FINS5530, Week 4 - 03:00:40 AM FinS 5530 Financial...

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Click to edit Master subtitle style 5/26/11 03:00:40 AM FinS 5530 Financial institutionS management Ilya Serov Week 4: Liquidity Management & Sovereign Risk
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5/26/11 03:00:40 AM Agenda Ø Liquidity Risk Ø Basic definitions Ø Case Studies Ø Methods of measuring liquidity risk Ø Regulatory mechanisms Ø Sovereign Risk Ø A little bit of history Ø Credit vs. sovereign risk 22
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5/26/11 03:00:40 AM Liquidity Risk Ø What is liquidity risk? Ø Methods of measuring liquidity risk Ø Regulatory mechanisms 33
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5/26/11 03:00:40 AM What is Liquidity Risk? Ø Liquidity risk is current and prospective risk arising from a bank’s inability to meet its obligations as they come due without incurring unacceptable losses. Ø Aspects of liquidity risk: Ø Inability to manage unplanned decreases or changes in funding sources Ø Failure to address changing market conditions which may affect the ability to liquidate assets quickly and with minimal loss in value 44
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5/26/11 03:00:40 AM The Great Depression 55
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5/26/11 03:00:41 AM Northern Rock (2007) 66
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5/26/11 03:00:41 AM FIs and Liquidity Risk Exposure Ø High exposure Ø Depository institutions Ø Loss of confidence in bank-to-bank lending affects liquidity in other markets Ø Moderate exposure Ø Life insurance companies Ø Low exposure Ø Mutual funds, hedge funds, pension funds, and property-casualty insurance companies. Ø Typically low, does not mean zero 77
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5/26/11 03:00:41 AM Causes of Liquidity Risk Ø Liability-side liquidity risk when depositors or policyholders cash in claims Ø With low cash holdings, FI may be forced to liquidate assets too rapidly Ø Faster sale may require much lower price Ø Asset-side liquidity risk can result from OBS loan commitments Ø Liquidity requirements from take down of funds can be met by running down cash assets, selling liquid assets, or additional borrowing 88
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5/26/11 03:00:41 AM Liability-side Liquidity Risk for DIs Ø Reliance on demand deposits Ø Core deposits Ø Depository institutions need to be able to predict the distribution of net deposit drains Ø Seasonality effects in net withdrawal patterns Ø Managed by: Ø Purchased liquidity management Ø Stored liquidity management 99
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5/26/11 03:00:41 AM Purchased Liquidity Management Ø Federal funds market or repurchase agreement market 10
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5/26/11 03:00:41 AM Purchased Liquidity Management Ø Managing the liability side preserves asset side of balance sheet Ø Borrowed funds likely at higher rates than interest paid on deposits Ø Deposits are insured but borrowed funds not necessarily protected Ø Regulatory concerns: Ø During financial crisis, wholesale funds were difficult and sometimes impossible to obtain 11
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5/26/11 03:00:41 AM Stored Liquidity Management Ø Liquidate assets to meet withdrawals Ø In absence of reserve requirements, banks still tend to hold reserves 12
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5/26/11 03:00:41 AM Stored Liquidity Management Ø Downsides: Ø Opportunity cost of holding excessive cash, or other liquid assets Ø Decreases size of balance sheet Ø Requires holding excess low return or zero return assets Ø Combine purchased and stored liquidity management 13
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