What is Liquidity management?

Liquidity:

Liquidity means the availability of fund in the amount and at the time needed at a reasonable cost.

In other words, the ability of the bank to maintain the necessary cash amount for fulfilling the promise and the ability to satisfy the clients’ withdrawal request whenever they demand.

Liquid Asset:

Liquid assets mean a readily marketable asset with a relatively stable price which is reversible. That is, it must have three characteristics:

i. A liquid asset must have a ready marketability to convert into cash.

ii. It must have stable price.

iii. It must be reversible, so that the seller can recover his or her original investments (principal) with minimum risk or loss.

The following assets are considered as liquid assets for a bank:

i. Cash in hand

ii. Items in the process of collection

iii. Balance lying in the central bank

iv. Balance with the other banks.

Demand and supply of Bank liquidity:

Supply of liquid Assets:

i. Increase of deposits

ii. Income from services

iii. Recovery of loan/ loan installment

iv. Proceeds from the sale of assets, if any

v. Borrowing from money market

vi. Borrowing from central Bank.

Demand for liquid Assets:

i. Withdrawals of deposits

ii. Disbursement of loan/ loan installment

iii. Repayment of borrowings

iv. Repayment of other short-term liabilities.

v. Payment of expenses

vi. Payment of cash dividend to the bank owners.

Liquidity vs Profitability:

Liquidity and profitability are two contradictory concepts. Excess of one may show down the other.

Causes for liquidity crisis:

i. Using short-term funds in long-term investment

ii. Large proportion of liabilities is repaid in shortest possible time.

iii. Over sensitiveness to the rates of profits. That is, collecting deposit by paying excess interest and disbursing in low interest rate.

iv. Lack of close observation of the deposits and investment behavior of the prime customers.

v. Inefficient customer service.

vi. Absence of linkage with the bank rating agencies.

vii. Inaccessibility to the money market

viii. Lack of skill personnel for loan recovery and loan securitization.

Strategies for liquidity managers:

i. Asset liquidity management providing liquidity from assets

ii. Liability liquidity management-Relying on borrowed liquidity to meet cash demand.

iii. Balanced (Asset and liability) liquidity management.