Liquidity management in banking

In brief

The current market environment, including inflation, interest rate changes and banking crises, highlights the need for banks to re-evaluate their liquidity management strategies
Liquidity management is crucial for banks to mitigate risks and meet short-term financial obligations promptly and without substantial losses
Implementing effective strategies, such as precise cash flow forecasting, efficient receivables management and predictive analytics, combined with the right software solution offers multiple benefits

March 2023 saw the biggest bank failure since the 2007-2008 financial crisis. In a matter of a weekend, Silicon Valley Bank (SVB) failed after a run on deposits. The resulting panic took down Signature Bank. It also put the final nail in the coffin of Credit Suisse, which was forced into an acquisition by UBS, its rival.

This story can teach banks of all sizes a valuable lesson — how not to manage their liquidity. SVB put its money into federal bonds without properly diversifying its portfolio. When its clients rushed to withdraw their funds, SVB had to quickly transform those bonds into cash — and the deal cost the bank $1.8 billion in losses.

In this period of turmoil, no bank is safe from a panic-induced run on deposits. So, how should banks approach liquidity management?

Let us at Zoreza Global, a DXC Technology Company, draw on our experience in serving the banking industry and break it down:

Liquidity management definition
Six effective liquidity management strategies
How technology can enhance your liquidity management
Four benefits of sound liquidity management in banking

Liquidity management: What’s in the name?

First, let’s answer one question — what is liquidity management? In banking, it’s the ensemble of actions banks take to mitigate liquidity risks. The purpose of liquidity management is to allow an organization to meet its short-term financial obligations promptly and without substantial losses.

Liquidity management in banks is crucial for multiple reasons. Investors use accounting liquidity to assess a bank’s financial health, for one. As March 2023 also demonstrated, a run on deposits can happen anytime, prompted by external panic-inducing events out of a bank’s control.

What characterizes sound liquidity management?

Continuous tracking of all incoming and outgoing cash flows
Diversification of revenue streams and investment portfolios to include highly liquid assets
Unceasing overview of receivables and liabilities
Precise, detailed, and constantly updated liquidity and contingency funding planning

How the current market environment impacts liquidity management

Several economic factors should push banks to rethink their liquidity management strategies.

Core inflation persists. In the U.S., while the peak of core inflation passed in September 2022 (6.6%), it remains high in March 2023 (5.6%). However, overall inflation shows signs of slowing down, from its peak in June 2022 (9.1%) to 5.0% in March 2023
Increasing interest rates. The U.S. Federal Reserve raised its interest rate to 4.75%–5% in March 2023. It’s the highest it’s been since 2007. The European Central Bank took a similar action. This increases consumer interest rates on savings and certificates of deposits (CDs), incentivizing consumers to park more money in banks
The ripple effect of SVB’s failure. Runs on deposits hit smaller banks like First Republic with more force than their larger counterparts (e.g., JPMorgan Chase). These banks should expect a decrease in their lending capacities

The ongoing banking crisis risks becoming a long-lasting one. That’s why any bank, large or small, has to ensure its liquidity at all times despite the turbulent conditions. Read on to find out how liquidity management can help banks weather the storm.

Six effective ways to mitigate liquidity risks

All of the factors above mean one thing — old approaches to liquidity management may not be as efficient anymore.

Fortunately, new technology in the field opens up more efficient ways to ensure liquidity. Here are six solid ways to tackle the ongoing challenges and successfully mitigate evolving liquidity risks.

1. Forecast cash flows with precision

Without anticipating cash flows accurately, it’s impossible to predict the bank’s financial standing in the future. So, executives can’t allocate inflowing cash to long-term investments without second-guessing their decision. The bank also risks being unprepared for foreign exchange volatility and finance industry turbulence.

Cash flow forecasting includes both sides of the equation — inflows and outflows. It relies on granular data of the bank’s past financial performance and payments due in the short and long run. It should also account for more significant economic trends, like federal interest rates.

To introduce precision to cash flow forecasting, banks need to automate manual processes and centralize all data necessary for prediction. Software tools like Planixs Realiti do both. They also automate real-time data collection and create and continuously adjust forecasts based on it.

2. Improve receivables management efficiency

Another liquidity risk in banks is lenders who miss out on their payments. This is one case where receivables management has to come in and power the bank’s collection efforts. Apart from loan payments, receivables in banking include investment profits, invoice payments and other sources of revenue that are not collected immediately.

A sound approach to receivables management allows banks to ensure they will receive the cash inflows when they are due. This prevents the risk of an unexpected misbalance between inflows and outflows that can make it impossible for them to meet their short-term financial obligations.

Here are four markings of efficient receivables management:

Proactivity in collections. Remind lenders and partners when their payments are due and notify them about any policy changes. Ensure paying is straightforward and convenient for them
Prompt response to past-due receivables. Don’t let receivables go uncollected for too long. Regularly contact past-due clients to remind them of the payments due and the penalties they may incur
Incentives and penalties. Consider offering a reward for early payments and a payment plan for past-due clients. Remember to add the stick to the carrot: Outline late fees and other penalties
Manual task automation. All three components above require automation to track all receivables due and send out various reminders on time

3. Conduct frequent analyses

Liquidity risks are constantly evolving based on rapidly shifting factors like:

Uncollected receivables
Seasonality
Stock market and foreign exchange volatility
The state’s monetary policy

That’s why banks can’t do a liquidity analysis once and leave it untouched for months.

Instead, some analyses, like cash flow forecasts, are best reviewed and updated at least weekly or, ideally, daily. When it comes to predictions, remember to create them for the following week, month, quarter and 12 months.

Of course, adjusting projections and performing systematic analyses can be labor-intensive without the right tools. That’s why banks will need a software solution that automatically:

Aggregates all the data executives need to conduct analyses
Calculates basic liquidity indicators like the cash ratio and liquidity position
Uses granular, industry, and macroeconomic data to create and adjust forecasts
Accounts for different possible scenarios in predicting banking liquidity

4. Centralize all financial data

If financial data remains fractured across multiple software tools, liquidity management is bound to be inefficient. It’ll take unnecessarily more time and human resources to pull that data together, update it and make sense of it. It also exposes the institution to the risk of human error.

To track liquidity, all the data should be accessible from a single interface. This is where, once again, technology saves time and money by automating data sourcing. Tools like Planixs Realiti can bring together all the internal data in one system:

Accounts receivable and payable
Data from other platforms (e.g., ERP systems, TMS or financial systems)
Actuals like account activity, turnover, transactions and balances
Cash pool structures
Asset portfolio
Multiple subsidiaries’ data

The chosen liquidity management tool should also account for external factors. To this end, it should automatically extract certain types of data from third-party sources, such as:

Federal interest rates
Inflation rates
Stock prices
Foreign exchange (FX) rates
Consumer confidence

5. Automate reporting

Manual reporting may unnecessarily take up a substantial chunk of working time. And like all manual tasks, it comes with a higher risk of human error.

A liquidity management software solution can eliminate that risk — and make reports available in a couple of clicks. This allows the top management to make data-driven decisions fast, especially if the report requires pulling data from multiple sources. Automation also facilitates compliance reporting across the board.

When shopping for a liquidity management tool, executives need to pay close attention to its reporting automation features. It should work with pre-built and custom-made templates for maximum reporting flexibility.

Moreover, some treasury management tools work with real-time data, meaning employees can generate end-of-day reports and projections. This will help the top management stay on top of the ever-shifting internal and external liquidity factors.

6. Introduce predictive analytics

With predictive analytics, a bank no longer needs a large team of analysts to forecast its liquidity. This AI-powered technology can do a better job than the most skilled analysts — in a fraction of the time.

That’s because predictive analytics algorithms can:

Continuously adjust forecasts based on changes in real-time data
Take into account hundreds of parameters
Run complex simulations for multiple scenarios in a matter of seconds
Analyze current risks and extrapolate them to predict future ones
Forecast settlement times and probability of failure
Account for external factors that may impact banking liquidity (seasonality trends, FX rates, monetary policy indicators and more)
Continuously scan for and warn about cash flow irregularities and other issues

Predictive analytics allows for unlocking the full potential of gigabytes of data and hundreds of indicators that banking liquidity depends on.

Emerging trend: Real-time liquidity management

Banks need real-time data to make the most out of all the liquidity management strategies above. After all, there’s no longer a substantial time lag between sending and receiving payments in banking. Now, any client, business or not, can send instant payments domestically.

This means cash inflows and outflows can change quickly within a day. Therefore, banks should closely monitor them on an intraday basis. This is where real-time liquidity management comes in.

Here are the six ways banks can benefit from switching to real-time liquidity management:

Reduced liquidity buffer and funding costs
Improved operational risk management
More accurate end-of-day funding
Automated regulatory compliance
Reduced cost of capital
Automated netting across accounts

Real-time liquidity management: Software is the solution

To implement real-time liquidity risk management in banks, banks need the right tool. It will automatically collect and continuously analyze mountains of data from multiple sources.

But what makes a software solution the right one? In our experience, it should fit the following bill:

Cloud-based infrastructure to ensure scalability and top-notch performance at all times
Predictive analytics to power forecasting and detect irregularities
Rapid deployment to go live with minimum friction
High performance to continuously process millions of transactions and data changes
Flexibility in customization to adapt the solution to match the client’s needs to the letter

To transition to a real-time liquidity management solution, banks need to approach it comprehensively and thoroughly. This means:

Bringing on board all stakeholders, from treasury teams to C-level executives, to map out the transition
Identifying the data types the solution needs to pull in and analyze
Carrying out the transition in phases, from a migration test to step-by-step infrastructure moves

If you don’t have the in-house expertise for the transition, consider turning to a reliable partner for system integration.

If you envision switching to a liquidity management solution, Zoreza Global would be honored to lend you a hand in the transition. We’re a trusted Planixs end-to-end integration partner with 45+ years of experience in serving the banking industry.

Four benefits of optimizing liquidity management

Why is it necessary to review the bank’s current liquidity management strategy — and upgrade it with the help of new technology? Here are the four ways to answer this question.

1. Improving control over cash forecasting

Sound liquidity management allows for predicting future liquidity positions precisely. This gives banks more control over the cash available at a given time.

Accurate cash forecasting helps minimize buffer costs and correctly calculate the liquidity funding required. So, the top management can commit cash to other expenditures with peace of mind. This allows driving the organization forward without risking liquidity issues or insolvency.

2. Unlocking trapped cash

Streamlining and standardizing liquidity management helps in avoiding trapped cash scenarios. Those can include:

Overcommitting capital to fund contingency and buffer costs
Not being able to mobilize funds fast enough due to legal restrictions
Risk of incurring substantial costs when moving funds or transforming assets into cash
Payments getting stuck in transit due to insufficient transaction data provided by the recipient or sender

Liquidity management strategies should also account for trapped cash scenarios if they do occur. Again, this improves the bank’s resilience in market turbulence or other unpleasant surprises.

3. Mitigating liquidity risks

The more precise the current liquidity assessment and forecasting are, the less likely the bank is to find itself unable to meet its financial obligations without substantial losses. This means decreasing the risk of having to sell relatively illiquid assets at a loss (like SVB had to) or defaulting on the debt altogether.

Apart from that, solid liquidity management should address operational risks, like human error or fraud. It should also include contingency plans for sudden large expenditures, lower-than-expected cash inflows and external factors that may cause a run on deposits.

Comprehensive liquidity risk management mitigates the insolvency risk and ensures the institution’s financial health in the long run.

4. Enhancing the bank’s image

If a bank has a solid, up-to-date liquidity management strategy, it becomes a more attractive prospect for investors. That’s because comprehensive and detailed liquidity data, along with multi-scenario forecasting, can demonstrate its financial health.

What’s more, solid liquidity management can improve the perception of the bank in the eyes of its business partners, creditors and clients. The reason is the same — it ensures the organization’s resilience and demonstrates its financial health.

And let’s not forget about the regulators and their requirements toward key liquidity indicators. Comprehensive and efficient liquidity management ensures compliance without over-the-board resource spending.

Ready to optimize your liquidity management?

Zoreza Global has already helped multiple global tier-1 institutions transition to products such as Planixs Realiti. Let us share with you our decades-long expertise in banking modernization and digital transformation and take your liquidity management to another level. Get in touch with us to discuss how we can be of service to you.