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      Aldo Soprano

      Liquidity Management

      This edition first published 2015

      © 2015 Aldo Soprano

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      John Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester, West Sussex, PO19 8SQ, United Kingdom

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      Library of Congress Cataloging-in-Publication Data

      Soprano, Aldo.

      Liquidity management: a funding risk handbook / Aldo Soprano.

      pages cm. – (The wiley finance series)

      Includes bibliographical references and index.

      ISBN 978-1-118-41399-9 (hardback) – ISBN 978-1-118-41396-8 (ebk) – ISBN 978-1-118-41398-2 (ebk) 1. Bank liquidity. 2. Risk management. I. Title.

      HG1656.A3S66 2015

      658.15′5–dc23

      2015002039

      A catalogue record for this book is available from the British Library.

      ISBN 978-1-118-41399-9 (hbk) ISBN 978-1-118-41396-8 (ebk)

      ISBN 978-1-118-41398-2 (ebk) ISBN 978-1-119-08794-6 (ebk)

      Cover Design: Wiley

      Cover Image: ©Getty Images/Steve Rawlings

      Acknowledgements

      In hoping this text is of interest and help in assessing and understanding liquidity risk, my first and greatest debt of gratitude goes to Werner Coetzee, Executive Commissioning Editor at Wiley, for suggesting and inspiring me to write it, but mostly for holding me to completing it when my first son's arrival kindly changed my private life and free time. A special mention is also owed to Carlo Magnani for his previous support and contribution. Lastly, I want to mention the many people over these difficult past years that have worked together with me on liquidity risk and deserve to be mentioned, without order or priority: Gianni Capezzuoli, Mario Prodi, Elena Conserva and Attilio Napoli.

      The opinions and indications presented in this book are those of its author and do not represent that of UniCredit Group.

      Introductory Note

      This book was first conceived of and begun two years ago, at the peak of what it is now commonly referred to as the Greek financial crisis. As many well remember, it was the nadir of the financial crisis, triggered by the chain of problems from Ireland, Portugal and then Greece, resulting in state rating downgrades and endless discussions in Brussels and Frankfurt about the way to solve the apparently unresolvable liquidity troubles. All this while the Lehman crisis was barely one year old. Then the contagion fear that affected the Republic of Italy, one the largest sovereign debt issuers in the world, spread and the troubles quickly also reached Spain, with the Bankia and Spanish banking sectors in dire straits and receiving European financial help. Many governments fell, dragged down by extremely high refinancing costs, unemployment rates and falling growth rates.

      Things have changed since. Mario Draghi's appointment at the helm of the European Central Bank and the pledge to assure unlimited support by the ECB on CEE Euro state members in August 2012 have been turning points in the delicate and complex liquidity transmission mechanism. Though liquidity market normalization is still distant, significant steps forward in recent months, including ECB Long Term Repurchasing Operations, have ensured liquidity to banks and cooled concerns. At least for the time being.

      Despite the exceptional environment and events, this book is not a descriptive chronicle of crises and political or monetary fallouts, but rather an attempt to present experiences and indications on liquidity funding risks, starting from a detailed reading and commentary on the bulky and often cumbersome regulatory texts. The reminders and references to regulations are a key driver as they will, in the end, inevitably be dealt with and will constitute compulsory requirements for most banks.

      This thread is followed through the first five chapters. The first is meant to present liquidity risk management in current financial markets and banking, with a first indication of how funding liquidity is an increasingly relevant factor to control and manage, together with an overview of regulatory frameworks.

      The second chapter focuses on funding liquidity in the shorter maturities, up to one year and mostly within the immediate refinancing time horizons that were so critical during the Lehman crisis and are at the heart of the new regulatory liquidity frameworks. The analysis will touch upon the construction and use of the cash flow ladder, moving on then to the calculation of the liquidity coverage ratio. Related to short-term obligations are the monitoring of specific risk indicators and the intraday liquidity risk, which is particularly important for banks' treasury operations. The analysis concludes with the funding concentration assessment, a necessary component for a complete grasp of exposure and sound funding risk management.

      Liquidity risk is also a matter of balance sheet sustainability, and the third chapter touches on structural funding strategies and valuation. It is here introduced as the Net Stable Funding Ratio, with a depositor's modelling overview completing it, essential for any meaningful analysis on funding stability. These are combined with scenario and stress testing, cash horizons and liquidity buffers, included here as components for the structural funding strategy rather than in the short-term section.

      Chapter 4 is included mostly for completeness and is a rapid overview of liquidity value at risk models and measurement techniques other than those in Chapters 2 and 3; it should indeed be the subject of a dedicated work and presented here is a compact and essential concept description, distinguishing liquidation adjusted value at risk on the assessment

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