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Liquidity Risk Management In Banks Economic And Regulatory Issues Pdf

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Liquidity Risk Management in Banks

Vilnius Gediminas Technical University E-mails: 'erika. Banks are the main part of financial sector in each economy and strength of banking system becomes vital for ensuring favourable economic stability and growth. Recent failure of two commercial banks in Lithuania showed that managers haven't evaluated liquidity risk or haven't dealt with it properly.

The tasks of the paper are to investigate Lithuanian banks position towards liquidity risk, analyse what kind of management tools banks use for ensuring favourable position towards liquidity and to explore the liquidity influence to profitability in Lithuanian banking sector.

The article examines liquidity and its management processes in Lithuanian banking sector. Description of liquidity importance is presented. Liquidity risk and its measurement as well as the ways of managing the above mentioned risk is analysed in the article. In order to analyse the relationship between liquidity risk and profitability of banks, analysis of scientific literature, research synthesis and generalizations have been made.

Keywords: liquidity, liquidity risk, bank's liquidity management, liquidity ratios, Lithuanian banking system. In today's context of globalization, the strength of banking system becomes vital for ensuring favorable economic stability and growth.

Banks are the main part of financial sector in each economy by enhancing flow of funds and providing liquidity Diamond, Rajan Moreover, banks stimulate the smoothness in goods and services markets and provide possibility to market members to make productive investments. In this manner banks stimulate innovation and help to develop new industries, what leads to improved employment rate and overall stability of the economic Arif, Nauman In order to capture the benefits that well organized banking system can bring, banks have to be able to control its stability and manage risks.

Liquidity risk is a risk that bank will not be able to cover obligations for its depositors. It is one of major todays issues that bank have to deal with Jenkinson The issue of liquidity became vital for banks from marketing site, when a lot of members of society in Lithuania have lost trust in banking system. However, maintaining a defensive liquidity risk position and management is extremely challenging and difficult in today's competitive and open economic system with strong external influences and sensitive market.

Successful and well-organized banks must have stable system not only for evaluation but also for management of liquidity risk. The aim of the article is to investigate liquidity influence to Lithuanian banks performance. In order to achieve the aim such tasks should be implemented: to describe the liquidity risk, as well as to identify importance of stable position towards liquidity, moreover, to identify what means for liquidity risk measurement can be used, analyze what kind of management tools can be applied in banks for ensuring favorable position towards liquidity and lastly - to describe in what possible manner liquidity influence to profitability in Lithuanian banking sector could be explored.

In order to fulfill tasks and achieve the aim of the paper analysis of scientific literature and normative documents, comparison and synthesis was made. To begin with, identifying importance of liquidity it is a must to understand meaning of the term "liquidity". Jones expressed liquidity as "the. This is an open-access article distributed under the terms of the Creative Commons Attribution-NonCommercial 4. The material cannot be used for commercial purposes. The liquidity in simplified terms is companies' ability to cover its obligations towards creditors calling funds at inconvenient time, expressed in measured number.

In other words, if the liquidity is not managed in proper way, firm can face situation of illiquidity and will technically be bankrupt or face losses. No manager wants to lead a company to this situation. That is main reason why companies have to be aware of liquidity risk management. Managers have to be ready to adapt to unfavorable economic conditions and possible changes in order to stay in the market and not to damage company's image and relationships with stakeholders Hawawini, Vialler The recent global financial crisis that started in occurred because of the failures in derivatives markets which negatively caused banks' ability to provide liquidity to third parties.

That shows that problems commonly came up after failures in the management of funds or unpredicted unfavorable economic conditions which lead to unpredictable liquidity withdrawals by the depositors Siddiqi Jones it was caused by liquidity problem Ross To sum up, the liquidity means companies' ability to cover its obligations without experiencing losses. Out of that there is clear view of liquidity importance: if a company or institution is not liquid enough it will suffer financially.

There can be a lot of examples through history found confirming the importance of appropriate management of liquidity. Banks should be equipped to deal with the changing monetary policy that shapes the overall liquidity trends and the banks' own transactional requirements and repayment of short term borrowing Akhtar According a comptroller of the currency acting in USA "Liquidity risk is a risk arising from a bank's inability to meet its obligations when they come due without incurring unacceptable.

While other literature analysis showed that liquidity risk - the risk that a bank may not meet its obligations Jenkinson as the depositors may call their funds at an inconvenient time, causing fire sale of assets Diamond, Rajan , negatively affecting profitability of the bank Chaplin, Emblow et al. According to The Bank of Lithuania it is the risk to meet difficulties in realizing financial asset fast and without losses LB According to State Bank of Pakistan: Liquidity risk is the potential for loss to an institution, arising from either its inability to meet its obligations or to fund increases in assets as they fall due without incurring unacceptable cost or losses.

So, in easier terms, liquidity risk can be defined as the risk of being unable to liquidate a position timely at a reasonable price Muranaga, Ohsawa The risk can influence both bank's capital and its earnings. If the risk is over valuated - bank cannot invest its funds in more profitable illiquid assets, so earnings will suffer.

If bank is under evaluating the risk it might have to handle fire sales and not surely to reasonable price, so it can damage the capital. This is why it becomes the top priority of a bank's management to ensure the availability of sufficient funds to meet future demands of providers and borrowers, at reasonable costs. Moreover, bank's position towards liquidity risk affects not just its performance but bank's reputation also Jenkinson If the bank will be late by providing funds for depositors, it will look not trustful and unsafe.

The bank may lose confidence and at the same time clients. The bank's reputation may become at stake in that kind of situation Arif, Nauman Liquidity risk has become a serious concern for the banks because of high competition for consumer deposits and new wide assortment of funding products in wholesale and capital markets with technological advancements.

The funding and risk management structure has completely been changed Akhtar A bank having good asset quality, strong earnings and sufficient capital may fail if it is not maintaining adequate liquidity Crowe , that is why management of liquidity risk became one of major bank's success factors. Furthermore, liquidity risk management is an essential component of the overall risk management framework, especially of the financial services industry, concerning all financial institutions Majid As financial institution, banks should manage the demand and supply of liquidity in an appropriate manner in order to safely run their business, maintain good relations with the stakeholders and avoid liquidity problem Ismal Well-managed bank.

A well-established system helps the banks in timely recognition of the sources of liquidity risk to avoid losses in both cases - undervalued liquidity risk and overvalued liquidity risk. The balance sheets of banks are growing in complexity and dependence upon the capital markets what has made the liquidity risk management more challenging Guglielmo The banks regularly find the liquidity imbalances between asset and liability side that needs to be equalized because banks issue liquid liabilities but invest in illiquid assets and result as liquidity risk which can end with losses for the bank Zhu In other words, if a bank fails to balance the gap, liquidity problems might occur followed by some unwillingness exposures such as high interest rate risk, high bank reserves or capital requirement, and lower bank's reputation.

Therefore, the ability of the bank to manage liquidity risk is very imperative to maintain the continuity of banking operations and stay competitive Ismal In banking sector both investors and borrowers are concerned about liquidity.

Investors desire liquidity because they are uncertain about when they will want to eliminate their holding of a financial asset. Borrowers are concerned about liquidity because they are uncertain about their ability to continue to attract or retain funding Diamond, Rajan Liquidity risk of course is important in any type of business, but because of banks' performance in providing liquidity for others and previously mentioned high impact to whole economy, the banks' liquidity is governed by the governmental instruments.

In the aftermath of the financial crisis bank regulators devised Basel III, a new rulebook that includes several measures to strengthen the resilience of the banking sector Varotto Basel III is an international framework for liquidity risk measurement, standards and monitoring issued at and edited at December According to it one of the key lessons of the crisis has been the need to strengthen the risk coverage of the capital framework.

Failure to capture major on- and off-balance sheet risks, as well as derivative related exposures, was a key destabilizing factor during the crisis.

In response to these shortcomings, the reforms raise capital requirements for the trading book and complex se-curitisation exposures, a major source of losses for many internationally active banks. The enhanced treatment introduces a stressed value-at-risk capital requirement based.

In addition, the Committee has introduced higher capital requirements for so-called re-securitisation in both the banking and the trading book. Banks always were required to have a minimum amount of capital to be able to absorb losses and still operate during the crisis. Moreover, the central bank imposes the condition of cash reserve requirement to survive unexpected liquidity problems. As a rule, bank always tries to avoid the capital injection from the government because this may place a given bank at the government's mercy Jeanne, Svensson Therefore, banks hold minimum cash balance to avoid liquidity problems Jenkinson ; Arif, Nauman However, during the recent crisis, the losses that banks suffered in their trading books have far exceeded minimum capital requirements BCBS c.

As a result, the Basel Committee has undertaken an extensive revision of bank regulation, which has resulted in several new measures BCBS c, b.

To increase the loss-absorbing capacity of bank capital the Basel Committee has introduced two additional capital requirements for the trading book, the "incremental risk capital" charge and the stressed value-at-risk. In extreme situations a vague management of liquidity may cause liquidity crisis which often results in a bank using up its reserve of liquid assets and being unable to replace its maturing liabilities.

As a consequence, the bank would have to sell its less liquid assets at unfavorable conditions and probably prices lower than market's price Falconer Therefore, the management of liquidity is a serious business which can show banks management position. Generally speaking, it might be that if bank is more liquidity aware it is probably safe, trustful but will have higher services prices. Whereas, if the bank's position towards liquidity is just exceeding minimum required liquidity ratio bank is probably more profitable and is able to lower its services' prices, however it is not so safe and trustful as in a first case.

Balance sheet liquidity management is concerned with the trade-off between the lower returns on liquid assets relative to the higher returns on illiquid assets. Or to put it in terms of the other side of the balance sheet, the trade-off between the lower cost of volatile funding is relative to the higher cost of stable funding.

Dedicated liquidity management information systems have an essential part to play in getting these balances right Falconer This leads to an outcome, that bank's position towards liquidity can show its priorities and indicate management.

At first there is a need to look and examine bank's organizational structure of liquidity management and then to state how liquidity and its risk is measured and controlled inside a bank. In addition, a sound basis for evaluating asset liability asset liability management is the process of managing the spread between interest earned and interest paid while ensuring adequate liquidity management requires an understanding of the bank, its customer mix, the nature of its assets and liabilities, and its economic and competitive environment.

Because no bank has the same state of mentioned aspects, no single theory can be applied universally to all banks. However, there most universal way to measure structural liquidity can be found. It is the underlying relationship between long-term illiquid customer loans and stable funding.

Because the funding is paramount therefore a bank should be continuously aware of the breakdown of its sources of funding in terms of different categories of customers, financial markets and instrument and keep its robust liquidity position through balance. Similar perception can be expressed through matching strategy. In other words it states, that firms' long term assets should be covered by long-term financing source and short-term investments by short-term debt.

By matching the life of an asset and the duration of its financing source, a firm can minimize the risk of not being able to finance the asset over its entire useful life. However, for most firms, the matching strategy is an objective rather than a day-today reality.

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Supreme Court Records. Other books on similar topics can be found in sections: Business , Finance , Law. The book was published on It has 54 pages and is published in Paperback format and weight g. Other books you can download below.

He holds a M. Roberto Ruozi is emeritus professor of financial markets and institutions at Bocconi University, Milan, Italy. He is a member of the board of banks, insurance companies and industrial companies. Skip to main content Skip to table of contents. Advertisement Hide. This service is more advanced with JavaScript available. Front Matter Pages i-v.

Liquidity Risk Management in Banks

He holds a M. Roberto Ruozi is emeritus professor of financial markets and institutions at Bocconi University, Milan, Italy. He is a member of the board of banks, insurance companies and industrial companies. Skip to main content Skip to table of contents. Advertisement Hide.

KG , Gale. Other books on similar topics can be found in sections: Law , Finance , Business. The book was published on It has 54 pages and is published in Paperback format and weight g.

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Liquidity Risk Management in Banks

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Marguerite G. 25.05.2021 at 05:57

Vilnius Gediminas Technical University E-mails: 'erika.

Kumbvamafi1980 02.06.2021 at 00:36

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