Chapter 12 Flashcards
What is liquidity risk and what is the first step to this liquidity risk?
Liquidity risk refers to the risk of banks not being able to pay back depositors their money
This risk is firstly associated with a bank panic
What are the two causes of liquidity risk?
1) Depositor drain (pull out their money)
2) Write off of loans (default loans)
If the bank is facing liquidity risks, what might it do?
Forced to liquidate assets quickly which is known as a fire sale?
What is a fire sale?
Selling an asset at a price below its fair value, creating a loss
What are the 2 sides of asset-liquidity risk? Explain both of them
1) Quality of the loans: handing out bad loans which was once an asset but are now default loans and take up capital creating liquidity risk
2) Too many contingent assets: too much off balance sheet items that get exercised which are lines of credits, credit cards, etc that get maxed out and are too much assets and not enough liabilities
What are core deposits
Any amount of money that banks hold in chequing, savings accounts or commercial accounts which are cheap ways for banks to get money since they don’t pay much or anything
How do banks manage the drain on deposits or liquidity
1) purchased liquidity management
2) stored liquidity management
What is purchased liquidity management
When the FI, after making their maturity schedule, realize they are short on cash, they offer GICs or other investments that cost the bank money
What is stored liquidity management
liabilities (deposits) that a bank must keep on hand and can’t do asset transformation on that liquidity. This rule doesn’t apply in Canada
What is wholesale funds
Big amounts of money that are overseen by an agent or another company that is NOT retail
What is financing gap?
It is the different between average loans and average deposits that allow banks to determine if they have liquidity shortage where they can then start purchasing deposits if needed
What is liquidity index
Asset that is sold at less than it’s fair value (fire sale) and indicated the percentage of fair value gotten from that sale
What is liquidity planning?
Making proper decisions before liquidity problems
Are excess reserves bad? Why?
They are bad because it means you are not efficient with deposits
Bank panics and bank runs can come from…
1) bank solvency
2) failure of a related FI
3) sudden changes in investor preferences
