1. 30) A bank should define and identify the liquidity risk it is exposed to in all jurisdictions in which it operates directly or through its subsidiaries, branches and related entities. A bank should evaluate each major on and off balance sheet position, including contingent exposures that may affect the bank’s sources and uses of funds, and determine how it can affect liquidity risk.
2. 31) A bank should consider the interactions between exposures to funding liquidity risk and market liquidity risk¹. A bank that obtains liquidity from capital markets and interbank markets should recognize that these sources may be more volatile than traditional retail deposits. For example, under conditions of stress, investors in money market instruments may demand higher compensation for risk, require roll over at considerably shorter maturities, or refuse to extend financing at all. Moreover, reliance on the full functioning and liquidity of financial markets may not be realistic as asset and funding markets may dry up in times of stress. Market illiquidity may make it difficult for a bank to raise funds by selling assets and thus increase the need for funding liquidity.
3. 32) A bank should ensure that assets are prudently valued according to relevant financial reporting and supervisory standards. A bank should fully factor into its risk management the consideration that valuations may deteriorate under market stress, and take this into account in assessing the feasibility and impact of asset sales during stress on its liquidity position.
4. 33) A bank should recognize and consider the strong interactions between liquidity risk and the other types of risk to which it is exposed. These include interest rate, credit, operational, legal and reputational risks, which may influence a bank’s liquidity profile. Liquidity risk often can arise from perceived or actual weaknesses, failures or problems in the management of other types of risk. A bank should identify events that could have an impact on market and public perceptions about its soundness, particularly in wholesale markets.

¹ See paragraph 6 for definitions of funding liquidity risk and market liquidity risk.

1. 34) Liquidity measurement involves assessing a bank’s cash inflows against its outflows and the liquidity value of its assets to identify the potential for future net funding shortfalls. A bank should be able to measure and forecast its prospective cash flows for assets, liabilities, off-balance sheet commitments and derivatives over a variety of time horizons, under normal conditions and under a range of stress scenarios, including scenarios of severe stress. It should also consider funding needs in currencies in which the bank is active and liquidity needs arising from correspondent banking and settlement activities. Below is an overview of what is expected under the above mentioned risk drivers.
2. Future cash flows of assets and liabilities
3. 35) A bank should have a robust liquidity risk management framework providing prospective, dynamic cash flow forecasts that include assumptions on the likely behavioral responses of key counterparties to changes in conditions and are carried out at a sufficiently granular level. A bank should make realistic assumptions about its future liquidity needs for both the short- and long-term that reflect the complexities of its underlying businesses, products and markets. The Central Bank reporting format attached to this manual can provide a good starting point.
4. 36) A bank should analyze the quality of assets that could be used as collateral, in order to assess their potential for providing secured funding in stressed conditions. A bank should also manage the timing of incoming flows in relation to known outgoing sources in order to obtain an appropriate maturity distribution for its sources and uses of funds.
5. 37) In estimating the cash flows arising from its liabilities, a bank should assess the “stickiness” of its funding sources. In particular, for large wholesale funds providers, both secured and unsecured, a bank should assess the likelihood of roll-over of funding lines and how the r fund providers are likely to behave under stress - and therefore consider the possibility that secured and unsecured funding might dry up in times of stress. For secured funding with overnight maturity, a bank should not assume that the funding will automatically roll over. In addition, a bank should assess the availability of term funding back up facilities and the circumstances under which they can be utilized. In assessing the ‘stickiness’ of retail deposits a bank should also consider factors such as size, interest-rate sensitivity, geographical location of depositors and the deposit channel (e.g. short term high interest rate promotion).
6. 38) Regarding the time horizons over which to identify measure, monitor and control liquidity risk, a bank should ensure that its liquidity risk management practices integrate and consider a variety of factors. These include vulnerabilities to changes in liquidity needs and funding capacity on an intraday basis; day-to-day liquidity needs and funding capacity over short and medium-term horizons up to one year; longer-term liquidity needs over one year; and vulnerabilities to events, activities and strategies that can put a significant strain on internal cash generation capability.
7. Sources of contingent liquidity demand
8. 39) A bank should identify measure, monitor and control potential cash flows relating to off-balance sheet commitments and other contingent liabilities. This should include a robust framework for projecting the potential consequences of undrawn commitments being drawn, considering the nature of the commitment and credit worthiness of the counterparty, as well as exposures to business and geographical sectors, as counterparties in the same sectors may be affected by stress at the same time.
9. 40) For banks engaged in securitization activities, they should monitor the existence of recourse provisions in asset sales, the extension of liquidity facilities to securitization vehicles and the early amortization triggers of certain asset securitization transactions. Banks should also consider the nature and size of the bank’s potential non-contractual “obligations”, where the support provided to securitization and conduit programmes is critical to maintaining ongoing access to funding and the bank reputation in the market.
10. 41) A bank should incorporate cash flows related to the re-pricing, exercise or maturity of financial derivatives contracts in its liquidity risk analysis, including the potential for counterparties to demand additional collateral in an event such as a decline in the bank’s credit rating or creditworthiness or a decline in the price of the underlying asset.
11. Guarantees and commitments
12. 42) Undrawn loan commitments, letters of credit and financial guarantees represent a potentially significant drain of funds for a bank. A bank may be able to ascertain a "normal" level of cash outflows under routine conditions, and then estimate the scope for an increase in these flows during periods of stress. For example, an episode of financial market stress may trigger a substantial increase in the amount of draw-downs of letters of credit provided by the bank to its customers. Similarly, liquidity issues can arise when a bank relies on committed lines of credit provided by others.
13. Currencies in which a bank is active
14. 43) A bank should assess its aggregate foreign currency liquidity needs and determine acceptable currency mismatches. A bank should undertake a separate analysis of its strategy for each currency in which it has significant activity, considering potential constraints in times of stress. The size of foreign currency mismatches should take into account: (a) the bank’s ability to raise funds in foreign currency markets; (b) the likely extent of foreign currency back-up facilities available in its domestic market; (c) the ability to transfer a liquidity surplus from one currency to another, and across jurisdictions and legal entities; and (d) the likely convertibility of currencies in which the bank is active, including the potential for impairment or complete closure of foreign exchange swap markets for particular currency pairs.
15. 44) A bank should be aware of, and have the capacity to manage, liquidity risk exposures arising from the use of foreign currency deposits and short-term credit lines to fund domestic currency assets as well as the funding of foreign currency assets with domestic currency. A bank should take account of the risks of sudden changes in foreign exchange rates or market liquidity, or both, which could sharply widen liquidity mismatches and alter the effectiveness of foreign exchange hedges and hedging strategies.
16. Correspondent, custody and settlement activities
17. 45) Where relevant, a bank should understand and have the capacity to manage correspondent, custodian and settlement bank services and how they can affect its cash flows. Given that the gross value of customers’ payment traffic (inflows and outflows) can be very large, unexpected changes in these flows can result in large net deposits, withdrawals or line-of credit draw-downs that impact the overall liquidity position of the correspondent or custodian bank, both on an intraday and overnight basis. A bank also should understand and have the capacity to manage the potential liquidity needs it would face as a result of the failure-to-settle procedures of payment and settlement systems in which it is a direct participant.

1. 46) A bank should employ a range of customized internal measurement tools, or metrics, as there is no single metric that can comprehensively quantify liquidity risk. To obtain a forward looking view of liquidity risk exposures, a bank should use metrics that assess the structure of the balance sheet (e.g. by source and tenor of funding and liquid assets composition) as well as metrics that project cash flows and future liquidity positions, taking into account off-balance sheet risks (liquidity gap reports). These metrics should span vulnerabilities across business-as-usual and stressed conditions over various time horizons.
2. 47) Under business-as usual conditions, the report should identify needs that may arise from projected outflows relative to routine sources of funding. Under stress conditions, the reports should be able to identify funding gaps at various horizons, and in turn serve as a basis for liquidity risk limits and early warning indicators.
3. 48) The scenarios for the reports can be based on assumptions of the future behavior of assets, liabilities and off-balance sheet items, and then used to calculate the cumulative net excess or shortfall over the time frame for the liquidity assessment. Measurement should be performed over incremental time periods to identify projected and contingent flows taking into account the underlying assumptions associated with potential changes in cash flows of assets and liabilities.
4. 49) Management should tailor the measurement and analysis of liquidity risk to the bank’s business mix, complexity and risk profile.
5. 50) A bank should take steps to ensure that its assumptions are reasonable and appropriate, documented and periodically reviewed and approved. They should also be updated in-line with changes observed in the market.
6.  

1. 51) A bank should have a reliable management information system designed to provide the board of directors, senior management and other appropriate personnel with timely and forward-looking information on the liquidity position of the bank.
2. 52) The management information system should have the ability to calculate liquidity positions in all of the currencies in which the bank conducts business – both on a subsidiary/branch basis in all jurisdictions in which the bank is active and on an aggregate group basis. It should capture all sources of liquidity risk, including contingent risks and the related triggers and those arising from new activities, and have the ability to deliver more granular and time sensitive information during stress events.
3. 53) To effectively manage and monitor its net funding requirements, a bank should have the ability to calculate liquidity positions on an intraday basis, on a day-to-day basis for the shorter time horizons, and over a series of more distant time periods thereafter. The management information system should be used in day-to-day liquidity risk management to monitor compliance with the bank’s established policies, procedures and limits.
4. 54) To facilitate liquidity risk monitoring, senior management should agree on a set of reporting criteria, specifying the scope, manner and frequency of reporting for various recipients (such as the board, senior management, and asset – liability committee) and the parties responsible for preparing the reports.
5. 55) Reporting of risk measures should be done on a frequent basis (e.g. daily reporting for those responsible for managing liquidity risk, and at each board meeting during normal times, with reporting increasing in times of stress) and should compare current liquidity exposures to established limits to identify any emerging pressures and limit breaches.
6. A bank must establish a forward-looking funding strategy that provides effective diversification in the sources and tenor of funding.
7. 56) A bank should diversify available funding sources in the short-, medium- and long term. Diversification targets should be part of the medium- to long-term funding plans and is aligned with the budgeting and business planning process.
8. 57) Funding plans should take into account correlations between sources of funds and market conditions. The desired diversification should also include limits by counterparty, secured versus unsecured market funding, instrument type, tenor, securitization vehicle, currency, and geographic market. As a general liquidity management practice, banks should limit concentration in any one particular funding source or tenor.
9. 58) For institutions active in multiple currencies, access to diverse sources of liquidity in each currency is required, since banks are not always able to swap liquidity easily from one currency to another.
10. 59) Senior management should be aware of the composition, characteristics and diversification of the bank’s assets and funding sources. Senior management should regularly review the funding strategy in light of any changes in the internal or external environments.
11. 60) An essential component of ensuring funding diversity is maintaining market access. Market access is critical for effective liquidity risk management, as it affects both the ability to raise new funds and to liquidate assets. Senior management should ensure that market access is being actively managed, monitored and tested by the appropriate staff.
12. 61) Managing market access can include developing markets for asset sales or strengthening arrangements under which a bank can borrow on a secured or unsecured basis. A bank should maintain an active presence within markets relevant to its funding strategy. This requires an ongoing commitment and investment in adequate and appropriate infrastructures, processes and information collection.
13. 62) A bank should not assume it can access markets in a timely manner for which it has not established the necessary systems or documentation, or where these arrangements have not been periodically utilized or the bank has not confirmed that willing counterparties are in place.
14. 63) A bank should have full knowledge of the legal framework governing potential asset sales, and ensure that documentation is reliable and legally robust.
15. 64) A bank should identify and build strong relationships with current and potential investors. The frequency of contact and the frequency of use of a funding source are two possible indicators of the strength of a funding relationship. A bank should also establish and maintain a relationship with the Central Bank.
16. 65) A bank needs to identify alternative sources of funding that strengthen its capacity to withstand a variety of severe yet plausible institution-specific and market-wide liquidity shocks. Depending on the nature, severity and duration of the liquidity shock, potential sources of funding include the following:
    • • Deposit growth.
    • • The lengthening of maturities of liabilities.
    • • New issues of short- and long-term debt instruments.
    • • Intra-group fund transfers, new capital issues, the sale of subsidiaries or lines of business.
    • • Asset securitization.
    • • The sale or repo of unencumbered, highly liquid assets.
    • • Drawing-down committed facilities.
    • • Borrowing from the central bank’s marginal lending facilities.
17. A Bank must establish a liquidity risk management framework including limits, warning indicators, communication and escalation procedures.

1. 66) A bank should set limits to control its liquidity risk exposure and vulnerabilities. A bank should regularly review such limits and corresponding escalation procedures. Limits should be relevant to the business in terms of its location, complexity, and nature of products, currencies and markets served.
2. 67) Limits should be used for managing day-to-day liquidity within and across lines of business and legal entities under “normal” conditions. The limit framework should also include measures aimed at ensuring that the bank can continue to operate in a period of market stress, bank-specific stress and a combination of the two.
3. 68) For example a commonly used simple limit is the size of cumulative net cash outflow (based on board approved assumptions) and covers various time horizons. The limit may also include estimates of outflows resulting from the drawdown of commitments or other obligations of the bank.

1. 69) A bank should design a set of indicators to aid this process to identify the emergence of increased risk or vulnerabilities in its liquidity risk position or potential funding needs. Such early warning indicators should identify any negative trend and cause an assessment and potential response by management in order to mitigate the bank’s exposure to the emerging risk.
2. 70) Early warning indicators can be qualitative or quantitative in nature and may include but are not limited to:
   • • Rapid asset growth, especially when funded with potentially volatile liabilities.
   • • Growing concentrations in assets or liabilities.
   • • Increases in currency mismatches.
   • • A decrease of weighted average maturity of liabilities.
   • • Repeated incidents of positions approaching or breaching internal or regulator limits.
   • • Negative trends or heightened risk associated with a particular product line, such as rising delinquencies.
   • • Significant deterioration in the bank’s earnings, asset quality, and financial condition.
   • • Negative publicity.
   • • A credit rating downgrade.
   • • Stock price declines or rising debt costs.
   • • Widening debt or credit-default-swap spreads.
   • • Rising wholesale or retail funding costs.
   • • Counterparties that begin requesting or request additional collateral for credit.
   • • Correspondent banks that eliminate or decrease their credit lines.
   • • Increasing retail deposit outflows.
   • • Increasing redemptions of CDs before maturity.
   • • Difficulty accessing longer-term funding.
3. 71) Early warning indicators should be closely monitored by senior management on a regular basis. Limits and analysis of the indicators above should be reviewed and breaches/emerging trends should be escalated up to the board committees or the full board if significant enough.
4. 72) Clear procedures and escalation criteria should be put in place based on the warning indicators; these include the circumstances where the Contingency Funding Plan (CFP) should be invoked.
5. A bank must conduct its own internal stress tests on a regular basis for a variety of institution specific and market wide stress scenarios (individually and in combination). The scenarios should be based on the individual bank specific circumstances and business model.
6. 73) While a bank typically manages liquidity under “normal” circumstances, it should also be prepared to manage liquidity under stressed conditions. A bank should perform stress tests or scenario analyses on a regular basis in order to identify and quantify its exposures to possible future liquidity stresses, analyzing possible impacts on the institution’s cash flows, liquidity position, profitability and solvency.
7. Stress testing process
8. 74) Tests should be :
   • • Test should be done on individual entity basis, group basis and business lines.
   • • Tests should consider the implication of the scenarios across different time horizons, including on an intraday basis.
   • • The extent and frequency of testing should be commensurate with the size of the bank and its liquidity risk exposures.
   • • Banks should build in the capability to increase the frequency of tests in special circumstances, such as in volatile market conditions or at the request of the Central Bank.
   • • Senior management should be actively involved in the stress test demanding rigorous assumptions and challenging the results.
   • • The board should be informed of the stress testing results and should be able to challenge outcomes, assumptions and actions taken on the basis of the tests.

1. 75) Banks should take into account the nature of the bank’s business, activities and vulnerabilities in designing stress scenarios. The scenarios should incorporate the major funding and market liquidity risks to which the bank is exposed. These include risks associated with its business activities, products (including complex financial instruments and off-balance sheet items) and funding sources. The defined scenarios should allow the bank to evaluate the potential adverse impact these factors can have on its liquidity position. Regardless of how strong its current liquidity situation appears to be, a bank should consider the potential impact of severe stress scenarios.
2. 76) Historical data and past experiences in addition to sound judgment should be used in the scenarios. A bank should consider short-term and long term stresses as well as institution-specific and market-wide scenarios and a combination of both in the stress tests scenarios. The stress test scenarios should consider the following:
   • • A simultaneous drying up of market liquidity in several previously highly liquid markets (inter-bank money markets, non UAE funding markets, securitization).
   • • Severe constraints in accessing secured and unsecured wholesale funding;
   • • The run-off of retail funding
   • • Contingent claims and more specifically, potential draws on committed lines extended to third parties or the bank's subsidiaries, branches or head office and the liquidity absorbed by off-balance activities.
   • • Severe operational or settlement disruptions affecting one or more payment or settlement systems.
   • • Take into account the link between reductions in market liquidity and constraints on funding liquidity. This is particularly important for banks with significant market share in, or heavy reliance upon, specific funding markets.
   • • A bank should also consider the results of stress tests performed for various other risk types and consider possible interactions between liquidity risk and these other types of risk (e.g. capital stress tests).
   • • Tests should reflect accurate time-frames for the settlement cycles of assets that might be liquidated (i.e. time to receive the sale proceeds).
   • • If a bank relies upon liquidity outflows from one system to meet obligations in another, it should consider the risk that operational or settlement disruptions might prevent or delay expected flows across systems. This is particularly relevant for firms relying upon intra-group transfers or centralized liquidity management.
   • • Additional margin calls and collateral requirements.
   • • The availability of contingent lines extended to the bank.
   • • The impact of credit rating triggers.
   • • The access to Central Bank facilities.
   • • The potential reputational impact when executing contingency /remedial action.
   • • Estimates of future balance sheet growth.
   • • A bank should consider the likely behavioral response of other market participants (similar response to market stress might amplify market strain).
   • • A bank should consider the likely impact of its own behavior on other market participants.
   • • Where a bank uses a correspondent or custodian to conduct settlement, the analysis should include the impact of those agents restricting their provision of intraday credit.
3. The scenario design should be subject to regular reviews to ensure that the nature and severity of the tested scenarios remain appropriate and relevant to the bank.

1. 77) Senior management should review stress test scenarios and assumptions as well as the results of the stress tests. The bank’s choice of scenarios and related assumptions should be well documented and reviewed together with the stress test results. Stress test results and vulnerabilities and any resulting actions should be reported to and discussed with the board and the Central Bank.
2. 78) Senior management should integrate the results of the stress testing process into the bank’s strategic planning process (e.g. bank management could adjust its asset-liability composition) and the firm's day-to-day risk management practices (e.g. through monitoring sensitive cash flows or reducing concentration limits). The results of the stress tests should be explicitly considered in the setting of internal limits.
3. 79) Senior management should decide how to incorporate the results of stress tests in assessing and planning for related potential funding shortfalls in the institution's contingency funding plan. To the extent that projected funding deficits are larger than (or projected funding surpluses are smaller than) implied by the bank’s liquidity risk tolerance, management should consider whether to adjust its liquidity position or to bolster the bank’s contingency plan in consultation with the board.
4. A bank must have a formal contingency funding plan (CFP) that clearly sets out the strategies for addressing liquidity shortfalls in emergency situations.
5. 80) A bank should put in place plans for responding to severe disruptions to its ability to fund some or all of its activities in a timely manner and at a reasonable cost.
   CFPs should have the following characteristics.
   • • Be commensurate with a bank’s complexity, risk profile, scope of operations and role in the financial systems in which the bank operates.
   • • Include a clear description of a diversified set of contingency measures for preserving liquidity and making up cash flow shortfalls in various adverse situations.
   • • CFP should articulate available potential contingency funding sources and the amount of funds a bank estimates can be derived from these sources; clear escalation/prioritization procedures detailing when and how each of the actions can and should be activated; and the lead time needed to tap additional funds from each of the contingency sources.
   • • The CFP's design, plans and procedures should be closely integrated with the firm’s ongoing analysis of liquidity risk and with the results of the scenarios and assumptions used in stress tests (requirement 9).
   • • CFPs should prepare the bank to manage a range of scenarios of severe liquidity stress that include both firm-specific and more generalized market-wide stress, as well as the potential interaction between them.
   • • The plan should include a diversified menu of options in order for management to have an overview of the potentially available contingency measures. Banks should also examine the time periods for which measures can be carried out under various assumptions and stresses.
   • • CFPs should contain clear specification of roles and responsibilities, including the authority to invoke the CFP.
   • • The establishment of a formal "crisis team" should facilitate internal coordination and decision-making during a liquidity crisis; names and contact details of members of the team responsible for implementing the CFP and the locations of team members; and the designation of alternates for key roles should also be clearly stated.
   • • To facilitate the timely response needed to manage disruptions, the plan should set out a clear decision-making process on what actions to take at what time, who can take them, and what issues need to be escalated to more senior levels in the bank.
   • • The plan should explicitly set out the procedures to deliver effective internal coordination and communication across the bank’s different business lines and locations. It should also address when and how to contact external parties, the Central Bank, stakeholders, market participants, and the media.
   • • A bank’s CFP (as well as the bank's day-to-day liquidity risk management) should reflect Central Bank lending programmes and collateral requirements.
   • • The plan should be reviewed and tested regularly to ensure their effectiveness and operational feasibility timely action should be taken by management to remedy any issue identified. Key aspects of this testing include:
     • ▪ ensuring that roles and responsibilities are appropriate and understood,
     • ▪ confirming that contact information is up to date,
     • ▪ proving the transferability of cash and collateral,
     • ▪ reviewing that the necessary legal and operational documentation is in place to execute the plan at short notice,
     • ▪ The ability to sell or repo certain assets or periodically draw down credit lines.
   • • Senior management should review and update the CFP at least every year for the board’s approval, or more often as business or market circumstances change.
   • • The CFP should be consistent with the bank’s business continuity plans and should be operational under situations where business continuity arrangements have been invoked.
6. A Bank must maintain a cushion of unencumbered, high quality liquid assets to be held as insurance against a range of liquidity stress scenarios.
7. 81) Although the predefined stress test in the LCR will result in a regulatory liquid asset requirement to be held by the bank to cover the stressed outflows, the bank should assess the need for holding liquid assets that can be sold or pledged to obtain funds in a range of stress scenarios beyond the regulatory minimum established by the LCR.
8. 82) The internal stress testing referred to in requirement 9 above should be used to determine the size and composition of the liquid asset pool required to maintain sufficient resilience to unexpected stress while the bank continues to meet its daily payment and settlement obligations on a timely basis for the duration of the stress.
9. 83) The liquidity cushion should include cash and high quality government bonds or similar instruments, to guard against the most severe stress scenarios. For insuring against less intense, but longer duration stress events, a bank may choose to widen the composition of the cushion to hold other unencumbered liquid assets which are marketable.
10. 84) A bank should be realistic about how much cash it will be able to obtain from the Central Bank against eligible assets. Moreover, a bank should not rely on the Central Bank altering the amount of or the terms on which it provides liquidity.
11. Banks are required to develop a transfer-pricing framework to reflect the actual cost of funding.
12. 85) Senior management should appropriately incorporate liquidity costs, benefits and risks in the internal pricing and performance measurement for all significant business activities (both on- and off-balance sheet). The sophistication of the transfer pricing framework should be in line with the bank level of sophistication and business complexity.
13. 86) These costs, benefits and risks should then be explicitly attributed to the relevant activity so that line management incentives are consistent with and reinforce the overarching liquidity risk tolerance and strategy of the bank, with a liquidity charge assigned as appropriate to positions, portfolios, or individual transactions.
14. 87) This assignment of liquidity costs, benefits and risks should incorporate factors related to the anticipated holding periods of assets and liabilities, their market liquidity risk characteristics, and any other relevant factors, including the benefits from having access to relatively stable sources of funding, such as some types of retail deposits.
15. 88) The quantification and attribution of these risks should be explicit and transparent at the line management level and should include consideration of how liquidity would be affected under stressed conditions.
16. 89) The analytical framework should be reviewed as appropriate to reflect changing business and financial market conditions and so maintain the appropriate alignment of incentives.