Notes - liquidity risk PDF

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liquidity risk...

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Causes of liquidity risk: -

Liability-side reason and Asset-side reason: o Liability-side:  When liability holders demand cash by withdrawing deposits.  Normally only a small proportion on FIs’ deposits will be withdrawn on a given day.  Core deposits: deposits provide an FI with a long-term funding source-like demand deposit.  Net deposit drains: the o Asset-side reason:  Risk from OBS loan commitments and other credit lines.

Manage net deposit drains: (5 marks) FI need to borrow additional funds or sell assets to meet the withdrawal. Purchased liquidity management: an adjustment to a deposit drain that occurs on the liability side of the balance sheet. (2.5 marks) -

Interbank market: Federal fund market, repurchase agreement market for shortterm loan.

Stored Liquidity management: an adjustment to a deposit drain that occurs on the asset side of the balance sheet. -

Liquidate some of the assets (sell some notes and bonds).

Measuring Liquidity risk exposure: -

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Sources and Uses of Liquidity: o Identify Sources of liquidity:  Cash  Borrow money in the market.  Excess cash reserve o Identify Uses of liquidity:  The amount of borrowed fund FI has already utilized.  The amount of cash FI has already borrowed. o Net liquidity = Sources - Uses Peer group ratio comparisons. Example: loans to deposits; borrowed funds to total assets. Liquidity index: a measure of the potential losses an FI could suffer (smaller I -> higher liquidity risk).

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Where: Wi = the per cent of each asset in the DI's portfolio Pi = the immediate sales price Pi* = the fair market price Financing gap and the financing requirement Financing Gap = average loans – average deposits If Financing Gap > 0, the DI must manage the liquidity risk: Financing Requirement = Financing Gap + Liquid Assets....