Liquidity Management Solutions: Targeting Financial Institution Treasury

Liquidity management is a topic that has received a substantial amount of interest in recent months. With the current financial crisis and the resulting challenges facing financial institutions, the money markets have tightened and bank treasury groups are placing a greater emphasis on optimizing their liquidity. As a result, firms are turning their attention to technology for assistance in managing and optimizing liquidity.

Why Liquidity Management is Important

Regardless of the type of company, effective liquidity management is a core responsibility of its treasury group. Within a financial institution's treasury, it is critical. Core revenue generating functions of banks " capital markets, lending, payments, etc. " depend on sufficient levels of liquidity to operate. Further, as the financial world has become increasingly global, were a bank to have insufficient liquidity to fund a time-sensitive CLS payment or to finance lending activities (think Northern Rock), the ripple effects would be felt across the globe and the reputation of the institution would be seriously, if not irreparably, damaged. With these critical responsibilities, the ability of a financial institution's treasury group to minimize idle balances and identify all cash flows is essential to its success.

Beyond the relationship between liquidity and the revenue generating functions of a financial institution are the costs resulting from inefficient management of it. Manual processes require excess staff, are prone to error and limit treasury's ability to focus on optimizing liquidity and other strategic responsibilities. Further, much of the information required for the liquidity management process exists across multiple, disparate systems, in batch form and is typically not available in real-time. This results in the inability to quickly identify the lowest cost of funds, resulting in increased interest costs. Additionally, this results in the need for treasury to maintain a liquidity "cushion" to ensure liquidity levels do not drop too low.

The Liquidity Management Process

Effective liquidity management requires three-steps in which treasury identifies, manages and optimizes liquidity. These steps are interdependent, each requiring the successful implementation of the other two to optimally manage liquidity.

Identifying liquidity is the foundation from which the entire liquidity management process depends. It involves understanding the balances and positions of the institution on an enterprise-wide level. This requires the ability to access and gather information across the institution's many lines of business, currencies, accounts and, often, multiple systems. Identifying liquidity is primarily a function of data gathering, and does not include the actual movement or usage of funds.

Managing liquidity within a bank's corporate treasury involves using the identified liquidity to support the bank's revenue generating activities. This may include consolidating funds, managing the release of funds to maximize their use, and tasks that "free up" lower-costing funds for lending or investment purposes to maximize their value to the institution.

Optimizing liquidity is an ongoing process with a focus on maximizing the value of the institution's funds. As the strategic aspect of liquidity management, optimizing liquidity balances requires a strong and detailed understanding of the financial institution's liquidity positions across all currencies, accounts, business lines and counterparties. With this information, the bank's treasury is able to map the strategic aspects of the institution into the liquidity management process.

The biggest challenge in the liquidity management process is the limited time and resources available to treasury. Although treasury groups are staffed with very capable personnel, a large amount of their time is spent on the task-based function of identifying liquidity instead of on the strategic elements necessary to optimize balances. This results in the entire liquidity management process being less efficient and affects the institution's bottom line.

Liquidity Management Solutions

Liquidity management solutions have gained attention in recent years as gains in technology enable solutions to meet the complex needs of financial institution treasury groups. Manual, time-consuming tasks can now be automated as a result of high-volume processing engines and bolt-on solutions that reduce the need for costly replacements of legacy systems. These solutions support treasury in automating balance and position information enterprise-wide, in real-time. Several offer a range of additional functionality, assisting treasury in such areas as payment flow control, collateral management, cash forecasting and predictive analytics.

However, despite these gains in technology, and the significant benefits and savings recognized by financial institutions that have adopted solutions, a relatively small number of solutions have been deployed to date. Unlike more established areas of financial services technology, the liquidity management technology space is still relatively new, and is rapidly developing. This results in an undefined market, along with significant differences among the features and functionality offered by each vendor's solution.

Benefits of these solutions are many and the differences offered by each, significant. A senior treasury employee at Tier 1 global financial institution described their vendor's solution as "invaluable" to their liquidity management process. This assisted them in improving enterprise-wide, intraday predicted liquidity positions from a variance of US$100 to US$300 million to a range of US$10 to US$20 million. Additional benefits to the organization included reduced staffing costs, improved client servicing to both internal and external clients, reduced interest costs and a shift from a task-focused to a strategically focused treasury. As these and other benefits of liquidity management solutions become more well-known throughout the industry, the number of vendors and the functionality offered will likely increase even more.

Liquidity management solutions offer an exciting and promising new opportunity for financial institutions to utilize technology and increase control in managing liquidity. At this stage in the evolutionary process of the liquidity management space, wide variances in the capabilities of each solution exist. Because of this, when selecting a solution, financial institutions should place the greatest emphasis on finding the solution with the features and functions best fitting the needs of the organization. This is a space in which cost should be of less importance as the significant differences between each solution makes it difficult to make cost comparisons, the benefits range according to functionality and the risks of inefficient liquidity management are so significant.