Chapter 6 - Managing Liquidity

Bank Liquidity

A bank’s capacity to acquire immediately available funds at a reasonable price

Cash Assets

Do not earn any interest, represents a substantial opportunity cost for banks

Liquid Assets

Can be easily and quickly converted into cash with minimum loss

Banks hold deposits at the Federal Reserve

The Federal Reserve imposes legal reserve requirements and deposit balances qualify as legal reserves

purpose of required reserves

to enable the Federal Reserve to control the nation’s money supply

Correspondent Banking Services

System of interbank relationships in which the correspondent bank sells services to the respondent bank.

Banker’s Bank

a special type of bank that serves other banks, not regular people or businesses. It is usually owned by a group of small or independent banks.

Short-Term Liquidity Planning

making sure the bank has enough legal reserves (cash or deposits at the central bank) to meet the minimum required by law, while keeping the cost as low as possible.

Float

The total value of checks that have been deposited but not yet cleared or approved by the bank.

The more liquid a bank is

the lower are its return on equity and return on assets, all other things equal

Core Deposits

a bank expects to remain on deposit, regardless of the economic environment

Volatile Deposits

The difference between actual current deposits and the base estimate of core deposits

Liability Liquidity

The ease with which a bank can issue new debt to acquire clearing balances at reasonable costs

Long-Term Liquidity Planning

A stage of liquidity planning where the bank forecasts its funding needs and sources over the next year or longer.

Forecasting Requirements

Involves predicting deposit growth, loan demand, and other changes that affect the bank’s cash position.

Liquidity Gap

The difference between expected uses of funds (like loans) and expected sources (like deposits), usually measured monthly.

Projection Categories

divided into base trends, short-term seasonal changes, and longer-term cyclical patterns.

The 1986 Basel Agreement

bank regulators proposed that U.S. banks be required to maintain capital that reflects the riskiness of bank assets

Capital requirements

reduce the risk of failure, providing access to financial markets to meet liquidity needs, and limiting growth

Primary Capital

refers to the bank's core capital, including common equity, disclosed reserves, and retained earnings.

Secondary Capital

includes subordinated debt and other hybrid instruments that are less permanent than primary capital.

most valuable type of capital

Stockholders' equity

Capital (Net Worth)

Represents ownership interest in a firm