The ALCO has responsibility for structuring the bank’s balance sheet or determining the mix of assets and liabilities to meet the bank’s goals. Key to this responsibility is balancing credit, liquidity and market risk.

 

Liquidity has three components: amount, timeliness and cost. As a bank’s liquidity declines it becomes harder to raise the amount of money needed to meet the bank’s obligations in timely way at the lowest possible cost.

 

Changes in the fair or market value of held-to-maturity securities are reported on one of the schedules in a bank’s quarterly Report of Condition and Income, but these changes are not reflected in the bank’s capital. Changes in the value of available-for sale securities are an adjustment to capital.

 

Core deposits are considered the most reliable and stable funding source because they are slow to change in response to market conditions, new competitors and interest rates.

 

Banks designate their investment securities as available-for-sale because of the liquidity function they perform. Income from these securities is important, but not as important as the liquidity they provide.

 

Strong capital and financial condition are key indicators of a borrower’s ability to repay. Banks with poor capital, low earnings and deteriorating financial conditions will be not be able to take advantage of certain funding sources because of legal restrictions or because lenders are leery about lending to institutions with less than stellar performance.

 

Like other aspects of a bank’s operation, the board of directors is responsible for ensuring that management has processes in place and procedures for providing the bank with adequate liquidity.

 

The primary focus of a liquidity policy is to ensure adequate liquidity at a reasonable cost. However, because many aspects of a bank’s operation are interrelated, it would not be unusual to see other policies (such as the loan and investment policies) incorporate limits and restrictions to help manage a bank’s liquidity position.

 

Generally there is a trade-off between how liquid an asset is and the return it provides. Cash, for instance, the most liquid of all assets, provides no return. Loans that provide a relatively high return generally provide less liquidity. In banking, there is a continual balancing act between risk and return. In liquidity management, the trade-off is between the need for liquidity and the need for earnings.

 

Whether you’re an individual or a bank borrowing money, knowing the terms of the deal—interest rate (whether it is fixed or variable), payment schedule, payment amount, penalties, financial condition covenants, collateral requirements—is key. Knowing the terms can help the bank avoid situations in which getting out of a deal can be costly.

 

The board of directors is ultimately responsible for these policies. The cashier may be of assistance. As part of executive management, the cashier is responsible for daily activities related to the policies, including taking steps to achieve compliance with these policies and for reporting to the board on compliance.

 

The ratio of loans to deposits is a very basic and simple measure of liquidity. As an indicator of your bank’s ability to support loan growth with existing deposits, this ratio serves as a starting point in many liquidity analyses. This ratio is also a common limit included in liquidity policies at banks.

 

These deposits placed in your bank by third parties are not core deposits. They tend to move quickly to banks paying higher rates and can also move out if a bank is perceived as having financial problems. They lack the stability of core deposits and are frequently more expensive than core deposits.

 

This ratio is calculated by taking noncore liabilities less short-term investments and dividing that by long-term assets.

 

Banking is basically the management of risk and it’s hard to imagine a risk-free transaction. Concerns regarding any type of borrowing are that if the condition of the bank deteriorates, the bank may experience difficulties in rolling over borrowing at a reasonable rate (as it matures) or the lender to the bank may demand return of funds.

 

Remember that liquidity risk is the risk that your bank won’t be able to raise cash quickly and at a reasonable cost when it needs to do so. Estimating the anticipated funding needs and sources for meeting those needs is a basic way of providing your bank with the necessary liquidity.

 

While a depositor who maintains a demand deposit account balance that comprises 50% of a bank’s total deposits would certainly enhance net income, a downside of such a customer is the need to maintain sufficient liquidity to cover the customer’s unexpected withdrawals. Many banks have encountered such “stable customers” that made significant unexpected withdrawals, for a variety of reasons, which caused liquidity difficulties for the banks. This can be tantamount to a “run” on the bank, creating an atmosphere where management panics and makes unwise decisions.

 

Loan maturities will affect anticipated funding needs so they are very relevant to liquidity risk.

 

It is the responsibility of the board to monitor the bank’s liquidity position and compliance with policies.