Navigating Financial Turmoil: Liquidity Management

The first quarter of 2023 was daunting for fund managers as the banking crisis unfolded. When the Federal Reserve raised interest rates in response to high inflation, it caused the collapse of three large banks and turmoil throughout the banking industry. Typically, bank failures have a domino effect on the financial system, leading to a liquidity crunch that can adversely affect other financial firms as well.

The collapse of Silicon Valley Bank, however, was symptomatic of a much bigger problem: excessive risk-taking by financial institutions. In this blog, we will explore the challenges buy-side firms face as a result of the banking crisis and provide insights on how to address these challenges with efficient treasury management and cash management.

Implications of Liquidity Risk for Buy-Side Firms

Buy-side firms are not subject to the same level of regulatory oversight and transparency as banks, which means they are more vulnerable to risks. For this reason, it is essential for asset managers to understand the risks associated with a banking crisis and implement effective risk management strategies.

One of the most common risks funds face during a banking crisis is liquidity risk. Liquidity risk is associated with a fund’s ability to meet its financial obligations. In buy-side firms, liquidity risk can arise for many reasons, such as a sudden increase in redemption requests, unexpected market movements, or counterparty defaults. A lack of sufficient liquidity may impair the fund’s ability to finance operations, make investments, or meet financial obligations on time.

Challenges in Liquidity Risk Management

Specifically, funds can encounter four major liquidity management challenges in a banking crisis. They are:

• Bank defaults/failures: Funds rely on banking partners for a variety of services, including financing, clearing, and settlements. The financial health and creditworthiness of banks or counterparties come under increased pressure during a crisis, and a bank failure or default can lead to significant losses and operational disruptions for funds. It is essential that funds regularly assess the stability of banking partners or counterparties and the associated credit risks.
• Business continuity: During a banking crisis, funds may face difficulties in accessing sufficient liquidity to meet current obligations. This can limit the ability to honor redemption requests from investors, meet margin calls, or fund day-to-day operations. Consequently, this can cause reputational damage, legal actions, and potential regulations.
• New bank onboarding: In order to relieve liquidity constraints, funds may look to onboard new banking partners in a crisis. However, this process is complicated and time-consuming. Assessing the financial health and risk profile of a new bank is critical, and thorough due diligence takes considerable time. Integrating systems between the fund and the new bank adds even more complexity, impacting operational efficiency.
• Regulatory scrutiny and compliance: During a financial crisis, regulatory bodies scrutinize buy-side firms much more closely to ensure compliance with risk management and reporting requirements. This increased regulatory pressure, along with the need to demonstrate sufficient liquidity and risk controls, can create additional burdens for funds and asset managers.

How IVP can help

The IVP Treasury Management platform can help fund managers mitigate the four major liquidity management risks associated with a banking crisis as well as prepare for similar scenarios in the future. Overall, this platform enables buy-side firms to:

1. Create forward-looking estimates that enable proactive liquidity risk management
2. Generate accurate and timely cash flow forecasts using scenario analysis with configurable parameters
3. Optimize cash management by tracking unencumbered cash and integrating with MMF platforms
4. Implement treasury workflows faster to allow quick onboarding of new banking partners
5. Track and monitor real-time cash across counterparties and currencies
6. Perform basis risk modeling to incorporate FX rates/yield curves

Effective liquidity risk management is crucial for buy-side firms, but especially during a banking crisis. The failure of banks can lead to a severe shortage of liquidity in financial markets, which in turn makes it difficult for buy-side firms to meet existing obligations. By implementing a comprehensive treasury management solution, asset managers can ensure access to necessary cash on hand while minimizing exposure to liquidity risk.

Learn more about the IVP Treasury Management platform or contact us at sales@ivp.in to schedule a live or online demo.