The fundamental role of banks in financial intermediation makes them inherently vulnerable to liquidity risk, of both an institution-specific and a market nature. Financial market developments have increased the complexity of liquidity risk and its management. During the early “liquidity phase” of the financial crisis that began in 2007, many banks – despite meeting existing capital requirements then in effect – experienced difficulties because they did not manage their liquidity in a prudent manner. The difficulties experienced by some banks, which, in some cases, created significant contagion effects to the broader financial system, were due to lapses in basic principles of liquidity risk measurement and management.

In response, in 2008 the Basel Committee on Banking Supervision published Principles for sound liquidity risk management and supervision (the “Sound Principles”), which provide detailed guidance on the risk management and supervision of funding liquidity risk. The Committee has further strengthened its liquidity framework by developing two minimum standards for funding and liquidity. These standards aim to achieve two separate but complementary objectives. The first objective is to promote the short-term resilience of a bank’s liquidity risk profile by ensuring that it has sufficient high-quality liquid assets (HQLA) to survive a significant stress scenario lasting for 30 days. To this end, the Committee published Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools.2 The second objective is to reduce funding risk over a longer time horizon by requiring banks to fund their activities with sufficiently stable sources of funding in order to mitigate the risk of future funding stress. To achieve this objective, the Committee published Basel III: The Net Stable Funding Ratio.3 These standards are an essential component of the set of reforms introduced by Basel III and together will increase banks’ resilience to liquidity shocks, promote a more stable funding profile and enhance overall liquidity risk management.