Liquidity Risk: Westpac and Bendigo and Adelaide Banks - Essay Example

Student’s Name Professor’s Name Course Name Date Liquidity Risk: Westpac and Bendigo & Adelaide Banks Introduction Liquidity risk is the level of risk that such financial institutions as banks face whenever they fall short of cash resources needed in paying-off borrowings and thus, fail to prevent the possible bankruptcy of both customer and bank deposits (Boffey & Powell 103). A fundamental objective of the banking sector rests with possible reduction or rather elimination of risks in order to ascertain higher levels of profits. In the 2008/2009 economic crisis, the collapse of most of the economies were brought about by the mere fact that banking institutions were unable to roll over their immediate short-term financing capacities that later led to liquidity squeeze (KPMG, 21). It is important to understand that liquidity risk is caused by two fundamental facets that involve a liability of asset-side rationale. The most common approach of measuring the level of liquidity facing a financial institution is through the formula; short term securities/ deposits. A high-quality liquid asset possess a number of characteristics that are deemed important in ascertain liquidity risk levels. For instance, they are easily converted into cash resources at a minimal or no loss of value at all. Subsequently, their underlying liquidity depends upon their stress scenario, volume that is monetized and also, timeframe under consideration. Short-term liquidity like bank deposits is one that can last for a few days or months. It is able to be converted into cash within a short period of time (Valentine, Ford, Edwards, and Sundmacher & Cropp 123-145). On the contrary, long-term liquidity like loans can last a few years between 3 and 5 and there is always a stringent challenge to convert them back to cash resources. Analysis of Liquidity Risk For this section, the paper will put up a discussion on three concepts like liquidity ratio, funding position as well as the notion of asset diversity. It is crucial to note that the annual reports of both Westpac and Bendigo & Adelaide Banks will be utilized to evaluate the liquidity risks involved. Liquidity Risks Definition and Liquidity Sources Westpac: This bank recognizes liquidity risk as being the level of risk that the group will be incapacitated to fund its asset base and also, meet both short and long-term obligations as the fall due. They are likely to occur whenever the following conditions are met. First, when there is an inability to secure both expected and unexpected levels of current and future cash flows as well as collateral needs without having to distort the daily operations of the bank. Second, it might arise whenever it is ascertained that there is inadequate level of market depth or market disruptions that will necessary impact the capacity of the bank to discard a favorable position within the underlying market price (Westpac 218). It is noted that the bank is able to manage liquidity risks through a BRMC-approved liquidity framework whereby the management function is assigned to the Treasury in accordance with requirements set forth by ALCO. It is important to note that the Treasury is able to manage the liquidity on a day-to-day basis and thereafter submit a set of monthly reports to ALCO as well as quarterly reports to the BRMC. Most significantly, monthly reports are availed to the APRA. Another key important feature of the Treasury rests with its responsibility to monitor and manage resultant funding bases in order to ensure that it’s adequately checked and diversified (Westpac 218). The banks liquidity risk management strategies shapes it ability to fund its immediate operations under both normal situations and also, in the course of crises. This specifically ensured in order to ascertain on the level of flexibility needed for accommodating a broadened range of market conditions (Westpac 218). Bendigo & Adelaide Bank: For this bank, liquidity risk is defined as being the inability to meet its immediate payment commitments as and whenever they fall due under both normal conditions and in terms of uncertainties. The bank’s Treasury is tasked with the responsibility of implementing liquidity based strategies as par the requirements set forth by the Asset Liability Management Committee as well as its Board Risk Committee (Bendigo & Adelaide 141). This certainly involves sustaining a significant level of liquid reserves as well as a diversified range of funding alternatives in order to meet its daily, short and long-term liquidity stipulations (Bendigo & Adelaide 141). Liquidity Ratio Analysis: Westpac and Bendigo & Adelaide Banks The level of liquidity risks for the two companies would be measured using the liquidity ratios. There are three fundamental liquidity ratios that are used and they include; simple liquidity ratio that is attained by dividing liquid assets to the total assets, loan/deposit ratio and also, the loan/non-deposit ratios. Liquidity Ratios for the Financial Year Ending 2013 Ratios/Banks Westpac Bendigo and Adelaide Banks Simple liquidity ratio= liquid assets/total assets (11,699+11,210+46,330+30,011)/696,603*100% = 14% (383.8+293.9+5,465.2+535.5+18.1)/ 60,282.2*100% =11% Loan/deposit ratio (382,702+153,462)/424,482 =1.26 (554.1+49,957.4)/47,439 =1.06 Loan/non-deposit ratio (382,702+153,462)/215,310 =2.49 (554.1+49,957.4)/8,409.2 =6.00 Analysis As it can be seen from the table above, the simple liquidity ratio for Westpac and Bendigo& Adelaide is placed at 14 and 11 per cent respectively. This means that the rather higher percentage ratio attributed to Westpac at 14 per cent postulates its capacity to engage in a higher level of liquidity risk activities in comparison to its counterpart. It also means that the firm is focused on operating with those assets for which it can quickly transform into quick cash for purposes of meeting its immediate short-term commitments as and whenever they fall due. Westpac’s loan/deposit ratio is placed at 1.26 as opposed to 1.06 ratio attributed to Bendigo & Adelaide Bank. This means that the former bank is more focused on maintains a higher loan base in relation to its deposits at the time in comparison to its counterpart. On the other hand, the loan/non-deposit ratio for Westpac is placed at 2.49 as opposed to 6.0 for Bendigo& Adelaide Bank. This means that although the two banks are striving hard to achieve a higher anon-deposit ratio, Bendigo& Adelaide has concentrated its operations with more a larger loan base. Funding Tools and Financial Liabilities A closer look into the annual reports of both Westpac and Adelaide & Bendigo indicates that they possess different tolls needed for the purpose of accessing and collecting capital funds from potential investors and other stakeholders. This is mainly attributed to the operational objective that is related to their intentions of accessing more money from customers through bank deposits and later using this liability to make more profits for that matter. Westpac practices mostly wholesale funding; it monitors both the composition and stability of its immediate funding base in order to remain relatively at par with the firm’s funding and liquidity risks appetite. This is inclusive of the firm’s initial target that is greater than 75 per cent for stable funding ratio. It is important to mention that the stable funding for Westpac comprises of such items as customer deposits, wholesale funding that possesses a maturity period that is greater than 12 months, equities and securitization (Westpac 220-222). Some of the notable liquidity sources for the bank include; customer deposits, debt issues, interest and fee incomes, deposits due to other banks as well as repurchase contracts with the central bank. The banks funding base was highly strengthened in the financial years ending 2013 in comparison to other years as notable improvements could be perceived in fundamental funding bases as well as liquidity metrics. For instance, there was a positive growth in customer deposits that subsequently promoted the stable funding ratio for the company of 99 basis points to 84 per cent as at the end of the financial year ending 2013 (Westpac 221). Consequently, customer deposits, in relation to the total funds, catapulted by 290 basis points to 61 per cent with additional stable funding sources comprising of 2 and 14 per cent securitization and long-term residual maturity based funds respectively. It also constituted a further 7 per cent equity funds. Following this composition, the bank is able to ascertain the importance of maintaining a rather diversified funding base in order to ensure that it possess both the capacity and flexibility to access a broadened array of funding markets and potential debt investors as a formidable way of managing substantive liquidity risk levels (Westpac 221). For instance, in the financial year ending 2013, the bank was able to raise a total of about $21.6 billion in terms of wholesale funding, with a significant weighted average maturity of 4.8 years (Westpac 221). The higher liquidity capability of the bank in regards to its strengthened product prowess allowed it to have extensive access to a broadened range of potential investors through placement of issues in a myriad number of formats that included placements of Tier 1 and 2 capital, covered bonds as well as superior unsecured debt funds. Furthermore, the higher liquidity prowess of the bank allowed purchasing back about $8.1 billion in terms of government-guaranteed debt over a period of only one year (Westpac 222). This has helped to reduce the refinancing stipulations of the company in the period between 2014 and 2015. On a contrary, Bendigo & Adelaide Bank is mostly focused on a funding portfolio that is characterized by highly marketable and diverse assets that can be liquidated in the event of possible uncertainty of firm’s cash flows. It is noted that the liquidity position of the bank is evaluated and managed under a given set of conditions that is substantively focused on significant stress factors that is related to either the market conditions or the group in specific. The following are some of the notable sources of liquidity for the bank; due to other financial institutions, customer deposits, notes payable, derivates, income tax payable and subordinated debt (Bendigo & Adelaide 141). In regards to liabilities in the financial year ending 2013, Bendigo & Adelaide has a base of about $ 55,848.2 while Westpac postulates figure of about $639,792. This basically means that the later bank is more focused on improving on its customer deposit base for operations. It also means that Westpac Bank has diversified its liability portfolio hence has access to alternative items for conducting business, which it can vehemently use to offset possible losses in the future while at the same time able to minimize the level of liquidity risk (Viney 12-27). Below is a table showing some of the notable liability items that can be found at each of the two banks’ annual reports. Banks Westpac ($m) Bendigo & Adelaide ($m) Liabilities Items Deposits and other borrowings Payables due to other financial institutions Derivative financial instruments Loan capital Financial liabilities at fair value through income statement Debt issues Current tax liabilities Life insurance liabilities Due to subsidiaries Provisions Deffered tax liabilities Other liabilities Deposits Other Payables Due to other institutions Derivative liabilities Notes payable Loans payable to securitization trusts Income tax payables Provisions Deferred tax liabilities Reset preference shares Loan capital Convertible preference shares Subordinated debt Total Liabilities 649,122 55,848.2 These two banks are similar only on the basis that they depend largely on customer deposits to conduct day-to-day business operations. This can be ascertained by the fact this item has continued to increase from one period to another for both banks indicating that the customers are certain about the future survival of the banks (Lange, Saunders & Cornett 115). Notwithstanding, these banks are completely differently on the manner for which they attract other forms of liquid assets. It is important to understand that because the two banks possess a substantive level of customer deposits they are thus able to attract other forms of funding options. Investors are only certain about putting their investments in productive operations as they are rest assured of future returns of investment made (Gup, Avram, Beal, Lambert & Kolari 27-34). Conclusion From the discussion above, it can be seen that Westpac and Bendigo & Adelaide banks though operate within a similar economy opt for different levels of funding options to execute their respective operations. While Westpac Bank is mainly focused on accessing funding options through wholesale funding, its counterpart; on the other hand, focuses of tradable market securities that have a higher liquidity option. Westpac Bank has a significant number of liquid assets on its disposal in comparison to Bendigo & Adelaide Bank. This means that the bank has diversified its funding options perfectly well in order to deal with both normal conditions and uncertain crises within the financial institutions. It is noted that a well diversified funding options like the one portrayed by Westpac is able to allow other forms of funding since investors are certain about the future of the firm for that matter. It is noted that both of these banks use their Treasury to ascertain and manage the level of liquid risks at any given moment in time. Westpac reports its liquidity risk management on a weekly and monthly basis, as approved by ALCO, to BRMC before it’s forwarded to APRA for approval purposes. On the other hand, Bendigo & Adelaide maintains a Board Risk Committee and Asset Liability Management Committees to supervise and oversee the levels of risks within the firm. While both of these banks are fully inclined towards customer deposits as a major source of funding options, they differ in the manner for which they are able to access other notable funding sources. Works Cited Boffey, R & Powell, R. Financial institutions management. Class Notes Presented within Faculty of Business and Law, (2014), Edith Cowan University. Bendigo & Adelaide. 2013 annual report. (2014), Retrieved from http://www.bendigoadelaide.com.au/public/shareholders/annual_reports.asp Gup, B. E., Avram, K., Beal, D., Lambert, R. & Kolari, J. W.Commercial banking: The management of risk. (2007), Milton: Wiley. KPMG. APRA conglomerates policy and risk management requirements. (2013), Retrieved from https://www.kpmg.com/AU/en/IssuesAndInsights/ArticlesPublications/Documents/apra-conglomerates-policy-risk-management-requirements-may-2013-v3.pdf Lange, H., Saunders, A., & Cornett, M. M. J. Financial Institutions Management. North Ryde, N.S.W: (2013), McGraw-Hill Australia. Valentine, T., Ford, G., Edwards, V., Sundmacher, M, & Cropp, R. Financial markets and institutions in Australia (2nd Ed.). (2006), Sydney: Pearson Education Australia. Viney, C. (2012). Financial institutions, instruments and markets (7th Ed,). (2006), Sydney: The McGraw Hill Companies, Inc. Westpac Bank. 2013 annual report. (2014), Retrieved from http://www.westpac.com.au/ Read More