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Liquidity Risk_ Managing Asset and Funding Risks
by Erik Banks.
ISBN: 1-4039-3399-5
New York Palgrave Macmillan
2005
253 pages
List of figures xi
List of tables xiii
List of boxes xv
Acknowledgments xvii
The author xix
List of acronyms xxi
PART I:ELEMENTS OF CORPORATE LIQUIDITY 1
1 Liquidity risk defined 3
Definitions of liquidity risk 3
Liquidity,risk,and the corporation 7
Market risk,credit risk,and liquidity risk 11
Overview of the book 13
2 Liquidity and financial operations 14
Liquidity operating requirements 14
General approaches to liquidity management 17
Financial imperatives 18
External requirements 19
The liquidity risk/return trade-off 20
Liquidity profiles across industries 22
Financial institutions 23
Non-financial service companies 29
Capital-intensive companies 29
Municipalities and sovereigns 30
Endogenous versus exogenous liquidity 32
3 Sources of liquidity 36
Sources of asset liquidity 37
Liquid assets 37
Cash and marketable securities 37
vReceivables 39
Inventories 40
Fixed assets and intangibles 41
Fixed assets 41
Intangibles 42
Sources of funding liquidity 42
Short-term funding markets 44
Commercial paper,Euro commercial paper 44
Short-term bank facilities 44
Payables 45
Deposits and repurchase agreements 45
Medium/long-term funding markets 47
Medium-term notes and Euronote facilities 47
Funding agreements and GICs 47
Long-term bonds 48
Loans 49
Equity capital 50
Sources of off-balance sheet liquidity 51
Securitization 51
Contingent financings 52
Leases 54
Derivatives 54
Amalgamating liquidity sources 56
PART II:LIQUIDITY PROBLEMS 61
4 Funding liquidity risk 63
Sources of funding liquidity risk 64
Unpredictable cash flows 64
Corporations 65
Financial institutions 66
Unfavorable legal or regulatory actions 69
Mismanagement 70
Negative perceptions/market actions 70
Exogenous considerations 71
The nature of funding problems 72
Rollover problems 73
Lack of market access 73
Commitment withdrawal 74
Excessive concentrations 75
The effects of funding liquidity risk 76
5 Asset liquidity risk 78
Sources of asset liquidity risk 81
Exogenous considerations 81
The nature of asset problems 83
viCONTENTSLack of asset marketability 84
Lack of unencumbered assets 85
Excessive concentrations 86
Misvalued assets 88
Insufficient collateralization 89
The effects of asset liquidity risk 90
6 Liquidity spirals and financial distress 92
Joint asset and funding risks 92
Problems 93
Causes 95
The liquidity spiral 97
Problems 97
Causes 99
Debt investors and banks 100
Rating agencies 101
Management reaction 102
Financial distress 103
7 Case studies in liquidity mismanagement 105
Drexel Burnham Lambert(1990)106
Askin Capital(1994)109
Orange County(1994)111
Long Term Capital Management(1998)114
General American(1999)117
Swissair(2001)119
Enron(2001)122
PART III:MANAGING LIQUIDITY RISKS 127
8 Measuring liquidity risk 129
Common liquidity measures 129
Liquidity ratios 130
Cash flow gaps 136
Financial instrument liquidity measures 140
Model-based measures,VAR and LAVAR 142
Haircuts 145
Stress tests 148
Market parameters 148
Cash flows 149
Asset disposals and pledging 150
Funding 150
Covenants and terminations 151
Collateral 151
Currency exposures 152
Event risks and joint scenarios 153
CONTENTSvii9 Controlling liquidity risk 156
Governance structure 156
Liquidity risk mandate 158
Risk plan 159
Financial and human resources 160
Management duties and responsibilities 161
Liquidity risk controls 162
Asset liquidity controls 163
Liquid and fixed asset limits 163
Liquid asset limits 164
Collateral/pledging limits 167
Funding liquidity controls 169
Diversified funding limits 170
Committed facility limits 173
Joint liquidity controls 174
Cash flow gap limits 174
Balance sheet target limits 176
Hybrid ratio limits 176
Off-balance sheet controls 177
Forward commitments and contingencies 177
Other safeguards 179
Reserves 179
Mark and model verification 180
Penalties 180
External relationship management 181
Liquidity risk monitoring 182
Asset and funding portfolios 182
Off-balance sheet commitments and contingencies 183
Forward balance sheet 184
Stress scenarios 184
General indicators 185
Monitoring goals 186
Technical capabilities 187
10 Liquidity crisis management 189
Scope and focus 189
Ex ante market access 192
Defensive measures 193
Recentralization 193
Funding management 193
Prioritizing funding draw-downs 193
Extending liability maturities 194
Suspending cash flows 195
Asset management 196
Risk hedging 197
Communications 197
viiiCONTENTSInvoking and terminating the program 198
Disaster recovery 199
Testing the plan 199
11 Summary:toward active liquidity risk management 201
The micro role:best practices 202
Creating a sound governance framework 202
Implementing proper measures and reporting 203
Using tactical controls 204
Developing a crisis management process 204
Performing ongoing reviews 205
The macro role 205
Conducting regular inspections 206
Promoting competition 207
Avoiding fragmentation 207
Minimizing costs 208
Harmonizing accounting treatment 208
Reinforcing proper capital allocations 208
Providing selective lender of last resort support 209
Notes 211
Selected references 223
Index 227
CONTENTSix