Liquidity Management

Liquidity Liquidity is the availability of funds or assurance that funds will be available to honour all cash outflow commitments (both on- and off-balance sheet) as they fall due

Liquidity Management Managing assets and liabilities (on- and off-balance sheet) both as to cash flow and concentration to ensure that cash inflows have an appropriate relationship to approaching cash outflows

Liquidity Planning Assessing potential future liquidity needs taking into account changes in economic regulatory or other operating conditions and weighing alternative assetliability management strategies to ensure that adequate cash inflows will be available to an institution to meet these needs

Operating Liquidity The liquidity required to meet day-to-day cash outflow commitments taking into account assetliability management techniques for controlling liquidity through the management of cash flows supplemented by assets readily convertible to cash or by the institutionrsquos ability to borrow

LETS EXPLORE IThellip

Introduction

We often hear the word liquidity used in combination with cash management Liquidity is a firmrsquos ability to pay its short-term debt obligations In other words if the firm has adequate liquidity it can pay its current liabilities such as accounts payable Usually accounts payable are debts owe to our suppliers

There are methods we can use to measure liquidity Financial ratio analysis will help us determine how liquid firm is or how successful it will be in meeting its short-term debt obligations The current ratio will help us determine the ratio of current assets to current liabilities Current assets include cash accounts receivable inventory and occasionally other line items such as marketable securities We need to have more current assets than current liabilities on our balance sheet at all times

The quick ratio will allow determining if we can pay your short-term debt obligations or current liabilities without having to sell any inventory Itrsquos important for a firm to be able to do this because if we sell have to sell inventory to pay bills that means we have to find a buyer for that inventory Finding a buyer is not always easy or possible

There is various other measure of liquidity that you will want to use to determine our cash position

When your business is just starting up we essentially run it out of a check book which is an example of cash accounting As long as there is cash in the account our business is solvent As business becomes more complex we will have to adopt financial accounting However we have to keep a focus on liquidity and cash management even though our track net income through financial accounting

PURPOSE

This document sets out the minimum policies and procedures that each institution needs to have in place and apply within its liquidity management programme and the minimum criteria it should use to prudently manage and control its liquidity

Although this document focuses on the institutionrsquos responsibility for managing liquidity and is intended to address liquidity management within the context of a strategic liquidity plan under ordinary or reasonably expected business conditions liquidity management cannot be conducted in isolation from other assetliability management considerations such as interest and foreign exchange rate risk or other risks However since liquidity determines the day-ti-day viability of an institution it must remain the principal consideration of assetliability management

Moreover this document presents the management of liquidity undifferentiated as to currency denomination since in principal through the foreign exchange markets commitments in one currency may be met by the availability of funds in another However institutions that conduct substantial business in foreign currencies need to make distinctions between the management of liquidity in domestic currency and that in other currencies

DEFINITION

honors all cash outflow commitments (both on- and off-balance sheet) as they all due These Liquidity is the availability of funds or assurance that funds will be available to commitments are generally met through cash inflows supplemented by assets readily convertible to cash or through the institutionrsquos capacity to borrow The risk illiquidity may increase if principal and interest cash flow related to assets liabilities and off-balance sheet items are mismatched

Liquidity for bank means the ability to meet financial obligations as they come due Bank lending finances investments in relatively liquid assets but it fund its loans with mostly short term liabilities Thus one of the main challenges to a bank is ensuring its own liquidity under all reasonable conditions

LIQUIDITY POLICIES IN BANK

Sound and prudent liquidity policies set out the sources and amount of liquidity required to ensure it is adequate for the continuation of operations and to meet all applicable regulatory requirements These policies must be supported by effective procedures to measure achieve and maintain liquidity

Operating liquidity is the level of liquidity required to meet an institutionrsquos day-to-day cash outflow commitments Operating requirements are met through assetliability management techniques for controlling cash flows supplemented by assets readily convertible to cash or by an institutionrsquos ability to borrow

Factors influencing an institutionrsquos operating liquidity include

1048707 cash flows and the extent to which expected cash flows from maturing assets and liabilities match and

1048707 The diversity reliability and stability of funding sources the ability to renew or replace deposits and the capacity to borrow

For regulatory purposes an institution is required to hold a specific amount of assets classed as ldquoliquidrdquo based on its deposit liabilities Generally undue reliance should not be placed on these assets or those formally pledged for operating purposes other than as a temporary measure as legally they may not be available for encashment if needed

In assessing the adequacy of liquidity each institution needs to accurately and frequently measure

1048707 the term profile of current and approaching cash flows generated by assets and liabilities both on- and off-balance sheet

1048707 the extent to which potential cash outflows are supported by cash inflows over a specified period of time maturing or liquefiable assets and cash on hand

1048707 the extent to which potential cash outflows may be supported by the institutionrsquos ability to borrow or to access discretionary funding sources and

1048707 The level of statutory liquidity and reserves required and to be maintained

Essentially operating liquidity is adequate if the institutionrsquos approaching cash inflows supplemented by assets readily convertible to cash or by an institutionrsquos ability to borrow are sufficient to meet approaching cash outflow obligations In this context because the timing and amount of these cash flows are not completely predictable because of risks such as credit defaults and events including honouring customer drawdownrsquos on credit commitments deposit redemptions and prepayments either on mortgages or term loans sound and prudent liquidity policies must deal with this uncertainty by carefully controlling the maturity of assets ensuring assets are readily convertible to cash or securing sources to borrow funds

Liquid assets should have the following attributes

1048707 diversified residual maturities appropriate for the institutionrsquos specific cash flow needs

1048707 readily marketable or convertible into cash and

1048707 Minimal credit risk

Holding assets in liquid form for liquidity purposes will often involve some loss of earnings capacity relative to other investment opportunities Nevertheless the primary objective with respect to managing the liquid asset portfolio is to ensure its quality and convertibility into cash

Liquidity lines and funding facilities may also have a role within an institutionrsquos liquidity programme by helping an institution protect itself against temporary difficulties that might occur when honouring cash outflow commitments Examples are the need to draw on credit facilities to meet unforeseen clearing commitments and to meet credit commitments with drawdown at the customerrsquos option Undue reliance should not be placed on these facilities (including those that may be irrevocable or for which a fee is paid) as substitutes for traditional funding sources as they are generally very short term in nature they are costly compared with other funding sources and their availability could be withheld by the provider of the facility Institutions using these sources for liquidity need to ensure that the provider of a facility has an appropriate credit standing and capacity

Importance of liquidity management

1Review the contractual terms of borrowing contracts and indentures to assess any liquidity implications Determine whether the contracts and indentures contain options and other option-like features that could have adverse liquidity implications

2 Ensure that management is aware of the terms triggers and parameters of borrowing relationships with the FHLB and FRB especially as they relate to lending curtailments and nonfunding under various scenarios Verify that management has appropriately considered and incorporated as applicable these features into its stress test and scenario analysis and contingent funding plan Obtain the results of the most recent FHLB and FRB current ratings and onsite loan reviews from bank management and assess the steps taken by management to address concerns anddocumentation exceptions

3 Verify that management periodically tests the availability of funds under its various borrowing relationships especially those involving nongovernment entities such as other banking organizations Ensure that such testing becomes more frequent when there is

evidence or indications of approaching stressful market conditions

4 Determine the trend and stability of deposits Ensure that management is aware that the FDIC is unlikely to grant brokered deposit waivers to savings associations falling below well-capitalized status and has considered this in its contingent funding plan

5 Determine the ability of the savings association to securitize and sell certain pools of assets including nontraditional mortgage products less than prime loans home equity loans credit card receivables automobile loans and commercial real estateloans

Remember the crisis in 2008

Features of liquidity management

1 Banks need liquidity to meet deposit withdrawal and to fund loan demands

2 The variability of loan demands and variability of deposits determine bankrsquos liquidity needs It represents the ability to accommodate decreases in liability and to fund increases in assets

3 It demonstrates the market place that the bank is safe and therefore capable of repaying its borrowings

4 It enables bank to meet its prior loan commitments whether formal or informal

5 It enables bank to avoid the unprofitable sale of assets

6 It lowers the size of the default risk premium the bank must pay for funds

Control procedures

Each licensee needs to develop and implement effective and comprehensive procedures and information systems to manage and control liquidity in accordance with its liquidity and funding policies These procedures must be appropriate to the size and complexity of the institutionrsquos liquidity and funding activities Internal inspectionsaudits are a key element in managing and controlling an institutionrsquos liquidity management programme Each institution should use

them to ensure that liquidity management complies with liquidity and funding policies and procedures Internal inspectionsaudits should at a minimum randomly test all aspects of liquidity management in order to

1048707 ensure liquidity and funding policies and procedures are being adhered to

1048707 ensure effective controls apply to managing liquidity

1048707 verify the adequacy and accuracy of management information reports and

1048707 ensure that personnel involved in the liquidity management fully understand the institutionrsquos liquidity and funding policies and have the

expertise required to make effective decisions

consistent with the liquidity and funding policies

Assessments of the liquidity management operation should be presented to the institutionrsquos Board of Directors on a timely basis for review

Liquidity management programme

Managing liquidity is a fundamental component in the safe and sound management of all financial institutions Sound liquidity management involves prudently managing assets and liabilities (on- and off-balance sheet) both as to cash flow and concentration to ensure that cash inflows have an appropriate relationship to approaching cash outflows This needs to be supported by a process of liquidity

planning which assesses potential future liquidity needs taking into account changes in economic

regulatory or other operating conditions Such planning involves identifying known expected and potential cash outflows and weighing alternative assetliability management strategies to ensure that adequate cash inflows will be available to the institution to meet these needs

The objectives of liquidity management are

1048707 honouring all cash outflow commitments (both on- and off-balance sheet) on an ongoing daily basis

1048707 avoiding raising funds at market premiums or through the forced sale of assets and

1048707 satisfying statutory liquidity and statutory reserve requirements

Although the particulars of liquidity management will differ among institutions depending upon the nature and complexity of their operations and risk profile a comprehensive liquidity management programme requires

1048707 establishing and implementing sound and prudent liquidity and funding policies and

1048707 developing and implementing effective techniques and procedures to monitor measure and control the institutionrsquos liquidity requirements and position

Funding policy

Deposit liabilities are the primary source of funding for all institutions In this context an important element of an institutionrsquos liquidity management programme is the diversification of funding by origination and term structure Each institution needs to have explicit and prudent policies that ensure funding is not unduly concentrated with respect to

1048707 individual depositor

1048707 type of deposit instrument

1048707 market source of deposit

1048707 term to maturity and

1048707 currency of deposit if the institution has liabilities (both on- and off-balance sheet) in foreign currencies

The primary funding risk is the unplanned deposit withdrawal or the reduced rate of deposit renewal at the time of maturity Deposits may decline due to a loss of confidence in the institution a general decline in savings more attractive investments elsewhere or as a result of other factors

Concentrated funding sources leave the institution open to potential liquidity problems as a result of such unexpected deposit withdrawal and may also restrict an institutionrsquos flexibility in managing its cash flow Institutions with excessive funding concentrations may require additional liquid assets

In the context of foreign currency deposits funding policies also need to ensure that foreign currency cash flows are prudently managed and controlled within the policies and procedures set out under the institutionrsquos foreign exchange risk management programme

Role of board of directors

The Board of Directors of each institution is ultimately responsible for the institutionrsquos liquidity In discharging this responsibility a Board of Directors usually charges management with developing liquidity and funding policies for the boardrsquos approval and developing and implementing procedures to measure manage and control liquidity within these policies

A Board of Directors needs to have a means of ensuring compliance with the liquidity management programme A Board of Directors generally ensures compliance through periodic reporting by management and internal inspectorsauditors The reports must provide sufficient information to satisfy the Board of Directors that the institution is complying with its liquidity management programme

At a minimum a Board of Directors should

1048707 review and approve liquidity and funding policies based on recommendations by the institutionrsquos management

1048707 review periodically but at least once a year the liquidity management programme

1048707 ensure that an internal inspectionaudit function reviews the liquidity and funding operations to ensure that the institutionrsquos policies and procedures are appropriate and are being adhered to

1048707 ensure the selection and appointment of qualified and competent management to administer the liquidity management function and

1048707 outline the content and frequency of management liquidity reports to the board

Role of

management in liquidity management

The management of each institution is responsible for managing and controlling the day-to-day liquidity of the institution according to the liquidity management programme

Although specific liquidity management responsibilities will vary from one institution to another management should be responsible for

1048707 developing and recommending liquidity and funding policies for approval by the Board of Directors

1048707 implementing the liquidity and funding policies

1048707 ensuring that liquidity is managed and controlled within the liquidity management and funding management programmes

1048707 ensuring the development and implementation of appropriate reporting systems with respect to the content format and frequency of information concerning the institutionrsquos liquidity position in order to permit the effective analysis and the sound and prudent management and control of existing and potential liquidity needs

1048707 establishing and utilizing a method for accurately measuring the institutionrsquos current and projected future liquidity

1048707 monitoring economic and other operating conditions to forecast potential liquidity needs

1048707 ensuring that an internal inspectionaudit function reviews and assesses the liquidity management programme

1048707 developing lines of communication to ensure the timely dissemination of the liquidity and funding policies and procedures to all individuals involved in the liquidity management and funding risk management process and

1048707 reporting comprehensively on the liquidity management programme to the Board of Directors at least once a year

BEST friend for financial institution

Setting tolerance level for a bank To manage the mismatch levels so as to avert wide liquidity gaps-The residual maturity profile of assets and liabilities will be such that mismatch level for time bucket of 1-14 days and 15-28 days remain around 20 of cash outflows in each time bucket To manage liquidity and remain solvent by maintaining short-term cumulative gap up to one year(short term liabilities-short term assets at 15 of total outflow of fund

Measuring and Managing Liquidity Risk

Stock Approach Flow Approach Stock Approach is based on the level of assets and liabilities as well as off balance sheet exposures on a particular date The following ratios are calculated to assess the liquidity position of the bank

Ratio of core deposits to total assets Net loans to total deposits ratio

Ratio of time deposits to total deposits

Ratio of volatile liabilities to total assets

Ratio of short term liabilities to liquid assets

Ratio of liquid assets to total assets

Ratio of short term liabilities to total assets

Ratio of prime assets to total assets

Ratio of market liabilities to total assets

Flow Approach Measuring and managing net funding requirements Managing Market Access Contingency Planning

Measuring and Managing net funding Requirements Flow method is the basic approach followed by Indian Banks It is called as gap method of measuring and managing liquidity It requires the preparation of structural liquidity gap report

Interest rate risk management

Interest rate risk is the volatility in net interest income(NII) or in variations in net interest margin(NIM)Gap The gap is the difference between the amount of assets and liabilities on which the interest rates are reset during a given periodBasis risk The risk that the interest rate of different assets and liabilities may change in different magnitudes is called basis riskEmbedded option Prepayment of loans and bonds andor premature withdrawal of deposits before their stated maturity dates

Yield curve It is a line on a graph plotting the yield of all maturities of a particular instrumentChanges in interest rates also affect theunderlying value of the bankrsquosRaise in interest rates the market value of thatAsset and fall in interest rate the market valueOf assets or liabilitiesThe gap is the difference between the amountof assets and liabilities on which interest ratesare during a given period

bull Mismatch occurs when assets and liabilities fall due for a different periods

bull The economic value of a bank can be viewed as the present value of the bankrsquos expected

Estimates derived from a standard duration generally focus on just one form of interest rate risk exposure The adverse impact on NII due to mismatches can be minimized by fixing appropriate on interest rate sensitivity gaps

Management of foreign exchange risk

bull Foreign exchange risk-Risk arising out of adverse exchange rate movements during a period in which it has open position in an individual foreign currency

bull Transaction exposure Change in the foreign exchange rate between the time the transaction is executed and the time it is settled

bull Forwards-Agreement to buy or sell forex for a predetermined amount at a predetermined rate on a predetermined date

Open position The extent to which outstanding contracts to purchase a currency exceed liabilities plus outstanding contracts to sell the currency amp vice versa

Overnight position-A limit on the maximum open position left overnight in all major currenciesDay-light position-A limit on maximum open position in all major currencies at any point of time during day Such limits are generally larger than overnight positions

Benefits of liquidity management

If an appropriate liquidity management solution is effectively implemented the corporation stands to enjoy a range of benefits (these otherwise representing opportunity costs)

Balance consolidation This is realized by eliminating the cost of maintaining cash deficits and surpluses in the same currency that could otherwise have been offset In financial terms it is determined by the differential between the interest rates applicable to the credit and debit balances that are offset

Balance aggregation Increasing the size of the aggregate cash position attracts better interest terms than those achievable on individual balances left idle or invested separately It is a function of the interest-rate differential between the rates achieved with and without aggregation

Balance stability Connecting multiple accounts into a larger liquidity structure has the portfolio effect of reducing overall net balance volatility As a result it becomes easier to identify and isolate a stable liquidity core within this net balance This confers two primary advantages

The structure is better able to absorb unexpected cash flow events and mitigate their impact thereby also

minimizing the effect of any inaccuracies in the cash forecasting process Determining accurate time slicing of available cash is easier thereby facilitating more efficient distribution of investments across the maturity spectrum

(An accurate assessment of this type of benefit is more complex and requires the utilization of statistical concepts)

Net balance utilization This is the minimization of the opportunity cost of being unable to extract the maximum value from the aggregate net cash flow The scale of this benefit depends upon various factors including

The size and stability of the core element Medium-term cash forecasting accuracy and The corporates financial position (ie whether typically a net depositor or borrower)

In financial terms the net balance utilisation benefit results from the interest-rate differential between the current and the alternative usage of the net liquidity (ie reduced funding cost or enhanced investment yield)

Other benefits Other potential benefits derived from effective liquidity management include

Management costtime savings particularly when using passive and fully automated techniques

Increased visibility and control of cash flows More rigorous counterparty risk management such as on idle balances or balances invested locally with institutions not validatedapproved by treasury Reduced dependency on local credit facilities Improved enterprise-wide liquidity risk management and Greater strategic financial flexibility

Bassel committee on bank liquidity management

The Committee believes that liquidity - the ability to fund increases in assets and meet obligations as they become due - is crucial to the ongoing viability of any banking organisation But the importance of liquidity transcends the individual bank since a liquidity shortfall at a single organisation can have systemic repercussions The management of liquidity is therefore among the most important activities conducted at banks

Over time there has been a declining ability to rely on core deposits and an increased reliance on wholesale funding Recent technological and financial innovations have provided banks with new ways of funding their activities and managing their liquidity but recent turmoil in global financial markets has posed new challenges for liquidity management In light of these developments the Committee is replacing the existing 1992 paper on liquidity - A framework for measuring and managing liquidity - with updated guidance The paper is organised around a set of 14 principles falling in the following key areas

Developing a structure for managing liquidity Measuring and monitoring net funding

requirements Managing market access

Contingency planning Foreign currency liquidity management Internal controls for liquidity risk management Role of public disclosure in improving liquidity Role of supervisors

The paper is not being issued formally for consultation but if you have strong views our Risk Management Group would be pleased to receive them

RBIrsquos Latest view on liquidity management

On a review of the current liquidity situation in the context of global and domestic developments it has been decided to reduce the CRR from its current level of 90 per cent of net demand and time liabilities (NDTL) by 50 basis points to 85 per Cent of NDTL with effect from the fortnight beginning October 11 2008 As a result of This reduction in the CRR an amount of about Rs 20 000 cores would be released Into the system This measure is ad hoc temporary in nature and will be reviewed on A continuous basis in the light of the evolving liquidity conditions Active liquidity management is a key element of the current monetary policy Stance Liquidity modulation through a flexible use of a combination of instruments has to a significant extent cushioned the impact of the international financial turbulence on domestic financial markets by absorbing excessive market pressures and ensuring orderly conditions In view of the evolving environment of heightened

uncertainty volatility in global markets and the dangers of potential spillovers to domestic equity and currency markets liquidity management will continue to receive Priority in the hierarchy of policy objectives over the period ahead The Reserve Bank will continue with its policy of active demand management of liquidity through appropriate use of the CRR stipulations and open market operations (OMO) including the MSS and the LAF using all the policy instruments at its disposal Flexibly as and when the situation warrants The overall stance of monetary policy in 2008-09 accords high priority to price stability well-anchored inflation expectations and orderly conditions in financial markets while being conducive to continuation of the growth momentum as set out In the Annual Policy Statement and reiterated in the First Quarter Review of July 2008 The overriding priority for monetary policy is to eschew any further intensification of inflationary pressures and to firmly anchor inflation expectations

RBI liquidity management measures

RBI announces Monetary Policy and Liquidity Management Measures Monetary Policy Measures On an assessment of the current macroeconomic situation it has been decided to take the following monetary policy measures as a part of the calibrated exit from the expansionary monetary policy

bull to increase the repo rate under the Liquidity Adjustment Facility (LAF) by 25 basis Points from 525 per cent to 550 per cent with immediate effect

bull To increase the reverse repo rate under the LAF by 25 basis points from 375 per Cent to 40 per cent with immediate effect Liquidity Management Measures Also on the basis of an assessment of the current liquidity situation the Reserve Bank has decided to extend the following liquidity management measures i) The additional liquidity support to scheduled commercial banks under the LAF to the extent of up to 05 per cent of their net demand and time liabilities (NDTL)

currently set to expire on July 2 2010 is now extended up to July 16 2010 For Any shortfall in maintenance of statutory liquidity ratio (SLR) arising out of availment of this facility banks may seek waiver of penal interest purely as an ad Hoc measure

ii) The second LAF (SLAF) will be conducted on a daily basis up to July 16 2010 Rationale for Monetary Policy Measures There have been significant macroeconomic developments since the April 2010 Monetary Policy Statement At the global level the recovery is strengthening However the outlook continues to be clouded by uncertainty in the Euro area

On the domestic front the revised growth estimates by the Central Statistical Organisation (CSO) for 2009-10 and for Q4 of 2009-10 suggest that the recovery is Consolidating The manufacturing sector has recorded robust growth in recent months Aided among others by expanding exports The strong underlying growth momentum is also evidenced by the sharp upturn in the capital goods sector acceleration in credit Growth and the widening current account deficit The monsoon situation so far has

been decidedly better than during last year holding prospects for good agriculture Growth In its April policy review the Reserve Bank projected real GDP growth for 2010-11 at 8 per cent with an upside bias More recent data suggest that the upside bias has Largely materialised The growth projection will be reviewed in the First Quarter Review On July 27 2010

The developments on the inflation front however raise several concerns Overall WPI inflation increased to 102 in May 2010 up from 96 per cent in April 2010 Food price inflation and consumer price inflation remain at elevated levels There have 2Been some moderation in food price inflation but the price index of food articles continues to increase More importantly the prices of non-food manufactured goods and fuel items have accelerated in recent months Year-on-year WPI non-food manufacturing products (weight 522 per cent) inflation which was (-) 04 per cent in November 2009 and 54 per cent in March 2010 rose further to 66 per cent in May 2010 Year-on-year fuel price inflation also surged from (-) 08 per cent in November 2009 to 127 per cent in March 2010 and further to 131 per cent in May 2010 Although entirely justified in terms of long-term fiscal and energy conservation objectives the recent increase in fuel prices will have an immediate impact of around one

percentage point on WPI inflation with second round effects being felt in the months ahead Significantly two-thirds of WPI inflation in May 2010 was contributed by non-food items suggesting that inflation is now very much generalised and that demand-side pressures are evident

Timing of the Action This mid-cycle policy action has been warranted by the evolving macroeconomic situation Even as data for real GDP growth and WPI inflation became available by mid-June 2010 it was considered inadvisable to raise the policy rates as the financial system was dealing with liquidity pressures triggered by sudden build-up in government cash balances occasioned by the larger than anticipated level of 3G spectrum and broadband wireless access auction realisations Through the month of June liquidity under LAF operations remained in deficit mode Consequently the call rate moved up significantly resulting in an effective tightening at the short end of the yield curve The liquidity situation has since begun to ease Rationale for Extension of Liquidity Management Measures In late May 2010 in anticipation of the liquidity pressures on account of payments for 3G spectrum and advance taxes the Reserve Bank took certain liquidity easing measures Even as the liquidity situation has begun to ease these measures are being extended since liquidity tightness may persist

Expected Outcomes The above monetary measures should contain inflation and anchor inflationary expectations going forward while not hurting the recovery process Easing liquidity and raising rates at the same time may seem apparently inconsistent It should be noted in this context that the liquidity easing measures have become necessary to manage what is essentially a temporary and unanticipated development In no way should they be viewed as inconsistent with the monetary policy stance of calibrated exit which remains focussed on containing inflation and anchoring inflationary expectations without hurting growth The Reserve Bank will continue to monitor the macroeconomic conditions particularly he price situation and take further action as warranted

Dynamic analysis

Future Business Assumptions

The first step in achieving a more accurate picture of exposure based on current figures above a normal (not stressed) scenario is to include planned roll-overs andreinvestments that are an integral part of ordinary operations Products such as Algorithmicsrsquo ALM with its Dynamic Trading Strategy (DTS) functionality permit

users to integrate planned transactions into the liquidity picture Large liquidity gaps are highly likely to disappear mismatches will be reduced and the probability distribution of mismatches will reflect a more realistic view of future exposures

Funding Alternatives

Since a firm is a living entity exposure to liquidity risk is subject to continuous change as a consequence not only of past operations but also of new business Effective management of liquidity risk must ensure that the company can raise enough finance to support the planned development of business in an orderly manner Failure to do so could jeopardize the growth of the firm or in the worst case strain its financial structure and increase risk exposure The ability to assess the impact

of different funding alternatives on the balance sheet is also crucial for optimizing debt and capital and boosting value creation Firms should have the ability to integrate business development strategies as well as inherent business constraints into their liquidity planning activities

Stress SimulationsSimulation exercises can help optimize business and funding strategies The growth of assets implies greater funding needs and affects variables such as asset maturity and duration New finance can be drawn from different sources with varying impacts on the firmrsquos liquidity equilibrium and capital structure Funding sources include cash flow from ordinary business new deposits issue of senior or subordinated debtshare capital increases securitizations and others Inherent constraints to consider include internal or regulatory targets such as limits maturity duration gaps amountof (senior or subordinated) outstanding debt amount of minimum available spare liquidity risk indicators as Cash Flow at Risk or Liquidity at Risk and othersStress simulations can produce a comprehensive view of a firmrsquos current exposure to liquidity risk as well as the potential evolution of liquidity risk within the businessPlanning horizon They also set the stage for effective crisis management planning In this way a firm can assess how capable it is of maintaining stability even under unforeseen severe adverse events both firm-specific and systemic Algorithmic ALM contributes here as well providing a comprehensive picture of liquidity exposures over time in both normal and stress contexts