Liquidity Risk Management

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This course focuses on all relevant liquidity risk measures that are being adapted to reflect the newly created complexities of modern financial markets

  • Course Instructor

    In his more than 20 years in the financial services industry, the Course Director has acted in various management capacities, both in strategic and operational functions while also being accountable for international projects of various sizes. His core area of work and experience is in financial risk management.

As long as most of the advanced financial markets provided plentifully, liquidity banks got used to sufficient and cheap liquidity and were unable to imagine that this could change. This was unexpectedly proved to be wrong. During the last financial crisis leading banks, with so far undoubted reputations, suddenly lost their funding ability and thus had to be taken over by other banks or socialised by the government. Consequently, liquidity risk has come to the forefront of the financial industry?s concerns.

A possible outburst of the liquidity pressure threatens these institutions with illiquidity while the introduction of regulations increases the cost of business potentially endangering existing business models. But understanding and successfully managing the economic and regulatory aspects of liquidity is not only a threat, it can also be seen as a competitive advantage.

Key Objectives and Learning Outcomes

  • Identify what liquidity risk is and how its different types can be distinguished
  • Hear about the best practice within leading international banks
  • Develop a consistent methodology to measure, monitor and manage illiquidity risk
  • Understand the role of liquidity risk in the bank?s transfer pricing process and quantify its direct and indirect costs
  • Understand the requirements and impacts of liquidity regulations such as Basel III and learn how to manage them
  • Learn to model liquidity risk exposures and their mitigating strategies

What Will Participants Learn?
This course will pinpoint the diverse types of liquidity risk and walk through a methodology for measuring and managing illiquidity risk. There will be an important focus on overcoming the difficulties of cash flow forecasting and dealing with uncertainties in general. As illiquidity risk is not a value risk, it cannot be mitigated by capital; as a substitute for capital the CounterBalancing Capacity of the bank?s liquidity buffer is described and examined. As a tool for managing the development of the balance sheet, the role of liquidity risk costs in transfer pricing will be analyzed. Finally Basel III is discussed, its impacts on bank?s business models are qualified and possible ways to manage the adherence to the rules are developed.

Who Should Attend? 
All staff in the treasury, risk, controlling, audit & front office departments involved in liquidity risk issues.

Day 1

The Financial Crisis of 2007-2009

  • What did happen?
    - Unrealistic business models and the resulting balance sheets
    - The eternal money generating machine: lend long and borrow short
    - Inadequately transfer pricing methods
    - Insufficient risk management
    - Deficient regulation and supervision
    - Collapse of money and repo markets
    - Fragile payment operations

Case studies: Northern Rock, German Landesbanks, Fortis and Dexia
Lessons from the crisis: learnt and forgotten

The Big Picture: Money Generation, Supply and Liquidity

  • Central banks and ‘fiat money’
  • Open market operations of the central bank
  • List of eligible assets
  • Money generation of commercial banks
  • Quantitative easing and its possible passing

Case studies: ‘Herstatt’, ‘ECB during the 2008 crisis’

The View of an Individual Bank

  • Financial transactions and their cash flows
  • The central bank nostro
  • Direct and indirect payments
  • The risks of the payment process
  • The risks of providing payment services for others

What is Liquidity? What is Liquidity Risk?

  • Key concepts: illiquidity and insolvency
  • Different types of liquidity risk
    - 1st degree liquidity risk: illiquidity risk
    - 2nd degree: liquidity induced value / earnings risks
  • Liquidity by term-structures: intra-day / short-term / long-term
  • Cash management vs. liquidity risk management

Liquidity Risk Exposure

Measuring Illiquidity Risk: The Forward Liquidity Exposure (FLE)

  • Starting with a static balance sheet 
  • Forecasting of the bank’s nostro 
  • Simulating the balance sheet as set of transactions
    - The bank’s complete set of transactions
    - External transactions
    - Internal & quasi-external transactions
  • The future payments of a transaction
  • Future payments with cash flows

Capturing Uncertainty with Cash Flows 

  • Expected cash flows (ECF)
  • Deterministic / non-deterministic cash flows
  • Floating cash flows (market simulations)
  • Conditional cash flows (client decision simulations)

Stochastic Concepts

  • Liquidity-at-Risk (LaR)
  • Cash-Flow-at-Risk (CFaR)
  • Value-Liquidity-at-Risk (VLaR)


Day 2 

Liquidity Risk Mitigation

 Why Capital is not a Buffer against the Lack of Liquidity

  • Capital and value risks (credit & market risk)
  • Shortness of funds: what can be done?
    - The bank’s ability to attract new funds
    - Creation of cash inflows through repo and sales of liquid assets

Liquid Assets 

  • Characteristics of liquid assets
  • Eligibility: available for the desired liquification process?
    - Encumberedness of assets
    - Liquification channels
  • Possession and ownership in time: the Forward Asset Inventory
  • Classification of liquifiability: the LiX of an asset

Liquidity Generation Strategies: The CounterBalancing Capacity (CBC)

  • Liquification classes
  • Liquification haircuts, value decays and upper limits
  • The liquification algorithm and its parameters
  • Scenarios for the CounterBalancing Capacity
  • Embedment of the CBC into the Gap Analysis (FLE)
  • Related Liquidity Generation concepts:
    - Liquidity Buffer, Day-Count-to-Default, Liquidity Barometer, Survival Horizon

Discussion: the Liquid Asset Buffer

  • Instruments to include
  • The right size
  • The funding
  • Optimizing costs

Integrating Dynamic Balance Sheet Behaviour

  • Why simulating a static balance sheet doesn’t make too much sense

Scenarios: Exposures and Strategies

  • Squaring the run-off balance sheet
  • Going-Concern and Business-As-Usual scenarios
  • Growth- and contraction-scenarios


  • Real Options and Liquidity Options
  • Contractual and non-contractual options
  • ‘Forgotten’ optionality: counterparty’s breach of contract
    - Credit risk adjustments and modelization of large defaults
    - Violation of liquidity and credit lines

Liquidity Units

  • The concept of subsets of the balance sheet which behave uniquely in a scenario

Liquidity Risk Stress Testing

  • Why stress testing is necessary for value risk (and why it is already embedded in the liquidity risk scenario methodology)
  • Overview of stress tests approaches

Workshop: Impact of various firm-specific and systematic stress events on liquidity risk metrics

Managing Liquidity Risk

  • Traffic light systems 
  • Limitation
  • Unadjusted limiting
  • CBC-adjusted limiting
  • Pricing of Liquidity (Risk)
  • Funding: term structured approach

Liquidity Contingency Plan

  • Essential components:
  • Defining stages, setting triggers, identifying potential responses, reporting requirements, communications requirements, testing

Intraday Liquidity Risk

  • Distinction between real intraday liquidity risks and enhanced FLE-type risks 
  • The payment process revisited
  • Risks in the bank’s proprietary payment process
  • Risks from payment services for clients 
  • Risks from using payment agents 
  • ‘Double use’ of collateral

Day 3

Governance – Views of Other Stakeholders

Rating Agencies

  • Risk of insolvency or illiquidity
  • Impact of a bank’s rating on its liquidity risk
  • Impact of liquidity risk on a bank’s rating


  • International regulations: Basel III - BCBS Consultative Document (Dec 2009)
    - BCBS LQR measures (liquidity coverage ratio + net stable funding ratio
    - BCBS LQR monitoring tools
  • National regulations issued by:
    - UK: FSA
    - DE: BaFin
  • Similarities and differences across regulations (stress testing assumptions such as survival horizons, definition of liquid assets,...)
  • Interrelationships between liquidity risk regulation, capital adequacy and other prudential measures
  • Other stakeholders: role of audit,..

Discussion: The Impact of liquidity risk regulation on banks’ business model

Liquidity Transfer Pricing

Best Practice (Funds) Transfer Pricing Methods and Processes

  • The purpose of Transfer Pricing: levelling the playing field or steering the balance sheet?
  • Generalized (Average Funding Rate) vs. individual (Match Funding) replication of originated transactions - objectives & challenges
  • The role of a central pricing department (treasury)
  • Multiple treasuries for interest rate, liquidity, collateral, credit, etc.

Transfer Pricing in a World with no Uncertainty

  • What is the ‘correct’ funding curve of the bank:
  • Risk neutral interest and structural liquidity costs
  • Funding instruments and venues

Integrating the Uncertainties of the Originated Transaction

  • Costs of expected and unexpected risks: credit, market and liquidity risk
  • Cost effects of credit risk and liquidity risk mitigation
  • Dealing with non-maturing instruments (with core and volatile parts)
  • Stochastic modelling of forecast & stochastic optimization

Integrating Regulatory Cost (from Basel III)

  • Total Net Cash Outflows & Stock of Highly Liquid Assets as a simplified FLE & CBC
  • The 75% rule: a simplified measure of uncertainty and a driver of costs
  • Differences between the regulatory and economic liquidity risk
  • The costs of improving the LCR / NFSR for the bank as a whole
  • How to split these cost between treasury and originating departments

Advanced Transfer Pricing Issues

  • Asset and liability driven banks
  • Dynamic vs. Static Balance Sheet Assumptions
  • Alternative funding curves for over / under funded time intervals
  • What is the right funding tenor of transaction from the trading book
  • Can transfer pricing substitute limiting?

Discussion: How to embed liquidity risk in banks’ pricing systems?

Course summary and close

  • The course director has spent over a decade in the treasury/dealing rooms of numerous international major banks like Banque Nationale de Paris and NatWest Markets as a money market liquidity manager where he traded interest rate products and derivatives. He has headed several ALM divisions and served numerous ALCOs. He was Head of Methodology and Policy, Liquidity & Treasury Risk at Deutsche Bank where he devised the methodology and successfully managed a project (LiMA), which still measures and limits the funding liquidity of Deutsche Bank Group. Subsequently, he coordinated the ALM and Liquidity Risk Solutions at Algorithmics Inc., Toronto. He was member of the board and Head of ALM & Risk Development at FERNBACH in Luxembourg.

    He holds a PhD in Pure Mathematics and worked for several years in mathematical research. He is Founder of ALM Lab and Liquidity Risk Corp. (LRC), where he advises private banks, central banks and regulators on liquidity risk methodologies and helps to build software solutions to implement the resulting policies. He is a regular speaker at the Bank of International Settlements’ Financial Stability Institute in Basel.

    Before and during the peak of the recent crisis he advised consultancies and various institutions including the ECB on liquidity risk measurement methodology. In the last years he helped banks (e.g. BNP Paribas Fortis) to build group-wide liquidity management solutions including modules for transfer pricing and Basel III.

Central London Hotel Venue, London, UK

All Euromoney Training courses are held at four or five star venues in Central London, Zone 1. We strive to provide you with a training environment of the highest quality, to ensure that the whole learning experience exceeds your expectations.

Your training venue will be confirmed by one of our course administrators approximately 3-4 weeks before the course start date.

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