Liquidity

Question 1

What is liquidity in relation to banks?

Answer 1

‘A measure of a bank’s ability to acquire funds immediately at a reasonable price in order to meet demands for cash outflows’

Not to be confused with capital adequacy

Question 2

What are the UK regulators worried about liquidity risk?

Answer 2

They are worried that a firm although solvent, does not have the sufficient financial resources available to enable it to meet its obligations as they fall due

Question 3

What situation highlighted liquidity problems?

Answer 3

• Financial crisis and Northern Rock

- If a run on the bank occurs liquidity can quickly be lost

Question 4

What must the banks consider when looking at liquidity?

Answer 4

The timing of both assets and liabilities and try to match them as far as possible
Asset concentrations where large numbers of recipts occur at the same time, should be avoided.
Liability concentrations should be avoided as well, sudden significant claims.
Spread maturity dates

Question 5

A firm’s assets can provide liquidity in 3 main ways?

Answer 5

• Being sold for cash
• By reaching their maturity date, for example a loan which is due to be repaid by a specific date
• By providing security for borrowing

Question 6

What is liquidity coverage ratio (LCR)?

Answer 6

Since 1 Oct 2015

- LCR establishes whether a bank can survive next 30 days has high quality assets

Question 7

How is LCR calculated?

Answer 7

2 components
1) Banks stock of High quality liquid assets (HQLA) - assets of the highest credit and liquidity such as government securities
2) Total Net cash outflows (TNCO) - cash going out minus cash coming in
HQLA/TNCO x100

Required ratio:
2015 = 80%
2017 = 90%
2018 = 100%

Question 8

Other requirements of standards?

Answer 8

• Banks and other deposit takers required to have systems that identify, measure and mnitor liquidity risk
• Stress testing must happen computer simulated
• Must document their policy for managing liquidity

Question 9

What will be the result for banks?

Answer 9

• Increase in capital because of requirements
• Reduce the level of risk weighted borrowing/finance (reduce overall lending or reduce the amount of associated risk)
• Additional costs to be compliant and may need to be factored into profit margin
• Globally systemically important banks may be more strict with their lending due to needing to be higher grade
• Especially punitive for leasing assets with high residual values
  Bank may look at mortgages instead which has lower risk weighting
  BUT - smaller banks not internationally active are not subject to Basel regulations