Friday, July 18, 2008

Liquidity Management

One of the most important tasks the management of any bank or other financial services provider faces in ensuring adequate liquidity at all times, no matter what emergencies may suddenly appear. A financial institution is considered to be “liquid” if it has ready access to immediately spend able funds at reasonable cost at precisely the time those funds are needed. This suggests that a liquid bank or other financial firm either has the right amount of immediately spend able funds on hand when they are required or can raise liquid funds in a timely fashion by borrowing or by selling assets.

The cash shortages that banks and other financial service providers in trouble often experience make clear that liquidity needs cannot be ignored. A bank or thrift institution can be closed if it cannot raise sufficient liquidity even though, technically, it may still be solvent. The competence of liquidity managers is an important barometer of management’s overall effectiveness in achieving any financial institution’s goals.

The demand supply and liquidity:

A bank or other financial institution’s need for liquidity immediately spendable funds can be viewed within a demand – supply framework. Demands for spendable funds come form two sources:
Ø Customers withdrawing money form their deposits
Ø Credit requests form customers the institution wishes to keep, either in the form of new loan requests or drawings upon existing credit lines.

Sources of demand and supply for liquidity for a depository institution

Supplies of liquid funds come form:
Incoming customer deposits
Revenues form the sale of nondeposit services
Customer loan repayments
Sales of assets
Borrowings form the money market

Demands for liquidity typically arise form:
Customer deposit withdrawals
Credit requests form quality loan customers
Repayment of nondeposit borrowings
Payment of stockholder cash dividends

Strategies for liquidity managers:

Experienced liquidity managers have developed several broad strategies for dealing with liquidity problems:

1)Asset liquidity management strategies:
This strategy calls for storing liquidity in the form of holdings of liquid assets, predominantly in cash and marketable securities. This liquidity management strategy is often called asset conversion because liquids funds are raised by converting noncash asset into cash. This strategy is preferred by small banks.

Liquid asset has got three strategies:
o It must have a ready resale market
o It must have a stable price
o It must be reversible

2)borrowed liquidity (liability) management strategies :
Borrowing enough immediately spendable funds to cover all anticipated demands for liquidity.
Some advantage
Ø A bank or other financial firm can choose to borrow only when it actually needs fund. Like as just in time approach.
Ø The volume and composition of asset portfolio in unchanged
Ø Controls lever the interest rate offered to borrow funds.

3)balanced liquidity management strategies :
Some of the expected demands for liquidity are stored in assets while other anticipated liquidity needs are covered by borrowings.


Liquidity needs & liquidity decision must be analyzed on a continuing basis to avoid both excess & deficit liquidity positions. Excess liquidity that is not reinvested the same day it occurs results in lost income, while liquidity defects must be dealt with quickly to avoid dire emergencies where the hurried borrowing of funds on sale of assets result’s in excessive losses for the bank or other financial firm involved. Indeed lack of adequate liquidity can be one of the first signs that a bank or financial institution is in real trouble. A trouble bank or thrift that is losing deposits wills likely is forced to dispose of some of its safer, more liquid assets.

http://www.citigroup/ .com
Bank management & financial services By PETER S.Rose

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