Liquidity Functions of Banks - Bank Management - Lecture Slides, Slides of Banking and Finance

Download Liquidity Functions of Banks - Bank Management - Lecture Slides and more Slides Banking and Finance in PDF only on Docsity! Liquidity Functions of Banks Docsity.com Liquidity Risk • Funding risk – Liability maturity structure • Timing risk – Reutilization of funds • Call risk – Off-balance sheet obligations Docsity.com 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 Docsity.com 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 Docsity.com 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) Docsity.com 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 Docsity.com 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 Docsity.com 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 Docsity.com Short Term Implications • Working Funds Approach • Cash Flow Approach Docsity.com 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 Docsity.com 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% Docsity.com 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 Docsity.com 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 Docsity.com 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 Docsity.com