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On Friday, the Basel Committee on Banking Supervision’s Working Group on Liquidity released a paper entitled “Liquidity Risk: Management and Supervisory Challenges”. In view of the relevance of the Working Group's review, the Basel Committee is publishing the key findings now. These highlight financial market developments that affect liquidity risk management, discuss national supervisory regimes and their components, and outline initial observations from the current period of stress.
"The extreme liquidity conditions of last summer and resulting difficulties that persist today are vivid illustrations of the critical importance of market liquidity to the banking sector," stated Nout Wellink, Chairman of the BCBS. "These events emphasised the links between market and funding liquidity, the interrelationship between funding liquidity risk and credit risk, and the fact that liquidity is a key determinant of banking sector soundness."
Last October, we reported that the BCBS said that the implementation of the Basel II capital framework would have gone some distance to alleviate the global credit crunch which had resulted from the sub-prime lending crisis. Wellink then said that Basel II was designed to combat liquidity risk and would have improved the robustness of valuation practices and market transparency for complex and less liquid products. This met with an amount of surprise from many industry participants. Liquidity risk is only specifically mentioned three times in Basel II and only in general terms such as saying it was crucial, of concern and that banks should have systems for measuring, monitoring and controlling it.
Chris Whalen, Editor of the Institutional Risk Analyst said at the time “With all due respect to Nout Wellink and the other members of the BCBS, we do not believe that the implementation of the Basel II proposal or anything that looks remotely like it would have alleviated the ongoing collapse of the market for complex structured assets. When an entire asset class literally dies in a matter of weeks, the risk is infinite. To us, measuring the liquidity or market risk of a Structured Investment Vehicle ("SIV"), with or without the Basel II framework, makes about as much sense as using statistics to predict corporate credit defaults.”
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