Liquidity decision in banking system

liquidity decision, an introduction of liquidity decision, the importance of the liquidity decision, estimating the liquidity needs, instruments of liquidity, theories of liquidity decision, liquidity procedure in the banking system

1. Liquidity Decision

2. contents Introduction Importance of Liquidity Decision Estimating Liquidity needs Instruments of Liquidity Theories Of Liquidity Decision Liquidity Procedure

3. Terminologies Financial distress : It arises when a firm is not able to meet it’s obligations to debt holder Cash conversion cycle: measures how long a firm will be deprived of cash if it increases its investment in resources in order to expand customer sales. It is thus a measure of the liquidity risk entailed by growth. Inventory policy: This policy outlines that inventory is properly controlled and losses or shortages are prevented. It applies to all inventory items, including raw materials, work in progress, and finished goods and consigned inventory. Financial Risk: Financial risk is the possibility that shareholders will lose money when they invest in a company that has debt,

4. Cash Reports: The Daily Cash Report is used to report on the daily cash balance and to help manage cash on a weekly basis. Spontaneous Finance:   Financing  which flows with the volume of sales activity during normal business operation that requires no additional assistance from lenders or creditors. Credit Policy: A company's  policy  on when its customers should pay for goods or service she terms and conditions for supplying goods on credit. steps to be taken in case of customer delinquency. Also called collection policy. Account Payable:  Money owed by a business to its suppliers shown as a liability on a company's balance sheet. ACH Payments: ACH payments are electronic payments made through the Automated Clearing House Network. They are a popular alternative to paper checks and credit card payments 

5. Introduction liquidity Decision takes one of two forms based on the definition of liquidity. One type of liquidity refers to the ability to trade an asset, such as a stock or bond, at its current price. other definition of liquidity applies to large organizations such as financial institutions. Banks are often evaluated on their liquidity, or their ability to meet cash and  collateral obligations*

6. Liquidity* is a firm’s ability to pay it’s short term debt obligations. If the firm has adequate liquidity, it can pay it’s current liabilities such as account payable. liquidity used in combination with Cash Management. liquidity decision* is concerned with the management of the current assets, which is a pre-requisite to long-term success of any business firm. This is also called as working capital decision.

7. Importance of Liquidity Decision To honor Cheque: Honoring the cheque in exchange of deposit is the key factor of maintaining public confidence. Although in regulation, the bank has to refund all the deposit To maintain cash reserve ratio: The bank hast o maintain sufficient amount of cash reserve to meet statutory obligation and to maintain minimum safety. To meet loan demand: to make profitable investment, bank should have sufficient cash balance. 

8. To meet administrative expenses: Bank has to pay administrative expenses in various sectors like payment of salary, rent, electricity charge, telephone billing etc. To pay bills of exchange*: it requires some fraction of bank's liquidity to use for such transaction.   To resolve economic fluctuation*: bank has to maintain adequate amount of liquidity to solve the problem created by economic fluctuation.

9. Estimating Liquidity needs Banks strive to maintain adequate liquidity- too much liquidity needlessly limits bank earnings, and too little liquidity exposes a bank to the possibility of costly emergency measures to secure needed funds. Liquidity should be sufficient to cover probable fluctuations in loans and deposits, with a small margin of excess liquidity as a safety measure

10. While liquidity needs cannot be predicted with certainty, they can be closely determined by reviewing past fluctuations in loans and deposits and by keeping a careful watch on the current business situation. If a bank has carefully evaluated and planned for its liquidity needs, it should hold a maximum liquidity when deposits are up and loan demand is down.

11. INSTRUMENTS OF LIQUIDITY Liquid assets: An Asset is said to be liquid if it is easy to sell or convert in to cash without any losses in its value. Cash in hand Statutory Liquidity Ratio Balances with other banks ( First Line Of Defense )* Money at call* and short notice Investments Government securities ( Bearer bonds)*

12. Liquid Liabilities are Time Certificates of Deposits* Borrowing from other commercial banks Borrowing from Central Bank Raising of Capital Funds*

13. THEORIES OF LIQUIDITY DECISION Commercial-Loan Theory: The bank should refrain from long term loans. should have short term self liquidating obligations. The bank holds a Principle that when money is lent against self liquidating papers, it is known as Real Bills Doctrine. The Shiftablity Theory: It must fulfill the attributes of immediate transferability to others without loss. In case of general liquidity crisis, bank should maintain liquidity by possessing assets which can be shifted to the Central Bank.

14. The Anticipated Income Theory : Must invest in term-lending* , working capital* ( is a financial metric which represents operating liquidity available to a business ) securities, but must also be secure about the deployment and repayment of funds. Bank must assess the potential of that person to repay back Liability Management Theory: an individual bank may acquire reserves from different sources by creating additional liabilities against itself. These sources include a number of items

15. LIQUIDITY PROCEDURE Identifying liquidity: Identifying liquidity is primarily a function of data gathering, and does not include the actual movement or usage of funds. Managing liquidity: It involves using the identified liquidity to support the bank’s revenue generating activities. This may include consolidating funds* , managing the release of funds to maximize their use.

16. Optimizing liquidity: It is an ongoing process with a focus on maximizing the value of the institution’s fund. It requires strong and detail understanding of bank’s liquidity position across all currencies, accounts, business lines and counter parties. The biggest challenge in the liquidity Decision process is the limited and resources available to it.

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