Funds management represents the core of sound financial planning. Although it is not a new concept, practices, techniques, and norms have been revised substantially in recent years. Funds management is the process of managing balance sheet and off-balance sheet instruments to maximize and maintain the spread between interest earned and paid while ensuring the bank’s ability to pay off liabilities and fund asset growth. Therefore, a bank’s funds management practices will affect earnings and liquidity.
The adequacy of policies, procedures, and management information systems must be determined, and the effect of funds management practices on liquidity and interest rate risk analyzed. Liquidity risk is related to, but substantially different from, interest rate risk. Liquidity risk arises from mismatching the maturities of assets and liabilities. Interest rate risk
arises from mismatching the repricing of assets and liabilities. Both risks may be increased by rumored or existing asset quality deterioration.
The cost of liquidity is a function of market conditions and the degree of risk, both interest and credit, reflected in the bank’s balance sheet. If liquidity needs are met through holdings of high quality liquid assets, the cost becomes the income sacrificed by not holding higher yielding long term and/or lower quality assets.
The adequacy of a bank’s liquidity will vary from bank to bank. In the same
bank, at different times, similar liquidity positions may be adequate or
inadequate depending on anticipated need for funds. In addition, a liquidity
position that is adequate for one bank may be insufficient for another bank.
Determining the adequacy of a bank’s liquidity position depends upon an
analysis of the bank’s:
· Present and anticipated asset quality.
· Present and future earnings capacity.
· Historical funding requirements.
· Current liquidity position.
· Anticipated future funding needs.
· Options for reducing funding needs or attracting additional funds.
· Sources of funds.
To provide funds to satisfy liquidity needs, a bank must perform one or a
combination of the following:
· Dispose of liquid assets.
· Increase short-term borrowing (and/or issue additional short- term deposit liabilities).
· Decrease holdings of nonliquid assets.
· Increase liabilities of a term nature.
· Increase capital funds.
