Compute the net liquidity position of a bank and show which factors push its liquidity supply and liquidity demand up or down.
The idea
A bank's net liquidity position is liquidity supply minus liquidity demand over a stated horizon. A positive figure is a surplus. A negative figure is a deficit that must be funded. Supply rises with new deposits, loan repayments, sales of liquid securities, maturing assets and unused borrowing capacity. Demand rises with deposit withdrawals, new loan requests, drawdowns on committed credit lines and repayment of maturing borrowings. A fall in the market value of securities or a haircut on them lowers supply. Borrowing lines count only for the part the bank can really draw. The usual mistakes are reversing the sign, treating a drawdown or a repayment of borrowings as an inflow, and ignoring haircuts. On the exam, sort every item into supply or demand before you add.
Formulas
Net liquidity position
Net liquidity position = liquidity supply − liquidity demand
- liquidity supply
- new deposits, loan repayments, sales of liquid securities after haircuts, maturing assets and drawable borrowing capacity
- liquidity demand
- withdrawals, new loan requests, drawdowns on committed lines and repayment of maturing borrowings
Over a stated horizon; negative is a deficit to fund. Sort each item before adding, since a drawdown or a repayment of borrowings is a demand, not supply.
A practice question
A bank expects the following over the next month, in USD million. Supply: deposit inflows 250, loan repayments 120, sales of securities 50. Demand: deposit withdrawals 300, new loan requests 140, repayment of maturing borrowings 25. Its net liquidity position is:
- Deficit of USD 45 million - correct
- A deficit of USD 95 millionWhy not: Omits the USD 50 million of security sales from supply.
- A surplus of USD 45 millionWhy not: Reverses the sign: net position is supply minus demand, so 420 - 465 is negative.
- A surplus of USD 5 millionWhy not: Treats the USD 25 million repayment of borrowings as an inflow instead of a demand on cash.
Supply = 250 + 120 + 50 = 420. Demand = 300 + 140 + 25 = 465. Net = 420 - 465 = -45, a deficit. Repaying borrowings is a use of cash, so it belongs on the demand side.
A harder one
A bank starts the quarter with a net liquidity position of a USD 35 million surplus. During the quarter depositors withdraw an extra USD 80 million and a client draws USD 50 million on a committed credit line. Assuming nothing else changes, the new net liquidity position is:
- Deficit of USD 45 millionWhy not: Counts the extra withdrawals but forgets that the credit line drawdown is also a demand on cash.
- A surplus of USD 5 millionWhy not: Treats the credit line drawdown as an addition to supply instead of demand.
- A surplus of USD 165 millionWhy not: Adds both items to the surplus, treating the withdrawals and the drawdown as inflows.
- A deficit of USD 95 million - correct
Both the extra withdrawals and the drawdown raise demand. New position = 35 - 80 - 50 = -95, a deficit of USD 95 million.
The hardest tier
A bank assesses next quarter's liquidity in USD million. Supply: cash 120; trading securities with market value 200 that can be sold at a 10% haircut; expected loan repayments 90; unused borrowing lines of 150, of which only 60% can actually be drawn. Demand: deposit withdrawals of 8% of deposits of 1,500; drawdowns of 40% on committed loan facilities of 300; repayment of maturing borrowings 100. The net liquidity position is:
- A surplus of USD 160 millionWhy not: Counts the securities at their full market value of 200 and ignores the 10% haircut.
- A surplus of USD 200 millionWhy not: Counts the borrowing lines at 150 rather than the 60% that can actually be drawn.
- A surplus of USD 240 millionWhy not: Leaves the USD 100 million repayment of maturing borrowings out of demand.
- A surplus of USD 140 million - correct
Supply = 120 + 180 + 90 + 90 = 480. Demand = 120 + 120 + 100 = 340. Net = +140. Securities count after the haircut and credit lines only to the extent they can be drawn.
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