1. Irwin/McGraw-Hill 1 Liability and Liquidity Management Chapter 18 Financial Institutions Management, 3/e By Anthony Saunders

2. Irwin/McGraw-Hill 2 Liquid Asset Management Examples: T-bills, T-notes, T-bonds Benefits of holding large quantities of liquid assets Costs of holding liquid assets Reasons for regulating minimum holdings of liquid assets: »Monetary policy »Taxation

3. Irwin/McGraw-Hill 3 U.S. Cash Reserve Requirements Incremental reserve requirements: »First $4.3 million 0.0% »$4.3 million to $52 million 3.0% »$52 million + 10.0% Banks view government securities as a buffer reserve.

4. Irwin/McGraw-Hill 4 Reserve Management Problem Computation period runs from a Tuesday to a Monday, 14 days later. Average daily reserves are computed as a fraction of the average daily deposits over the period. This means that Friday deposit figures count 3 times in the average. “Weekend Game” Sweep accounts

5. Irwin/McGraw-Hill 5 Reserve Management The maintenance period, differs from the computation period by 2 days Allowance for up to a 4% error in average daily reserves without penalty. Undershooting by more than 4% penalized by a 2% markup on rate charged against shortfall. Frequent undershooting likely to attract scrutiny by regulators

6. Irwin/McGraw-Hill 6 Funding Risk versus Cost Funding Cost Funding Risk

7. Irwin/McGraw-Hill 7 Liability Management Note the tradeoff between funding risk and funding cost. Demand deposits are a source of cheap funds but there is high risk of withdrawal. NOW accounts: manager can adjust the explicit interest rate, implicit rate and minimum balance requirements to alter attractiveness of NOW deposits.

8. Irwin/McGraw-Hill 8 Deposit Accounts Passbook Savings Accounts: Not checkable. Bank also has power to delay withdrawals for as long as a month. Money market deposit accounts: Somewhat less liquid than demand deposits and NOW accounts. Impose minimum balance requirements and limit the number and denomination of checks each month.

9. Irwin/McGraw-Hill 9 Time Deposits and CDs Retail CDs: Face values under $100,000 and maturities from 2 weeks to 8 years. Penalties for early withdrawal. Unlike T-bills, interest earned on CDs is taxable. Wholesale CDs: Minimum denominations of $100,000. Wholesale CDs are negotiable.

10. Irwin/McGraw-Hill 10 Fed Funds Fed funds is the interbank market for excess reserves. 90% have maturities of 1 day. Fed funds rate is highly variable »especially around the second Tuesday and Wednesday of each period. ( May rise as high as 30% and fall close to 0% on some Wednesdays).

11. Irwin/McGraw-Hill 11 Repurchase Agreements RPs are collateralized fed funds transactions. Usually backed by government securities. Can be more difficult to arrange than simple fed funds loans.

12. Irwin/McGraw-Hill 12 Other Borrowings n Bankers acceptances n Commercial paper n Medium-term notes n Discount window loans

13. Irwin/McGraw-Hill 13 Historical Notes Since 1960, ratio of liquid to illiquid assets has fallen from about 52% to about 30%. But, loans themselves have also become more liquid. In the same period, there has been a shift away from sources of funds that have a high risk of withdrawal. Reliance on borrowed funds does have its own risks as with Continental Illinois.

14. Irwin/McGraw-Hill 14 Liquidity Risk in Other FIs n Insurance companies Diversify across contracts Hold marketable assets n Securities firms Example: Drexel Burnham Lambert