Liquidity Management

10 Key excerpts on "Liquidity Management"

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  eBook - ePub

  The Principles of Banking

  • Moorad Choudhry(Author)
  • 2012(Publication Date)
  • Wiley

    (Publisher)

  In this and the next three chapters we discuss the “water of life” of banking: Liquidity Management. The recommended practices described in this chapter should not be followed because they are required by the national regulator or by the BIS, but because they are essential for any bank that wishes to continue in business on a sustained basis over the business cycle. In other words, sensible banking demands this practice; that regulators have to enforce it by fiat demonstrates the extent to which poor bank management exists in countries around the world. The central tenet of the principles of banking is that of liquidity risk management; therefore, by definition it should be part of the strategy of every bank to be able to survive a liquidity crisis. Liquidity Management is the most important risk management function in banking, at the individual bank level and at the aggregate industry level. Failure to survive a liquidity crisis is a failure of management.

  This chapter introduces and defines the concept of liquidity risk. It then covers the principles of sound Liquidity Management, before looking in detail at the elements of a bank liquidity policy statement, including (i) the liquid asset buffer, (ii) central bank funding facilities and (iii) the contingency funding plan.

  This is a long chapter, but worth persevering with as it is perhaps the most important chapter in the book.

  Bank Liquidity

  A search of “bank liquidity” on Google undertaken when writing this chapter returned “about 8,160,000 results” in 0.24 seconds. The first line of the first website on the list offered the following: Liquidity for a bank means the ability to meet its financial obligations as they come due. Bank lending finances investments in relatively illiquid assets, but it funds its loans with mostly short-term liabilities. Thus one of the main challenges to a bank is ensuring its own liquidity under all reasonable conditions.2 This definition is accurate and sufficient for our purposes, although we preferred Wikipedia's definition, which stated,

  In banking, liquidity is the ability to meet obligations when they become due.

  In other words, maintenance of liquidity at all times

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  Financial Management for Nonprofit Organizations

  Policies and Practices

  • Jo Ann Hankin, Alan Seidner, John Zietlow(Authors)
  • 2011(Publication Date)
  • Wiley

    (Publisher)

  20 Changing the last phrase to read “to attain its mission” recasts the definition for nonprofit organizations. Gallinger and Healey allege that the failure of managers to provide adequate liquid resources to both meet near-term bills and finance growth initiatives has been the cause of as many business failures as have economic recessions. They indicate that the most fundamental objective of Liquidity Management is to ensure corporate solvency (pay bills as they become due) or ensure corporate survival. The key issues in Liquidity Management are to minimize “insolvency risk” by (1) determining how much to invest in each component of current assets and allocate funding needs to each component of current liabilities, and (2) managing these investments and allocations effectively and efficiently.

  (a) LAYERS OF LIQUIDITY.

  We can view Liquidity Management in a way useful to managers by establishing “tiers of liquidity.”21 Here the organization’s liquidity is viewed in tiers of decreasing liquidity, with six major layers of liquidity (see Exhibit 2.1 ).

  For our discussion of nonprofit Liquidity Management, it is helpful to distinguish among solvency, liquidity, and financial flexibility.

  (b) SOLVENCY.

  An organization is solvent when its assets exceed its liabilities. The larger the degree to which assets exceed liabilities, the more solvent the organization is. In the nonprofit context, this difference has been labeled positive fund balances or equity fund balances and more recently positive net assets (see Chapter 6 for definitions of these items). When evaluating solvency, we usually go one step further by computing net working capital, which equals current assets minus current liabilities. This data is available on the organization’s balance sheet, which we also detail in Chapter 6 .

  (c) LIQUIDITY.

  Further, an organization is liquid

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  Commercial Banking in an Era of Deregulation

  • Emmanuel Roussakis(Author)
  • 1997(Publication Date)
  • Praeger

    (Publisher)

  Liquidity 197 Some of the factors that have limited the success of management science include difficulty of expressing constraints precisely, poor-quality data, and man- agement preference for low-risk positions over profit maximization during changing economic conditions. For small banks, computers and trained person- nel may be too costly in relation to the expected benefits. This problem is lessening as more bankers are receiving training in the use of the computer and as more banks install their own computer systems, join computer time-sharing networks, and provide personal computers to individual staff members. IDENTIFYING LIQUIDITY NEEDS AND DETERMINING REQUIREMENTS In its quest for an optimal allocation of bank funds, management is constantly confronted with the issue of making adequate liquidity provisions to meet cus- tomer demands for funds. A bank must maintain sufficient amounts of highly liquid assets and/or be able to raise funds quickly from money-market sources to meet deposit withdrawals and legitimate loan requests. Liability management for liquidity is generally relied upon by large money-center banks and some aggressive regional banks, whereas the vast majority of U.S. banks have tradi- tionally relied upon liquid assets to provide for the varied demands for funds. The maintenance of liquid assets against deposit demands has been termed by some analysts ‘‘deposit liquidity’’ or ‘‘protective liquidity,’’ as distinguished from ‘‘lending liquidity’’ or ‘‘portfolio liquidity,’’ which applies to the main- tenance of liquid assets for meeting the community’s additional loan demands. Before discussing the nature of the assets that meet these liquidity needs, we will examine how banks go about establishing their liquidity requirements. This is all the more important because an excessive or deficient liquidity position can result in an unprofitable operation.

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  Managing Liquidity in Banks

  A Top Down Approach

  • Rudolf Duttweiler(Author)
  • 2009(Publication Date)
  • Wiley

    (Publisher)

  Liquidity Management and funding are like a set phrase with two elements: turning the screw on one side affects the other side immediately and congruently. To know what to do in Liquidity in the Context of Business and Financial Policy 43 Liquidity Management is one issue; to have investors who get along with you is another one. Lenders do not care about a company’s need. For them, avoiding unnecessary risk is at the forefront of their thinking. Their perception about the financial solidity of a firm is made up of items like capital ratio, level and solidity of earnings and debt ratio, just to mention some key financial issues. To strike a sound balance is the first priority. At the moment, it would not be fitting to go deeper into the matter. It is more appropriate first to get a proper overview and understanding of the interrelationship from various positions. We will come back to it when we summarise the findings at the end of the section. 2.2.3.2 Profitability related to liquidity The link between profitability and liquidity is simultaneously both complementary and con-tradictory. The latter refers to cost implied when liquidity is generated and held. Spremann (1996, page 198f.), for example, segregates situation-specific and structural liquidity. On this understanding, planning to secure payments at the due dates is situation specific. As all plans contain an element of uncertainty, a buffer is required in the form of a reserve. Keeping reserves is expensive and the higher the reserves, the more expensive they are. Structural liquidity refers to the composition of the balance sheet.

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  Bank Asset and Liability Management

  • (Author)
  • 2018(Publication Date)
  • Wiley

    (Publisher)

  PART 2 MANAGING LIQUIDITY RISK AND INTEREST RATE RISK Passage contains an image

  CHAPTER 4 Liquidity Management

  Learning outcomes

  After studying this chapter, you should be able to:

  1. Define key concepts used in measuring liquidity risk including the liquidity coverage ratio, the net stable funding ratio and the BCBS principles to manage liquidity risk.
  2. Describe the funding needs of banks, including loan and deposit trend forecasting, meeting liquidity gaps and liquidity planning.
  3. Explain the role of stress testing in managing liquidity.

  Introduction

  Liquidity is key to the operations of banks and other financial institutions, and managing liquidity risk is a very important function that is often overlooked. At times, the need for liquidity can override profitability or the choice of products that a bank handles. The liquidity resources of a bank are important factors in determining the credit-worthiness of the institution itself as well as the rating accorded to it by agencies like Moody's, Standard & Poor's or Fitch Ratings. At the end of the day, liquidity and solvency are inter-related. Without adequate liquidity, banks may not be able to meet their obligations, even if they have a positive balance sheet.

  Effective Liquidity Management is an intrinsic part of effective bank asset and liability management (BALM). In fact, it is almost impossible to properly manage the latter without effectively managing the former. Liquidity risk is, at the end of the day, one of the key risks that banks have to consider as part of their operations. Liquidity risk comes into play in a broad range of operational areas and can be affected by legal and tax events or regulatory requirements, to name just two examples. At its very core, liquidity risk is the risk that a bank or other authorised institution (AI) may be unable to meet its obligations as they fall due. This inability to meet obligations could be caused by a variety of factors including an AI's ability to liquidate assets or access short-term funding through discount windows or interbank facilities. Problems can also be caused by problems of liquidity in the broader market at times of crisis.1 At times of dropping interest rates or slowing economic growth, liquidity risk generally rises and drops as economic recovery kicks in and interest rates start to go up, to mention but one overly simplified example. (See Lehman Brothers case study in Chapter 7

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  Understanding Risk

  The Theory and Practice of Financial Risk Management

  • David Murphy(Author)
  • 2008(Publication Date)
  • Chapman and Hall/CRC

    (Publisher)

  337 C H A P T E R 9 Liquidity Risk Management INTRODUCTION The last chapter considered the interest rate and FX risks an institution might take as part of its funding strategy. One of the central questions was how much the bank’s cost of funds might change if interest rates moved given how it plans to borrow. Here we look at another aspect of funding: the risk that the firm might not be able to borrow at all , or only at prohibitive cost, perhaps due to a fall in confidence or to a market-wide crisis. This is liquidity risk .* Liquidity risk in a firm occurs due to the mix of assets and liabilities, so we look at both sides. Asset liquidity concerns the ability to turn an asset into an amount of cash close to where it is marked; liability liquidity concerns the behaviour of a fi rm’s liability base in various conditions. Once we have seen how some of the different parts of the balance sheet behave, liquidity risk management is introduced; this process is designed to keep liquidity risk within bounds without subjecting the firm to too high a cost of funds. Contingent liquidity instruments are the ones which supply or demand liquidity under certain conditions such as uncommitted LOCs. We touch on these to highlight the liquidity options a firm might have positions in. Finally, liquidity in a crisis is discussed and the techniques firms use for dealing with these events are touched upon. 9.1 LIQUIDITY OF SECURITIES AND DEPOSITS Liquidity is the ability to meet demands for cash. These demands might be either expected , as in a coupon that we know we have to pay on an issued security, or unexpected , as in the early exercise of an option. * For a wider and more comprehensive discussion of liquidity risk, see Avinash Persuad’s Liquidity Black Holes: Understanding, Managing and Quantifying Liquidity Risk or Erik Bank’s Liquidity Risk .

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  Managing Liquidity

  • Lance Moir(Author)
  • 1997(Publication Date)
  • Woodhead Publishing

    (Publisher)

  9 Liquidity Management in practice • Putting the theory into practice • Some simple case studies T h e p r i n c i p a l objective of liquidity m a n a g e m e n t is always to m a i n t a i n liquidity so t h a t a c o m p a n y o r o r g a n i s a t i o n (or for t h a t m a t t e r a n individual) c a n c o n t i n u e to m e e t its c o m -m e r c i a l objectives. B u t t h e r e is also t h e task of m a n a g i n g t h e liquidity in a n o p t i m a l w a y in t h e best interests of t h e o r g a n i s a t i o n . T h e g e n e r a l a p p r o a c h to liquidity m a n a g e m e n t in p r a c t i c e h a s a l r e a d y b e e n set o u t as safety, liquidity a n d profitability, to w h i c h c a n n o w b e a d d e d t h e m a n a g e m e n t of risk. B y p u t t i n g all these t o g e t h e r w e c a n n o w a d d r e s s t h e following p r a c t i c a l questions: h o w m u c h , for h o w long, w h a t i n s t r u m e n t a n d for w h a t r e t u r n ? B u t liquidity m a n a g e m e n t c a n n o t b e r e d u c e d to o n e decision, say, to invest in a C D for 3 m o n t h s at 1 0 % a n d to leave it at t h a t . T h e d y n a m i c s of b o t h t h e m a r k e t -p l a c e a n d t h e u n d e r l y i n g business m e a n t h a t decisions n e e d to b e k e p t u n d e r active r e v i e w to e n s u r e t h a t overall objectives ( a n d espe-cially t h e p r i n c i p a l objective of m a i n t a i n i n g liquidity) c o n t i n u e to b e m e t . 1 4 7 Managing liquidity The general approach I n earlier c h a p t e r s t h e v a r i o u s c o n c e p t s a n d tools u s e d in li-quidity m a n a g e m e n t h a v e b e e n described. W e c a n n o w p u t these t o g e t h e r to see h o w decisions m i g h t o p e r a t e in relatively c o m p l i c a t e d situations. T h e starting-point is to d e v e l o p a cash forecast for a given future p e r i o d a n d t h e n look at it critically in t h e c o n t e x t of t h e business.

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  Managing Banking Risks

  Reducing Uncertainty to Improve Bank Performance

  • Eddie Cade(Author)
  • 2013(Publication Date)
  • Routledge

    (Publisher)

  Chapter Four Liquidity risk Banks must be capable of meeting their obligations when they fall due. Such obligations mainly comprise deposits at sight or short notice, term deposits and commitments to lend, including unutilised overdraft facilities. The mix of these obligations and their incidence in any period of time will vary between banks, but the maintenance of an assured capacity to meet them is an essential principle of banking which is common to all. The Management of Liquidity', Bank of England, July 1982 This chapter discusses: Liquidity Management and regulation. Systemic risk. The impact of derivatives on systemic risk. The process of asset and liability management. 'Liquidity' is a term used by different bankers in different ways. Traders have in mind market depth and the relative ease or difficulty with which they can encash/liquefy/liquidate their positions. Other observers speak of liquidity risk as applying to nothing less than a tidal run on deposits, caused by loss of market confidence in the bank; in other words, as an extreme symptom of some other problem rather than a risk that can exist in its own right. Bank treasurers have to take a more comprehensive view: that liquidity risk has its sources on both sides of the balance sheet, and that management of the risk has to address normal as well as stressed conditions. Liquidity risk, the potential for running short of cash in hand to settle debts and commitments when due, has some kinship with solvency risk (Chapter 3). Both are crystallised in an inability to meet financial obligations in full; but illiquidity is temporary, and insolvency permanent. Insolvency in a normally capitalised bank is the direct consequence of massive losses, whereas illiquidity is not necessarily associated with losses or writedowns but results from incoming and outgoing cash flow relationships

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  Value-Based Working Capital Management

  Determining Liquid Asset Levels in Entrepreneurial Environments

  • G. Michalski(Author)
  • 2014(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  2

  Understanding and Measuring Financial Liquidity Levels

  T his chapter presents a definition of financial liquidity and liquidity-level measurements. This chapter contains four subchapters that address the specific role of short-term financial decisions, a classification of definitions of financial liquidity , sources of information about liquidity level, and liquidity-level measurements (Lazaridis and Tryfonidis 2006; Long, Malitz, and Ravid 1993; Kieschnick, Laplante, and Moussawi 2009).

  Financial liquidity definition and liquidity-level measurements

  Here we have an opportunity to present the author’s opinion on what assets should be financed with short-term funds and what the level of liquidity is in an enterprise (Michalski 2012a). The discussion also pertains to the issue of the dividing line between long-term and short-term decisions, with greater emphasis on the durability of their effects, rather than the decision-making speed. This section also attempts to answer the question: What are the short-term effects of operations under conditions of uncertainty and risk? The reason for the considerations in this section is the need to characterize the decisions that affect the level of enterprise liquidity. The research hypothesis of this monograph assumes that differences between more risk sensitive and less risk sensitive enterprises are seen in Liquidity Management. Simply because the enterprises, during financial Liquidity Management, take into account the differences in their risk sensitivity.

  2.1. Short-term and long-term financial decisions: A perspective in context of strategic and tactical decisions

  Current financial management is associated with how a managing team’s actions have an impact on the funding needed for its activity in the short term. Considerations about the long term differ in many respects from those concerned with short term.

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  Asset and Liability Management Handbook

  • G. Mitra, K. Schwaiger, G. Mitra, K. Schwaiger(Authors)
  • 2011(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  15 Asset-Liability Management is a generic term that is used to refer to a number of things by different market participants. We define it as the high-level man- agement of a bank’s assets and liabilities; as such it is a strategy-level discipline and not a tactical one. It may be set within a bank’s Treasury division or by its asset-liability committee (ALCO). The principal objective of the ALM function is to manage interest-rate risk and liquidity risk. It also sets overall policy for credit risk and credit risk management, although tactical-level credit policy is set at a lower level within credit committees. Although the basic tenets of ALM would seem to apply more to commercial banking, rather than investment banking, in reality it is important that it is applied to both functions. A trading desk still deals in assets and liabilities, and these must be managed for interest- rate risk and liquidity risk. In a properly integrated banking function, the ALM desk will have a remit covering all aspects of a bank’s operations. In this chapter we describe the essential principles of the asset-liability man- agement responsibility of a bank. This is illustrated using examples and an investment bank case study. We also look at the function of the guardians of ALM at a bank, the asset-liability committee or ALCO. The remainder of the chapter looks at Liquidity Management, the key liquidity risk reporting metrics and a sample framework for a bank’s internal funding rate policy. 2.1 Basic concepts of bank asset-liability management In financial markets, the two main strands of risk management are interest-rate risk and liquidity risk. ALM practice is concerned with managing these risks. Interest-rate risk exists in two strands. The first strand is the more obvious one, the risk of changes in asset-liability value due to changes in interest rates.

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