Liquidity Functions of Banks. Liquidity Risk Funding risk – Liability maturity structure Timing...
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Transcript of Liquidity Functions of Banks. Liquidity Risk Funding risk – Liability maturity structure Timing...
![Page 1: Liquidity Functions of Banks. Liquidity Risk Funding risk – Liability maturity structure Timing risk – Reutilization of funds Call risk – Off-balance.](https://reader035.fdocuments.in/reader035/viewer/2022062408/56649f2f5503460f94c4a1fd/html5/thumbnails/1.jpg)
Liquidity Functions of Banks
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Liquidity Risk
• Funding risk – Liability maturity structure
• Timing risk – Reutilization of funds
• Call risk – Off-balance sheet obligations
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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
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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
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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
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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
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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)
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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
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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)
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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
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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
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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
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Managerial Actions in Liquidity Management
• Core activity– Pricing of assets and liabilities
• Related problem– Interest risk management
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Tools for Liquidity Management
• Short term implications
• Long term implications
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Short Term Implications
• Working Funds Approach
• Cash Flow Approach
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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
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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%
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Long term Implications
• Asset Management
• Liquidity Management
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Reserve Bank of India Guidelines on Liquidity Management
• Fortnightly statement of structural liquidity
• Fortnightly statement of short term (up to 90 days) dynamic liquidity
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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
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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
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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
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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
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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
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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