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MGT411 GDB Fall 2019 Solution & Discussion Last Date: 28-01-2020

Due Date: January 28, 2020                                      Marks: 5

 

Learning Objective:

The objective of this question is to enable the students to understand the concept of liquidity risk for banks its sources and how banks manage it thorough different strategies.

 

Discussion Question:

Liquidity is a term used to describe the ease with which an asset can be converted into cash. Most of the time businesses face a situation where they have to meet sudden demand of cash or liquid funds that creates liquidity risk. Banks face liquidity risk on both sides i.e. asset and liability side of their balance sheet. On liability side, it is due to sudden deposit withdrawals and on asset side it is due to failure of banks to provide loans to their customers when demanded. One way to manage liquidity risk is to hold sufficient excess reserves but it is considered to be expensive one. The other two ways are adjusting assets and adjusting liabilities. Banks can manage it from asset side by selling a portion of its securities, selling some of its loans to other banks or by simply refusing to renew a customer loan that has come due which is absolutely not very appealing. On liability side; banks can manage it by attracting additional deposits or by borrowing either from the Central Bank or any other bank. But banks prefer to find other sources of funds instead of selling existing assets to manage liquidity risk.

Keeping this in mind; answer the following questions:

  • Briefly explain why keeping excess reserves in banks is considered to be expensive?
  • Why do banks prefer to manage liquidity risk by adjusting liability side instead of assets?

 

 

Important Instructions:

  1. Your discussion must be based on logical facts.
  2. The GDB will remain open for 07 working days.
  3. Do not copy or exchange your answer with other students. Two identical / copied comments will be marked Zero (0) and may damage your grade in the course.
  4. Obnoxious or ignoble answer should be strictly avoided.
  5. Questions / queries related to the content of the GDB, which may be posted by the students on MDB or via e-mail, will not be replied till the due date of GDB is over.

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