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Liquidity Risk Measurement, Analysis & Management of LIQUIDITY RISK ALM 99 Paris, Pre-Seminar, 27 Sep 1999.

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Presentation on theme: "Liquidity Risk Measurement, Analysis & Management of LIQUIDITY RISK ALM 99 Paris, Pre-Seminar, 27 Sep 1999."— Presentation transcript:

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2 Liquidity Risk Measurement, Analysis & Management of LIQUIDITY RISK ALM 99 Paris, Pre-Seminar, 27 Sep 1999

3 Liquidity Risk Intro 9 h 00 - 9 h !5 Dr. Robert E. Fiedler Deutsche Bank AG

4 Liquidity Risk Timetable

5 Liquidity Risk Timetable

6 Liquidity Risk Timetable

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12 Liquidity Risk Timetable

13 Liquidity Risk Timetable

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22 Liquidity Risk Timetable

23 Liquidity Risk Overview 9 h 15 - 9 h 45 Dr. Robert E. Fiedler Deutsche Bank AG

24 Liquidity Risk Overview Why? What? How? Solutions DBs solution Q & A

25 Liquidity Risk Why ? Rising/unstable refinancing costs: - General downgrading trend for banks - Emigration of classic “cheap” liabilities - Changing money markets (Euro, Repo) Increasing risk of large short/long cash positions: - Increasing clearing activities (Euro) - Imperfect redistribution of central bank funds - “Unpredictable” flows from (derivative) trading - Volatile customer decisions Upgrading of risk management standards: - Isolation of single risk types - Increasing regulatory demands - Standing in peer group

26 Liquidity Risk Funding Liquidity Solvability = ability to pay debt when due - right time - right currency / payment system Digital: To be or not to be solvent Probability(Staying solvent)  Liquidity Target: High Liquidity (= Low risk of insolvency) Problem:Not cost-neutral Conclusion: Solvability is not everything

27 Liquidity Risk Successful in the future (no future default) Successful in the future (no future default) Liquidity (Cash) Management & Liquidity Risk Management Cash Management Liquidity Risk Management Successful in the past (no past default) =  / / Risk = Uncertainty about future The past is not the future

28 Liquidity Risk Example: Repo-Book Repo with Bonds - O/N - 85% self-funding on average (incl. Haircut) Investment position: 100‘‘‘ EUR Bonds Self-financing: 85‘‘‘ EUR Rest at MM-desk: 15‘‘‘ EUR at O/N What is the Liquidity Risk? - Trader: 15‘‘‘ EUR (CashMgt) - Controller:100‘‘‘ EUR

29 Liquidity Risk Anatomy of Insolvency Insolvency := Inability to meet contractual obligations when they fall due Systemic: - Central bank allocates not enough money - Redistribution process does not work Specific: - Credibility shock - Solvency doubtful Technical: - Excessive forward payment structure - Uncertainty about forward payment structure

30 Liquidity Risk Cash-Status Interest Rate Normal Status We Raise Funds LIBOR - X% LIBOR Flat We Buy / Repo Intraday Assets We Sell / Repo Intraday Assets Ctrl Bank Lombard Rate CtrlBank Eligible Assets Ctrl Bank Purchase Rate CtrlBank Eligible Assets Illiquidity Conclusion: two-sided but not symmetrical  A Liquidity Trader’s View

31 Liquidity Risk Two-sided definition Cashflow Liquidity Risk is the Risk of: only being able to raise funds at rates higher than or place funds at rates lower than (credit ranking adjusted) market rates not being able to raise enough funds to meet contractual obligations (illiquidity, insolvability) having correctly anticipated a market development but ending up with a “wrong” position

32 Liquidity Risk Classic Approach

33 Liquidity Risk Problem: Contingent Cashflows Classic Approach (Liquidity Gap Analysis)

34 Liquidity Risk Maximum Cash Outflow (MCO) General Principle Maximum Out / Minimum In (MCO/MCI) Contractual Cashflows, but: “Probabilistic Contingency Premium” - “Some more” outflows than expected - “Some less” inflows than expected

35 Liquidity Risk Maximum Cash Outflow (MCO) Define contingent Contingent measure ? Risk up there ?

36 Liquidity Risk Stochastic Nature of Cashflows Contractual On- & Off- BalanceSheet Certain Fixed Loan / Deposit Uncertain... MarketDriven IRS, FRA, Future CounterpartyDriven Non-Maturing Account Market Rate & Optionality Variable in Time and/or Amount Dynamic Changing BalanceSheet Stochastic Cashflows

37 Liquidity Risk Expected Cash Liquidity (ECL) mean 

38 Liquidity Risk Expected Cash Liquidity (ECL)

39 Liquidity Risk Expected Cash Liquidity (ECL)

40 Liquidity Risk Expected Liquidity at Risk (ELaR) mean  -quantile  -quantile

41 Liquidity Risk Expected Liquidity at Risk (ELaR)

42 Liquidity Risk Expected Liquidity at Risk (ELaR)

43 Liquidity Risk Albert EINSTEIN  “Everything should be made as simple as possible - but not simpler.”

44 Liquidity Risk Conclusion DB developed a methodology to quantify (Funding)Liquidity Risk Result: global / local Liquidity Gap Analysis - Expected Cash Liquidity – ECL - Expected Liquidity at Risk – ELaR (analogue VaR ) Conclusion after discussions with central banks, supervisors, industry groups other banks: Currently the most advanced methodology.

45 Liquidity Risk Robert.Fiedler @ db.com

46 Liquidity Risk Timetable


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