LM-2.5 LM-2.5 Cash-flow Approach to Managing Liquidity Risk
LM-2.5.1
Banks must adopt a cash-flow approach to managing liquidity risk, under which they must have in place a robust framework for projecting comprehensively future cash flows arising from assets, liabilities and OBS items over an appropriate set of time horizons. The framework must be used for:
(a) monitoring on a daily basis their net funding gaps under normal business conditions; and(b) Conducting regular cash-flow analysis based on a range of stress scenarios.August 2018LM-2.5.2
Unless otherwise specified, the cash-flow management requirements in this chapter apply generally to banks under both normal and stressed situations.
August 2018Scope, Coverage and Frequency of Cash-flow Projection
LM-2.5.3
Cash-flow projections involve the estimation of a bank's cash inflows against its outflows and the liquidity value of its assets to identify the potential for future net funding shortfalls. The projections must be forward-looking and based on reasonable assumptions and techniques, covering liquidity risks stemming from:
(a) On-balance sheet assets and liabilities;(b) OBS positions and derivative transactions (including sources of contingent liquidity demand and related triggering events associated with such positions);(c) Special Purpose Vehicles; a bank must have a detailed understanding of its contingent liquidity risk exposure and event triggers arising from any contractual and non-contractual relationships with special purpose vehicles; and(d) Core business lines and activities (for example, correspondent, custodian and settlement activities).August 2018LM-2.5.4
Cash-flow projections must address a variety of factors over different time horizons, including:
(a) Vulnerabilities to changes in liquidity needs and funding capacity on an intraday basis;(b) Day-to-day liquidity needs in, say, 5 to 7 days ahead;(c) Funding capacity over short and medium-term horizons (e.g. 14 day, 1, 2, 3, 6 and 9 months) of up to 1 year;(d) Longer-term liquidity needs over 1, 2, 3, 4 and beyond 5 years; and(e) Vulnerabilities to events, activities and strategies that can put a significant strain on a bank's capacity for generating liquidity.August 2018LM-2.5.5
Cash-flow projections must cover positions in Bahraini Dinar (BHD/USD), where appropriate and in all significant currencies in aggregate. Separate cash-flow projections must also be performed for individual foreign currencies in which a bank has significant positions. Please refer to LM-3: Foreign currency liquidity management for the identification of significant positions in other currencies.
August 2018Net Funding Gaps
LM-2.5.6
In order to meet their obligations as they fall due and thereby stay in business, banks need to ensure:
(a) Positive cash-flow position is maintained; or(b) Sufficient cash can be generated from their assets; or(c) Adequate funding sources to cover their funding gaps promptly.August 2018LM-2.5.7
Net funding gaps can be assessed through the construction of a maturity profile, supplemented where relevant with additional analysis of the funding capacity of specific on- or off-balance sheet items.
August 2018LM-2.5.8
A bank's maturity profile should encompass adequate time bands so that the bank can monitor its liquidity needs for various time horizons. It is generally expected to have daily time bands in the very short term (say for a period of 5 to 7 days ahead), which may be followed by wider and less granular time bands for other periods.
August 2018LM-2.5.9
Banks must set internal limits to control the size of their cumulative net mismatch positions (i.e. where cumulative cash inflows are exceeded by cumulative cash outflows), at least for the shorter-term time bands (e.g. next day, 5 to 7 days ahead, 14 days, 1, 2, 3, 6 and 9 months). Such limits must be in line with the established liquidity risk tolerance, and must take into account the potential impact of adverse market conditions on the bank's funding capacity. Maturity mismatch limits must also be imposed for individual foreign currencies in which a bank has significant positions.
August 2018LM-2.5.10
The maturity mismatch limits must be properly documented in the Liquidity Risk Management Policy statement. Banks must regularly review the suitability of such limits.
August 2018Cash Flow Projection Assumptions and Techniques
LM-2.5.11
While certain cash flows can be projected based on contractual maturities, some may need to be estimated based on certain assumptions. In these circumstances, banks should make realistic assumptions (with a reasonable degree of prudence) to reflect the characteristics of their businesses and products, as well as economic and market conditions. For example, banks may take into account the following factors in setting the assumptions for cash flow projection:
(a) Expected future growth or contractions in the balance sheet;(b) The proportion of maturing assets and liabilities that banks reasonably expect to roll-over or renew;(c) The quality and proportion of liquid assets or other marketable securities that can be used as collateral to obtain secured funding;(d) The behaviour of assets and liabilities with no clearly specified maturity dates, such as repayment of overdrafts and demand deposits as well as sticky deposits;(e) The potential cash flows arising from off-balance sheet activities, e.g., drawdown under loan commitments and contingent liabilities (including all potential draws from contractual or non-contractual commitments);(f) The behaviour of cash flows under different service delivery channels (e.g. branches vs e-banking channels);(g) The convertibility of foreign currencies;(h) The lead time required for the monetization of marketable debt securities; and(i) Access to wholesale markets, standby facilities and intragroup funding.August 2018LM-2.5.12
Techniques employed by banks for designing cash flow assumptions must be commensurate with the nature and complexity of their business activities.
August 2018LM-2.5.13
In deriving behavioural cash flow assumptions, banks may analyse historical observations on cash flow patterns. While there is no standard methodology for making such assumptions, it is important that the assumptions used are consistent and reasonable and they should be supported by sufficient historical or empirical evidence.
August 2018LM-2.5.14
Banks must document in their liquidity risk management policy statement, the underlying assumptions used for estimating cash flow projections and the rationale behind them. The assumptions and their justifications must be approved, and subject to regular review, by the ALCO to take account of available statistical evidence and changing business environment.
August 2018
