Working Funds Approach for Liquidity risk management

Under this approach, liquidity position is assessed based on the quantum of working funds available to the bank. Since working funds reflect the total resources available with the bank to execute its business operations, the amount of liquidity is given as a percentage to the total working funds. The bank can arrive at this percentage based on its historical performance. This approach of forecasting liquidity requirement takes a broad overview of the liquidity position since the working funds are taken as a consolidated figure.

The working funds comprise of owned funds, deposits and float funds. Instead of a consolidated approach, the bank can have a segment-wise break up of the working funds to arrive at the percentage for maintaining liquidity. Based on the position of the limit arrived as above and the available liquidity, the bank will have to invest borrow the surplus/deficit balances to adjust the liquidity position. In this approach, the bank will have to assess the liquidity requirements for each of the components of working funds.

The liquidity for the owned funds component, due to its very nature of being owners’ capital will be nil. The second component of working funds is deposits, the liquidity requirements of which depend on the maturity profile. Thus, prior to assessing the liquidity requirements of these deposits, the bank should categorize them into different segments based on the withdrawal pattern. All deposits based on their maturity fall under the following three categories:

-  Volatile Funds

-  Vulnerable Funds

-  Stable Funds

Volatile funds include those deposits, which are sure to be withdrawn during the period for which the liquidity estimate is to be made. These include, short-term deposits like the 30 days deposits, etc. raised from the corporate high net worth clients of the bank. The probability of these funds being withdrawn before or on their maturity is high. Included in this category of volatile funds are current deposits of corporates that also have a high degree of variability. Due to the nature of the volatile funds, they demand almost 100 percent liquidity maintenance since the demand for funds can arise at any time.