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FSA/PN/134/2007
19 December 2007

The Financial Services Authority (FSA) has today published a Discussion Paper (DP) reviewing liquidity requirements for banks and building societies. The paper draws some early lessons from recent market turbulence, suggests how future liquidity policy should develop, and sets out key issues for discussion with the banking industry and other stakeholders.

The FSA's preliminary conclusions are that a principles-based approach is right, but that the application of existing high-level standards needs to be toughened and some form of quantitative liquidity requirements remains necessary. The DP re-emphasises the primary responsibility of firms' boards and management for maintaining adequate liquidity and managing their liquidity risk. It also looks at the market failure and cost-benefit issues involved.

Acting Managing Director of Wholesale Markets, FSA, Thomas Huertas said:

"Assuring adequate liquidity at all times is critical for a bank, and in this paper we recommend that banks take a belt and braces approach. The 'belt' is a comprehensive view of all the demands for funds that a bank could face as well as a plan to meet those demands. The 'braces' are a quantity of cash or assets that can be turned into cash at short notice even under stressed market conditions.

"This paper draws important lessons from how we saw banks and building societies coping with the recent market turbulence. We also analyse the liquidity risks inherent in some of the newer structures such as SIVs, and other off balance sheet or contingent arrangements. Nor is it a one-sided review – we also challenge our own existing policies, as well as firms' liquidity management.

"We already know, following the events of the late summer, that individual firms' stress testing and contingency funding plans need improvement, and our ongoing supervision is addressing this. Banks and building societies need to achieve a higher level of resilience to funding stress.

"But we also want to have a constructive and intelligent debate with the industry about how - in the longer term - liquidity requirements can best, and most cost-effectively, achieve our objectives of consumer protection and market confidence."

The DP delivers on a commitment in the Chancellor's statement of 11 October. The closing date for responses is 31 March 2008. The DP will be followed up with consultation on firmer proposals next summer.

The FSA intends to develop UK policy in line with international work being undertaken by the Basel Committee and the Committee of European Banking Supervisors (CEBS).

Notes for editors

1. Liquidity risk is the risk that a firm, although solvent in balance sheet terms, does not have, or cannot generate, enough cash to meet its payment obligations in full as they fall due.
2. The Discussion Paper: 'Review of the liquidity requirements for banks and building societies' can be found on the FSA website.
3. Following the recent turmoil in the world's financial markets the Chancellor called for an acceleration of the work on international standards for regulating liquidity. The Chancellor's statement can be found on the Treasury's website.
4. At a recent appearance at the Treasury Select Committee, the FSA committed to examine: the extent to which the FSA's framework for assessing risk within firms should place further importance on liquidity issues; whether changes should be made to the FSA's liquidity regime, and the interrelationship between the UK's and other countries' liquidity regimes; the strengthening of stress-testing within firms, and the challenge to this from FSA supervisors; and the continuing strengthening of the FSA's supervisory resources. The memorandum can be found on the FSA website.
5. The FSA regulates the financial services industry and has four objectives under the Financial Services and Markets Act 2000: maintaining market confidence; promoting public understanding of the financial system; securing the appropriate degree of protection for consumers; and fighting financial crime.
6. The FSA aims to promote efficient, orderly and fair markets, help retail consumers achieve a fair deal and improve its business capability and effectiveness.