A. Information and reporting arrangements

Virtually every financial transaction or commitment has implications for a bank's liquidity. Moreover, the transformation of illiquid assets into more liquid ones is a key activity of banks. Thus, a bank's liquidity policies and liquidity management approach should form key elements of a bank's general business strategy. Understanding the context of liquidity management involves examining a bank's managerial approach to funding and liquidity operations and its liquidity planning under alternative scenarios.

In particular, all banks should have an articulated and specific liquidity policy setting out the general importance management places on liquidity. Such a policy should also enunciate specific policies on particular aspects of liquidity management, such as the relative reliance on the use of certain financial instruments and the encouragement of closer relationships with supervisors. This general policy should be approved by a bank's board of directors.

An important element in such a policy will be a liquidity reporting structure designed to provide senior management with timely information and to be flexible enough to deal with various contingencies that may arise during crises. Banks that stress the importance of liquidity assign ultimate responsibility for setting liquidity policy and reviewing liquidity decisions to the bank's highest level of management, and their decisions need to be reviewed periodically by the board of directors.

A bank's investment in information systems designed to gather and analyse detailed information on assets and liabilities may need to be substantial. Because market conditions and a bank's own liquidity needs change constantly, extensive computer systems are often necessary to provide management with relevant information on an accurate and up-to-date basis. Such systems can also be helpful in projecting the bank's liquidity positions under a variety of conditions. Sometimes these systems are integrated into information systems monitoring other activities or risk exposures of the bank.

Finally, a schedule of frequent routine liquidity reviews and less frequent, but more in-depth reviews should be provided for. These reviews provide the opportunity to re-examine and refine a bank's liquidity policies and practices in the light of a bank's liquidity experience and developments in its business.

B. Treatment of foreign currencies

Hence, when a bank conducts its business in multiple currencies, its management must make two key decisions. The first concerns management structure. A bank with funding requirements in foreign currencies will generally use one of three approaches. It may completely centralise liquidity management (the head office managing liquidity for the whole bank in every currency). Alternatively, it may decentralise by assigning operating divisions responsibility for their own liquidity, but subject to limits imposed by the head office or frequent, routine reporting to the head office. For example, a non-European bank might assign its London office responsibility for the liquidity management for its European operations in all currencies. As a third approach, a bank may assign responsibility for liquidity in the home currency and for overall coordination to the home office, and responsibility for the bank's global liquidity in each major foreign currency to the management of the foreign office in the country issuing that currency. For example, the treasurer in the Tokyo office of a non-Japanese bank could be responsible for the bank's global liquidity needs in yen. All of these approaches, however, provide head office management with the opportunity to monitor and control worldwide liquidity.

The second decision concerns the liquidity strategy in each currency. In the ordinary course of business, a bank must decide how foreign currency funding needs will be met. To what extent, for example, will a bank fund foreign currency needs in domestic currency and convert the proceeds to foreign currency through the foreign exchange market or currency swaps? How will a bank manage the associated risk that exchange markets will cease to be available? A bank's assessment will depend on the size of its funding needs, its access to foreign currency funding markets, and its capacity to rely on off-balance-sheet instruments (e.g. standby lines of credit, swap facilities, etc.).

A bank must also develop a back-up liquidity strategy for circumstances in which its normal approach to funding foreign currency operations is disrupted. Such a strategy will call for drawing either on home currency sources and converting them to foreign currency through the exchange markets or drawing on back-up sources in particular foreign currencies. For example, back-up liquidity for all currencies may be provided by the head office using the home currency, based on an assessment of the bank's access to the foreign exchange market and the derivative markets under the conditions in which the original liquidity disturbance is likely to occur. Alternatively, a bank's management may decide that certain foreign currencies make up a sufficient part of its liquidity needs to warrant separate liquidity back-up. In that case, either the home office or the regional treasurer for each specific currency would develop a contingency strategy and negotiate liquidity backstop facilities for those currencies.