When your Board still doesn’t understand ILST vs. LCR

Liquidity management is more than a regulatory requirement—it's essential for protecting your bank's reputation and ensuring long-term resilience. Frameworks like Internal Liquidity Stress Testing (ILST) and the Liquidity Coverage Ratio (LCR) can be complex and difficult for non-financial professionals to grasp. This guide simplifies these concepts, offering actionable strategies for effective communication with your board.

ILST: The Tailored Safety Plan

Internal Liquidity Stress Testing (ILST) is a bank’s internal approach to simulating liquidity stress scenarios. It’s designed to address the specific risks your institution might face and ensure your unique business model is prepared for the unexpected.

Key Characteristics of ILST:

• Customized scenarios and assumptions tailored to your bank’s risk profile (e.g., sudden deposit outflows or market disruptions).

• Flexible timeframes—ranging from a few days to several months.

• Focus on operational resilience, helping identify vulnerabilities and mitigation strategies.

Analogy: Think of ILST as a personalized fitness plan designed for your specific health needs. It’s customized, adaptable, and built to address your unique strengths and weaknesses.

LCR: The Universal Standard

The Liquidity Coverage Ratio (LCR), by contrast, is a globally standardized framework. It ensures banks maintain enough easily sellable assets to survive a 30-day stress scenario, regardless of their individual risk profiles.

Key Characteristics of LCR:

• Requires banks to hold high-quality liquid assets (like cash or government bonds).

• Focuses on a fixed 30-day stress period.

• Standardized by regulators to ensure comparability and compliance.

Analogy: LCR is like a universal health checkup—it sets a baseline to ensure all banks meet minimum standards

How to Communicate These Concepts Effectively

1. Frame the Concepts in Practical Terms

• ILST: “This is our custom outlook for different potential liquidity stress environements unique to our bank.”

• LCR: “This is the industry’s minimum standard for short-term liquidity health.”

2. Use Real Examples

• Highlight scenarios from your bank: "Our ILST showed we could withstand a 20% drop in deposits over three months without needing external funding."

3. Relate to Strategic Decisions

• Link ILST to specific actions like adjusting funding strategies.

• Explain how LCR compliance protects the bank’s reputation and regulatory standing.

4. Visualize the Frameworks

• Use a diagram showing ILST’s flexible timelines compared to LCR’s fixed 30-day focus.

Common Questions from the Board

1. Why do we need both ILST and LCR?
   ILST is a custom tool for managing our unique risks out to 1 year of stress, while LCR ensures we meet regulatory expectations focused on the first 30 days. Both are regulatory required and capture different sides of the same 'potential stress’ coin

2. How does ILST inform decision-making?
   It identifies vulnerabilities specific to our operations, allowing us to allocate resources more effectively and mitigate risks before they escalate.

3. What happens if we fail LCR requirements?
   Failure to meet LCR could lead to regulatory penalties, reputational damage, and increased scrutiny from stakeholders.

Conclusion

When it comes to liquidity risk management, ILST and LCR are complementary tools that work together to ensure your bank is resilient, compliant, and prepared for the unexpected. By simplifying these concepts and connecting them to the bank’s strategic goals, boards can better oversee liquidity risk and make informed decisions.

Boards that actively engage with these frameworks strengthen their institution's ability to navigate both regulatory requirements and real-world challenges.