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.
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.
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.
A bank must have a formal contingency funding plan (CFP) that clearly sets out the strategies for addressing liquidity shortfalls in emergency situations.
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.
A Bank must maintain a cushion of unencumbered, high quality liquid assets to be held as insurance against a range of liquidity stress scenarios.
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.
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.
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.
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.
Banks are required to develop a transfer-pricing framework to reflect the actual cost of funding.
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.
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.
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.
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.
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.