We all know the old saying “money makes the world go round”, but money can only do that in a liquid sate. Liquidity refers to how easily an asset can be transferred, the more “liquid” an asset is the quicker you can convert it into cash and get your organization out of potential financial strife.
Managing an organization's liquidity is an important element in any business, but this is far more critical on the wholesale banking and high value payments markets. If a corporate runs out of money the impact is generally contained, if a Bank runs out of money the impact could cause market collapse.
For reference, insufficient liquidity was a contributing factor in the demise of Lehman Brothers, which in turn sparked the 2008 Financial Crisis and more recently the collapse of Silicon Valley Bank (SVB). Luckily SVB did not create the same cascading systemic failure in our financial systems (the GFC) that Lehman Brothers did. Some interesting speculation (food for thought) is the underpinning driver for SVB, Signature and First Republic banks is related to the COVID driven devaluation of the commercial property sector, whereas the GFC was a result of retail property devaluation, if this is true we may see this financial crisis play out over the coming years as commercial property contracts mature.
In today’s business landscape, technology and regulation within the financial sector is changing at an ever-increasing pace, and the pressure is on for global corporations, banks, and financial institutions to manage liquidity more effectively on an intra-daily basis.
Introduction
In this blog, I’ll investigate the advantages and the significance of effective liquidity management, and the risks of not doing so, particularly when dealing with high value payments on the interbank and wholesale markets.
Financial agility is vital to remain prepared for any potential business risks and to enable quick decision-making when potential risks become unfortunate situations. Effective liquidity management allows organizations to maintain adequate cash positions to meet immediate and short-term obligations.
The first step to effective liquidity management is visibility, if you cannot see the obstacles ahead you stand very little chance of successfully navigating your way through.
How real-time visibility is helping achieve effective liquidity management
This is not a new phenomenon, it should not take anyone by surprise that as the world accelerates into conducting business in real-time, so does the need to manage cash in real-time. The speed at which bad news travels on Twitter can create a ‘bank run’ so quickly that it will empty your deposit accounts and collapse your Bank before you have time to react; just as we saw happen with Silicone Valley Bank.
Historical data, stable investments and predictable monthly cash-flow cycles are a thing of the past, financial institutions are now recognizing that the world moves very quickly these days and if you do not have real-time visibility across your current financial position you are at risk of imminent collapse.
At the core of effective liquidity management is being able to see the full financial picture. Making the right decision at the right time is dependent on having visibility into every transaction and cash flow as they happen in real time, managing data collection and analysis of that data dynamically has never been more crucial to ensure our Banks are stable and financially viable.
Not all liquidity related issues result in spectacular collapses, most are smaller in nature without dramatic consequences, but they do occur more frequently. Real-time visibility also highlights smaller errors as they occur, which allows for corrective action to be taken before these smaller problems escalate into large one with associated SLA or regulatory penalties.
While the need for real-time transaction and liquidity monitoring solutions is evident, not every bank has the infrastructure, motivation, or the ability to effectively manage their real-time liquidity and associated transactions.
The pitfalls of idle cash reserves
Every large bank or financial institution holds some cash reserves, in most jurisdictions this is described as a minimum Capital Adequacy Ratio (CAR) and enforced by central banks and regulators.
The most profitable approach is to not have any cash reserves with all funds put towards investments, however without idle cash reserves a Bank would become illiquid very quickly when a few customers withdraw their deposits, alternatively too much idle cash and profitability suffers as the funding is no available for higher return investments. The CAR is a regulatory measure to make sure Banks do not run out of money, but the same rules apply in balancing settlement obligations against higher investment returns.
Breach the CAR and you risk regulatory penalties and high risk of encountering liquidity issues, but to far above the CAR with too much idle cash appearing repeatedly on a balance sheet can be viewed negatively by an organization’s investors.
Most Banks will tend to stay close to the CAR and maximize their returns by locking into longer term investments, with funds locked away in long positions short-term funding becomes highly impacted by the immediate, in-flight transactional activity of payments occurring in real time.
How real-time payment processing benefits liquidity management
As banks and financial institutions globally move away from traditional cut-off times and end-of-day-processing to faster real-time payment and settlement systems, the benefits to business are rapidly emerging.
Payment settlement in seconds, rather than hours or days creates far more agility in budgeting and liquidity management:
- Faster payments boost consumer confidence and facilitate economic interaction and trade both in goods and services.
- Financial controllers and treasury teams no longer need to wait for the next business day to check on the progress of cross-border or high value payments.
- FX exposure is reduced, as are intra-day limits and associated bank fees.
- Ability to plan, strategize and make decisions based on real time cash flows fortifies currency and bank counterparty risk management practices, and at the same time improves working capital optimization.
The speed of cash movement introduces new risks in managing liquidity, but having the right information and systems to help us understand how that cash is moving in real time allows us to manage these new introduced risks.
The fundamental strategy for effective liquidity management
Effective liquidity management has been a discussion topic for many years, many papers have been written on the topic and a quick Google search for “key liquidity strategies successful organizations adopt” will result in many possibilities to explore.
Many aspects of liquidity management are important in their own way, however only one stands out as fundamental cornerstone to all of them and that is having the right data at the right time in the first place.
In a real time world where liquidity now moves intra-day, it is not enough to rely on an end-of-day report to protect against possibilities such as a run-on your Bank, by the time you get your end-of-day report your deposit accounts could already be cleared out.
Being able to monitor your liquidity positions as they happen is now more important than ever and as more countries and global banking systems adopt 24x7 real time payment systems this problem is likely to expand to not only monitoring intra-day payments but also ones that occur outside of business hours, on weekends and public holidays.
How IR can help optimize liquidity management in high value payments
High value payments have a vital role in the global financial landscape. When dealing with high value payments, it’s imperative that businesses have a comprehensive insight into these payments as they’re processed. Without these insights, organizations face the risks of losing customer trust, regulatory action, and penalties.
IR Transact’s High Value Payment solution simplifies the complexity of managing your entire payments environment, providing the best possible solution for monitoring the health of your high value in-flight transactions in real time.
