LIQUIDITY RISK

Liquidity refers to the firms ability to meet its

current obligations
sources of liquidity for a bank
for a bank are its own assets and liabilities - the
liabilities which provide liquidity to the bank are
share capital, long term deposits (domestic,
non resident and those with central bank), interbank borrowing and short term money market
instruments etc. Similarly, the assets which
provide liquidity to a bank are investments in
government securities, loans and advances.

USES OF LIQUIDITY
to meet routine expenses
to provide for large deposit
withdrawals
to provide for the extreme case of a
Bank Run

 This demands that banks should

remain liquid at all times and ensure
interaction between both these
forces of sources and uses of
liquidity, preferably leading to
coinciding of maturity periods of
liabilities and assets

liquidity Risk.
. If unstable components exist that
may result in inability on the part of
the bank to manage unplanned
decrease or changes in funding
sources. This situation is known as
liquidity Risk.

liquidity Risk.
is no universally accepted definition
of liquidity risk.
DIFFERENT PERSPECTIVES
FROM THE PERSPECTIVE OF
REGULATOR
FROM THE PERSPECTIVE OF
INVESTMENT FIRM
FROM THE PERSPECTIVE OF
BORROWER /DEPOSITOR

FROM THE PERSPECTIVE OF REGULATOR

Liquidity risk is risk to a banks

earnings and capital arising from its
inability to timely meet obligations
when they become due without
incurring unacceptable losses.
[Office of the Comptroller, USA,
2000]2

FROM THE PERSPECTIVE OF INVESTMENT FIRM

Liquidity risk includes both the

risk of being unable to fund (its)
portfolio of assets at appropriate
maturities and rates and the risk of
being unable to liquidate a position
in a timely manner at reasonable
prices. [J P Morgan Chase, 2000]3

FROM THE PERSPECTIVE OF BORROWER

/DEPOSITOR

Liquidity risk for a bank is the risk

that it will not have the funds
available, when called upon to meet
a demand for repayment made by a
depositor, or to satisfy a demand for
funding a borrower whom a
commitment has been given by the
bank to lend. [Tripe and Tozer,
1998]4

LIQUIDITY RISK: THE SOURCES

Lack of financial infrastructure,
unexpected changes in cost of
funding (capital), unexpected and
abnormal changes in financial
markets, wrong judgements about
behaviour, changes in interest rates,
economy wide imbalances , downgrading of the bank by rating
agency, etc.

LIQUIDITY RISK MEASUREMENT: THE

APPROACHES

NET LIQUIDITY STATEMENT

RATIO ANALYSIS
PEER GROUP COMPARISON
LIQUIDITY INDEX
FINANCING GAP AND THE FINANCING
REQUIREMENT
MATURITY LADDER/SCENARIO
ANALYSIS

NET LIQUIDITY
STATEMENT
positive net liquidity position
[sources > uses] or a
negative net liquidity position
[ sources < uses ]

RATIO ANALYSIS
SEVERAL RATIOS TO BE EXAMINED AS PER
SINKEY ARE:
Large Liability Dependence
Core Deposits to Assets
Loans and Leases to Assets
Loans and Leases to Core Deposits
Temporary Investments to Assets
Brokered Deposits to total Deposits
Investment Securities : Market to Book Value
Pledged Securities to total securities6

Ajay Kumar (2007)

Core deposits to total Assets

Net loans to total Deposits ratio
Time deposits to total Deposits
Volatile liabilities to liquid Assets
Liquid Assets to total Assets
Short term liabilities to total assets
Prime assets, to total assets
Market Liabilities to Total Assets7

LIQUIDITY INDEX
This index measures the potential
losses a bank could suffer from a
sudden or fire-sale disposal of assets
compared to the amount it would
receive at a fair market value
established under normal market
conditions

 I=
Where wi = Percentage of each assets in the
FIs portfolio
Pi = price it gets if FI liquidates assets i today
Pi* = Price it gets if FI liquidates assets i at
the end of the month.
The liquidity index is always between 0 and
1. smaller the liquidity index, higher is the
liquidity risk to bank.10

FINANCING GAP
Financing Gap = Average Loans
Average Deposits

RESERVE BANK OF INDIA (RBI)

APPROACH
For measuring and managing net
funding requirements, the use of a
maturity ladder and calculation of
cumulative surplus or deficit is
adopted as a standard tool by RBI.
RBI guidelines require banks to
prepare two statements for liquidity
i.e. (a) statements of structural
liquidity (b) statements of Dynamic
liquidity.

STRATEGY

 As revealed by the study, though

liquidity in banks is not a serious
issue till date but due to changing
micro and macro economic
environment banks must identify
alternatives to meet any impending
liquidity crisis

 . Some of the options that can be

explored by banks are RBI, Call
money, CBLO (Collaterised
Borrowing and Lending Mechanism,
Lines of credit, Mutual funds,
Certificate of Deposits, securitsation
etc. of banks

BASEL III
Liquidity coverage ratio
Net stable funding ratio
RBI had issued guidelines on the
implementation of Basel III capital
regulation in India in May 2012.
These guidelines have been
implemented from January 1, 2013 in
a phased manner and are to be fully
implemented by March 2018.