Contingency Planning

Recent volatility in the wholesale funding markets has highlighted both the importance of sound liquidity risk management practices and the fact that financial institutions can and have experienced liquidity problems even during good economic times. As a result, a bank management's ability to adequately meet daily and emergency liquidity needs while controlling liquidity risk through risk identification, monitoring, and controls is receiving increasingly intense regulatory scrutiny. To meet the new demands of liquidity risk management, banks have evolved new techniques.

Banks should have a formal contingency plan of policies and procedures to use as a blueprint in the event the bank is unable to fund some or all of its activities in a timely manner and at a reasonable cost. Industry experts generally agree that these crises tend to develop very rapidly. Their onset is no longer measured in days but rather hours.

A comprehensive contingency funding plan can provide a useful framework for meeting both temporary and long-range liquidity disruptions. A good plan should emphasize a reliable but flexible administrative structure, realistic action plans, ongoing communications at all levels, and a set of metrics backed by adequate management information systems. Periodic testing of contingency MIS requirements ensures the availability of timely reports for rapid decision-making.

Excerpt from: The Changing Character of Liquidity and Liquidity Risk Management: A Regulator's Perspective, by Paul A. Decker (April 2000).