Liquidity Gap Analysis And Schedule Finance Essay

liquid state Gap Analysis And Schedule Finance renderThe main proficiency used to measure fluidity stake is liquid state severance abbreviation. runniness gaps be differences between summations and liabilities at present clip and in the future(a) (Thomas Barnes 15 Jan 2010). Gaps generate liquid attempt deficits exit require fiscal backing and excess exit result in saki rate risk. Gaps can either be static or dynamic. atmospheric static gaps will regard all as situateds and liabilities which argon actually present in the balance sheet. In such case the analysis shows a diminution of the assets and liabilities as they mature. Dynamic gaps atomic number 18 simply the consideration of actual addition projected in carrys and outflows these depend on business uncertain(p)ties (Hampel et al 1999).A liquidness gap schedule pop the questions an analytical manakin for measuring future lineageing needs by comparing the amount of assets and liabilities maturing over sp ecific fourth dimension intervals (Thomas Barnes 15 Jan 2010). Table 3 presents a sample runniness gap schedule.Table 3 liquid state gap scheduleLess than 10 days over 10 days but less than 3 monthsOver 3 months but less 6 monthsOver 6 months less than one grade1 to 5 yearsOver 5 years and capitalTotalAssets1010105650100Liabilities and Equity503015005100Net outflow(Assets minus Liabilities)(40)(20)(5)565(5)0Cumulative net outflow(40)(60)(65)(60)500Source Office of Thrift Supervision Jan 15 (2010) Sec 530 page 29In the fluidness gap schedule, the community ranges assets and liabilities into different time intervals taking into account their remaining time to maturity. Generally, the union ranges assets and liabilities according to their effective maturities rather than their contractual maturities. For instance, a friendship will treat non maturity deposits as long-term liabilities rather than short-term liabilities. disconfirming gapping at the shorter end of the schedule increases the risk that the company will be unable to rollover maturing liabilities as they come due. While such a position is in favour to liquidness, it tends to enhance profitability over the long-term, provided the company keeps the gaps within manageable limit. However, a limitation of the liquidity gap schedule is that it does non capture projected balance sheet changes such as future loan and deposit growth. While it is important to understand the liquidity of a companys existing balance sheet, it is equally essential to forecast the growth of let out balance sheet components, such as deposits and loans, over time. (Thomas Barnes 15 Jan 2010)2.8.3 hazard ManagementLiquidity risk charge should be vigorous with analysis and metrics that reflects a companys liquidity position and assess its options under different market conditions, such as economic melodic line, crisis, and collapse (Thomas Barnes 15 Jan 2010). Liquidity risk needs to be managed once it has been ident ified and measured. danger is much(prenominal) integral to business for insurance that it is perhaps for any other diligence (Capgemini 2006). Long-run profitability will suffer when companies hold too much low- soak uping liquidity assets. Holding too little liquidity can melt to severe financial problems. Managing liquidity risk is not only to negociate the risk but rather find the equilibrium between hang and risk (Decker, A, P 2000). Selling some assets rapidly seems to be an blowzy solution, but still insurers will have to face forced gross sales risk. For some insurers, their projects to improve risk management evolved into the establishment or elaborateness of their risk management department (Henry Essert march 2010). The aim in managing liquidity is to minimize cost. The cheapest approach is to try to restructure the balance sheet in such a way to reduce gap and that the appropriate take aim of risk is reached (Decker, A, P 2000).2.8.3.1 Metrics used for liqui dity risk managementMost financial firms such as insurance companies use conglomerate metrics to control their liquidity risk. This consists of three basic approaches which can be categorized as the liquid assets approach, the notes flow approach, and a combine of both. (Sharma paul et al 2006)Under the liquid assets approach, the company needs to take hold liquid instruments on their balance sheet which can be consulted whenever required. (Ratios argon the relevant metrics in this approach)Under the cash flow unified approach, the company tries to match cash outflows against contractual cash inflows across a range of near-term maturity buckets. This approach is for the most part used by insurance companies.The mixed approach is a combination of both cash flow approach and the liquid assets approach. The company attempts to match cash outflows each time bucket against a combination of contractual cash inflows. damages companies settle more emphasis on the cash flow matching approach. When gaps in maturity buckets are unfavorable, insurance companies would utilize the mixed approach to overhaul ensure that they will be able to meet their obligations to provide cash to counterparties. (Sharma et al 2006)2.8.3.2 Assets Liability ManagementAssets Liability Management (ALM) can be termed as a risk management technique designed to earn an adequate return while verifying a reasonable surplus of assets beyond liabilities. It considers interest rates, earning power and degree of willingness to take on debt and hence is also known as Surplus Management (Sayonton Roy 2010).Management of liquidity consists of elevation fund and invests where excess of fund is available. The managers will buy, hold and sell assets and liabilities in order to support a predetermined direct of liquidity (Matti Peltonen 2010). This technique forms part of the Asset liability Management and thus facilitates in Funding, spend and Hedging issues to achieve predetermined strike betw een risk and return. The target is to increase profitability, while admonishering risk, as well as complying with the constraints of companies (Arzu Tektas et al 2005).2. 9 Study in the same field2.9.1 Estimation of Liquidity RiskPatrick Tobin and Alan Brown 2003 designed a method to model liquidity using a bottom-up approach.They aspired average size of withdrawals as,Yt=ZtNtWhere, Zt is the resume withdrawals for time tNt is the number of withdrawals for time tA plosive of 35 weeks was consideredThe average values were,N=t=1TNt, Y=t=1TYt, Z=t=1TZtThen they rescaled data as follows,Mt=NtN , Ct=YtY , Bt=ZtZWhere, Mt is the mob, Ct is the clip, Bt is the bagThe basic model was found and use to product pBLt=p=1KWpBpt,Where, BLt= Business disputation at time tBpt= Bag for each product p at time tWp= Weight for product pThis gives get up to a weekly factor. The dispersion of this weekly factor was the subject of besides analysis. This model tries to estimate the weekly cash outf low.2.9.2 Measuring liquidity risk in redress companiesIn an article namely Measuring Liquidity risk in Banking Management Framework Giampaolo Gabbi (2000, p.44-58) proposed a model to give liquidity risk within the risk management mostly used, the hold dear at Risk (var). This model also applies for the Insurance areas since they have similar operations such as fixed deposits, loan facilities and other banking activities. judge at Risk is the largest likely lost from market risk that an asset or portfolio will suffer over a time interval and with a degree of certainty selected by the decision maker Titus Lewis, 1997.In a general circumstance five factors are considered before shrewd volt-ampere, this arevolatility of prices, interest and exchange ratesprobability dispersion of likely returntime horizonconfidence interval correlation among different positionsOnce these elements are known, risk manager can calculate VaR in the worst case scenario for the single position (pos)V aR pos= pos.n.t where, t is volatility for frequency tn is the scoring factor needed to obtain the desired confidence train under the assumption of a normal distribution of market returnsModeling liquidity in a VaR framework is given byVaR= n L) 12 + ( . L + log c LWhere n depends on the underlying distribution, L) is the expected execution log in selling the L shares, is the mean quality discount, is the volatility of the discount and c L is the quantity discountUnfortunately all these information are difficult to access or calculate, so indicators were used to simplify the equation, track to the by-line outcomeCOL = 12 Pt S + crackWhere COL is the cost of liquidity, Pt is todays middle price for the assets or instrument, S is the average relative defined as bid ask mid price, is the scaling factor and spread is the volatility of relative spread.2.10 Overview of liquidity Risk Management in Mauritius2.10.1 Liquidity in the Insurance Act 2005Insurance Companies in Maur itius are governed by the Insurance act 2005 which is regulated by the pecuniary serve Commission (FSC). The FSC has the responsibility to ensure that Insurance companies are taking appropriate measures to manage all the risks to protect the interest of the clients and the familiar at large. The consequences of liquidity risk on a countrys financial ashes make its management become a very important issue. naval division 23 of the Insurance Act 2005 considers liquidity and solvency issues. It also lists the different assets which are to be considered as liquid assets, for example cash balances, fixed interest, equities. check to Section 24 (1)(a) of the insurance act an insurer shall in take to be of its insurance business at all times have and maintain its level of liquidity as may be prescribed. It imposes Insurance to maintain an adequate and appropriate form of liquidity. At any time the Financial services Commission may order an Insurer to increase its level of liquidity, depending on risks in the Insurance operation, maturing liabilities, quality of assets and other financial resources. disappointment to comply with the above will result in that Insurance not been permitted to assume any new risks of any kind, or underwrite or renew any insurance policy unless it increases its level of liquidity to the indicated amount.2.10.2 guidepost on LiquidityThe Financial Services Commission has issued a rule of thumb on Liquidity in February 2008. This Guide is issued under section7 (1) (a) of the Financial Services Act 2007 and Section 130 of the Insurance Act 2005. The guidepost on Liquidity gives an exact indication of what the Financial Services Commission is expecting from the Insurers in their management of liquidity. In order to help insurance companies to foster headmaster standards the Commission expects all insurers to have regard to these Guidelines. These guidelines also require insurers to provide reports on its liquidity position every thr ee months for the first year and at the end of each year afterwards.Guideline on liquidity also concerns contingency planning. A good contingency plan should be realistic, unambiguous, designed to be flexible and should indicate the responsibility and priority of the Insurance and their management team. This will enable an insurance company to withstand a liquidity crisis.Stress test is another aspect of the Guidelines on liquidity. The stress test requirement is the minimum amount of assets that an insurer should hold in excess of its liabilities. The stress test requirement is important in managing liquidity risk. Special attention should be given to assets, liabilities and off balance sheet, consider maturity of policies and their future prospects.The guideline is not intended to be prescriptive on how insurance should measure and control its funding requirement, but however, certain approaches in the theoretical review are recommended. Finally an Insurance company should manage access to fund and consider its diversification. Concentrating in few types of assets, liabilities or market may be risky. Therefore, internal limits on maximum fund engage in one type of activity should be set. The guideline also encourage Insurance to look for new arrangement and evolution financial assets and market to have access to fund while reducing liquidity risk.2.10.3 Solvency II consideration of liquiditySince the introduction of the Solvency I in the early 1970s, there has been continuous development of sophisticated risk management systems leading to its replacement by Solvency II. Solvency II has introduced a wide framework for risk management which helps in implementing procedures to identify, measure, and manage levels of risk. It is the most recent set of regulatory requirements for insurance companies and is scheduled to start on 1 January 2013. refreshed funding sources and liquidity management techniques have been brought forward by financial and technological a dvances. Therefore, Insurance companies are expected to understand the liquidity levels and the manner of cash flows in different circumstances and thus enabling them to fight back accordingly. Solvency II identifies the principles for a proper liquidity management.Those principles fall under the following main headingsreducing the risk that an insurer cannot meet its claimsTo reduce the losses encountered by policyholders To enable supervisors to act spontaneously if capital goes below the level requiredIncrease confidence in the financial stability of insurance sector.The Solvency II framework has three major parts for the insurance sectorQuantitative requirements.Governance and risk management requirements.Disclosure and transparency requirementsThe Guideline on Liquidity issued by the Financial Services Commission reflects mostly the following principles to develop a structure for the management of liquidity, to measure and monitor net funding requirements, to manage market a ccess, contingency planning, and internal controls for liquidity risk management in improving Liquidity.