The notion of liquidity in the economic literature relates to the ability of an economic agent to exchange his or her existing wealth for goods and services or for other assets.
This definition has two important concepts that need further elucidation.
First, liquidity can be understood in terms of flows (as opposed to stocks), in other words, it is a flow concept.
In this scenario liquidity will refer to the unhindered flows among the agents of the financial system, with a particular focus on the flows among the central bank, commercial banks and markets.
Secondly, liquidity refers to the ability of realising these flows. Inability of doing so would render the financial entity illiquid. Hence,
An asset is liquid if it can be bought or sold quickly at low transaction costs at a reasonable price.
Liquidity also refers to the availability of instruments (market and nonmarket) that can be used to transfer wealth across time periods.
An asset is liquid if it allows agents to consume inter-temporally as they please.
Banking sector liquidity
Similarly, the IMF provides a definition of funding liquidity as the ability of solvent institutions to make agreed upon payments in a timely fashion.
Liquidity for a bank means the ability to meet its financial obligations as they come due. Bank lending finances investments in relatively illiquid assets, but it funds its loans with mostly short term liabilities.
Thus one of the main challenges to a bank is ensuring its own liquidity under all reasonable conditions.
The funding liquidity of banks, given their importance in distributing liquidity in the financial system requires closer analysis and explanation hence will dwell on this one in this article
The starting point hence becomes the identification of the liquidity sources for banks since the knowledge of these sources is important in order to better understand the liquidity linkages.
Depositors who entrust their money to the bank is the first source of liquidity and the sometime the major source.
Secondly, the market is another source of liquidity for the banks. A bank can always go to the asset market and sell its assets or generate liquidity through securitisation, loan syndication and the secondary market for loans, in its role as originator and distributor.
Thirdly the bank can get liquidity from the interbank market, arguably the most important source of liquidity.
Finally, a bank can also choose to get funding liquidity directly from the central bank.
The banking sector over the last few years has been marred with declining confidence by the general public which has seen the public shying away from doing business with the banks.
During the same period, the
This among other issue led to the banking sector liquidity challenges that the country faced hence a plethora of new measures being put in place to address this.
Measures being pursued to solve liquidity challenges
The banking sector and Government putting in measures for resolving the confidence issues so that the unbanked comes into the banking fold.
This would ensure that those banks are able to attract as much deposits as much as possible given this is supposed to be the major source of liquidity.
The banking sector is in the process of designing relevant financial literacy and financial inclusion programs which are meant to teach the public the importance of keeping their money in the banking system.
There is need for the country to put in place the right policies that will attract foreign direct investment and lines of credit.
The current debt overhang of
A good track record in following through on these programs has the potential to unlock resources for the country.
However, caution is still needed so as not to blindly follow the prescriptions of the financiers in the implementation of the various programs.
The Government as pronounced in the 2014 National Budget Statement, should fully resource the central bank through re-capitalisation and injecting the resources for it to activate the interbank market where it the CB will play the lender of last resort.
With an active interbank market, the Banks will be able to cover any shortfall position in case of a gap at the close of trading day.
At the moment, the interbank market remains constrained with little activity.
With a well-funded lender of last resort facility, the
Measures to unlock resources in non-performing loans are also important given that a lot of the assets of the banks are now tied up in non-performing assets.
The Monetary Policy Statement has alluded to the Government finalising the legal framework for credit reference bureaus which will strengthen credit risk management in banking institutions and assist in reducing over-indebtedness.
This measure is likely to ensure that credit is advanced to those who are creditworthy and have good standing that they would pay on time without affecting the liquidity position of the banks.
Most Popular Stories
- Obama Administration Releases Proposal to Regulate For-Profit Colleges
- Apple, HP, Intel May Take a Hit from Slowdown in Smartphone Sales Growth
- Elizabeth Vargas' Husband Marc Cohn Addresses Rumors
- Keurig Adds Peet's coffee, Alters Starbucks deal
- U.S. to Relinquish Gov't Control Over Internet
- Motley Crue's Nikki Sixx Marries Model Courtney Bingham
- Quiznos Files for Chapter 11
- Chinese e-Commerce Giant Alibaba Gears for IPO in U.S.
- FDIC Files Lawsuit on Behalf of Banks Allegedly Hurt by Libor Scandal
- Some California Cities Seeking Water Independence