1Liquidity Management Outline Estimating liquidity needs Sources and uses of funds methodStructure-of-deposits methodFunding and market liquidity needsAsset liquidityPrimary reservesManaging the money positionSecondary reservesLiability managementFunds management of liquidityLiquidity ratiosOptimum bank liquidityRegulatory view of bank liquidity
2Estimating liquidity needs Sources and Uses of Funds Method:Calculate future changes over time in loans and deposits from past experience and future expectations.Example of estimation:
3Estimating liquidity needs Structure-of-Deposits Method:Example of estimation:
4Estimating liquidity needs Funding and market liquidity needsFunding-liquidity risk refers to maintaining sufficient cash to meet investment needs.Market-liquidity risk is related to market disruptions that can temporarily widen bid-ask spreads and make it difficult to close out open positions in derivatives, securities, etc. without sustaining losses.General definition of liquidity: Amount of liquidity needed relative to ability to meet liquidity demands.
5Asset liquidity Role of asset liquidity Liquid assets are an alternative source of funds.A reserve to protect the bank from financial market loss of confidence that could threaten safety and soundness.Primary reserves -- vault cash and cash held on deposit at the Federal Reserve district bank.Secondary reserves -- money market instruments held by the bank under no formal regulatory requirements.
6Asset liquidity Primary reserves Lagged reserve requirements (see next page)Calculate daily average balances of transactions deposits during a 14-day period (computation period).Calculate average daily vault cash in the next 14-day period. Skip 3 days.Maintain reserve balances at the Federal Reserve during a subsequent 14-day period (maintenance period). Thus, 17 days between end of computation period and beginning of maintenance period.LRR lowers management costs and improves the quality of information on required balances.
7Asset liquidityManaging the money position (minimize cash holdings which generally means to meet reserve requirements).
8Asset management Secondary reserves T-bills, Federal agency securities, repurchase agreements (RPs or Repos), bankers’ acceptances, negotiable certificates of deposit (CDs), federal funds, and commercial paper.Aggressive liquidity approachYield curve relationships can be used to buy longer-term or short-term securities (e.g., 30-day 2-year securities).Securitization of loans (asset-backed financing)Loans are converted to securities with greater liquidity.Credit risk is reduced.
9Liability managementPurchase the funds needed to meet loan demands and deposit withdrawals.Correspondent balances of smaller banks with larger banks.RisksInterest rate increases reduce interest rate margins.Capital losses on securities and other assets can occur as interest rates increase.Loss of public confidence would prevent the bank from rolling over purchased funds.Increased borrowing causes financial risk to increase (i.e., variability of earnings per share).Capital market risk can occur when interest rates are low and investors shift funds from deposits to higher earning capital assets in the financial marketplace.
10Funds management of liquidity Compare the total liquidity needs to total liquidity sources.Liquidity ratiosLoans/depositsLoans/nondeposit liabilitiesU.S. government securities/nondeposit liabilitiesU.S. government securities/large denomination time depositsLiquid assets and liabilities in period t/estimated liquidity needs in period t(i.e., liquidity relative to needs)Optimum bank liquidityBalance risks and returns … high enough liquidity to meet unexpected needs but not so high to incur high opportunity costs of near-cash assets.Uncertainty in forecasted needs and sources affects optimum also.
11Funds management of liquidity Regulatory view of bank liquidityAdequacy of bank liquidity (not least cost or optimum liquidity strategy).The availability of assets readily convertible into cashThe structure and volatility of depositsThe reliance on interest-sensitive fundsThe ability to sustain any level of borrowings over the business cycleThe bank’s formal and informal commitments for future lendingThe ability to adjust rates on loans when rates on interest-sensitive sources of funds fluctuateThe examiner-analyst