Capital & Liquidity Management: Risk, Regulation and Technology

In the ever-evolving landscape of banking, capital and liquidity remain a constant topic of conversation and a primary driver of organizational change. Our recent webinar brought together leading experts and thought leaders to discuss the key themes and challenges facing treasury and risk management leaders in the banking sector, particularly in light of Basel III regulations and ongoing financial & regulatory pressures.

In this checklist, we delve into the key requirements and considerations for financial resource management and the optimal technological infrastructure to effectively capitalize on opportunities and mitigate risks. With the appropriate preparations, banks can ensure resilience and compliance in a rapidly evolving financial environment.

Financial Resource Management (FRM): The impact of Basel III Endgame & other critical considerations

A key focus of Basel III Endgame is the allocation and utilization of risk-weighted assets (RWAs). While Basel III is still a work-in-progress, there is talk of scaled-back increase of RWAs from the original 16% to 5%¹. Although this is a relief for everyone in banking, RWAs do have a holding cost so the allocation of them becomes more critical once Basel III is deployed. Treasury leaders must focus on optimizing RWAs through strategic planning, stress scenarios, and effective risk management. 

FRM teams need to ensure optimal allocation & utilization of RWAs

• Ensure capital adequacy by planning the balance sheet for both base case and stress scenarios
• Lead strategic planning efforts around capital triggers and contingencies
• Integrate robust risk management practices to ensure cohesive operations

Treasury leaders are in a crucial role that brings together various parts of the business to work towards the same goal of financial resiliency. For example, treasury's involvement in CCAR, a stress-test regime for large US banks, highlights their role in annual budget planning, requiring high familiarity with the sources and uses of capital at the bank. 

Treasury leaders must act as the first line of defense

• Hybrid role: lead in managing opportunities and risks, while the risk management team serves as the second line
• Connectivity and intimacy: maintain close coordination with risk management, liquidity, capital, and interest rate risk
• Harmonious relationships: foster harmony between treasury, risk, senior management, and planning teams

FRM teams increasingly rely on real-time data about critical assets and capital triggers for strategic planning. Monitoring real-time data on High-Quality Liquid Assets (HQLAs) and other critical assets of a bank's balance sheet, as well as keeping an eye on other key triggers, is important for proper contingency planning. 

Key triggers and metrics to track

• Liquidity coverage ratio (LCR): regularly track and manage the coverage ratio of HQLAs with frequent updates using real-time or near-time data
• Net stable funding ratio (NSFR): monitor the stability of funding sources
• Stress testing: conduct regular stress tests to assess the resilience of the balance sheet
• Asset-side data: focus on collecting and analyzing data related to asset quality and performance

Treasury should lead the business in tackling interest rate risk in the banking book (IRRBB), regardless of the size of the bank or the structure across technical accounting and mode of risk management. Integrated risk management becomes very important as we think about capital and liquidity, market conditions, credit and operational risk, and interest rate risk. 

A well-integrated risk management framework

• Holistic approach: adopt an integrated approach to managing risk across capital and liquidity, market conditions, credit, operational, and interest rate risk
• Real-time monitoring: implement systems for real-time or near-time monitoring of risk metrics and capital ratios
• Scenario planning and stress testing: implement exploratory analysis and advanced modeling techniques for stress scenarios, ensuring they align with current market conditions and the bank's risk profile
• Regulatory reporting: ensure compliance with regulatory reporting requirements and maintain high standards of data quality
• Data integrity: obtain reliable data in a timely manner from regional depots
• Continuous training: provide ongoing risk education to strengthen the risk management culture at the bank to keep up with evolving standards and practices 

Managing interest rate sensitivity and regulatory trends

• Interest rate risk in the banking book (IRRBB): stay updated on regulatory guidance and trends related to IRRBB.
• Held to maturity (HTM) accounting: understand the implications of HTM accounting on interest rate risk management—this has been a widely adopted tool to accrete NII without taking the mark-to-market book.
• NII and PV metrics: improve the management of Net Interest Income (NII) and Present Value (PV) metrics under different scenarios.
• Technology Integration: leverage advanced technology for capturing and optimizing risk data and fulfilling regulatory reporting requirements.

Ultimately, treasury is a cross-functional role that is at the epicenter of any robust risk management policy.

Five best practices in capital risk management

• Integrated risk management systems: adopt integrated frameworks aligning with regulatory guidelines, establish clear governance structures and practices, and use advanced analytics to enhance risk visibility and decision-making
• Capital stress testing and planning: conduct stress tests across base case, severe adverse, and reverse stress scenarios. Develop a capital plan that integrates with strategic planning and risk appetite
• Data management and technology integration: invest in technology to capture and manage complex balance sheets and products. Ensure data integrity and lineage for regulatory reporting and internal risk assessments
• Monitoring and compliance: regularly review and adjust risk indicators and trigger points based on market conditions to maintain compliance and enhance contingency planning
• Training and development: establish and foster a culture of risk awareness and accountability throughout the organization. Provide ongoing training across all tiers of risk management to adapt to evolving regulatory and market dynamics. 

Technology implications 

"Technology today is accelerating in a way that's almost hard to believe, actually, in terms of how you can capture a very complex balance sheet across complex products and services and be able to optimize against it" - David Petrie, 4M Consulting Group

Technological advancements facilitate the capital and liquidity management practices detailed above and enable firms to transition from reactive decision-making to proactive and predictive strategies. In the realm of financial data governance and regulatory compliance, there's a strong emphasis on data quality and management. Regulatory bodies have been stringent in penalizing institutions for inaccuracies in reported data. To navigate these demands, leaders in data technology and regulatory reporting must consider several key initiatives.

Firstly, continuous monitoring is crucial for ensuring data excellence across the six dimensions of data quality. Establishing an enterprise-wide data source and minimizing duplicates are essential steps to mitigate risks associated with outdated or inconsistent data across different business lines.

Ensuring data quality requires four standard practices

• Continuous data monitoring: ensure the accuracy, validity, completeness, consistency, uniqueness, and timeliness of data.
• Enterprise data source: maintain a single, unified copy of data to avoid outdated or inconsistent information.
• Data quality tools: implement integrated tools for data collection, quality oversight, and exception resolution
• Automation and reconciliation: invest in automation to reduce manual reconciliation efforts and costs.

Organizations have implemented enterprise-wide data sources by creating large databases to house all of their information and deploying data quality processes. However, equally as important as building the database is ensuring that all users with access understand the structure of the database, what information they are looking at, and how to manipulate it as necessary. Therefore, implementing a robust data governance framework is equally vital. This includes defining clear policies, raising awareness, assigning data stewardship roles, and cataloging data to ensure its relevance and integrity. 

Develop a robust data governance framework

• Established policies for data usage, storage, and access
• Awareness programs to educate employees on data governance principles
• Clearly assigned data stewardship roles
• Cataloging of data assets and metadata to facilitate understanding and usage
• Mechanisms to correlate data across various sources 

With the proper data quality and governance infrastructure in place, the next point of evaluation is breaking down “integrated data management”. Technological advancements such as data management platforms, lineage tools, and advanced analytics are indispensable and once integrated together enables banks to elevate their data strategy into a more proactive approach. These tools facilitate the transition from reactive decision-making to proactive and predictive strategies, thereby enhancing capital risk management and regulatory compliance.

Components of optimally integrated data management

• Centralized data platform: centralize data sources to support cross-business line integration
• Advanced analytics and AI: leverage cloud computing and scalable infrastructure for advanced analytics and AI to enhance decision-making
• Metadata management: maintain an organized and accessible metadata catalog, an underestimated concept that empowers users across the enterprise
• Data quality management: move away from spreadsheets and build robust data quality management systems into integrated data management technologies
• Data-driven culture: foster a culture that prioritizes data-driven decision-making

The modernization and centralization of data platforms introduces another challenge: data localization and sovereignty rules. With varying regulations across markets like Luxembourg, Singapore, and China, banks must deploy hybrid cloud solutions that support global data localization while adhering to regional data protection laws. 

Technologies essential to secure sensitive data and maintain localization compliance

• Data protection and privacy: ensure data protection and privacy across different geographic locations.
• Data lineage: document data lineage from data in motion to data storage.
• Data masking: implement data masking techniques for sensitive data crossing geographic boundaries.
• Data fencing and access controls: enforce restricted access based on geographic location.
• Cloud infrastructure: validate data storage and motion across multiple vendors and platforms.

Conclusion 

Ultimately, building a cohesive capital risk maturity framework and a modern data platform that integrates various tools and technologies is critical. This approach not only enhances financial resilience and enhances regulatory adherence, but also fosters a data-driven culture within financial institutions. As central banks hint at future rate cuts, these strategies become even more crucial for treasury teams, enabling them to navigate economic uncertainties with informed decisions and resilient risk management practices.

The nine essential pillars of capital risk maturity framework: 

• Risk governance: ensure the right level of governance is in place across teams, credit policy committees, compensation plans, and your capital risk appetite and risk profiles are aligned
• Finance team management: evaluate areas that need to be assessed, including contingency planning, RWAs, HQLAs, NSFRs, etc.
• Enterprise risk management: review and monitor capital risk appetite monitoring, capital triggers, models, risk ratings and oversight
• Independent assessments: note that with integrated risk management, other areas can impact capital risk management whether it's liquidity, credit, market conditions, or strategic risks - internal audits, credit risk reviews, and issue tracking can surface these for evaluation and correction.
• Strategic and capital management: include strategic plan linkage to capital plans and risk appetites, competitive analysis, capital stress testing, and plan development and updates.
• Advanced analytics: leverage advanced technologies and models for analytics on capital performance, stress test scenarios, economic forecasts, and return on capital
• Transformation - unified capital information: make use of data lineage, aggregation and normalization, centralized sources of data
• Data management: take advantage of data quality and governance frameworks, established data storage and usage, data architecture, and capital data stewardship

Arcesium helps capital markets firms manage investment and client data efficiently, streamline workflows, and meet regulatory requirements. Contact us to schedule a demo or learn more about how we can support your goals.

Sources:

^{1 Federal Reserve Floats Weaker Version of Planned Bank-Capital Overhaul, Bloomberg, June 24, 2024}