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Section 6.1 - Liquidity and Funds Management
Last Updated 02/21/2005 supervision@fdic.gov
Introduction
Liquidity represents the ability to fund assets and meet obligations as
they become due. Liquidity is essential in all banks to compensate for
expected and unexpected balance sheet fluctuations and provide funds for
growth. Liquidity risk is the risk of not being able to obtain funds at
a reasonable price within a reasonable time period to meet obligations
as they become due. Because liquidity is critical to the ongoing
viability of any bank, liquidity management is among the most important
activities that a bank conducts.
Funds management involves estimating and satisfying liquidity needs in
the most cost-effective way possible and without unduly sacrificing
income potential. Effective analysis and management of liquidity
requires management to measure the liquidity position of the bank on an
ongoing basis and to examine how funding requirements are likely to
evolve under various scenarios, including adverse conditions.
The formality and sophistication of liquidity management depends on the
size and sophistication of the bank, as well as the nature and
complexity of its activities. Regardless of the bank, good management
information systems, strong analysis of funding requirements under
alternative scenarios, diversification of funding sources, and
contingency planning are crucial elements of strong liquidity management.
The adequacy of a bank's liquidity will vary. In the same bank, at
different times, similar liquidity positions may be adequate or
inadequate depending on anticipated or unexpected funding needs.
Likewise, a liquidity position adequate for one bank may be inadequate
for another. Determining a bank's liquidity adequacy requires an
analysis of the current liquidity position, present and anticipated
asset quality, present and future earnings capacity, historical funding
requirements, anticipated future funding needs, and options for reducing
funding needs or obtaining additional funds.
To provide funds to satisfy liquidity needs, one or a combination of the
following must occur:
Liquidity has a cost, which is a function of market conditions and the
risk profile of the bank. If liquidity needs are met through holdings of
high quality short-term assets, generally the cost is the income
sacrificed by not holding longer term and/or lower quality assets. If
funding needs are not met through liquid asset holdings, a bank may be
required to incur additional liabilities, possibly under adverse market
conditions at an undesirable cost.
**Regulatory/Statute and Regulations Codified Bank Secrecy Act § 103.120
31 CFR Ch. I (7–1–06 Edition)*