Description
This is a presentation explaining about Liquidity flow; Reserves of Depository Institutions; Liquidity management under normal situation; Liquidity management under stress
LIQUIDITY MANAGEMENT
Liquidity management - normal situation
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The Central Bank provides or absorbs liquidity at the margin Inter-bank market provides the main mechanism for demand supply equilibrium Banking system and financial markets (short term loans, bonds, CP) meet the credit needs of business While risks are priced into the transactions (appropriate interest rate) there is implicit belief in solvancy of banks Value of assets and the extent of capital are adequate to cover liabilities and risks The Central Bank steps in to inject liquidity in Solvant banks – such events are not frequent The Central Bank presides over the functioning of the financial markets and banks – the main instrumentalities of a modern economic system
Markets under stress
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Inter-bank market ? Banks reluctant to lend each other ? Solvancy ? ? Large scale illiquidity ? ? Asset liability mismatch ? Credit market ? Banks reluctant to lend to firms ? CPs do not get renewed General crisis of confidence ? Bank to bank ? Business to bank System stability is under threat – meaning ?
Markets under stress
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Are normal methods of liquidity management relevant?
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What role does the central bank play in such a situation ?
Markets under stress
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?
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The Central Bank may provide liquidity to a few banks but they may refuse to onlend to other banks In that case The Central Bank may end up supporting each and every bank Can it really do so ? What are the system consequences ? What happens to its own balance sheet ? Banks do not lend to business not do they buy the CPs of businesses That creates further doubts about the solvancy of banks Which in turn creates more reluctance to lend in interbank market What is the way out ?
Outcome
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Repayment worries ? Roll-over difficulties ? Solvancy doubts ? Bank depositors ? Health of the deposit guarantee company ? (Find out the cash depletion of FDIC from Jan 2008 till date) While falling asset prices are eroding value of assets, some financial firms are already bankrupt, some firms are made to go that way Risk premia skyrocket but even at high premia money is unavailable Fear of general break-down of system Social – Political fall out
The Plight of the Central Bank
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Repeated liquidity support fails to bring life in the inter-bank market Lowering of interest rates creates little immediate impact Willingness and ability to lend – both are under cloud The Central Bank then becomes ? The lender of the first resort not only to the banking system but to the general business as well To start with it provides funding against high-quality assets
The Plight of the Central Bank
?
?
?
The CB then ? begins to provide accommodation against lowquality illiquid assets ? persuades the Government to buy illiquid assets of banks ? provides capital support to banks ? persuades the Government (Min of Finance or the Treasury) to guarantees bank debt ? also buys CPs and other asset backed paper of businesses and provides funding to MMMF ? Within a few months it looms large over the entire financial market The CB turns out to be the only credible intermediary in the financial markets In addition to acting as the CB it starts acting as a normal commercial bank with a difference – no deposit acceptance from customers
Liquidity flow – the crisis paradigm
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?
?
? ?
?
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In the normal situation liquidity flows through interconnected pipes via the banks and financial markets – changing hands several times and deposits multiplying into credit This is when the CB is the lender of the last resort In a stress ridden situation with the CB as the lender of the first resort Pipes run one way Credit does not multiply Money velocity remains impaired In a manner of speaking only one balance sheet works in the financial markets - that of the Central Bank
FEDERAL RESERVE statistical release 2-Jan-09 Reserve Bank credit, related items Week ended Dec 31, 2008 Millions of dollar Change From Week Ended Jan 2, 2008
Reserve Bank credit Securities held outright Repurchase agreements (4) Term auction credit Other loans Primary dealer and other broker-dealer credit (5) Asset-backed commercial paper money market mutual fund liquidity facility Credit extended to American International Group, Inc. (6) Net portfolio holdings of Commercial Paper Funding Facility LLC (7) Net portfolio holdings of LLCs funded through the money market investor funding facility (8) Net portfolio holdings of Maiden Lane LLC (9) Net portfolio holdings of Maiden Lane II LLC (10) Net portfolio holdings of Maiden Lane III LLC (11) Other Federal Reserve assets
2,246,527 496,227 80,000 450,219 187,770 38,476
+1,354,752 + + + + 244,384 40,250 410,219 181,983 38,476
23,797
+
23,797
38,924
+
38,924
332,410
+
332,410
0 26,974 20,059 27,990 + + +
0 26,974 20,059 27,990
625,741
+
559,086
Reserves of Depository Institutions Millions of Dollar Total Jan 2005 Dec 2005 Jan 2007 Jan 2008 Apr 2008 Aug 2008 Dec 2008 Apr 2009 May 2009 Jun 2009 50369 45141 44591 44038 43488 44052 821240 881814 902914 809823 Required 48630 43240 43046 42397 41644 42059 53841 57433 58809 58441 Monetary Base 763776 793376 816772 824415 823379 840146 1659327 1748347 1770584 1679381
Source: US Fed website
doc_771809733.ppt
This is a presentation explaining about Liquidity flow; Reserves of Depository Institutions; Liquidity management under normal situation; Liquidity management under stress
LIQUIDITY MANAGEMENT
Liquidity management - normal situation
? ?
?
?
?
?
?
The Central Bank provides or absorbs liquidity at the margin Inter-bank market provides the main mechanism for demand supply equilibrium Banking system and financial markets (short term loans, bonds, CP) meet the credit needs of business While risks are priced into the transactions (appropriate interest rate) there is implicit belief in solvancy of banks Value of assets and the extent of capital are adequate to cover liabilities and risks The Central Bank steps in to inject liquidity in Solvant banks – such events are not frequent The Central Bank presides over the functioning of the financial markets and banks – the main instrumentalities of a modern economic system
Markets under stress
?
?
?
?
Inter-bank market ? Banks reluctant to lend each other ? Solvancy ? ? Large scale illiquidity ? ? Asset liability mismatch ? Credit market ? Banks reluctant to lend to firms ? CPs do not get renewed General crisis of confidence ? Bank to bank ? Business to bank System stability is under threat – meaning ?
Markets under stress
?
Are normal methods of liquidity management relevant?
?
What role does the central bank play in such a situation ?
Markets under stress
?
?
? ? ? ?
? ?
?
The Central Bank may provide liquidity to a few banks but they may refuse to onlend to other banks In that case The Central Bank may end up supporting each and every bank Can it really do so ? What are the system consequences ? What happens to its own balance sheet ? Banks do not lend to business not do they buy the CPs of businesses That creates further doubts about the solvancy of banks Which in turn creates more reluctance to lend in interbank market What is the way out ?
Outcome
? ? ? ? ?
?
?
?
?
Repayment worries ? Roll-over difficulties ? Solvancy doubts ? Bank depositors ? Health of the deposit guarantee company ? (Find out the cash depletion of FDIC from Jan 2008 till date) While falling asset prices are eroding value of assets, some financial firms are already bankrupt, some firms are made to go that way Risk premia skyrocket but even at high premia money is unavailable Fear of general break-down of system Social – Political fall out
The Plight of the Central Bank
? ?
? ?
?
Repeated liquidity support fails to bring life in the inter-bank market Lowering of interest rates creates little immediate impact Willingness and ability to lend – both are under cloud The Central Bank then becomes ? The lender of the first resort not only to the banking system but to the general business as well To start with it provides funding against high-quality assets
The Plight of the Central Bank
?
?
?
The CB then ? begins to provide accommodation against lowquality illiquid assets ? persuades the Government to buy illiquid assets of banks ? provides capital support to banks ? persuades the Government (Min of Finance or the Treasury) to guarantees bank debt ? also buys CPs and other asset backed paper of businesses and provides funding to MMMF ? Within a few months it looms large over the entire financial market The CB turns out to be the only credible intermediary in the financial markets In addition to acting as the CB it starts acting as a normal commercial bank with a difference – no deposit acceptance from customers
Liquidity flow – the crisis paradigm
?
?
?
? ?
?
?
In the normal situation liquidity flows through interconnected pipes via the banks and financial markets – changing hands several times and deposits multiplying into credit This is when the CB is the lender of the last resort In a stress ridden situation with the CB as the lender of the first resort Pipes run one way Credit does not multiply Money velocity remains impaired In a manner of speaking only one balance sheet works in the financial markets - that of the Central Bank
FEDERAL RESERVE statistical release 2-Jan-09 Reserve Bank credit, related items Week ended Dec 31, 2008 Millions of dollar Change From Week Ended Jan 2, 2008
Reserve Bank credit Securities held outright Repurchase agreements (4) Term auction credit Other loans Primary dealer and other broker-dealer credit (5) Asset-backed commercial paper money market mutual fund liquidity facility Credit extended to American International Group, Inc. (6) Net portfolio holdings of Commercial Paper Funding Facility LLC (7) Net portfolio holdings of LLCs funded through the money market investor funding facility (8) Net portfolio holdings of Maiden Lane LLC (9) Net portfolio holdings of Maiden Lane II LLC (10) Net portfolio holdings of Maiden Lane III LLC (11) Other Federal Reserve assets
2,246,527 496,227 80,000 450,219 187,770 38,476
+1,354,752 + + + + 244,384 40,250 410,219 181,983 38,476
23,797
+
23,797
38,924
+
38,924
332,410
+
332,410
0 26,974 20,059 27,990 + + +
0 26,974 20,059 27,990
625,741
+
559,086
Reserves of Depository Institutions Millions of Dollar Total Jan 2005 Dec 2005 Jan 2007 Jan 2008 Apr 2008 Aug 2008 Dec 2008 Apr 2009 May 2009 Jun 2009 50369 45141 44591 44038 43488 44052 821240 881814 902914 809823 Required 48630 43240 43046 42397 41644 42059 53841 57433 58809 58441 Monetary Base 763776 793376 816772 824415 823379 840146 1659327 1748347 1770584 1679381
Source: US Fed website
doc_771809733.ppt