69)A bank should design a set of indicators to aid this process to identify the emergence of increased risk or vulnerabilities in its liquidity risk position or potential funding needs. Such early warning indicators should identify any negative trend and cause an assessment and potential response by management in order to mitigate the bank’s exposure to the emerging risk.
70)Early warning indicators can be qualitative or quantitative in nature and may include but are not limited to:
•Rapid asset growth, especially when funded with potentially volatile liabilities.
•Growing concentrations in assets or liabilities.
•Increases in currency mismatches.
•A decrease of weighted average maturity of liabilities.
•Repeated incidents of positions approaching or breaching internal or regulator limits.
•Negative trends or heightened risk associated with a particular product line, such as rising delinquencies.
•Significant deterioration in the bank’s earnings, asset quality, and financial condition.
•Negative publicity.
•A credit rating downgrade.
•Stock price declines or rising debt costs.
•Widening debt or credit-default-swap spreads.
•Rising wholesale or retail funding costs.
•Counterparties that begin requesting or request additional collateral for credit.
•Correspondent banks that eliminate or decrease their credit lines.
•Increasing retail deposit outflows.
•Increasing redemptions of CDs before maturity.
•Difficulty accessing longer-term funding.
71)Early warning indicators should be closely monitored by senior management on a regular basis. Limits and analysis of the indicators above should be reviewed and breaches/emerging trends should be escalated up to the board committees or the full board if significant enough.
72)Clear procedures and escalation criteria should be put in place based on the warning indicators; these include the circumstances where the Contingency Funding Plan (CFP) should be invoked.
A bank must conduct its own internal stress tests on a regular basis for a variety of institution specific and market wide stress scenarios (individually and in combination). The scenarios should be based on the individual bank specific circumstances and business model.
73)While a bank typically manages liquidity under “normal” circumstances, it should also be prepared to manage liquidity under stressed conditions. A bank should perform stress tests or scenario analyses on a regular basis in order to identify and quantify its exposures to possible future liquidity stresses, analyzing possible impacts on the institution’s cash flows, liquidity position, profitability and solvency.
Stress testing process
74)Tests should be :
•Test should be done on individual entity basis, group basis and business lines.
•Tests should consider the implication of the scenarios across different time horizons, including on an intraday basis.
•The extent and frequency of testing should be commensurate with the size of the bank and its liquidity risk exposures.
•Banks should build in the capability to increase the frequency of tests in special circumstances, such as in volatile market conditions or at the request of the Central Bank.
•Senior management should be actively involved in the stress test demanding rigorous assumptions and challenging the results.
•The board should be informed of the stress testing results and should be able to challenge outcomes, assumptions and actions taken on the basis of the tests.