FSB urges non-banks to improve liquidity risk management

Non-banks should be better at providing liquidity for margin and collateral calls, according to a new study from the Financial Stability Board (FSB).

The report, published on December 10, discusses the liquidity risks associated with non-banks in the centrally and non-centrally cleared derivatives and securities markets. It says that during previous crises, non-banks sometimes struggled to find the liquidity to answer margin and collateral calls.

The FSB analysed four episodes of liquidity stress among non-banks in recent years. These were associated with the Covid-19 pandemic, the Archegos collapse, Russia’s invasion of Ukraine and the UK’s liability-driven investment funds crisis. The report also includes a survey of financial authorities and feedback from industry stakeholder outreach events.

It says that weaknesses in liquidity risk management and governance are the “key causes” of non-banks’ ill-preparedness. The “dash for cash” in March 2020, for example, suggested money market funds needed to strengthen their liquidity provision.

The report says the identified weaknesses hampered non-banks’ ability to anticipate liquidity needs. Some non-banks may not have fully understood the conditional demands on liquidity resources, while others may have consciously decided not to secure contingent funding. The report adds that non-banks may have “overlooked the impact of correlated behaviours during times of stress”.

The FSB uses the report to issue eight policy recommendations to non-bank market participants. These include evaluating exposure to margin and collateral calls, establishing contingency funding plans and conducting regular reviews of liquidity risk frameworks.

The report recommends that non-banks carry out stress tests simulating scenarios of margin and collateral calls, and for these tests to cover “extreme but plausible” scenarios. It also says firms should improve their collateral management practices.