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How To Handle Liquidity Management on Banks

 

How To Handle Liquidity Management on Banks

Simply liquidity management is a trade-off between the demand for liquidity and supply of liquidity. To explain this process, we can see a FI’s need for liquidity that means the immediately spendable funds in a demand-supply framework.

Bank Liquidity Management

Bank Liquidity Management

Demand for liquidity:
For banks, the most pressing demands for spendable funds come from following sources:
1. Customer’s deposit withdrawal
2. Credit requests from quality loan customers
3. Repayment of non-deposit borrowings
4. Operating expenses and taxes
5. Payment of stockholder cash dividends
Supply of liquidity:
To meet the foregoing demands for liquidity, banks can draw upon several potential sources of liquidity supply, such as:
1. Incoming deposits
2. Revenues from non-deposit services
3. Sales of assets
4. Borrowing from money market
These various sources of liquidity demand and supply come together to determine each bank’s net liquidity position at any moment of time.
A bank’s net liquidity position = Total supplies of liquidity – Total demand for liquidity
When the result is negative, the bank is in a liquidity deficit position and when the result is positive, it is in liquidity surplus position.
The essence of the liquidity management problem for a bank may be described in two concise statements:
1. Rarely the demand for liquidity equal to the supply of liquidity in a particular moment in time. A bank must continually deal with either a liquidity surplus or liquidity surplus.
2. There is a trade-off between liquidity and profitability. The more resources are tide for meeting liquidity demand, the lower the bank’s expected profitability; if all other factors remain constant.
Thus, ensuring adequate liquidity is a never-ending problem for management that will always have significant implications for profitability.

Why banks face significant liquidity management problems?

Liquidity crisis may be generated from various sources, like as:

  1. Mismatch of maturities between asset and liability; often banks create long-term assets by short-term liabilities.
  2. To meet a high volume of payment obligations like as huge amount of fixed deposit withdrawal or payment of money market borrowing
  3. Sensitivity to changes in interest rate

 

Strategies of Liquidity Management:

Over the years, experienced liquidity managers have developed several broad strategies for dealing with liquidity problems. Generally, we can discuss three broad strategies here as below:

  1. Providing liquidity from assets; Asset Liability Management Strategy
  2. Relying on borrowed sources to meet cash demand; Borrowed Liquidity Management Strategy, and
  3. Balanced Liquidity Management Strategy

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