Integrated balance-sheet management: banking executives need to rethink approaches to governance, organization and technology to identify and manage risk in a holistic fashion

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Date: Dec. 2010
From: Bank Accounting & Finance(Vol. 24, Issue 1)
Publisher: CCH, Inc.
Document Type: Report
Length: 2,869 words
Lexile Measure: 1510L

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The financial crisis has highlighted interdependencies across different risk categories, for example, the impact of market liquidity risk on counterparty credit risk. In the aftermath of a crisis, leaders are eager to promise solutions and change. But as memory fades, complacency can set in. It may be recalled that in the late 1990s, the collapse of Long-Term Capital Management was followed by banks, trade groups and regulators debating the need to manage market, credit and liquidity risks in a more unified fashion. Fast-forward to the present, and one could be forgiven for having a strong sense of deja vu. This time, however, appears different. The general thrust of future financial regulation--from a rulemaking, monitoring and enforcement perspective--is pushing banks toward a more integrated approach to the management of risks, capital and funding.

The new Basel III rules, for instance, recognize the linkages between capital and liquidity and seek to increase the resilience of the banking system to financial and economic shocks through higher capital and liquidity buffers in particular, but also through requiring robust systems supported by high-quality data. In addition, the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") requires periodic stress testing that should create further alignment between capital and liquidity. This is emphasized by the recent U.S. Federal Reserve requirement for the 19 Supervisory Capital Assessment Program (SCAP) banks to show how their integrated stress tests support their capital plans, including the impact of Basel III and Dodd-Frank. Meanwhile, the concept of bank "living wills," or recovery and resolution plans that are central to the new U.S. legislation, is intimately connected with a holistic view of the business, while emphasizing the importance of legal entity, line of business and "economic function" dimensions. These broader perspectives all seek to take into account an organization's funding, liquidity and capital in terms of the business and legal structure. A key goal for institutions is to understand how a bank's balance sheet might behave in times of stress as well as understand the impact of potential management actions.

Many decisions that, in the past, were made in isolation will have to be examined within a common framework. For example, until recently, many large banks formulated their capital contingency plans (CCPs) and contingency funding plans (CFPs) separately. This separation can fuel contradictory and potentially harmful decisions, such as a large sale of assets under a CFP that leads to a significant realized mark-to-market loss that undermines a bank's capital position in a way not anticipated within the CCP. Further, in developing recovery and resolution plans, banks will need to ensure alignment across jurisdictions and their capital and funding contingency plans at both group and subsidiary levels.

Silo-Based Management: Causes and Consequences

Before the global financial crisis, when banks spoke of integrated risk management, their scope was often narrow--perhaps involving only market and credit risks that were of great interest to all stakeholders and also quite well-defined. After all, the trading of market and credit risks had helped drive profits, so significant...

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Gale Document Number: GALE|A248093673