18 June 2009 Comments

 

Comment: Turner Review - overcoming the liquidity conundrum

Elizabeth Sipiere, Microgen

The impact of the banking crisis has permeated into all markets beyond the financial sector and the result is a global recession. Leading economists forecast that the impact will be felt well into next year, with the UK predicted to bear the brunt of it. To avoid previous pitfalls such as the great depression in 1929-33 economists and governments are turning their attentions to the lessons learnt and how not to repeat history, with liquidity management being a central topic.

At the centre of the investigations into what went wrong lies Lord Turner's much anticipated review of the financial system. Published on March 18, it proposes to change regulation and the supervisory approach required to create a more robust banking system while at the same time, addressing the long term challenge of reducing its severity and preventing it happening again by returning to direct liquidity controls. As Turner put it, managing bank liquidity is as critical as capital management and should be restored to a position of central importance. He stressed that banks will have to gain a better transparency into liquidity and be able to profile this on demand. 

Prior to Turner's much anticipated review, Goldman Sachs chief executive Lloyd Blankfein summed up the failure to profile liquidity risk in a recent Financial Times article ("Goldman chief calls for tighter controls", 8 February) about the banking crises; ‘"If more institutions had properly valued their positions and commitments at the outset, they would have been in a much better position to reduce their exposures," he wrote.

Such proposed changes in the liquidity regime have created urgency in the banking sector to profile liquidity within and across legal entities based on actual financial holdings. Banks are now analysing their response to outlined rule changes.

Rising to the challenge

In December 2008 the FSA published proposals for substantial changes in the banks liquidity regime and these were largely addressed by Lord Turner in his review. Within the proposal is a long list of requests to which banks must adhere including extensive information requirements, system-wide reporting and requests for cross-system analysis of liquidity trends.  

Such demands however, risk adding further short term manual and spreadsheet based solutions to enable banks' to create the enterprise-wide visibility required to provide such a granular level of reporting. These processes in themselves increase systemic and operational risk as targeted by the Basel II requirements.

Sustaining liquidity is top of mind for most financial institutions, and being able to demonstrate it to the FSA on demand requires the creation of effective solutions to manage it.  Many banks have transparency into liquidity risk in parts of their business, such as their investment division, however, creating a complete picture of exposures across the enterprise and systems is more challenging. Given the exceptionally complex structure of financial institutions with their many divisions and legal entities, all with different assets and liabilities, a partial picture is insufficient.

Transparency is key to achieving this and a lack of process automation prevents responsiveness. Traditionally banks have tended to really heavily on manual processes, which inevitably provide opportunity for error. 

FSA rule changes

It would be a mistake to assume that the current crisis can be resolved merely by enforcing Basel II type regulations on the banking sector. Recognising this, the FSA estimated that aside from rule changes, a £1 billion investment in IT would be required for banks to overhaul their operations.

Thus far, the current processes on which many financial institutions rely have proved to be incapable of providing the enterprise-wide financial clarity required to rapidly understand their liquidity profile and the risk associated with it. Technology will play a key role in helping banks to achieve this and untangle the interwoven relationships they have with each other so that they can better understand the assets and liabilities that make up their liquidity profile.

Hand-in-hand with this go best practices and the implementation of processing standards. Lord Turner's recommendations will become mandatory in November 2009, leaving little time to implement the changes. Like the banks, the FSA was caught unawares by the credit crunch and is adamant that good risk management practices, which it will monitor and regulate, will become common practice on an enterprise-wide, cross-border level.  

In short, IT departments will rise from the ranks of back office operational roles to the forefront of board level decision making. They will become relied upon for underpinning banking decisions with automated processes which will be a key catalyst to accomplishing liquidity. Only by automating their business processes in a manner that is agile, enterprise wide yet quick to implement can banks improve their financial transparency, prevent future crises, and respond positively to the recovery when it starts.

Elizabeth Sipiere is managing director, banking, at Microgen