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Inconsistent appetite

Last week I was discussing liquidity and market risk with two different banks. On reflection, it’s apparent that the way we set risk appetite is inconsistent.

For liquidity risk one of the key measures is the liquidity coverage ratio. The survival period is measured on a stressed basis. This is relatively severe and is backed up with chapter and verse from the regulator on how it’s done and what happens if you don’t do it properly. This risk has had the full treatment.  Consequently, banks hold much more liquidity than a decade ago. But there are still breaking points.

Has market risk had the full nine yards too? No.

We know that on a series of bad days you can lose a fortune so we add stress testing to gaps, deltas and vars. But does it go to the same extent as liquidity in battening down the hatches? I think not.

It’s as if, encouraged by QE, market risk is the dog that didn’t bite.

Inconsistencies like this can cost us dear. Have we overcooked “liquidity” and underdone “market”?

If we have we are buying insurance for something we don’t need whilst taking on a risk for which we aren’t properly prepared.

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