Measurement and Management': Liquidity Risk

‘Liquidity risk: measurement
and management’
Presented by
Mansi Gupta
1
Liquidity risk
Liquidity risk is the inability of a bank to
meet such obligations as they become due,
without adversely affecting the bank’s
financial condition.
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Types of Liquidity Risk
• Funding Liquidity Risk – the risk that a bank
will not be able to meet efficiently the expected
and unexpected current and future cash flows and
collateral needs without affecting either its daily
operations or its financial condition.
3
• Market Liquidity Risk – the risk that a bank
cannot easily offset or eliminate a position at the
prevailing market price because of inadequate
market depth or market disruption.
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Liquidity Risk Management
Effective liquidity risk management helps
ensure a bank’s ability to meet its obligations
as they fall due and reduces the probability of
an adverse situation developing.
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Principles for Sound Liquidity
Risk Management
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Fundamental principle for the
management and supervision
of liquidity risk
• A bank is responsible for the sound

management of liquidity risk. A bank
should establish a robust liquidity risk
management framework.
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Governance of liquidity risk
management
•A bank should clearly articulate a

liquidity risk tolerance that is
appropriate for its business strategy
and its role in the financial system.
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• Senior management should develop a
strategy, policies and practices to manage
liquidity risk in accordance with the risk
tolerance and to ensure that the bank
maintains sufficient liquidity.
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• A bank should incorporate liquidity costs,
benefits and risks in the internal pricing,
performance measurement and new
product approval process for all
significant business activities (both on-
and off-balance sheet).
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Measurement and Management
of liquidity risk
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• A bank should have a sound process for
identifying, measuring, monitoring and
controlling liquidity risk. This process
should include a robust framework for
comprehensively projecting cash flows.
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• A bank should actively monitor and
control liquidity risk exposures and
funding needs within and across legal
entities, business lines and currencies.
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• A bank should establish a funding strategy
that provides effective diversification in the
sources and tenor of funding. It should
maintain an ongoing presence in its chosen
funding markets and strong relationships with
funds providers to promote effective
diversification of funding sources.
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• A bank should actively manage its intraday
liquidity positions and risks to meet payment
and settlement obligations on a timely basis
under both normal and stressed conditions
and thus contribute to the smooth functioning
of payment and settlement systems.
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• A bank should actively manage its collateral
positions, differentiating between encumbered
and unencumbered assets. A bank should
monitor the legal entity and physical location
where collateral is held and how it may be
mobilised in a timely manner.
16
• A bank should conduct stress tests on a
regular basis for a variety of short-term and
protracted institution-specific and market-
wide stress scenarios (individually and in
combination)
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• A bank should have a formal contingency
funding plan (CFP) that clearly sets out the
strategies for addressing liquidity shortfalls in
emergency situations.
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• A bank should maintain a cushion of
unencumbered, high quality liquid assets to be
held as insurance against a range of liquidity
stress scenarios, including those that involve
the loss or impairment of unsecured and
typically available secured funding sources.
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Public Disclosure
• A bank should publicly disclose information on
a regular basis that enables market
participants to make an informed judgment
about the soundness of its liquidity risk
management framework and liquidity
position.
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Ratios in respect of
Liquidity Risk Management
1. (Volatile liabilities – Temporary Assets)

/(Earning Assets – Temporary Assets)
• Measures the extent to which volatile money
supports bank’s basic earning assets.
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2. Core deposits/Total Assets
• Measures the extent to which assets are
funded through stable deposit base.
3. (Loans + mandatory SLR + mandatory CRR +
Fixed Assets)/Total Assets
• Loans including mandatory cash reserves and
statutory liquidity investments are least liquid
and hence a high ratio signifies the degree of
‘illiquidity’ embedded in the balance sheet.
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4. (Loans + mandatory SLR + mandatory CRR +
Fixed Assets) / Core Deposits
• Measure the extent to which illiquid assets are

financed out of core deposits.
5. Temporary Assets/Total Assets
• Measures the extent of available liquid assets. A

higher ratio could impinge on the asset
utilisation of banking system in terms of
opportunity cost of holding liquidity.
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6. Temporary Assets/ Volatile Liabilities
• Measures the cover of liquid investments

relative to volatile liabilities. A ratio of less
than 1 indicates the possibility of a liquidity
problem.
7. Volatile Liabilities/Total Assets
• Measures the extent to which volatile liabilities

fund the balance sheet.
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‘Liquidity risk: measurement

• A bank is responsible for the sound

•A bank should clearly articulate a

1. (Volatile liabilities – Temporary Assets)

• Measure the extent to which illiquid assets are

5. Temporary Assets/Total Assets

• Measures the extent of available liquid assets. A

• Measures the cover of liquid investments

7. Volatile Liabilities/Total Assets

• Measures the extent to which volatile liabilities

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