Bank practices undermined liquidity, BIS says
In the approach to the credit crisis, practices such as securitisation, dependence on the money markets and use of collateral increased the danger of a liquidity shortfall, according to a report released by the Bank of International Settlements (BIS).
The BIS said that banks had become reliant on the money markets, which "tend to be more volatile than traditional retail deposits", as a source of liquidity. Using securitisation, especially including backstop provisions, had also laid them open to liquidity risk, as had the use of complex financial instruments, which make liquidity risk assessments more difficult. More frequent margin calls - often at least daily - made collateral more sensitive, as it could produce calls for more collateral at short notice.
Banks need to do more stress testing (something they resisted before the crisis) and improve their contingency plans to avoid more damage in the future, the BIS concluded. The BIS also called on supervisors to pay closer attention to reports of liquidity risk management problems in future.
See also: The liquidity link
Basel II backlash
A question of funding
All dried up
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