Working Fund Approach Part II for Liquidity Risk Management

Deposits, which are likely to be withdrawn during the planning tenure, are categorized as vulnerable deposits. A very good example of this type of deposits is the savings deposits. However, the entire quantum of savings deposits cannot be considered as vulnerable. On an average, it can be observed from the operations of the bank, that there will be a certain level up to which the funds are stable i.e. the level below which the funds will not be withdrawn. Hence, the liquidity requirements to meet the maturity of the vulnerable funds will be less than 100 percent and varies depending upon the risk-return policy of the bank.

Finally, the residual of the deposit base after segregating them into the above two categories will fall under the stable funds category. These deposits have the least probability of being withdrawn during the planning period and hence the liquidity to be maintained to meet the maturing stable deposits will also be lower when compared to the other two types of deposits. As explained above, the stable portion of the savings deposits fall under this category. Most of the term deposits, by their nature fall under this category. 

Float funds, which are the third component of the working funds, are much similar to the volatile funds. These funds are generally in transit and comprise of DD’s, Banker’s cheques, etc. which may be presented for payment at any time. However, this segment also has a minimum level over and above which the variability occurs. Hence, 100 percent liquidity will have to be provided for the variable component. 

Based on the working funds, consolidated or component-wise, the bank will have to assess the cash balances/ liquidity position in the following manner:

- Lay down the average cash and bank balances to be maintained as a percentage of total working funds.

- Lay down the range of variance that can be taken as the acceptance level.

 Having obtained the consolidated/component-wise working funds, the bank will now have to estimate the average cash and bank balances that are to be maintained. This average balance can be maintained as a percentage to the total working funds. This percentage level is based on forecasts, the accuracy levels of which vary depending on the factors affecting the cash flows. Hence, it is advisable for the bank to set up a variance range for acceptance depending on its profitability requirements. Thus, as long as the average balances vary within this tolerance range, profitability and liquidity are ensured. Any balance beyond this range will necessitate corrective action either by deploying the surplus funds or by borrowing funds to meet the deficit. This acceptance level is, however, a dynamic figure since it depends on the working funds that may keep changing from time to time.