Liquidity Management For Banks

A bank is considered to be liquid if it has ready access to immediate spendable funds at reasonable cost at precisely the time those funds are needed.

A liquid bank is one that has the right amount of spendable funds at hand when it is required or can raise liquid funds by buying or selling assets back of adequate liquidity. When a bank fails to meet up the demand for spendable funds, it is a first sign that the bank is in trouble. The bank begins to loose deposits from customers and has to borrow funds at a higher rate or dispose of more liquid asset.

The reason why banks especially commercial bank have liquidity problem is because they accept large amount of short term deposits from their customers either individuals or businesses and then turn round and give out medium or long term credit to their customers.

Theories of Liquidity Management

Banks can choose to manage their liquidity by adopting any of these theories.

• Commercial loan theory: Under this theory, the ideal assets of commercial banks should consist of short term business loans made to business firms for management of their working capital. This is because the major components of commercial banks have always been of short term nature. When a bank finances the working capital of a firm, it expects funds for repayment to come from the management of the working capital itself. However, commercial loan theory has some set backs because it cannot satisfy the structure of demands of borrowers. It also cannot aid economic growth and development because short term loans cannot satisfy the needs of the borrowers as well as the economy.

• Shiftability Theory: Investment in securities which forms a part of the asset structure of commercial banks brought about the shift in management emphasis from loans portfolio to securities portfolio for liquidity. In shiftability theory, banks are rather encourage d to invest their funds in short term liquidity assets like Treasury bill. The idea is that if a bank is faced with a short term liquidity problems, they can easily sell off the securities in the open market.

• Theory of Anticipated Income: A Change in the structure of loan demand by the non-bank public also brought about the emergence of another theory known as the anticipated income. These loans are mostly consumer and mortgage loans. The theory of anticipated income is different from the commercial loan theory in the sense that loans granted are nor self-liquidating or of short term duration, and are not easily shiftable. The loans are paid out of the income of the debtors, as a result of their transactions with third parties. The theory provides the basis for some form of planning in liquidity management. This is because such loans are repaid periodically, and therefore provide for a continuous flow of cash, based on the maturity structure of the loans portfolio.

• Liability Management Theory: This is a shift from asset management to the management of liabilities. In order to manage the liquidity of the bank, the theory says that banks assets should be increased by increasing the bank's liabilities. The liability management says that banks do nor have to sell their short term assets in order to meet up with temporary liquidity problems, they can keep the assets till maturity but borrow from the money market in order to meet up with their short term liquidity problems.