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Managing Liquidity in Banks by Rudolf Duttweiler

This article was inspired by Rudolf Duttweiler's Managing Liquidity in Banks . If you enjoy this article then consider purchasing or borrowing the book.

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How to Control Your Bank’s Liquidity

“Even in smoothly running markets, the liquidity structure of the bank could change significantly, based on policy decisions regarding growth in all its facets.”

The best definition of “liquidity” as it refers to banks is the “capacity to fulfill all payment obligations as and when they fall due – to their full extent and in the currency required.” If your bank doesn’t have enough money to meet problems when they appear, it will suffer “illiquidity.”

A bank should not rely on deposits to support long-term loans, as depositors can withdraw at any time. When banks borrow from the market, their reputation affects lenders’ willingness to provide assistance. The interest rates your bank charges affect the availability of loans. No one wants to help a bank that is in trouble and can’t repay a loan. A bank develops illiquidity if it can’t turn capital into money fast enough to meet demands.

There are four types of risks to liquidity:

  1. “Call liquidity risk” – When requirements, like an unexpected withdrawal, occur without warning and are difficult to meet.
  2. “Term liquidity risk” – Clients can put off loan repayments, affecting available cash.
  3. “Funding liquidity risk” – When a bank pays for long-term benefits, using short-term liabilities, it risks greater expenses at a later date.
  4. “Market liquidity risk” – With greater market changes, a bank may be unable to turn assets into cash or secure loans.

Banks always need to have access to liquidity if they are to survive. In order to do this, you must have contingency plans for various kinds of liquidity situations, and you need expert advice on the rates cash flows in and out of your bank. Ensure that your liquidity policy possesses these eight elements:

  1. “Policy scope and frame” – You must decide what the policy applies to and what should be its boundaries.
  2. “Defining terms” – Use plain terminology. Do not allow ambiguity in your policy.
  3. “Authorities and responsibilities” – Use a chart to demonstrate who is in control of the bank’s different operations. A committee should exist solely for managing the liquidity policy.
  4. “Methods and tools” – Choose what types of currency your bank will track and over what time period.
  5. “Scenarios and concepts employed” – Develop possible scenarios where the bank functions normally or during time of a crisis. Check the viability of these scenarios on a regular basis.
  6. “Limits and limit structures” – Establish boundaries. What restrictions do you want to put on the amounts, type of currency and locations of liquidity?
  7. “Reports and reporting frequency” – Create a communication chain that allows employees at the lowest levels to supply high ups with information.
  8. “Contingency planning” – Look at the seven other aspects of your policy and have a plan for problems when they arise for each one of these elements. Establish what kind of indicators will reveal a problem with an aspect of the policy.

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