114.The financial market crisis underscores the importance of assessing the potential impact of liquidity risk on capital adequacy in a bank’s ICAAP. Senior management must consider the relationship between liquidity and capital since liquidity risk can affect capital adequacy, which, in turn, can aggravate a bank’s liquidity profile.

115.Another facet of liquidity risk management is that a bank must appropriately price the costs, benefits and risks of liquidity into the internal pricing, performance measurement, and new product approval process of all significant business activities.

116.A bank is expected to be able to thoroughly identify, measure and control liquidity risks, especially with regard to complex products and contingent commitments (both contractual and non-contractual). This process must involve the ability to project cash flows arising from assets, liabilities and off-balance sheet items over various time horizons, and must ensure diversification in both the tenor and source of funding. A bank must utilise early warning indicators to identify the emergence of increased risk or vulnerabilities in its liquidity position or funding needs. It must have the ability to control liquidity risk exposure and funding needs, regardless of its organisation structure, within and across legal entities, business lines, and currencies, taking into account any legal, regulatory and operational limitations to the transferability of liquidity.

117.A bank’s failure to effectively manage intraday liquidity could leave it unable to meet its payment obligations at the time expected, which could lead to liquidity dislocations that cascade quickly across many systems and institutions. As such, the bank’s management of intraday liquidity risks must be considered as a crucial part of liquidity risk management. It must also actively manage its collateral positions and have the ability to calculate all of its collateral positions.

118.While banks typically manage liquidity under “normal” circumstances, they must also be prepared to manage liquidity under stressed conditions. A bank must perform stress tests or scenario analyses on a regular basis in order to identify and quantify their exposures to possible future liquidity stresses, analysing possible impacts on the bank’s cash flows, liquidity positions, profitability, and solvency. The results of these stress tests must be discussed thoroughly by management, and based on this discussion, must form the basis for taking remedial or mitigating actions to limit the bank’s exposures, build up a liquidity cushion, and adjust its liquidity profile to fit its risk tolerance. The results of stress tests must also play a key role in shaping the bank’s contingency funding planning, which must outline policies for managing a range of stress events and clearly sets out strategies for addressing liquidity shortfalls in emergencies.

119.The Central Bank’s reserves the right to set higher liquidity requirements in Pillar 2.