Represents the ability to efficiently and economically accommodate decreases in deposits and other liabilities, as well as fund increases in assets.
Bank is located in a metropolitan area and is experiencing strong loan growth. Management intends to fund this growth through borrowings. What are the risks of this funding method?
cost of funding
availability of borrowings
Whole-sale bank relying on purchasing funds from other banks as part of usual management. This bank had suffered loss and had received bad publicity. What is concern?
"Purchased money runs" - cost of funding necessary to support long-term assets already on books would increase and squeeze/cause negative margin. Banks relying on core, insured funds are usually better able to withstand such developments.
Wholesale Bank: Retail Bank:
Asset management vs. liability management.
Asset management - Liquidity needs may be met by managing the bank's asset structure through either the sale or planned run-off of readily marketable assets specifically set aside to meet liquidity needs.
Banks which rely solely on asset management focus on adjusting price and availability of credit and the level of liquid assets held in response to changes in customer asset and liability preferences. May not fulfill all loan demand. Keep eye on pledging, depreciation, etc. Asset liquidity is primary importance in asset management strategies. Remember: assets normally assumed to be liquid sometimes are not liquidated easily and/or profitably. Also, holding liquid assets for liquidity purposes can become less attractive because of thin margin spreads and capital maintenance requirements.
Liability management - liability needs can be met through discretionary acquisition of funds on the basis of interest rate competition. Larger banks better able to control. Risks include:
To maximize profitability, management must carefully weigh the full return on liquid assets (yield plus insurance value) against the expected higher return associated with less liquid assets. Income derived from higher yielding assets may be offset if a forced sale is necessary due to adverse balance sheet fluctuations.
Component Ratings?
Bank's level of liquid assets is insufficient to ... and its reliance on interest sensitive funds is approaching unreasonable proportions, rating? 3
"1" indicates a more than sufficient volume of liquid assets and/or ready and easy access on favorable terms to external sources of liquidity within the context of the bank's overall asset-liability management strategy.
A bank developing a trend toward decreasing liquidity and increasing reliance upon borrowed funds, yet still within acceptable proportions, may be accorded a "2" rating.
A liquidity rating of "3" reflects an insufficient volume of liquid assets and/or reliance on interest- sensitive funds that is approaching unreasonable proportions for a given bank.
A rating of "4" represents an increasingly serious liquidity position.
Banks with a liquidity position so critical as to constitute an imminent threat to continued viability should be accorded a "5" rating. Such banks require immediate remedial action or external financial assistance to allow them to meet their maturing obligations.
Liquidity is rated 1 through 5 with respect to:
In assessing liquidity, attention should be directed to the bank's average liquidity over specific time period as well as its liquidity position on a particular day.
Factors that may require increased liquidity. (6.1-2)
(1) The competitive environment is such that customers can invest in alternative instruments
(2) Recent trends show substantial reduction in large liability accounts
(3) Substantial deposits are short-term municipal special assessment-type accounts
(4) A substantial portion of the loan portfolio consists of large problem credits with little likelihood of reduction
(5) Large unused LOCs or commitments are expected to be utilized in the future
(6) A concentration of credits has been extended to an industry with present or anticipated financial problems
(7) A close relationship exists between individual demand accounts and principal employer in the trade area who has financial problems
Calculate Dependency Ratio
Volatile liabilities - short term investments = net volatile liabilities
Earning assets - short term investments = long term earning assets
Calculate Liquidity Ratio
Short term investments + marketable assets + cash - reserve - secured liabilities
Deposits - secured liabilities
I was given a balance sheet in the separate test booklet and asked to calculate a dependency ratio. The accounts were all very straightforward . . . no guess work. Just make sure that you have the calculation memorized when you get in there.
What should be included in a funds management policy? (6.1-4)
B.Periodic review of the bank's deposit structure
C.Method of computing the bank's cost of funds
E.Determine permissible investments, desired mix, maturities, and pledging requirements
F.Determine types of desirable loans, mix, volume, maturities, and loan commitments outstanding
G.Determine the extent to which the bank is funding long-term assets with short-term liabilities, and establish a target ratio and/or parameters
H.Establish target ratios for RSA/RSL and gap. Provide for periodic calculation to measure.
I.Review performance with the bank's liquidity ratio target and compliance with required legal reserves
J.Review possible alternative sources of funds
Bank has lots of funds that are large depositors and municipalities. Their liquidity/investment policy should address what?
Scenario: Good bank. Population expected to decline. Other local economic declines. What should the bank's liability management policy address?
Management
Recognize factors to increase liquidity (6.1-1)
When is the best time for asset mgmt? liability mgmt?
Asset Management: Stable Deposit Base, Predictable Loan Demand, Low liquidity required
Liability Management: When have easy access to discretionary funds at low costs, (more risks w/liab mgmt)
What does a positive dependency ratio indicate?
The bank is funding long-term assets with volatile liabilities.
A bank has increasing reliance on borrowed funds and trend is toward decreasing liquidity. This is an example of what liquidity rating?
1) 1
3) 3
4) 4
Know types of volatile liabilities.
Given a financial statement, calculate liquidity.
Given a financial statement, calculate volatile liability dependence.
Liquidity scenario: Well-capitalized bank in MSA with concentration in agricultural loans. Deposit structure primarily savings deposits and MMDA. Executive officers all related. Local industry closing down causing 100,000 people to lose jobs. What is bank's main problem?
Agricultural bank. Which of following are true?
Liquidity highest at beginning of harvest season
Liquidity lowest at beginning of harvest season
Liquidity would not be affected
Some other strange choice
What would improve liquidity?
· Increase holding of reverse repos
Given a financial statement, calculate liquidity. The information was presented in an unusual format, and there were some strange accounts.
Scenario described problems in bank's monitoring of interest rate risk. Management/Board were not monitoring the bank's position. Bank also dependent on volatile liabilities. What should be included in the A/L policy to correct the problem. The answer included all of the things in a policy. You have to eliminate the ones not appropriate to this particular circumstance.
What are the potential risks of asset management?
ALCO takes steps to adjust sensitivity position based on expectations. Position goes from net asset position (25MM) to (75MM). What is ALCO anticipating?
Bank has increased liability sensitive position in hopes that rates will fall (and thus increase NIM)
Calculate Liquidity & Dependency Ratios for an unusual bank financial statement?
Interest Bearing Balances < 1 year
+ Federal Funds Sold & Repos (Securities purchased with the intent to resell - reverse repo) + Trading Account Assets
+ Securities Maturing in 1 Year or Less (include sub-investment quality if marketability is okay) = TEMPORARY INVESTMENTS
Adjustments:
+ Other Money Market Instruments (commercial paper, bankers acceptances, other due in < 1 year) = TOTAL SHORT-TERM INVESTMENTS
US & Agency Securities Maturing in over 1 Year
+ Other Investment Quality Securities Maturing in over 1 Year (no sub-investment securities) + Other Marketable Assets (Describe) (interest bearing balances > 1 year, loans, investment = TOTAL OTHER MARKETABLE ASSETS quality corporate equities, OA able to be resold in established markets, mutual funds - unless sub-investment quality) Do not include stripped MBS or residuals.
TOTAL SHORT-TERM INVESTMENTS
+ TOTAL OTHER MARKETABLE ASSETS
+ Cash & Noninterest Bearing Balances
+ Appreciation or (Depreciation) in above Securities (HTM)
Brokered Deposits
+ CDs 100M & Over
+ Deposits Held in Foreign Offices
+ Federal Funds Purchased & Repos (securities sold with the intent to repurchase) + Other Borrowings & Debt Due in One Year
= TOTAL POTENTIALLY VOLATILE LIABILITIES
Transaction Accounts (Account for ALL deposits) + Money Market Deposits Accounts
+ Other Savings Accounts
+ CDs under 100M
= TOTAL CORE DEPOSITS
TOTAL POTENTIALLY VOLATILE LIABILITIES
+ TOTAL CORE DEPOSITS
- Liabilities Secured by Any of the Above
= NET DEPOSITS & SHORT-TERM LIABILITIES
Liquidity Ratio:
NET CASH, SHORT-TERM, & MARKETABLE ASSETS / NET DEPOSITS & SHORT-TERM LIABILITIES
TOTAL POTENTIALLY VOLATILE LIABILITIES
- TOTAL SHORT-TERM INVESTMENTS
= NET POTENTIALLY VOLATILE LIABILITIES (ASSETS)
Total Earning Assets (From Pg 2)
- TOTAL SHORT-TERM INVESTMENTS
= LONG-TERM EARNING ASSETS
Dependency Ratio:
NET POTENTIALLY VOLATILE LIABILITIES / LONG-TERM EARNING ASSETS
(Positive = extent that potentially volatile liabilities are funding long term assets.
Negative = short-term investments exceed potentially volatile liabilities)
Leave out long-term borrowings and other liabilities.
Remember to make adjustments for any liabilities secured by assets above, ex. securities repurchase agreement - subtract out of securities above the line and subtract out of securities below the line.
Also remember: reserve requirements, deposits secured by securities, applicable depreciation,
(borrowings) loans sold w/recourse According to the manual, on the liquidity and dependency ratios schedule, AFS securities should be included as securities maturing in one year or less with the net amount noted in the footnote section. However, if the examiner believes that the bank is unlikely to sell the securities within one year, these securities should be reported as "Other Marketable Assets" with the net amount noted in the footnote section.