Chapter 11 - Liquidity and Reserves Management: Strategies and Policies - Quản lý tài chính | Trường Đại học Hà Nội

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Chapter 11 - Liquidity and Reserves Management: Strategies and Policies CHAPTER 11
LIQUIDITYAND RESERVES MANAGEMENT: STRATEGIES AND POLICIES
Goal of This Chapter: The purpose of this chapter is to explore the reasons why financial
institutions often face heavy demands for immediately spendable funds (liquidity) and learn
about the methods they can use to prepare for meeting their cash needs. Key Topics in This Chapter
Sources of Demand for and Supply of Liquidity
Why Financial Firms Have Liquidity Problems
Liquidity Management Strategies Estimating Liquidity Needs
The Impact of Market Discipline
Legal Reserves and Money Management Chapter Outline
I. Introduction: Meaning of Liquidity
II. The Demand for and Supply of Liquidity
A. Sources of Liquidity Demands
B. Sources of Liquidity Supplies
C. Net Liquidity Position and Liquidity Surpluses and Deficits
III. Why Financial Firms Often Face Significant Liquidity Problems A. Maturity Mismatches
B. Sensitivity to Changes in Market Interest Rates
C. Meeting Demand for Liquidity and Public Confidence
IV. Strategies for Liquidity Managers
A. Asset Liquidity Management (or Asset Conversion) Strategies
B. Borrowed Liquidity (Liability) Management Strategies
C. Balanced Liquidity Management Strategies
D. Guidelines for Liquidity Managers V. Estimating Liquidity Needs
A. The Sources and Uses of Funds Approach
B. The Structure of Funds Approach
C. Liquidity Indicator Approach
D. The Ultimate Standard for Assessing Liquidity Needs: Signals from the Marketplace 1. Public confidence 2. Stock price behavior
3. Risk premiums on CDs and other borrowings 4. Loss sales of assets
5. Meeting commitments to credit customers
6. Borrowings from the central bank 11-1 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies
VI. Legal Reserves and Money Position Management A. The Money Position Manager B. Legal Reserves
C. Regulations on Calculating Legal Reserve Requirements 1. Reserve Computation 2. Reserve Maintenance 3. Reserve Requirements
4. Calculating Required Reserves
5. Penalty for a Reserve Deficit 6. Clearing Balances
D. Factors Influencing the Money Position 1. Controllable Factors 2. Noncontrollable Factors 3. An Example
4. Use of the Federal Funds Market
5. Other Options besides Fed Funds
6. Bank Size and Borrowing and Lending Reserves for the Money Position 7. Overdraft Penalties
VII. Factors in Choosing among the Different Sources of Reserves A. Immediacy of need B. Duration of need
C. Access to the market for liquid funds
D. Relative costs and risks of alternative sources of funds E. The interest rate outlook
F. Outlook for central bank monetary policy
G. Rules and regulations applicable to a liquidity source
VIII. Central Bank Reserve Requirements around the Globe IX. Summary of the Chapter Concept Checks
11-1. What are the principal sources of liquidity demand for a financial firm?
The most pressing demands for liquidity arise principally from customers withdrawing money
from their deposits and from credit requests. However, demands for liquidity can also come
from paying off previous borrowings, operating expenses and taxes incurred during operations
and from payment of a cash dividend to stockholders.
11-2. What are the principal sources from which the supply of liquidity comes?
Supplies of funds stem principally from incoming deposits, sales of assets, particularly
marketable securities and repayments of outstanding loans. Liquidity also comes from the sale of
nondeposit services and borrowings from the money market. 11-2 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies
11-3. Suppose that a bank faces the following cash inflows and outflows during the coming
week: (a) deposit withdrawals are expected to total $33 million, (b) customer loan repayments
are expected to amount to $108 million, (c) operating expenses demanding cash payment will
probably approach $51 million, (d) acceptable new loan requests should reach $294 million, (e)
sales of bank assets Concept Check are projected to be $18 million, (f) new deposits should
total $670 million, (g) borrowings from the money market are expected to be about $43 million,
(h) nondeposit service fees should amount to $27 million, (i) previous bank borrowings totaling
$23 million are scheduled to be repaid, and (j) a dividend payment to bank stockholders of $140
million is scheduled. What is this bank’s projected net liquidity position for the coming week? (In millions of dollars) Cash Inflows Cash Outflows Customer Loan Repayments $108 Deposit Withdrawals $33 Sales of Bank Assets 18 Operating Expenses 51 New Deposits 670 New Loan Requests 294 Money-Market Borrowings 43
Repayment of Previous Borrowings 23 Nondeposit Service Fees 27 Dividend to Stockholders 140 Total Cash Inflows $866 Total Cash Outflows $541 Net Liquidity Position Total Cash Total Cash Projected for = Inflows - Outflows the Coming Week = $866 million - $541 million = + $325 million
11-4. When is a financial institution adequately liquid?
A financial institution is adequately liquid if it has adequate cash available precisely when cash
is needed at a reasonable cost. Management can monitor the cash position over time, and also
monitor what is happening to its cost of funds. One indicator of the adequacy of the liquidity
position is its cost - a rising interest cost may reflect greater perceived risk for the borrowing
bank as viewed by capital-market investors.
11-5. Why do financial firms face significant liquidity management problems?
Financial institutions are prone to liquidity management problems due to: 11-3 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies
(1) A maturity mismatch situation in which most depository institutions hold an unusually
high proportion of liabilities subject to immediate payment, especially demand (checkable)
deposits and money market borrowings;
(2) The sensitivity of changes to their assets and liabilities values towards market interest-rate movements; and
(3) Their central role in the payments process.
11-6. What are the principal differences among asset liquidity management, liability
management, and balanced liquidity management?
Asset management is a strategy for meeting liquidity needs, used mainly by smaller banks, in
which liquid funds are stored in readily marketable assets that can be quickly converted into
cash as needed. Liability management involves borrowing enough immediately spendable funds
to cover demands for liquidity made against a bank. Balanced liquidity management calls for
using both asset management and liability management to cover a bank's liquidity needs.
11-7. What guidelines should management keep in mind when it manages a financial firm’s liquidity position?
It is important for a liquidity manager to: (a) keep track of the activities of other departments
within the bank; (b) know in advance the planned activities of the bank's largest credit and
deposit customers; (c) set clear priorities and objectives in liquidity management; and (d)
react quickly to liquidity deficits and liquidity surpluses.
Liquidity managers must know what other departments within the institution are doing because
their activities affect the liquidity position and liquidity management decisions. The liquidity
manager can make better decisions to profitably invest surplus liquid funds or avoid costly, last-
minute borrowings if he or she knows what the bank's principal depositors and creditors will do
in advance. By setting clear priorities and objectives the liquidity manager has a better chance to
make sound decisions plus an ability to act quickly to invest surpluses in order to gain
maximum income or avoid costly deficits and prolonged borrowings.
11-8. How does the sources and uses of funds approach help a manager estimate a financial
institution’s need for liquidity?
The sources and uses of funds approach estimates future deposit inflows and estimated outflows
of funds associated with expected loan demand and calculates the net difference between these items in each planning period. 11-4 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies
When sources and uses of liquidity do not match, there is a liquidity gap, measured by the size
of the difference between sources and uses of funds. When sources of liquidity (e.g., increasing
deposits or decreasing loans) exceed uses of liquidity (e.g., decreasing deposits or increasing
loans) then the financial firm will have a positive liquidity gap (surplus). Its surplus liquid funds
must be quickly invested in earning assets until they are needed to cover future cash needs. On
the other hand, when uses exceed sources, a financial institution faces a negative liquidity gap
(deficit). It now must raise funds from the cheapest and most timely sources available.
11-9. Suppose that a bank estimates its total deposits for the next six months in millions of
dollars to be, respectively, $112, $132, $121, $147, $151 and $139, while its loans (also in
millions of dollars) will total an estimated $87, $95, $102, $113, $101 and $124, respectively,
over the same six months. Under the sources and uses of funds approach, when does this bank
face liquidity deficits, if any? Estimated Total Deposits Estimated Total Loans $112 $87 132 95 121 102 147 113 151 101 139 124 Estimated Liquidity Change in Deposits Change in Loans Deficit or Surplus $ --- $ --- $ --- +20 +8 +12 -11 +7 -18 +26 +11 +15 +4 -12 +16 -12 +23 -35
Clearly, the bank has projected liquidity surpluses (which should be profitably invested) in
three out of six months, but a deficit is estimated for the third and last month which will have to
be covered through borrowings and possibly through the sale of liquid assets. 11-5 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies
11-10. What steps are needed to carry out the structure of funds approach to liquidity management?
In the first step, the institution's deposits and other funds sources are divided into categories
based upon their estimated probability of being withdrawn and, therefore, lost to the financial
firm. Second, the liquidity manager must set aside liquid funds according to some desired
operating rules for those categories. Categories can include "hot money" liabilities, vulnerable funds, and stable funds.
11-11. Suppose that a thrift institution’s liquidity division estimates that it holds $19 million in
hot money deposits and other IOUs against which it will hold an 80 percent liquidity reserve,
$54 million in vulnerable funds against which it plans to hold a 25 percent reserve, and $112
million in stable or core funds against which it will hold a 5 percent liquidity reserve. The thrift
expects its loans to grow 8 percent annually; its loans currently stand at $117 million, but have
recently reached $132 million. If reserve requirements on liabilities currently stand at 3
percent, what is this depository institution’s total liquidity requirement?
Total Liquidity Requirement = 0.80 ($19 million - 0.03 x $19 million)
+ 0.25 ($54 million - 0.03 x $54 million)
+ 0.05 ($112 million - 0.03 x $112 million)
+ ($132 million +O.08 x $132 million - $117 million) = $58.831 million
11-12. What is the liquidity indicator approach to liquidity management?
The liquidity indicator approach uses tell-tale financial ratios (e.g., total loans/total assets or cash
assets/total assets) whose changes over time may reflect the changing liquidity position of the
financial institution. The ratios are used to estimate liquidity needs and to monitor changes in the liquidity position.
11-13. First National Bank posts the following balance sheet entries on today’s date: Net
loans and leases, $3,502 million; cash and deposits held at other banks, $633 million; Federal
funds sold $48 million; U.S. government securities, $185 million; Federal funds purchased,
$62 million; demand deposits, $988 million; time deposits, $2,627 million; and total assets,
$4,446 million. How many liquidity indicators can be calculated from these figures? 11-6 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies (In millions of dollars) Assets Liabilities Cash Deposits held at Federal Fund Purchased $ 62 other Banks $ 633 U.S. Government securities $ 185 Demand Deposits $ 988 Net Loans and Losses $ 3,502 Time Deposits $ 2,627 Federal Funds Sold $ 48 Total Assets $ 4,446
The liquidity indicators that we can construct from the foregoing figures include: Cash Position Indicator:
Cash and Deposits Due from Other Banks = $633 = 14.24 percent Total Assets $4446 Net Federal Funds Position:
(Federal Funds Sold – Federal Funds Purchased) = ($48 - $62) = - 0.31 percent Total Assets $4446 Capacity Ratio: Net Loans and Leases = $3,502 = 77.77 percent Total Assets $4446 Deposit Composition Ratio: Demand Deposits = $988 = 37.61 percent Time Deposits $2,627 Liquid Securities Indicator: U.S. Government Securities = $185 = 4.16 percent Total Assets $4446
11-14. How can the discipline of the marketplace be used as a guide for making liquidity management decisions? 11-7 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies
No financial institution can tell for sure if it has sufficient liquidity until it has passed the
market's test. Specifically, management should look at these signals: public confidence, stock
price behavior, risk premiums on CDs and other borrowings, loss sales of assets, meeting
commitments to credit customers and borrowings from the Federal Reserve banks. If problems
exist in any of these areas, management needs to take a close look at its liquidity management
practices to determine whether changes are in order.
11-15. What is money position management?
Money position management is the management of a financial institution’s liquidity position
that requires quick decisions which may have long-run consequences on profitability. Most large
depository institutions have designated an officer of the firm as money position manager. A
money position manager is responsible for ensuring that the institution maintains an adequate
level of legal reserves. Legal reserve requirements apply to all qualified depository institutions,
including commercial and savings banks, savings and loan associations, credit unions, and
agencies and branches of foreign banks that offer transaction deposits or nonpersonal (business)
time deposits or borrow through Eurocurrency liabilities.
11-16. What is the principal goal of money position management?
The money-position management’s goal is to ensure that the bank has sufficient legal reserves
to meet its reserve requirements as imposed by the central bank. Also make sure that it holds not
more than the minimum legal requirement because excess legal reserves yield no income for the bank.
11-17. Exactly how is a depository institution’s legal reserve requirement determined?
Each reservable liability item is multiplied by the stipulated reserve requirement percentage set
by the Federal Reserve Board to derive the bank's total legal reserve requirements. Thus, total
required legal reserves equal the reserve requirement on transaction deposits times the daily
average amount of net transaction deposits over a designated period plus the reserve requirement
on nontransaction reservable liabilities times the daily average amount of nontransaction
reservable liabilities. Currently nontransaction liabilities have a reserve requirement of zero. 11-8 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies
11-18. First National Bank finds that its net transactions deposits average $140 million over the
latest reserve computation period. Using the reserve requirement ratios imposed by the Federal
Reserve as given in the textbook, what is the bank's total required legal reserve? Total Required Legal Reserves
= 0.03 * [First $43.9-$9.3 million of Transaction Deposits] +
.10*[Amount of Transaction Deposits in Excess of $43.9 million]
= .03 * $34.6 + .10 * ($140 - $43.9)
= $1.038 million + $9.61 million = $10.648 million
11-19. A U.S. savings bank has a daily average reserve balance at the Federal Reserve bank in
its district of $25 million during the latest reserve maintenance period. Its vault cash holdings
averaged $1 million and the savings bank's total transaction deposits (net of interbank deposits
and cash items in collection) averaged $200 million daily over the latest reserve maintenance
period. Does this depository institution have a legal reserve deficiency? How would you
recommend that its management responds to the current situation?
The bank's total required legal reserves must be:
Required Legal Reserves = 0.03 x [First $43.9 – $9.3 million of Transactions Deposits]
+ 0.10 x [Transactions Deposits Over $43.9 million]
= .03*$34.6 + .10*($200 - $43.9)
= $1.038 million + $15.61 million = $16.648 million
The average vault cash of $1 million plus the $25 million at the district Reserve Bank indicates
total maintained reserves of $26 million, meaning the bank is over required reserves by
$9,352,000. Management will have to plan how to invest this excess reserve taking into account
any anticipated drain on funds in the near future and taking into account any reserve deficit in the previous period.
11-20. What factors should a money position manager consider in meeting a deficit in a
depository institution’s legal reserve account?
Several factors must be taken into account by the money position manager, including current
and expected future levels of interest rates, projected changes in monetary policy, the bank's
borrowing capacity and current holdings of liquid assets, the bank's forecast of future deposit
growth and loan demand, the expected size and duration of any liquidity deficits or surpluses,
and his or her knowledge of the future plans of the bank's largest depositors and borrowers with credit lines.
11-21. What are clearing balances? Of what benefit can clearing balances be to a depository that
uses the Federal Reserve System’s check-clearing network? 11-9 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies
Any financial institution using the Federal Reserve check clearing system has to maintain a
minimum balance with the Federal Reserve. The amount is determined by its estimated check
clearing needs and its recent record of overdrafts. The clearing balance can be a benefit because
the institution earns credits from holding this balance with the Fed and this credit can be used to
pay the fees the Fed charges for services.
11-22. Suppose a bank maintains an average clearing balance of $5 million during a period in
which the Federal funds rate averages 6 percent. How much would this bank have available in
credits at the Federal Reserve Bank in its district to help offset the charges assessed against
the bank for using Federal Reserve services?
Reserve Credit = Avg. Clearing Balance x Annualized Fed Funds Rate x 14 days/360
days = $5,000,000 x .06 x 14/360 = $11,666.67
11-23. What are sweeps accounts? Why have they led to a significant decline in the total legal
reserves held at the Federal Reserve banks by depository institutions operating in the United States?
A sweeps account is a service provided by banks where they sweep money out of accounts that
carry reserve requirements (such as demand deposits and other checking accounts) into
savings accounts which do not carry reserve requirements overnight. This service lowers the
bank’s overall cost of funds while still allowing the customer access to their deposits for
payments. These sweep arrangements account for nearly $200 billion in deposit balances today
and therefore have significantly reduced the total reserve requirements of banks. Problems 11-10 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies
11-1. Pretty Lake Hills State Bank estimates that over the next 24 hours the following cash
inflow and outflows will occur (all figures in millions of dollars): Deposit withdrawals $98 Sales of bank assets 40 Deposit inflows
87 Stockholder dividend payments 150
Revenues from sale of nondeposit Scheduled loan repayments 89 services 95 Acceptable loan requests
56 Repayments of bank borrowings 60 Borrowings from the money market 75 Operating expenses 45
What is this bank’s projected net liquidity position in the next 24 hours? From what sources
can the bank cover its liquidity needs? Deposit withdrawals $98 - Deposit inflows $87 + Scheduled loan repayments $89 + Acceptable loan requests $56 -
Borrowings from the money market $75 + Sales of bank assets $40 + Stockholder dividend payments $150 -
Revenues from sale of nondeposit services $95 + Repayment of bank borrowings $60 - Operating expenses $45 -
= + [$87+ $89+ $75+ $40+ $95] - [$98+ $56+ $150+ $60+ $45] = - $23 million.
Faced with an expected liquidity deficit Pretty Lake Hills State Bank could arrange to increase its
money market borrowings from other institutions or sell some of its assets or do some of both.
11-2. Mountain Top Savings is projecting a net liquidity deficit of $5 million next week partially
as a result of expected quality loan demand of $24 million, necessary repayments of previous
borrowings of $15 million, disbursements to cover operating expenses of $18 million, planned
stockholder dividend payments of $5 million, expected deposit inflows of $26 million, revenues
from nondeposit service sales of $18 million, scheduled repayment of previously made customer
loans of $23 million, asset sales of $10 million, and money market borrowings of $15 million.
How much must Mountain Top’s expected deposit withdrawals be for the coming week? 11-11 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies
Supplies of Liquidity Flowing into the Mountain Top Savings Expected deposit inflows $26 million Revenues from nondeposit 18 million service sales Scheduled repayments of prev. made customer loans 23 million Asset sales 10 million Money market borrowings 15 million Total Source of Liquidity $92 million
Demands on the Mountain Top Savings for Liquidity Expected quality loan demand $24 million Necessary repayments of previous borrowings 15 million Disbursements to cover operating expenses 18 million Stockholder dividend payments 5 million
Total Uses of Liquidity Excluding Deposit Withdrawals $62 million Then Net Liquidity Deficit
= Liquidity Supplies - Liquidity Demands - Deposit Withdrawals - $5 million
= $92 million - $62 million - Deposit Withdrawals
Therefore, expected deposit withdrawals must equal $35 million for the next week.
11-3. First National Bank of Lawrenceville has forecast its checkable deposits, time and savings
deposits, and commercial and household loans over the next eight months. The resulting
estimates (in millions) are shown in below. Use the sources and uses of funds approach to
indicate which months are likely to result in liquidity deficits and which in liquidity surpluses if
these forecasts turn out to be true. Explain carefully what you would do to deal with each
month’s projected liquidity position. 11-12 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies Checkable Time and Commercial Consumer Month Deposits Savings Loans Loans Deposits January 120 550 650 140 February 115 500 650 200 March 100 500 700 200 April 90 485 700 150 May 105 465 710 150 June 80 490 700 175 July 90 525 700 175 August 100 515 675 175 Solution: Change Change Total from Total from Month Deposits Previous Loans Previous Source Use Net Month Month January 670 ---- 790 ---- February 615 -55 850 +60 0 115 -115 March 600 -15 900 +50 0 65 -65 April 575 -25 850 -50 50 25 +25 May 570 - 5 860 +10 0 19 -15 June 570 0 875 +15 0 15 -15 July 615 +45 875 0 45 15 +45 August 615 + 0 850 -25 25 0 +25
January-February, February-March, April-May and May-June will all have liquidity deficits as a
result of decreasing deposits, increasing assets, or both. March-April, June-July, and July-August
will all have liquidity surpluses as a result of increasing deposits, decreasing loans, or both. 11-13 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies
First National has several options available:
January-February, February-March, April-May and May-June the bank faces deficits ranging
from $15 to $115 million. These deficits can be met by:
1. aggressive advertising to attract NOW deposits,
2. issuing negotiable CDs in the money market,
3. if they have a holding company, the holding company could sell commercial paper
and pass the proceeds through to the bank subsidiary, 4. borrowing Federal funds,
5. borrowing from the Federal Reserve district bank (although this is not a likely alternative for most banks),
6. selling securities under agreements to repurchase,
7. selling some of their loans,
8. selling some of their securities, or
9. a combination of a number of these alternatives.
March-April, June-July, and July-August the bank faces anticipated surpluses ranging from
$25 to $45 million. These surpluses afford the bank the opportunity to:
1. aggressively pursue new loans,
2. invest in various money market instruments, such as Treasury securities, or,
3. a combination of these alternatives.
Since both periods are relatively short lived, the bank should opt for more temporary
measures, that is, use of the money market. However, if their longer-term forecasts hold
promise for continued growth, they may well want to develop strategies for attracting more deposits and loans, as well.
11-4. King Savings is attempting to determine its liquidity requirements today (the last day of
August) for the month of September. September is usually a month of heavy loan demand due
to the beginning of the school term and the buildup of business inventories of goods and
services for the fall season and winter. This thrift institution has analyzed its deposit accounts
thoroughly and classified them as explained below.
Management has elected to hold a 75 percent reserve in liquid assets or borrowing
capacity for each dollar of hot money deposits, a 20 percent reserve behind vulnerable deposits
and a 5 percent reserve for its holdings of core funds. Assume time and savings deposits carry a
zero percent reserve requirement and all checkable deposits carry a 3 percent reserve
requirement. King currently has total loans outstanding of $2,389 million, which two weeks ago
were as high as $2,567 million. Its loans’ mean annual growth over the past three years has
been about 8 percent. Carefully prepare low and high estimates for King’s total liquidity requirement for September. 11-14 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies Millions of Checkable Time Dollars Deposits Savings Deposits Deposits Hot money funds $10 $____ $782 Vulnerable funds 22 152 540 Stable (core) funds 30 285 172 Checkable Savings Nonpersonal Source deposits deposits time deposits Totals Hot money funds $10 ---- 782 792 Vulnerable funds 22 152 540 714 Stable (core) funds $30 285 172 487 Totals 62 437 1,494 1,993
Deposit Liquidity Requirement = 0.75 [Net "Hot Money" Funds] + 0.20 [Net Vulnerable Funds] + 0.05 [Net "Core" Funds]
a) Net Hot Money Funds = [$10 million - ($10 million * 0.03)] + [$0 million] + [$782 million]
= $9.7 + $0 + $782 = $791.7 million
(b) Net Vulnerable Funds = [$22 million - ($22 million * 0.03)] + [$152 million] + [$540 million]
= $21.34 + $152 + $540 = $713.34 million
(c) Net Core Funds = [$30 million - ($30 million * 0.03)] + [$285 million] + [$172 million]
= $29.1 + $285 + $172 = $486.1 million
Therefore, deposit liquidity requirement = 0.75 [$791.7] + 0.20 [$713.34] + 0.05 [$486.1]
= $593.775 + $142.668 + $24.305
= $760.748 million OR $761 million
Total liquidity requirement = additional loan demand + deposit liquidity requirement
Recent experience: Currently, loans total $2,389 million, but recently have been as high
as $2,567 million, or an additional $178 million.
Historically (based on past three years), loan growth has averaged 8 percent annually.
Anticipated additional loan demand (low estimate) = $2,389 * 1.08 = $2,580
Anticipated additional loan demand (high estimate) = $2,567 * 1.08 = $2,772
Therefore, additional loan demand could range from $191 million to as much as $383(2772-2389) million. 11-15 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies
Total liquidity requirement (low estimate) = $761 + $191 = $952 million.
Total liquidity requirement (high estimate) = $761 + $383 = $1,144 million.
11-5 Using the financial information for Watson National Bank, calculates as many of the
liquidity indicators discussed in this chapter for Watson as you can. Do you detect any
significant liquidity trends? Which trends should management investigate? Most recent year Previous year Assets: Cash and due from depository institutions $345000 $358,000 U.S. Treasury securities $176,000 $178,000 Other securities $339,000 $343,000 Pledged securities $287,000 $223,000 Federal funds sold and reverse repurchase agreements $175,000 $131,000 Loans and leases net $2,148,000 $1,948,000 Total Assets $3,200,000 $3,001,000 Liabilities: Demand deposits $500,000 $456,000 Savings deposits $730,000 $721,000 Time deposits $1,100,000 $853,000 Total deposits $2,430,000 $2,130,000 Core deposits $850,000 $644,000 Brokered deposits $58,000 $37,000 Federal funds purchased and repurchase agreements $217,000 $237,000 Other money market borrowings $25,000 $16,000 11-16 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies Cash and due from depository institutions $345,000 $358,000 U.S. Treasury securities $176,000 $178,000 Other securities $339,000 $343,000 Pledged securities $287,000 $223,000 Federal funds sold and reverse repurchase agreements $175,000 $131,000 Loans and leases Net $2,148,000 $1,948,000 Total Assets $3,200,000 $3,001,000 Liabilities: Demand deposits $500,000 $456,000 Savings deposits $730,000 $721,000 Time deposits $1,100,000 $853,000 Total deposits $2,430,000 $2,130,000 Core deposits $850,000 $644,000 Brokered deposits $58,000 $37,000 Federal funds purchased and repurchase agreements $217,000 $237,000 Other money market borrowings $25,000 $16,000 Most Recent Year Previous Year Cash position indicator: 345,000/3,200,000 358,000/3,001,000
Cash and due from banks/Total assets = .1078 = .1193 Liquid securities indicator: 176,000/3,200,000 178,000/3,001,000 U.S. Govt. sec. / Total assets =.055 =.0593 Net federal funds position: (175,000-217,000)/3,200,000 (131,000-237,000)/3,001,000
(Fed funds sold-Fed funds purchased) =-.0131 =-.0353 /Total Assets Capacity ratio: 2,148,000/3,200,000 1,948,000/3,001,000
Net loans and leases/Total assets =.6713 =.6491 Pledged security ratio: 287,000/515,000 223,000/521,000
Pledged securities/Total securities =.557 =.428 Hot Money Ratio: 345,000+176,000+175,000 358,000+178,000+131,000
Money mkt assets*/Volatile liabilities 217,000 + 25,000 237,000 + 16,000
Cash, U.S. Govt Sec., Fed Funds Sold =2.88 X =2.64 X 11-17 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies Deposit brokerage index 58,000/2,430,000 37,000/2,130,000
Brokered deposits/Total deposits =.0239 =.0174 Deposit Composition Ratio 500,000/1,100,000 456,000/853,000 Demand deposits/Time deposits =.4545 =.5346 Core deposit ratio 850,000/3,200,000 644,000/3,001,000 Core deposits/Total assets =.2656 =.2146
Watson appears to have mixed liquidity trends, though most indicators reflect declining
liquidity. Cash assets are falling relative to total assets, though holdings of U.S. Government
securities are rising relative to total assets. Net loans are rising, squeezing out some liquid assets
from total assets and more of the government securities the bank holds are now pledged to back
government deposits and, therefore, are not available for liquidity needs. Another area of
concern that needs management's attention is the near tripling in the proportion of deposits
coming from security brokers. A comforting offsetting trend, however, is the decline in volatile
demand deposits relative to more stable time deposits.
11-6. The Bank of Your Dreams has a simple balance sheet. The figures are in millions of dollars as follows: Assets Liabilities and Equity Cash $100 Deposits $4000 Securities 1,000 Other liabilities 500 Loans 4,000 Equity 600 Total Liabilities and Total assets 5,100 equity 5100
Although the balance sheet is simple, the bank’s manager encounters a liquidity challenge
when depositors withdraw $500 million.
a. If asset conversion method is used and securities are sold to cover the deposit
drain, what happens to the size of Bank of Your Dreams?
b. If liability management is used to cover the deposit drain what happens to the size of Bank of Your Dreams?
a. In this case, the bank would shrink by the amount of deposit withdrawals. Thus total
assets would decrease to $5,100 – 500 = $4,600.
b. There would be no change in the size of the bank. 11-18 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies
11-7. The liquidity manager for the Bank of Your Dreams needs cash to meet some
unanticipated loan demand. The loan officer has $600 million in loans that he wants to
make. Use the simplified balance sheet provided in the previous problem to answer the following questions:
a. If asset conversion is used and securities are sold to provide money for the loans, what
happens to the size of the Bank of Your Dreams?
b. If liability management is used to provide funds for the loans, what happens to the size of the Bank of Your Dreams?
a. Since securities are simply replaced by loans there will be no change in size
b. In this case, the size of the bank would increase by the amount of total new
loans. Thus, Total assets would increase to $5,100 + 600 = $5,700
11-8. Suppose Victoria Savings Bank's liquidity manager estimates that the bank will
experience a $375 million liquidity deficit next month with a probability of 10 percent, a $200
million liquidity deficit with a probability of 40 percent, a $100 million liquidity surplus with a
probability of 30 percent, and a $250 million liquidity surplus bearing a probability of 20
percent. What is this savings bank’s expected liquidity requirement? What should management do? Liquidity Deficits or Associated Surpluses Probabilities -$375 million 10% -$200 million 40 +$100 million 30 +$250 million 20 100%
The bank's expected liquidity requirement is:
Expected Liquidity Requirement = 0.10 *(-$375 million) + 0.40 * (-$200 million) +
0.30* (+$100 million) + 0.20 * (+$250 million)
= -$37.5 million - $80 million + $30 million + $50 million = -$37.5 million
Faced with a expected liquidity deficit the bank's liquidity manager must still begin preparing
for meeting the institution's cash needs through arranging for credit lines or deposits from other
banks and actual or potential deposit customers and strengthening the bank's liquid asset position. 11-19 lOMoARcPSD|44744371
Chapter 11 - Liquidity and Reserves Management: Strategies and Policies
11-9. First Savings of Rainbow, Iowa, reported transactions deposits of $75 million (the daily
average for the latest two-week reserve computation period). Its nonpersonal time deposits over
the most recent reserve computation period averaged $37 million daily, while vault cash
averaged $0.95 million over the vault-cash computation period. Assuming that reserve
requirements on transaction deposits are 3 percent for deposits over $9.3 million and up to $43.9
million and 10 percent for all transaction deposits over $43.9 million while time deposits carry a
3 percent required reserve, calculate this savings institution’s required daily average reserve at
the Federal Reserve Bank in the district.
Daily required reserves at Fed= [($43.9-9.3)*0.03] + [($75 – $43.9)*.10] + [$37 * 0.03] -$0.95 =
$1.038 + $3.11 + $1.11 - $0.95 = $5.258- $0.95 = $4.308 million
11-10. Elton Harbor Bank has a cumulative legal reserve deficit of $44 million at the Federal
Reserve bank in the district as of the close of business this Tuesday. The bank must cover this
deficit by the close of business tomorrow (Wednesday).
Charles Tilby, the bank's money desk supervisor, examines the current distribution of
money market and long-term interest rates and discovers the following: Money Market Instrument Current Market Yield Federal funds 1.98%
Borrowing from the central bank’s discount 2.25 window
Commercial paper (one-month maturity) 2.33
Banker's acceptances (three-month maturity) 2.30
Certificates of deposit (one-month maturity) 2.52
Eurodollar deposits (three-month maturity) 3.00
U.S. Treasury bills (three-month maturity) 1.85
U.S. Treasury notes and bonds (1-year maturity) 2.57
U.S. Treasury notes and bonds (5-year maturity) 3.65
U.S. Treasury notes and bonds (10-year maturity) 4.19
One week ago, the bank borrowed $20 million from the Federal Reserve's discount window,
which it paid back yesterday. The bank had a $5 million reserve deficit during the previous
reserve maintenance period. From the bank's standpoint, which sources of reserves appear to be
the most promising? Which source would you recommend to cover the bank's reserve deficit? Why? 11-20