International Banking, Measure of Asset Liquidity - Assignment Example

INTERNATIONAL BANKING By International Banking: Theinternational banking sector came to the fore when counting the sectors that contributed much to the financial crisis that rocked the world in the years 2007/2008. Through the same crisis, other effects like the subprime mortgage crisis were bore and they continued the effect that the financial crisis had already created. In the quest to make things better, many financial institutions considered more enhanced created policies through government regulations that would safe guard the lender from such activities that led to the financial crisis. In the development below, the measures if bank liquidity and the relationship between bank liquidity and bank stock returns are discussed leading to a thorough understanding of the financial crisis and its implications to the financial world. The same crisis had an impact on the costs of funding also influencing the changes in the liquidity of the market. The following questions discuss this effect and the several implications it has on the banking sector. Question one: Understanding the liquidity risk refers to understanding the ability of a given security that a bank has or asset to convert into cash or convert it quickly through trade to avoid market losses. The conversion could fail to recover a profit required. For proper and efficient measure of liquidity, there is need to understand the different causes of the liquidity challenge and the different kinds of liquidity risk. Understanding these will help one understand the liquidity effects arise and hence easily measuring their effects. There exists two major kinds of liquidity risks that range from market liquidity and funding liquidity. The liquidity risks all differ in the way they affect the banking filed. Market liquidity: Market liquidity refers to the risk that an asset fails to sell due to the liquidity lack in the market (Cook, 2005, p.4). A number of risks within the market make it impossible to provide liquidity of an asset hence a risk to the banking business. The widening of bid normally occasions these risks or the different offers spread wide, the lengthening of the period through which an asset is held as per VaR calculations and the making liquidity reserves that prove explicit in nature. All these pose more risks to the banking field and may amount to gross losses that may affect the general returns of the banking filed and business. Funding liquidity risks: These risks relate to the funding of different liabilities that the banking sector could hold (Brunnermeier, & Lasse, 2009). These risks relate to failure to meet the different liability demands when due, the possibility of meeting these liabilities is only through uneconomic prices that may prove difficult and the liabilities prove name-specific in nature (Banks, 2013, p.78). There exist numerous causes of liquidity difficulties basing on different grounds ranging from the risks occasioned by the limited trade abilities of the asset. Parties holding these assets suffer the liquidity effect and affect the business ability of their assets. The liquidity risk aspects differ from the different manifestations that indicate drop in prices of the asset. These price drops indicate the worthless nature of the asset that may affect the different abilities of the asset to trade normally. Uncertain liquidity also causes liquidity risks. Fall in credit ratings would result into liquidity risks. Unexpected cash flows and different financial implications also indicate to liquidity risks. The two aspects of market liquidity and funding liquidity affect the liquidity risk differently. They both have a compounding effect on each other. The difficulty of funding an item that investors have no funding abilities for would indicate an impossibility hence compounding the effect of the liquidity risk. Managing liquidity risk follows the management of the market forces and the credit effects including other risks that may compound to cause a massive effect to the banking field. The compounding of other risks will lead to major changes in the banking field and hence the need to control them. In measuring the liquidity risk, a number of means prove applicable. These ranges from liquidity gap identification and the liquidity risk elasticity. These combined with asset liquidity, one understands the risk better and derives better means of managing it and ensuring that the effects are limited hence limited losses to the company. Considering the liquidity gaps, seeking to identify the net liquid assets that a company has and the excess of the liquid assets that the company has over the volatile liabilities available will enable a company understand their liquidity levels. Negative liquidity gaps indicate the need to focus on liquidity balances and development of measures that could help improve the values for the better. The negative of this measure is that it does not indicate the changes that the gap would have considering an increase in marginal funding of a company and the cost. Liquidity risk elasticity also covers the measure of the changes that the assets experience as a result of overfunded aspects that features as liabilities (Oxford Business Group, 2010, p.215). Considering a risk in the marginal funding and its cost that a bank suffers, a rise in it leads to a rise in the elasticity of the risk. Measuring this elasticity effect would result from labor aspects, non-financial aspects also measured through commercial rates. The negative aspect of using this means of liquidity management is that it assumes that all changes occurring are parallel in nature. Measure of asset liquidity: As stated above, measure of the liquidity of the asset is followed using any of the following means that include bid-offer spread, market depth, immediacy and resilience. Bid-offer spread refers to the market risk measure that considers the different ratios that indicate the spread that the liquidity has on the mid prices of the product. A small ratio indicates a more liquidity while a huge ratio indicates a smaller liquidity. This spread covers the operational processing costs and the different administrative costs that a company assumes. Relating these with the compensation requirements that possible traders may apply to embrace more informed trade situations is possible. Market depth considers the measurement of the different risks (Matz, 2011). This is considered as the amount that an asset a company holds or a bank holds that is easily bought and or sold based on the different bids spread. The slippage effect comes to consideration here based on the different calculation of the liquidity costs that is executed as the difference between the price of execution and the initial price of execution. Immediacy considers the time within which the trade is successfully possible in relation to a certain asset and the cost prescribed to it. Resilience is also a means of measuring through measuring the period with which the prices of the asset normalize. This is only possible to determine over a period. Considering the information provided, the liquidity measure is explainable through the graph as below that indicates the graphical changes that reflect liquidity. Considering the graph above, one understands the changes of the spread considering the different months and the effects that the assets are identified as per the Return on Assets (ROA) indicates and the tedspread effect indicates. Through this, the measure of the liquidity aspect as indicated. This considers the year 2006 alone and follows the needs of the liquidity development. Question two: Considering the liquidity of the banks and the bank stock returns, one identifies a relationship that drives the two items. The liquidity of the bank relates with the bank stock returns represented as per the graph below: Graphical representation of tedspread and stock return monthly: Considering the graph above, one learns that for a clear distinction of the liquidity aspects in relation to stock returns as per the bank. The relationship indicates that as the stock returns continue on a monthly scale, the tedspread is affected in different way. The tedspread varies continuously as the stock liquidity effects vary. Considering the effects that the stock market has on the banks in relation to their liquidity relations, one learns that tedspread effects indicate the level of liquidity that affects the banking sector. The effects that the liquidity and the banking financial systems and the economic growth. The financial systems that the banks have put in place influence the stock returns on a monthly basis. Considering the level of stock returns, one understands the growth of the economy that has been contributed by the financial institutions. Bank liquidity causes many differences in the assets abilities and market values. Understanding the market effects that the liquidity will have on the economy makes one easily understand and devise measures that help in countering the liquidity effects. The relationship between the banks and other financial institutions relates to the growth of the economy. This makes economic growth one of the major aspects that the bank liquidity affects. The relationship of banks liquidity and bank stock returns also features in improving the investment opportunities available to the community. For sound investment, there is need to strongly invest in the bank stocks. This is only possible if the returns provide a valuable aspect to the community and the different investors. Considering the market aspects, one learns how the stocks trade and the effects that the assets will suffer if not well planned for. It therefore indicates the ability of the banks to improve the business community by educating people on liquidity effects. The liquidity aspect is much correlated with the current and future rates of the growth of the economy and the capital accumulation aspect. Liquidity affects the rates in different ways based on the ability of the assets that the bank has to convert the items to cash (Levine & Zeros, n.d, p.3). The ability will allow for flexible interest rates that will not aim at helping the banks recover their investment. The rates that the banks set for interest and other activities depend majorly on the level of risk that the transactions hold. Identifying these risks and taking care of them with interest rates imposed on the facilities relates to the different prevailing market conditions. As per the market situation, the banks set interest rates hoping to recover their principal and cater for the different needs that may arise. The interest rates also have an effect on the growth rate of the economy and the general economic growth rates. The ability to convert the assets into liquidity supports economic growth and these indicate the relationship between the liquidity aspect and the banks stocks. Stock trading has provided for the improvement of the economic strength of the different economies making it possible to impact them positively. In conclusion, some of the occurrences that caused the financial crisis in the years 2007/2008 were majorly occasioned by poor policies affecting the economic condition of the different countries and the international world. Understanding these effects will guide one in understanding the different implications that each decision on financial aspects has on the economies of the world. References: Banks, E. 2013. Liquidity Risk: Managing Funding and Asset Risk. Palgrave Macmillan. Brunnermeier, M. & Lasse, H. P. 2009. Market Liquidity and Funding Liquidity pdf. Review of Financial Studies 22(6): 2201-2238. Doi:10.1093/rfs/hhn098. Cook, D. 2005. Stock Market Liquidity and the Macro economy. International Monetary Fund. Levine, R. & Zeros, S. n.d. Stock Markets, Banks, and Economic Growth. Retrieved from http://www.worldbank.org/html/prddr/prdhome/pdffiles/wp1690.pdf Matz, L. 2011. Liquidity Risk Measurement and Management. Xlibris Corporation. Oxford Business Group. 2010. The Report: Bahrain, 2010. Oxford Business Group. Read More