Dear SAP Banking Community members,
As you know, when we try to measure a Bank’s liquidity, we often use liquidity ratios comparing its most liquid assets with its short-term liabilities.
The common approach considers the greater the coverage of liquid assets to short-term liabilities the better, as it is a clear signal that a Bank can pay its debts that are coming due in the near future and still fund its ongoing operations.
On the other hand, a Bank with a low coverage rate should raise a red flag informing about expected difficulties for meeting its obligations.
Typical examples are:
- “Current ratio” which tests a Bank’s liquidity by deriving the proportion of current assets available to cover current liabilities
- “Quick ratio” which further refines the “current ratio” by measuring the amount of the most liquid current assets a bank has to cover current liabilities.
- “Cash ratio” which further refines both the “current ratio” and the “quick ratio” by measuring the amount of cash; cash equivalents or invested funds a bank has in current assets to cover current liabilities.
- Other examples of a Bank’s liquidity ratios are: cash and unpledged marketable securities divided by total assets; total deposits divided by borrowed funds; volatile funds divided by liquid assets; and total loans divided by total deposits.
In my opinion all those ratios lack in offering a clear view of Bank’s capacity to meet his payment obligations because they’re static snapshots of the Bank liquidity situation while the liquidity is a dynamic magnitude. They are all the result of having used the General Ledger as the main source of information for the Bank’s operations.
By using a cash-flow based accounting system we can build a liquidity planning system whose objective is matching assets and liabilities maturities, as the cash-flow maturities and not the assets or liabilities types are the more relevant parameter which define the financial instrument liquidity.
But even on that case our model is not complete, as the maturities, by definition; represent the agreed cash-flow (on the financial instrument contract) but not the expected cash-flows.
On the other hand, Bank’s measure the credit risk of their portfolios for evaluating the probability of having loses on the portfolios (and also its Capital requirements through the Risk Weighted Assets Calculation), but the risk is also a measure of not receiving the cash-flow payment on time.
By including the credit risk into the equation we know the probability of the “agreed” cash-flow to actually be successful, so the risk gives the basis for calculating the expected cash-flows.
Finally, by matching the maturities of the expected cash-flows of Bank’s assets (plus cash position) with the maturities of the Bank’s liabilities, the Bank can build a much more accurate and dynamic view of the Bank’s capacity of meeting its obligations.
But the whole construction requires the system for planning the liquidity to be feed from a “structure” which stores the “agreed” cash-flows and the risk related to the cash-flow.
Looking forward to read your opinions.
Kindest Regards.
Ferran.
As you know, when we try to measure a Bank’s liquidity, we often use liquidity ratios comparing its most liquid assets with its short-term liabilities.
The common approach considers the greater the coverage of liquid assets to short-term liabilities the better, as it is a clear signal that a Bank can pay its debts that are coming due in the near future and still fund its ongoing operations.
On the other hand, a Bank with a low coverage rate should raise a red flag informing about expected difficulties for meeting its obligations.
Typical examples are:
- “Current ratio” which tests a Bank’s liquidity by deriving the proportion of current assets available to cover current liabilities
- “Quick ratio” which further refines the “current ratio” by measuring the amount of the most liquid current assets a bank has to cover current liabilities.
- “Cash ratio” which further refines both the “current ratio” and the “quick ratio” by measuring the amount of cash; cash equivalents or invested funds a bank has in current assets to cover current liabilities.
- Other examples of a Bank’s liquidity ratios are: cash and unpledged marketable securities divided by total assets; total deposits divided by borrowed funds; volatile funds divided by liquid assets; and total loans divided by total deposits.
In my opinion all those ratios lack in offering a clear view of Bank’s capacity to meet his payment obligations because they’re static snapshots of the Bank liquidity situation while the liquidity is a dynamic magnitude. They are all the result of having used the General Ledger as the main source of information for the Bank’s operations.
By using a cash-flow based accounting system we can build a liquidity planning system whose objective is matching assets and liabilities maturities, as the cash-flow maturities and not the assets or liabilities types are the more relevant parameter which define the financial instrument liquidity.
But even on that case our model is not complete, as the maturities, by definition; represent the agreed cash-flow (on the financial instrument contract) but not the expected cash-flows.
On the other hand, Bank’s measure the credit risk of their portfolios for evaluating the probability of having loses on the portfolios (and also its Capital requirements through the Risk Weighted Assets Calculation), but the risk is also a measure of not receiving the cash-flow payment on time.
By including the credit risk into the equation we know the probability of the “agreed” cash-flow to actually be successful, so the risk gives the basis for calculating the expected cash-flows.
Finally, by matching the maturities of the expected cash-flows of Bank’s assets (plus cash position) with the maturities of the Bank’s liabilities, the Bank can build a much more accurate and dynamic view of the Bank’s capacity of meeting its obligations.
But the whole construction requires the system for planning the liquidity to be feed from a “structure” which stores the “agreed” cash-flows and the risk related to the cash-flow.
Looking forward to read your opinions.
Kindest Regards.
Ferran.
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