Part 1

Question 1

How can liquidity risk be managed?

Answer 1

By using Maturity ladders

Question 2

What are the two main causes of liquidity risk?

Answer 2

Asset liquidity risk

Funding liquidity risk

Question 3

What liquidity risk management tools are there?

Answer 3

Stress testing
accurate est of future funding requirements
having a range of sources of funds
liquidity limits
scenario analysis
diversification
behavioural analysis
nettiing
market dislocation

Question 4

What does liquidity risk lead to? (Northern Rock)

Answer 4

Need to borrow
Sell assets to raise cash 
forced balance sheet reduction 
regulatory breaches
repetitional damage

Question 5

What 2 types of liquidity risk does the Basel Committee define?

Answer 5

Funding liquidity risk - firm won’t be able to meet expected and unexpected current and future cash flow and collateral needs

Market liquidity risk - firm can’t easily offset or eliminate a position at the market price due to inadequate market depth or market disruption

Question 6

What do the Principles for Sound Liquidity Risk Management and Supervision entail?

Answer 6

Designed to raise standards in:

• governance and articulation
• liq risk measurement
• awareness of what effects
• stress testing
• buffers e.g. liquidity coverage ratio
• disclosure to be regular
• risk sensitive approach
• banks must hold a pool of high quality assets as a liquidity buffer
• must be met by 2015

Question 7

What do maturity ladders do?

Answer 7

Look at inflows (debt repayments) and outflows (loans, interst payments) over the same period. Compares the 2 in order to understand net funding requirements.

• Drawn p based on contractual agreements
• Leads to contingency plans, back up cash flow

Question 8

Asset liquidity risk

Answer 8

Some assets are easily converted to cash, with minimum loss in value.
Highly liquid, with plentiful potential buyers

Not all assets are liquid, and these pose asset liquidity risk

Question 9

What is funding liquidity risk?

Answer 9

Risk that the firm can’t efficiently meet expected and unexpected cash flows without affecting cash flow or daily operations
Avoid over-reliance on customer deposits.

Question 10

Estimated future funding requirements demands an analysis of ‘stickiness’ / loyalty of deposits. What are the 8 factors to determine stickiness?

Answer 10

Deposit…

Insured?
Secured?
Controlled? (Owner)
Other rels with bank?
Net borrower?
Funds provider lack internet access to funds?
Counterparty financially unsophisticated?
Bank obtain deposits directly or through a broker? (broker source more volatile)

ALSO: Should have diversified sources of liquidity to safeguard future funding

Question 11

What are the 4 types of netting (set off)

Answer 11

1. Payment (reduce settlement)
2. Closeout (reduce pre settlement)
3. Bilateral (common in OTC markets)
4. Multilateral (multiple parties)

Question 12

What is liquidity risk?

Answer 12

The risk that financial commitments can’t be paid as they fall due

Banks should ensure compliance with the Liquidity principles as set by the Basel Committee.