1. Liquidity Functions of Banks

2. Liquidity Risk
Funding risk – Liability maturity structure
Timing risk – Reutilization of funds
Call risk – Off-balance sheet obligations

3. Liquidity Management
Reserve Bank of India
Ability to efficiently accommodate deposit and other liability decreases as well as loan portfolio growth and the possible funding of off-balance sheet items
Funding through deposits
Liability side management
Asset side management
Managing off-balance sheet transactions

4. Liquidity Risk for Banks
Bank faces a stagnant deposit portfolio while demand for loans and advances from corporate sector increases Or
Bank is required to increase the asset base to meet its increased overheads
Mismatch of the composition of assets and liabilities
Short term liabilities are used to fund long term assets

5. Conflict in Liquidity Risk Management
Pricing of assets and liabilities determines the short term problems in liquidity management for banks
Balancing returns in relation to fund requirements is the core of liquidity management
If liabilities are priced less (rate of interest on a deposit in a bank is lower than that of other peer level banks), there will be more outflow, assuming assets (loans and advances, investment) remain at the same level

6. Conflict in Liquidity Risk Management
If liabilities are priced low (rate of interest on bank deposit is lower than other banks), the bank will face shortage of inflow, assuming asset demand remains the same
An ideal balance is to be maintained between the levels of liabilities and assets so as to avoid the liquidity trap

7. Focal Areas for Banks in Liquidity Management
Composition of liabilities, particularly the level of demand liabilities (current accounts and saving bank accounts) in relation to term liabilities (fixed deposits)
Build up of assets, particularly the level of term assets (term loans beyond 3 years and investments in long term securities to be held till maturity) in relation to short term assets net of non-performing assets (cash credit, overdrafts, demand loans)

8. Focal Areas for Banks in Liquidity Management
Predominant area of operation
Dominant customer profile of the bank
Ownership of the bank (Government holding, Institutional holding, Public holding)
Public image of the bank 8

9. Action Plan
Realistically assess on an ongoing basis the likely inflow of deposits and likely demand for bank loans and also the bank’s own policy towards investment in securities
Possibility of renewal of maturing liabilities (fixed deposits) and core deposits in current liabilities (current accounts, savings bank account) as also of revolving assets (cash credit, overdraft)
Reliability of assets (recovery from borrowers on demand and sale of investment and other assets when necessary)

10. Action Plan
Ability to utilize opportunities arising in the banking system
Likelihood of a larger outflow of deposits may arise if the bank’s image is tarnished or a scam has occurred in a bank or there is a sudden change in the public perception
Top priority to relationship with bank customers so as to build and maintain confidence in the bank

11. Action Plan
Funding requirement of the bank to be assessed on a daily basis keeping in view likely future inflows and outflows
Classifying assets and liabilities over the applicable time buckets
Ability of the bank to function on a conservative basis to meet an adverse situation that may occur at any point of time

12. Action Plan
Ability of the bank to maintain its investment in securities and avoid distress sale on account of liquidity crisis
Ability of the bank to avoid high cost borrowing from the Reserve Bank and other market borrowings on a frequent basis 12

13. Managerial Actions in Liquidity Management
Core activity
Pricing of assets and liabilities
Related problem
Interest risk management

14. Tools for Liquidity Management
Short term implications
Long term implications

15. Short Term Implications
Working Funds Approach
Cash Flow Approach

16. Working Funds Approach
Bank resources:
Owned capital
Deposits
Volatile deposits (30 days)
Vulnerable deposits (core / non-core)
Core funds
Float funds
Transit funds
Funds on issue of drafts / pay orders / cheques
Full Liquidity
Full Liquidity

17. Cash Flow Approach
Estimation of anticipated deposit base
Likely quantum of recycling of funds that have been lent (includes loan recovery of non performing assets)
Assessment of quantum of maturity of deposits and withdrawals
Likely amount of deployment in loans and advances or investments
Computation of liquidity level for a specific period with a variance level of 10 to 15%

18. Long term Implications
Asset Management
Liquidity Management

19. Reserve Bank of India Guidelines on Liquidity Management
Fortnightly statement of structural liquidity
Fortnightly statement of short term (up to 90 days) dynamic liquidity

20. Statement of Structural Liquidity
Statement on the basis of liabilities and assets on the last reporting Friday
Time buckets on the residual maturity of each item of assets and liabilities

21. Time Buckets
1-14 days
15-28 days
29 days to 3 months
Over 3 months to 6 months
Over 6 months to 1 year
Over 1 year to 3 years
Over 3 years to 5 years
Over 5 years

22. Short term Dynamic Liquidity
Fortnightly statement of outflows and inflows of assets and liabilities for a period of 90 days.
Time Buckets
1-14 days
15-28 days
29 days to 3 months
Mismatch / cumulative mismatch as a percentage of the total outflows

23. RBI Format – Dynamic Liquidity
1-14 days
15-28 days
29-90 days
A.Outflows
Net increase in loans and advances
Net increase in investments
(i) Approved securities
(ii) Money market instruments (other than treasury bills)
(iii) Bonds/debentures/shares
(iv) Others
Inter-bank obligations
Off-balance sheet items (repos, swaps, bills discounted)
Others
Total outflows

24. RBI Format – Dynamic Liquidity
1-14 days
15-28 days
29-90 days
B. Inflows
Net Cash position
Net increase in deposits (less CRR obligations)
Interest on investments
Inter-bank claims
Refinance eligibility (Export credit)
Off-balance sheet items (reverse repos, swaps, bills discounted)
Others
Total inflows

25. RBI Format – Dynamic Liquidity
1-14 days
15-28 days
29-90 days
C. Mismatch (B – A)
D. Cumulative mismatch
E. ( C) as a percentage to total outflows