im08 - Chapter 14 Liquidity Planning and Managing Cash...

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Chapter 14 Liquidity Planning and Managing Cash Assets Chapter Objectives 1. Identify the nature of cash assets and objectives of managing the bank's cash position. 2. Describe the relationships between cash holdings and liquidity requirements. 3. Demonstrate the requirements for meeting legal reserves. 4. Explain the impact of sweep accounts on legal reserves at banks. 5. Describe procedures and problems in clearing checks and managing float. 6. Describe the rationale for correspondent balances and the associated pricing. 7. Describe the link between bank liquidity, credit risk, interest rate risk, and profitability. 8. Examine the strengths and weaknesses of traditional balance sheet measures of liquidity. 9. Introduce liquidity planning models for the reserve maintenance period and longer periods. Construct liquidity GAP measures which indicate a funding surplus or need. 10. Analyze the liquidity problems of Continental Illinois in 1984 and the regulatory response. Key Concepts 1. Cash assets, such as value cash, demand balances held at Federal Reserve Banks, demand balances held at other financial institutions, and CIPC, produce no interest income. Banks prefer to hold as few cash assets as possible, yet still meet payments and service requirements. 2. Banks hold deposit balances at the fed or correspondent banks, in part, to clear checks. Deposit flows represent a link between a banks cash position and its liquidity position. When deposit balances are reduced, a bank must replenish the funds via asset sales or new debt issues. When deposit balances increase, a bank has additional funds to invest. 3. From 1968 through February 1984, the Federal Reserve employed lagged reserve accounting (LRA). In this system, banks held legal reserves that were determined primarily by their deposit liabilities that were outstanding over a prior two-week period. From March 1984 through June 1998, the Federal Reserve employed a contemporaneous reserve accounting system. Under this system, the amount of required bank reserves was determined largely by the volume of bank deposit liabilities over the same period – and not by lagged, known deposit amounts. Thus, contemporaneous reserve accounting forced banks to monitor both their deposit balances and qualifying reserve assets concurrently and make adjustments under less certainty. In July 1998, the Federal Reserve moved back to LRA. 4. Many banks sweep customer funds from deposit accounts that are subject to a 10% legal reserve requirement into MMDA accounts that are not subject to legal reserves. The sweep has the effect of removing the 10% reserve requirement against certain deposit accounts. Since mid -1995, banks have sharply increased the volume of sweep accounts such that the Federal Reserve has less direct control over bank deposits in the aggregate. 5. It normally takes several days for a check to clear as the item is transferred between financial institutions.
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im08 - Chapter 14 Liquidity Planning and Managing Cash...

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