Liquidity risk

Question 1

Types of liquidity risk

Answer 1

Market liquidity risk, funding liquidity risk

Question 2

what is market liquidity risk

Answer 2

related to the ability of a bank to trade an asset at short notice, low cost and with little impact on its price,.

Question 3

what is funding liquidity risk

Answer 3

related to ability of a bank to meet its cash needs as they arise. Flow concept- entity is liquid as long as inflows ≥ outflows

Question 4

what is liquidity risk management

Answer 4

process of generating funds to meet contractual or relationship obligations at reasonable prices at all times.

Question 5

Causes of funding liquidity risk

Answer 5

Liability side reason, asset side reason.

Question 6

Liquidity side reason of funding liquidity risk

Answer 6

banks liability holders such as depositors seek to cash in their financial claims immediately

Question 7

asset-side reason of funding liquidity risk

Answer 7

Occurs with loan commitments that allow customers to borrow funds from bank on-demand, or from changes in values of assets.

Question 8

How to meet liquidity requirements

Answer 8

Running down cash assets, selling liquid assets or additional borrowing. If low cash holdings, may be forced to liquidate assets too quickly at a lower price.

Question 9

How to cope with liquidity issues.

Answer 9

Purchased liquidity management. Borrowing funds from external sources, such as central banks or interbank loans. Stored liquidity management- bank converts liquid assets into cash to meet requirements.

Question 10

Dynamic approach to liquidity position and how to calculate liquidity position.

Answer 10

Liquidity gap is the difference between sources and uses of funds. 1) Loans and deposits forecast for planning period. 2) Forecast estimated changes of loans and deposits. 3) Difference in estimated changes is liquidity surplus or deficit. Future forecast of growth in loans and deposits can be divided into 3 components.

Question 11

3 components of forecasting growth in deposits and loans

Answer 11

Trend component- construct trend line using sufficient time period. Seasonal component- growth defined by taking most recent info as reference. Cyclical component- deviation from estimated sum of trend and cyclical due to business cycle.

Question 12

Static approach to liquidity position.

Answer 12

Stock perspective where structure of liabilities is classified into categories based on probability of each category to be withdrawn. 1) hot money liabilities. 2) vulnerable funds. 3) stable funds.

Question 13

Alternative static approaches to liquidity position.

Answer 13

Measuring gaps- financing gap and liquidity gap. Liquidity ratios- core deposits ratio, hot money ratio, loan to deposit ratio, loan commitment ratio.

Question 14

Basel III as result of GFC

Answer 14

Extreme levels of liquidity assistance required from CB’s in GFC. Basel Committee developed 2 new standards for liquidity risk supervision in Basel III. Require banks to respect 2 ratios as well as capital requirements. LCR and NSFR

Question 15

What does liquidity coverage ratio do

Answer 15

Aims to ensure banks maintain adequate level of high quality liquid assets that can be coverted to cash to meet liquidity needs for 30-day horizon.

Question 16

what does net stable funding ratio do

Answer 16

Ensure long term assets funded with minimum amount of stable liabilities, limiting reliance on short term wholesale funding.

Question 17

How to liquidity plan

Answer 17

Define managerial details and responsibilities, detailed list of fund providers, identify size of potential deposits and withdrawls over various time horizons, set internal limitis, bounds for acceptable risk premiums, asset disposal strategy

Question 18

Tradeoff involving reserve requirements.

Answer 18

Liquid assets less payoff than others, so tradeoff between profitability and liquidity management.