to liquidity dislocations that cascade quickly across
many systems and institutions. If risk controls are over-
whelmed, these dislocations could alter many banks’
intraday or overnight funding needs, including their
demands for central bank credit, and potentially affect
conditions in money markets. The delay of other less
critical payments also might cause other institutions
to postpone their own payments, cause many banks to
face increased uncertainty about their overnight fund-
ing needs and potentially increase the impact of any
operational outages.”
Liquidity is considered to be “highly procycli-
cal, growing in good times and drying up in times
of stress.”92 During the build up to the present crisis,
banks and other financial institutions had an incentive
to minimise the cost of holding liquidity.93 Given the
fact that liquidity could also be pro cyclical and given
its role in the recent crisis, perhaps four dimensions
to pro cyclicality should have been introduced in the
Impact Assessment Document94 amending the Capital
Requirements Directive—incorporating liquidity as a
fourth heading.
The growing importance of formalisation within the
bank regulatory framework is also attributed to the gaps
which exist within a discretionary based system of bank
supervision—as was revealed in the aftermath of Baring
Plcs collapse. The recent crisis has also highlighted the
need for formal risk assessment models—as demon-
strated by the demise of Lehman Brothers where the
failures of auditors to detect balance sheet irregularities
(owing co creative accounting practices) was brought
to light.
The formal framework for the measurement of
capital adequacy at European Community level, as
exemplified by the International Convergence of
Capital Measurements and Capital StandardsfRevised
Framework), namely Basel 2, is to be commended, not
only because of “the need for a consistent framework
for the reporting and comparative analysis of bank
capital positions, the demand of regulated institutions
for transparency and equality in the application of
regulatory standards”, but also because of“the exigen-
cies of the international convergence process—which
requires the transparent and uniform implementa-
tion of harmonised rules by the regulators of every
country.”95
As part of measures aimed at consolidating and
“promoting consistency in international liquidity risk
supervision”, and in response to the “inaccurate and
ineffective management of liquidity risk”—as was
prominently highlighted during the recent financial
crisis, the Basel Committee has developed a “minimum
set of monitoring tools to be used in the ongoing
monitoring of the liquidity’ risk exposures of cross bor-
der institutions and in communicating these exposures
amongst home and host supervisors.”96
The Liquidity Coverage Ratio97 and the Net Stable
Funding Ratio98 are two regulatory standards for
liquidity’ risk which serve the purpose of attaining the
objectives of “promoting short-term resiliency of the
liquidity’ risk profile of institutions” (by ensuring that
they have adequate high quality liquid resources to
survive during periods of extreme stress which last for
about one month) and “promoting resiliency over lon-
ger-term periods” ( through the creation of additional
incentives for banks to Kind their activities with more
stable sources of funding on an ongoing basis).99
In addition to the above-mentioned standards, the
Basel Committee recommends that supervisors also
implement designated monitoring tools on a consistent
basis. Such monitoring tools, along with the standards,
are intended to provide supervisors with information
which should aid their assessment of liquidity risks
attributed to a particular bank.100 These monitor-
ing tools include: Contractual Maturity’ Mismatch,
Concentration of Funding, Available Unencumbered
Assets and market—related monitoring tools.101
C. Disclosure
As well as the need for greater focus on liquidity
risk, there is also the need for greater reliance on dis-
closure requirements. This will be facilitated through
an effective monitoring process whereby identified
risks are effectively communicated across all levels of
management.
Enhanced transparency does not only have the
potential to “improve an understanding of the mecha-
nism at play in structured finance”, but also facilitate
the identification of risks and ensure that risks are well
controlled.102 Risky loans which were “repackaged and
sold to institutional investors”—some of whom did not
frilly comprehend the implications of the transactions
36 ∙ bonking & Financiol Services Policy Report
Volume 30 ∙ Number 9 ∙ September 2011