Liquidity

Question 1

What are the 3 reasons why a bank holds reserves

Answer 1

1) To meet reserve requirements
2) For precautionary motives
3) For payment needs

Question 2

How can a bank acquire liquid assets if it needs to?

Answer 2

• Borrowing reserves in the overnight money market or from CB
  -Borrowing (longer term) (such as issuing bonds)
• Selling assets.

Question 3

What happened with reserves at the start of the GFC

Answer 3

• Increase in demand due to uncertainty
• Supply of reserves wasn’t high enough
• No bank held the reserves they wanted so didn’t trust other banks to lend.

Question 4

What impact does a reserve shortage have on interest rate?

Answer 4

Puts upward pressure on interest rates of demand exceeds supply

Question 5

What is the difference between funding and market liquidity?

Answer 5

• Funding liquidity
  -> The ability of an institution to raise cash (or equivalent) either via asset sales or borrowing
• Market liquidity
  -> Ability to buy and sell assets in large quantities without significantly affecting prices

Question 6

Give 4 market liquidity problems

Answer 6

• Uncertainty about asset values
• Difficulty finding counterparty to trade with
• Uncertainty about the financial strength of potential counterparties
• Assets that were thought to be easily convertible into cash are not

Question 7

What can the CB do as a lender of last resort?

Answer 7

Can buy assets if market ceases
Mitigate financial uncertainty

Question 8

What are the 3 responsibilities of CBs

Answer 8

• Price stability
• Financial stability
• Provide safe and efficient means of payment