The ECB Guide to Internal Liquidity Adequacy: A Principles-Based Approach
34 Pages Posted: 18 May 2021
Date Written: May 14, 2021
The global financial crisis exposed the need for coherence and transparency in bank liquidity management. The problem of asymmetry of information associated with liquidity was particularly acute during the crisis, leading to both adverse selection and moral hazard problems. The inability to refinance in the market eventually required central banks and states to intervene to purchase assets or provide guarantees at the market level and supply public funds, or nationalize individual banks, to correct the market. The European Central Bank Guide to Internal Liquidity Adequacy places significant focus on management’s oversight and responsibilities in addressing these issues before they materialize, or the existence of contingency plans to manage materialized risks. This guide is simply one component of a complex web of supervisory instruments and tools for banks’ liquidity management. This chapter argues that the crisis prevention narrative is delegated to banks to discharge their obligations in bank supervision so as to minimize the asymmetry of information problems created by their business and improve the way they manage adverse scenarios and the risks to depositors, markets, and supervisory authorities. The first part explains the rationale for a principles-based approach; the second part explores the premise of the principles for liquidity management, namely the responsibility of the bank per se to discharge adequate liquidity management as a form of self-regulation; the third part explains some of the key features of the principles; and the fourth part looks at the features of the principles with specific reference to the crisis prevention measures to improve banks’ responses to liquidity risks. This ‘nuts and bolts’ approach surprisingly lacks reference to bank corporate culture as an important all-encompassing matter when it comes to banks and risk-taking. The final section reflects on these preventive elements and highlights the importance of the ECB combining a risk-based and forward-looking ‘judgement’ based approach to supervision.
Keywords: Liquidity Risk, Liquidity Regulation, ILAAP
JEL Classification: G23, G28, G32, K23,
Suggested Citation: Suggested Citation