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Liquidity model validation: A critical component of liquidity risk management

So many decisions and transactions affect liquidity, which is why financial institutions are taking extra steps to implement a robust liquidity risk-management framework to help identify, monitor, measure, and control the institution’s day-to-day liquidity management and ensure they are adequately prepared for any unforeseen liquidity demands.

The primary purposes of liquidity risk management are to assess the need for funds to meet obligations and ensure the availability of cash or collateral to fulfill those needs at the appropriate time by coordinating the available sources of funds under both normal and stressed conditions.

A critical component of liquidity risk management is the liquidity model, which is used to demonstrate an institution’s ability to fund its balance sheet during the normal course of business and when unexpected events cause stress on liquidity. Since financial institutions heavily rely upon the liquidity model, it is important to validate the model regularly. A robust model validation will:

  • Review the conceptual framework of your general approach to monitoring and managing your liquidity position;

  • Assess the effectiveness of measurement metrics employed for current and future liquidity positions;

  • Confirm methodologies for projecting and assessing expected liquidity needs;

  • Affirm your liquidity policy appropriately documents and communicates your liquidity risk management philosophy and your framework for liquidity risk measurements, monitoring, management, limits and controls;

  • Assess the adequacy of your contingency funding plan (CFP) with respect to your business needs, regulatory mandates and stress testing;

  • Ensure the model adheres to key regulations, including Supervisory Guidance on Model Risk Management (SR 11-7) and 2010 Interagency Policy Statement on Funding and Liquidity Risk Management.

To learn more about key elements to liquidity risk management, register and attend the upcoming webinar by MountainView Financial Solutions, a Situs company, “Measuring and Managing Liquidity Risk,” on October 3, 2018 at 1 p.m. EDT.