The Basel Committee on Banking Supervision issued for public comment the latest version of its principles for liquidity risk management and supervision, aiming to address some of the deficiencies revealed by the credit market disruption.

It says that the draft principles represent a substantial revision of the committee’s existing liquidity guidance that was published in 2000. The new version reflects the lessons of the financial market turmoil and is intended to strengthen banks’ liquidity risk management and improve global supervisory practices.

The principles underscore the importance of establishing a robust liquidity risk management framework that is well integrated into the bank-wide risk management process. The primary objective of this guidance is to raise banks’ resilience to liquidity stress.

Among other things, the principles seek to raise standards in:

> governance and the articulation of a firm-wide liquidity risk tolerance;

> liquidity risk measurement, including the capture of off-balance sheet exposures, securitization activities, and other contingent liquidity risks that were not well managed during the current turmoil;

> aligning the risk-taking incentives of individual business units with the liquidity risk exposures their activities create for the bank;

> stress tests that cover a variety of institution-specific and market-wide scenarios;

> management of intraday liquidity risks and collateral positions;

> maintenance of a robust cushion to help survive protracted periods of liquidity stress; and

> public disclosures, both quantitative and qualitative, of a bank’s liquidity risk profile and management.

The principles also strengthen expectations about the role of supervisors, including the need to intervene in a timely manner to address deficiencies and the importance of communication with other supervisors and public authorities, both within and across national borders.

“The Basel Committee’s goal in developing these global standards is to significantly raise the bar for the management and supervision of liquidity risk at banks” stated Nout Wellink, chairman of the Basel Committee and president of the Netherlands Bank. “The committee fully expects banks and supervisors to implement the enhanced principles promptly and thoroughly. We will vigorously assess the degree to which the principles are implemented.”

“The principles are based on the fundamental premise that a bank’s liquidity risk framework should ensure it maintains sufficient liquidity to withstand a range of stress events, including those that affect secured and unsecured funding” noted Nigel Jenkinson, co-chairman of the Basel Committee’s Working Group on Liquidity and executive director of the Bank of England.

Arthur Angulo, the other co-chairman of the Working Group and senior vice president of the Federal Reserve Bank of New York, added that “supervisors, for their part, should assess the adequacy of both a bank’s liquidity risk management framework and its liquidity position. In order to protect depositors and to limit potential damage to the financial system, supervisors should take prompt action if a bank is deficient in either area.”

Comments are invited by July 29.