Liquidity management is one of the most critical aspects of banking. When done right, it ensures that a bank can meet its obligations without unnecessary costs or disruptions. When done poorly, it can trigger a crisis. In today’s volatile market conditions, banks must strike a careful balance between maintaining liquidity buffers and optimising funding strategies to remain both resilient and competitive.
What Are Liquidity Buffers?
Liquidity buffers are high-quality liquid assets (HQLA) that banks hold to withstand short-term liquidity shocks. These assets must be easily convertible to cash without significant loss of value, ensuring that the bank can meet outflows during periods of stress.
Regulators, such as the Basel Committee on Banking Supervision (BCBS), define liquidity requirements through measures like the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR). LCR ensures banks have sufficient HQLA to cover 30 days of net cash outflows, while NSFR promotes a stable funding structure over a one-year horizon.
However, holding liquidity buffers comes at a cost. These assets, typically government bonds or central bank reserves, generate lower returns than alternative investments. This makes it essential for banks to integrate liquidity buffers into a broader funding strategy that balances resilience with profitability.
The EBA’s Role in Liquidity and Funding Requirements
The European Banking Authority (EBA) plays a key role in shaping liquidity and funding regulations for banks within the EU. Its evolving regulatory framework ensures that banks remain resilient in the face of financial stress. In 2025, the EBA is expected to sharpen its focus on liquidity and funding risks, particularly in response to lessons learned from recent banking crises.
One of the key areas of focus includes Intraday Liquidity Management, where the EBA has outlined best practices to ensure banks can monitor and manage liquidity on a real-time basis. Additionally, the EBA is expected to reinforce stress-testing frameworks, making it imperative for banks to integrate these requirements into their liquidity strategies.
As part of its supervisory role, the EBA is also aligning its expectations with Basel III final reforms, emphasising the importance of forward-looking funding strategies. Banks will need to demonstrate not just compliance with LCR and NSFR, but also the ability to proactively manage liquidity risks under both normal and stressed conditions.
Key Funding Strategies for Banks
An effective funding strategy should ensure access to stable and diversified funding sources while optimising costs and regulatory compliance. Here are some key elements:
1. Diversification of Funding Sources
Relying too heavily on a single funding source—such as short-term interbank markets—can leave a bank vulnerable to market disruptions. A well-structured funding strategy incorporates multiple sources:
- Retail Deposits: Generally a stable and low-cost funding source.
- Wholesale Funding: Bonds, commercial paper, and interbank lending.
- Secured Funding: Repo agreements and covered bonds that offer stability during crises.
- Central Bank Access: An important backstop for liquidity in stressed conditions.
2. Matching Assets and Liabilities
Banks must align their asset duration with funding maturity to prevent liquidity mismatches. Short-term funding to finance long-term assets creates refinancing risk. A robust Asset and Liability Management (ALM) framework ensures stability by optimising the maturity structure.
3. Stress Testing and Contingency Planning
Liquidity stress testing helps banks assess their ability to withstand adverse scenarios—such as a sudden withdrawal of deposits or a market freeze. With the EBA’s increasing focus on stress testing methodologies, banks must refine their models to align with updated regulatory expectations. Developing contingency funding plans (CFPs) ensures preparedness for such events, including predefined actions like tapping central bank facilities or raising emergency funding.
4. Cost vs. Benefit Analysis of Liquidity Buffers
While holding liquidity buffers enhances resilience, excess reserves can lead to opportunity costs. Banks must evaluate:
- How much liquidity is ‘enough’ to meet regulatory requirements and internal risk appetite?
- What is the trade-off between holding buffers and deploying capital for higher-yield investments?
Finding the Right Balance
Optimising liquidity buffers and funding strategies is a delicate balancing act. Banks need enough resilience to withstand market shocks but must also remain competitive by efficiently managing funding costs. The key is to integrate liquidity planning into a dynamic risk management framework—one that is adaptable to changing market conditions, regulatory developments, and bank-specific risk profiles.
With the EBA sharpening its regulatory lens on liquidity risks, banks must not only comply but also evolve their funding strategies to remain resilient. At MORS Software, we help banks achieve this balance with an integrated Treasury and ALM system that provides real-time visibility, scenario modelling, and automated compliance with regulatory requirements. Because in banking, agility and foresight in liquidity management aren’t just advantages—they’re necessities.