Liquidity risk management in Europe
Authored by: Synechron Business Consulting Group
The Dutch Central Bank (DNB) introduced the Internal Liquidity Adequacy Assessment Process (LAAP) in the Netherlands in June 2011. ILAAP has been introduced in addition to Basel III/CRD IV and its Liquidity Coverage Ratio (hereafter ‘LCR’), Net Stable Funding Ratio (hereafter ‘NSFR’) and other liquidity risk management monitoring tools.
DNB requires banks to set up a recurring ILAAP whereby the bank thoroughly evaluates its liquidity risk management function. The qualitative and quantitative criteria of Dutch ILAAP are based on certain guidelines and principles. These guidelines and principles are put forward in various papers and other related pieces of advices, directives from the Basel Committee on Banking Supervision (BCBS) and the European Banking Authority (EBA).
The regulatory/mandatory evaluation of the Dutch ILAAP is on top of the Basel III/CRD IV liquidity requirements, which focuses primarily on liquidity buffers and monitoring tools. The Dutch ILAAP covers 13 liquidity topics that requires a robust set up of banks liquidity risk management function both at strategic (e.g. governance) level as well as at operational (e.g. processes / IT architecture) level.
We note that the treatment of liquidity risk in Pillar 2 (also called the ‘Supervisory Review Process’) is lacking in Europe. In Pillar 2, there are no specific requirements for management of liquidity risk as there are for other types of risks. In Internal Capital Adequacy Assessment Process (ICAAP), there are no specific requirements for management of liquidity risk as there is for other type of risks. The Basel III guidelines for liquidity risk management in ‘Supervisory Review Evaluation Process’ (SREP) do not go into a very detailed level.
We recommend that the Dutch ILAAP self-assessment and rulebook procedure should function as a baseline to mitigate a critical gap present in Pillar 2 of the Basel III framework.
Why use Dutch ILAAP as baseline?
- Single comprehensive overview necessary elements to have a robust liquidity risk management function in place, based upon best practices from BCBS and EBA. This reduces search cost and ambiguity on what to regard as ‘best practice’.
- Mature set of operational liquidity rules that have been continuously improved since 2011 resulting from valuable interactions between DNB, banks and consultancy firms active in the Netherlands. The discussions are regarding translating operational implications of BCBS and EBA liquidity principles to concrete functional, technical and data requirements.
- Proven methodology: Financial institutions already report ILAAP to DNB in a similar way as in the context of the ICAAP/SREP since 2011.