ChapterElevenLiquidityandReservesManagement:StrategiesandPolicies1

KeyTopicsSourcesofDemandforandSupplyofLiquidityWhyFinancialFirmsHaveLiquidityProblemsLiquidityManagementStrategiesEstimatingLiquidityNeedsTheImpactofMarketDisciplineLegalReservesandMoneyManagement11-22

IntroductionOneofthemostimportanttasksthemanagementofanyfinancialinstitutionfacesisensuringadequateliquidityatalltimesAfinancialfirmisconsideredtobe“liquid”ifithasreadyaccesstoimmediatelyspendablefundsatreasonablecostatpreciselythetimethosefundsareneededThissuggeststhataliquidfinancialfirmeitherhasTherightamountofimmediatelyspendablefundsonhandwhentheyarerequiredTheycanraiseliquidfundsintimelyfashionbyborrowingorsellingassetsLackofadequateliquiditycanbeoneofthefirstsignsthatafinancialinstitutionisintroubleAfinancialfirmcanbeclosedifitcannotraisesufficientliquidityeventhough,technically,itmaystillbesolvent11-33

TheDemandforandSupplyofLiquidityDemandsforLiquidityCustomerdepositwithdrawalsCreditrequestsfromqualityloancustomersRepaymentofnondepositborrowingsOperatingexpensesandtaxesPaymentofstockholderdividendsSuppliesofLiquidFundsIncomingcustomerdepositsRevenuesfromthesaleofnondepositservicesCustomerloanrepaymentsSalesofbankassetsBorrowingsfromthemoneymarket11-44

TheDemandforandSupplyofLiquidity(continued)Thesevarioussourcesofliquiditydemandandsupplycometogethertodetermineeachfinancialfirm’snetliquiditypositionatanymomentintimeThatnetliquidityposition(L)attimetisLiquidityDeficitisLt0andLiquiditySurplusisLt011-55

TheDemandforandSupplyofLiquidity(continued)TheessenceofliquiditymanagementproblemsforfinancialinstitutionsRarelyaredemandsforliquidityequaltothesupplyofliquidityatanyparticularmomentintimeThefinancialfirmmustcontinuallyd