Liquidity lessons learned a decade after the financial crisis
“Wow, I can’t believe I can say that the financial crisis was a decade ago,” said Chris Mills, Managing Director of Model Validation Services for MountainView, a Situs company, during Wednesday’s liquidity risk webinar. “It doesn’t feel like a decade.”
Time flies when you are trying to emerge from a global financial crisis. Now, 10 years later, financial industry executives are assessing whether their financial risk management strategies will enable them to meet ongoing cash and collateral obligations if another crisis, or liquidity event, occurs. Indeed, since the crisis, regulators identified that ineffective liquidity risk management was a key contributor to the crisis.
Mills, a seasoned executive banker and balance sheet strategist, made it clear in the webinar that predicting the next downturn is not nearly as important as preparing your institution for the next downturn. “The industry was ill-prepared for an extreme systemic crisis,” said Mills. “We just didn’t have the proper plans in place, and stress testing was not a mainstream.”
With that in mind, Mills asked the audience to consider some of the key deficiencies from the last financial crisis. Here are a few she listed from her own experience:
(1) Insufficient Holdings of Liquid Assets
Financial institutions did not have the appropriate buffers in place, whether it was cash or cash equivalent, short-term investments, or un-pledged security portfolios.
(2) Risky Funding Strategies
Some financial institutions were funding risky illiquid assets with more volatile, short-term liabilities and had high non-core funding dependence.
(3) Shortsighted Growth Plans
Growth and competition is great, but growth for the sake of growth is a shortsighted approach. Many financial institutions placed emphasis on improving earnings per share, pleasing shareholders and increasing stock prices. Many institutions entered into new lending markets and new, unfamiliar products and did not fully understand the underwriting risk and product nuances.
(4) Lack of Policy and Governance
Many institutions did not have contingency funding plans (CFP) in place, or did not start developing those plans until after regulators called them to the table.
(5) Inadequate Cash-Flow Projections
Few warning systems were in place to monitor all the dynamic forces affecting liquidity.
Reflecting on the crisis, Mills further explained that many Institutions had a siloed approach to risk management. Key risk red flags from one area of the institution were managed separately from other areas, without knowing how interdependent these risks were. Now, said Mills, we’ve spent a full decade trying to fix these problems.
How have we done? What strategies, processes, systems, measurements and tools should institutions have in place today?