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Lecture 11: Liquidity risk management - Coggle Diagram
Lecture 11: Liquidity risk management
Introduction
GFC (in 2008) was due to liquidity risk
liquidity risk may result from an asset or liability side
asset side
risk from OBS loan commitments and other credit lines
problems associated with
quick asset sales
high cost for turning assets into cash
low sale price, in worst case,
fire sale price
liability side
depositors and other claim holders decide to cash in their financial
claim immediately
=>
DI has to borrow additional funds or sell assets
DI needs to predict the distribution of
net deposit drains
(
positive
deposit drains =>
new deposits insufficient to offset withdrawals
=> DI not growing but
contracting
)
Net deposit drains
: the difference between
deposit withdrawals and deposit additions
on any specific normal banking day
Liquidity risk at depository institutions
liability side
large reliance on
demand deposits
and deposits raised through other transaction accounts (mostly at call deposits)
DI can rely on
core deposits
core deposits
: long- term funding source
most
demand deposits
act as core deposits on a
day- by- day basis
Managing liquidity
purchased
liquidity management (nowadays)
liquidity can be purchased in financial markets (borrow funds from other banks or institutional investors)
borrow funds are likely to be at
higher rates
than interest paid on deposits (borrowed at
market rate
) =>
expensive
allows DI to
maintain
their overall
balance sheet size
liability side adjustment
stored
liquidity management (traditionally)
asset side adjustment
liquidate assets
: banks tend to hold
excess reserve assets
(in the form of cash)
downside of excess cash
: opportunity cost of reserves
decreases size of balance sheet?
requires holding excess
non- interest bearing assets
APRA introduces
two new requirements
for ADIs to
ensure they hold sufficient liquidity
the liquidity coverage ratio (LCR)
the net stable funding ratio (NSFR)
Asset- side liquidity risk
the
exercise
of loan commitments and other credit lines by borrowers
unexpected changes of interest rate
=> change in value of
investment securities portfolios
Herd behaviour
: traders want to make the
same type of trade
at any particular time
sell off
=> liquidity dries up => securities sold at
fire- sale prices
(sell at discounted price) =>
value of investment portfolio falls
=> stored liquidity decreases =>
liquidity risk increases
Net liquidity statement
show the sources and uses of liquidity
sources
sale of liquid assets with minimum price risk
borrowing funds in money market
using excess cash reserves
uses
borrowed or money market funds already
utilized