Podcast
Questions and Answers
Which scenario would MOST likely necessitate a bank to secure funding from the money market at elevated costs?
Which scenario would MOST likely necessitate a bank to secure funding from the money market at elevated costs?
- A planned reduction in the bank's lending portfolio.
- Strategic investment in long-term government bonds.
- Consistent growth in customer deposit accounts.
- An unanticipated surge in deposit withdrawals. (correct)
Which factor is LEAST likely to directly contribute to internal liquidity risks within a bank?
Which factor is LEAST likely to directly contribute to internal liquidity risks within a bank?
- Insufficient liquidity planning and coordination.
- Inadequate management of assets and liabilities.
- Mismatched maturities between assets and liabilities.
- A sudden economic recession impacting the broader market. (correct)
In the context of liquidity risk management, 'stress tests' primarily aim to:
In the context of liquidity risk management, 'stress tests' primarily aim to:
- Optimize daily cash flow operations.
- Evaluate employee performance under pressure
- Assess the effectiveness of marketing strategies.
- Simulate the bank's resilience to adverse liquidity scenarios. (correct)
Which strategy would be LEAST effective for a bank facing an immediate liquidity shortfall?
Which strategy would be LEAST effective for a bank facing an immediate liquidity shortfall?
Which statement accurately describes how liquidity risk exposure affects a bank's equity?
Which statement accurately describes how liquidity risk exposure affects a bank's equity?
What is the MOST likely immediate impact on a bank's balance sheet if a large number of depositors unexpectedly withdraw their funds?
What is the MOST likely immediate impact on a bank's balance sheet if a large number of depositors unexpectedly withdraw their funds?
What is the primary goal of 'purchased liquidity'?
What is the primary goal of 'purchased liquidity'?
Which activity does NOT represent a method of 'purchasing liquidity'?
Which activity does NOT represent a method of 'purchasing liquidity'?
Why must banks maintain a store of liquid assets?
Why must banks maintain a store of liquid assets?
What is the disadvantage of banks storing liquidity?
What is the disadvantage of banks storing liquidity?
What does the 'liquidity gap' represent?
What does the 'liquidity gap' represent?
If a bank has more liquidity sources than its uses, what type of liquidity gap does it have?
If a bank has more liquidity sources than its uses, what type of liquidity gap does it have?
The liquidity ratio measures...
The liquidity ratio measures...
A high liquidity ratio indicates:
A high liquidity ratio indicates:
What is the MOST accurate description of the Maturity Ladder approach to liquidity risk management?
What is the MOST accurate description of the Maturity Ladder approach to liquidity risk management?
As per the text, what is the primary concern when there is a mismatch in the maturities of assets and liabilities when considering liquidity risk?
As per the text, what is the primary concern when there is a mismatch in the maturities of assets and liabilities when considering liquidity risk?
What range should banks use when following the Maturity Ladder approach?
What range should banks use when following the Maturity Ladder approach?
In the context of liquidity risk, what is typically compared across specified time intervals when one is applying the Maturity Ladder approach?
In the context of liquidity risk, what is typically compared across specified time intervals when one is applying the Maturity Ladder approach?
In liquidity risk management, what does the term 'stress testing' refer to?
In liquidity risk management, what does the term 'stress testing' refer to?
According to the text what is a possible effect of stress testing?
According to the text what is a possible effect of stress testing?
According to the text Basel put what in place to manage liquidity after observing what happened in 2008?
According to the text Basel put what in place to manage liquidity after observing what happened in 2008?
What does a high quality liquid asset involve?
What does a high quality liquid asset involve?
Net Stable Funding Ratio (NSFR) helps...
Net Stable Funding Ratio (NSFR) helps...
If a small company has a deposit with a bank but it is NOT stable is that something rated as a high-quality liquid asset?
If a small company has a deposit with a bank but it is NOT stable is that something rated as a high-quality liquid asset?
True or false: Liquidity risk only affects the liability side of a financial institution.
True or false: Liquidity risk only affects the liability side of a financial institution.
True or false: An increasing source of liquidity compared to use represents a deficit.
True or false: An increasing source of liquidity compared to use represents a deficit.
What does it mean when a bank has a positive gap between the sources of liquidity and the use of liquidity?
What does it mean when a bank has a positive gap between the sources of liquidity and the use of liquidity?
Which of the following is an example of purchasing liquidity?
Which of the following is an example of purchasing liquidity?
Which of the following is one of the items that the central bank has the authority to do?
Which of the following is one of the items that the central bank has the authority to do?
Why would a bank prefer to have more deposits for liquidity?
Why would a bank prefer to have more deposits for liquidity?
What is the end result of what is called, liquidity coverage ratio?
What is the end result of what is called, liquidity coverage ratio?
What is the objective for using assumptions that deal with the most severe outcomes and their effect on the proportions from the supervisory authorities?
What is the objective for using assumptions that deal with the most severe outcomes and their effect on the proportions from the supervisory authorities?
Which of the following is NOT one of the main tasks that central bankers engage in.
Which of the following is NOT one of the main tasks that central bankers engage in.
Why are higher interest rates dangerous for liquidity?
Why are higher interest rates dangerous for liquidity?
What is the banks must balance when considering all these considerations.
What is the banks must balance when considering all these considerations.
If a bank is trying to ensure that their business will still be viable months or years out what are the two measures they will consider for stability?
If a bank is trying to ensure that their business will still be viable months or years out what are the two measures they will consider for stability?
What would the central bank likely do if the lower threshold was hit by a financial institution?
What would the central bank likely do if the lower threshold was hit by a financial institution?
Flashcards
Liquidity Risk
Liquidity Risk
Risk that a bank cannot meet its obligations when due.
Purchased Liquidity
Purchased Liquidity
Buying liquid assets to meet short-term obligations.
Stored Liquidity
Stored Liquidity
Maintaining liquid assets for unexpected needs.
Liquidity Gap
Liquidity Gap
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Liquidity Ratio
Liquidity Ratio
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Maturity Ladder Analysis
Maturity Ladder Analysis
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Liquidity Coverage Ratio (LCR)
Liquidity Coverage Ratio (LCR)
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Net Stable Funding Ratio (NSFR)
Net Stable Funding Ratio (NSFR)
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Sensitivity Analysis/Stress Tests
Sensitivity Analysis/Stress Tests
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Liquidity Index
Liquidity Index
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Liquid Assets
Liquid Assets
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Study Notes
Liquidity Risk Management
- Liquidity risk management involves overseeing the ability of an organisation to meet its financial obligations
Key Concepts
- Liquidity Index: Measures the liquidity of an asset or a portfolio
- Purchase Liquidity: Obtaining funds to meet obligations by selling assets
- Ladder Maturity: A schedule of assets and liabilities categorized by maturity dates, used to assess liquidity gaps
Objectives
- To explore the definition of liquidity risk and its causes
- To clarify how liquidity risk impacts equity
- To look at the measurement methodologies for bank liquidity exposure
Chapter Outline
- Definition of liquidity risk
- Factors that cause liquidity risks
- Impact of liquidity risk on equity
- Bank exposure measurement
- Sensitivity analysis (stress tests) for liquidity risk
Meaning and Definition of Liquidity Risk
- The financial crisis of mid-2007 highlighted the significance of liquidity risk, affecting financial institutions
- Managing liquidity and evaluating it under possible scenarios is crucial to restore investor confidence
Understanding Liquidity Risk
- The risk arises from the inability to secure the required funds for meeting commitment during the maturity period
- This may be due to requests related to the outflow of funds as a result of an unexpected change in depositor behaviour
- The bank may have to borrow to meet its cash needs, which impacts profits
Managing Liquidity Shortfalls
- A shortage in liquidity causes the bank to engage in unusual activity in short-term funding, at high rates
- Understanding the needed liquidity needs and the rate offered to supply it is essential in this situation
Causes of Liquidity Risk
- Liquidity risk arises from internal and external factors
Internal Factors
- Inability to manage assets and liabilities due to poor liquidity planning and coordination
- Mismatch between the maturity of assets and debts
External Factors
- Economic recession and crises that may arise in financial markets can cause liquidity issues
- High interest rates in financial markets compared to the rates in banks
- Political instability
Bank Liquidity Management
- Banks generally maintain liquid funds and liquid assets to face unexpected demand for liquidity and ensure financial liquidity
Impact of Liquidity Risks of Equity
- Liquidity risks arise from either side of the balance sheet
- Includes risks of liability liquidation (increase in withdrawal) and assets liquidation (difficulty in liquidating assets)
Funding Liquidity
- Refers to obtaining liquid funds to meet the withdrawal requests from the bank
- Also termed "borrowed liquidity" or "liabilities management"
- This may involve options such as borrowing from other banks, issuing certificates of deposit, repurchase agreements, or discounting commercial instruments
Measuring a Bank's Liquidity Exposure
- Assessing the degree of liquidity exposure involves measures the comparison of liquidity sources and uses
- This includes liquidity ratio, funding gap, comparing ratios for peer groups, and maturity ladder
Sources and uses of liquidity (Net liquidity)
- Should be reported daily by the manager in charge
- Can be determined from by liquidity status report
Principles
- Inflow comes through increased deposits and reduced funding costs
- Outflow comes from decreased deposits and increased lending rates
Formulas
- The formula for measurement is liquid assets - liability = surplus
- An estimate of 5-20% of the liabilities is estimated, which can increase or decrease the liquidity ratio
Liquidity Coverage Ratio
- Seeks to determine if a financial institution has adequate highly liquid assets to withstand a period of stress
- It should always be at least, the value of highly regarded equity to the amount of net cash
Net Stable Funding Ratio
- Complements the liquidity coverage ratio through a comparison of the volume liability assets
Analysis
- Liquidity testing is achieved when an adequately-sized liquid fund is available to deal with unforeseen issues
Central Bank's Role
- Central banks can help lower liquidity risk through a mandatory minimum amount of liquid assets required
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