ECB thematic review of Intraday Liquidity Risk

On 13 November 2024, the European Central Bank (ECB) published a thematic review of Intraday Liquidity titled Sound practices for managing intraday liquidity risk. This review was prompted by recent liquidity-driven market events, such as the collapse of Silicon Valley Bank and the failure of Credit Suisse in 2023, the UK gilt market turmoil and the energy crisis in 2022 and the Covid-19 pandemic in 2020. It underscores the importance of robust intraday liquidity controls, payment-flow prioritisation, and reliable forecasting and is applicable to firms supervised by the ECB.

The paper provides key practices observed among a sample of global systematically important banks (GSIBs) and highlights a point of reference for designing an effective intraday liquidity risk management framework including governance, forecasting and monitoring capabilities, in particular the ability to prioritise and actively manage outflows, identification of funding sources per currency, stress testing practices and methodologies.

What does this mean?

The review has identified seven sound practices, which are largely based on common practices among institutions. These practices build on existing international standards and guidelines such as the BCBS Principles for Sound Liquidity Risk Management and Supervision (BCBS 144), BCBS Monitoring tools for intraday liquidity management (BCBS 248), the EBA Guidelines on ILAAP, and the ECB guide to ILAAP.

The key practices include:

Formalising the risk management framework to include clear definitions of intraday liquidity risk and liquidity risk drivers and documenting intraday risk policy and formalising the role of the second line and third line of defence (Principle 1).
Establishing a functioning dedicated forum which meets at least monthly to discuss trends in intraday liquidity risk and establish procedures to quickly escalate as may be required (Principle 2).
Understanding payment priorities to enable the projection of liquidity requirements (Principle 3).
Implementing monitoring capabilities to track current and end-of-day balances, collateral requirements and transactions in the real time (Principle 4).
Managing outflows including the timing and priority of outflows in all major currencies (Principle 5).
Identifying additional sources of liquidity including access to central bank facilities and other funding sources to ensure flexibility during stressed conditions (Principle 6).
Reviewing intraday liquidity buffers in both normal and stressed conditions and performing regular stress testing to identify any vulnerabilities to intraday liquidity shocks and improve the response strategies; and assessing intraday liquidity transferability between legal entities (Principle 7).

Whilst the ECB thematic review is provided from an Euro Area perspective, the UK Prudential Regulation Authority’s (“PRA”) expectations are broadly aligned and seek to achieve similar objectives whilst not being as exhaustive in terms of best practices. The two relevant PRA publications are the PRA Statement of Policy, Pillar 2 liquidity and the PRA Supervisory Statement SS24/15 “The PRA’s approach to supervising liquidity and funding risks”.

On 21 January 2025, the PRA published its letter to UK Deposit Takers and International banks and designated investment firms setting out its supervisory priorities for the year ahead. Several of their priorities are aligned with the above principles. First, the PRA emphasised that firms’ senior management and Boards should ensure robust governance, risk management and controls frameworks are in place - ensuring these are adaptive and resilient, leveraging stress scenario analysis to inform risk management, strategy and business planning. Second, the PRA highlighted that firms needed to prepare for significant changes to the funding and liquidity landscape for UK banks as a result of the Bank of England (BoE) balance sheet normalisation and changing market dynamics. This includes being operationally ready to use the BoE Sterling Monetary Framework facilities regularly and at scale. This will require firms to actively manage their collateral, including intraday and to have an appropriate risk management framework in place.

What do firms need to do?

Formalise and document an intraday liquidity risk management framework reflecting all material intraday liquidity risk drivers and governance structures, ensuring accountability and risk ownership.

Establish forecasting and monitoring capabilities in real time in order to prioritise and actively manage cash outflows including managing time-specific obligations.

Run regular comprehensive and conservative stress tests in each material currency, in business as usual and stressed conditions and with consideration given to the sources of intraday liquidity.

Firms should review their intraday liquidity risk management practices across these areas to identify any gaps and applicability to their business model and where necessary consider enhancements. This includes managing timing mismatches between inflows and outflows across currencies and maintaining adequate intraday liquidity buffers.

This could include reviews across six key areas.

1. Intraday Liquidity Risk Management Framework:

Define the Risk: Clearly outline what intraday liquidity risk means for your firm.
Policy and Responsibilities: Develop a documented policy detailing responsibilities for managing intraday liquidity risk.
Identify Risk Drivers: Use both qualitative and quantitative methods to identify what causes intraday liquidity risk, creating a clear risk classification.
Risk Limits and Oversight: Review risk limits within the risk management framework to ensure oversight across the three lines of defence with a defined escalation process in the event of breaches.

2. Governance Structure and Reporting:

Governance Structure: Ensure that the management of intraday risk involves all three lines of defence with active involvement of the first and second line of defence on an ongoing basis.
Management Reporting: Review the reports received by senior management to ensure they highlight significant risks and liquidity positions. Review the ability to generate ad hoc reports in a timely manner for unusual activities and have a clear escalation process.

3. Forecasting and Monitoring Capabilities:

Real-Time Monitoring: Assess capabilities to track payments, cash flows, collateral, and funding needs in real time.
Stakeholder Engagement: Engage with clients and partners to anticipate intraday and next day payment flows.
Cash Forecasting: Regularly project end-of-day balances and plan for time sensitive and large transactions.

4. Effective Management of Outflows:

Outflow Management: Review how well your firm manages the timing and priority of outflows in all major currencies.
Disruption Handling: Ensure there are mechanisms in place to handle unexpected disruptions and meet urgent payments in a timely manner.
Collateral Management: Test operational effectiveness to use collateral to secure necessary intraday funding.
Liquidity Asset Buffer: Determine the need for liquidity reserves in normal and stressed conditions. Ensure business as usual buffers are adequately designed for meeting intraday liquidity needs under normal conditions.

5. Sources of Intraday Liquidity:

Liquidity Sources Review: Examine all available liquidity sources to meet intraday needs for major currencies.
Diversification: Ensure a diversified set of liquidity sources, maintaining minimum levels of cash and pre-pledged assets.
Facility Testing: Regularly test the reliability of liquidity facilities and adjust strategies based on findings.
Transferability Assessment: Evaluate how easily liquidity can be moved between legal entities, especially under stress.

6. Stress Testing:

Scenario Analysis: Review potential risks under various scenarios, including extreme but plausible ones.
Liquidity Impact Review: Assess all potential impacts on liquidity, including outflows and inflows.

Next steps

The ECB sound practices will underpin future supervisory engagements, guided by proportionality and will serve as a foundation for ECB Banking Supervision to harmonise and strengthen existing industry practices. We expect similar supervisory insights in other jurisdictions.

As outlined in the PRA 2025 supervisory priorities we expect the PRA to continue to focus on firms’ governance, risk management and controls frameworks. These should be supported by appropriate information to allow firms to proactively identify and mitigate risks such as intraday.