Bank Liquidity

Overview

Banks are financial organizations that borrow money from deposits and lend to customers who have more immediate spending needs. The money borrowed by a bank is listed as the liabilities of the bank, and the loans made are the banks assets. When a banks assets are worth more than the banks liabilities, the bank is solvent.

However, the banks liabilities will require the bank to pay cash at various times. Sometimes these dates are known contractually through a term contract, but often times, these pay dates are random, as when a liability is an on demand deposit where the customer can withdraw at any time.

If the banks assets are locked up entirely as loans, it may not have cash available. This means that the bank can be solvent and yet still fail to meet its required payments. This is the issue of liquidity. Liquidiy is a measure of how easily an asset can be turned into cash in order to make a required cash payment. A bank needs enough liquidity to meet its obligations.

Of course the difficulty is that liquid assets typically dont pay very well, so a bank wants to hold illiquid loans or other securities in order to make profits, but needs to hold liquid assets to cover its cash outflows.

Bankers and regulators have come up with various formulas to calculate the liquidity position of a bank.

liquidity and market microstructure

Measuring Liquidity

There are multiple ways one can go about measuring and controlling liquidity.

• The Basel III Accords provided a set of simple ratios for measuring and managing liquidity.
• Deposit Modeling is the process of creating a statistical model of a banks deposits in order to get a more precise measure of liquidity and the assumptions underlying that model.