Observations on Liquidity and Credit Risk Management

Effective liquidity and credit risk management controls are critical elements in a broker-dealer’s risk management framework, and should be documented in a firm’s books and records.¹⁹ FINRA routinely reviews firms’ practices in these areas, and in Regulatory Notice 15-33 (Guidance on Liquidity Risk Management Practices) shared observations on liquidity management practices.

FINRA shares the following practices that some firms used to strengthen their liquidity management programs.

• Liquidity Contingency Plans – Small clearing and introducing firms developed contingency plans for operating in a stressed environment and outlined specific steps to address certain stress conditions. Further, firms’ contingency plans identified the firm staff responsible for enacting the plan, the process for accessing liquidity during a stress event or standards to determine how liquidity funding would be used.
• Liquidity Risk Management Updates – Firms updated their liquidity risk management practices to take into account their current business activities.
• Stress Tests – Firms conducted stress tests in a manner and frequency that was appropriate for their business model. In addition, such stress tests evaluated the potential impact of off-balance sheet items on liquidity. Some firms that relied on a shared funding source with affiliated entities for their liquidity stress test and their shared Master Credit Agreement confirmed that source would be ring-fenced for them during a stress event.
• Credit Risk Management – Firms maintained a robust internal control framework to capture, measure, aggregate, manage and report credit risk.²⁰ In particular, firms evaluated their risk management and control processes to review whether they were accurately capturing their exposure to credit risk; maintained approval and documentation processes for increases or other changes to assigned credit limits; and monitored exposure to their affiliated counterparties.

Additional Resources

• 2018 Report – Liquidity
• Regulatory Notice 10-57 (Funding and Liquidity Risk Management Practices)
• Funding and Liquidity Topic Page