Question

The Balance Sheet of Eastern Bank Ltd with its value ($m), liquid (%) and volatile (%) are provided below:

Assets	Value ($m)	Liquid (%)
Cash	10	40
Investments	50	90
Commercial Loans	50	-5
Consumer Loans	10	20
Other Assets	8	50
Total	128
Liabilities	Value ($m)	Volatile (%)
Corporate Deposits	20	70
Customer Deposits	60	30
Other Liabilities	35	80
Equity	13
Total	128

1. a) Calculate total amount of liquid assets and total amount of volatile liabilities.
   

2. b) Calculate Liquidity Surplus / Deficit.

3. c) How this Liquidity Surplus / Deficit should be managed from Asset and Liability sides respectively?

Answer 1

Answer :

S.No	Assets	Value	Liquid ( % )	Liquid Assets
A	Cash	10	40%	4
B	Investments	50	90%	45
C	Consumer Loans	10	20%	2
D	Other Assets	8	50%	4
E	Total Liquid assets			55

S.No	Liabilities	Values	Volatile (% )	Volatile Liabilities
F	Corporate Deposits	20	70%	14
G	Custom Deposits	60	30%	18
H	Other Liabilities	35	80%	28
I	Total Volatile Liabilities			60
J	Liquidity Surplus / ( Deficit ) (E - 1 )	( 5 )

( a ) Total Liquid assets - 55 & Total Volatile Liabilities - 60

( b ) Liquidity Surplus / Deficit - 5

( c )

• Strategies that experienced liquidity managers have developed for dealing with liquidity problems include:
  • Providing liquidity from assets (asset liquidity management)
  • Depending on borrowed liquidity to meet cash demands (liability management)
  • Balanced (asset and liability) liquidity management.

1. Asset Liquidity Management (or Asset Conversion) Strategies

• The asset conversion strategy entails storing liquidity in assets, mainly in cash and marketable securities,
• so that when liquidity is needed, selected assets can be easily converted into cash to meet all demands.

2..Borrowed Liquidity (Liability) Management Strategies

• A liability management (purchased liquidity) strategy is an approach extensively used by the largest firms, i.e., which often borrow close to 100% of their liquidity needs.
• It entails borrowing immediately spendable funds to cover all anticipated demands for liquidity.
• The number one advantage of this approach is that it calls for borrowing funds only when the firm needs to contrast to storing liquidity in assets where a storehouse of liquid assets should be held at all times, lowering potential returns.
• It also allows the firm to leave the volume and asset composition of its portfolio the same if it is satisfied with the assets it currently holds.
• However, liquidity management comes with an interest rate offered to the borrowed funds.
• If the borrowing firm needs additional funds, it merely raises the offer rate until it generates the required amount of funds. The firm may lower its offer rate if it requires few funds.

3. Balanced Liquidity Management Strategies

• The balanced liquidity management strategy entails combining both asset and liability management.
• It entails storing a portion of the expected demands for liquidity in assets while backstopping other anticipated liquidity needs by advance arrangements for lines of credit from potential suppliers of funds.
• Near-term borrowings are used to meet unexpected cash needs, while short-term and medium-term assets are used to meet longer-term liquidity needs.
• It must, therefore, Raise funds from the cheapest and most timely sources available.

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