Why Banks Face Liquidity Crisis? [8 Reasons]

Why Banks Face Liquidity Crisis?

Liquidity management is an important problem of commercial banks. There are many possible reasons which may cause such a problem. 8 of the reasons for the liquidity crisis are:

  1. Using short-term funds in long-term investment;
  2. A large proportion of liabilities is repaid in the shortest possible time;
  3. Sensitiveness to the rates of interest;
  4. Indifference and or lack of cautious & close observation of deposits and loan behavior of the large prime corporate/institutional customers;
  5. Lack of constructive efforts to raise the skill of the personnel for loan recovery and loan securitization;
  6. Absence of linkage with the bank rating agencies;
  7. Inaccessibility to the money market; and
  8. Inefficient front-line counter service.

Short-term funds used in long-term investment

Experienced bank managers never use short-term funds for long-term loans & investments whether there is enough possibility of profit or not.

After analyzing the primary liquidity crisis of many banks, which faced bankruptcy due to liquidity crisis, we find that bank fund managers practiced such wrong loan and/or investment policies to get the cheap complement of senior management.

Ultimately, these banks could not meet short-term liquidity requirements due to the utilization of short-term funds in long-term loans & investments.

As such, utilizing the bank’s funds is imperative: short-term investments should be made out of short-term funds, and long-term investors should be made from long-term funds.

A large proportion of liabilities is repaid in a short time Period

Efficient bank officers should keep the liabilities balanced by different terms, sources, and instruments.

Arrangements are made to make repayments of liabilities not in bulk but in installments. It lowers the bank s risk in liability repayment and needs to make a single large refund not arise at a time.

For example, if a current deposit of a bank is 60% of total deposits, then that bank or branch can not bear the risk of a sizeable long-term investment. Bank’s reputation will also deteriorate if it delays meeting the withdrawal request of such deposits.

Over sensitiveness to the rates of interest

Interest rate is an important factor for banking business, but being excessively enthusiastic about giving excessive loans or collecting too many deposits at the time of decrease or increase in the rate of interest in an unplanned way will most likely create an imbalance in fund management.

This may severely increase or decrease the demand for liquidity from both the perspective of assets and liabilities.

Otherwise, it would create a wrong decision on the pan of the bank fund manager and put the bank into a severe liquidity crisis. Thus, prior consideration is required about the deposit, deposit mix, and the need for short-term, intermediate-term, and long-term liquidity.

Indifference and lack of close observation of the deposits and loan behavior of the prime corporate customers and institutional customers

In many banks or branches, some individuals or institutional clients (depositors and creditors) are known as prime corporate customers, and these clients usually transact in large denominations.

The experienced banker should maintain close contact with such clients who are the larger depositors and holders of large credit lines to determine the timing and pattern of withdrawal or deposit.

This will help the bank maintain the liquid funds accordingly and enable the bankers to provide them liquidity as and when they require and make a planned investment of the large deposits when made by these customers.

The more accurate the prediction of likely loan requests and deposits from these customers are, the more efficient and accurate the liquidity management will be.

Inefficient counter service

This is about the immediate liquidity problems often observed in sonic branches II counter service provided by efficient, skilled, and well-behaved persons.

The clients, mainly depositors and installment lakers of borrowers, will patiently wait without any objection and do not complain to the higher authority about the unavailability of money.

Thus, no bad impression about the service of the bank spreads among the general public. The adverse situation that will arise dial is panic for delayed liquidity due to inefficient counter service.

Absence of maintaining linkage with the bank rating agencies

Government bank regulatory authority. Private bank rating agencies and information-selling institutions collect necessary information about the banks from direct or indirect sources.

Ultimately, they provide in-depth high-class professional analysis and evaluation of the bank’s financial condition, including liquidity position.

Suppose the bank maintains regular linkage-building rapport with these institutions. In that case, they may get regular & complete data & information from the bank with detailed clarifications regarding liquidity and other operational trends of banks.

With the help of such information and advice, understanding & reporting about the bank’s liquidity will be easier with clarifications.

Inaccessibility to the money market

Despite taking many precautionary measures, many banks fall into liquidity crises more or less due to uncertainty.

To overcome this crisis, banks should rake develop connections and accessibility to the money market players and can take advanced steps to manage interbank loans or sell short-term securities in the money market whenever required.

Thus, if a liquidity crisis arises, the bank can overcome the situation by collecting the necessary funds. The bank, which sells security with more reliability, credibility, and stability, has the ability to avoid liquidity crises timely or even can avoid the same more efficiently.

Lack of constructive efforts to raise the skill of the personnel for loan recovery and loan securitization

Management of banks by professionally skilled and experienced personnel of deposits and loans can avoid many problems, not to mention liquidity. A liquidity crisis must occur if the loan cannot be recovered at the right time and right amount.

On the other hand, the loan portion may be converted into debenture and can be sold in the cash market, and thereby, liquidity is managed by managerial maneuvering.

Thus, by efficient and planned loan recovery and by ensuring loan conversion opportunity, the liquidity crisis can be avoided and minimized by experienced and professionally trained bank personnel.

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