Scribd
Upload
7 views

lecture (3)

The document discusses liquidity management in financial systems, focusing on regulatory guidelines for banks to maintain sufficient liquid assets to address sudden withdrawals or loan drawdowns. It explains the importance of reserve requirements, which mandate a certain percentage of liquid assets based on customer deposits, and distinguishes between demand and time deposits. The document also outlines the two-tier structure of reserve requirements, including Cash Reserve and Statutory Liquidity Reserve, and indicates that further sessions will explore reserve requirements in India and the United States.

Uploaded by

shivpatil10062002
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
7 views

lecture (3)

The document discusses liquidity management in financial systems, focusing on regulatory guidelines for banks to maintain sufficient liquid assets to address sudden withdrawals or loan drawdowns. It explains the importance of reserve requirements, which mandate a certain percentage of liquid assets based on customer deposits, and distinguishes between demand and time deposits. The document also outlines the two-tier structure of reserve requirements, including Cash Reserve and Statutory Liquidity Reserve, and indicates that further sessions will explore reserve requirements in India and the United States.

Uploaded by

shivpatil10062002
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 2

Banking and Financial Markets : A Risk Management Perspective

Prof. P C Naryan

Week 1

Managing Liquidity – Part 1

In this session, we will look primarily at the regulatory guidelines and directives to manage
potential problems of liquidity in any financial system. Liquidity problems arise primarily for
two reasons —either because of a sudden unforeseen withdrawal of deposits by customers or,
two, sudden drawdown against loan commitments by customers.

To meet this sudden outflow of funds and the consequent likely adverse impact on liquidity,
financial asset companies, particularly banks, are mandated by the central bank of the country
to maintain sufficient liquid assets. By that, we mean assets that can be turned into cash at short
notice at a low transaction cost without any loss in the value of the asset. The most liquid asset
is, of course, cash, followed by government securities. Since both cash and government
securities offer no returns or low returns, banks have to trade-off between profitability and
liquidity when maintaining cash and government securities on the asset side of their balance
sheet.

Banks do not, however, have a choice in this regard in view of the primary need to ensure short-
term liquidity in the financial system as mandated by the central bank of the country. Reserve
requirements refer to the amount of liquid assets to be maintained by the bank as mandated by
the central bank, either as cash in the vault of the bank or as balances in its current account
with the central bank or as investments in government securities.

Almost all central banks mandate a reserve ratio, and by that, we mean the amount of liquid
assets to be maintained as a percentage of customer deposits in the bank's books. Do remember,
these customer deposits comprises either demand deposits, represented by the balances in the
savings account, and current account of the customers that can be withdrawn anytime by the
customers or time deposits such as fixed deposits and certificate of deposits.

Time deposits are less risky from a liquidity perspective since they have a specific maturity
date and closure prior to the maturity date is not permitted, and in most cases, if there is a
premature closure, the customer will be required to pay a penalty. While central banks in some
countries have mandated that reserve requirements will only be a percentage of the demand
deposits that means current account and savings account only.

© All Rights Reserved. This document has been authored by P C Narayan and is permitted for use only within the course Banking and Financial
Markets : A Risk Management Perspective delivered in the online course format by IIM Bangalore. No part of this document, including any
logo, data, illustrations, pictures, scripts, may be reproduced, or stored in a retrieval system or transmitted in any form or by any means –
electronic, mechanical, photocopying, recording or otherwise – without the prior permission of the author.
Banking and Financial Markets : A Risk Management Perspective

Prof. P C Naryan

Week 1

Several central banks around the world have included time deposits, as well, in computing the
reserve requirements. Furthermore, in several countries where the reserve requirements include
time deposits as well, regulators have implemented a two-tier structure for the reserve
requirements: one called the Cash Reserve, and the other called the Statutory Liquidity
Reserve.

While Cash Reserve represents the cash held in the vault or in the bank's current account with
the central bank, Statutory, Liquidity Reserves in normally held as investment in government
securities that are highly liquid and can be converted to cash at very short notice. To further
clarify and understand the computation and maintenance of reserve requirements, in the next
couple of sessions, we will work through the logic and the arithmetic of computing reserve
requirements in one emerging country, i.e., India and one developed country, i.e., the United
States.

© All Rights Reserved. This document has been authored by P C Narayan and is permitted for use only within the course Banking and Financial
Markets : A Risk Management Perspective delivered in the online course format by IIM Bangalore. No part of this document, including any
logo, data, illustrations, pictures, scripts, may be reproduced, or stored in a retrieval system or transmitted in any form or by any means –
electronic, mechanical, photocopying, recording or otherwise – without the prior permission of the author.

You might also like