LIQUIDITY MANAGEMENT

Liquidity management is on the front line of the banking

business.
Increased competition and decreased profit margins have put
pressure on banks to improve .their efficiency of operations.
It Competent liquidity management not only keeps banks from
.experiencing serious cashouts that could threatens solvency
but it can also help to reduce bank operating risks and
increase profits.

Liquidity management consists of two parts:

- Estimate funds needs
- Meeting liquidity needs
- Asset liquidity
- Liability liquidity
Bank management must develop a liquidity plan or strategy that
balances risks and returns.
Estimating liquidity needs
These needs arise primarily from
- deposit withdrawals.
- loan demands
Methods for estimating liquidity needs
- Sources and uses of funds method
- forecasting changes in loan demand
- forecasting changes in deposit demand
- adjusting the forecasts for various factors
- Structure-of-deposit methods
- Listing the different types of deposits
- assigning a probability of withdrawal to each
type of deposits
- finding out.expected deposit withdrawals
I

Asset liquidity
- Liquidity stored in money market instruments that are
liquidated to meet large loan demands and deposit
withdrawals.
- Role of asset liquidity:.
- Serves as an alternative source of funds
- Serves as a reserve to forestall problems that
threatens bank solvency.
1; Primary reserves: Cash held in banks' vaults and deposit at
Federal Reserve district bank.
2. Secondary reserves are near-.moneyfinancial instruments
that have no formal regulatory requirements and .provide an
additional reserve of liquid assets to meet cash needs.
. 3. Principal money market instruments
T-bills
Fed agency securities
Repurchase agreements (repos)
Bankers' acceptances
Negotiable certificates of deposits
Fed funds
Commercial paper
/

Liability Liquidity
- An alternative approach to liquidity management is to
purchase the funds necessary to meet liquidity needs.
- The primary advantage of liability management is that
assets can be shifted from lower earning money market
instruments to higher earning loans and longer-term
securities.
- The downside risks of liability management relates to
- the increase in cost of funds if interest rates rise;
- the increase in the exposure to interest rate risk;
- the increase in financial risk; and
- the increase in capital market risk.

FUNDS MANAGEMENT OF LIQUIDITY

- Management of liquidity is best handled by combining
asset liquidity and liability liquidity which has come to
be known as funds management approach.
- Funds management involves comparing total liquidity
needs with total liquidity sources.
- Ratios used to understand current liquidity position
includes:
- Loans/deposits
Loans/non-deposit liabilities
- Unencumbered liquid assets/non-deposit liabilities
- Near-cash assets/larqe-denomlnatlon liabilities
Optimum bank liquidity
- A 'question that bank management must ultimately face
is whether the liquidity ratio is optimal.
- Optimum liquidity is achieved by balancing risks and
returns.