Why liquidity risk management is crucial: Insights from the FSB’s latest report

key takeaways

• The FSB has released two reports to strengthen oversight of non-bank financial institutions.
• Recommendations include setting possible limits on leverage and greater transparency.
• Technology will play an important role in helping firms comply.

Over the past five years, unexpected events have rocked financial markets, from the pandemic to geopolitical tensions and fluctuating tariff policies. These dynamics prompted regulators and policymakers to delve deeper into the different segments of the industry and the risks they pose.

One sector under increased scrutiny has been the so-called shadow banks or non-financial bank institutions (NBFIs). The Financial Stability Board (FSB) – an international body that monitors and makes recommendations about the global financial system – has actively developed a policy to bolster the oversight and resilience of this rapidly expanding group.

This policy’s main focus is to reduce excessive spikes in liquidity demand, enhance the resilience of liquidity supply in stress, and improve liquidity risk monitoring and the preparedness of authorities and market participants. The FSB, in collaboration with standard-setting bodies (SSBs), proposed policies in early 2024 to enhance margining practices and the liquidity preparedness of non-bank market participants for margin and collateral calls.

What Is liquidity risk management? Why does it matter for financial institutions?

Liquidity risk is the risk of loss resulting from an organization’s inability to meet payment obligations in full and on time when they become due. Effective liquidity risk management minimizes this risk by ensuring that the organization has enough cash on hand to meet its immediate and short-term obligations.

For financial institutions, this includes identifying, assessing, and managing potential risks that could cause losses. It also helps to avoid unnecessary borrowing and keeps borrowing costs down – both of which are fundamental to maintaining financial strength, maintaining the trust and confidence of all stakeholders, and ensuring long-term viability.

FSB’s progress report

As part of the organization’s NBFI work program, the FSB published a progress report titled Enhancing the Resilience of Non-bank Financial Intermediation, in mid-July 2025. The report covers the FSB’s recent and ongoing work in collaboration with SSBs, with that completed to date largely comprising completing the original policy elements of the NBFI work program agreed upon after the March 2020 market turmoil. The FSB is now shifting its focus to implementation monitoring and the ongoing assessment of vulnerabilities in this sector; further work to address data challenges, information sharing, and discussions on authorities’ policy approaches; and monitoring implementation of the agreed policies.

This year’s progress report reveals that NBFIs such as hedge funds, private credit providers, and insurers accounted for $218 trillion of the world’s financial assets in 2022 (just under 50 percent). It also highlights the belief among central bankers and regulators that hedge funds and other non-bank actors – seen as heavy users of leverage but with lighter regulation than banks – need greater oversight.

Leverage must be managed properly

As noted in FSB’s Leverage in NBFI report, released in early-July 2025, leverage in NBFI can be an important amplifier of stress. If not properly managed, it can create risks to financial stability.

The FSB’s July 2025 progress report also cites several flashpoints where NBFIs threatened the stability of the global financial system. These include hedge funds’ rapid unwinding of $90 billion in basis trades during the 2020 US Treasury market turmoil, their part in the collapse of Archegos Capital in 2021, and the UK mini budget-induced pension liability-driven investment crisis in 2022.

The measures recommended by the FSB, which was set up by the G20 group of countries after the 2008 crisis to coordinate global financial regulation, include requiring non-banks to disclose more data on leverage. The proposals also involve making more transactions centrally cleared, imposing tougher rules on borrowing via refinancing markets, and setting outright limits on leverage levels for some funds.

The FSB also announced the formation of the Non-bank Data Task Force to tackle the ongoing data challenges and to improve the ability of FSB member authorities to identify and assess vulnerabilities stemming from non-bank sectors.

The July 2025 report followed the FSB’s final report – Liquidity Preparedness for Margin and Collateral Calls – which was issued at the end of 2024. This report also focused on leverage, but in the context of margin and collateral calls.

How to enhance liquidity preparedness

FSB observes that “while margin and collateral calls are a necessary protection against counterparty risk, they can also amplify the demand for liquidity by market participants if they are unexpected in times of stress and affect a large enough part of the market. The increase in such calls can impact market participants differently depending on the size of positions and level of liquidity preparedness.”

For example, it notes that hedge funds often employ substantial debt to amplify returns, which can cause rapid deleveraging during market tension. The result is significant price movements, affecting liquidity in the underlying assets.

Banks and broker-dealers, on the other hand, act as prime brokers, and play a central part in providing leverage to hedge funds. Monitoring positions can prove difficult because the larger players typically diversify their leverage across several prime brokers. If a major hedge fund fails, this could cause substantial losses for prime brokers and reverberate across the financial spectrum.

To address these risks, the FSB issued eight recommendations to enhance the liquidity preparedness of NBFIs in terms of margin and collateral calls in centrally and non-centrally cleared derivatives and securities markets. These range from risk identification and monitoring to the use of leverage in core financial markets, and having a more coordinated regulatory approach.

Stress testing and governance frameworks

In particular, the FSB proposes liquidity stress testing and scenario design to analyze a range of extreme but plausible liquidity pressures triggered by changes in margin and collateral calls, as well as market participants’ overall liquidity position.

Liquidity stress testing – which focuses on a financial institution’s ability to withstand hypothetical liquidity shocks – is not novel or new. Conversely, financial authorities have traditionally employed liquidity stress tests to assess the materiality of liquidity risk within the financial sector – in a stress situation, liquidity becomes concentrated in stronger firms, and liquidity stress tests help the authorities identify the weakest players.

The FSB also asks for better collateral management practices, whereby market participants have active, transparent, and regular interactions with their counterparties and third-party service providers to ensure operational resilience. Importantly, incorporating margin and collateral stress testing into the overall risk management governance framework is integral to a cohesive approach and ensures resilience against liquidity shocks that impact margin calls and collateral management.

Implications for market participants

The FSB is not alone in addressing systemic risks. The reports cited in this blog build on the Basel Committee on Banking Supervision’s work on counterparty credit risk management, and the joint work to address margining practices undertaken by the Basel Committee, the Bank for International Settlements’ Committee on Payments and Market Infrastructures, and the International Organization of Securities Commissions (IOSCO).

Technology’s role in meeting and overcoming these hurdles will be crucial. Market participants – including banks, asset managers, and others – will need a detailed plan for digital transformation that encompasses seamless automated workflows, liquidity risk management systems, and the ability to optimize collateral. This requires a holistic back-to-front infrastructure that is flexible and can comply with current and future regulatory changes.

ION – a global leader in mission-critical trading and workflow automation software, high-value analytics and insights, and strategic consulting – has a proven track record of enabling the digital transformation of financial institutions, central banks, governments, and corporate organizations. By design, our solutions and services simplify complex processes, boost efficiency, enable better decision-making, ensure compliance with regulations, and support effective risk management.