Liquidity Risk

Question 1

Definition of liquidity risk

Answer 1

refers to the possibility of banks being unable to meet short term financial obligations without incurring significant loss

Question 2

market liquidity

Answer 2

refers to how quickly and easily banks can buy and sell assets without significantly affecting the price

Question 3

funding liquidity risk

Answer 3

refers to how easily the bank can obtain funds to meet short term liabilities in necessaryl markets

Question 4

what is liquidity management

Answer 4

refers to process of generating funds to meet collateral obligations at reasonable price and times

Question 5

liability side risk

Answer 5

occurs when bank liability holders seek financial claims immediately

Question 6

asset side risk

Answer 6

off balance sheet loan commitments being exercised

this can also can be due to asset price changes

Question 7

what is stored liquidity

Answer 7

liquidity that is accessed through liquid assets and cash to cover the liquidity deficit

Question 8

purchased liquidity

Answer 8

meeting obligations with external financing such as repo agreements and wholesale funding

Question 9

what is a dynamic approach

Answer 9

an approach that sees liquidity management adapted to constant changes to the market, risk profile and regulations

Question 10

what does a dynamic approach consist of (2)

Answer 10

Real time monitoring and reporting: implement systems to integrate real time data with automated tools

Advanced forecasting scenarios: Estimating changes in deposit and loans to prepare for future

Question 11

what should be considered in dynamic forecasts (3)

Answer 11

Trend components: use past data to construct a trendline

Seasonal components: taking reference point of recent information

Cyclical components: deviation due to business cycles

Question 12

static approach

Answer 12

maintaining fixed strategies and policies that do not adapt to changing market conditions

Question 13

Liquidity cover ratio (LCR)

Answer 13

aims to ensure bank maintains adequate levels of high quality liquid assets that can be converted into cash to meet a 30 day time horizon

Question 14

Liquidity cover ratio formula

Answer 14

stock of high quality liquid assets
/
total net cash outflow over the next 30 days

Question 15

Benefits of cover liquidity ratio (5)

Answer 15

1. allows for banks to be prepared for short term crisis
2. easier to align with regulatory requirements
3. creates a regulation standard
4. investor reassurances
5. fairly simple

Question 16

Drawbacks of liquidity cover ratio (3)

Answer 16

1. banks may face operational costs
2. banks may change strategies to meet requirements
3. may only priorities short term liquidity problems

Question 17

Net stable funding ratio (NSFR)

Answer 17

regulations standard introduced by BASEL III accords to promote long term funding stability over a 1 year horizon

Question 18

Net stable funding ratio (NSFR) formula

Answer 18

amount of stable funds
/
required amount of stable funds

(there consist of tier 1 and 2 securities)

Question 19

Benefits of NSFR (4)

Answer 19

1. ensuring long term stable funding
2. reduced risk of bank runs
3. decreases contagion
4. ensure a standardised measure

Question 20

Drawbacks of NSFR) (3)

Answer 20

1. long term funding makes cost of capital higher
2. complex models to work out
3. may hold onto lower yield high quality bonds

Question 21

Stress testing and scenario analysis

Answer 21

BASEL III require stress tests across banks called a Internal Liquidity Adequacy Assessment Process (ILAAP)

Question 22

Benefits for scenario analysis (4)

Answer 22

1. risk identification
2. preparedness
3. regulatory compliance
4. risk management

Question 23

Drawbacks of scenario analysis (3)

Answer 23

1. required data
2. complex modelling
3. resource draining

Question 24

study regarding stress tests (2)

Answer 24

1. stress tests lead to more conservative liquidity practise
2. can reduce liquidity creation in the economy but increase stability

Question 25

study regarding regulation on liquidity (4)

Answer 25

1. lending decreases with more regulation
2. changes in lending composition like low risk lending
3. less risky credit lending
4. more conservative lending