GAP Analysis of Liquidity and Funding
Liquidity Risk: Gap Analysis is a process that helps in determining what all steps are required to be taken by the businesses so that they can make best possible use of all the current resources. In other words, it means comparison between the actual performance and expected performance. When a company is not utilizing its resources economically that means the company is performing below its potential. It is also called need gap analysis or need assessment.
Liquidity simply means the availability of liquid assets to a market or to a company. It determines up to what extent a person or company has the ability to meet its short term commitments. Now liquidity fund means a mutual fund that invests into a large number of securities, bonds and options that have high credit rating but for a short duration. Funding simply means money provided by any bank, financial institutions, Government etc. for particular purpose.
In finance liquidity risk is defined as a risk in which a particular security cannot be traded rapidly in the market to prevent loss. A liquidity gap can be positive or negative depending on the number of assets and liabilities that the company have. Liquidity risk maintains the postures of business ‘AS USUAL’ and thus causing more adverse position. The latest events relating to financial crisis have made a good enough impact on the mind of regulators and have concluded that this matter can’t be taken lightly.
A contingency funding plan frames the firm’s strategies and determines liquidity shortfalls in crucial situations. There are two types of risk:-
Funding Liquidity Risk
It is the risk where the firm is able to fulfill both present as well as future cash flow needs and collateral needs only after changing daily operations and financial position of the firm.
Market Liquidity Risk
It is the risk where because of poor market depth or disruption firm cannot equipoise a position at market price.
Points To Be Considered To Manage Liquidity
In order to manage liquidity gap following points should be considered:
1Allocate cash flows over various time horizons.
2 To control the mismatches set target gap and also warning gap for deficit positions.
3 Design a structure to attain disparities within target gap limits.
Challenges Faced By Company against Liquidity Risk
A company has to face various challenges against liquidity risk and these are:
- Positive or active approach to liquidity management.
- Incorporate a liquidity culture in the company.
- More investment in technology and research their results.
- To sustain stability, evenness and symmetry between business and risk.
- To measure effect of negative result.
- Applying rules and various assumptions while creating models
- High pressures in achieving models designed.
- Evaluating and analyzing funding sources and framing strategies in order to fulfil urgent liquidity needs.
Solutions to the weaknesses
Cost Impact Ratios
- Volatile liabilities to Total deposits: It explains the share of volatile liabilities to total deposits. As per the given records it is 77%
- Purchased funds to total assets: It explains the quantum of high cost funds to create assets.
- Volatile liabilities to total assets: Through this we get to know about the assets funded through volatile liabilities. It is 55% in the given records. This ratio can be considered adequate.
Cash Flow Impact Ratios
- Customer deposits/Total Assets: It gives knowledge about how the asset can be funded.
- Liquid Assets / Short term liabilities: It determines the availability of assets to meet short term liabilities or immediate liabilities.
- Large Deposits/Total Deposits: It shows the weight of large liabilities.
- Large Advances/ Total Advances: Similarly this measures the advances.
- Commitment Ratios/ Total Assets : It includes record of off balance sheet items to on balance sheet items
According to the data, the company has a cash ratio of 39% which is good. But on the other hand it has deposit ratio of 77% which is quite high and the asset ratio of 55% is adequate enough. Thus overall Liquidity risk of the company is not that worse.
Global Association of Risk Professionals, 2013, Risk Education
Liquidity & Funding Risk, 2013, Examine Balance Sheet Structures under New regulations