Risk assessment in liquid assets’ pricing

The agenda of a wide array of topics discussed in the World Economic Forum in Davos is an opportunity for political and industrial leaders to deliver messages to public about the good management practises and future expectations on resilient dynamism. However, despite a review of global development trends and panel discussions on human capital, leadership, energy, healthcare, technology, value chain and other topics, I would like to focus on risk management which is an integral part of financial stability and social-economic outlook.

 

The most recent subjects broadly discussed in financial stability context are the increase of the US debt ceiling and amendments of the Basel III. According to the Statement by the Press Secretary released on 18 January, 2013, Barack Obama, a president of the US, expressed an importance of the timely Congress decisions on payments of bills and committed to further deficit reduction in a balanced way. A failure of the US to pay its bills could lead to the national default and meltdown of the financial markets.

Similarly, loser liquidity risk management standards for financial sector those were agreed by the Basel Committee on 6 January, 2013, may cause underestimation of risks. A liquidity coverage ratio measures the requirements for sufficient High Quality Liquid Assets in comparison to the net cash outflows. The minimum LCR requirement for banks in 2015 is 60 percentages which is projected to increase till 100 percentages in 2019, id. est. banks should possess as much High Quality Liquid Assets as it needs to cover a total net cash outflows. Made amendments regarding the definition of HQLA and assets treated as cash outflows enabled banks to increase the numerator of the ratio and reduce the denominator which implies higher percentage of LCR. However, despite the changed requirements of what is allowed, could the Basel Committee publish the guidance of what is more favourable?

In both of these cases the market participants will have to reassess the value of liquid assets and management of liquidity risk. Moreover, assets pricing distortions due to high volatility may also cause difficulties in management of liquidity risks. Risk is a probability of  default. However, according to the Basel III, LCR is defined by the assets’ features to be sold quickly in the markets. In general, all publicly traded securities are liquid and risks arise due to the price they may be sold. The financial stability depends on whether sold assets produce gains or losses.

A distortion in prising is a risk itself. When assets pricing and future values are not clear risks could be hedged with derivative instruments. However, these deals also involve financial obligations, the transfer of money, the gains or losses according to the agreed conditions and markets’ circumstances.  

Thus, I would like to distinguish two drivers of the resilient dynamism: competence and power of negotiations. Both of them are equally important to succeed.