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PURPOSE
This document sets out the minimum policies and procedures that
each institution needs to have in place and apply within its liquidity
management programme, and the minimum criteria it should use to
prudently manage and control its liquidity.
Although this document focuses on the institutions responsibility for
managing liquidity, and is intended to address liquidity management
within the context of a strategic liquidity plan under ordinary or
reasonably expected business conditions, liquidity management
cannot be conducted in isolation from other asset/liability
management considerations, such as interest and foreign exchange
rate risk, or other risks. However, since liquidity determines the dayto-day viability of an institution, it must remain the principal
consideration of asset/liability management.
Moreover, this document presents the management of liquidity
undifferentiated as to currency denomination, since in principle,
through the foreign exchange markets, commitments in one currency
may be met by the availability of funds in another. However,
institutions that conduct substantial business in foreign currencies
need to make distinctions between the management of liquidity in
domestic currency (Jamaican dollars) and that in other currencies.
DEFINITION
Liquidity is the availability of funds, or assurance that funds will be
available, to honour all cash outflow commitments (both on- and offbalance sheet) as they fall due. These commitments are generally met
through cash inflows, supplemented by assets readily convertible to
cash or through the institutions capacity to borrow. The risk of
illiquidity may increase if principal and interest cash flows related to
assets, liabilities and off-balance sheet items are mismatched.
Funding Policies
Deposit liabilities are the primary source of funding for all
institutions. In this context, an important element of an institutions
liquidity management programme is the diversification of funding by
origination and term structure. Each institution needs to have explicit
and prudent policies that ensure funding is not unduly concentrated
with respect to:
individual depositor;
1
2 ROLE OF THE BOARD OF DIRECTORS
The Board of Directors of each institution is ultimately responsible for
the institutions liquidity. In discharging this responsibility, a Board of
Directors usually charges management with developing liquidity and
funding policies for the boards approval, and developing and
implementing procedures to measure, manage and control liquidity
within these policies.
A Board of Directors needs to have a means of ensuring compliance
with the liquidity management programme. A Board of Directors
generally ensures compliance through periodic reporting by
management and internal inspectors/auditors. The reports must
provide sufficient information to satisfy the Board of Directors that
the institution is complying with its liquidity management
programme.
At a minimum, a Board of Directors should:
review and approve liquidity and funding policies based on
recommendations by the institutions management;
review periodically, but at least once a year, the liquidity
management programme;
ensure that an internal inspection/audit function reviews the
liquidity and funding operations to ensure that the institutions
policies and procedures are appropriate and are being adhered
to;
ensure the selection and appointment of qualified and
competent management to administer the liquidity management
function; and
outline the content and frequency of management liquidity
reports to the board.
ROLE OF MANAGEMENT
The management of each institution is responsible for managing and
controlling the day-to-day liquidity of the institution according to the
liquidity management programme.
Although specific liquidity management responsibilities will vary
from one institution to another, management should be responsible
for:
developing and recommending liquidity and funding policies
for approval by the Board of Directors;
implementing the liquidity and funding policies;
ensuring that liquidity is managed and controlled within the
liquidity management and funding management programmes;
ensuring the development and implementation of appropriate
reporting systems
establishing and utilizing a method for accurately measuring the
institutions current and projected future liquidity;
monitoring economic and other operating conditions to forecast
potential liquidity needs;
ensuring that an internal inspection/audit function reviews and
assesses the liquidity management programme
developing lines of communication to ensure the timely,
dissemination of the liquidity; and
reporting comprehensively on the liquidity management
programme to the Board of Director is at least once a year.
BANK LIQUIDITY
Liquidity for a bank means the ability to meet its financial obligations
as they come due. Bank lending finances investments in relatively
illiquid assets, but it fund its loans with mostly short term liabilities.
Thus one of the main challenges to a bank is ensuring its own
liquidity under all reasonable conditions.
Asset Management Banking
Commercial banks differ widely in how they manage liquidity. A
small bank derives its funds primarily from customer deposits,
normally a fairly stable source in the aggregate. Its assets are mostly
loans to small firms and households, and it usually has more deposits
than it can find creditworthy borrowers for. Excess funds are typically
invested in assets that will provide it with liquidity such as Fed funds
loaned and U.S. government securities. The holding of assets that can
readily be turned into cash when needed, is known as asset
management banking.
Liability Management Banking
In contrast, large banks generally lack sufficient deposits to fund their
main business -- dealing with large companies, governments, other
financial institutions, and wealthy individuals. Most borrow the funds
they need from other major lenders in the form of short term liabilities
which must be continually rolled over. This is known as liability
management, a much riskier method than asset management. A small
bank will lose potential income if gets its asset management wrong. A
large bank that gets its liability management wrong may fail.
1. BACKGROUND
The overhaul of the countrys Payments System by the Reserve Bank
of India is bringing about structural and operational changes which
will have a profound effect on the way banks do business and in
particular would effect the treasury departments of the banks and on
the way they manage intra-day liquidity. These changes will create a
need for measurement of payment flows, use of queuing techniques to
regulate payment flows, better communications, and a generally
higher awareness by treasury managers of payments processing.
2. COMPLEXITY AND IMPACT
The problem of liquidity management is also made more complex
because the treasury/funds management departments in banks would
be connecting to different payment infrastructures (RTGS, NDS-SSS,
FX etc) and this will necessitate the management of multiple intra-day
liquidity positions. Banks would be required to put in processes,
procedures and Information Technology systems to establish liquidity
and operational bridges between these various infrastructure and
systems.
3. LIQUIDITY ISSUES
The causes of liquidity fragmentation can be broadly classified into
the following categories: operational, technical, policy and bank
procedure. It should be noted that the first three classifications refer to
the operations of the payments system while the last refers to the
actual use of the system by participating banks. However, even in this
scenario of liquidity pools if banks stick to the rules of the game
and implement best practices there should be very few payment
problems such as gridlocks, end of day positions and liquidity swaps.
The Liquidity Management Process -
Basic steps for liquidity managementHow companies are implementing steps to improve their liquidity
management using these three steps:
1. Improve visibility with centralized payment workflow & approval
2. Reduce costs with electronic execution of payments
3. Reduce fraud and erroneous payments
The economic downturn is affecting how financial institutions manage
liquidity in a number of ways. It has particularly affected the liquidity
of financial instrument portfolios, which now need to be thoroughly
reappraised.
This indicates the present scenario of liquidity management Liquidity management procedures are inadequate, and
restrictions are obsolete and prevent business from going
forward
The existing level of control over liquidity and cash flows is no
longer sufficient
Additional volume of liquid reserves needs to be attracted to
close the liquidity gap
Liquidity contingency plans are not realistic in the current
market conditions
NECESSARY
PROCESSES
FEATURES
OF
LIQUIDITY
CONTROL
60.0
40.0
20.0
0.0
Date
-5000
Rs. Crore
-10000
-15000
Months
scheme was operationalised effective March 29, 2004 under which the
reverse repo rate was reduced to 6.0 per cent and aligned with bank
rate. Normal facility and backstop facility was merged into a single
facility and made available at a single rate. The third stage of fullfledged LAF had begun with the full computerisation of Public Debt
Office (PDO) and introduction of RTGS marked a big step forward in
this phase. Repo operations today are mainly through electronic
transfers. Fixed rate auctions have been reintroduced since April 2004.
The possibility of operating LAF at different times of the same day is
now close to getting materialised. In that sense we have very nearly
completed the transition to operating a full-fledged LAF.
With the introduction of Second LAF (SLAF) from November
28, 2005 market participants now have a second window to fine-tune
the management of liquidity. In past, LAF operations were conducted
in the forenoon between 9.30 a.m. and 10.30 a.m. SLAF is conducted
by receiving bids between 3.00 p.m. and 3.45 p.m. The salient features
of SLAF are the same as those of LAF and the settlement for both is
conducted separately and on gross basis.
The introduction of LAF has been a process and the Indian
experience shows that phased rather than a big bang approach is
required for reforms in the financial sector and in monetary
management.
15
10
5
0
20.00
15.00
Call Money
Per cent
Reverse Repo
Repo
10.00
5.00
0.00
initially even while capital flows had distinctly increased since 199394. However, in face of large surplus liquidity since 2000, MSS was
evolved as a very useful instrument of monetary policy to sustain
open market operations. MSS has marginal costs, but it has helped the
monetary authorities manage business and liquidity cycles through the
surpluses and the deficits. With MSS, the monetary authorities now
have the option of assigning LAF for day-to-day liquidity
management, using MSS for addressing semi-durable liquidity
mismatches, while using outright sales/purchases of dated securities
for truly long-term liquidity surpluses or deficits. The MSS experience
tells us that operating framework and procedures undergo changes and
one need to keep innovating to calibrate market operations to the
evolving liquidity conditions.
Fourth, by focusing on the microstructure of the markets and by
facilitating development of a wider range of instruments such as
Collateralised Borrowing and Lending Obligation (CBLO) 4, market
repo, interest rate swaps, Certificates of Deposit (CDs) and
Commercial Papers (CPs), in a manner that avoided market
segmentation while meeting demand for various products, liquidity
management could be placed on a much firmer footing. Market and
central bank practices evolved to institutional developments.
However, the payment and settlement system proved to be the most
difficult area, but one which delivered the enabling environment for
micro and macro developments supportive of the liquidity
management procedures now in place. The focus on micro-aspects
reinforced the central bank's ability to signal and transmit policy
changes.
Fifth, with efforts to build up indirect instruments for liquidity
management, the transmission of monetary policy has improved. The
link between overnight interest rates and yields on T-bills and liquid
dated securities has become far stronger. While the lending rates and
even more so deposit rates have been taking considerable time to
adjust, the strength of the transmission has been in evidence in recent
periods. It is important to note that in a situation of large surplus
4
CONCLUSION
Liquidity risks are endemic to banking given the maturity
transformation they undertake. First line of defence should be
appropriate liquidity policy on asset and liability side, supported by
adequate capital and firm supervision. Despite these, solvent banks
can face liquidity difficulties at times of stress necessitating liquidity
support.
REFERENCES
Theory
and
WEBLIOGRAPHY
www.google.com
www.kognostech.com
www.bankofJamaica.com
www.icraratings.com
www.aleri.com
www.keedsee.com
www.hsbcbank.com
www.banknetindia.com