B. ILAAP Construction
1. General Definition of the ILAAP
The Internal Liquidity Adequacy Assessment Process (ILAAP) is defined as “the processes for the identification, measurement, management and monitoring of liquidity implemented by the bank pursuant to SAMA liquidity risk management regulations”. It thus contains all the qualitative and quantitative information necessary to underpin the risk appetite, including the description of the systems, processes and methodology to measure and manage liquidity and funding risks.
These ILAAP guidelines shall only serve as a starting point in supervisory dialogues with banks. Therefore, they should not be understood as comprehensively covering all aspects necessary to implement a sound, effective and comprehensive ILAAP. It is the responsibility of the bank to ensure that its ILAAP is sound, effective and comprehensive duly taking into account the nature, scale and complexity of its activities.
2. Objectives of the ILAAP
The main objectives of the ILAAP are as follows:
i. Enhances corporate governance and risk management processes in banks and the financial system in general.
ii. Establishes the minimum liquidity required for regulatory purposes and helps identify planned sources of liquidity to meet these objectives.
iii. For a bank's Board of Directors to proactively assess its liquidity requirements in line with its strategies, business plans and risks.
In additions, the ILAAP document should be for Senior Management to inform the Board of Directors and SAMA on the ongoing assessment of the bank's liquidity risk profile, liquidity risk appetite, strategic plan and liquidity adequacy. It also documents how the bank intends to manage these risks, and how much liquidity is necessary for its future plans.
3. Scope and Proportionality
i. These guidelines shall be applicable to all locally incorporated banks licensed and operating in the Kingdom of Saudi Arabia.
ii. The ILAAP is, above all, an internal process, and it remains the responsibility of individual banks to implement it in a proportionate and credible manner. The bank’s ILAAPs has to be proportionate to the nature, scale and complexity of the activities of the bank.
4. Major Building Blocks of the ILAAP
4.1 Banks’ Roles and Responsibilities for the ILAAP
i. A Bank should produce, at least once per year, an ILAAP approved and signed by the Board of Directors.
ii. A bank is required to demonstrate to SAMA that its ILAAP processes are comprehensive, rigorous and ensures that it has liquidity that is commensurate with its risk profile.
iii. A bank is required to put in place ILAAP processes and methodologies based on SAMA requirements and on its strategic and operational plans as set by its Board of Directors.
4.2 ILAAP as Part of Pillar 2
The Pillar 2 liquidity framework should focus on liquidity risks not captured, or not fully captured, under Pillar 1 requirements. It is incumbent on banks to undertake their own assessment of liquidity risks, including Pillar 2 risks, and take appropriate measures to reduce or manage these risks.
5. The ILAAP Process
5.1 ILAAP Governance
The ILAAP process should remain the responsibility of the Board of Directors and Senior Management of the bank. The ILAAP should be well integrated into the bank’s processes and decision-making culture. In this regard, banks are required to ensure the following:
i. The Board of Directors has the ultimate responsibility for the implementation of the ILAAP, and the Board of Directors or its delegated authority is required to approve an ILAAP governance framework with a clear and transparent assignment of responsibilities, adhering to the segregation of functions. The governance framework should include a clear approach to the regular internal review and validation of the ILAAP.
ii. All of the key elements of the ILAAP should be approved by the Board of Directors or its delegated authority, and be consistent with the risk appetite set by the Board of Directors, and with the bank’s approach for measuring and managing liquidity and funding risks.
iii. The Board of Directors or its delegated authority, Senior Management and relevant committees are required to discuss and challenge the ILAAP effectively.
iv. Each year, the Board of Directors or its delegated authority is required to provide its assessment of the liquidity adequacy of the bank, supported by ILAAP outcomes and any other relevant information, by reviewing and approving the bank’s ILAAP.
5.2 Strategic and Liquidity Planning
i. The ILAAP should support strategic decision-making and, at the same time, be operationally aimed at ensuring that the bank maintains adequate liquidity on an ongoing basis, thereby promoting an appropriate relationship between risks and rewards. All methods and processes used by the bank to steer its liquidity as part of the strategic or operational liquidity management process are expected to be approved, thoroughly reviewed, and properly included in the ILAAP and its documentation. The quantitative and qualitative aspects of the ILAAP should be consistent with each other and with the bank’s business strategy and risk appetite.
ii. The ILAAP should be aligned with the business, decision-making and risk management processes of the bank. It should also be consistent and coherent throughout the group.
5.3 Documentation
Banks are required to maintain sound and effective overall ILAAP architecture and documentation of the interplay between the ILAAP elements and the integration of the ILAAP into the bank’s overall governance and management framework.
5.4 Comprehensive Risk Quantification
The ILAAP should ensure that risks, that a bank is or may be exposed to, are adequately quantified. The bank is required to do the following:
i. Implement risk quantification methodologies that are tailored to its individual circumstances, i.e. they are expected to be in line with the bank’s risk appetite, market expectations, business model, risk profile, size and complexity.
ii. Determine sufficiently conservative risk figures, taking into consideration all relevant information.
iii. Ensure adequacy and consistency in its choice of risk quantification methodologies.
iv. Ensure that key parameters and assumptions cover, among other things, confidence levels and scenario generation assumptions.
5.5 Stress-Testing
Banks should conduct a comprehensive, robust stress-testing that is consistent with SAMA Stress-testing Rules, taking into consideration the following:
i. The impact of a range of severe but plausible stress scenarios on the bank’s cash flows, liquidity resources, profitability, solvency, asset encumbrance and survival horizon.
ii. Selecting stress scenarios that reveal the vulnerabilities of the bank’s funding. In addition to performing a tailored and in-depth review of the bank’s vulnerabilities, capturing all material risks on an institution-wide basis that result from the bank’s business model and operating environment in the context of stressed macroeconomic and financial conditions. The review should be conducted on a yearly basis and more frequently, when necessary, depending on individual circumstances. On the basis of this review, the bank is required to define an adequate stress-testing programme for both normative and economic perspectives. As part of the stress-testing programme, the bank is required to determine adverse scenarios to be used under both perspectives, taking into account other stress-tests it conducts.
iii. Conducting reverse stress-testing in a proportionate manner.
iv. Continuously monitoring and identifying new threats, vulnerabilities and changes in its environment to assess whether its stress-testing scenarios remain appropriate and, if not, adapt them to the new circumstances.
v. Regularly updating the impact of the scenarios. In the case of material changes, the bank should assess its potential impact on its liquidity adequacy.
The degree of conservatism of the stress-testing scenarios adopted and assumptions made by the bank should be discussed in the ILAAP document.
5.6 Review and Independent Validations
The ILAAP shall be subject to a regular internal review, at least once a year, taking into consideration the following:
i. Both qualitative and quantitative aspects, including, for example the use of ILAAP outcomes, the stress-testing framework, risk capture, and the data aggregation process.
ii. Establishing a defined process to ensure proactive adjustment of the ILAAP to any material changes that occur, such as entering new markets, providing new services, offering new products, or changes in the structure of the bank.
iii. Adequately back-testing and measuring the performance of the ILAAP outcomes and assumptions, covering, for example, liquidity planning, scenarios, and risk quantification.
iv. Conducting a regular independent validation of the ILAAP risk quantification methodologies, taking into account the materiality of the risks quantified and the complexity of the risk quantification methodology. The overall conclusions of the validation process should be reported to Senior Management and the Board of Directors, used in the regular review and adjustment of the quantification methodologies, and taken into account when assessing liquidity adequacy.
5.7 ILAAP Reporting to SAMA
i. The ILAAP shall be submitted to SAMA by 31st of August each year using 30th of June as a reference date.
ii. Banks are required to provide, at minimum, details on all items mentioned in these guidelines or explain why any item is not relevant for their respective banks, taking into account the size, complexity and business model of the bank.
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