I never thought I would be writing this, but the regulation that banks now face as a result of the financial crisis in 2008 has given them some benefits. In particular, in the area of risk management, the regime is onerous. There are rules which we could describe as prescriptive, and there are also regulations that, while not telling you how to do things, make it very clear that senior executives are personally responsible. This means that banks and building societies have been forced to align their thinking with that of the regulator.
By way of contrast, if we look at non-financial institutions that experience the same types of risks that banks do, the pressure has not been the same. Regulation is not as much of a concern; it is about whether the risk management you are putting in place represents value for money in a commercial sense.
This is evident when I work with non-banks, where commercial reality outweighs any regulatory need. That said, things in the banking world are relevant and applicable to the corporate sector: let’s say it’s a chance to benefit from what banks have gone through (every cloud has a silver lining). With this in mind, let us look at how intraday risk can improve what we do.
Intraday risk is the potential for financial loss or disruption that can occur during the course of a day and is primarily due to the management of liquid assets.
Whilst your intraday risk may not be of the same magnitude as that of a bank, it’s worth putting it into context.
As a trader, the bank I was working for had to finance the positions we collectively held. At the time, there was an active and liquid interbank market, so all you needed to do was borrow the right amount on an overnight basis. It was that simple.
Two decades later, I was having a conversation where the Head of Operations explained the difficulties of settling extremely large bond trades. This was all about timing differences. Sometimes payments were hundreds of millions or billions of pounds, and they needed to be made before receiving a similar matching sum of money into the account.
This intraday exposure created problems—the payment bank would not grant credit for such a short-term window of the magnitude required.
The seriousness of this situation was explained as the reputational risk and cost associated with a failed settlement.
There are several steps we can take to mitigate the risk, including real-time settlement, collateralised borrowing, and access to the Bank of England. These options aren’t available to non-banks. But, the risk can nevertheless be managed.
Centralising liquidity management into one area or unit to ensure all surplus positions across the business are consolidated and managed centrally is one approach. Depending on the size of the business, this is not always easy because it relies on obtaining real-time information from various accounts.
In addition, some type of risk analysis is beneficial as it allows you to understand the problem. This analysis would generally look at the cash flows themselves, but it may also monitor things like counterparty risk to ensure your cash is held with sufficiently robust counterparts.
Almost irrespective of the size of the business, having several relationship banks reduces the reliance on any one particular bank to effect payments. This redundancy in your process is considered a useful risk mitigant. Furthermore, it should be tested regularly.
These are all things borrowed from banking, and there’s more.
Improved cash flow forecasting that also looks at real-time data is a very helpful way of understanding cash inflows and drawdowns in the business on a day-to-day basis. This helps us get closer to answering the question, “how much liquidity?”
Steps could include obtaining information from the business; this is preferably daily time series data over the course of, say, a year.
Such an approach would track outgoing payments and incoming receipts during the day to provide a real-time view of the intraday liquidity risk faced by the treasury at various points during the day, for example on an hourly basis or at the end of the day.
We can then dig into exactly what causes the drawdowns because the larger they are, the more we have to set aside to deal with their eventuality. We could go further.
For example, using a simple model that combines real-time monitoring of cash positions with some statistical modelling. This borrows a value at risk type approach which can then be improved by stress testing. Having this information to hand helps set internal limits for intraday liquidity and develop contingency plans for scenarios when and if it is insufficient.
How far you go down this route is up to you; it all boils down to how intraday shortfalls would affect your business.
You can think like a bank even if you aren’t one.
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