Basel II and the 13 Principles For Liquidity Risk Management

Principle 1:A bank should regularly gauge its capacity to raise
A bank is responsible for the sound management offunds quickly from each source. It should identify the
liquidity risk. A bank should establish a robust liquiditymain factors that affect its ability to raise funds and
risk management framework that ensures itmonitor those factors closely to ensure that
maintains sufficient liquidity, including a cushion ofestimates of fund raising capacity remain valid.
unencumbered, high quality liquid assets, to withstandPrinciple 8:
a range of stress events, including those involving theA bank should actively manage its intraday liquidity
loss or impairment of both unsecured and securedpositions and risks to meet payment and settlement
funding sources.obligations on a timely basis under both normal and
Supervisors should assess the adequacy of both astressed conditions and thus contribute to the
bank's liquidity risk management framework and itssmooth functioning of payment and settlement
liquidity position and should take prompt action if asystems.
bank is deficient in either area in order to protectPrinciple 9:
depositors and to limit potential damage to theA bank should actively manage its collateral positions,
financial system.differentiating between encumbered and
Principle 2:unencumbered assets. A bank should monitor the
A bank should clearly articulate a liquidity risklegal entity and physical location where collateral is
tolerance that is appropriate for its business strategyheld and how it may be mobilised in a timely manner.
and its role in the financial system.Principle 10:
Principle 3:A bank should conduct stress tests on a regular basis
Senior management should develop a strategy,for a variety of short-term and protracted
policies and practices to manage liquidity risk ininstitution-specific and market-wide stress scenarios
accordance with the risk tolerance and to ensure(individually and in combination) to identify sources of
that the bank maintains sufficient liquidity. Seniorpotential liquidity strain and to ensure that current
management should continuously review informationexposures remain in accordance with a bank's
on the bank's liquidity developments and report toestablished liquidity risk tolerance.
the board of directors on a regular basis.A bank should use stress test outcomes to adjust its
A bank's board of directors should review andliquidity risk management strategies, policies, and
approve the strategy, policies and practices relatedpositions and to develop effective contingency plans.
to the management of liquidity at least annually andPrinciple 11:
ensure that senior management manages liquidity riskA bank should have a formal contingency funding plan
effectively.(CFP)that clearly sets out the strategies for
Principle 4:addressing liquidity shortfalls in emergency situations.
A bank should incorporate liquidity costs, benefits andA CFP should outline policies to manage a range of
risks in the internal pricing, performance measurementstress environments, establish clear lines of
and new product approval process for all significantresponsibility, include clear invocation and escalation
business activities (both on- and off-balance sheet),procedures and be regularly tested and updated to
thereby aligning the risk-taking incentives of individualensure that it is operationally robust.
business lines with the liquidity risk exposures theirPrinciple 12:
activities create for the bank as a whole.A bank should maintain a cushion of unencumbered,
Principle 5:high quality liquid assets to be held as insurance
A bank should have a sound process for identifying,against a range of liquidity stress scenarios, including
measuring, monitoring and controlling liquidity risk. Thisthose that involve the loss or impairment of
process should include a robust framework forunsecured and typically available secured funding
comprehensively projecting cash flows arising fromsources.
assets, liabilities and off-balance sheet items over anThere should be no legal, regulatory or operational
appropriate set of time horizons.impediment to using these assets to obtain funding.
Principle 6:Principle 13:
A bank should actively monitor and control liquidityA bank should publicly disclose information on a
risk exposures and funding needs within and acrossregular basis that enables market participants to
legal entities, business lines and currencies, taking intomake an informed judgement about the soundness
account legal, regulatory and operational limitations toof its liquidity risk management framework and
the transferability of liquidity.liquidity position.
Principle 7:According to the Bank of International Settlements,
A bank should establish a funding strategy thatmany banks had not considered the amount of
provides effective diversification in the sources andliquidity they might need to satisfy contingent
tenor of funding. It should maintain an ongoingobligations, either contractual or non-contractual, as
presence in its chosen funding markets and strongthey viewed funding of these obligations to be highly
relationships with funds providersto promoteunlikely.
effective diversification of funding sources.