Question

1.   Because of the panic in the banking sector, a small retail bank (which is a subsidiary of a major finance group) is facing a bank run so that it needs short-term liquidity to restore depositors’ confidence. The bank run is expected to end within the next 2 or 3 days. The bank is holding a significant amount of U.S. Treasury securities and its management is considering whether they should sell some of these securities, or else seek for help from the parent company. On the other hand, a pension fund company has significant cash holdings, ready for any investment opportunities of any term. Under the current situation, discuss the options for this bank to deal with the bank run. Show the various risks involved.

Answer 1

The company should be trying to raise the fund through selling of the equity to the pension funds because the pension Fund company is already holding a significant cash holding and if the company is trying to self some part of its equity in order to generate cash it will be a better option rather than liquidation of the treasury security if the treasury security is mostly in form of treasury bonds and treasury notes, because these are long term securities.

If the company is having the treasury security in form of treasury bills, than it should be trying to offload these treasury bills which will always be providing with the higher rate of liquidity and it is a short term money market instrument, so this company can liquidate the treasury bill but in case the company is having the treasury Bond and treasury note then, it should not liquidate all those long term securities, rather than it should be trying to raise the the equity from selling of equity shares to pension Fund because it will help the company to sustain and survive in next 3 days or company can also try to raise money through the interbank lending rate or overnight funds by other bank or it can also go for discounting window of the Federal Reserve in order to have access to the short term funds so it has multiple option in order to stop itself from becoming insolvent and hence it can be said that it should be trying to explore those options rather than trying to sell treasury bonds which are mostly of long-term and it will be causing loss to the company because of the liquidation.