SC5-Chapters 17 & 18- Managing Liquidity Risk & Liability and Liquidity Mgt1

SC5-Chapters 17 & 18- Managing Liquidity Risk & Liability and Liquidity Mgt1

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1 Managing Liquidity
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2 What is Bank Liquidity Bank liquidity refers to the ability of a bank to quickly obtain cash at a reasonable cost
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3 Banks with adequate liquidity are able to pay creditors meet unexpected deposit run-off (i.e. withdrawals) accommodate unexpected changes in loan demand fund normal growth in loan and securities portfolios without having to make costly balance sheet adjustments Banks without adequate liquidity will be unable to meet these needs without costly adjustments and in extreme cases may become insolvent Importance of Liquidity
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4 Two Main Sources of Liquidity Risk- Liabilities Unexpected withdrawal of deposits (i.e. net deposit drain) Usually associated with Rising interest rates (opportunity cost) Perception of solvency problems Banks need to be aware of the withdrawal risk- funding cost trade-off associated with many of their liabilities as they consider funding their assets. There is often a negative or inverse relationship
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5 Two Main Sources of Liquidity Risk- Assets Unexpected Loan Demand Particularly associated with Timing and amount of draw down on off-balance sheet Letters of credit Lines of credit Revolving credit arrangements Prepayment uncertainty New loan growth
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6 Providing for a bank’s liquidity needs can be challenging funding demands can change unexpectedly other asset and liability management decisions will often affect a bank’s liquidity position and vice versa A bank’s liquidity position that is adequate under one set of conditions could quickly become inadequate when conditions change Importance of Liquidity
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7 Liquidity Management Involves the trade-off between profitability and the risk of illiquidity The key is to find the right balance between illiquidity and profitability The right balance is a moving target
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SC5-Chapters 17 & 18- Managing Liquidity Risk & Liability and Liquidity Mgt1

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