Building an Optimal Execution Plan for Liquidity Management Using SAS

Liquidity risk management is the management of the bank‟s ability to meet its obligations as they come due, w ithout incurring losses. Liquidity ris k management is seen to be of paramount importance and a subject of great interest for the regulators because a liquidity shortfall at a s ingle significant institution can lead to system-w ide effects. In contrast to risk based capital for other for ms of risks such as market and credit r isk, the cushion for liquidity ris k is not created through additional capital. Since the main purpose of the cushion for liquidity risk is to mitigate the n et cumulative cash outflows, it is done by us ing a pool of high-quality liquid assets that can be sold immediately or used in collater al for short-term loan (repo) transactions to raise funds. Given a sufficient liquidity hedging portfolio banks also need to consider strategizing its response to liquidity crisis in advance. Most notably, this includes having a strategy for liquidity execution. That is, building a plan for optimal liquidity execution. Liquidity execution is therefore one of the core functions in the bank and management of liquidity risk has become even more important after the recent financial crisis. In a liquidity execution, apart from the financial cost of the execution itself, a firm must also take into account reputational and opportunity cost. When multiple liquidity distress stages are anticipated banks can be more w illing to hold on to the most liquid assets, and not risk a fire sale of illiquid assets, in later more severe distress stages. This is clearly a decision making process based on a long ter m survival strategy. Therefore an important aspect of liquidity management and in particular liquidity execution is to recognize the fact that a liquidity distress period usually evolves in multiple stages, and, w hen the funding liquidity s hortage evolves so does the borrow ing cost and market liquidity as w ell. An institutions liquidity execution plan should therefore incorporate this multi-stage nature of the liquidity distress and the fact that execution costs, liquidity depth and other market factors vary across stages.