How to define and measure Liquidity,liquidity risk tolerance and cushion value for a bank?

A bank is responsible for the sound management of liquidity risk. A bank should establish a robust liquidity risk management framework that ensures it maintains sufficient liquidity, including a cushion of unencumbered, high quality liquid assets, to withstand a range of stress events, including those involving the loss or impairment of both unsecured and secured funding sources. Supervisors should assess the adequacy of both a bank's liquidity risk management framework and its liquidity position and should take prompt action if a bank is deficient in either area in order to protect depositors and to limit potential damage to the financial system.

Correct, one uses stethescope for primitive measure and move ahead rather than sticking there. I agree that one cant reach in higher education before primary one.

Thanks and regards,

Sanjay

Dear KS, Thanks for showing interest in discussion of liquidity. Please find following excerpt from the circular of RBI (BP.BC. 8/21.04.098/99 ).

"The Statement of Structural Liquidity ( Annexure I ) may be prepared by placing all cash inflows and outflows in the maturity ladder according to the expected timing of cash flows. A maturing liability will be a cash outflow while a maturing asset will be a cash inflow. It would also be necessary to take into account the rupee inflows and outflows on account of forex operations. While determining the likely cash inflows / outflows, banks have to make a number of assumptions according to their asset - liability profiles. For instance, Indian banks with large branch network can (on the stability of their deposit base as most deposits are rolled-over) afford to have larger tolerance levels in mismatches in the long-term if their term deposit base is quite high. While determining the tolerance levels the banks may take into account all relevant factors based on their asset-liability base, nature of business, future strategy, etc. The RBI is interested in ensuring that the tolerance levels are determined keeping all necessary factors in view and further refined with experience gained in Liquidity Management."

If you are further interested you visit Basel website (www.bis.org) and may read bcbs 144.pdf for further understanding.

I hope this is clear now.

I appreciate your participation. I expect your kind feedback.

regards,

Sanjay

Ratio Analysis is, no doubt, a useful tool. However, cash flow analysis help understand real quantum of cash/cash equivalent available than a relative figure supplied by a ratio. Secondly, and most importantly, bank focuses more on management of short-term liquidity- daily, weekly and fortnightly basis, and hence cash flow suits definately better. Its true that RBI does manage liquidity of the system through SLR and CRR on macro level, but the format suggested by RBI for micro-level liquidity management (at bank level) is cash flow based. One may check RBI website for more detail. Additionally, basel committee has even proposed intra-day liquidity management, which, is  based on cash flow analysis due to obvious reasons.

Ratio Analysis is, no doubt, a useful tool. However, cash flow analysis help understand real quantum of cash/cash equivalent available than a relative figure supplied by a ratio. Secondly, and most importantly, bank focuses more on management of short-term liquidity- daily, weekly and fortnightly basis, and hence cash flow suits definately better. Its true that RBI does manage liquidity of the system through SLR and CRR on macro level, but the format suggested by RBI for micro-level liquidity management (at bank level) is cash flow based. One may check RBI website for more detail. Additionally, basel committee has even proposed intra-day liquidity management, which, is  based on cash flow analysis due to obvious reasons.

Ratio Analysis is, no doubt, a useful tool. However, cash flow analysis help understand real quantum of cash/cash equivalent available than a relative figure supplied by a ratio. Secondly, and most importantly, bank focuses more on management of short-term liquidity- daily, weekly and fortnightly basis, and hence cash flow suits definately better. Its true that RBI does manage liquidity of the system through SLR and CRR on macro level, but the format suggested by RBI for micro-level liquidity management (at bank level) is cash flow based. One may check RBI website for more detail. Additionally, basel committee has even proposed intra-day liquidity management, which, is  based on cash flow analysis due to obvious reasons.

Well, Measuring liquidity is like treating serious heart problem based on stethscope. Like stethscope, ratio may be consider as the begining point of investigation but certainly not "the best" solution. At aggregate level(macro level), it may be used but It can never be used for micro level (day to day) liquidity management. Thats why RBI manages liquidity through CRR/SLR but advise banks to follow cash flow based gap management (and even cash flow-at-risk) to use for day to day liquidity management. Basel, going one step ahead, suggest to do itra-day liquidity manaement which has to b cash flow based than ratio. One important thing one has to remember is that banking assets are, in general, are of longer maturity funded by short term maturity funding, hence liquidity ratio estimation need extra-care to decide "liquid assets/liabilities".It becomes complecated once one consider "behavioural pattern" of assets/liability at the place of "contractual maturity". Therefore, a deposit for, say, a month may stay more than a year through rolled over.Similarly, ODs and other revolving lines of credit/LCs has drawn on the liquidity of the bank which need to be estimated through assigning a probability to the cash flow. Ratio analysis couldnt at all capture these behaviour issue. I hope this clarifies.

Look most of us are thinking in terms of Cash available when we say cashflow anslysis. Yes it is important. But we cannot ignore the importance of ratio analysis. Though some of you might be right in saying that ratios can be tempered with. I say that if clarity and transparency is there in your approach than even ratio analysis will work. But as a thumb rule cashflow analysis is good for measuring the Liquidity.

yes sanjay totally agree with you cash flow analysis  is better when it comes to measure the liquidity and to control them...lets see what are others perspective on this one...

I beleive cashflow approach of liquidity gap analysis- within time buckets is a better  way to measure liquidity and control it. It may also help define liquidity risk tolerance and cushion amount. This method further can help define business conditions- like normal, stress conditions and severe stress conditions.