Question

Discuss liquidity management of a bank and the tools and options to address liquidity by bank managers.

Answer 1

Banking liquidity refers to the willingness of a bank to fulfill its financial obligations when they occur. This may come from direct cash reserves in the currency or on account of the Federal Reserve or some other central bank. More often than not, it comes from the purchase of shares that can be sold easily with limited losses. This effectively notes highly creditable securities, consisting of government bills with short-term maturity.

If their maturity is short enough, the bank can simply wait for them to repay the principle at maturity. In the short term, very secure securities prefer trading in liquid markets, meaning that large quantities can be sold without shifting too many prices and at low transaction costs. Nonetheless, the liquidity state of the bank , especially in the event of a crisis, will be affected by much more than just this reserve of cash and highly liquid securities. The maturity of its less liquid assets will also be significant. As some of them can mature before the cash crunch passes, providing an additional source of funds.

If the maturity of any assets is reduced to the point that they mature during the period of the cash crunch, then there is a direct profit. Second, shorter maturity assets are generally more liquid.

Assets that mature over the time span of an real or possible cash crunch can still be critical liquidity sources if they can be sold in a timely manner without any redundant losses. Banks can increase the value of assets in several ways. Usually, securities are more volatile than loans and other properties, even though some large loans are now presented as being fairly easy to sell on wholesale markets. It is therefore an aspect of degree, not an absolute argument. Some of the shorter maturity assets are more liquid than the longer ones. Securities issued in large quantities and by large firms are more liquid as they offer more creditable securities.

Common stocks are almost equal to a perpetual maturity deal, with the added advantage that no interest or related annual payments have to be made. The longer the length of the debt, the less it is required to mature when the bank is already in a cash crisis.

A bank can, if appropriate, scale up another bank or insurer or, in some cases, a central bank to ensure cash connections in the future. For example , a bank can pay a line of credit from another bank. In certain nations, banks have reserves pre-positioned with their central bank that can be further exchanged as collateral to employ cash in a crisis. Each of the above methods used to achieve liquidity have a net expense in normal times. Generally, capital markets have an upward sloping yield curve, suggesting that interest rates for long-term securities are higher than they are for short-term securities.