BF433 PRESENTATION examination preparation .pptx

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1. Describe the following Monetary tools used in managing bank liquidity 1.Contractual Maturity Mismatch 2.Concentration of funds 3.Available Unencumbered assets 4.Market related monetary tools 5.Liquidity coverage ratio by significant currency

2. Contractual Maturity Mismatch It refers to the gap between inflows and outflows of liquidity arising from long term illiquid assets and liquid liabilities Such mismatches are inherent to banks given their fundamental role in the wider economy of transforming liquid liabilities such as deposits into illiquid assets such as long term loans It also a situation where the maturities of assets and liabilities on a bank or company balance sheet do not match, it occours when a company has long term assets but short term liabilities or vice versa Contractual maturity mismatches can create liquidity risks for a company if the short term liabilities cannot be met when they become due it may lead to financial distress ,default or the need to refinance the debt at potentially unfavorable terms Managing contractual maturity mismatches is an important aspects of financial risk management Banks may employ various strategies to mitigate these risks such as matching the maturities of their assets and liabilities refinancing short term debt with long term debt maintaining sufficient cash reserves or establishing credit lines to address short term funding needs Refinancing :The Bank can refinance its short term debt with long term obligations, the bank aligns the maturity of its liabilities with the expected cash flows from its long term assets this allows the company to have a more balanced maturity profile and reduces the risk of being unable to meet short term obligations Cash management : Banks can implement effective cash management practices to ensure it has sufficient liquidity to meet its short term obligations, this can involve closely monitoring cash flows and maintaining appropriate cash reserves and by having adequate cash on hand the bank can avoid liquidity issues even if there is a contractual maturity mismatch Asset liability matching : The bank can strive to match the maturities of its assets and liabilities, it can do this by aligning the duration of its assets with the expected cash outflows of its liabilities for example if the bank has a long term project with cash flows expected in three years, it can seek long term financing options or issue long term debt instruments with a similar maturity to match the cash flow timeline Diversification of funding sources :Relying on a single source of funding can increase the risk of contractual maturity mismatches the bank can mitigate this risk by diversifying its funding sources, for instance it can secure financing from various lenders or investors with different maturity profiles this provide flexibility and reduces the reliance on a single source of short term funding

3. Concentration of funds Refers to the aggregation of funds from multiple bank accounts into one concentration account or centralized account It allows for quick disbursement of funds of funds as needed, for example dividends payment to shareholders and paying back principal amount and interest to investors or depositors When funds are centralized into one account, a bank can easily and efficiently maintain minimum balances in other accounts,if other accounts fall below their requirements thresholds then the funds can quickly be moved to the account with a short fall to restore account balances to their requirement threshold thereby avoiding costly penalty fees by central banks Cash Pooling : It is technique where funds from multiple accounts such as various branches or subsidiaries are physically or notionally pooled into a single this allows banks to optimize their cash positions by effectively utilizing excess funds in one location to cover short falls in other Notional Pooling : It is a virtual form of cash pooling where balances from different accounts are notionally offset against each other but physical transfers do not take place this technique allows banks to optimize interest income or expense by offsetting debit and credit positions within the pool reducing the need for actual cash movements Liquidity Forecasting: Concentration of funds facilitate accurate liquidity forecasting since it provide consolidated view of available funds, banks can monitor their cash flows more effectively, identify potential liquidity gaps or surplus and take proactive measures to manage their liquidity positions By implementing concentration of funds techniques banks can achieve several benefits in liquidity management, including enhanced control over cash positions, improved liquidity utilization, reduced funding costs and more accurate liquidity forecasting However its important for banks to carefully asses the regulatory and legal requirements associated with concentration of funds as well as potential risk such as counterpart risk and operational challenges

4. Available unencumbered assets These are assets with no debt associated with them, no any competing claims such as property taxes and not listed as collateral for any debts. They are fully owned by a company. For example stocks (shares) purchased in cash, land, buildings and equipment. When a bank is in financial turmoil, shares purchased in cash can be liquidated quickly and used for a bank’s immediate needs or can be used as collateral security for secured loans. Central bank: Unencumbered assets are often required by central banks as eligible collateral for participating in various liquidity facilities and operations. A house free mortgage can be used as a collateral security for secured loans when sourcing finance from other financial institutions. Collateral for borrowing: Banks can use unencumbered assets as collateral to borrow funds from other banks or central bank. This borrowing helps to address short term liquidity needs and maintain the required level of cash reserves. Repo transactions: Banks can use unencumbered assets in repurchase agreement (repo) transactions . In a repo, the bank temporarily sells its assets to another party with an agreement to repurchase them at a later date. This allows the bank to obtain short term funding while using the unencumbered assets as collateral Overally , unencumbered assets provide banks with flexibility and options to manage their liquidity effectively. They serve as collateral ,liquidity buffers and can be converted into cash or used in various financial transactions to address short term liquidity needs.

5. Market related monetary tools Open Market Operations (OMOs): This tool involves the buying and selling of government securities such as treasury bonds or bills by the central bank in the open market. When the central bank buys these securities it injects money into the banking system increasing liquidity. Conversely, when it sells securities , it absorbs money from the system reducing liquidity. Repurchase agreements (Repos): Repos are short term transactions where the central bank sells securities to banks or other financial institutions with agreement to repurchase them at a later date. This tool provides temporary liquidity to banks , allowing them to obtain funds by temporarily pledging their securities Discount Window: The discount window is a facility provided by central banks where banks can borrow funds directly from the central bank for a short period. This tool helps banks meet short term liquidity needs during times of financial stress. Reserve requirements: Banks are required to maintain a certain percentage of their deposits as reserves with the central bank. By adjustingthese reserve requirements , central banks can influence the amount of money banks can lead and therefore affect liquidity conditions. Interest Rate Policy: Central banks can use their authority to set benchmark interest rates, such as the federal funds rate in the United States or the repo rate in India. By adjusting these rates, the central bank can influence the cost of borrowing and consequently, the availability of liquidity in the banking system. Standing Facilities: Central banks can offer standing facilities to banks as a way to manage their liquidity needs. These facilities include the liquidity adjustment facility (providing overnight funds) and the marginal lending facility (providing longer term funds). Banks can facilities to borrow funds from the central bank when needed or deposit excess funds These market related monetary tools provide central banks with various mechanisms to manage bank liquidity effectively, stabilize financial markets and control inflation within an economy . The specific tools used can vary depending on the country and the prevailing eceonomic conditions.

6. Liquidity coverage ratio by significance currency It refers to the proportion of highly liquid assets held by financial institutions to ensure their ongoing ability to meet short term obligations . Liquidity Coverage Ratio is a requirement under Basel 111 whereby banks are required to an amount of highly- quality liquid assets that are enough to fund cash outflows for 30 days. 30 days was chosen because it allows banks to have cushion of cash in the event of a run on banks during a financial crisis. The 30 day requirement also provides central banks such as the Federal Reserve Bank time to step in and implement corrective measures to stabilize the financial system. The LCR is a stress test that aims to anticipate market-wide shocks and make sure that financial institutions possess suitable capital preservation to ride out any short term liquidity disruptions. High-quality liquid assets , total net cash flows and significant currencies are the information needed when calculating LCR High-quality liquid assets are assets that can be easily converted into cash without significant loss of value e.g cash, government securities and high quality corporate bonds Total net cash outflows include expected cash outflows from contractual obligations such as loan repayments and funding commitments. They also include potential contingent outflows such as deposit withdrawals and margin calls Significant currencies are the currencies that are considered significant for the bank’s liquidity risk management. Typically banks consider the currencies in which they have significant exposures or operational activities. It is calculated by dividing a bank’s high-quality liquid assets by its total net cash flows over a 30 day stress period. LCR = HQLA in significant currency)/ Total Net Cash Out flows in significant currency The LCR promotes financial stability by ensuring that banks maintain an adequate liquidity buffer. This helps prevent a situation where a bank faces a sudden liquidity shortage and is unable to meet its obligations. Another advantage of LCR is that it improves market confidence in the banking system . It reassures depositors and investors that banks have the necessary liquidity resources to honor their commitments even in adverse markets conditions. A limitation of LCR is that it requires banks to hold more cash and might lead to fewer loans issued to customers and businesses.