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Structured Liquidity Statement

This document provides an overview of liquidity risk management. It defines asset-side and funding liquidity risks and discusses factors that affect funding liquidity. It also outlines approaches to measuring and managing liquidity risk, including through structural liquidity statements, liquidity risk limits, and purchasing or storing liquidity. Key aspects of liquidity risk management include analyzing deposit flows, maintaining adequate highly-liquid assets, and monitoring cashflow mismatches across maturity buckets.

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794 views

Structured Liquidity Statement

This document provides an overview of liquidity risk management. It defines asset-side and funding liquidity risks and discusses factors that affect funding liquidity. It also outlines approaches to measuring and managing liquidity risk, including through structural liquidity statements, liquidity risk limits, and purchasing or storing liquidity. Key aspects of liquidity risk management include analyzing deposit flows, maintaining adequate highly-liquid assets, and monitoring cashflow mismatches across maturity buckets.

Uploaded by

Being Shonu
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Liquidity Risk Management

Sanjay Basu, NIBM, September 2011.

Lecture Outline
Definition and drivers of Liquidity Risk; need for Liquidity Risk Management. Liability Side Liquidity Risk: (i) Purchased Liquidity Management (ii) Stored Liquidity Management . Asset-Side Liquidity Risk. Structural Liquidity Statements and liquidity risk limits.

Two faces of Liquidity Risk


Asset or Market Liquidity Risk: Inability to sell assets at normal market prices because the size of the trade is much larger than normal trading lots.
The market is unable to absorb such volumes at quoted prices.

Funding or cash-flow liquidity risk: Inability to meet payment obligations.


Inability to pay depositors on demand.

Inability to meet OBS loan commitments and guarantees on demand.

Factors affecting Funding Liquidity


Banks need funding liquidity to meet deposit and loan requirements.
The demand for funding liquidity depends on the variability of loan demand and deposit inflows and outflows. Since loan demand and deposit flows depend on market rates, even liquidity positions are affected by rate fluctuations. It also depends on the strength of deposit insurance and lenderof-last resort (LOLR) facilities in a crisis. Liquidity Risk Management (i) reduces future cost of funding (ii) adds to bank reputation (iii) avoids needless fire-sale of assets and loss of interest income and future capital gains.

Liability-Side Liquidity Risk


Focus on the volume of stable, long-term, core deposits and net deposit drains (deposit outflows less new deposit and other inflows each day). Need to predict the distribution of net deposit drains.

1. Behavioural analysis of NMDs. 2. Behavioural analysis of premature withdrawal, especially for high-value deposits. 3. Analysis of renewal patterns of maturing term deposits.

Purchased Liquidity Management


1. Borrowing from the call money or repo market. 2. Issuing additional deposits or selling bonds. Managing the liability side without touching the asset side of the balance sheet.
Purchased liquidity can insulate the asset side from deposit drains.

Borrowing funds at higher rates to offset drains in low-interest deposits. Uninsured funds may not be available for large deposit drains.

Stored Liquidity Management

Liquidation of assets to meet deposit drains.


Compute the MV of all assets by assigning conservative (or worst-case) discount rates. Adequacy of cash capital the difference between the MVs of tradable assets and short-term interbank funding plus volatile deposits. Threat of depreciation or interest revenue losses. Focus on liquid, short-term T-bills conflict between liquidity and returns.

Maintenance of excess CRR.


Opportunity cost of noninterest-bearing cash reserves to be compared with losses on sudden deposit runs.

Asset-side Liquidity Risk


Risk from loan commitments and other credit lines:
(i) borrowing funds or (ii) running down reserves.

Maintaining high levels of savings deposits


As loan commitments (e.g. unutilized portion of CC/OD balances) are utilized during tight liquidity conditions, banks with high levels of S/B deposits are in a better position to pay their borrowers on demand. Correlation between liquidity demand from depositors and borrowers have been found to turn negative during crises.

Cash-flow uncertainty from credit risky assets.

Measuring Liquidity Exposure


Structural Liquidity Statements (SLS): Based on Maturity Ladder approach followed by BIS.
Based on residual maturity of assets and liabilities. Cash inflows are ranked by future dates or intervals when assets mature or credit lines can be drawn down. Cash outflows can be ranked by future dates on which liabilities fall due. Trading portfolios can be slotted in the earliest buckets indicating the ease with which they can be liquidated. Interest should be included.

Measuring Liquidity Exposure


The difference between expected cash inflows and outflows (gap) in each bucket captures the excess or deficit of liquidity within a specific future interval. Depending on balance sheet structures and strategies, one bank can have negative gaps while another has positive gaps, unlike trading liquidity risks.
Banks reliant on short-term funding will actively monitor the first few buckets. Monitoring longer-term gaps allows the bank to frame strategies which alter product maturities.

Proposed Liquidity Buckets by RBI


Next day.
2 days - 7 days. 8 days 14 days. 15 days 28 days. 29 day - 3 months. 3 months - 6 months. 6 month - 12 months. 1yr. - 3 yrs. 3yrs. - 5yrs. Over 5 years.

Liquidity Risk Limits


Liquidity Risk Limits can be based on:
Cumulative cashflow mismatches: Upper bound on net funding gaps across buckets, as a fraction of liabilities, assuming a conservative liquidation value of tradable assets. l Liquid assets to short-term liabilities: Whether the worst-case resale value, of the traded assets, is enough to cover short-term outflows to specify lower bound on preferred assets. Reliance on a particular source of funding: Upper bound on volatile liquidity sources like NMDs or CDs.

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