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Abstract The author provides an analysis of the underlying structural liability in the banking business by analysing balance sheets across the banking industry. He shows that the structural liability of different banks varies enormously. He argues that asset and liability management professionals need to have a deep understanding of the financial markets and of the many lines that their banks will be running. Even then he suggests that liquidity crises are very difficult to predict or control.
Keywords Banking, Asset management, Liability, Liquidity, Balance sheets
Let him who desires peace, prepare for war (Vegetius, fourth-fifth century AD).
The nature of liquidity
Liquidity represents a bank's ability to accommodate decreases in its liabilities and its ability to fund increases in its assets. A bank has adequate liquidity when it can obtain sufficient funds either by increasing liabilities or by converting its liquid assets promptly into cash at a reasonable cost.
In normal circumstances, the management of liquidity within a bank should not lead to any threat to its solvency. However, if adverse circumstances arise, such as a decline in a bank's reputation, or if a more general crisis occurs in the money and capital markets or indeed in the financial conditions of similar institutions, a bank's liquidity may suffer. In extreme situations a liquidity crisis may result in a bank using up its reserve of liquid assets and being unable to replace its maturing liabilities. As a consequence, the bank would have to sell its less-liquid assets at "fire sale" prices resulting in a liquidity crisis spilling over into an impairment of a bank's capital base. Therefore, the management of liquidity is a serious business, particularly in a world of deregulated foot-loose capital flows.
This article looks first at the organisational structure of liquidity management and how liquidity is measured and controlled within a bank. It then examines a bank's balance sheet as it appears in its annual report and reformats the contents from a liquidity perspective. In doing this it becomes apparent that comparing the structural liquidity of one bank against that of another is very difficult due to the limited and diverse accounting standards of disclosure employed by banks in different countries. However, what is worthwhile is the examination of the...