With changing economic trends, technology growth, the rise of AI, and social media, banks need to effectively predict and track their capital inflows and outflows to minimise capital loss. One of the best ways to prevent loss and closure is by closely monitoring the liquidity risk factor of the bank.
The banks’ liability gap, which is measured as a difference between the asset maturity term and the liability overdue, helps banks detect if they have to be worried about a liquidity risk.
Students of accounting and finance need to be aware of the nuances of the liquidity risk factor to reduce its impact on banking operations. It will not only help them perform well in the Certified Management Accounting exam but also secure lucrative jobs in the financial crisis management department of the banking sector. In this regard, pursuing account-related courses in Ahmedabad will prove beneficial to CMA exam aspirants and other finance students.
Here are some tips for banks to monitor and minimise their liquidity risk:
1. Banks need to have a contingency funding plan to handle a liquidity shortfall
A strategic contingency plan will help banks foresee unfavourable situations and develop fail-safe plans to tackle them. Often known as a backup plan, a contingency funding plan (CFP) and its components will help banks function normally even during crises.
A contingency plan also gives the bank the requisite confidence to return to its normal state despite encountering undesirable situations like a cash crunch.
One of the most important aspects of a contingency funding plan is to identify key risks and rank them according to their level of importance. After this, the CFP team will need to recognise and allocate resources for the different crises. A detailed plan comprising risk factors and resources should be mapped and shared with all the relevant stakeholders.
2. Revamp the banks’ stress testing techniques to match technology growth
Many stress testing techniques of banks are designed for offline banking transactions only. But, owing to the growth of technology, the social media scare can lead even a healthy, functioning bank to fail with online transactions and fund transfers. Hence, the stress testing techniques should factor in the worst-case scenarios and help detect bank vulnerabilities in the age of growing social media and artificial intelligence use.
3. Effectively manage solvency and liquidity buffer
Solvency, which is the bank’s ability to handle long-term liabilities with ease, needs to factor in its close connection with the liquidity buffer. When banks are leaning towards solvency, their liquidity buffer can be on the lower end. But regular measures to determine the banks standing on the solvency spectrum are important. If the bank is leaning towards insolvency, then having cash reserves in the form of a liquidity buffer is essential. The rate of insolvency of rural banks tends to be higher than that of urban banks, on account of the many concessions offered to the rural sector. So, such banks need to closely monitor insolvency and manage their liquidity buffer accordingly.
4. Monitor the risks encountered by funding
Another important facet of liquidity risk management is incorporating it into the banking institutions’ key executive decisions and plans. In many situations, banks fail to take into account the liquidity risk while formulating the interest rates on loans for different sectors.
By knowing how much money is allocated to equity, core deposits, and wholesale funds, a bank can predict the fund recovery rate. Also, by knowing the history of depositors and their behaviours, the cash inflow and cash outflow of the bank can be determined.
5. Leverage the power of financial data
Data analytics can help banks manage liquidity risk very effectively. By forecasting and recognising cash flow patterns using financial data analytics tools, banks can invest in assets that have the least risk and maximum returns. For instance, the influence of demand and pricing on cash flow can be effectively determined using the power of data mining and analytics.
Data analytics not only predicts financial data but also helps optimise the working capital of the bank. Working capital is the difference between current assets and liabilities. Optimising the capital available with the bank for regular operations will help it minimise cash deficits effectively.
Additionally, the power of data analytics can also be used to monitor indicators of liquidity risk like the liability gap, liquidity fund reserve, stress tests, and others. This will further help banks mitigate liquidity risk and focus on improving banking opportunities.
Final Word
Though technology growth can sometimes be a deterrent for banking operations that are more built for brick-and-mortar banking operations, keeping up with technology and data will help a bank survive in the modern world where everything and everyone is dominated by artificial intelligence.
As a result, students who are pursuing different financial courses, like account-related courses in Ahmedabad, need to be on par with the varied financial trends of liquidity risk management if they want to have a successful career in banking.