Managing Bank Liquidity in Real Time

Just a decennary ago the conception of bank liquidness was for all intents and purposes only one for the Bank Regulator to really concern himself with. A bank had to stay liquid –critical if it were to enjoy the assurance of its depositors – but this criticalness was an “after the event” issue.

Then banks enjoyed a high grade of namelessness and pick in how it managed its liquidity. This was as a consequence of the techniques then used for settling interbank obligations. These techniques had been devised and refined over two or more than centuries. They had come up from a pre-computer human race that relied on manual transaction processing of instruments such as as cheques. Early travels at computerization of bank procedures simply mechanised the manual attack by using the batch processing system. So the critical factor that related to to the measurement of a bank’s liquidness could only be determined after the end of the trading twenty-four hours had been completed and all the “ins” and the “outs” were matched up. Even then, a bank had a safety net, provided by the cardinal bank, which in most states was prepared to screen any shortfall, and then to backdate this cover to the former trading day.

A growth apprehension of settlement hazard and the possible contagious disease to systemic failure led cardinal banks, almost without exception, to implement payment systems, usually under their ain direct control that ensured conclusiveness of settlement. Real Number Time Gross Settlement (RTGS) especially where high value payments were involved have go the accepted chemical mechanism of ensuring safety in national payment systems.

This was followed by the need to guarantee that the settlement of stock exchange transactions also took topographic point in a secure mode and that bringing of the shares was only against the exchange of a payment that was concluding and irrevocable. The RTGS attack fitted this need admirably.

Foreign exchange settlements were the adjacent problem. The collapse of the Herrstadt Bank had caused major problems. The solution propsed by a grouping of major international banks was for the chlorines (continuous linked settlement) system which won the approval of the major cardinal banks. Again the RTGS system was pressed into usage to supply the secure payments leg. Additional factors such as as consecutive through processing (STP) provided the reward of mistake free transactions. All this have added to the need to manage liquidness in existent time.

Each new payment dimension (i.e. RTGS, DvP, CLS) adds to the complexness of the problem. Funds flows now affect domestic, foreign and securities payments as a minimum – each flow is really dependent on the other flows. There may be other dimensions too, depending on local arrangement and conditions, where other settlements may be necessitate to be settled in real-time and on RTGS principles, such as as ACH trading trading operations or check glade operations.

The complexness of these demands was the topic of an intensive survey in 2000 by the Payments Hazard Committee of the Federal Soldier Modesty Bank of New House Of York (“Interday Liquid in the Evolving Payment System: A survey of the impact of the Euro, chlorines Bank and bits finality”). The survey examined the possible deductions for United States dollar intraday liquidness hazards that would come up about from planned changes to payment systems in the United States and elsewhere. In the words of the commission the report was “intended to excite duologue on the issue and to suggest some possible best practices”. Even though the chief focusing was on the liquidness consequence to banks in the US, the problems and the solutions are applicable to banks everywhere. A cardinal determination is quoted below in full, and illustrates the direction in which bank liquidness management have been heading.

“These changes will make a need for better measuring of payments flows, usage of queuing techniques to modulate payment flows, better communications, and a generally higher consciousness by exchequer managers of developments in the payments processing functions. Payment trading operations will presume some of the features of uninterrupted industrial procedures where real-time measurement is required to measure the buildup of imbalances within systems, place gridlocks within and between systems, and set up more than elaborate contingency plans. The interconnectednesses between systems will also necessitate new control procedures in order to get by with unexpected volume and systems changes.”

Bank liquidness management is a critical area. However, up to the present time, many banks have got got not yet fully realized the personal effects that the real-time flows of finances have on their operations.

Depending on the size of the bank, the basic problem that is human faces will be different. As an example, in a smaller bank, the problem could well be one of trying to fit the magnitudes of the inflows and the outflows in "approximate" real-time. This kind of problem makes not originate in the lawsuit of the larger banks simply because they direct and have high volumes of payments almost continuously throughout the day. So essentially they have got a natural flow of finances that assists with the matching process. In states where chlorines is now fully operational banks have got got establish that they have another dimension to this real-time aspect. What have happened is a whole range of fresh scenarios as a consequence of interactions between the liquidness side of the RTGS system (which one must retrieve are real-time domestic payments) and the chlorines system (which is real-time Forex settlement). A additional illustration of this procedure is the RTGS interaction with the securities system. One manner to see the problem is to envisage a game of chess. The real-time liquidity challenge presented by an RTGS system alone, can be viewed as a game of chess, in two dimensions. However once 1 adds CLS, Securities and other real-time funds flows one gets to add further “chessboards” to the first. One can visualise these extra chessboards as being stacked vertically so that in world there are a number of games in three dimensions, one above each other. They are all beingness played at the same clip and each game is affected by and interacts with each of the others. Checkmate on any 1 degree can lead to checkmate on all the others. In kernel 1 is forced to play a game of 3-dimensional chess, replacing the traditional one.

To successfully manage intraday payment liquidness affects a high grade of technical and analytical skill. Until recently the technical complications of successfully implementing such as a system on a bank broad footing have got been hard to overcome. New engineerings are changing this. The basic rule of such as a system lies in the effectual mold of payment inflows and outflows on a timed footing throughout the trading day. To theoretical account these flows three key information beginnings are required:

•Actual data. Actual information relating to payments that have got already been received or made

•“In the Pipeline”. Data relating to “pending” payments. This may be payments in an internal RTGS queue, or scheduled to be made in terms of chlorines or any other commitment. In certain cases inward payments may also be modeled with certainty such as as chlorines settlements due

•Forecast of payments flows. In some cases an estimation will need to be made of unaccounted for payment flows that are anticipated for the residual of the trading day. This information may be based on historical information adapted in terms of day, the clip of the month, financial calendar events and so on.

The timing of these assorted flows may be entirely random, as in an RTGS system or it may be to a specific agenda linked to pre-defined settlement modern times such as as for ACH, Securities, CLS, Check and other similar settlements. The range of payments that need to be covered is essentially the whole range of payments that the bank is involved in clearing. For a typical bank this may affect all or most of the following elements:

•The RTGS system

•CLS duties either as a direct participant or as a sponsored member or conventional foreign exchange flows

•Securities settlements
These three flows are relatively straightforward as they only affect the “credit” flow of finances – this intends that payments are generated by the paying to the payee bank.

•ACH trading trading trading operations which will include the conventional debit entry entry and credit payment flows as well as Giro type payments

•Cheque glade operations

•Credit/ Debit card glade operations which would include EFTPOS transactions

•Other transaction flows such as as the settlement of existent banknote backdowns and sedimentations with the cardinal bank or other parties.

These four scenarios are more than composite in that they affect the processing of both credit and debit transactions, usually in the same systems. An illustration to illustrate what is meant would be a bank sending out both credit and debit entry entry ACH transactions – Credit payments would be an outflow to the bank, while debit transactions would stand for an inflow of funds. The procedure is made more than composite by the fact that very often transactions are returned for one ground or another – checks will not be paid; credit transfers cannot be applied because the account have been closed etc.

An often heard unfavorable judgment against including the flows for these last four systems in an overall liquidness management system is that while they stands for high volumes of transactions their value be givens to be trivial and hence irrelevant to the overall place of the bank. This depends entirely on the customs duty and patterns of the banking trading operations in the country concerned. In some states values of check and non-RTGS electronic payments may transcend the sum of RTGS values. In others cheques, as an example, still stand for a important volume and sometimes important values.

The technique in managing intraday payment flows is relatively simple in principal – more than hard though in practice. The techniques described below are based on the well-established process used by many of the world’s larger banks to manage their overall liquidness place in terms of assets and liabilities. Banks usage this technique or a fluctuation of it over a time period of hebdomads or months. This technique can be adapted to manage the specific demands of a bank intraday and end-of-day payments flow.

While this technique focuses on the usage of the model by larger banks in-so-far as the range and diverseness of the assorted payment systems used, this attack is equally applicable to bank payment liquidness measuring and control, even for local, strictly domestic banks. The basic rules go around around:

•Good management

•Information systems

•Centralized liquidness control

•Analysis of nett support demands under option scenarios, and

•Contingency planning

All these are important elements of strong payment liquidness management at a bank of any size or range of operations. The information systems and analysis needed to implement the approach, however, can probably absorb fewer resources and be much less complex at a local bank or a bank that is active in fewer payment systems than the large, internationally active banks.

A bank’s “Treasury Manager” needs not only to have got got the appropriate liquidness available, but also he needs to have a range of strategies to assist him struggle this “war”. The strategies and techniques that he volition utilize will include derivatives, swaps, repurchase understandings etc.

The Treasurer’s office have go the bid station in this new liquidness “battle” and a cardinal component is going to be the information that he will need for each day’s operations. This information will include inside information of:

•Current twenty-four hours transactions and flows

•Details of transactions that are still in the “pipe-line”

•Estimates of expected transactions (for those transactions that have got not quiet reached the pipeline), but based on cognize events, tendencies and historical information.

•Some very intelligent computer science that combines all these beginnings of information into a single scenario that the bank hoarded wealths can use, effectively.