Liquidity Buffer Management and Banks’ Counterbalancing Capacity

Jill Cetina and Katherine Gleason

Chapters 1–3 discussed how supervisory expectations about a bank’s liquidity buffer evolved following the 2007–9 financial crisis, after it became apparent banks’ liquidity buffers were too small and, in some cases, contained assets that were not of sufficient liquidity quality to ameliorate the stress banks were under. The Basel Committee on Banking Supervision (BCBS) “principles for sound liquidity risk management and supervision” established the principle that banks should maintain a cushion of unencumbered, high-quality liquid assets (HQLA) to be held as insurance against a range of liquidity stress scenarios (Basel Committee on Banking Supervision 2008). The BCBS later quantified that principle via a new short-term liquidity standard, the liquidity coverage ratio (LCR) (Basel Committee on Banking Supervision 2013a). However, both the “principles” and the LCR are rooted in long-standing best practices: using short-term cashflow metrics to evaluate potential liquidity mismatches and setting aside a buffer of HQLA to cover expected and unexpected shortfalls.3535See, for example, Moody’s net cash capital tool in Matz and Neu (2007, p. 258) and also Board of Governors of the

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