Exam 14: Liquidity Risk

Correct Answer:

Verified

$\bold{\text{Immediate liquidity obligations:}}$ Occur in both contractual and relationship form.For, contractual liquidity obligations the DI must have sufficient funds to repay in full all maturing liabilities.Relationship liquidity obligations relate to the strength of the customer-base relationship and satisfying the liquidity requirements of those customers through the provision of funds for new legitimate loan demand which meets the DI's credit standards.
$\bold{\text{Seasonal short-term liquidity needs:}}$ Classified as predictable or unpredictable and may arise: Predictable events include increased deposit withdrawals during December and Easter holiday periods and in a farming community in spring (planting and fertilisation) when loan demand rises and deposits fall and in summer when deposits rise (sale of harvest), Unpredictable needs can arise from large depositors and large borrowers that may influence short-term liquidity needs of a DI disproportionately.
$\bold{\text{Trend liquidity needs:}}$ Determined over a longer time span.Trend liquidity needs are likely to be associated with a DI's particular customer base.For example, a large proportion of age pensioners bank with the CBA and, as such, the CBA's liquidity increases significantly on pensioner payment day and drops gradually over the next two weeks until the next pensioner payment.
$\bold{\text{Cyclical liquidity needs:}}$ Much more difficult to predict and are usually out of the control of any individual DI.Liquidity needs vary with the business cycle; for example, in boom economic conditions DIs have high liquidity needs as loan demand grows rapidly and deposits decline as consumers spend more and save less.By contrast, during recessions deposits tend to grow and loan demand shrinks.
$\bold{\text{Contingent liquidity needs:}}$ Caused by events that are difficult, if not impossible, to predict, such as unexpected deposit outflow due to a loss of confidence in the DI.By their very nature, contingent liquidity needs are impossible to forecast accurately and are difficult to meet, as typically contingent liquidity needs arise at the worst possible time for the DI.It is because of such events that regulators, in order to avoid system risk, impose liquidity regulations.