Recent events have exposed flaws in traditional liquidity risk management, including the failure to account for highly correlated events and the failure to establish a proper model of the enterprise. As a result, institutions throughout the world are facing internal and external pressure—greater scrutiny of counterparty exposure and daily cash management, for example—to update their liquidity management processes. Robust liquidity stress testing requires building scenarios that stress interest rates, exchange rates, credit spreads, and a multitude of economic factors such as GDP, unemployment, and the Housing Price Index. These stress tests must be flexible enough to allow institutions, as they create Contingency Funding Plans (CFPs), to integrate and quickly modify business strategies. Such flexibility is particularly critical considering CFPs are growing even more important as market participants and supervisory bodies work to ensure that mechanisms are in place to reduce the likelihood of a systemic crisis.
Cash and Counterparty Management Processes Protect Institutions in the Short Term
QRM assists clients to create dynamic liquidity analysis that models haircuts, downgrade triggers, potential exposure, and repos driven by any market or credit risk factor. Through such analysis, our clients can evaluate both counterparty and principal posting collateral agreements that enable them to better manage their collateral policies, more effectively measure liquidity stresses, and optimize balance sheet liquidity. The analysis often incorporates simulated margin calls and collateralized credit exposure calculations, including time lags. When incorporated into a forecasting process, these methodologies improve our clients’ understanding of liquidity risk by enabling them to visualize forecasted exposure under a multitude of scenarios and prepare for liquidity shortfalls that may otherwise have been unforeseen.
Stress Tests Help Clients Better Manage the Liquidity and Build Better Contingency Funding Plans
QRM assists clients to build comprehensive stress tests that include all assets, wholesale and retail funding, and off-balance sheet commitments. Our clients often stress interest rates, exchange rates, volatilities, credit spreads, and economic factors simultaneously; their analysis can identify and measure any source of liquidity risk over a one-day to two-year horizon. Our clients also build stress scenarios that test previous market disruptions against current balance sheets, such as a severe credit downgrade or market disruption.
Within their stress tests, our clients establish new business growth projections, pricing decisions, and funding strategies, to determine how the organization may best respond to stressed environments. Clients often calculate future liquidity exposure and liquidity-at-risk, and then apply counterbalancing strategies to alleviate that exposure. Importantly, the modeling approaches ensure that these assumptions can be modified quickly, allowing management to conduct “what-if” analysis, and in turn create a CFP that does not sacrifice their bottom line to regulatory oversight.
Many clients have moved beyond an arcane trial and error approach to establishing CFPs. QRM’s clients often create strategies incorporating portfolio optimization to calculate optimal asset allocations and funding profiles given certain economic or business limits.
Versatile Reporting Also Enables Clients to Meet All Regulatory Reporting Requirements
Robust liquidity management requires that institutions be able to visualize and understand how events are impacting their organization at any level, including those defined by business line, legal entity, and/or region. Such granular analysis and visualization enable our clients to identify which areas of the balance sheet pose the greatest risk to their liquidity position, and to create business strategies that mitigate that threat. Additionally, when properly architected, the same analysis and reporting often fulfills the full spectrum of liquidity reports demanded by regulators.
In addition to working with clients to refine their liquidity management operations, QRM has worked with regulators worldwide to understand forthcoming liquidity reporting requirements. Our reporting consultants have worked with clients across the globe to build out formats designed for fast and automated submission.
Best Practice Liquidity Analysis that Protects the Institution and Increases Shareholder Value
Institutions emerging from the recession recognize that sound liquidity management now, more than ever, requires a firm understanding of how adverse market conditions may impact not just a business line, but rather the entire organization, and how the organization will respond to such events. Superior practices will enable institutions not only to weather the storm, but to capitalize on adverse conditions while easily satisfying an increasingly strident regulatory environment. QRM is the only firm that assists clients to meet the new liquidity requirements without sacrificing profitability and shareholder value.