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Chapter 10- Liquidity Risk (10.4 Elements of sound LR Management practice,…
Chapter 10- Liquidity Risk
cash flow from bank assets coming from investments (HTM,HFT,AFS) , loans, repo
hqla or assets must be uncumbered and marketable
market liquidity - ability to sell with low cost, short term , little impact to the price
low bid-ask price, indepth market, market resilience
credit quality of the assets and the pledged back
liquidity of the instrument
mv of the ints/collateral counterparty funding rates
10.4 Elements of sound LR Management practice
4) Measurement and management of LR
Process
4) controlling
limit settings
regularly review the limits and escalation procedures
-bank to be operate during the market stress, bank specific stress and combination of both
1)identifying-liquidity needs and sources that available
bank's business and product mix
balance sheet structure
cash flow profiles of its on-and off balance sheet obligations
3) monitoring
monitored following time horizons:-
i. intraday LR
ii. day-to-day LR
iii. liquidity needs over short and medium term horizons up to one year
iv. longer-term liquidity needs over one year
2)measuring
assessing bank's cash inflows and outflows , liquidity value of its assets to identify the potential for future new funding shortfalls.
3) Different approaches to LTP
1) Zero cost of funds approach
views funding liquidity as essentially free
3) Matched maturity of funding approach
the rates charged for the use of fund
the rates credited for benefit of funding
the above are based on term liquidity premiums corresponding to the maturity of the transaction
2) Pooled cost of funds approach
entails the calculation of a single average rate based on the cost of funds across all existing funding sources
2) Governance
LR management strategy
Strategies include
specific policies on lR management
approach to intraday liquidity management
assumptions on liquidity and marketability of assets
strategy on liquidity needs under normal conditions as well as under period of liquidity stress
high-level quantitiative and qualitititative targets
Responsibilities of senior management
develop and implementing the LR management strategy in accordance with the bank's risk tolerance
determine the structure, responsibilities and control for managing LR and for overseeing the liquidity positions
BOD have to establish liquidity risk tolerance
define the bank's level on LR that willing to assume
be articulated that all level management clearly understand the trade off between risk and profits
ensure that the bank manages its liquidity during normal times in such a way that it is able to withstand a prolonged period of stress
1) LR Management Framework
ensure the bank is able to withstand a range of stress events affecting both its secured and unsecured funding
Ensure the bank holds an adequate liquidity cushion of unencumbered , high quality liquid assets commensurate with its liquidity profile
ensure high degree of confidence that the bank is in a position to address its daily liquidity obligations
10.3 liquidity risk strategy - 2 approaches to address asset liability liquidity risk
purchased liquidity management
stored liquidity management
10.2 Liability based LR
stable source of funding
non stable source of funding
quality of funding source, have beware of volatile source of liabilities fund
10.2 Assets based LR
cash flow from bank's assets
ability to use the assets as collateral to raise funds
liquidation of the assets for cash
securitization of the assets to raise funds
Assets that can be easily converted know to be high liquid, higher quality
Bank fund its assets growth or pay its obligations as they come due is to sell its existing assets
maturity transformation of short-term deposits into long term loans
LR is bank's ability to fund increases in assets and meet obligations as they come due without incurring unacceptable losses
when bank cant able to fund increases in the assets and meet obligations as they come due without incurring unacceptable loses
ALM risk
3 main objective -maturity mismatch risk
interest rate
risk-->IR increase, funding cost increase
liquidity
-mismatch during the stress scenario
capital management
-structural mismatch generates negative income, will impact retained earnings
Key
ALM activities -matching or mismatching of mix of assets and liabilities
liquidity risk management
strategically deploying excess liquidity while ensuring that the bank maintains sufficient level of liquidity that will allow it to withstand stress events
capital management
maximize return on capital by choosing the optimal level of risk weighted assets and the apppriaate level an quality of capital
irrbb
optimises net interest income by maximizing interest income earned from loans and investments; or by minimizing interest expenses incurred from funds generated