This approach rests on two simple facts;
- For a depository institution, liquidity rises as deposits
increase, and loans decrease.
- Liquidity decreases when deposits decrease, and loans
increase.
The liquidity gap arises when the sources and uses of liquidity
do not match. It is the size of the difference between sources and
uses of funds. A positive liquidity gap (surplus) arises
when the sources of liquidity exceed the uses of liquidity. On the
other hand, a negative liquidity gap (deficit) emerges
when the uses exceed sources.
The crucial steps for the sources and uses of funds approach for
a bank are as follows:
- Forecasting loans and deposits for a given planning
period.
- Calculating the estimated change in loans and deposits for the
same period.
- Estimating the net liquid funds’ surplus or deficit for the
planning period by comparing the estimated change in loans (or
other uses of funds) to the estimated change in deposits (or other
funds sources).
The bank’s liquidity manager might prepare the following
forecasting model:
Estimated change in the total loans for the coming period is a
function of:
- Projected growth in the economy
- Projected quarterly corporate earnings
- Current rate of growth in the money supply
- Projected prime loan rate or cd rate
- The estimated rate of inflation.
Estimated change in total deposits for the coming period is a
function of:
- Projected growth in personal income in the economy
- The estimated increase in retail sales,
- The current growth rate of the money supply
- The projected yield on the money market deposits
- The estimated rate of inflation.
The bank can then estimate its needs for liquidity by
calculating;
Estimated liquidity deficit(-)or surplus (+)for the coming
period=Estimated change in deposits−Estimated
Future deposits (other fund sources) and loans (other fund uses)
can also be calculated by dividing the forecast of future deposit
and loan growth into three components:
- A trend component, estimated by constructing a trend
(constant-growth) line using reference points year-end, quarterly,
or monthly deposit and loan totals established over a base period
sufficiently long to define a trend growth rate (at least 10
years).
- A seasonal component, measuring how other funds
sources and other funds use is expected to look like in each week
or month due to seasonal factors, relative to the most recent
year-end deposit or loan level. The seasonal component compares the
average level of deposits and loans for each week over the past 10
years to the average level of deposits and loans for the final week
of December over the preceding 10 years.
- A cyclical component, reflects the difference between
expected deposit and loan levels in each week during the preceding
year (measured by the trend and seasonal elements) and the actual
volume of total deposits and total loans the bank posted that
week.