Introduction

• The banking industry’s interest in intraday liquidity risk in the United States can be traced back to the early 1980s. The Federal Funds rate dramatically increased from an average of 11.2% in 1979 to a peak of 20% in June of 1981, resulting in an extended period of high real interest rates. At the time, the Fed did not pay interest on bank deposits, and correspondent banks could not pay interest on operating balances in demand deposit accounts (both of which are now permitted). Due to this, banks actively managed their balances down to the minimums called for by: (a) Reserve requirement regulations (at their Federal Reserve accounts). (b) Compensation arrangements for services provided by correspondent banks. This often meant their accounts were in a negative position during the day (hence the terms intraday daylight and overdraft). Large overdrafts became endemic in the banking systems in the middle of the business day during this period, and there were not many incentives for banks to leave idle cash reserves at the Federal Reserve (Fed) and correspondent banks.

• There were two reasons why central banks were concerned about daylight overdrafts: First, central banks wished to avoid inadvertently extending credit to their member banks. Second, intraday overdrafts were significantly expanding the effective money supply, causing central bankers to worry about this “shadow” money supply.
• The Federal Reserve released a policy in 1985 that began the process of containing and eventually shrinking daylight overdrafts in the banking system. This table compares the annual average peak intraday overdraft (calculated system-wide) and the M1 money supply in five-year snapshots beginning in 1986, when the Federal Reserve began measurements. Peak overdrafts routinely approached 10% or more of the money supply in the early years. In today’s environment, which is characterized by low interest rates and accommodative monetary policy, intraday overdrafts are much smaller, both in nominal terms and in proportion to the M1 money supply.

	1986	1991	1996	2001	2006	2011	2013
Peak Intraday Overdraft ($billions)	62.9	106.2	67.4	99.4	140.0	29.4	16.6
M1 Money Supply ($billions)	666.3	859.0	1106.9	1140.2	1374.8	2009.6	2511.3
OD as % of M1	9.4%	12.4%	6.1%	8.7%	10.2%	1.5%	0.7%

• The trend in aggregate intraday overdrafts illustrated in this table demonstrates the success of the Fed’s efforts to more effectively manage payment systems risk. Since then, the Board of Governors has continued to expand and modify its payment systems risk policies by introducing new tools and refining existing ones to reduce the aggregate level of intraday overdrafts.
• International interest in intraday liquidity risk began to accelerate during the mid-1980s as well. In 1980, the central banks of the Group of Ten (G10) countries established a working group called the Group of Experts on Payment Systems, which in 1990 became the Committee on Payment and Settlement Systems (CPSS) and is now the Committee on Payments and Market Infrastructures (CPMI), a committee of the Bank for International Settlements (BIS).
• Most recently, the CPMI (which now consists of representation from twenty-five central banks) has been focused on the implementation of its Principles for Financial Market Infrastructure, a set of standards and policies designed to guide credit, liquidity, and systemic risk management at payments, clearing, and settlement systems. Reflecting the influence of CPMI, the central banks of most developed countries around the world are striving to align their regulations with the risk management principles espoused by CPMI (formerly CPSS). CPMI has worked in conjunction with the Basel Committee on Banking Supervision (BCBS), another committee of central bank experts that is part of BIS. In response to the 2007-08 financial crisis, BCBS significantly expanded its work in liquidity risk and began incorporating intraday liquidity risk into its framework. In April 2013, BCBS published Monitoring Tools for Intraday Liquidity Management, a paper designed to help regulators and banks track intraday risk more empirically.

Shortage Of Intraday Liquidity

• Banks face a shortage of liquidity during the day because of two reasons:
  • First, certain market conventions and behaviors that have been engrained over decades serve to institutionalize intraday overdrafts. For example, the typical pattern is to borrow to cover funding shortfalls in the afternoon and return the funds at the opening of business the next day. Thus, a bank that is a net borrower of fed funds may overdraft its Federal Reserve account during the middle of the day after returning borrowed funds from the previous day.
  • The second type of behavior that generates daylight overdrafts is the provision of intraday credit to clients. Many banks allow their corporate and institutional clients to deploy cash intraday without sufficient funds in their accounts. For instance, a commercial client may expect a large wire transfer to be received in the afternoon but still wish to fund its payroll in the morning.

Uses Of Intraday Liquidity

• The common uses of intraday liquidity are:
  1. Outgoing wire transfers
     • Outgoing wire payments, on behalf of clients or the bank’s own account, are typically the largest use of intraday liquidity. Payment activity runs the entire length of the business day and typically follows a fairly predictable pattern. Some large banks have to carefully manage the volume of outgoing payments when their daylight overdraft approaches the level of their debit cap. This is accomplished by “throttling” outgoing payments and closely monitoring incoming credits to ensure the cap is not exceeded. Most large value payment systems (LVPSs) and some other payment, clearing, and settlement systems (PCSs) have hard controls that prevent participants from exceeding their intraday credit limits.
  2. Settlements at PCS systems
     • Most PCS systems have one settlement per day, with many occurring in the late afternoon timeframe. This may serve as either a source or use of funds depending on the net position of a participant on any given day.
  3. Funding of nostro accounts
     • Banks manage the cash they place in correspondent bank accounts to a target average monthly balance as part of the compensation provided to the correspondent for its banking services. On any given day, the account funding position may act as a source or use of funds to the bank’s overall liquidity profile, depending on the net position of the activity flowing through the account that day. Nostro account balances are replenished or drawn down on a daily basis.
  4. Collateral pledging
     • Some banking activities, such as over-the-counter capital markets trading and deposits of certain public funds, require a bank to earmark and set aside collateral. Acquiring additional collateral to support an increasing liability (or as a result of a mark-to-market induced margin call) is a frequent use of intraday funding. Collateral positions are adjusted on a daily basis.
  5. Asset purchases/funding
     • Funding other balance sheet assets, such as securities purchases for the investment portfolio, client loans, and fixed asset purchases, is another common use of intraday liquidity.

Sources Of Intraday Liquidity

The Common Sources of Intraday Liquidity

1. Cash Balances
   The most obvious source of intraday liquidity is the starting cash held on the bank’s balance sheet at the beginning of the day. This includes deposits at the central bank and at a correspondent bank’s accounts.
2. Incoming Funds Flow
   Incoming flows from payments and FMU settlements are the largest source of intraday funding in periods of normal market function. Some inflows, including LVPS payments, are real-time. Other credits are batch-oriented, such as net settlements with clearinghouses, retail payment systems, etc.
3. Intraday Credit
   Central banks serve as a large source of intraday credit for the banking system, and their borrowing terms vary across jurisdictions. The Federal Reserve provides an unsecured committed line of credit (in the form of its Net Debit Cap program) and charges interest for tapping the line. The Bank of England requires intraday overdrafts to be collateralized by the highest quality government securities but does not charge interest. FMUs and other banks may also provide intraday credit. Interbank daylight overdraft lines of credit are generally uncommitted and free, but there are some signs of change, especially in Europe. FMUs extend daylight credit by allowing a participant to enter trades or transactions during the day while potentially accumulating a large settlement position that must be met at the end of the day. The final section of this chapter discusses multiple risk management tools used by FMUs to mitigate these exposures.
4. Liquid Assets
   Banks typically carry a buffer of highly liquid, near-cash investments that can be liquidated for cash within short order. This pool of assets includes money market instruments, time deposits, banker’s acceptances, and high-quality, short-term government debt.
5. Overnight Borrowings
   Fed funds, London Interbank Offered Rate (LIBOR), and Eurodollar deposits are examples of overnight borrowings that can provide quick, intraday liquidity for a bank. These types of borrowings are not repaid on the same day, so they will remain on the borrower’s balance sheet overnight. When determining whether or how much to borrow overnight, the bank treasury must weigh the potential cost of having excess liquidity at the end of the day against the risk of not being able to complete the current day’s business (or facing reputational risk exposure from delayed transactions) due to breaching a daylight overdraft limit.
6. Other Term Funding
   Similar to overnight borrowing, a bank can tap into other funding sources (e.g., Federal Home Loan Banks (FHLB) borrowings, term repos) further out on the maturity curve if the lenders can provide funding at a time of day that meets the bank’s intraday funding needs. Again, the bank would only do this if it has the appetite for longer-term funding (one week, one month, etc.). This type of borrowing is generally viewed as an incremental factor to include in a given day’s liquidity positioning ledger rather than a consistent source of intraday funding.

From these different sources, the volume of cash inflows and outflows within the bank must be managed to ensure that the bank remains within the limits of its daylight credit resources and ends the day with the appropriate target balances in its accounts. There are three main issues that need to be addressed:

1. Variability of Cash Flow Patterns
   While many activities generate consistent patterns of inflows and outflows over time, there can be high levels of volatility day-to-day, with little advance notice of large cash requirements or sources.
2. Impact of Market Forces
   Daily volatility in asset prices can result in unanticipated margin calls that require additional cash funding. Additionally, central bank money desks that implement monetary policy directly may influence available liquidity in the marketplace, impacting a bank’s ability to source or deploy intraday funds.
3. Lack of Real-Time Data
   Most bank treasurers today do not have a comprehensive, single source for real-time balances and expected transaction flows, which complicates the task of determining and forecasting cash throughout the day.

Governance Structure Of Intraday LRM

• All risk management frameworks start with a governance structure that defines the roles and responsibilities of various bank employees and committees in overseeing risk-related activities. The following are the characteristics of an effective governance structure for overseeing intraday liquidity risk:

1) Active risk management

• In many institutions, intraday liquidity risk is accepted as a cost of doing business and is not as actively managed with the same level of rigor as other types of enterprise risk or even other liquidity risks.
• The leading banks with large volumes of PCS activities recognize the criticality of understanding and working to reduce their intraday liquidity risks.
• These institutions classify settlement and systemic risks as components of their risk taxonomy and, critically, incorporate them into the firm’s risk appetite framework.

2) Integration with risk governance

• Oversight of intraday liquidity risk management is integrated into the bank’s overall risk oversight structure. This ensures that:
  • The intraday liquidity risk management framework follows the industry’s three lines of defense model, with particular emphasis on expertise in the second line of defense to coordinate across the institution.
  • Roles and responsibilities for all aspects of intraday liquidity risk management in all lines of defense are clearly defined.
    • Treasury is the first line of defense, actively managing the intraday and end-of-day funding positions of the bank as well as the risk management programs related to funding activities.
    • Corporate Risk Management is the second line of defense, responsible for overseeing funding-related policy and procedures, advising in the development of risk management programs, monitoring the ongoing risk-taking activities across all of a bank’s funding desks, aggregating reporting across the bank, and providing an independent view of the effectiveness of the bank’s overall intraday liquidity risk management programs.
    • Internal Audit is the third line of defense, responsible for independently assessing the bank’s adherence to its intraday risk policies and procedures.
  • Key decisions are made and reviewed by the appropriate level of management.
  • Oversight committees have the appropriate representation from the critical areas (e.g., treasury, operations, IT, lines of business).

3) Risk assessment

• At leading institutions, intraday liquidity risk is incorporated into the risk taxonomy and is a component of risk self-assessments.
• Through this analysis, settlement risks related to existing and potential new products and operational processes are identified, measured, and evaluated.
• The line of business and risk management review the effectiveness of controls in mitigating settlement risk.

4) Risk measurement and monitoring

• There are two perspectives from which leading institutions monitor their intraday liquidity risk:
  1. The amount of intraday credit the institution is extending to clients.
  2. The amount of intraday credit the institution utilizes.
• For the first perspective, systemically important financial institutions (SIFIs) have made significant investments in recent years to upgrade their ability to compile and monitor their clients’ real-time cash positions.
• The second measurement perspective should provide a holistic and comprehensive view of all intraday credit used by an institution. This is more challenging because of the following reasons:
  • Availability of cash accounts data – Not all FMUs have real-time account position data.
  • Data aggregation – Consolidating data into a single repository that enables comprehensive analysis and monitoring poses significant institutional challenges.

Measurement Of Intraday Liquidity

Measures for Understanding Intraday Flows

1) Total Payments

• A bank and its intraday risk management teams should maintain statistics concerning the amount of payments it makes on all electronic payments systems in which it participates.
• For every payment, a bank would store in a data warehouse the critical information needed for analysis, such as payment amount, time received or originated, times for each processing step in the payment workflow, routing information, payer and payee, payment system used, any suspensions of the payment, and so on.

2) Other Cash Transactions

• A bank should also track its intraday and end-of-day settlement positions at all financial market utilities in which it participates.
• The bank should try to maximize the amount of transaction-level detail captured and stored for further analysis.
• Securities settlements networks (SSN), particularly those utilizing a central counterparty (CCP) model, often manage their intraday and overnight risk exposures through collateralization.
• A bank participating in an SSN should strive to capture snapshots of its account and collateral positions throughout the trading day. For example, the Federal Reserve uses one-minute intervals for tracking collateral positions.

3) Settlement Positions

• If complete data to reconstruct account positions at any time of day is not available, at a minimum, a bank should maintain data on its settlement positions with all its FMUs.
• These critical, deadline-specific payments, often with large transaction amounts, are critical to managing intraday liquidity and systemic risk.
• A bank should monitor patterns in settlement positions and correlate them with external market factors to improve its ability to predict upcoming liquidity requirements earlier in the day.

4) Time Sensitive Obligations

• Similar to settlement positions, these transactions require completion at a specific time during the day.
• Examples include transactions concerning market activities (such as the return of borrowings), margin payments, and other payments critical to a bank’s business or reputation (e.g., client closing on a corporate acquisition).
• Failure to settle certain time-sensitive obligations could result in a financial penalty or other negative consequences.
• A bank should monitor the volume and settlement patterns of these time-specific obligations by recording the amounts and deadline times.

5) Total Intraday Credit Lines to Clients and Counterparties

• A bank risk manager looking after the bank’s own intraday liquidity risk needs to understand the potential and actual amounts of intraday credit the bank is extending to clients and counterparties.
• In some cases, these intraday credit lines could be committed and disclosed to the client, but most are uncommitted and undisclosed.
• In addition to the credit lines, the bank should have data regarding average and peak usage, and the ability to model activity at the client and portfolio levels.

6) Total Bank Intraday Credit Lines Available and Usage

• As demonstrated through the requirements for preparing resolution plans, regulators increasingly expect financial institutions to understand and manage the amount of systemic risk they pose to the overall financial system (in addition to the risk posed to taxpayers and industry-funded insurance plans).
• A key component of that analysis is the amount of intraday credit that a bank relies on in business-as-usual conditions and the maximum amount of intraday borrowing it can draw down.
• This data captures the amount of committed and uncommitted intraday credit (and usage thereof) the bank has at its disposal, ideally across all of its cash and settlement accounts.

---

Measures for Quantifying and Monitoring Risk Levels

1) Daily Maximum Intraday Liquidity Usage

• This is a measure of the bank’s usage of an intraday credit extension.
• This calculation does not require real-time monitoring of an account to capture all of the negative positions.
• The measure is the ratio of the day’s largest net negative balance relative to the size of the committed or uncommitted credit line.
• Typically, the peak and average of this metric are tracked over a period of time (e.g., monthly).
• At a minimum, this measure should be tracked for every cash account held at the central bank, FMUs, and correspondent banks.
• Ideally, a bank should also monitor its consolidated position across all accounts between which liquidity can be readily transferred intraday.

2) Intraday Credit Relative to Tier 1 Capital

• This measure is a broad representation of the intraday settlement risk posed by a bank.
• The measure should be tracked for total intraday credit and unsecured intraday credit, available and used, under the theory that posting high-quality collateral mitigates intraday settlement risk.
• Available, unsecured intraday credit relative to an institution’s tier 1 capital is a rough measure of the inadvertent systemic risk that the institution poses to the financial system.
• Such measures, when viewed as a time series, and in comparisons to other institutions, provide bank risk managers with an understanding of the relative systemic risk of their business model as well as changes in their risk profile over time.

3) Client Intraday Credit Usage

• This measure is derived by comparing a client’s peak daily intraday overdraft to the established (committed or uncommitted) credit line.
• Tracking aggregate intraday credit exposures provides a bank with an indicator of required liquidity needed to support its clients’ business activities.
• Monitoring the averages, volatility, and correlation of these measures to other money market indicators provides useful insights for understanding how client activity impacts the bank’s ability to manage its own intraday liquidity.
• Tracking client usage of intraday credit lines at the individual client level enables risk managers to pinpoint clients that run frequent overdrafts and determine if these clients need to change their practices or if the bank needs to increase its charges for this credit extension.
• Monitoring these measures over time can provide indicators of the success of any initiatives undertaken to modify client behavior in order to reduce reliance on intraday credit.
• Finally, bank risk managers can use this data to inform policies regarding the provision and size of intraday credit lines relative to industry cohorts and client risk levels.

4) Payment Throughput

• These measures track the percentage of outgoing payment activity relative to the time of day.
• For banks that are direct participants in FMUs, it is useful to actively measure and monitor the flow of outgoing payment transactions relative to total payments or time markers for several reasons:
  1. To track its volume patterns and help ensure that all of the day’s payments are processed in time.
  2. In some cases, to meet FMU requirements for submitting a target percentage of payments by a deadline.
  3. To help the bank identify and monitor its peak periods over time and the correlation of this activity with its intraday liquidity on hand and intraday credit usage.
• In addition, a bank can track its peak intraday credit usage relative to total volumes with an FMU to provide an indicator of the efficiency of the FMU’s usage of daylight credit.
• FMUs employ different system rules and operating models resulting in variations in how efficiently they use intraday liquidity.
• Understanding these differences can enable a bank to redirect payment flows as a tool to manage intraday liquidity needs, assuming it has the requisite operational capabilities.