known unknowns: assessing liquidity in the age of COVID-19 Pandemic forces financial institutions to get ready for once-in-a-lifetime liquidity reporting challenges
by Don Mumma Throughout the COVID-19 pandemic, as governments prepared themselves for worst-case scenarios and financial markets whipsawed between record one-day losses and gains, a single variable has been keeping the world’s central bankers awake at night – liquidity. With memories of the 2008 financial crisis still fresh, monetary authorities are all too familiar with the chaos a credit liquidity crunch could cause, and they responded quickly and aggressively with stimulus and interventions designed specifically to stave off that risk. Along with the focus on maintaining liquidity through central bank actions, the COVID-19 crisis conjured several other spirits of the crisis past. Among them is the host of new liquidity reporting requirements for financial institutions that were put in place after the 2008 crisis. Few thought they would ever be used again. Many thresholds have already been reached by many institutions – offering a roadmap for what is required and reporting best practices. Others are still looming in the background – providing little indication of how financial firms will comply or whether they will reach the point where safety switches will need to be flipped.
new thresholds trigger new requirements Throughout the crisis, AxiomSL has been surveilling the situation and monitoring liquidity reporting thresholds globally. Following is a rundown of some of the most prominent liquidity reporting requirements that are either being triggered presently or at risk of being triggered if the crisis continues much longer, along with a brief description of the reporting requirements associated with each. • Basel III Alternative Liquidity Approach: Plunge into the depths of Basel III, and we will find a seemingly obscure provision outlining the eligibility for alternative liquidity approaches. The regulation was designed for financial institutions that have an insufficient supply of high-quality liquid assets (HQLA), also known as Level 1 assets, in their domestic currency to meet the demand of their specific significant currency exposures. In that scenario, banks are allowed certain alternative means of evaluating and recognizing Level 1 assets, such as from other currencies or elevations of Level 2 assets at higher haircut costs, when certain eligibility requirements are met. Originally intended to address situations in developing nations where lining up liquid collateral to support significant holdings or to support fledgling entities can be a challenge, the uncertainties and liquidity shortages caused by the COVID-19 crisis have triggered such treatments for many mature and well-funded financial institutions. Intelligent Risk - July 2020
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