The purpose of the report is to discuss the concepts of Liquidity risk, Basel III liquidity requirements, and Australian banks' liquidity position. The aim of the report is to answer certain questions. The questions have been answered in the following sections. At first, liquidity risk and asset liquidity are discussed. This is followed by discussion on liability liquidity and features of effective liquidity management This is followed by the calculation and discussion of Liquidity Ratios of four major Australian banks. At last, a discussion on Liquidity Coverage Ratio and Net Stable Funding Ratio is done.
2.0 Liquidity Risk and Asset Liquidity
As is indicated by Branch (2016), liquidity risk could be defined as the risk to the capital or earnings that are related to the financial institutions’ capabilities to meet their obligations to the needs of borrowers and depositors through exchanging their assets into cash fast enough with little loss or being able to generate funding from other sources when needed and therefore having enough cash in hands to implement profitable trading activities. It is important to realize that the liquidity risk of banks could result from the side of asset and the side of liabilities. As is indicated by Gavalas (2015), the asset liquidity suggests that the liquidity risk results from the loan commitment and other credit lines and there are many issues that are associated with the fast asset disposition. For example, there are high costs that are associated with turning assets to cash because many assets are illiquid and it is hard to sell such assets in the open market. Furthermore, if the requirement of cash is urgent, companies may have to sell assets very fast and only low prices are available. The liquid assets include many aspects such as coins, notes, bank bills, ES funds, certificates of deposits, and semi government securities. The banks have to choose which assets they have to hold and this is affected by the risk and return preferences. There is always a trade-off between yield, liquidity, and credit risks. The banks may need to match the maturities of the assets and those of the liabilities so that the transaction costs are minimized when banks intend to get liquidity.
3.0 Liability Liquidity
In the meantime, the liability liquidity suggests that the claimholders and depositors decide to withdraw money from the banks or to cash in their other claims at the same time but the banks do not immediately have so much cash in hand to satisfy such demands. One consequence is that the financial institutions have to engage in more borrowing or selling assets in order to satisfy such claim holders. Furthermore, another aspect of the liability liquidity is that the financial institutions have to predict the frequency and also distribution of future deposit drains. The deposit withdraws and the deposit additions would net against each other and the high net deposit drains could affect the cash position of the banks in a banking day. Banks have to raise funds in order to meet the unexpected needs for cash and it would be costly and significantly affect the profitability of the banks. As is indicated by Gavalas (2015), the bank crisis is very serious when depositors do not have confidence in the solvency of their banks so that bank runs occur. Many customers would withdraw money from the banks at the same time. As a result, the cost of raising short term capital is very high and the banks immediately become insolvent.
4.0 Features of Effective Liquidity Management
There are many features of the effective liquidity management. For example, it is important to realize that the liquidity management would focus on many different time frames. As is indicated by Chang et al (2016), effective liquidity management would cover the immediate liquidity obligations, seasonal short term liquidity obligation, trend liquidity needs, cyclical liquidity needs, and contingent liquidity needs. Also, the effective liquidity management focuses on creating a balance between the risk and return. There is always a conflict between the illiquidity risk and the cost of generating high liquidity is the essence of liquidity management. The more liquid assets the banks hold the lower the returns the banks would generate. Also, the effective management of liquidity always requires the banks to hold the optimal amount of liquidity plus a buffer and also banks have to conform to the right regulatory rules. This would allow the banks to reduce the liquidity risk and in the meantime have proper amount of returns.
