Learning Objectives:

  • Understand the sources of bank funding and their characteristics.

  • Apply liquidity risk measurement and management techniques.

  • Explain the role of the Liquidity Coverage Ratio and Net Stable Funding Ratio.

  • Understand the importance of contingency funding planning.

2.1 Sources of Bank Funding

Banks fund their assets through a mix of sources. The University of Nottingham’s Treasury section identifies “financing” as a core responsibility: “Determining the level and timing of funding required in conjunction with the budget and 5 year plan and sourcing that funding” . The ICAI materials note that banks must generate funds “at the lowest fund cost. Operational effectiveness at the lending and investment front can become incidental if the cost of funds is too high to create acceptable margin, particularly in the modern competitive environment” .

Customer Deposits: The most stable and cost-effective source of funding. The University of Reading’s investment policy notes that operational cash balances are managed separately from investment portfolios .

Wholesale Funding: Borrowing from other banks or through capital markets. The ICAI materials cover “management of Nostro Funds to advise latest funds position” .

Central Bank Funding: Access to central bank facilities. The back-office function includes “settlement through CCIl or direct through Nostro, RTGS as applicable” .

2.2 Liquidity Risk Management

Liquidity risk is the risk that a bank will not be able to meet its financial obligations as they fall due. The GFOA’s Treasury and Investment Management exam covers “cash flow forecasting” as a core topic .

Key Components:

  • Cash Flow Forecasting: Monitor bank balances, forecast cash flows to ensure sufficient short term funds .

  • Liquidity Buffer: The University of Reading’s investment policy notes that “part of the portfolio is available as a source of emergency liquidity funding, to cope with unexpected issues and ebbs and flows in cash receipts” .

  • Contingency Funding: Planning for stress scenarios.

2.3 Key Liquidity Metrics

Liquidity Coverage Ratio (LCR): High-quality liquid assets divided by total net cash outflows over 30 days (minimum 100%). This ensures banks have sufficient liquid assets to survive a stress scenario.

Net Stable Funding Ratio (NSFR): Available stable funding divided by required stable funding (minimum 100%). This ensures banks maintain a stable funding profile over a one-year horizon.

Loan-to-Deposit Ratio: A measure of funding reliance on deposits. Lower ratios indicate greater funding stability.

2.4 The Role of the Mid-Office in Liquidity Management

The mid-office plays a critical role in liquidity management through:

  • Interacting with the bank’s Risk Management Department on liquidity and market risk .

  • Monitoring open currency positions .

  • Stress testing and back testing of investment and trading portfolios .

 

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