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Measuring and managing liquidity needs are vital for effective operation of commercial banks. By assuring a bank s ability to meet its liabilities as they become due, liquidity management can reduce the probability of an adverse situation developing.
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scenarios. Net funding requirements are determined by analyzing the banks future cash flows based on assumptions of the future behavior of assets and liabilities that are classified into specified time buckets and then calculating the cumulative net flows over the time frame for liquidity assessment. Future cash flows are to be analysed under what if scenarios so as to assess any significant positive / negative liquidity swings that could occur on a day-to-day basis and under bank specific and general market crisis scenarios. Factors to be taken into consideration while determining liquidity of the banks future stock of assets and liabilities include their potential marketability, the extent to which maturing assets /liability will be renewed, the acquisition of new assets / liability and the normal growth in asset / liability accounts. Factors affecting the liquidity of assets and liabilities of the bank cannot always be forecast with precision. Hence they need to be reviewed frequently to determine their continuing validity, especially given the rapidity of change in financial markets.
The liquidity risk in banks manifest in different dimensions: (a) Funding Risk need to replace net outflows due to unanticipated withdrawal/non-renewal of deposits (wholesale and retail); assets; and Ads by Google (c) Call Risk due to crystallisation of contingent liabilities and unable to undertake profitable business opportunities when desirable. (b) Time Risk need to compensate for non-receipt of expected inflows of funds, i.e. performing assets turning into non-performing
How is it measured :
Liquidity measurement is quite a difficult task and can be measured through stock or cash flow approaches. The key ratios, adopted across the banking system are Loans to Total Assets, Loans to Core Deposits, Large Liabilities (minus) Temporary Investments to Earning Assets (minus) Temporary Investments, Purchased Funds to Total Assets, Loan Losses/Net Loans, However, the ratios do not reveal the intrinsic liquidity profile of Indian banks which are operating generally in an illiquid market. Experiences show that assets commonly considered as liquid like Government securities, other money market instruments, etc. have limited liquidity as the market and players are unidirectional. Thus, analysis of liquidity involves tracking of cash flow mismatches. For measuring and managing net funding
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Thus, analysis of liquidity involves tracking of cash flow mismatches. For measuring and managing net funding requirements, the use of maturity ladder and calculation of cumulative surplus or deficit of funds at selected maturity dates is recommended as a standard tool.
The following prudential limits are considered by Banks to put in place to avoid liquidity crisis:(i) Cap on inter-bank borrowings, especially call borrowings; ii) Purchased funds vis- -vis liquid assets; iii) Core deposits vis- -vis Core Duration of liabilities and investment portfolio; v) M aximum Assets i.e. Cash Reserve Ratio, Statutory Liquidity Ratio and Loans; iv)
Cumulative Outflows across all time bands; vi) Commitment Ratio track the total commitments given to corporates / banks and other financial institutions to limit the off-balance sheet exposure; vii) Swapped Funds Ratio, i.e. extent of Indian Rupees raised out of foreign currency sources.
Principle 6: A bank should analyse liquidity utilising a variety of what if scenarios. Principle 7: A bank should review frequently the assumptions utilised in managing liquidity to determine that they continue to be valid. Managing Market Access Principle 8: Each bank should periodically review its efforts to establish and maintain relationships with liability holders, to maintain the diversification of liabilities, and aim to ensure its capacity to sell assets. Contingency Planning Principle 9: A bank should have contingency plans in place that address the strategy for handling liquidity crises and include procedures for making up cash flow shortfalls in emergency situations.
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Foreign Currency Liquidity Management Principle 10: Each bank should have a measurement, monitoring and control system for its liquidity positions in the major currencies in which it is active. In addition to assessing its aggregate foreign currency liquidity needs and the acceptable mismatch in combination with its domestic currency commitments, a bank should also undertake separate analysis of its strategy for each currency individually. Principle 11: Subject to the analysis undertaken according to Principle 10, a bank should, where appropriate, set and regularly review limits on the size of its cash flow mismatches over particular time horizons for foreign currencies in aggregate and for each significant individual currency in which
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