidence) without accepting large 'fire sale' discounts, which would further erode the market's confidence in them," the paper argues.
Lastly, the paper stresses the need to ensure liquid assets are held in the appropriate place and not constrained by any legal, regulatory or operational impediments that would make it difficult to access them when needed.
Cebs opened a consultation period on its guidelines on July 7, running until October 31. It intends to hold a public hearing with interested parties on September 22 in London.
The consultation comes as the UK Financial Services Authority (FSA) is working on new liquidity requirements, set to come into force on a phased basis from the start of 2010. The FSA rules will cover a number of areas, including the holding of liquid assets and much more stringent regulatory reporting of liquidity positions.
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