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Showing posts with label liquidity needs. Show all posts
Showing posts with label liquidity needs. Show all posts

Tuesday, 20 June 2017

08:10

Risks Associated with Bankers’ Acceptances

Risks Associated with Bankers’ Acceptances
For purposes of the OCC’s discussion of risk, the OCC can be said to assess banking risk relative to its impact on capital and earnings. From a supervisoryperspective, risk is the potential that events, expected or unexpected, may have an adverse impact on a bank’s earnings or capital. The OCC has defined ninecategories of risk for bank supervision purposes. These risks are credit,interest rate, liquidity, price, foreign currency translation, transaction, compliance, strategic, and reputation.
The risks associated with bankers’ acceptances are transaction, compliance,credit, liquidity, foreign currency translation, and reputation. These risks are discussed more fully in the following paragraphs. (Once an examiner determines whether the bankers’ acceptances are held as a loan or investment,they should refer to the appropriate booklet in the Comptroller’s Handbook for further guidance.)
Transaction Risk
Transaction risk is the current and prospective risk to earnings and capital arising from fraud, error, and the inability to deliver products or services,maintain a competitive position, and manage information. Risk is inherent in efforts to gain strategic advantage, and in the failure to keep pace with changesin the financial services marketplace. Transaction risk is evident in each product and service offered. Transaction risk encompasses product development and delivery, transaction processing, systems development,computing systems, complexity of products and services, and the internal
control environment.
Banks should work closely with borrowers seeking bankers’ acceptance financing to ensure that the borrower fully understands the supporting documentation and timely processing requirements related to this type of financing. The basic documentation for a bankers’ acceptance consists of
A bankers’ acceptance credit agreement which contains the borrower’s promise to repay the bank when the acceptance
matures.
• A “purpose statement” or letter from the borrower that describes the underlying trade transaction being financed, certifies that no other
financing is outstanding, and specifies that the transaction has not been refinanced.
• A draft.
Compliance Risk
Compliance risk is the current and prospective risk to earnings or capital arising from violation of, or nonconformance with, laws, rules, regulations,prescribed practices, internal policies and procedures, or ethical standards. Compliance risk also arises in situations where the laws or rules governing certain bank products or activities of the bank’s clients may be ambiguous or untested. This risk exposes the institution to fines, civil money penalties,payment of damages, and the voiding of contracts. Compliance risk can lead to diminished reputation, reduced franchise value, limited business opportunities,reduced expansion potential, and lack of contract enforceability.
The major compliance risk associated with bankers’ acceptance financing relates to creating ineligible bankers’ acceptances but treating them as if they were eligible for Federal Reserve discount. If this occurs, the Federal Reserve will generally impose a retroactive reserve requirement on the accepting bank.
If the bank has created a bankers’ acceptance based upon accurate information provided by the borrower in the purpose statement, only to learn later that it erroneously considered the transaction eligible, the bank will not be able to collect compensation from the customer to cover the reserves.
Compliance with the legal lending limit must be considered. When a bank discounts or holds its own bankers’ acceptances, they are converted to a loan and included in the legal lending limit. Purchased bankers’ acceptances are exempt
Credit Risk
Credit risk is the current and prospective risk to earnings or capital arising from an obligor’s failure to meet the terms of any contract with the bank or
otherwise to perform as agreed. Credit risk is found in all activities where success depends on counterparty, issuer, or borrower performance. It arises
any time bank funds are extended, committed, invested, or otherwise exposed through actual or implied contractual agreements, whether reflected on or off
the balance sheet.
Bankers’ acceptances contain credit risk not only for the bank creating the acceptance, but also for the exporter, for banks purchasing another bank’s acceptances, and for other investors (such as money market mutual funds, trust departments, state and local governments, insurance companies, pension funds, corporations, and commercial banks) who buy bankers’ acceptances.
The principal credit risk of this instrument is that the importer will be unable to make payment at maturity of the bankers’ acceptance — leaving the accepting bank responsible to make payment. For acceptances purchased in the market, credit risk is somewhat mitigated because bankers’ acceptances
are considered to be “two-name paper,” which means that the importer is secondarily liable on the instrument. In addition, the instrument is a contingent obligation of the drawer (exporter). In other words, the exporter (drawer) is contingently liable if the importer does not pay. The acceptance is also an obligation of any other institutions that have endorsed it. That is,“holders in due course” that have bought and sold the acceptance in the market.
Liquidity Risk
Liquidity risk is the current and prospective risk to earnings or capital arising from a bank’s inability to meet its obligations when they come due without incurring unacceptable losses. Liquidity risk includes the inability to manage unplanned decreases or changes in funding sources. Liquidity risk also arises from the failure to recognize or address changes in market conditions that affect the ability to liquidate assets quickly and with minimal loss in value.
Partly because the maturities of most bankers’ acceptances are short, the  market generally views acceptances as safe and liquid. The fact that “name”
banks dominate acceptance financing also limits liquidity risk. Liquidity risk will be greater if the accepting bank is lower rated, is not a “name” or “prime”
institution, or if the instrument is not eligible for Federal Reserve discount.

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Sunday, 20 November 2016

05:05

How to Survive a Cash Crunch

How to Survive a Cash Crunch

In a perfect world, you would accurately project your cash flows and avoid liquidity issues. In reality, even very profitable small businesses can experience a cash crunch. If you’re on the brink of a temporary cash crunch, there are a few accounts payable tactics you can use to escape it unscathed.

Identify the Cause
The first step in addressing poor cash flow is to understand the underlying cause. It could be your receivables have built up and you’re not collecting them fast enough. If your business is seasonal in nature, cash flows may dwindle for a few months. Small businesses that have a few large contracts can also experience a “feast or famine” cash flow pattern. Ideally, you’ll have a cash reserve to handle these slow months. If your reserves are low, this can cause a temporary cash gap. Run an accounts receivable aging schedule — a common feature in most accounting software — to understand what monies are owed to you and increase your collection efforts. Communicate with the customers with the largest invoices and get a commitment for a payment date.

Understand Your Commitments
Once you’ve identified the cause of your cash crunch and understand when cash inflows will increase, you may need to readjust your payment schedule to avoid liquidity issues. Carve out some time to analyze your accounts payable situation. Run an accounts payable aging schedule to generate a list of current bills, noting vendor, payment terms, payment amount, and due date. Add any routine payments that you know you’ll incur in the next month or so, like payroll and utilities. If you suspect you’ll have more invoices or bill payments coming soon, add estimated bills to the list based on recent activities.

Try to Get Late Fees Waived
A particularly bad cash crunch means you may not be able to pay all of your bills on time. Evaluate each vendor late-fee policy to help prioritize payments. Some vendors allow a one- or two-week grace period before charging a late-payment fee. For large suppliers and banks, ask if they’ll waive the late fee completely. Many major corporations and banks are happy to waive charges for good customers, especially if you alert them in advance. A quick phone call can often net you a few extra weeks or months to pay a substantial bill.

Renegotiate Payment Terms
Using the aging schedule, identify any supplier financing with short payment terms. You may have previously agreed to 10- or 30-day terms but when you have cash flow issues, you should aim for terms of 45, 60, or even 90 days. Doing so will help you better match receivable collections with incoming bills and avoid future cash flow issues. Contact vendors with unfavorable lending terms and try to negotiate a longer time frame for payment. If you’ve been a repeat customer and make sizable purchases, many vendors and suppliers are willing to extend payment terms to keep your business. If they’re hesitant to make the switch, offer the vendor something in return as an incentive. For example, you can offer to prioritize them over other suppliers and give them more of your business. They may be more likely to agree if you promise to revisit payment terms on a periodic basis.

Source:QuickBooks
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Sunday, 20 September 2015

08:51

The Fed's Interest On Reserves Policy Is Not "Paying Banks Not To Lend"

The Fed's Interest On Reserves Policy Is Not "Paying Banks Not To Lend"

The FOMC has decided not to raise interest rates – for now. But it’s still widely expected that rate rises will come soon, possibly by the end of the year. Some people think that QE should be unwound first, but the Fed’s plan is to raise rates first. The Fed will unwind QE gradually as the securities it has purchased mature.

This creates a problem. Because of QE, the banking system is awash with reserves. Banks have more cash on deposit at the Fed than they need to settle customer deposit withdrawals (payments), and they therefore don’t need to borrow funds from each other as they would in normal times. Because of this, the Fed Funds rate – the rate at which banks borrow from each other – no longer influences bank behaviour. It has fallen to zero.

Well, nearly zero. Actually the Fed Funds rate hovers somewhere between zero and 0.25%. This is because the Fed is paying interest at 0.25% on excess reserves (IOER). Paying IOER prevents the Fed Funds rate from falling to zero. The Bank of England, which also pays IOER though at a slightly higher rate (0.5% instead of 0.25%), helpfully explains how this works (my emphasis):

Reserves accounts are effectively sterling current [checking] accounts for banks. Reserves balances can be varied freely to meet day to day liquidity needs, for example to accommodate unexpected end of day payment flows. The rate paid by the Bank on reserves account balances is also the means by which the Bank keeps market interest rates in line with Bank Rate.

Since March 2009, implementation of the Bank’s monetary policy has involved both keeping short-term market interest rates in line with Bank Rate, and undertaking asset purchases financed by the creation of central bank reserves in line with MPC decisions (so-called ‘Quantitative Easing’).

Under the reserves averaging regime used in more normal times, the Bank supplies the amount of reserves required for banks to meet their aggregate reserve targets. An excess supply of reserves, relative to that demand, would tend to push down on market interest rates. As a result of large scale asset purchases, the supply of reserves largely varies in response to the MPC’s policy decisions, rather than the changes in the demand for reserves. This potential imbalance in the demand and supply of reserves could have resulted in loss of control over market interest rates had banks been required to continue to set and meet targets. The Bank therefore suspended reserves averaging in March 2009, and banks are not currently required to set targets for their reserves balances.

Instead, the Bank currently operates a ‘floor system’ whereby all reserves balances are remunerated at Bank Rate. Because banks will not lend their surplus reserves to other banks at rates lower than can be obtained by depositing them with the Bank, this has the effect of flattening the demand curve for reserves after the point where there are sufficient reserves in the system for banks to manage their day to day liquidity needs.

So by paying banks to deposit funds with them, central banks set a “floor” on the rate at which banks will lend funds to each other – the Fed Funds rate, or “Bank Rate” in the UK. Therefore IOER is monetary policy. It enables the Fed to retain control of interest rates when the system is flooded with excess reserves.

Unfortunately the purpose of IOER has been widely misunderstood in mainstream media. Here’s Binyamin Appelbaum in the New York Times, for example:

Yet the Fed has found itself forced to experiment. The immense stimulus campaign that it started in response to the 2008 financial crisis changed its relationship with the financial markets. It has pumped so many dollars into the system that it cannot easily drain enough money to discourage lending, its traditional approach. Instead, the Fed plans to throw more money at the problem, paying lenders not to make loans.

Sorry, Binyamin, this is completely wrong. Banks are not being paid not to make loans. They don’t lend out reserves to customers. They only lend reserves to each other. By competing with banks in the market for reserves, the Fed controls the price at which they lend reserves to each other. It has nothing whatsoever to do with customer lending.

Source :Forbes.com
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