BUS307 Topic 4 - Topic 4 Liquidity Risk BUS307 Commercial Banking 1.0 Importance of Liquidity Liquidity Ability to access funds to make payments as they

BUS307 Topic 4 - Topic 4 Liquidity Risk BUS307 Commercial...

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Topic 4 Liquidity Risk BUS307 Commercial Banking
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1.0 Importance of Liquidity Liquidity Ability to access funds to make payments as they become due Payments consist of: Withdrawals by depositors Draw-down of loans by borrowers Funds come from: Liquid assets Access to borrowed funds
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1.1 Liquidity Risk Risk that a bank will have a shortage of liquidity Stems from difficulty in predicting liquidity needs Overall exposure depends on: Size of liquidity buffer Volatility of liquidity needs
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1.2 Costs of Liquidity Storage May have to limit new lending May have to borrow funds at penalty rates May have to sell assets at a loss Worst case: withdrawal or loan refused This will threaten confidence
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1.2 Costs of Liquidity Storage Major concern is that liquidity shortage will lead to a bank run An attempt by depositors to withdraw their funds immediately because they fear their bank may become insolvent Bank runs can potentially spread to other banks affecting the entire financial system
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1.3 Prudential Supervision of Liquidity Banks are required to implement a liquidity management policy that must be approved by the Australian Prudential Regulation Authority (APRA) Policy must cater for two specific scenarios Day-to-day liquidity management Bank specific or ‘name’ crisis
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1.4 Limiting Exposure to Liquidity Risk Matching of maturities of assets and liabilities will limit exposure to liquidity risk In practice this is extremely difficult Borrowers and depositors typically have different time preferences Banks manage liquidity by limiting mismatches Ensure bank has sufficient funds for current payments Through Exchange Settlement Account Estimate future settlement needs Ensure access to funds when needed
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1.5 Exchange Settlement Accounts Exchange Settlement Accounts are held with the Reserve Bank of Australia ESAs pay interest at 25 basis points below RBA target cash rate ESAs are not allowed to be overdrawn Banks are required to settle inter-bank payments through ESAs
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1.6 Payment Processing Deferred Net Settlement (DNS) Large number of transactions is accumulated throughout the day Overnight transactions are aggregated Net balances owed or owing are resolved against ESA Used for small-value, high-volume payments
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1.6 Payment Processing (Continued) Real Time Gross Settlement (RTGS)
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  • Summer '19
  • Liquidity, liquidity needs, Prudential Supervision of Liquidity

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