1. The Principles of Banking Moorad Choudhry
Chapter 12
Principles of Bank Liquidity Management
WHUT
Robert R. Reitano

2. Principles of Bank Liquidity Management
One Definition of Liquidity:
Liquidity for a bank means the ability to meet its financial obligations as they come due.
Asset/Liability Mismatches Create Liquidity Risks
Banks Require Continuous Ability to Roll-Over Funding
Otherwise, long loans/investments are impossible
WHUT
Robert R. Reitano

3. Principles of Bank Liquidity Management
Elements of Liquidity Risk Management
WHUT
Robert R. Reitano

4. Principles of Liquidity Management
Sustainable Banking: 9 Principles
Fund Illiquid Assets with Core Customer Deposits
More stable than wholesale funds
Lower risk of withdrawal in downturn
If not Available, Fund with Long-Term Wholesale Funding Sources
Minimum 1 year
Ideally, Suited to maturity of asset
WHUT
Robert R. Reitano

5. Principles of Liquidity Management
Sustainable Banking: 9 Principles (Cont’d)
No Over-Reliance on Wholesale Funding
Long-term (>1 year) preferred over short term
Author suggests < 20-30% short term funding
Note: Borrow Short –
Invest Long
WHUT
Robert R. Reitano

6. Principles of Liquidity Management
Sustainable Banking: 9 Principles (Cont’d)
Maintain “Liquidity Buffers” of Instantly Liquid Assets
For Firm-specific and industry-wide stresses
Example: short-term government bills, CDs, FRNs
Low yielding, but cost justified in crisis
Establish a Liquidity Contingent Plan
Establish borrowing facility at Central bank, etc.
Plan must be updated and tested regularly
WHUT
Robert R. Reitano

7. Principles of Liquidity Management
Sustainable Banking: 9 Principles (Cont’d)
Know What Central Bank Facilities are Available
Know requirements
Test access periodically
Be Aware of Bank Liability Exposures
Be aware of reputational obligations
Lines of credit, lines of liquidity, etc.
Liquidity Risk is not a Single Metric
Requires an array of metrics (Ch. 13)
WHUT
Robert R. Reitano

8. Principles of Liquidity Management
Sustainable Banking: 9 Principles (Cont’d)
Internal Funding Pricing (Ch. 15 Transfer Pricing)
Framework must be set correctly and adequately
Inappropriate pricing yields poor business decisions
Liquidity Risk Framework “Owned” by the Group Management Board
Policy is Centralized
All exceptions authorized by Board
Board ultimately responsible for funding
WHUT
Robert R. Reitano

9. Principles of Liquidity Management
Additional Principles
All Legal Entities required to be “stand-alone” w.r.t. liquidity and funding
Including liquidity contingency plans
Maintain high proportion of stable customer funding
Understand liquidity of collateral under stressed and normal conditions
Les risk if re-collateralized daily
WHUT
Robert R. Reitano

10. Principles of Liquidity Management
(FSA) Liquidity Stress Tests
WHUT
Robert R. Reitano

11. Principles of Liquidity Management
Liquidity Risk Drivers: Regulators Approach (FSA)
Requires Stress Tests
Wholesale Funding Risk
Behavioral characteristics during stress test scenarios
Intra-Group Funding Risk
Must be “Self-Sufficient,” not reliant on Parent
Intra-Day Liquidity Risk
Concern: Delays from CPY’s payments when stressed
Cross-Currency Liquidity Risk
Split by currency and tenor
WHUT
Robert R. Reitano

12. Principles of Liquidity Management
Liquidity Risk Drivers (Cont’d)
Retail Funding Risk
Varies by bank-customer relationship, account type, etc.
Off-Balance Sheet Liquidity Risk
Contingent liabilities, lines-of-credit, liquidity facilities
Franchise Viability Liquidity Risk
Ability of bank to delay obligations
Marketable/Non-Marketable Asset Risk
Ability to use as collateral, to liquidate, etc.
WHUT
Robert R. Reitano

13. Principles of Liquidity Management
Liquidity Policy Governance Structure
WHUT
Robert R. Reitano

14. Principles of Liquidity Management
Liquidity Policy Statement
WHUT
Robert R. Reitano

15. Principles of Liquidity Management
Liquidity Policy Statement
WHUT
Robert R. Reitano

16. Principles of Liquidity Management
The Liquidity Asset Buffer (“LAB”)
Guidelines from European Supervisors
Covers additional needs under stressed conditions
Use 3 stress tests – loss of rollovers, liquidity loss
Survival period >1 month
Cash, core assets (CB eligible and highly liquid)
Manage liquid assets to be ever available
Locate and size buffers to be adequate to bank BUs
WHUT
Robert R. Reitano

17. Principles of Liquidity Management
The Liquidity Asset Buffer (“LAB”)
Definition of “Liquid”
Convertible to Cash Quickly and Easily,
With no Loss of Value
Proxies:
Bid-offer spread
Price “error” – market versus model proce
Number of market-makers
Size and depth of asset class
WHUT
Robert R. Reitano

18. Principles of Liquidity Management
The Liquidity Asset Buffer (“LAB”)
Securities in the LAB
Highly liquid, high-quality Government debt
Reserves in Central Banks
Bonds issued by multilateral development banks
Two Tiers Recognized by UK FSA
Sovereign securities
Agency securities, corporates AA-/Aa3, secured bonds
WHUT
Robert R. Reitano

19. Principles of Liquidity Management
The Liquidity Asset Buffer Cost Calculation
WHUT
Robert R. Reitano