1、Chapter 13,1,Chapter 13. Liquidity Risk and Liability Management,Learning Objectives: 1. To understand the importance of liquidity to banks and to the economy 2. To distinguish between core deposits and managed (volatile) liabilities 3. To understand the tradeoff between liquidity and profitability
2、4. To understand how to measure bank liquidity,Chapter 13,2,Learning Objectives (cont.) and Chapter Theme,5. To understand securitization as a tool of liquidity and risk management Chapter Theme Banks need liquidity to meet deposit withdrawals and to satisfy customer loan demand. This liquidity can
3、be stored in banks balance sheets or purchased in the marketplace. Being too liquid, however, is costly and not having enough liquidity is risky. As a tool of risk management, securitization permits banks to remove risk from their balances sheets and generate liquidity.,Chapter 13,3,The Importance o
4、f Liquidity,Consider these headlines from the American Banker Viewpoint: Too Many Banks Arent Ready for Looming Liquidity Crisis Spare Change: Liquidity Steering Group Going in Circles In Focus: Liquidity Rivaling Credit Quality as Crisis du Jour,Chapter 13,4,LEMAC: The Inverted CAMEL,L = Liquidity
5、E = Earnings M = Management A = Asset Quality C = Capital Adequacy,Chapter 13,5,Recent Liquidity Episodes,The aftermath of the “Attack on America” The bailout of LTCM The stock market of 1987 Contrast these events with what the Fed did after the stock-market crash of 1929,Chapter 13,6,Discussion Top
6、ic: Quote from John Reed (1987),We were providing as much liquidity as we could. Quite a few of the firms went right up to their loan limits. We didnt take physical possession of securities, but we were damn close to our customers. You have a tremendous conflict there. On one hand, theres a need for
7、 liquidity in the system. On the other hand, when youre dealing in $100 million lot sizes, you cant afford to be wrong. We cant take a $100 million write-off to save a broker. The stockholders would lynch me and with good reason.,Chapter 13,7,The Role of Confidence,A confidence function: Net worth (
8、+) Stability of earnings (+) Quality of information (+) Government guarantees (+) Liquidity (+),Chapter 13,8,The Evolution of Liquidity Management,Commercial-loan theory or real-bills doctrine (1920s and earlier) Asset-conversion or shiftability approach (post World War II through 1940s) Anticipated
9、-income theory (1950s) Liability management (late 1960s and early 1970s) Asset-liability management and securitization (mid-1970s to mid-1990s) Risk management (mid-1990s to present),Chapter 13,9,The Instruments of Liability Management (LM, see Box 13-1),Federal funds Repurchase agreements (RPs, rep
10、os) Negotiable CDs Consumer CDs Brokered deposits Eurodollar CDs Global CDs,Chapter 13,10,LM Instruments (continued),MMDAs IRAs Commercial paper Notes and debentures Volatile liabilities,Chapter 13,11,Chrysler Financial Corporation: Case Study of a Liquidity Crisis,Year-end 1989 financial profile: C
11、P outstanding = $10.1 billion Equity capital (E) = $2.8 billion Total assets (A) = $30.1 billion CP/A = 33.5% E/A = 9.3% or EM = 10.75 Note: CP = commercial paper,Chapter 13,12,The Credit Event,In 1990, Chryslers commercial paper (CP) was downgraded from P-2 to P-3 and subsequently to N.P. ( Not Pri
12、me) and its long-term bond rating was lowered from Baa to Ba Under these conditions, Chryslers CP was not attractive to the money market at rates that Chrysler was willing to pay, that is, it would have to pay a premium to obtain refinancing,Chapter 13,13,CP Background: Orderly Exit and Asset Sales,
13、Bank back-up lines of credit, standby letters of credit, and medium-term note facilities Asset sales,Chapter 13,14,Lines of Credit vs. Standby Letters of Credit,Since bank line-of-credit (LOC) contracts typically contain material-adverse-change (MAC) clauses, they are not guarantees and they have an
14、nual clean-up and rate resets. Strength of customer relation is important. In contrast, a standby letter of credit virtually guarantees payment, i.e., the bank will pay off the issue if the borrower cannot.,Chapter 13,15,Chryslers Strategy,An aggressive program of asset sales and securitization,Chap
15、ter 13,16,“The rest of the story .”,Immediate cash shortfall is met by borrowing $1.3 billion under its parent companys banks lines of credit By year-end 1990, CP outstanding is $1.1B, a decrease of $9B Sales of receivables in 1990 generates $18.3B Year-end 1990 assets total $24.7B with equity of $2
16、.8B (capital ratio of 11.3%),Chapter 13,17,The story continues .,To repay maturing debt of $3.6B in 1991 and $3B in 1992, Chrysler continued its asset-sales strategy.,Chapter 13,18,Epilogue,At year-end 1996, CFC was servicing $39.1B of receivables (94% auto related) up from $22.5B at year-end 1992.
17、Other data for 1996 are: CP = $2.6B, Senior term debt = $8.4B, NI = $0.376B, TA = $17.5B, E = $3.288B ROE profile: ROE = ROA x EM 0.1144 = 0.0215 x 5.32,Chapter 13,19,Discussion of other Cases,First National Bank of Browning, Montana (1980) Continental Illinois (Chicago, 1984) Bank of New England (1
18、991) REBs and FHLB Advances,Chapter 13,20,Liquidity Versus Profitability,Given a positively sloped yield curve, short-term rates long-term rates Short-term assets are safer while longer-term assets are riskier When the yield curve is inverted, safer assets have higher returns but such rates are expe
19、cted to decline based on the expectations theory,Chapter 13,21,Discussion Questions,Explain the basic yield-curve shapes and the embodied tradeoffs Over the interest-rate/business cycle, how does the yield curve move? How do bank loan and deposit flows move? Distinguish between stored liquidity and
20、purchased liquidity,Chapter 13,22,Effective Liquidity Management,Confidence Maintaining relationships Avoiding “fire sales” Cost of capital and default-risk premiums Avoiding the Feds discount window,Chapter 13,23,Core Deposits Versus Managed Liabilities,Core = sum of interest-bearing deposits in do
21、mestic offices minus large time deposits in domestic offices plus domestic demand deposits Core deposits are relatively stable funds gather in local markets They vary inversely with bank size,Chapter 13,24,Managed Liabilities,Managed liabilities have four components: Interest-bearing deposits in for
22、eign offices Large time deposits in domestic offices FF purchased/Repos Other interest-bearing liabilities “Hot money” is volatile and use of it varies directly with bank size,Chapter 13,25,Types of Interest-Bearing Liabilities,Savings accounts Small time deposits Large time deposits Deposits in for
23、eign offices FF purchases and RPs Discuss use of these funds by banks of various sizes,Chapter 13,26,Noninterest-Bearing Liabilities,Why do banks hold such funds? How have these funds varied over time? What forces have been driving these trends?,Chapter 13,27,The Cost of Bank Funds,Distinguish and d
24、iscuss the following pairs of terms with respect to cost: Foreign vs. domestic Core vs. managed liabilties Explicit vs. implicit interest Eras of interest-bearing checking accounts: Pre-1933 1933-1980 Post 1980,Chapter 13,28,A Banks Weighted Average Marginal Cost of Funds,Source of funds (as a % of
25、balance sheet) Interest cost Operating cost Total cost Weighted cost Weighted average,Chapter 13,29,Example (no operating costs),Source Amt Cost Weighted cost Deposits .85 5% 4.25% Nondep.debt 0.05 7% 0.35% Equity* .10 14% 1.40% Weighted 1.00 6.00% *Shareholder required return,Chapter 13,30,Market D
26、iscipline and Cost of Funds,Since riskier banks will have to pay more for funds than safer banks, bank should want to signal/demonstrate to money and capital markets that they are safe (e.g., have adequate capital the K in TRICK) To the extent that banks engage in cost plus pricing, they might just
27、ignore this discipline with respect to the costs of deposits and nondeposit debt; however, higher shareholder required returns and lower stock values should get managers attention,Chapter 13,31,Measures of Bank Liquidity,Sources and uses of funds Large-liability dependence Various ratios (to assets)
28、 Core deposits Loans Temporary investments Other ratios: Loans to deposits, pledged securities, brokered deposits, market to book (of securities),Chapter 13,32,The Dynamics of Liquidity Management,Role of expectations Properties of time series data Forecasting techniques,Chapter 13,33,The Three Face
29、s of Liability Management,Minimize interest expense Segment markets Meeting loan demand to enhance customer relationships Desire to reduce regulatory burdens associated with reserve requirements and deposit-insurance fees (and Reg Q when it existed),Chapter 13,34,The Risks of Liability Management,Ma
30、intaining the confidence of the marketplace is critical Government guarantees help and may even thwart market discipline “hot money,” however, tends to run and it does so electronically in todays world,Chapter 13,35,Chapter Summary,The importance and interaction of liquidity and confidence are captu
31、red by the following statements:“Liquidity always comes first; without it a bank doesnt open its doors; with it, a bank may have time to solve its basic problems“ (Donald Howard, Chief Financial Officer, Citicorp).,Chapter 13,36,Summary (continued),“Our whole financial system runs on confidence and
32、not much else when you get down to it. What weve learned is that when confidence erodes, it erodes very quickly“ (L. William Seidman, former Chairman, FDIC).,Chapter 13,37,Summary (continued),On the topic of liquidity and the availability of capital, also consider, this by David Ruder, former chairman of the SEC, following the stock market crash of October 1987 : “I personally regard that question is probably the most important one to come out of the market decline.,
