Liquidity risk: lessons for a financial services-wide challenge

For banks and insurers, the game has changed. Digital models, social media and intraday payment pressures have turned liquidity risk into a fast, public and highly contagious threat. Banks have long been at the forefront of managing liquidity risks, setting standards that other Financial Services (FS) sectors increasingly look to emulate. In the UK, the Prudential Regulation Authority (PRA) has raised expectations: Boards must own liquidity risk appetite, approve robust ILAAPs and be able to execute credible contingency actions at speed. That shift puts liquidity at the centre of strategy, not just compliance and provides FS-wide lessons.

Our latest article on ‘Top ten risks for financial services firms in 2026’, examined the key risks for FS firms and how to prepare for the start of 2026. To explore these dynamics, we will discuss common themes across FS, bringing insights from our Chief Risk Officer (CRO) clients and our own CRO experience. Leveraging hands-on industry experience within insurance and banking, we uncover practical insights for FS firms. In our discussions, we focused on three critical areas relevant across the sector: liquidity risk management, stress testing and model risk management. These topics matter for banks and insurers and offer opportunities to compare sector-specific approaches.

This first article explores liquidity risk management across FS firms, examining common challenges and highlighting evolving practices. We look at how approaches differ across sectors and where lessons can be drawn, recognising that different sub-sectors face different liquidity risk exposures. The goal is to share perspectives that strengthen resilience across the industry as liquidity risks continue to emerge from diverse and changing sources.

Why is liquidity risk so key for FS firms?

Liquidity risk has moved from the back office to the boardroom as the speed and visibility of crises have changed, reinforced by recent events. Firms must understand risk arising from their outflows, retail deposits, corporate treasuries, wholesale funding and collateral calls as these can all behave unexpectedly under stress. Funding diversification is critical, as concentrated profiles amplify shocks. High-quality liquid assets only help if they are operationally accessible intraday and under stress. Silence during a crisis creates runs, communication is now a liquidity tool.

These lessons travel well. Insurers can adopt banking’s discipline on stress testing and contingency planning within their ORSA and liquidity risk management frameworks.

What are the challenges, and how can FS firms prepare for and manage liquidity risk?

Liquidity risk is complex and multidimensional making it hard to measure, predict and manage. This is why robust risk management is necessary despite different business models. There are common principles in managing liquidity risk for banks and insurers:

• Stress testing and scenario analysis: both sectors rely on forward-looking scenarios to anticipate severe but plausible shocks, whether deposit runs or large insurance losses.
• Governance and board oversight: the PRA expects banks to embed ILAAP and insurers to embed liquidity risk in their ORSA process and reports. Strong governance is essential.
• Contingency funding plans: FS firms need executable plans, pre-arranged lines, collateral readiness and tested operational steps.
• Monitoring and early warning indicators: continuous monitoring of liquidity drivers and triggers for action is critical in both sectors.
• Integration with strategy: liquidity risk management is tied to risk appetite and strategic planning, not siloed compliance.

These shared foundations create opportunities for cross-sector learning. Banks can adopt insurers’ long-term perspective, while insurers can leverage banking’s rigor in short-term liquidity execution.

How insurers can leverage banking practices

Insurers face liquidity shocks differently like catastrophic losses, collateral calls and market dislocations but they can borrow proven banking disciplines to strengthen resilience:

• Adopt banking-style liquidity ladders: map immediate cash, “repoable” assets, committed credit lines and contingent reinsurance recoveries.
• Run collateral call drills: simulate collateral shocks and rehearse settlement routes.
• Create internal short-term coverage ratios: add a shorter-term liquidity metric, e.g. sub 1 month.
• Integrate liquidity into investment mandates: avoid assets that are “liquid in theory” but illiquid under stress.
• Embed liquidity in stress testing: include scenarios for rapid collateral calls, operational losses, etc.

What banks can learn from insurers

Cross-sector learning works both ways. Banks can also take valuable lessons from insurers’ long-term resilience mindset:

• Forward-looking liquidity planning: insurers embed liquidity risk into their ORSA, linking it to multi-year strategy. Banks should integrate liquidity into strategic planning beyond 30-day survival horizons.
• Stress testing for non-traditional risks: insurers model extreme events. Banks should expand stress tests to include cyber-driven payment outages and systemic contagion.
• Asset liquidity assessment: insurers scrutinise operational liquidity under stress. Banks should apply similar rigor to High-Quality Liquid Assets (HQLA) portfolios, testing settlement speed and haircut volatility.
• Governance and board engagement: the ORSA makes liquidity a board-level discussion. Banks should elevate liquidity beyond Treasury, ensuring boards challenge assumptions and rehearse crisis communications.
• Integration with investment strategy: insurers align liquidity buffers with liability profiles. Banks can link liquidity appetite to lending strategy, deposit mix and product design.

Emerging challenges

Liquidity risk is evolving. Social media accelerates outflows, intraday liquidity matters as much as daily ratios and operational resilience failures like cyber incidents or payment outages can block access to cash. Firms must embed these realities into stress testing and recovery planning.

Liquidity risk is dynamic. Its sources multiply, amplification accelerates and regulatory expectations continue to rise. Banking’s experience offers tested disciplines. Meaningful progress will come from cross-sector learning and the ability to implement improvements swiftly.

Measuring and managing liquidity accurately therefore requires the use of multiple practices including:

• Cashflow forecasting which involves predicting inflows and outflows. This is difficult because customer behaviour, market conditions, losses and macroeconomic factors are uncertain.
• Asset and liability management to understand and reduce the risk of mismatches.
• Understanding the sources/uses of liquidity and the risks they give rise to. Documenting a methodology for calculating liquidity risk metrics.
• Establishing liquidity risk indicators and board-approved risk appetite limits and buffers. In banking, this includes LCR, NSFR and HQLA monitoring, and reporting. Ensuring there is clear and consistent reporting and escalation lines on liquidity matters up to the Board.
• Establishing clear contingency and recovery plans that are tested and sufficiently detailed to allow firms to be prepared and limit their impact on the market in the event of a worst-case scenario manifesting.
• Stress testing for severe but plausible scenarios that could result in a liquidity shortfall and analysing the potential management actions that could prevent failure.

Firms with good liquidity risk management practices usually go above and beyond regulatory requirements to ensure they effectively manage and mitigate causes of liquidity risk and optimise their liquidity position. Liquidity risk management should be forward looking and inform business and strategic planning. For example, instead of focusing only on historical data or regulatory ratios, using scenario analysis, stress testing and predictive analytics to anticipate emerging risks like cyber threats, climate change and geopolitical shocks is where the real benefits of risk management can be seen. In our next article, we will discuss the challenges and opportunities involved in stress testing in more detail.