Question

The first half of 2020 has been very challenging for the Australian banking sector with major bush fires, then several severe storms (e.g. Canberra hailstorm) and now the COVID-19 outbreak and shutdown of the Australian economy. We have discussed, how the impact these events—particularly COVID-19—has had on the banks as well as how the banks and regulators have responded to the challenges.
You are the team leader of the Strategy and Operations team at the Commonwealth Bank of Australia. The CEO and Board has asked you to write a series of three short memos outlining the impact that COVID-19 has had on the bank and your recommendations for operations in the next 6 to 12 months. Each of the memos will focus on one fundamental risk and should be written independent of the other memos so that each memo is self-contained (e.g. when reading memo 1, you do NOT need to read the memos 2 and 4 to understand memo 1).

Question 3
Write a memo outlining the impact that COVID-19 has had on liquidity risk for the CBA. Suggest some strategies the bank can use to manage this risk in the next 6-12 months.

Answer 1

In response to the recent adverse market activity, the Federal Reserve Board (the Fed) has taken steps to stabilize the financial markets through the purchase of Treasuries and government guaranteed mortgage-backed securities, reviving the Primary Dealer Credit Facility to offer loans to securities firms, reestablishing the Money Market Mutual Fund Facility, and substantially expanding its repo operations1 The Fed has also encouraged banks to start borrowing from its discount window and regulators have extended the timeline for certain regulatory requirements (e.g. the Current Expected Credit Losses implementation) in an effort to reduce some pressure on bank resources. The capital and liquidity buffers that banks now have in place were designed to be available sources of capital and liquidity to support the economy during adverse situations such as the impacts of COVID-19 and to enable banks to continue lending. The Fed is encouraging banks to use their capital and liquidity buffers as they make loans available to households and businesses affected by the COVID-19 restrictions, assuming this lending is done in a safe and sound manne

CBA as well as other banks shall consider the followng actions :

Given the challenges that banks are likely experiencing, organizations should take certain steps to address these challenges promptly to effectively manage current liquidity risk and better prepare for longerterm actions.

1. Rapidly assess and take action on liquidity challenges and management requests

As during the financial market crisis, preserving cash and access to liquidity is the overarching goal for banking organizations. Understanding the size, timing, and funding of cash requirements will likely be the highest priority request from senior management. Quick and effective responses may require a focused, dedicated team (e.g., a task force) that can react quickly to offer innovative approaches and adjust processes.

2.Strengthen liquidity monitoring and reporting capabilities

It’s critical that banks utilize accurate and updated information to manage liquidity during a crisis. Tactical solutions leveraging existing reporting, data, processes, and resources implemented after 2008 can be leveraged to enhance the scope, depth, and timeliness of liquidity and funding reporting. Bespoke tactical approaches can be used to overcome liquidity monitoring challenges arising from segregated data, incompatible data structures, and fragmented monitoring and reporting capabilities.

3.Establish processes for coordinating regulatory responses

Banks should implement processes to respond efficiently to regulatory inquiries and changes in reporting requirements. Using the financial market crisis as a precedent, banks should expect inquiries based on existing reporting regimes as well as inquiries that extend or build upon those regimes. These inquiries are likely to compete with internal requests for information. Liquidity task force teams should assess whether existing regulatory reporting teams are capable of supporting regulatory responses and internal needs concurrently, and whether supplemental resources should be brought in to enhance existing capabilities.

4.Revise cash flow forecasts and liquidity model assumptions

Liquidity model and cash flow forecast modifications will likely need to be made to more accurately reflect current and projected conditions given the COVID-19 crisis (and in the aftermath, as the economy adjusts and recovers). Modeling assumptions including asset haircuts and cash flow timing (e.g., roll-off, drawdown assumptions) should be assessed in the context of the current environment. As market pricing observability declines, haircuts and related assumptions should be updated. Consulting subject matter resources on assumption reasonableness is encouraged. In addition, banks should consider whether in-house modeling teams have the capacity to keep pace with necessary revisions and consider whether supplemental resources may be needed to overcome constraints or skill gaps, and address the most impactful changes as efficiently as possible.