3. liquidity mgmt

7/27/2019 3. Liquidity Mgmt

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LIQUIDITY MANAGEMENT

Ram Kumar Thapa


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Liquidity of the Individual Bank Liquidity refers to availability of readily spendable funds. Assessment of liquidity is not only the matter of compliance but also subjective issue.

It involves analysis of associated risk and return. A higher amount of liquidity adversely affects the

profitability goals but helps mitigate the risk of running outof liquidity. A common type of yield curve is upward-sloping andindicates that higher interests rates are associated withlonger-term, less liquid assets, and lower yields areassociated with shorter-term, more liquid assets.

Sometimes, liquidity problem of individual financialinstitutions is alleviated by government intervention.


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Compliance as Regards to Liquidity in Nepal

Cash Reserve Ratio (CRR):Commercial Banks Dev Banks Finance Co.

6.0% 5.5% 5.0%(Circular No. 2/2069/070)FIs Which do not accept Current and Call Deposits are required to maintain a

CRR of 2%.

Statutory Liquidity Ratio(SLR):As a percentage of the local currency deposits of the previous month.Commercial Banks Dev Banks Finance Co.

15.0% 11.0% 10.0%(Directive No. 13/2069 (4)Prompt Corrective Action (PCA):PCA shall be applied on the basis of Liquidity and Non-Performing Assets besides Capital Adequacy from this F.Y. (2069/070/) onwards. (MonetaryPolicy 2069/070)


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Bank Liquidity

Liquidity can be stored in assets or purchasedthrough borrowings.Sources of stored liquidity: Net funds sold to other banks Money market securities Loss reserve Central and Local Government SecuritiesSources of purchased liquidity: Central bank discount window loans

Borrowings Repurchase agreements Certificate of deposits (CDs)


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Bank Liquidity

Selected Liquidity of Commercial BanksLiquid Assets Mid Oct.2008

(In Million)Mid July 2010(In Million)

Assets earnings no interest (Cash Bal.) 558,69.55 17,573.1

Bank Balances incl. money at call 253,78.37 85,175.9

Government Securities (Incl. NRB Bonds) 649,748.5 80,466.4

Total Liquid Assets 1,462,22.77 183,215.4

Total Balance Sheet Assets 7,256,43.35 787,300.9

% of liq. Assets over T. Assets 20.15% 23.27%


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Sources of Demand and Supply for Liquidity

Supplies of Liquid Funds Demand for Bank LiquidityIncoming customer deposits Customer deposit withdrawals

Sale of non-deposit services Acceptance of quality creditrequests

Customer loan repayments Repayment of non-depositborrowings

Sale of bank assets Operating expenses and taxes

Borrowings from money market Payment of stockholder cash

dividend

Banks net liquidity position=Supplies of liquidity-Demand for Liquidity


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Strategies for Liquidity Management

1. Asset Liquidity Mgmt./Stored LiquidityMgmt. Strategies :

This strategy calls for storing liquidity in theform of holdings of liquid assets.

Liquidity needs are met by selling selectedassets

Its also called asset conversion becauseliquid funds are raised by converting near-cash assets into cash.


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2. Liability Liquidity Mgmt./PurchasedLiquidity Mgmt. Strategies:

This strategy calls for borrowing enoughimmediately spendable funds to cover allanticipated demands for liquidity.

It comes with its own control lever i.e.interest rate offered to borrow funds.

Interest rates rise until the requisite amount of funds flow in, ceteris paribus .


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3. Balanced (Asset and Liability) LiquidityMgmt. Strategies:

Borrowing liquidity involves risk , whereasstoring liquidity involves costs .

This strategy is a compromise between assetand liability liquidity management strategies.

Under this strategy, some of the expecteddemands for liquidity are stored, while other anticipated liquidity needs are met by

borrowings.


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Estimating a Banks Liquidity Needs

1. The Sources and Uses of Funds Approach: Basic premises of the method are:1. Bank liquidity rises as deposits increase and loans decrease.2. Bank liquidity declines when deposits decrease and loans

increase. The difference between sources and uses of liquidity is a

liquidity gap. Key Steps:

Loans and deposits must be forecasted for a given liquidity planning period.

The estimated change in loans and deposits must be calculated for thatsame planning period. The liquidity manager must estimate the banks net liquid funds,

surplus or deficit, for the planning period by comparing the estimatedchange in loans to the estimated change in deposits.


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Example of Sources and Uses of Fund Method(Figures in millions of Rupees)

End of Est ima t e d Est ima t e d Est ima t e d

Month Tota l Loans Tota l Deposit s Loans Deposit s Liq . Need

De c . 68000 85000 - - -J a n 70000 90000 2000 5000 -3000

Fe b 79000 86000 9000 -4000 13000

Ma rc h 89000 83000 10000 -3000 13000

April 96000 78000 7000 -5000 12000

Ma y 95000 79000 -1000 1000 -2000

J une 88000 80000 -7000 1000 -8000

Estimat ed Change


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2. The Structure of Funds Approach: The basic idea is to divide banks deposits and other funds

sources into categories based on their estimated probability of being withdrawn.

Unstable deposits (High Risk) require substantial liquidity tosupport them, or stable deposits require relatively lessliquidity.

Categories of deposit and non-deposit liabilities: Hot Money Funds - Deposits and other funds that are very sensitive or

most of the deposits will be drawn during the current period. Vulnerable Funds - Customer deposits of which a substantial portion

will be removed form the bank sometime during the current period. Stable Funds or Core Deposits - Funs that mgmt. considers most

unlikely to be removed from the bank.


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2. The Structure of Funds Approach Contd.: The liquidity reserve behind the banks deposit and

nondeposit liabilities =

Liq. Reserve % of Hot Money Funds * (Hot Money

Funds-Legal reserve held)+ Liq. Reserve % of Vulnerable Funds * (Vulnerable

Funds-Legal reserve held)+ Liq. Reserve % of Stable Funds * (Stable Funds-

Legal reserve held)+1.00* (Potential loans outstanding-Actual loans

outstanding)


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Legal Reserves Management Reserves that must be held at central bank

behind the institution's deposits. In the US, TWO kinds of assets- cash in

the banks vault and deposits with theFederal Reserve bank- can be used for this

purpose.

In Nepal, only deposit with NRB iscounted as legal reserve (CRR).


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Legal Reserves Management Contd. Deficit legal reserve is subject to interest

penalty equal to discount rate plus 2% onthe amount of deficiency. (Nepal - Bank Rate7% (2068/69), 8% (069/70)

Reserves are computed based on the averagedeposits of a fixed period called reservecomputation period.

The required reserve computed as abovemust be held with central bank over thedesignated period called reserve maintenance period.


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Methods of Calculating LegalReserves

1) Lagged Reserve AccountingLagged reserve calculation was used fromthe late 1960s until 1984, when

contemporaneous calculations wereimplemented. But the Fed decided to revertback to the lagged calculation in 1998 inorder to obtain more accurate data. This

type of reserve calculation is still being usedtoday.


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Lagged Reserve Time Line


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Reserve Ratios In October 2008, the Federal Reserve Banks began paying interest on balances maintained

to satisfy reserve balance requirements and on excess balances.Reserve Ratios The following table shows the reserve ratios that are prescribed for all depository

institutions, banking Edge and agreement corporations, and U.S. branches and agencies of foreign banks for 2012.11 11. For institutions that report weekly, these ratios take effect forthe reserve computation period that begins Tuesday, November 29, 2011, and the

corresponding reserve maintenance period that begins Thursday, December 29, 2011. Category Reserve ratios Net transactions accounts: For the amount from $0 to (and including) $11.5 million* 0 percent For the amount over $11.5 million to (and including) $71.0 million** 3 percent For the amount over $71.0 million 10 percent Nonpersonal time deposits 0 percent Eurocurrency liabilities 0 percent

*$11.5 million is the exemption amount. **$71.0 million is the amount of the low reserve tranche.


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Methods of Calculating Legal Reserves

2) Contemporaneous Reserve Accounting It was used from 1984 to 1998. Previously,

banks were required to use the lagged reservecalculation going back to the late sixties. Butthe Fed went back to using the laggedcalculation in 1998 in order to obtain a moreaccurate financial data.


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Thank You !

3. liquidity mgmt

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