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• Present and anticipated asset quality

• Present and future earnings capacity

• Present and planned capital position

As all banks are affected by changes in the economic climate, the monitoring of economic and money market trends is key to liquidity planning. Sound financial management can minimize the negative effects of these trends while accentuating the positive ones. Management must also have an effective contingency plan that identifies minimum and maximum liquidity needs and weighs alternative courses of action designed to meet those needs. The cost of maintaining liquidity is another important prerogative. An institution that maintains a strong liquidity position may do so at the opportunity cost of generating higher earnings. The amount of liquid assets a bank should hold depends on the stability of its deposit structure and the potential for rapid expansion of its loan portfolio. If deposit accounts are composed primarily of small stable accounts, a relatively low allowance for liquidity is necessary.

Additionally, management must consider the current ratings by regulatory and rating agencies when planning liquidity needs. Once liquidity needs have been determined, management must decide how to meet them through asset management, liability management, or a combination of both.

B. Asset Management

Many banks (primarily the smaller ones) tend to have little influence over the size of their total assets. Liquid assets enable a bank to provide funds to satisfy increased demand for loans. But banks, which rely solely on asset management, concentrate on adjusting the price and availability of credit and the level of liquid assets. However, assets that are often assumed to be liquid are sometimes difficult to liquidate. For example, investment securities may be pledged against public deposits or repurchase agreements, or may be heavily depreciated because of interest rate changes. Furthermore, the holding of liquid assets for liquidity purposes is less attractive because of thin profit spreads.

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* Contributed by -
Sayonton Roy,
MBA (Finance), IMT Ghaziabad,
Currently working as Consultant - Global Financial Services (Risk and Business Solutions Group) at Ernst & Young, Mumbai.