Prof. Dr. Rainer Stachuletz
Banking Academy of Vietnam
Based upon: Bank Management, 6th edition.
Timothy W. Koch and S. Scott MacDonald
Funding the Bank and
Managing Liquidity
Chapter 8
Prof. Dr. Rainer Stachuletz – Banking Academy of Vietnam - Hanoi
The Relationship Between Liquidity
Requirements, Cash, and Funding Sources
 The amount of cash that a bank holds
is influenced by the bank’s liquidity
requirements
 The size and volatility of cash
requirements affect the liquidity
position of the bank
 Deposits,
withdrawals, loan
disbursements, and loan payments
affect the bank’s cash balance and
liquidity position
Effect of Maturing Certificates of Deposit and Loan
Use on a Bank’s Deposit Balances at the
Federal Reserve
Recent Trends in Bank Funding Sources
 Bank customers have become more
rate conscious
 Many customers have demonstrated a
a strong preference for shorter-term
deposits
 Core deposits are viewed as
increasingly valuable
 Bank often issue hybrid CDs to appeal
to rate sensitive depositors
Types of Hybrid CDs
 Jump Rate (Bump-up) CDs

Customers have the option (right) to request
a change in rate one time prior to maturity.
 Indexed CD

CD rates float with some base rate (index)
such that the yield changes as the index
changes
 CD Special

CDs with unusual maturities (13 months or
23 months) in which the bank pays an above
market rate. At maturity the CD converts to a
traditional 12 month or 2-year CD.
Recent Trends in Bank Funding Sources
 Retail Funding
 Deposit Accounts
 Transaction accounts
 Money market deposit accounts
 Savings accounts
 Small time deposits
 Borrowed Funding
 Federal Funds purchased
 Repurchase agreements
 Federal Home Loan Bank borrowings
Recent Trends in Bank Funding Sources
 Wholesale Funding
 Includes
borrowed funds plus large
CDs
 Equity Funding
 Common
stock
 Preferred stock
 Retained earnings
Recent Trends in Bank Funding Sources
 Volatile Liabilities
 Funds
purchased from rate-sensitive
investors
Federal Funds purchased
 Repurchase agreements
 Jumbo CDs
 Eurodollar time deposits
 Foreign Deposits

 Investors
will move their funds if other
institutions are paying higher rates
Change in Total Deposits, Borrowed Funds,
Subordinated Notes, and Total Equity Over
Time, 1935–2004
Percent of total funding
Percent of total funding
25%
Total Deposits
Total Deposits
90%
Borrowed Funds
80%
70%
20%
15%
10%
Total Equity
60%
5%
Subordinated Notes
50%
0%
'38 '44 '50 '56 '62 '68 '74 '80 '86 '92 '98 '04
Borrowed Funds, Sub. Notes and
Total Equity
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Change in the Percentage Contribution of Various
Bank Funding Components, 1992–2004
75%
12/31/1992
12/31/2000
12/31/1996
12/31/2004
50%
25%
0%
The Percentage Contribution of Various
Sources of Bank Funds by Bank Size, 2004
< $100 M
3655
$100M $1B
3530
$1B $10B
360
Total deposits
Deposits held in domestic offices
Transaction accounts
Demand deposits
Nontransaction accounts
Money market deposit accounts (MMDAs)
Other savings deposits (excluding MMDAs)
Time deposits of less than $100,000
Time deposits of $100,000 or more
Deposits held in foreign offices
Federal funds purchased & repurchase agreements
Trading liabilities
Other borrowed funds
FHLB advances
Memo: Volatile liabilities
Subordinated debt
All other liabilities
Equity capital
83.68%
83.67%
26.29%
13.90%
57.38%
10.59%
9.19%
24.97%
12.63%
0.01%
0.91%
0.00%
3.28%
3.10%
14.69%
0.01%
0.60%
11.52%
80.85%
80.67%
19.76%
11.48%
60.91%
15.87%
11.60%
19.68%
13.76%
0.18%
2.54%
0.00%
5.73%
5.37%
18.61%
0.08%
0.79%
10.00%
Deposits held in domestic offices
Noninterest-bearing deposits
Interest-bearing deposits
Core (retail) deposits
IRAs and Keogh plan accounts
Brokered deposits
Fully insured
Estimated insured deposits
83.67%
14.09%
69.58%
71.04%
4.17%
1.45%
1.25%
67.31%
80.67%
13.55%
67.12%
66.92%
3.63%
2.86%
2.61%
58.43%
Number of institutions reporting
> $10 B
All CBs
85
7630
68.50%
67.36%
10.03%
7.28%
57.33%
23.47%
10.42%
11.53%
11.91%
1.14%
8.17%
0.00%
10.05%
6.77%
26.57%
0.40%
1.97%
10.90%
63.47%
49.93%
6.69%
5.42%
43.24%
23.74%
7.20%
5.08%
7.22%
13.55%
7.50%
4.45%
9.17%
2.01%
34.96%
1.67%
3.76%
9.95%
66.48%
49.93%
6.69%
5.42%
43.24%
23.74%
7.20%
5.08%
7.22%
13.55%
6.87%
3.33%
8.75%
2.97%
31.68%
1.31%
3.15%
10.10%
67.36%
11.89%
55.47%
55.45%
2.63%
4.35%
3.52%
41.51%
49.93%
11.72%
38.21%
42.71%
1.61%
4.58%
2.34%
28.24%
49.93%
11.72%
38.21%
42.71%
1.61%
4.58%
2.34%
28.24%
Average Annual Interest Cost of
Liabilities by Bank Size, 2004
$100M–
$1B
<$100M
1.56%
1.55%
Total interest expense on total liabilities
1.43%
1.49%
Interest expense on deposits
1.43%
1.49%
Domestic deposits
0.45%
0.54%
MMDAs and savings deposits
2.42%
2.36%
Time deposits <$100K
2.59%
2.47%
Time deposits >$100K
1.22%
0.57%
Deposits foreign offices
3.83%
2.55%
Fed funds purchased
3.44%
3.60%
U.S. notes & other borrowed funds
4.69%
3.91%
Subordinated notes & deb.
Source: BankSearch, Highline Data, © Highline Data, LLC.
$1B–
$10B
1.44%
1.22%
1.22%
0.35%
2.21%
2.47%
1.50%
4.20%
2.88%
4.25%
>$10B
1.36%
1.16%
1.02%
0.34%
2.21%
2.51%
1.67%
4.96%
3.01%
4.80%
All CB
1.34%
1.17%
1.09%
0.34%
2.19%
2.45%
1.62%
4.54%
2.73%
4.49%
Characteristics of Retail-Type Deposits
 Retail Deposits
 Small
denomination (under $100,000)
liabilities
 Normally held by individual investors
 Not actively traded in the secondary
market
Transaction Accounts
 Most banks offer three different
transaction accounts
 Demand

Deposits
DDAs
 Negotiable

NOWs
 Automatic

Order of Withdrawal
ATS
Transfers from Savings
Transaction Accounts
 Demand Deposits
 Checking
accounts that do not pay
interest
 Held by individuals, business, and
governmental units

Most are held by businesses since
Regulation Q prohibits banks from
paying explicit interest on for-profit
corporate checking accounts
Transaction Accounts
 NOW Accounts
 Checking
accounts that pay interest
 ATS Accounts
 Customer
has both a DDA and savings
account
 The bank transfers enough from
savings to DDA each day to force a
zero balance in the DDA account
 For-profit corporations are prohibited
from owning NOW and ATS accounts
Transaction Accounts
 Although the interest cost of
transaction accounts is very low, the
non-interest costs can be quite high
 Generally,
low balance checking
accounts are not profitable for banks
due to the high cost of processing
checks
Non-Transaction Accounts
 Non-transaction accounts are interest-
bearing with limited or no checkwriting privileges
 Money Market Deposit Accounts
 Pay
interest but holders are limited to 6
transactions per month, of which only
three can be checks
 Attractive to banks because they are
not required to hold reserves against
MMDAs
Non-Transaction Accounts
 Savings Accounts
 Have
no fixed maturity
 Small Time Deposits (Retail CDs)
 Have
a specified maturity ranging from
7 days on up
 Large Time Deposits (Jumbo CDs)
 Negotiable
CDs of $100,000 or more
 Typically can be traded in the
secondary market
Estimating the Cost of Deposit Accounts
 Interest Costs
 Legal Reserve Requirements
 Check Processing Costs
 Account Charges
 NSF
fees
 Monthly fees
 Per check fees
Estimating the Cost of Deposit Accounts
 Transaction Account Cost Analysis
 Classifies

check-processing as:
Deposits
 Electronic
 Non-Electronic

Withdrawals
 Electronic
 Non-Electronic
Estimating the Cost of Deposit Accounts
 Transaction Account Cost Analysis
 Classifies

check-processing as:
Transit Checks
 Deposited
 Cashed
Account Opened or Closed
 On-Us checks cashed
 General account maintenance

 Truncated
 Non-Truncated
Estimating the Cost of Deposit Accounts
 Transaction Account Cost Analysis
 Electronic

Transactions
Conducted through automatic deposits,
Internet, and telephone bill payment
 Non-Electronic

Conducted in person or by mail
 Transit

Transactions
Checks
Checks drawn on any bank other than
the bank it was deposited into
Estimating the Cost of Deposit Accounts
 Transaction Account Cost Analysis
 On-Us Checks Cashed
 Checks drawn on the bank’s own
customer’s accounts
 Deposits
 Checks or currency directly deposited
in the customer's account
 Account Maintenance
 General record maintenance and
preparing & mailing a periodic
statement
Estimating the Cost of Deposit Accounts
 Transaction Account Cost Analysis
 Truncated Account
 A checking account in which the
physical check is ‘truncated’ at the
bank and the checks are not returned
to the customer
 Official Check Issued
 A check for certified funds.
 Net Indirect Costs
 Those costs not directly related to the
product such as management salaries
or general overhead costs
Cost and Revenue Accounting Data for
Deposit Accounts at FirstBank
Demand
Income
Interest income (estimated earnings credit)
Noninterest income (monthly estimates per account)
Service charges
Penalty fees
Other
Total noninterestiIncome
Expenses
Activity charges (unit costs per transaction)
Deposit—electronic
Deposit—nonelectronic
Withdrawal—electronic
Withdrawal—nonelectronic
Transit check deposited
Transit check cashed
On-us check cashed
Official check issued
Monthly overhead expense costs
Monthly account maintenance (truncated)
Monthly account maintenance (nontruncated)
Net indirect expense
Miscellaneous expenses
Account opened
Account closed
Unit Cost
Savings
2.6%
Time
2.5%
3.0%
$
$
$
$
2.80
4.32
0.63
7.75
$
$
$
$
0.44
0.28
0.16
0.88
$
$
$
$
0.11
0.27
0.05
0.42
$
$
$
$
$
$
$
$
0.0089
0.2219
0.1073
0.2188
0.1600
0.2562
0.2412
1.02
$
$
$
$
$
0.0502
0.7777
0.4284
0.7777
0.5686
$
$
$
$
0.1650
3.1425
0.5400
1.4933
$
$
$
2.42
8.60
4.35
$
4.10
$
1.99
$
1.81
$
18.38
$
$
9.46
5.67
$
$
33.63
20.18
$
$
5.78
3.38
Calculating the Average Net Cost of Deposit
Accounts
 Average Historical Cost of Funds
 Measure
of average unit borrowing
costs for existing funds
 Average Interest Cost
 Calculated
by dividing total interest
expense by the average dollar amount
of liabilities outstanding
Average Net Cost of Bank Liabilitie s 
Interest Expense  Noninteres t Expense - Noninteres t Income
Average Balance Net of Float x (1 - Required Reserve Ratio)
Calculating the Average Net Cost of Deposit
Accounts
 Example:
A
demand deposit account that does
not pay interest has $20.69 in
transaction costs charges, $7.75 in
fees, an average balance of $5,515, and
5% float would have a net cost of
3.29%
Average Net Cost of Demand Deposit 
$0  $20.69 - $7.75
 12  3.29%
$5,515  (1 - .05)  (1 - .10)
Calculating the Average Net Cost of
Deposit Accounts
Low Balance, Low
Activity, Truncated
Income
Interest income
on average monthly balance (after float)
Activity
Monthly
Income /
Expenses
$ 500
$
0.93
$
$
$
$
$
2.80
8.56
0.63
11.99
12.92
1
1
15
3
1
1
2
$
$
$
$
$
$
$
$
$
0.01
0.22
1.61
0.66
0.16
0.26
0.48
3.40
1
$
$
$
$
2.42
4.35
6.77
$
$
$
Noninterest income (average montly estimates)
Service charges
Penalty fees (estimated for account)
Other
Total noninterest income
Total revenue
Expenses
Activity charges
Deposit—electronic
Deposit—nonelectronic
Withdrawal—electronic
Withdrawal—nonelectronic
Transit check deposited
Transit check cashed
On-us checks cashed
Official check issued
Total activity expense
Monthly expenses
Monthly account maintenance (truncated)
Monthly account maintenance (nontruncated)
Net indirect expense
Total reoccurring monthly expenses
Interest expense
Total expense
Net revenue per month
-
Average percentage cost (net of service charges and fees)
Average interest cost
Average noninterest cost
Average noninterest income
Average account balance
Required reserves
Float
Medium Balance,
High Activity,
Nontruncated
Activity
Monthly
Income /
Expenses
Activity
Monthly
Income /
Expenses
$ 4,589
$
8.50
$11,500
$
21.30
$
$
$
$
$
2.80
6.32
0.63
9.75
18.25
$
$
$
$
$
2.80
2.01
0.63
5.44
26.74
$
$
$
$
$
$
$
$
$
0.02
0.67
1.29
3.06
0.32
0.51
0.72
6.59
$
$
$
$
$
$
$
$
$
0.02
0.67
1.07
1.75
0.32
0.51
0.72
5.06
$
$
$
$
6.60
4.35
10.95
$
$
$
$
6.60
4.35
10.95
10.17
$
$
17.54
$
$
16.01
2.75
$
0.71
$
10.73
2
3
12
14
2
2
3
1
-5.12%
0.00%
28.53%
33.66%
$
High Balance
500
10%
5%
$
2
3
10
8
2
2
3
1
2.38%
0.00%
5.36%
2.98%
1.29%
0.00%
1.95%
0.66%
4,589
10%
5%
$ 11,500
10%
5%
Characteristics of Large Wholesale Liabilities
 Wholesale Liabilities
 Customers
move these investments on
the basis of small rate differentials, so
these funds are labeled:
Hot Money
 Volatile Liabilities
 Short-Term Non-Core funding

Characteristics of Large Wholesale Liabilities
 Wholesale Liabilities
 Includes:
Jumbo CDs
 Federal Funds Purchased
 Repurchase Agreements
 Eurodollar Time Deposits
 Foreign Deposits

Characteristics of Large Wholesale Liabilities
 Jumbo CDs
 $100,000 or more
 Negotiable
 Can be traded on the secondary market
 Minimum maturity of 7 days
 Interest rates quoted on a 360-day year
basis
 Insured up to $100,000 per investor per
institution
 Issued directly or indirectly through a
dealer or broker (Brokered Deposits)
Characteristics of Large Wholesale Liabilities
 Jumbo CDs
 Fixed-Rate
 Variable-Rate
 Jump Rate (Bump-up) CD
 Depositor has a one-time option until
maturity to change the rate to the
prevailing market rate
 Callable
 Zero
Coupon
 Stock Market Indexed

Rate tied to stock market index
performance
Characteristics of Large Wholesale Liabilities
 Individual Retirement Accounts
 Each
year, a wage earner can make a
tax-deferred investment up to $3,000 of
earned income
 Funds withdrawn before age 59 ½ are
subject to a 10% IRS penalty

This makes IRAs an attractive source of
long-term funding for banks
Characteristics of Large Wholesale Liabilities
 Foreign Office Deposits
 Eurocurrency

Financial claim denominated in a
currency other than that of the country
where the issuing bank is located
 Eurodollar

Dollar-denominated financial claim at a
bank outside the U.S.
The Origin and Expansion of Eurodollar
Deposits
Characteristics of Large Wholesale Liabilities
 Federal Funds Purchased

The term Fed Funds is often used to refer to
excess reserve balances traded between
banks



This is grossly inaccurate, given reserves
averaging as a method of computing reserves,
different non-bank players in the market, and
the motivation behind many trades
Most transactions are overnight loans,
although maturities are negotiated and can
extend up to several weeks
Interest rates are negotiated between trading
partners and are quoted on a 360-day basis
Characteristics of Large Wholesale Liabilities
 Repurchase Agreements (RPs or
Repos)
 Short-term
loans secured by
government securities that are settled
in immediately available funds
 Identical to Fed Funds except they are
collateralized
 Technically, the RPs entail the sale of
securities with a simultaneous
agreement to buy them back later at a
fixed price plus accrued interest
Characteristics of Large Wholesale Liabilities
 Repurchase Agreements (RPs or
Repos)
 Most
transactions are overnight
 In most cases, the market value of the
collateral is set above the loan amount
when the contract is negotiated.

This difference is labeled the margin
 The
lender’s transaction is referred to
as a Reverse Repo
Characteristics of Large Wholesale Liabilities
 Borrowing from the Federal Reserve


Discount Window
Discount Rate


Policy is to set discount rate 1% (1.5%) over the
Fed Funds target for primary (secondary) credit
loans
To borrow from the Federal Reserve, banks
must apply and provide acceptable collateral
before the loan is granted
 Eligible collateral includes U.S. government securities,
bankers acceptances, and qualifying short-term
commercial or government paper
Characteristics of Large Wholesale Liabilities
 Borrowing from the Federal Reserve
 Primary
Credit
Available to generally sound depository
institutions on a very short-term basis,
typically overnight
 It serves as a backup source of shortterm funds for sound depository
institutions

 Secondary

Credit
Available to depository institutions that
are not eligible for primary credit
Characteristics of Large Wholesale Liabilities
 Borrowing from the Federal Reserve
 Seasonal Credit
 Designed to assist small depository
institutions in managing significant
seasonal swings in their loans and
deposits
 Emergency Credit
 May be authorized in unusual and
exigent circumstances by the Board of
Governors to individuals, partnerships,
and corporations that are not depository
institutions
Characteristics of Large Wholesale Liabilities
 Federal Home Loan Bank Advances
 The FHLB system is a government-sponsored
enterprise created to assist in home buying
 The FHLB system is one of the largest U.S.
financial institutions, rated AAA because of the
government sponsorship
 Any bank can become a member of the FHLB
system by buying FHLB stock
 If it has the available collateral, primarily real
estate related loans, it can borrow from the
FHLB
 FHLB advances have maturities from 1 day to
as long as 20 years
5,100
Amount Outstanding (Billions)
Number of Banks
1 92 93 94 95 96 97 98 99 00 01 02 03 04
9
19 19 19 19 19 19 19 19 19 20 20 20 20 20
4,100
3,100
2,100
1,100
100
Advances
$450
$400
$350
$300
$250
$200
$150
$100
$50
Number of Banks with FHLB
Commercial Banks with FHLB Advances
Advances
Billions of Dollars of FHLB
Commercial Banks with FHLB Advances,
1991–2004
Electronic Money
 Intelligent Card
 Contains a microchip with the ability to store
and secure information
 Memory Card
 Simply store information
 Debit Card
 Online
 PIN based
 Transaction goes through the ATM system
 Offline
 Signature based transactions
 Transaction goes through the credit card
system
Distribution of the Number of Noncash
Payments in 2000 and 2003
2000
Online Debit,
4.14%
2003
EBT, 0.99%
EBT, 0.69%
Online Debit,
6.53%
Offline Debit,
7.31%
Offline Debit,
12.68%
ACH, 8.55%
Check, 45.20%
ACH, 11.21%
Credit Card,
21.52%
Check, 57.79%
Credit Card,
23.40%
Source: The 2004 Federal Reserve Payments Study, http://www.frbservices.org/Retail/pdf/2004PaymentResearchReport.pdf.
Note: Online debit payments are PIN-based, which includes purchases at the point of sale with ATM cards, and offline debit
payments, which are signature-based transactions. EBTs are electronic benefits transfers. Data does not include Fedwire or CHIPS
wire transfers.
Check 21
 Check Clearing for the 21st Century Act
 Facilitates
check truncation by
reducing some of the legal
impediments
 Foster innovation in the payments and
check collection system without
mandating receipt of check in
electronic form
 Improve the overall efficiency of the
nation’s payment system
Check 21
 Check Truncation
 Conversion
of a paper check into an
electronic debit or image of the check
by a third party in the payment system
other than the paying bank
 Facilitates check truncation by
creating a new negotiable instrument
called a substitute check
Check 21
 Substitute Check
 The legal equivalent of the original
check and includes all the information
contained on the original
 Check 21 does NOT require banks to
accept checks in electronic form nor
does it require banks to create
substitute checks
 It
does allow banks to handle checks
electronically instead of physically
moving paper checks
Substitute Check Authorized by Check 21
The Check Clearing Process
Check Clearing Process
 Banks typically place a hold on a
check until it verifies that the check is
“good”
 Expedited Funds Availability Act
 Under
Reg CC, it states that:
Local check must clear in no more than
two business days
 Non-local checks must clear in no more
than five business days
 Government, certified, and cashiers
checks must be available by 9 a.m. the
next business day

Measuring the Cost of Funds
 Average Historical Cost of Funds
 Many banks incorrectly use the
average historical costs in their pricing
decisions
 The primary problem with historical
costs is that they provide no
information as to whether future
interest costs will rise or fall.
 Pricing decisions should be based on
marginal costs compared with marginal
revenues
Measuring the Cost of Funds
 Marginal Cost of Funds
 Marginal

Measure of the borrowing cost paid to
acquire one additional unit of
investable funds
 Marginal

Cost of Equity
Measure of the minimum acceptable
rate of return required by shareholders
 Marginal

Cost of Debt
Cost of Funds
The marginal costs of debt and equity
Measuring the Cost of Funds
 Costs of Independent Sources of Funds



It is difficult to measure marginal costs
precisely
Management must include both the interest
and noninterest costs it expects to pay and
identify which portion of the acquired funds
can be invested in earning assets.
Marginal costs may be defined as :
Marginal Cost of Liability j
Interest Rate  Servicing Costs  Acquistion Costs  Insurance

Net Investable Balance of Liability j
Measuring the Cost of Funds
 Costs of Independent Sources of
Funds
 All
elements in the numerator are
expected costs
Measuring the Cost of Funds
 Costs of Independent Sources of Funds

Example:





Market interest rate is 2.5%
Servicing costs are 4.1% of balances
Acquisition costs are 1.0% of balances
Deposit insurance costs are 0.25% of
balances
Net investable balance is 85% of the balance
(10% required reserves and 5% float)
0.025  0.041  0.01  0.0025
Marginal Cost 
 0.0924  9.24%
0.85
Measuring the Cost of Funds
 Cost of Debt
 Equals
the effective cost of borrowing
from each source, including interest
expense and transactions costs
 This cost is the discount rate, which
equates the present value of expected
interest and principal payments with
the net proceeds to the bank from the
issue
Measuring the Cost of Funds
 Cost of Debt
 Example:

Assume the bank will issue:
 $10 million in par value subordinated notes
paying $700,000 in annual interest and a 7year maturity.
 It must pay $100,000 in flotation costs to an
underwriter.
 The effective cost of borrowing (kd) is 7.19%:
7
$700,000 $10,000,00 0
$9,900,000  

t
7
(1

k
)
(1

k
)
t 1
d
d
Thus k d  7.19%
Measuring the Cost of Funds
 Cost of Equity
 The
marginal cost of equity equals the
required return to shareholders

It is not directly measurable because
dividend payments are not mandatory.
 Several
methods are commonly used to
approximate this required return:
Dividend Valuation Model
 Capital Asset Pricing Model (CAPM)
 Target Return on Equity Model

 Cost of Debt + Risk Premium
Measuring the Cost of Funds
 Preferred Stock
 Preferred stock acts as a hybrid of debt
and common equity
 Claims are superior to those of common
stockholders but subordinated to those
of debt holders
 Preferred stock pays dividends that may
be deferred when management
determines that earnings are too low.
 The marginal cost of preferred stock can
be approximated in the same manner as
the Dividend Valuation Model however,
dividend growth is zero
Measuring the Cost of Funds
 Trust Preferred Stock
 Trust preferred stock is attractive because it
effectively pays dividends that are tax
deductible
 To issue the securities, a bank or bank holding
company establishes a trust company.
 The trust company sells preferred stock to
investors and loans the proceeds of the issue
to the bank
 Interest on the loan equals dividends paid on
the preferred stock
 This loan interest is tax deductible such that
the bank effectively gets to deduct dividend
payments as the preferred stock
Measuring the Cost of Funds
 Weighted Marginal Cost of Total Funds
 This
is the best cost measure for
asset-pricing purposes
 It recognizes both explicit and implicit
costs associated with any single
source of funds
 It assumes that all assets are financed
from a pool of funds and that specific
sources of funds are not tied directly
to specific uses of funds
Measuring the Cost of Funds
 Weighted Marginal Cost of Total
Funds

Steps to compute WMC
1.
2.
3.
Forecast the desired dollar amount of
financing to be obtained from each
individual debt and equity source
Estimate the marginal cost of each
independent source of funds
Combine the individual estimates to
project the weighted costs, which
equals the sum of the weighted
component costs across all sources
Measuring the Cost of Funds
 Weighted Marginal Cost of Total
Funds

Steps to compute WMC
4.
Management should combine the
individual estimates to project the
weighted cost, where wj equals each
source’s weight and kj equals the
single-source j component cost of
financing such that:
m
WMC   w jk j
j1
Measuring the Cost of Funds
 Example
Liabilities and Equity
(g)
(d)
Weighted
Processing
(f)
Marginal
and
(a)
(b)
(c)
(e)
Component Cost of
Average Percent Interest Acquisition Nonearning Marginal
Funds
Amount of Total Cost
Costs
Percentage
Costs
(b) x (f)
Demand deposits
Interest checking
Money market demand accounts
Other savings accounts
Time deposits < $100,000
Time deposits > $100,000
Total deposits
Federal funds purchased
Other liabilities
Total liabilities
$
$
$
$
$
$
$
$
$
$
28,210
5,551
13,832
3,640
18,382
9,055
78,670
182
4,550
83,402
Stockholders' equity
Total liabilities and equity
$ 7,599
$ 91,001
31.0%
6.1%
15.2%
4.0%
20.2%
10.0%
86.5%
0.2%
5.0%
91.7%
2.5%
3.5%
4.5%
4.9%
5.0%
5.0%
8.4% 18.9%*
100.0%
8.0%
6.5%
3.0%
1.2%
1.4%
0.3%
18.0%
15.0%
3.0%
1.5%
1.0%
0.5%
9.76%
10.59%
6.70%
5.79%
6.36%
5.34%
0.0302
0.0065
0.0102
0.0023
0.0129
0.0053
0.0%
0.0%
0.0%
40.0%
5.00%
0.00%
0.0001
4.0%
19.69%
0.0164
Weighted marginal cost of capital ———————————————————————————->
8.39%
Funding Sources and Banking Risks
 Banks face two fundamental
problems in managing liabilities.
Uncertainty over:
 What
rates they must pay to retain and
attract funds
 The likelihood that customers will
withdraw their money regardless of
rates
Funding Sources: Liquidity Risk
 The liquidity risk associated with a
bank’s deposit base is a function of:
 The
competitive environment
 Number of depositors
 Average size of accounts
 Location of the depositor
 Specific maturity and rate
characteristics of each account
Funding Sources: Liquidity Risk
 Interest Elasticity




How much can market interest rates change
before the bank experiences deposit
outflows?
If a bank raises its rates, how many new
funds will it attract?
Depositors often compare rates and move
their funds between investment vehicles to
earn the highest yields
It is important to note the liquidity advantage
that stable core deposits provide a bank
Funding Sources: Interest Rate Risk
 Today, many depositors and investors
prefer short-term instruments that can
be rolled over quickly as interest rates
change
 Banks must offer a substantial
premium to induce depositors to
lengthen maturities
 Those banks that choose not to pay
this premium will typically have a
negative one-year GAP
Funding Sources: Interest Rate Risk
 One strategy is to compete for
aggressively compete for retail core
deposits
 Individual
are not as rate sensitive as
corporate depositors and will often
maintain their balances through rate
cycles as long as the bank provides
good service
Funding Sources: Credit and Capital Risk
 Changes in the composition and cost of
bank funds can indirectly affect a bank’s
credit risk by forcing it to reduce asset
quality



For example, banks that substitute
purchased funds for lost demand deposits
will often see their cost of funds rise
Rather than let their interest margins
deteriorate, many banks make riskier loans
at higher promised yields
While they might maintain their margins in
the near-term, later loan losses typically rise
with the decline in asset quality
Holding Liquid Assets
 Banks hold cash assets to satisfy
four objectives:
1.
2.
3.
4.
To meet customers’ regular
transaction needs
To meet legal reserve requirements
To assist in the check-payment
system
To purchase correspondent banking
services
Holding Liquid Assets
 Banks own four types of liquid assets
 Vault
Cash
 Demand Deposit Balances at the
Federal Reserve
 Demand Deposit Balances at private
financial institutions
 Cash Items in Process of Collection
(CIPC)
Holding Liquid Assets
 “Cash Assets”


Do not earn any interest
Represents a substantial opportunity cost for
banks

Banks attempt to minimize the amount of cash
assets held and hold only those required by
law or for operational needs
 Liquid Assets

Can be easily and quickly converted into
cash with minimum loss
Holding Liquid Assets
 “Cash Assets” do not generally satisfy
a bank’s liquidity needs
 If
the bank holds the minimum amount
of cash assets required, an unforeseen
drain on vault cash (perhaps from an
unexpected withdrawal) will cause the
level of cash to fall below the
minimum for legal and operational
requirements
Holding Liquid Assets
 Assets That Provide Bank Liquidity
 Cash
and due from banks in excess of
requirements
 Federal funds sold
 Reverse repurchase agreements
 Short-term Treasury and agency
obligations
 High-quality, short-term corporate and
municipal securities
Holding Liquid Assets
 For a financial institution that regularly
borrows in the financial markets, liquidity
takes on the added dimension of the ability
to borrow funds at minimum cost or even
the ability to issue stock.

It explicitly recognizes that such firms can
access cash by:




Selling assets
New borrowings
New stock issues
Bank Liquidity

Refers to a bank’s capacity to acquire
immediately available funds at a reasonable
price
Objectives of Cash Management
 Banks must balance the desire to hold
a minimum amount of cash assets
while meeting the cash needs of its
customers
 The fundamental goal is to accurately
forecast cash needs and arrange for
readily available sources of cash at
minimal cost
Reserve Balances at the Federal Reserve Bank
 Banks hold deposits at the Federal
Reserve because:
 The
Federal Reserve imposes legal
reserve requirements and deposit
balances qualify as legal reserves
 To help process deposit inflows and
outflows caused by check clearings,
maturing time deposits and securities,
wire transfers, and other transactions
Reserve Balances at the Federal Reserve Bank
 Required Reserves and Monetary Policy
 The
purpose of required reserves is to
enable the Federal Reserve to control
the nation’s money supply
 The Fed has three distinct monetary
policy tools:
Open market operations
 Changes in the discount rate
 Changes in the required reserve ratio

Reserve Balances at the Federal Reserve Bank
 Required Reserves and Monetary Policy
 Changes
in reserve requirements
directly affect the amount of legal
required reserves and thus change the
amount of money a bank can lend out
Reserve Balances at the Federal Reserve Bank
 Required Reserves and Monetary Policy
 For example, a required reserve ratio of 10%
means that a bank with $100 in demand
deposits outstanding must hold $10 in legal
required reserves in support of the DDAs
 The bank can thus lend out only 90% of its
DDAs
 If the bank has exactly $10 in legal reserves,
the reserves do not provide the bank with
liquidity
 If the bank has $12 in legal reserves, $2 is
excess reserves, providing the bank with $2 in
immediately available funds
Reserve Balances at the Federal Reserve Bank
 Impact of Sweep Accounts on Required
Reserve Balances



Under Reg. D, banks have reserve
requirements of 10% on demand deposits,
ATS, NOW, and other checkable deposit (OCD)
accounts
MMDAs are considered personal saving
deposits and have a zero required reserve
requirement ratio.
Sweep accounts are accounts that enable
depository institutions to shift funds from
OCDs, which are reservable, to MMDAs or
other accounts, which are not reservable
Growth of Sweep Transaction Deposits into
MMDAs: 1994–2004
700
Monthly Averages of Initial Amounts
Cumulative Total
Billions of Dollars
.
600
500
400
300
200
100
0
Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04
Reserve Balances at the Federal Reserve Bank
 Sweep Accounts
 Two

Types
Weekend Program
 Reclassifies transaction deposits as
savings deposits at the close of business
on Friday and back to transaction
accounts at the open on Monday
 On average, this means that for three days
each week, the bank does not need to hold
reserves against those balances
Reserve Balances at the Federal Reserve Bank
 Sweep Accounts
 Two

Types
Threshold Account
 The bank’s computer moves the customer’s
DDA balance into an MMDA when the dollar
amount reaches some minimum and returns
funds as needed
 The number of transfers is limited to 6 per
month, so the full amount of funds must be
moved back into the DDA on the sixth
transfer of the month
Meeting Legal Reserve Requirements
 Required reserves can be met over a
two-week period
 There are three elements of required
reserves:
 The
dollar magnitude of base liabilities
 The required reserve fraction
 The dollar magnitude of qualifying
cash assets
Meeting Legal Reserve Requirements
Type of Deposit
Net transactions Accounts
Exempt amt.
$ 7.00 mill
Up to
$ 47.60 mill
Over
$ 47.60 mill
All other liabilities
Percentage
Effective Date
of Applicable
Percentages
0.00%
3.00%
10.00%
0.00%
12/23/2004
12/23/2004
12/23/2004
12/27/1990
Meeting Legal Reserve Requirements
 Historical Problems with Reserve
Requirements
 Historically,
reserve requirements
varied with the type of bank charter
and each bank’s geographic location
 Currently, banks use a lagged reserve
account (LRA) system

Reserves are held for a two-week
period against deposit liabilities held
for the two-week period ending almost
three weeks earlier
Meeting Legal Reserve Requirements
 Lagged Reserve Accounting
 Computation

Consists of two one-week reporting
periods beginning on a Tuesday and
ending on the second Monday
thereafter
 Maintenance

Period
Period
Consists of 14 consecutive days
beginning on a Thursday and ending
on the second Wednesday thereafter
Meeting Legal Reserve Requirements
 Lagged Reserve Accounting
 Reserve

Balance Requirements
The balance to be maintained in any
given maintenance period is measured
by:
 Reserve requirements on the
reservable liabilities calculated as of
the computation period that ended 17
days prior to the start of the
maintenance period
 Less vault cash as of the same
computation period
Meeting Legal Reserve Requirements
 Lagged Reserve Accounting
 Reserve
Balance Requirements
Both vault cash and Federal Reserve
Deposits qualify as reserves
 The portion that is not met by vault
cash is called the reserve balance
requirement

Reserve Requirement Percentages for
Depository Institutions
Type of Deposit
Net transactions accounts
Exempt amt.
$ 7.0 mill
Up to
$ 47.6 mill
Over
$ 47.6 mill
All other liabilities
Percentage
Effective Date
of Applicable
Percentages
0.0%
3.0%
10.0%
0.0%
12/23/2004
12/23/2004
12/23/2004
12/27/1990
Relationship between the Reserve Maintenance
and Base Computation Periods under Lagged
Reserve Accounting
Sun
Mon
Tue
Wed
Thu
Fri
Sat
8-Aug
9-Aug
10-Aug
11-Aug
12-Aug
13-Aug
14-Aug
15-Aug
16-Aug
17-Aug
18-Aug
19-Aug
20-Aug
21-Aug
22-Aug
23-Aug
24-Aug
25-Aug
26-Aug
27-Aug
28-Aug
29-Aug
30-Aug
31-Aug
1-Sep
2-Sep
3-Sep
4-Sep
5-Sep
6-Sep
7-Sep
8-Sep
9-Sep
10-Sep
11-Sep
12-Sep
13-Sep
14-Sep
15-Sep
16-Sep
17-Sep
18-Sep
19-Sep
20-Sep
21-Sep
22-Sep
23-Sep
24-Sep
25-Sep
Lagged reserve computation period and vault cash application period
Reserve maintenance period
Report of Reversible Liabilities and
Offsetting Asset Balances
Lagged Computation
Tue
Wed
Thu
Balances at Close of Business Day (millions of dollars)
Fri
Sat
Sun
Mon
Tue
Wed
Thu
Fri
Sat
Sun
Mon
Period
10-Aug 11-Aug 12-Aug 13-Aug 14-Aug 15-Aug 16-Aug 17-Aug 18-Aug 19-Aug 20-Aug 21-Aug 22-Aug 23-Aug
DDAs
992
995
956
954
954
954
989
996
960
959
958
958
958
990
Auto trans from savings
0
0
0
0
0
0
0
0
0
0
0
0
0
0
NOW and Super NOW
221
221
222
223
223
223
223
224
225
225
225
225
225
225
Deductions:
DD bal from U.S. dep.
163
281
190
186
186
186
159
159
274
178
182
182
182
164
CIPC
96
96
78
78
78
78
95
98
92
79
81
81
81
88
Net trans. accounts
954
839
910
913
913
913
958
963
819
927
920
920
920
963
Vault Cash
28
30
31
33
33
33
38
30
31
32
32
32
32
TwoWeek
Total
$ 13,573
$
0.0
$ 3,130
$
0.0
$ 2,672
$ 1,199
$ 12,832
36 $
Daily
Average
$ 969.50
$
0.0
$ 223.57
$
0.0
$ 190.86
$ 85.64
$ 916.57
451 $ 32.21
Required Reserves Report, August 10–23
Reservable Liabilities for
Daily Avg.
Deposit
Liab. ($mill)
Aug 10–23
Net trans. accounts
Exempt up to
$ 7.0 mill
7.00
Over 7 up to
$ 47.6 mill
$
40.60
Over
$ 47.6 mill
$
868.97
Total
$
916.57
Gross reserve requirement
Daily average vault cash
Net reserve requirement
Reserve carry-forward (from prior period)
Minimum reserves to be maintained with Federal Reserve
Maximum reserves to be maintained
Reserve
Percentage
0.0%
3.0%
10.0%
Daily Avg.
Requirement
($ mill)
$0.000
$1.218
$86.897
$88.115
$32.214
$55.901
($ 2.276)
$58.177
$61.702
(0.04 x 88.115) + 58.177
If a surplus carry forward of
$
1.500
Minimum reserves to be maintained with Federal Reserve
Carry forward (4% of gross reserve requirement)
Maximum reserves to be maintained
(0.04 x 88.115) + 54.401
$54.401
$3.525
$57.926
Correspondent Banking Services
 System of interbank relationships in
which the correspondent bank
(upstream correspondent) sells
services to the respondent bank
(downstream correspondent)
Correspondent Banking Services
 Common Correspondent Banking Services









Check collection, wire transfer, coin and
currency supply
Loan participation assistance
Data processing services
Portfolio analysis and investment advice
Federal funds trading
Securities safekeeping
Arrangement of purchase or sale of securities
Investment banking services
International financial transactions
Liquidity Planning
 Short-Term Liquidity Planning
 Objective
is to manage a legal reserve
position that meets the minimum
requirement at the lowest cost
Short-Term Liquidity Planning
 Below are some of the factors that
affect the bank’s legal reserve position
Factors Increasing Reserves
Nondiscretionary
Yesterday's immediate cash letter
Deferred availability items
Excess from local clearinghouse
Deposits from U.S. Treasury
Discretionary
Currency/coin shipped to Federal Reserve
Security sales
Borrowing from Federal Reserve
Federal funds purchased
Securities sold under agreement to repurchase
Interest payments on securities
New certificates of deposit, Eurodollar issues
Factors Decreasing Reserves
Nondiscretionary
Remittances charged
Deficit in local clearinghouse
Treasury tax and loan account calls
Maturing certificates of deposit, Eurodollars
not rolled over
Discretionary
Currency and coin received from Federal
Reserve
Security purchases
Payment on loans from Federal Reserve
Federal funds sold
Securities purchased under agreement to resell
Managing Float
 During any single day, more than $100
million in checks drawn on U.S.
commercial banks is waiting to be
processed
 Individuals,
businesses, and
governments deposit the checks but
cannot use the proceeds until banks
give their approval, typically in several
days.
 Checks in process of collection, called
float, are a source of both income and
expense to banks.
The Payments System
 Payments between banks can be made
either by check or electronically
 Checks
drawn against transactions
accounts are presented to the
customer’s bank for payment and
ultimately “cleared” by reducing the
bank’s deposit balance at the Federal
Reserve or a correspondent bank
 Payments made electronically directly
and immediately alter balances held at
Federal Reserve Banks
The Payments System
 Example of the Check Clearing Process
The Payments System
 Electronic Funds Transfer Networks
 Fedwire

Operated by the Federal Reserve
 Clearinghouse
Interbank Payments
System (CHIPS)
Operated by New York Clearing House
 Typically handles Eurodollar transfers
or foreign exchange trading

Liquidity versus Profitability
 There is a short-run trade-off between
liquidity and profitability
 The
more liquid a bank is, the lower are
its return on equity and return on
assets, all other things equal
In a bank’s loan portfolio, the highest
yielding loans are typically the least
liquid
 The most liquid loans are typically
government-guaranteed loans

The Relationship Between Liquidity, Credit,
and Interest Rate Risk
 Liquidity risk for a poorly managed
bank closely follows credit and
interest rate risk
 Banks
that experience large deposit
outflows can often trace the source to
either credit problems or earnings
declines from interest rate gambles
that backfired
 Potential liquidity needs must reflect
estimates of new loan demand and
potential deposit losses
The Relationship Between Liquidity, Credit,
and Interest Rate Risk
 New Loan Demand
 Unused
commercial credit lines
outstanding
 Consumer credit available on bankissued cards
 Business activity and growth in the
bank’s trade area
 The aggressiveness of the bank’s loan
officer call programs
The Relationship Between Liquidity, Credit,
and Interest Rate Risk
 Potential deposit losses are affected by:
 The composition of liabilities
 Insured versus uninsured deposits
 Deposit ownership between: money fund
traders, trust fund traders, public
institutions, commercial banks by size,
corporations by size, individuals, foreign
investors, and Treasury tax and loan
accounts
 Large deposits held by any single entity
 Seasonal or cyclical patterns in deposits
 The sensitivity of deposits to changes in the
level of interest rates
Traditional Aggregate Measures of Liquidity
Risk
 Asset Liquidity Measures
 The
most liquid assets mature near
term and are highly marketable
 Any security or loan with a price above
par, in which the bank could report a
gain at sale, is viewed as highly liquid
 Liquidity measures are normally
expressed in percentage terms as a
fraction of total assets
Traditional Aggregate Measures of Liquidity
Risk
 Highly Liquid Assets
 Cash and due from banks in excess of
required holdings
 Federal funds sold and reverse RPs.
 U.S. Treasury securities and agency
obligations maturing within one year
 Corporate obligations and municipal
securities maturing within one year and rated
Baa and above
 Loans that can be readily sold and/or
securitized
Pledging Requirements
 Not all of a bank’s securities can be
easily sold
 Like
their credit customers, banks are
required to pledge collateral against
certain types of borrowings
 U.S. Treasuries or municipals normally
constitute the least-cost collateral and,
if pledged against debt, cannot be sold
until the bank removes the claim or
substitutes other collateral
Pledging Requirements
 Collateral is required against four
different liabilities:
 Repurchase
agreements
 Discount window borrowings
 Public deposits owned by the U.S.
Treasury or any state or municipal
government unit
 FLHB advances
Liability Liquidity Measures
 Liability Liquidity
 The
ease with which a bank can issue
new debt to acquire clearing balances
at reasonable costs.
 Measures typically reflect a bank’s
asset quality, capital base, and
composition of outstanding deposits
and other liabilities.
Liability Liquidity Measures
 The following measures are commonly used:
 Total equity to total assets
 Risk assets to total assets
 Loan losses to net loans
 Reserve for loan losses to net loans
 The percentage composition of deposits
 Total deposits to total liabilities
 Core deposits to total assets
 Federal funds purchased and RPs to total
liabilities
 Commercial paper and other short-term
borrowings to total liabilities.
Liability Liquidity Measures
 Volatile Deposits
 The
difference between actual current
deposits and the base estimate of core
deposits
Longer-Term Liquidity Planning
 Projections are separated into:
 Base
Trend
 Short-Term Seasonal
 Cyclical
 Liquidity Needs
 Equals

Forecasted change in loans + change
in required reserves – forecasted
change in deposits
Forecasts of trend, seasonal, and cyclical
components of deposits and loans
reference balance sheet.
Assets
Liabilities
Cash and due from banks
$ 160
Loans
1,400
Investment securities
Other assets
Total
400
40
$2,000
Transaction accounts and
nonnegotiable deposits
Certificates of deposit and other
borrowing
Stockholders' equity
Total
$1,600
280
120
$2,000
Forecasts of trend, seasonal, and cyclical
components of deposits and loans
Deposit forecast
End of
Month
January
February
March
April
May
June
July
August
September
October
November
December
Trend
Deposits
(2)
Seasonal
Deposit
lndext
(3)
Seasonal
Deposits Dec.
Deposits
(4)
Cyclical
Deposits
(5)
Total
$1,608
1,616
1,623
1,631
1,639
1,647
1,655
1,663
1,671
1,680
1,688
1,696
99%
102
105
107
101
96
93
95
97
101
104
100
-$16
+32
+80
+112
16
-64
-112
-80
-48
+16
+64
0
-$3
8
7
10
1
-8
-15
-9
-4
0
+3
0
$1,589
1,656
1,710
1,753
1,656
1,575
1,528
1,574
1,619
1,696
1,755
1,696
Forecasts of trend, seasonal, and cyclical
components of deposits and loans
Loan forecast
End of
Month
January
February
March
April
May
June
July
August
September
October
November
December
Trend
Loans*
Seasonal
Loan
lndext
Seasonal
LoanDec. Loans
Cyclical
Loans
$1,413
1,427
1,440
1,454
1,467
1,481
1,495
1,510
1,524
1,538
1,553
1,568
101%
97
95
94
97
102
108
106
103
99
98
100
$14
-42
-70
-84
-42
28
112
84
42
-14
-28
0
$6
-9
-18
-21
-15
-3
9
17
11
5
0
0
Total
$1,433
1,376
1,352
1,349
1,410
1,506
1,616
1,611
1,577
1,529
1,525
1,568
Monthly liquidity needs
 The bank’s monthly liquidity needs
are estimated as the forecasted
change in loans plus required
reserves minus the forecast change
in deposits:
 Liquidity
needs =
Forecasted Dloans + Drequired
reserves - forecasted Ddeposits
Estimates of Liquidity Needs
End of
Month
January
February
March
April
May
June
July
August
September
October
November
December
DDeposits
DRequired
Reserves
DLoans
Liquidity
Needs*
11.0
56.0
110.0
153.0
56.0
-25.0
-72.0
-26.0
19.0
96.0
155.0
96.0
1.1
5.6
11.0
15.3
5.6
-2.5
-7.2
-2.6
1.9
9.6
15.5
9.6
$ 33.0
-24.0
-48.0
-51.0
10.0
106.0
216.0
211.0
177.0
129.0
125.0
168.0
$42.9
-74.4
-147.0
-188.7
-40.4
128.5
280.8
234.4
159.9
42.6
-14.5
81.6
Liquidity GAP measures
 Management can supplement this
information with projected changes in
purchased funds and investments with
specific loan and deposit flows.
 The bank can calculate a liquidity GAP by
classifying potential uses and sources of
funds into separate time frames according
to their cash flow characteristics.
 The Liquidity GAP for each time interval
equals the dollar value of uses of funds
minus the dollar value of sources of funds.
Liquidity gap estimates (millions of dollars)
0–30 Days
Potential Uses of Funds
Add: Maturing time deposits
Small time deposits
5.5
Certificates of deposit over $100,000
40.0
Eurodollar deposits
10.0
Plus: Forecast new loans
Commercial loans
60.0
Consumer loans
22.0
Real estate and other loans
31.0
Minus: Forecast net change in transactional accounts
Demand deposits
- 6.5
NOW accounts
0.4
Money market deposit accounts
1.6
Total uses
$173.0
Potential Sources of Funds
Add: Maturing investments
Money market instruments
8.0
U.S. Treasury and agency securities
7.5
Municipal securities
2.5
Plus: Principal payments on loans
80.0
Total sources
98.0
Periodic Liquidity GAP
75.0
75.0
Cumulative Liquidity GAP
31–90 Days
91–365 Days
8.0
70.0
10.0
34.0
100.0
30.0
112.0
46.0
23.0
686.0
210.0
223.0
105.5
5.5
3.0
155.0
10.0
7.0
6.0
1,260.0
16.5
10.5
1.0
262.0
290.0
-135.0
- 60.0
36.5
40.0
12.5
903.0
992.0
268.0
208.0
Potential funding sources (millions of dollars)
Time Frame
Purchased Funds Capacity
Federal funds purchased (overnight and term)
Repurchase agreements
Negotiable certificates of deposit
Local
National
Eurodollar certificates of deposit
Total
Additional Funding Sources
Reductions in federal funds sold
Loan participations
Sale of money market securities
Sale of unpledged securities
Total
Potential Funding Sourcesa
Potential Extraordinary Funding Needs
50% of outstanding letters of credit
20% of unfunded loan commitments
Total
Excess Potential Funding Sources
0–30
Days
31–90
Days
91–365
Days
$20
10
$20
10
$30
10
50
20
20
$120
50
20
20
$120
60
25
20
$145
$5
20
5
10
$40
$160
$5
20
5
10
$40
$160
$5
20
5
10
$40
$185
5
25
$30
$130
10
30
$40
$120
15
35
$50
$135
Considerations in Selecting Liquidity Sources
 Asset Sales
 Brokerage
fees
 Securities gains or losses
 Foregone interest income
 Any increase or decrease in taxes
 Any increase or decrease in interest
receipts
Considerations in Selecting Liquidity Sources
 New Borrowings
 Brokerage
fees
 Required reserves
 FDIC insurance premiums
 Servicing or promotion costs
 Interest expense
Considerations in Selecting Liquidity Sources
 The costs should be evaluated in
present value terms because interest
income and expense may arise over
time
 The choice of one source over another
often involves an implicit interest rate
forecast
Bank Management, 6th edition.
Timothy W. Koch and S. Scott MacDonald
Copyright © 2006 by South-Western, a division of Thomson Learning
Funding the Bank and Managing
Liquidity
Chapter 8
Prof. Dr. Rainer Stachuletz edited and updated the PowerPoint slides for this edition.