Liquidity Risk Flashcards
(25 cards)
Definition of liquidity risk
refers to the possibility of banks being unable to meet short term financial obligations without incurring significant loss
market liquidity
refers to how quickly and easily banks can buy and sell assets without significantly affecting the price
funding liquidity risk
refers to how easily the bank can obtain funds to meet short term liabilities in necessaryl markets
what is liquidity management
refers to process of generating funds to meet collateral obligations at reasonable price and times
liability side risk
occurs when bank liability holders seek financial claims immediately
asset side risk
off balance sheet loan commitments being exercised
this can also can be due to asset price changes
what is stored liquidity
liquidity that is accessed through liquid assets and cash to cover the liquidity deficit
purchased liquidity
meeting obligations with external financing such as repo agreements and wholesale funding
what is a dynamic approach
an approach that sees liquidity management adapted to constant changes to the market, risk profile and regulations
what does a dynamic approach consist of (2)
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
what should be considered in dynamic forecasts (3)
Trend components: use past data to construct a trendline
Seasonal components: taking reference point of recent information
Cyclical components: deviation due to business cycles
static approach
maintaining fixed strategies and policies that do not adapt to changing market conditions
Liquidity cover ratio (LCR)
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
Liquidity cover ratio formula
stock of high quality liquid assets
/
total net cash outflow over the next 30 days
Benefits of cover liquidity ratio (5)
- allows for banks to be prepared for short term crisis
- easier to align with regulatory requirements
- creates a regulation standard
- investor reassurances
- fairly simple
Drawbacks of liquidity cover ratio (3)
- banks may face operational costs
- banks may change strategies to meet requirements
- may only priorities short term liquidity problems
Net stable funding ratio (NSFR)
regulations standard introduced by BASEL III accords to promote long term funding stability over a 1 year horizon
Net stable funding ratio (NSFR) formula
amount of stable funds
/
required amount of stable funds
(there consist of tier 1 and 2 securities)
Benefits of NSFR (4)
- ensuring long term stable funding
- reduced risk of bank runs
- decreases contagion
- ensure a standardised measure
Drawbacks of NSFR) (3)
- long term funding makes cost of capital higher
- complex models to work out
- may hold onto lower yield high quality bonds
Stress testing and scenario analysis
BASEL III require stress tests across banks called a Internal Liquidity Adequacy Assessment Process (ILAAP)
Benefits for scenario analysis (4)
- risk identification
- preparedness
- regulatory compliance
- risk management
Drawbacks of scenario analysis (3)
- required data
- complex modelling
- resource draining
study regarding stress tests (2)
- stress tests lead to more conservative liquidity practise
- can reduce liquidity creation in the economy but increase stability
