Banks can improve the way they measure liquidity risks
Economic Commentaries, News A new Economic Commentary describes how a supplementary liquidity metric, based on Liquidity Coverage Ratio (LCR), can be calculated to take account of the additional liquidity need required for banks to be able to cope throughout the entire stressed 30-day period covered by the LCR and not just at day 30. According to the authors, Tobias Lindqvist and Erik Olausson, near-term liquidity risks are particularly important to track as there is little time for action.
One of the most common metrics used by banks around the world to measure their liquidity risk is the LCR. The metric shows the net outflows of money a bank in generally is expected to have under stressed conditions over the next 30 days. One problem with the metric is that it does not take into account the time at which cash inflows and outflows occur over the next 30 days, but only measures aggregate flows after 30 days. In order for liquidity reserves to also cover the maturity risks occurring before day 30 and thus further secure short-term solvency, it may be justified to study banks' cash flows a little closer and examine how the LCR could be complemented by an adjusted metric to show the maturity risks over the whole period.
We have therefore chosen to develop an adjusted LCR metric that considers cash flows day by day over these 30 days. The adjusted metric could be used to assess whether banks are holding sufficient liquid assets to last until day 30. This is a good basis for preventing liquidity crises.
Authors: Tobias Lindqvist and Erik Olausson.