Liquidity management refers to those activities within a financial institution to ensure that holdings of liquid assets (e.g. cash, bank deposits and other financial assets) are sufficient to meet its obligations as they fall due, including unexpected transactions. Banks are primarily in the business of raising deposits and making loans that transform liquid liabilities into liquid assets.
Liquidity, or the ability to fund increases in assets and meet obligations as they come due, is crucial to the ongoing viability of any banking organization. Therefore, managing liquidity is among the most important activities conducted by banks. Sound liquidity management can reduce the probability of serious problems.
Maintaining cash reserves is a fundamental liquidity management strategy. It involves holding a certain amount of cash or highly liquid assets that can be readily converted into cash. These reserves act as a buffer to cover unexpected expenses, manage fluctuations in cash flows, and provide funds for short-term needs. Cash reserves can be held in bank accounts, money market funds, or short-term government securities.
The main strategies
that bank takes positively for effective liquidity management are as follows:
1.
Each bank has to formulate a suitable but specific liquidity policy
2.
Based on the past information or
data, ALCO or liquidity management committee must bring desired changes in the
composition of assets and liabilities.
3. Continuous customer relationships with large borrowers, depositors, and other liability holders, etc. will help the bank to secure required funds during a liquidity crisis.
4.
The bank should prepare a contingency plan including arrangements for line of
credit with large banks and suppliers of credit adverse liquidity position
arising from banks specific crisis or general market crisis.
5.
The internal norms/limits may be fixed for certain types of transactions that
will have an adverse impact or liquidity position. For example:
i)
Borrowing from the call money market as well as from the repo market,
ii) Desired ratios for short-term liabilities to short-term assets, loans to total deposits.
6. Cash flow forecasting is a proactive strategy that involves projecting future cash inflows and outflows to assess liquidity needs accurately. By analyzing historical data, upcoming financial obligations, and business projections, organizations can estimate their cash positions for specific periods. Cash flow forecasting enables better planning, helps identify potential cash shortfalls or surpluses, and allows businesses to take appropriate actions to manage liquidity effectively.
7.
Effective management of working capital is crucial for maintaining liquidity.
Strategies for working capital management include optimizing inventory levels,
managing receivables and payables, and controlling costs. By efficiently
managing working capital, businesses can free up cash and improve their overall
liquidity position.
So,
banks must visualize and evaluate liquidity needs under different business
scenarios. Liquidity represents the ability to deal with shortage of funds and
surplus of funds. Irrespective of the size of a bank, adequate liquidity is
essential to meet commitments when due and to undertake new transactions when desirable.