Chapter 8: Liquidity Risk Flashcards
Causes of Liquidity Risk
- FI’s liability holders seek to withdraw their financial claims
- when commitments made by the FI and recorded off-the-balance-sheet are exercised by the commitment holder
is a financial institution whose main source of funds is deposits from customers.
Depository Institution
are contracts that give the holders the right to put their financial claims back to the DI on any given day and demand immediate repayment of the face value in cash.
Demand Deposit Account
Deposits that provide a relatively stable, long-term funding source to a depository institution.
Core Deposit
The amount by which cash withdrawals exceed additions; a net cash outflow.
Net Deposit Drains
2 major ways for the FI to manage Deposit on Drains
- Purchased liquidity management
- Stored liquidity management
An adjustment to a deposit drain that occurs on the liability side of the balance sheet.
Purchased liquidity management
An adjustment to a deposit drain that occurs on the asset side of the balance sheet.
Stored liquidity management
True or False
Traditionally, DI managers relied on stored liquidity as the primary mechanism of liquidity management
True
True or False
Today, many DIs—especially the largest banks with access to the money market and other nondeposit markets for funds—rely on stored liquidity, whereas smaller DIs—such as community banks—more often look to purchased liquidity.
False
Today, many DIs—especially the largest banks with access to the money market and other nondeposit markets for funds—rely on purchased liquidity, whereas smaller DIs—such as community banks—more often look to stored liquidity.
A DI manager who __________________ to offset a deposit drain turns to the markets for purchased funds, such as the federal funds market and/or the repurchase (repo) agreement markets, which are interbank markets for short-term loans. Alternatively, a DI manager could issue additional fixed- maturity certificates of deposit or additional notes and bonds.
purchases liquidity
These methods take into account the DI’s excess cash reserves and its ability to raise additional purchased funds.
Measuring a Bank’s Liquidity Exposure
is to compare certain of its key ratios and balance sheet features, such as loans to deposits, core deposits to total assets, borrowed funds to total assets, and commitments to lend to assets ratios.
Peer Group Ratio Comparisons
True or False
A high ratio of loans to deposits and borrowed funds to total assets and/or a low ratio of core deposits to total assets means that the DI relies heavily on the short-term money market rather than on core deposits to fund loans.
True
which lists sources and uses of liquidity and, thus, provides a measure of a DI’s net liquidity position.
net liquidity statement
Just as deposit drains can cause a DI liquidity problems, so can loan requests, resulting from the exercise, by borrowers, of loan commitments and other credit lines.
Asset Side Liquidity Risk
A measure of the potential losses a DI could suffer as the result of a sudden (or fire-sale) disposal of assets.
Liquidity index
The difference between a DI’s average loans and average (core) deposits.
Financing Gap
The financing gap plus a DI’s liquid assets.
Financing requirement
Formula of Financing Gap
FG = Liquid Assets + Borrowed Funds
Fourmula of Financing gap
FG = Average loans - Average deposits
Formula of Financing req.
Financing req. = Financing gap + liquid assets
True or False
If the financing gap is negative, the DI must find liquidity to fund the gap. This funding can come either purchased or stored liquidity management.
False
If the financing gap is positive, the DI must find liquidity to fund the gap. This funding can come either purchased or stored liquidity management.
BIS stands for
Bank for International Settlements
It is essential for managing liquidity risk and costs, as it allows managers to make borrowing decisions before problems arise, lowering fund costs and minimizing excess reserves.
Liquidity Planning
Liquidity Plan Components:
- delineation of managerial responsibilities
- a detailed list of fund providers most likely to withdraw as well as the pattern of fund withdrawals
- the identification of the size of potential deposit and fund withdrawals over various time horizons
- internal limits on separate subsidiaries’ and branches’ borrowings as well as bounds for acceptable risk premiums to pay in each market
is the risk that a depository institution (DI) may not have enough liquid assets to meet short-term obligations
Liquidity Risk
Factors Contributing to Abnormal Deposit Drains:
- Concerns about a DI’s solvency
- Failure of a related DI
- Sudden changes in investor preferences regarding holding nonbank financial assets relative to another DI
is a sudden and unexpected increase in deposit withdrawals from a DI
Bank Run
operates on a first-come, first- served basis
Demand Deposit Contracts
True or False
Quick withdrawals when problems arise make banks less stable
True
a systemic or contagious run on the deposits of the banking industry as a whole.
Bank Panic
Regulatory mechanisms are in place to ease DIs’ liquidity problems and to prevent bank runs and panics
-deposit insurance
- liquidity window
a Philippine government-run deposit insurance fund
Philippine Deposit Insurance Corporation (PDIC)
The window shall meet the liquidity needs of the financial system under normal conditions and shall be distinct from overdrafts and emergency advances.
liquidity window