Bank Mgt. 5th Ed, Chapter 7 Revised

Bank Mgt. 5th Ed, Chapter 7 Revised - Chapter 7 Managing...

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Unformatted text preview: Chapter 7 Managing Liquidity The Acquisition & Retention of The Bank Funds Bank James B. Bexley, Chair James Smith-Hutson Endowed Chair of Banking Sam Houston State University Huntsville, Texas How Important Is Liquidity? How s During the banking crisis of the 80s & 90s: – Lack of liquidity was the greatest cause of bank Lack failure. failure. s Unanticipated deposit outflows can cause Unanticipated serious problems for a bank. serious s The importance of cash and liquid assets is The reflected by having liabilities that can be readily sold to obtain cash for liquidity. * readily Sources of Liquidity Needs Sources s Maturing deposits – Example:(Exhibit 1) $100,000 maturing CD: » Direct Fed to wire transfer funds to another bank. » Net impact is bank has less cash, which worsens bank’s Net reserve position because it was part of legal reserves. reserve s New loans New – Example: (Exhibit 2a) $250,000 Credit Drawdown: » Existing customer borrows against open credit line for wire Existing transfer to purchase goods. Deposit at Fed decreases. transfer – Example: (Exhibit 2b) $500,000 New Loan: » When new loan is made it is credited to an account in bank, When but when check is written for $500,000 purchase, a potential reserve deficiency is created. reserve Factors Affecting Liquidity Needs Factors s Potential deposit losses: – – – – – Magnitude of uninsured deposits Deposit ownership by type of depositor Large deposits held by any single customer Seasonal or cyclical patterns in deposit flows The sensitivity of deposits to interest rate The changes changes – Funding loan commitments & other off-balance Funding sheet commitments. * sheet Factors Affecting Liquidity Needs (Continued) Needs s New loan demand: – – – – – Unused commercial credit lines outstanding Unused consumer credit card lines Business activity & growth within trade area Aggressiveness of bank’s call program Funding borrowing against unused loan Funding commitments * commitments Sources vs. Uses of Funds Sources s Sources of Funds – – – – Decrease in an asset Increase in a liability Increase in equity Depreciation & Depreciation amortization amortization s Uses of Funds Uses – – – – Increase in asset Decrease in liability Decrease in equity Cash dividends/stock Cash buyback buyback Liquid Assets Liquid s Liquid assets are highly marketable because Liquid they are attractive to investors. they s Treasury securities are most liquid because Treasury there is no default risk. there s Short-term securities are less volatile in Short-term price than long-term securities, and therefore, are marketable. * therefore, Features of Highly Liquid Assets Features s s s s s s s Cash & due balances in excess of required Cash holdings. holdings. Fed funds sold and repurchase agreements Fed (securities purchased under agreement to resell) (securities Short-term, interest bearing deposits $100,000 or Short-term, more held at other institutions more Treasury securities maturing less than year Federal agency securities maturing less than year Commercial paper or other high quality short-term Commercial securities securities Government-guaranteed portion of loans * Factors Preventing Security Sales Factors s Security pledged as collateral against a Security bank liability bank – – Public deposits Federal Reserve borrowings s Security held to maturity * Liquidity Plan Liquidity s s s s s All banks must have a liquidity plan--regulators All will be critical of bank that has no plan will Establish lines with banks for contingency needs Capital base, quality of assets, & bank’s reputation Capital will impact ability of bank to obtain liquidity will Match funding opportunities using Federal Home Match Loan Bank Loan Federal Home Loan Bank is excellent source of Federal liquidity liquidity Liquidity vs. Profitability Liquidity s s s s s Short-run trade-off between liquidity and Short-run profitability--more liquidity=less profitability profitability--more Liquid asset holdings sacrifice income because of Liquid risk/reward relationship on both loans and securities risk/reward Banks with substantial core deposits & few Banks purchased liabilities pay lower rates which generates higher profits generates ROE suffers with high equity impacting ROE profitability profitability Highly liquid bank is in best position to make Highly critical changes that has long-term benefits to profitability in spite of short-term costs * profitability Non-deposit Short-term Funds Non-deposit s Borrowing from Federal Reserve. s Federal funds purchased. s Securities sold under agreement (repos). s Eurodollar & other foreign sources. s Bankers’ acceptances. s Other liability forms. Measuring & Using The Cost of Funds Funds s A bank will generally seek the lowest cost of bank funds in its market. funds s A reasonably accurate cost of funds measure reasonably is necessary to determine the returns a bank must obtain on earning assets. s The types of sources of funds a bank obtains The & the employment of these sources have a major impact on the bank’s risks. major Measuring & Using The Cost of Funds Funds s Historic average cost of funds. s Marginal cost of funds. s Pooled marginal cost of funds. s Weighted average projected cost. Risks Associated With Raising Funds Funds s Liquidity risk. s Interest rate risk associated with funding. s Interactions with credit risk. s Interactions with capital risk. Relationship Between Liquidity Risk, Credit Risk, & Interest Rate Risk Credit s s s s s s Management assumes excessive risk in either the Management loan portfolio or by mismatching asset & liability maturities; maturities; The bank reports a decline in earnings; Media publicizes bank’s problems; Depositors get nervous & bank begins to pay Depositors higher rates to keep customers from moving & attract new deposits; attract Earnings decline further with non-accruing loans & Earnings reduced net interest margins, and reduced Uninsured depositors move their funds Liquidity Planning Exhibit 4-Liquidity Daily Reserves at Fed s Factors Increasing Factors Reserves: Reserves: – Nondiscretionary » » » » » » » » » » Yesterday cash letter Deferred availability items Excess local clearings Treasury deposits Currency/coin to Fed Security sales Fed borrowings Fed funds purchased Repurchase securities sold Interest payments on Interest securities securities s Factors Decreasing Factors Reserves: Reserves: – Nondiscretionary » Remittance charged » Clearinghouse deficit » TTL account calls – Discretionary » Currency/coin from Fed » Security purchases » Payment on loans from Payment Fed Fed » Fed funds sold » Repurchase securities Repurchase purchased purchased Source: Bank Management by Koch & MacDonald – Discretionary Liquidity Planning Exhibit 5-Liquidity Planning Over Monthly Intervals s s s s s s Liquidity planning over periods involves forecasting Liquidity loans and deposits net of reserves. loans It is sum of maturing time deposits and new loans, It less changes in transaction accounts net of reserves equals potential use of funds. equals Maturing investment securities & principal payments Maturing on loans equals potential sources of funds. on Liquidity gap=potential uses of funds-potential Liquidity sources of funds. sources Positive gap is funding deficiency. Negative gap suggests excess of investable funds. Loan to Deposit Ratios Loan s Loan/deposit ratios increased sharply in 1990s s Loan/deposit ratios declined some thru 2003 s Loan/deposit rations increased slightly to date s Banks under $100 million 82.8% s Banks over $100 million 95% s How does loan/deposit ratio impact liquidity? Changes in Loans vs. Deposits Changes s Let’s hear from several of you about your Let’s bank’s experience with recent loan growth vs. deposit growth. vs. s How did it impact profitability & risk going How forward? ** forward? ...
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This note was uploaded on 09/30/2010 for the course FIN 468 taught by Professor Bexley during the Fall '10 term at Sam Houston State University.

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