Liquidity management

This study guide was written by Joachim Bald, working under the auspices of Bankakademie, Frankfurt, for Deutsche Gesellschaft für Technische Zusammenarbeit (gtz), Eschborn/ Germany. It is designed as a training resource for small financial institutions, particularly those focused on microfinance, in different regions of the world and at varying stages of institutional development.

The material is not country-specific. It focuses instead on those common principles of liquidity management that are independent of the particular operating conditions and supervisory regulations that an individual financial institution might face. The presentation emphasizes the reasoning behind various alternative approaches to liquidity management. Since there is no simple recipe for optimizing liquidity in all types and sizes of financial institutions, the objective is to provide the conceptual tools that enable the reader to develop an individualized action plan for improving liquidity practices in his or her own institution.

The study guide is divided into 10 lessons. Lessons 1 - 4 form a basic course and cover the most essential elements of liquidity management including forecasting the cumulative cash position. Lessons 5 – 7 provide the material for an extended course of study, covering such topics as vault cash planning and methods of active liquidity planning. Lessons 8 – 10 cover advanced topics such as managing liquidity in multiple currencies and integrating liquidity into risk management. Each lesson is clearly set out with learning objectives, a pre-test, questions and exercises and a final multiple choice test.

Attached to the study guide is an Excel workbook (click on Multimedia) which provides a practical tool for implementing the liquidity methodology introduced in the text. To make use of this software it is important to read the introductory notes that are provided. Throughout the lessons, items and explanations relevant to different sections of the spreadsheets have been highlighted with an icon: a computer mouse for input sheets and a computer screen for output sheets.

Resources

resource title type year resource
Lesson 01: Introduction to liquidity management Lesson 2000
This resource appears in: Liquidity management

This lesson forms part of the basic course. It aims to enable the reader to:

  • be able to define liquidity, cash assets and liquid assets
  • understand the basic objectives of liquidity management
  • have a sense of some practical liquidity issues facing microfinance institutions
Author Bankakademie
Region / Country Global
Lesson 02: The strategic framework of liquidity management Lesson 2000
This resource appears in: Liquidity management

This lesson forms part of the basic course. It aims to enable the reader to:

  • be able to distinguish between strategic, operational and short-term tactical planning
  • understand how liquidity planning is connected to all levels of the planning process
  • understand the distinction between the source of liquidity requirements and active liquidity management
Author Bankakademie
Region / Country Global
Lesson 03: Measuring liquidity on the balance sheet Lesson 2000
This resource appears in: Liquidity management

This lesson forms part of the basic course. It aims to enable the reader to:

  • be able to define and compute the most common liquidity ratios
  • understand the advantages and limitations of liquidity measurement based on ratios
  • have a sense of the typical value range of certain liquidity ratios in a micro-finance institution
  • be able to identify a set of liquidity ratios that might be appropriate for your institution to track
Author Bankakademie
Region / Country Global
Lesson 04: Dynamic liquidity planning Lesson 2000
This resource appears in: Liquidity management

This lesson forms part of the basic course and covers the most crucial aspect of liquidity management - cash flow forecasting. By the end of the lesson the reader should be able to:

  • explain the basic trend and seasonal factors that affect the demand for loans and the supply of customer deposits
  • develop a forecast of the net changes in deposits and loans over a 12 month period
  • estimate cash flow from interest payments
  • plan the cash flow consequences of loan losses
  • work out the cash effects of operating expenses
  • account for cash flows from long-term investing and other singular transactions
  • derive the total "operating" liquidity change and capture explicit liquidity management actions
Author Bankakademie
Region / Country Global
Lesson 05: Special Adjustments to the Cash Flow Plan Lesson 2000
This resource appears in: Liquidity management

This lesson is the first in the extended course and deals with special features and adjustments to the basic cash flow plan. When you have studied this lesson you should be able to:

  • explain how inflation expectations are incorporated into the cash flow plan,
  • make the necessary adjustments to accommodate for the special effects of compulsory savings in the cash budget,
  • describe the basic properties of minimum reserve regulations,
  • identify the most common reservable liabilities,
  • define the concept of free reserves,
  • adjust the liquidity ratios and the cash flow plan for the effect of minimum reserve requirements,
  • describe the three basic scenarios of restricted funding,
  • adjust the cash flow schedule to account for funding restrictions.
Author Bankakademie
Region / Country Global
Lesson 06: Vault Cash Planning Lesson 2000
This resource appears in: Liquidity management

The predominance of physical cash transactions in the MFI environment is the reason for this lesson on vault cash management. It covers the basic trade-offs between shipment frequency, average vault levels and cash demand. When you have studied this lesson you should be able to:

  • explain why vault cash is of special importance to micro-finance organizations,
  • describe how some MFIs avoid dealing with vault cash entirely,
  • specify the costs of vault cash and explain the trade-off between holding costs and shipment costs,
  • develop plausible rules of thumb for setting upper and lower vault cash limits,
  • use the Miller-Orr model to derive vault cash parameters for minimizing costs,
  • calculate the total operating vault cash change per period in a dynamic approach to vault cash planning,
  • derive a forward-looking plan for vault cash shipments based on forecasted demand.
Author Bankakademie
Region / Country Global
Lesson 07: Instruments of Active Liquidity Management Lesson 2000
This resource appears in: Liquidity management

Lesson 7 elaborates on the action variables of liquidity management on both the asset and the liability side. On the liability side, it includes a detailed examination of "strategic" funding sources, which are generally outside of the control of the liquidity manager. Nevertheless, a good basic understanding of these options is essential for the derivation of the liquidity requirements generated by the primary MFI functions. When you have studied this lesson you should be able to:

  • distinguish active liquidity management from passive liquidity measurement,
  • decide which types of liquid assets might be suitable instruments for holding your institution's liquidity stock,
  • develop a strategy for reducing the opportunity cost of stored liquidity,
  • name the properties of securities that characterize suitable liquid assets,
  • develop strategies for raising cash from non-liquid assets,
  • explain the liquidity consequences of strategic funding decisions concerning equity, bonds, long-term loans and deposits,
  • describe how savings product design, bank reputation and convenience influence the development of the deposit base,
  • distinguish purchased funds from retail deposits,
  • develop a short-term borrowing strategy for your institution,
  • discuss advantages and problems of inter-MFI liquidity pools and so-called apex institutions,
  • assess different funding options in the four dimensions of direct and indirect financial costs, administrative costs and liquidity risk.
Author Bankakademie
Region / Country Global
Lesson 08: Integrating Liquidity into the Risk Management Framework Lesson 2000
This resource appears in: Liquidity management

Risk taking is the business of banking. It is the conscious engagement in risks that constitutes the economic value of financial intermediation. The key to successful bank management is not to entirely avoid the risks, but to properly balance the risks against the rewards from potential profits. When you have studied this lesson you should be able to:

  • identify the main categories of risks facing a financial institution,
  • distinguish between the transaction risk and the portfolio risk in the lending business,
  • develop strategies for diversifying the portfolio risk of a micro-lending operation,
  • explain the interaction between interest rate risk and liquidity risk,
  • use the yield-curve to predict future interest rates,
  • define foreign exchange risk and explain its connection to credit risk and liquidity risk.
Author Bankakademie
Region / Country Global
Lesson 09: Managing Liquidity in Multiple Currencies Lesson 2000
This resource appears in: Liquidity management

The objective of liquidity management in a multiple currency environment is essentially the same as in a single currency operation: to ensure that all payment obligations in every currency are met in a prompt and cost-efficient manner. When you have studied this lesson you should be able to:

  • determine the total cash requirements from operations in each relevant currency,
  • develop a liquidity management action plan assuring that cash requirements and appropriate safety margins are observed for all currencies,
  • describe some of the basic instruments for moving liquidity between currencies,
  • calculate a foreign exchange forward rate on the basis of interest rates for different currencies.
Author Bankakademie
Region / Country Global
Lesson 10: Implementing Liquidity Management Systems Lesson 2000
This resource appears in: Liquidity management

So far in this study guide the focus has been on the general principles of liquidity: how to measure it, store it and procure it. This final lesson looks at liquidity from an organizational perspective and addresses the question of how to make sure that liquidity management is appropriately reflected in the policies and procedures of a MFI. When you have studied this lesson you should be able to:

  • identify the most important components of a formal liquidity policy,
  • define the scope of responsibility and authority of a liquidity manager,
  • explain the most important aspects of liquidity management in a branch banking environment,
  • distinguish between implicit funds transfer pricing and discretionary liquidity management transactions.
Author Bankakademie
Region / Country Global
Liquidity Manager - a spreadsheet application Software 2000
This resource appears in: Liquidity management

Liquidity Manager" is the companion software to the liquidity management study guide. It has been developed using Microsoft Excel. The application workbook contains 17 worksheets that closely follow the logic and terminology of the main study guide. Once you have worked through the corresponding lessons, you should easily be able to understand the purpose and data requirements of the worksheets.

The workbook contains formulas for all computations. Data are only entered once in the designated input sheets and are carried forward to other sections of the workbook. Colours have been used to make working with the spreadsheets easier. Light green is used for all labels and computed fields. Data entry fields are indicated by an orange background. Dark blue bars signal the borders of the user-relevant area in the worksheets.

"Liquidity Manager" is detailed enough to be used as a planning tool in an actual microfinance operation. In practice, the data in "Liquidity Manager" will have to be re-based every month, in order to take account of the new actual cash flows that have occurred in the interim. There are no embedded macros or hidden Visual Basic statements. All logical expressions and formulas have been written into the actual cells. Thus the sheets can easily be adapted to suit an MFI's specific needs within the familiar EXCEL interface.

The workbook provided contains the data from the PeopleBank exercise used in the accompanying study guide.

Publisher Bankakademie
Region / Country Global
Keywords Liquidity Planning Tool, Liquidity Management

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