11M ago

For banks, managing liquidity risk must consider the regulatory ratios and limits. However, such limits are snapshots that do not necessarily mean the bank has a full understanding of its liquidity risks over time and how various bank products would affect the bank’s cash flows due to the options available to the customers, such as prepayments and early withdrawals. At the same time, the bank should not retain too much excess idle cash or it would reduce earnings.

Finding the right balance requires a clear understanding of the bank’s cash flows over time as well as modeling the customer’s behaviors to have an accurate measurement of liquidity. Performing sensitivity analysis as well as stochastic simulation can also produce useful information in relation to liquidity risk.

Rebalancing the bank’s cash flow can be done through promoting new business, setting pricing margins, and through hedging portfolios by redistributing future cash flows and income gaps while observing internal and regulatory risk limits.