Flashcards in Part 1 Deck (12)
How can liquidity risk be managed?
By using Maturity ladders
What are the two main causes of liquidity risk?
Asset liquidity risk
Funding liquidity risk
What liquidity risk management tools are there?
accurate est of future funding requirements
having a range of sources of funds
What does liquidity risk lead to? (Northern Rock)
Need to borrow
Sell assets to raise cash
forced balance sheet reduction
What 2 types of liquidity risk does the Basel Committee define?
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
What do the Principles for Sound Liquidity Risk Management and Supervision entail?
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
What do maturity ladders do?
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
Asset liquidity risk
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
What is funding liquidity risk?
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.
Estimated future funding requirements demands an analysis of 'stickiness' / loyalty of deposits. What are the 8 factors to determine stickiness?
Other rels with bank?
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
What are the 4 types of netting (set off)
1. Payment (reduce settlement)
2. Closeout (reduce pre settlement)
3. Bilateral (common in OTC markets)
4. Multilateral (multiple parties)