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FUNDAMENTAL REAPPRAISAL OF THE DISCOUNT MECHANISM
DISCOUNT POLICY AND
BANK SUPERVISION
BENJAMIN STACKHOUSE
Prepared for the Steering Committee for the Fundamental Reappraisal of the
Discount Mechanism Appointed by
the Board of Governors of the Federal Reserve System
The following paper is one of a series prepared by the research staffs of the Board of Governors
of the Federal Reserve System and of the Federal Reserve Banks and by academic economists
in connection with the Fundamental Reappraisal of the Discount Mechanism.
The analyses and conclusions set forth are those of the author and do not necessarily indicate
concurrence by other members of the research staffs, by the Board of Governors, or by the Federal
Reserve Banks.
FUNDAMENTAL REAPPRAISAL OF THE DISCOUNT MECHANISM
Discount Policy
and
Bank Supervision
Benjamin Stackhouse
Bank Examinations Department
Federal Reserve Bank of New York
November 6, 1968
TABLE OF CONTENTS
Page
I • Introduction
II.
1
A. Summary Conclusions
B. Definition of Liquidity
1
3
C. Secular Trend in Commercial Bank Liquidity
4
Supervisory Approaches to Liquidity
7
A. One Approach to Liquidity
7
1. Rationale of the New York Reserve Bank Formula
a. Liquidity Requirements for Deposits
b. Liquidity Requirements for Portfolio.
c. Liquidity Instruments Held
2. Other Analyses Made "by Examiners in Appraising
A Bank1 s Liquidity
3- Evaluation of the New York Reserve Bank's Examining
Approach to Liquidity
a. Non-Money Market Banks
*•
b. Money Market Banks
.
c. Summary
8
9
10
11
12
13
14
l6
17
B. Other Liquidity Standards
18
1. Board of Governors
19
2. Comptroller of the Currency
19
3. New York State Banking Department
20
4. Comparison of Various Approaches to Liquidity
21
III. Liquidity Standards and Changes in Discount Policy
24
Appendices
A. Estimating Liquidity Requirements, February 15, 1965
B. Example of an Examiner's Comments Concerning the
Excessive Liquidity Position of a Non-Money Market
Bank
C. Example of an Examiner's Comments Concerning the
Marginal Liquidity Position of a Non-Money Market
Bank
D.
Example of an Examiner's Comments Concerning the Adequate
Liquidity Position of a Money Market Bank
E.
Example of an Examiner's Comments Concerning the Tight
Liquidity Position of a Money Market Bank
F.
Form for Analyzing Bank Capital, Board of Governors,
FR 363, April 1956
G.
Supervisory Circular Letter CB-14, May 6, 1959, State of
New York Banking Department
H.
Regional Newsletter, Second National Bank Region,
July 1966
I. Application of Formulas to Sample Bank
ii
I. INTRODUCTION
The purpose of this study is to examine the relationship between the
discount policy and bank supervision.
Bank supervision, being concerned with
the condition of individual components of the commercial banking system, is
primarily affected by discount policy as that policy, in turn, affects the
supply of funds available to individual member banks to meet anticipated
demands. Any change in discount policy which increases or decreases that
supply will necessarily lead to some adjustment in liquidity management for
individual banks.
It is one of the responsibilities of bank supervision to
identify possibly needed adjustments and, where appropriate, to counsel banks
how best to make them. This study considers the present approach to liquidity
used by examiners for the New York Federal Reserve Bank, and compares this
approach with some other liquidity standards, concluding with some comments
on the consequences for the bank examiner's approach to commercial bank
liquidity of proposed changes in discount policy.
A. Summary Conclusions
The changing asset structure of banks, the development of new money market
instruments and the decline during the post-war period in commercial bank liquidity as measured by traditional indices have focused attention on the problem of bank liquidity. The primary responsibility for maintaining adequate
liquidity rests with the individual bank; this is particularly true under the
present provisions of Regulation A which provide for the extension of Federal
Reserve credit only on a short-term basis except in emergency or other unusual
situations. As a result, supervisors place great emphasis on liquidity in
their examinations of banks. A number of liquidity formulas have been developed
to assist both bank management and the examiners by providing useful reference
standards for assessing and evaluating bank liquidity.
2
Various proposals made in connection with the overall study of the
discount mechanism would liberalize the administration of the System's facilities so as to provide greater assistance to the banks in supplying funds either
on a short-term basis or perhaps for longer periods of time. Any liberalization of Regulation A to permit readier access to the discount window would,
of course, tend to reduce in some degree the need for member banks to make
provision for their own liquidity since they could rely to a greater extent
on the Reserve Bank.
Under a more liberal discount policy, the examiner's emphasis would be
shifted to some degree from the short-term liqudity position, and additional
emphasis would be placed on the quality and soundness of the longer-term
assets, to the adequacy of capital and to the adequacy of earnings to cover
the costs of borrowing. Examiners would continue to criticize any banks
using the discount facilities for purposes inconsistent with statutory and
regulatory requirements and sound banking principles.
B. Definition of Liquidity
Bank liquidity may be defined as the ability of a bank to meet the known
and foreseeable demands for money that may be made upon it. These demands may
come from the depositors or they may come from the bank's borrowing customers.
A bank is considered to have an adequate liquidity position when it can meet
normal cash withdrawals and requests for loans without having to sell or
liquidate medium or long-term assets. Adequate liquidity can be achieved by
holding, in addition to cash or its equivalent, a sufficient quantity of other
highly liquid assets readily convertible into cash (secondary reserves) and by
spacing maturities of loans and investments to assure the necessary inflow of
cash.
3
Aside from the legal resfeifves that banks must maintain against their
demand and time deposits, there are no uniform supervisory standards governing
the liquidity of American banks. The responsibility for maintaining adequate
liquidity is left to the individual bank, which must solve its problem in the
light of the ever-changing conditions under which it operates.
The foregoing definition of liquidity is asset-oriented and suggests
that banks provide for their normal liquidity needs out of their own resources.
It is recognized, however, that in some instances many banks rely
on borrowed funds as sources of funds for meeting deposit withdrawals and
credit demands. These borrowings are of a short-term nature and include, in
descending order of importance, purchase of Federal funds, loans from correspondents, sale of securities under repurchase agreements, and direct borrowings from the Reserve Banks. In recent years negotiable time certificates
of deposit and Euro-dollar deposits have provided additional sources of funds.
While these various types of essentially short-term funds provide a cash flow,
each such short-term borrowing itself represents a requirement for liquid
funds for its repayment at some near-term date. From time to time this borrowing may create problems for some or all of the banks, because sources of
outside funds are not always readily available at reasonable cost in time of
need.
Borrowings from the Reserve Bank or from other sources, such as those
mentioned above, do provide funds to meet short-term demands. However, borrowings from the Reserve Bank differ in character from other short-term
borrowings. Under the present administration of Regulation A, control of
the use of the discount window rests with the Reserve Banks. In practice,
banks traditionally have been reluctant to borrow from the Reserve Banks,
preferring to obtain needed funds from other sources. Several of the
4
proposals to liberalize the use of the window might alter or at least modify
bank attitudes regarding borrowings from the Reserve Banks and the use of
the discount window as a "lender of last resort", and call for reconsideration
of the general concept of bank liquidity.
C. Secular Trend in Commercial Bank Liquidity
Although the need to maintain adequate liquidity in individual institutions has always been present in the American banking system it has become
increasingly important in the years since the end of World War II. For most
of the period between 1934 and 1944, liquidity problems were generally of
minor concern in the affairs of commercial banks, since the Federal Reserve
System maintained a generally stimulative monetary policy and total excess
reserves of member banks ranged between one and five billion dollars. Moreover, since the loan demands of business were at a low ebb, commercial banks
invested heavily in United States government securities. Tfy 1940 the volume
of such Government securities held by commercial banks was nearly equal to
the volume of loans in their portfolios.
The financing of the war efforts during the early 1940fs greatly intensified this trend and resulted in the growth in the volume of Government
securities held by commercial banks far outstripping the growth in loans.
By the end of 1945> the volume of Government securities held by the commercial banks was more than 3 l/2 times the aggregate of their loan portfolios. At that time liquidity, as measured by the inverse of the commonly
used ratio of loans-to-deposits, amounted to 82.6 percent. Moreover, until
1951 the Federal Reserve System supported the Government securities market,
so that, in effect, these securities, regardless of maturity, were fully
liquid assets, being readily convertible into cash without loss.
5
The post-World War II period has seen an expanding economy which has
sought more and more bank credit. While deposits have increased during this
period, their growth has not been sufficient to provide fully for the expanding demand for credit. As this demand increased, commercial banks reduced
their holdings of Government securities in order to enlarge their lending
activities. Accordingly, their liquidity positions underwent a steady erosion.
This changing asset structure of the commercial banks, and the revision
in 1955 of Regulation A which emphasized the responsibility of the individual
banks for maintaining adequate liquidity, created interest in the development
of a more sophisticated approach to the measurement of liquidity needs. Such
an approach would enable both the commercial bank management and the supervisors to evaluate and discuss the liquidity position of a bank.
In 196l, negotiable certificates of deposit were introduced on a large
scale, providing commercial banks with an additional source of funds, and
changing somewhat the structure of their liability accounts. While this new
money market instrument was designed originally as a defensive measure to
protect banks from the drainage of deposits to other short-term markets, it
soon came to be used in an aggressive manner. Through the use of the certificate of deposit, many banks were able to attract a large volume of
deposits within a relatively short period of time, the proceeds of which
were used for loan expansion by individual banks far beyond the expansion
which would have been possible by the liquidation of securities. More
recently the large commercial banks have looked to the Euro-dollar market
as an additional source of funds.
Recourse to these new types of time deposits and other liabilities as
sources of funds has made more complex the banks1 problems of maintaining
6
adequate liquidity, and has altered to some extent the traditional methods
of assessing liquidity positions. In turn, they have increased the pressure
for the development of a more sophisticated approach to the measurement of
liquidity needs.
7
II. SUPERVISORS APPROACHES TO LIQUIDITY
A. One Approach to Liquidity
Revision of Regulation A in 1955 led the Federal Reserve Bank of New York
to develop a new approach to the problem of commercial bank liquidity in the
examination of Second District State member banks. This included a means of
measuring bank liquidity which was designed to provide non-money-market banks
with a convenient method of analyzing their own situations and to assist
examiners and supervisors in evaluating management's efforts in maintaining
§, sound liquidity position.
The liquidity formula adopted by the Federal Reserve Bank of New York in
1955 was introduced to its bank examiners by a bulletin noting that under the
revision of Regulation A, "The responsibility of providing for normal seasonal
swings of funds, or for finding funds to expand the loan portfolio, is placed
squarely on the individual member bank." The bulletin describes the liquidity
formula as a means of assisting examiners in appraising the degree to which
a bank has provided itself with adequate liquidity, and as a possible guide
to member banks themselves. It emphasizes that the formula does not provide
a hard-and-fast rule, that it has no substitute for logical reasoning or more
extensive analysis, and that it is primarily designed as a starting place or
rough screening device to focus proper attention on such liquidity problems
as may exist in individual commercial banks. In the following discussion of
the Federal Reserve Bank of New York's liquidity formula, this emphasis on
its limitations in the total evaluation of a commercial bank's liquidity is
important to keep in mind.
In the final evaluation of liquidity which
accompanies every report of examination of a commercial bank, the New York
Reserve Bank examiner brings to bear not only the results of the application
8
of the liquidity formula, but his knowledge of the "bank's history and of the
financial markets in which it operates, his understanding of the broader
financial and economic developments affecting the bank's operations, the
pattern of the bank's borrowings at the discount window and elsewhere, and
his discussions with the management of the bank and with his colleagues in
the Examinations and Discount Departments of the Federal Reserve Bank,
This liquidity formula has been refined and expanded since 1955*
The
instruction memorandum currently in use by the Examining Division of the
New York Federal Reserve Bank, dated February 15, 19&5*
Appendix A.
ma
y ^ e found in
The basic principles of the formula are summarized below:
1. Rationale of the Mew York Reserve Bank Formula, The New York Reserve
Bank's liquidity formula endeavors to evaluate a bank's liquidity requirements
and position as follows:
(a) Projects a bank's liquidity position over and above the
day-to-day legal reserve requirements and minimum cash
balances needed to be maintained with its correspondent's.
(b) Projects a bank's liquidity needs on the basis of a con-'
current loss of deposits and an expansion of the loan
pcxctfol-io.
l/ The formula and the other analyses described later in this paper generally
do not take into consideration the cash flow from term and other amortizing
loans which would be available for liquidity purposes* In practice, the
cash flow from loans generally rolls over into new loans to maintain the
volume of the loan portfolio. Nevertheless, the cash flow does provide a
bank some freedom of action with respect to liquidity in that in extreme
emergencies, a bank could curtail its lending activities and use the cash
flow from loans as a source of funds to meet deposit withdrawals.
9
On the basis of these projections of liquidity position and needs a
fairly comprehensive and effective appraisal of a bank!s loan and investment
policies is possible. The New York Reserve Bank's liquidity formula contains
two principal parts, namely, an estimation of the liquidity requirements
arising from fluctuations in deposit and loan demands, and the availability
of liquid assets to meet such requirements. Since liquidity is needed not
only for the everyday operations of a bank but also to meet future demands
for funds, the formula classifies the liquidity needs and instruments held
into three time categories:
Short term
Under 1 year
Medium term
1 - 2 years
Longer term
2 - 5 years
These liquidity needs and instruments are described as follows:
a. Liquidity Requirements for Deposits (italics). The New York Reserve
Bank's formula distributes deposits into three classifications based on the
degree of stability.
The minimum requirement for each such liquidity classi-
fication is considered to be satisfied by distributing funds so classified
among short-term, medium-term and longer-term investments in specified percentages.
Demand and time deposits are considered separately but the
liquidity requirements depend to a greater degree upon whether such deposits
are determined to be volatile, vulnerable or residual.
"Volatile" deposits are those most, likely to be withdrawn and
include seasonal deposits. They should be fully covered by
liquid assets of the shortest maturities.
"Vulnerable" deposits are those the sudden or unexpected
withdrawal of which would place heavy pressure on the bank's
10
liquidity position. These are usually the larger deposits, i.e.,
those in excess of l/2 of 1 percent of total deposits. Deposits
classified as "volatile" are deducted from the sum of the large
deposits to arrive at the total of "vulnerable" deposits. The
formula requires a liquidity provision of 20 percent against
such deposits in the form of so-called medium-term instruments
with maturities of 1 to 2 years.
"Residual" deposits are regarded as the "hard core" deposits
which may be fully invested in earning assets. However, as a
precaution the formula prescribes a liquidity provision of
10 percent for such deposits classified as demand and 5 percent
for deposits classified as time.
In addition, the formula specifies higher liquidity requirements for certain
types of deposits deemed to be subject to unusual liquidity pressures.
b. Liquidity Requirements for Portfolio (Italics).
The requirements for
portfolio consist of liquid funds available for the purpose of making additional loans or investments. These holdings protect a bank from having to
borrow undully or to dispose of securities, possibly at a loss, to meet
possible credit needs of its customers.
categories:
Loan demand is divided into three
Seasonal, Unexpected and Projected.
The Unexpected demand
represents an arbitrary figure equal to twice the bankfs legal lending limit
for unsecured loans. Seasonal and Unexpected loan demands require full
coverage in short-term liquid instruments; the Projected demand requires
100 percent coverage, divided equally between short-term instruments and
those maturing in one to two years.
The anticipated liquidity needs for deposits and portfolio are totaled
for each time category to show the aggregate needs for liquid assets.
11
c. Liquidity Instruments Held (italics). The liquidity instruments held
are generally considered to consist of cash or bank balances (primary reserves)
and investments in assets readily marketable with minimal risk of loss
(secondary reserves).
For purposes of liquidity analysis, such liquid assets
are classified according to their remaining maturity - short-term, medium-term,
and long-term.
Not all primary reserves are available for liquidity because a certain
portion of the balances is required for everyday operations. Thus, only those
primary reserves in excess of established working needs are considered as
qualifying for liquidity purposes.
Likewise, some of the secondary reserves,
such as brokers loans and loans to correspondent banks, involve normal customer relationships and it is unlikely that a bank would permit them to fall
below certain specified levels, except in cases of extreme contingency. Thus,
the full arhount of such assets should not be included as liquid assets; only
the amounts in excess of the average amounts of such loans over the previous
12 months or jga excess of the minimum amounts specified by the management may
be considered as liquid assets.
The liquidity instruments in the three categories are totaled and any borrowings are deducted from the short-term category.
Net liquidity in the three
time categories is determined by deducting liquidity demands from available
liquid assets.
A composite liquidity index is computed by weighting the dollar amounts
of the liquidity requirements and net instruments held in each of the three
time categories and comparing the total of the instruments held to the total
requirements. A composite index of 100 or more is normally considered to
denote adequate liquidity.
12
2. Other Analyses Made by Examiners in Appraising A Bankfs Liquidity.
Since, as stated earlier, the New York Reserve Bank's liquidity formula serves
merely as a starting point or a rule of thumb for evaluating liquidity, its
examiners prepare other analyses which are equally important in the overall
evaluation of a bank's liquidity position and its loan and investment policies.
Such analyses include the following:
(a) A review of the bank's procedures in computing the daily
record of required and maintained reserves to determine
whether or not the bank is handling its money position
properly.
If the review shows periodic closing of
reserve periods with either deficiencies or heavy excess
reserves, the situation is discussed with management and
recommendations are made for correction.
(b) A complete analysis of the bank's borrowing activities
for the period between examinations, based in part on the
record of the bank's borrowings from the Federal Reserve
Bank, the reasons advanced for such borrowings and when
appropriate, discussions with members of the Reserve
Bank's Credit and. Discount Department; and also including
a determination of:
(l) the principal sources of borrowings, with particular
emphasis on the volume and steadiness of the bank's
utilization of the discount window as compared with
purchases of Federal funds and the use of other
sources of borrowings, and
13
(2) whether the borrowings were used to maintain the
bank's legal reserves due to seasonal deposit
fluctuations, inaccurate projections of deposit
and loan growth, or because of an over-extended
loan and investment position.
(c) A general review of the bank's loan and investment
policies to determine the extent to which they have
affected the liquidity position.
Such an analysis
would include a review of outstanding loan commitments,
distribution of loans by type and a projection of the
cash flow from the loan and investment portfolios.
(d) Consideration of general trends in national and local
economic and financial conditions, including such
factors as interest rates, loan demand and the state
of capital markets, that may affect liquidity.
3. Evaluation of the New York Reserve Bank's Examining Approach to
Liquidity. While the liquidity formula and other analyses discussed above
constitute the general approach used by the New York Reserve Bank's examiners
in the appraisal of a bank's borrowings and liquidity position, the manner
in which they are utilized depends largely upon the judgment of the individual
examiner.
In practice, the liquidity formula and other analyses are normally
geared to the specific circumstances of a particular bank. The examiner's
conclusions are predicated on a careful consideration of the following basic
concepts with regard to the appropriate utilization of borrowed funds,
regardless of source, to support a bank's operations:
14
(a) That borrowings at the Reserve Bank, regardless of
size, which do not conform to the 1955 revision of
Regulation A, are objectionable.
(b) That steady and somewhat heavy borrowings from sources
other than the Reserve Bank may be considered a normal
occurrence in banks that are active participants in the
money market. The extent to which such borrowings are
used to support other than money market operations is
an important factor in determining whether the borrowing activities of these banks might be subject to
criticism.
(c) That steady and somewhat heavy borrowings from sources
other than the Reserve Bank are objectionable if used
to support unsound extensions of credit or other
practices inconsistent with prudent banking.
In view of the differences in the appropriateness of borrowings and
since there are wide differences in the operations of non-money market banks
compared with the operations of banks connected with the money market, the
approach to liquidity and borrowings in these two broad classifications of
banks differs considerably and the evaluation of the approach should be
reviewed accordingly.
a. Non-Money Market Banks (italics). Traditionally, banks in this
group generally have been reluctant to borrow from any source, preferring
to obtain needed liquidity by making adjustments to their own loan and
investment portfolios.
In many cases, particularly among the smaller1 banks,
15
estimates of liquidity, needs have resulted in either very illiquid positions
or, more often at the other extreme, excessive liquidity with a resultant
loss of income.
The New York Reserve Bank's liquidity formula has proven to be a
valuable instrument to the examiners in evaluating liquidity in this group
of banks in this District. More importantly, because of its relative
simplicity, it has been useful in assisting the managements of these banks
to better understand their liquidity needs and the means by whifch such needs
can be met without resorting to excessive use of the Reserve Bank's discount
facilities or by selling assets at a loss.
In other instances, it has helped
management to recognize its excessive liquid position and to make the necessary
adjustments to improve earnings. We believe that the formula has been responsible for developing a common understanding of liquidity on the part of both
the examiners and bank management and for making more appropriate use of borrowings .
The Federal funds market has provided the country banks with a convenient
and flexible means of adjusting their excess reserve positions. Until recent
years, the country banks were largely excluded from the use of this market
because of the size of the trading unit. However, with the increased demand
by the large city banks for borrowed funds to maintain positions in relatively
high-yielding assets, these large banks, at least in the Second Federal
Reserve District, have been willing to trade in much smaller units to tap
the excess reserves of even the smallest institutions.
Access to the Federal
funds market has enabled the country banks to put otherwise idle funds to
profitable use. While these banks generally enter the market on the "selling"
side, the increased knowledge of this market permits them on occasion to
purchase Federal funds, thus reducing their dependency on the discount window.
16
Examples of the type of comments made by the New York Reserve Bank
examiners in connection with non-money market banks found to have excessive
liquidity positions and those with marginal liquidity positions may be
found in Appendices B and C.
b. Money Market Banks (italics).
The application of the New York Reserve
Bank's liquidity formula to banks in this category poses somewhat different
problems. For one thing, the formula was not designed primarily for application to these large banks; for another, these banks maintain a close and
continuing watch over their liquidity positions and attempt to provide the
necessary liquidity through a wide variety of transactions which have not
been fully recognized in the formula.
While these large banks have their normal levels of deposits of individuals, partnerships and corporations, the examiner's analysis of the
liquidity position and the application of the formula is governed largely
by the extent to which these banks are financing money market transactions,
such as loans to U.S. Government bond dealers, operation of bond trading
accounts, etc.
It is generally recognized that these banks support these
money market transactions by borrowing.
In addition, these banks usually
are actively engaged in providing correspondent bank services to banks located throughout the United States. Besides the usual correspondent bank
services, the money market banks are a major source through which the country
banks can adjust their reserve positions by selling Federal funds• Many of
the large banks increasingly rely on the availability of such funds when
projecting their own liquidity requirements.
Moreover, in recent years these large banks probably have seen greater
changes in their deposit structure than the country banks and they have had
to seek loanable funds by obtaining time deposits because demand deposits
IT
have shown little growth. The time deposits generated have been largely in
the form of negotiable certificates of deposit.
In common with most banks,
the money market banks also have seen a steady decline in their short-term
liquid assets as these assets have been converted into longer-term, higheryielding loans to offset the increased costs of their growing volume of time
and savings deposits. The tight money conditions which existed in 1966 and
the unstable short-term money rate structure placed severe strains on the
liquidity positions of most of the money market banks. As a result, a
number of these banks were forced to place greater reliance on their ability
to borrow to support their heavily-invested positions in loans and securities
as well as their money market activities.
Because of these conditions, the examiners have had to analyze each
situation carefully and to modify the liquidity formula in order to arrive
at satisfactory conclusions with respect to a money market bank's actual
liquidity position. For example, the liquidity requirements against certain
types of deposits, such as the negotiable certificate of deposit, did not
appear realistic in the light of present day conditions and were increased.
In addition, the examiners have given consideration to the relationship
between the bank!s activities in the money market and the volume of borrowings
from all sources to support these activities.
Examples of the type of comments made by the New York Reserve Bank's
examiners in connection with money market banks with adequate liquidity
positions and those with tight liquidity positions may be found in
Appendices D and E.
c. Summary (italics).
The New York Bankfs liquidity formula has been
a useful tool for both examiners and bank management in evaluating and discussing bank liquidity and borrowings, particularly in non-money market
18
banks.
The present formula is somewhat inadequate when applied to the
larger banks in part because of their increased reliance on liability
management. Modifications of the formula, based in part on experience
gained during the recent period of tight money, are needed to make it
more effective for that purpose.
B. Other Liquidity Standards
There is a variety of ratios and other formulas used to measure bank
liquidity.
Probably the two ratios most widely used are the liquid assets-
to-liability ratio and the loan-to-deposit ratio. The first ratio shows
the relationship of the means of cash payment to the possible demands for
payment.
It is usually computed by taking the sum of cash and due from
banks, brokers and dealers loans, and short-term Government securities,
less any borrowings, as a percentage of total deposits less cash items in
process of collection and reserves on deposit at the Federal Reserve Bank.
The loan-to-deposit ratio, as the name implies, relates the volume of loans
outstanding to the volume of deposits to indicate the extent to which deposits
are tied up in relatively illiquid assets. These ratios, either used in
combination or separately, are at best only rough measures of the liquidity
position. They are not considered to be adequate for supervisory purposes
because they omit any consideration of the flow of funds from loan repayments,
the amount of funds that a bank may be called upon to supply, or the varying
stability of different types of deposits.
Among the formulas in use for measuring the liquidity position are those
used by the examiners for the New York State Banking Department and the examiners
for the Comptroller of the Currency.
In addition, the examining staff of the
Board of Governors of the Federal Reserve System includes a liquidity calculation section in its Form For Analyzing Bank Capital (F.R. 363) attached hereto
as Appendix F.
Each of these measurements is described briefly below.
19
1. Board of Governors. As noted above the examining staff of the Board
of Governors of the Federal Reserve System includes a liquidity calculation
2/
in its Form For Analyzing Bank Capital.—
In the strictest sense, the liquidity
calculation is not a measurement of a bank's liquidity position but merely incates the extra capital which would be needed to cover possible losses in the
event that a forced liquidation of portfolio assets was required to supplement
liquidity provided by primary and secondary assets. The calculation is based
on certain assumptions as to deposit shrinkage, made on the basis of a review
by the Board's staff of historical data.
2. Comptroller of the Currency.
The formula currently used by the
National bank examiners is explained briefly in the "Regional Newsletter,
Second National Bank Region, July 1966", a copy of which is attached as
Appendix H.
It is a much simpler formula than that used by the New York
Reserve Bank and relates liquidity only to deposit liability.
Liquid assets
are considered to be cash and balances due from banks, the market value of
the bank!s unpledged security portfolio, including bonds pledged in excess of
legal requirements, and Federal funds sold. From the total of such assets
are deducted borrowings, Federal funds purchased, and required reserves. The
resulting figure is considered to be the net liquid asset position of the bank.
A net deposit figure is obtained by deducting secured deposits from total
deposits and a percentage of liquidity is computed by dividing net liquid
assets by net deposits.—'
It is understood that the Comptroller's office
2/ See Appendix F. This form (F.R. 363) is completed by the New York Reserve
examiners during their examinations of all Second District State member banks.
3/ At the year-end Call for 1966, the three Federal supervisory agencies requested
banks under their supervision to complete liquidity forms patterned after this
formula.
20
would consider a percentage of 35 percent or more as reflecting a reasonably
adequate liquidity position.
The value of this formula in the analyses of the liquidity positions of
National banks cannot be readily determined because discussions of liquidity
and borrowings in reports of examination of these banks are generally not
extensive. This liquidity formula appears to serve as a rough rule of thumb
for calculating deposit liquidity as on the examination date. It does not
include any consideration of the liquidity needs for the portfolio nor does
it include any projection of liquidity needs for deposits and loans.
3. New York State Banking Department. At each examination the New York
State examiners compute a "Quick Asset Ratio", which is similar to the liquid
assets-to-liability ratio described above. The quick assets consist of cash
and due from banks, readily marketable stocks and bonds at market value
(excluding securities deposited for purposes other than as security for
deposits or borrowings, as for example, securities deposited to secure trust
activities), loans secured by readily marketable collateral and other quick
assets.
Secured deposits and borrowings are deducted from the total of quick
assets to arrive at net quick assets the sum of which is related to net liabilities consisting of total liabilities less the secured deposits and borrowings .
The New York State Banking Department considers this ratio to be a useful
measurement of the proportion of a bank's assets intrinsically liquid in
character.
However, it is a view of the bank's liquidity position which con-
templates the liquidation of secured loans, thus implying an unusual and
severe contingency.
To supplement the quick asset ratio and to index the
extent to which immediate conversion of assets to cash is possible without
interfering with the normal activities of the institution, the Department has
21
developed a "primary liquidity" formula. This formula is explained in
Supervisory Circular Letter CB-14 dated May 6, 1959, a copy of which is
attached as Appendix G.
The primary liquidity formula is similar in approach to that of the
New York Reserve Bank's liquidity formula, except that it does not distribute the liquidity requirements and instruments held into different time
periods.
In addition, the use of liquidity instruments as "primary
reserves" in the formula is limited, for the sake of uniformity, to the
five different types listed in Circular Letter CB-14.
Moreover, the formula
does not include a reduction in "primary reserves" due to outstanding borrowings; such borrowings are treated as a deduction from the total of quick
assets in the quick asset ratio.
4. Comparison of Various Approaches to Liquidity. The New York Reserve
Bank liquidity formula differs in concept from those developed by the staffs
of the Comptroller and the Board of Governors. The New York approach attempts
to gauge the relationship between those assets which may readily be liquidated
with little, if any, loss in order to meet the foreseeable needs of a bank
with respect to changes in-loan volume or deposit losses during the normal
course of its business. Such an approach is also used to some extent by
examiners of the New York State Banking Department.
Both the Comptroller's
and the Board of Governor's examining staff formulas, on the other hand, seek
essentially to determine a bank's ability to meet any deposit loss short of
going into liquidation; neither of the latter formulas recognizes the
liquidity needs for the portfolio. The Board staff's approach, however, is
the more sophisticated of the two since it places a ceiling on any possible
deposit losses and recognizes that under certain circumstances a bank may
22
have to rely for liquidity on assets other than those considered to be
primary or secondary reserves.
Comparison of these various measurements of liquidity for a typical
country bank (whose balance sheet as of December 31> 1966 appears on page 1
of Appendix I), including the different types of ratios and the formulas
used by the examining staffs of the New York Reserve Bank, the Board of
Governors and the Comptroller are set forth in Appendix I. A computation
of the primary liquidity formula used by examiners for the New York State
Banking Department has not been made because the formula is similar to
that used by the New York Reserve Bank.
The results of computing these various ratios and formulas indicate
the following regarding the sample bank's liquidity position:
(a) Loan-to-Deposit ratio at 68.6 per cent indicates a
fairly heavy loan position. Member banks in New York
State outside of New York City had a ratio of about
6l percent at year-end 1966.
(b) Liquid Assets-to-Liability ratio at 11.8 percent seems
to reflect an adequate position when compared with the
December 21, 1966 average ratio of 8.2 percent for all
weekly reporting member banks in the Second Federal
Reserve District outside of New York City.
(c) New York State's Quick Asset ratio at 41.4 percent,
however, indicates a tight liquidity position. The
average ratio for all banks in New York State outside
of New York City was 55 percent in 1966. However, the
23
State Banking Department also reviews the "bank's liquidity
position on the "basis of the State's primary liquidity
formula discussed previously.
(d) New York Reserve Bank's liquidity formula reflects an
adequate liquidity position on the basis of the consolidated index of 113• The net liquidity in the three time
categories shows adequate liquidity for the short- and
long-term categories and a deficit for the medium-term
category. The examiner's comments regarding this bank
(see Appendix C) indicate that if certain large public
demand deposits were reclassified as volatile, the bank's
short-term position might not appear as favorable.
(e) Board of Governor's Form For Analyzing Bank Capital
shows that the bank would need additional capital of
$206,000 against assets, other than primary and secondary
reserves used for liquidity.
Such a requirement would
represent 26 precent of the total capital required and
would account for the low ratio of actual capital to
required.
(f) Comptroller of the Currency's liquidity formula at
30.3 percent also reflects a tight liquidity position.
24
III. LIQUIDITY STANDARDS AMD CHANGES
IN DISCOUNT POLICY
Changes in discount policy including such concepts as a "basic
borrowing privilege" and a "seasonal borrowing privilege", involving
freer and perhaps more frequent access to the discount window, would of
course require some modification of the examiner's approach to liquidity
and overall evaluation of bank management and loan and investment policies.
Under such a liberalization of discount policy, an additional responsibility
may be placed on the bank examiner in counseling the management of some
banks as to how to operate effectively in such an environment. Bank supervision would have the responsibility of reminding management of the possible dangers of relying to heavily on the discount window, and of assuring
that the banks retain the skills necessary to manage their liquidity
positions in times when exclusive reliance on borrowings may be unprofitable
for them.
The studies conducted in connection with the Fundamental Reappraisal of
the Discount Mechanism have served to re-emphasize the desirability of establishing uniform standards of capital and liquidity, and the need to take
changes in discount policy into account in developing such standards. One
result has been the .establishment within the Federal Reserve System of a
Study Group to consider the various, approaches to capital adequacy and
liquidity and the possibility of introducing such techniques and cash flow
analysis in the evaluation of liquidity, with a view toward developing
standards that may meet with general acceptance among bankers and bank
supervisors.
APPENDIX A
February 15, 1965
ESTIMATING LIQUIDITY REQUIKEMEMTS
An Explanatory Memorandum of the Bank Examinations Department,
Federal Reserve Bank of New York
The Function of Liquidity
The problem of bank liquidity is essentially that of having available
sufficient funds (or marketable assets readily convertible into funds) to meet at
all times the demands for money that may be made on a bank. Adequate liquidity
is the basic protection afforded against losses that could develop should the
bank have to sell or forceably liquidate creditworthy assets in an adverse market.
Maintaining adequate liquidity, therefore, means having enough funds on hand or
readily available with which to meet the actual or potential demands for funds by
the bank's depositors or borrowing customers.
The liquidity requirements of an individual bank will vary from day to
day as funds flow into and out of the bank. Management's responsibility is to
measure these requirements and to anticipate them on a current and continuing
basis.
Our objective, therefore, has been to develop a yardstick capable of
systemizing the variables involved and producing as accurate and simple a measure
as possible.
The Background
The Bank Examinations Department of the Federal Reserve Bank of New
York has for some time been using a measure of bank liquidity as an adjunct to
its regular bank examinations. Several years1 development of bank liquidity
standards and their application in the field has seen widening interest on the
part of bankers and supervisory authorities in the objectives of such measurements.
The first of these is to provide bankers with a convenient means of
analyzing their own situations, thereby encouraging closer attention to their
liquidity positions. The second is to aid bank examiners and supervisors in
evaluating management's performance in maintaining sound liquidity positions.
A-2
A third objective might be to create a measure of relative liquidity which could
be used to evaluate the impact of credit policy changes on groups of banks.
Banks, themselves, for the most part have not developed any systematic
procedures for estimating liquidity needs. Rough measures generally used, such
as loan-deposit ratios or ratios of liquid assets to total loans and investments,
do not adequately reflect prospective demands for funds. Most often liquidity
needs have been estimated by intuition born of experience or calculated so as not
to be "out-of-line" with other banks whose needs may be entirely different. A
need for guiding principles and uniformity of approach seemed clear. For these
reasons, the Liquidity Position Form described in detail below was developed as
a basis for management's necessary exercise of judgment.
The Liquidity Position Form
A form for estimating the Liquidity Position is shown in Table 1. The
Liquidity Requirements are first computed (as described below).
The Holdings of
liquid assets are then listed and compared with needs to arrive at a Net Liquidity
(excess or deficit) in the individual banks1 positions. Both requirements and
holdings of liquidity instruments are shown separately for short-term needs (under
1 year) medium-term needs (1-2 years) and longer term needs (2-5 years).
Excesses
of liquid assets in the shorter maturities may of course be used to satisfy the
longer term requirements.
These time periods play a key part in deciding upon how to assign and
apportion liquid assets. Liquidity Requirements have been established primarily
to provide for normal or seasonal changes in deposits and loan demand plus a
margin of safety for cyclical variations or unforeseeable events. Liquidity
Instruments which mature within 1 year are considered the first line of protection, and the only holdings sufficiently fluid to meet correspondingly short-term
liquidity needs. But defense in depth is also advisable to allow for maneuverability in less predictable circumstances. Liquid assets with maturities of
APPENDIX A
TABLE 1
LIQUIDITY POSITION
REQUIREMENTS
Deposit Liquidity
Demand deposits
•Volatile
Vulnerable
Large
(-) Volatile
Residual
Total
(-) Large
Amount
($ thousand)
i.
Under
1 Year
1,150
88
1,012
1,233
1,150
9,520
1.233
Time deposits
•Volatile
Large
NegotiableC/D 's
•Special
Residual
Total
11,125
(-) Above
940
20
8,287
10
440
270
96
422
40
22
96
29
10,185
5
54
509
1,503
1,338
100
100
300
20
100
10
10
350
10
-0-
1,853
81
1,338
HOLDINGS
Liquidity Instruments Held
Excess reserves and correspondent
bank balances
Acceptances, brokers loans, commercial
XGLL
paper, and loan participations
High-grade securities
Under 1 year
1-2 years
2-5 years
Firm commitments from others to
purchase assets
NET LIQUIDITY
Aggregate Holdings
40
278
400
1,175
117
1,378
100
1,378
1,853
1,853
-0IQQ
Adjust percentage in accordance with legal reserve requirement
Ik
40
300
Aggregate Requirement
•
829
200
Portfolio Requirements
Net holdings
Aggregate Requirement
$ Excess ( + ) or Deficit (-)
Liquidity Index
2-5 Years
17
20
20
Deposit Requirements
Portfolio Liquidity
Seasonal loan demand
Unexpected demand
Projected (special
loan increase)
1-2 Years
117
81
36
1,378
1,338
144
103
40
A-3
1-2 and 2-5 years are more realistically termed Shiftable Reserves.
Segregating
these from Liquidity Holdings emphasizes the essential difference, even though
borderline distinctions are often difficult to apply.*
LIQUIDITY REQTJIREME3CTS
Demands for funds on a bank may be made by its depositors or by its
customers seeking credit.
Deposits
Bankers know from experience that the major portion of liquidity need
is related directly to the volume and stability of their Demand and Time deposits.
Obviously, not all deposits are equally active and do not require the same degree
of liquidity.
The actual requirement is related to the likelihood that any
specific deposit or group of deposits will be withdrawn.
Forecasts cannot be
made with certainty, but it is feasible to rank potential demands for funds by
degrees of intensity:
those that will surely occur; those that are likely, but
not certain to occur; and finally, those that are less likely but, under certain
circumstances, could possibly occur. These groupings are more precisely shown on
the Liquidity Position form as Volatile, Vulnerable, and Residual deposits. Time
deposits are considered separately because of their somewhat greater stability
under normal circumstances.
Volatile Deposits; The greater the likelihood of withdrawal, the
larger the percentage of liquidity required and the shorter the maturities of
*
Depending upon market conditions, shiftable reserves may sometimes prove
highly liquid. However, these cannot always be relied upon to meet shortterm liquidity needs. They are instead relied upon to meet the longer term
demands anticipated on the Form. These reserves can, however, serve as
reinforcements for converting during emergencies when there are liquidity
deficits and no alternatives available. But they do not fully pass the major
test of "liquiditytf—the ability to convert to cash with no risk of sizable
loss whenever sold. Of course, the passage of time, as well as shifts in
response to changing money market conditions, may see securities of over1 year maturity flowing into the under-1 year liquidity classification with
appropriate changes in entries on the Form.
A-4
the liquid assets that should be held. Deposits with the greatest likelihood
of being withdrawn are termed "Volatile" and should be covered f u U y by liquid
assets with the shortest maturities, ranging from cash to high-grade securities,
and other instruments maturing within 1 year. Prescribing 88$ as the liquidity
need directly reflects the current member bank legal reserve requirements set
at 12$ for demand deposits at country member banks,* This amounts to saying
that the total of the two types of reserves covers the volatile withdrawals
in full. The dollar entry of volatile demand deposits ($1,150 thousand on the
Table) is not the product of guesswork but reflects the bank's accumulated
experience. Typical of volatile deposits are the "local payroll accounts which
are built up weekly or biweekly and immediately checked against; the municipal
deposits of tax monies which are known to be drawn down over a period of time
to meet municipal expenses; and seasonal deposit fluctuations that are also of
the same character.
The extent of such short-term deposit swings can be most simply shown
by a chart of month-end deposit totals. Chart A shows the bank's recent experience in clear visual form. Chart B similarly depicts the volatility of time
deposits. The trend line connecting the low points determines the "base" line.**
At any particular point on the chart the amount of deposits above the "base" line
are considered volatile and required to be covered in full by liquid assets plus
the automatic release of required reserves.
*
**
For banks in reserve cities the comparable percentage would be 83.5$.
In charting deposits, or the loan figures mentioned later, there will sometimes be unusually sharp increases or decreases. These may not represent
a change in trend but rather a change in level. For example, if a new large
deposit account is obtained—or if one is lost—it will raise or lower the
level of total deposits without affecting the trend. The base lines may
therefore have to be adjusted upward or downward without changing their
directions. This further underscores the continuing need for management
to exercise judgment in the individual situations confronting its bank*
APPENDIX A
CHART A
DEMAND DEPOSITS
Millions of dollars
Millions of dollars
J
A
S
O
N
D
J
F
M
A
M
J
J
A
S
O
N
D
F
M
A
M
J
J
A
S
O
APPENDIX A
CHART B
TIME DEPOSITS
11.2
Millions of dollars
11.2
11.0
11.0
10.8
10.8
10.6
10.6
Millions of dollars
S
10.4
y
10.4
10.2
10.2
/
10.0
fi
9.8
9.6
9.4
y
\v/y
10.0
9.8
9.6
94
INTEREST RATE INCREASED
FROM 3 % TO 3 5 % 1 / 1 / 6 2
9.2
9.2
9.0
9.0
8.8
88
8.6
86
/
84
^
84
8.2
8.2
8.0
8.0
7.8
1
S
1960
!
1
O
N
D
I
!
!
1
M A M
1
1 1
A
1961
S
!
O
N
D
J
\
!
'
F M A M
1962
j
1
J
A
1
S
7.8
O
A-5
By the same token, the aggregate amount below the line indicates the
nonvolatile deposits. This status does not, however, exempt them from the need
for some liquidity. Should unusual withdrawals carry deposits below the base
line, the need for a second, or even a third, line of liquidity defense will
come into play. These liquid assets, however, may be comprised of securities
in somewhat longer term maturities if interest considerations justify it from
an investment viewpoint. As shown on the Table, these longer term assets are
assigned against the Vulnerable and Residual deposits.
Vulnerable deposits are those whose sudden or unexpected withdrawal
would place heavy pressure on the bank's liquidity position. They are likely
to be the bank's larger deposit accounts.* These accounts, in any event, should
be identified and more closely followed by the officer responsible for the
liquidity position. Experience will generally show that most of the volatility
of demand deposits will be in these large, and therefore vulnerable accounts.
(A time deposit, of course, can be large and vulnerable even though it does not
fluctuate at all.)
Volatile deposits, having already been determined and provided for,
are therefore deducted from the total of large demand deposits to determine the
"vulnerable" deposits in the Table and a 20$ requirement of 1-2 year maturities
set up for them.
The choice of intermediate rather than shortest term maturities
would seem to provide reasonable protection against possible but unanticipated
withdrawals of substantial magnitude.
Residual deposits are those remaining deposits which are neither
volatile nor vulnerable. They represent what is often referred to as the "hard
core" of stable deposits which can be fully invested in earning assets. A more
*
For purposes of uniform practice "large deposits" have been defined as those
exceeding, in round figures, 1/2 per cent of total deposits.
A-6
conservative view, however, calls for a precautionary margin of liquidity even
for such stable deposits. A 10$ requirement in liquid assets with maturities
ranging out to 5 years, when market conditions justify,* is suggested.
ultra-*conservative this requirement may seem low.
To the
But it should be remembered
that this requirement, as well as that against vulnerable deposits, is supplemented to the extent of 12$ of the demand deposit loss (4$ for time deposits)
by the release of required reserves.
Time Deposits
Although under normal circumstances there may be less immediacy with
respect to liquidity needs for time deposits, banking practice and experience
has shown that time deposits share several characteristics normally attributed
to demand deposits. For this reason much that has been said above about demand
applies to time deposits as well. For example time deposits, too, often exhibit
seasonal fluctuations:
Christmas Club accounts are almost entirely seasonal and
such seasonality, readily discernible from Chart B, represents a volatile portion
of time deposits requiring full liquidity reserves.
This protection is afforded
by a 96$ reserve of liquid assets in conjunction with the 4$ release of required
reserves brought about by a time deposit decline.
Large savings deposits, as noted above, can be vulnerable without
being volatile. Against such deposits, together with large time deposits held
indefinitely (such as State time deposits in many localities), a 20$ liquidity
reserve in medium-term liquidity assets is recommended.
Negotiable Time Certificates of Deposit are also considered vulnerable
and a liquidity requirement of 20$ is prescribed.
These certificates are usually
short-term and, therefore, the liquidity reserve generally should be in short-term
liquidity assets.
*
Investment specialists counsel lengthening maturities when interest rates are
relatively high and shortening maturities when interest rates are low.
A-7
Special Time Deposits refers to some large time deposits that management
may know will be withdrawn at maturity or even after a relatively short period of
time.
An example of such deposits would be the proceeds of a school bond issue
scheduled for disbursement as the school construction progresses.
Such accounts
are considered "special deposits" and require specific liquidity provision in
the light of their prospective withdrawal.
Residual liquidity reserves of 5$ for remaining time deposits are prescribed for the same reasons set forth earlier in connection with demand deposits.
Maturities may be of somewhat longer term and, in times of high interest rates,
might be concentrated toward the longer end of the 2-5 year range.
Portfolio Liquidity
Portfolio liquidity, as the term is used here, consists of liquid funds
for the purpose of making additional loans or investments. These holdings safeguard the bank against the need of having to borrow unduly or sell securities at
a loss in order to meet the foreseeable credit needs of its customer. Three
categories of loan demand are identified:
Seasonal, Unexpected, and Projected.
Seasonal loan demand is one of the surer fluctuations bankers can
anticipate.
Chart C shows month-end loan figures similar in principle to Chart A.
The trend line, this time connecting high (instead of low) points, is the loan
"ceiling"—the amount to which loans may be expected to rise seasonally or periodically based on recent experience. The amounts by which loans at any time drop
below this ceiling measure the*.bank's liquidity needs to meet normal or seasonal
loan variations.
These needs should be provided for in full.
Unexpected and unusual loan demand, by definition, cannot be foreseen.
A minimum provision would seem to be an additional fund of liquid assets equal to
at least 20$ of capital and surplus (twice the 10$ legal loan limit on unsecured
borrowings).
The bank is then reasonably prepared to accommodate somfe loan re-
quests from good customers who may not have borrowed in recent years and whose
need for credit is not reflected in the chart.
APPENDIX A
CHARTC
LOANS
Millions of dollars
11.8
Millions of dollars
11.8
INCREASE THROUGH EXPANSION
OF INSTALMENT LOANS
S
O
N
D
J
F
M
A
M
J
J
A
S
O
N
J
F
M
A
M
1962
J
J
S
O
A-8
Projected Loan Increase superimposes on the preceding categories any
definite loan expansion plans that management may have in mind and provides for
any expected net increase in the Community's demand for credit in the foreseeable
future, at least to the extent that such demand may exceed accompanying deposit
increases. Additional liquidity provision would be made and closely related to
the size of, and time when the demands are expected.
No specific requirement
can be allocated other than by management with its detailed knowledge of the
local community and its needs.
In addition to the foregoing, there may exist a need for further modification of this formula approach. Management may know of some change in policy
to become effective in the near future which would affect the bank's liquidity
requirements.
For instance, a change in the rate of interest paid on savings
accounts or time accounts might be expected to change the deposit level materially.
If such a situation exists, an adjustment of the liquidity requirements should be
made.
LIQUIDITY INSTRUMENTS HELD
Adequate liquidity means the bank's ability to meet the immediate and
potential demands for funds as outlined above.
Liquid assets are generally
thought to consist of cash or bank balances (primary reserves), and investments
in short-term assets readily marketable with minimal risk of loss (secondary
reserves).
Such liquid assets are subdivided on the Liquidity Position Form
into maturity categories having varying degrees of ready convertibility into
money.
Excess Reserves and Correspondent Balances
A bank requires some working balances at all times to carry on its
daily business.
For this reason, a portion of bank balances, over and above
A-9
the required legal reserves, is not truly liquid; and, for purposes of this
analysis, the Liquidity Holdings should include only that part of primary
reserves which is freely available. Only excess reserves, therefore, and
correspondent balances exceeding essential working balances are countable as
Liquidity Instruments Held.
Other Liquidity Instruments-Secondary Reserves
The remaining stocks of liquid assets include money-market loans such
as brokers1 loans and commercial paper, and investment-grade securities maturing
within one year.*
The distribution of longer term high-grade securities enumerated on
the Form is directly related to the nature of the individual bank's deposits
and its potential loan demands spelled out in some detail earlier,
(it is worth
repeating at this point that the legal reserves freed by withdrawals of demand
and time deposits are among the liquidity sources. Although not enumerated as
a liquidity instrument they have been implicitly recognized in the setting of
and 96$ in liquid reserves against volatile demand and time deposits.)
MET LIQUIDITY
The aggregated figures on either side of the Liquidity scale provide
useful information. However, better perspective for bank appraisal is obtained
by netting the two categories and showing the bank's excess or deficit liquidity
balance in each category.
The illustration given on the Liquidity Position Table
shows, for example, that the bank is in balance regarding its shortest term
liquidity requirements and holdings and is in a surplus position relative to its
longer term needs.
*
There are instances, however, where short-term securities are pledged to
secure specific deposits and certain banking functions. In such cases,
pledged short-term securities should not be considered available for meeting
liquidity requirements—unless available "nonliquid" securities holdings may
be substituted in their place.
A-10
In the process of comparing requirements with holdings, banks1
responses to cyclical changes should come to light in the aggregated statistics
over a period of time.* It is well, however, to emphasize here that the Bank
Examinations Department regards its immediate function more narrowly, and gives
primary attention to the condition of individual banks on a case-by-case basis.
Liquidity Index
Because of wide differences in banks1 size, it would be helpful to
convert the individual net dollar liquidity positions to a Liquidity Index that
would lend itself to drawing inter-bank comparisons on a comparable base. This
is illustrated on the last line of the Form, Table 1.
Such indicators lend them-
selves to a study of relationships between banks1 Liquidity Indexes grouped by
bank size, unit or branch structure, geographic location; and, going further, with
other statistics of local or nation-wide economic and business data.
Comments up to now have been mainly restricted to banks' short-term
liquidity positions. The longer term securities, however, account for an important share of holdings and the bank's ability to meet its projected longer term
deposit and loan responsibilities.
Although a distinction has been drawn between
short-term and longer range liquidity needs, it may prove useful to combine the
short and longer term categories into a composite index that gives recognition
to the total liquidity distribution over time.
The Form, Table 2, illustrates the method followed in computing the
Consolidated Index of Liquidity.
The Bank Examinations Department has assigned
weights to the dollar amounts of Liquidity Requirements and Net Liquidity
Holdings. The weights are tailored to the relative importance of short, medium,
*
A distinction must be drawn, however, between the banking system and the
single bank. While liquidity of the entire system is the concern of the
monetary authorities, the liquidity position of the individual bank is local
management's responsibility and may either directly reflect or run counter
to general trends.
A-ll
and longer term liquidity needs. The dollar amounts, rather than the Liquidity
Indexes shown in the Form, Table 1, are used in arriving at the Consolidated
Index, in order to avoid any distortion.
TABLE 2
CONSOLIDATED INDEX
Under 1 year (Weight 2x)
1-2 years
( "
lx)
2-5 years
( " -5x)
Consolidated Index:
Liquidity
Requirements
Net
Holdings
3/706
8l
669
3,706
117
689
4,456
4,512
101
Conclusion
The major purpose of the Position Form is to lend practical assistance
in measuring liquidity rather than to establish a "grading" system. Nor is there
any intention of imposing a formal liquidity ratio upon banks to which they must
measure up in a way comparable, say, to legal reserve requirements. It should
also seem clear that ways toward improvement in banks1 practice and the methods
of accounting therefor
are, as yet, far from closed.
The most likely way toward improvement in both directions lies in
objective appraisal by the bank examiner followed by frank discussion with management.
But the examiner's "still-photograph" taken at the time he is on the
premises will require continuing follow-ups by the banker since liquidity needs
will obviously vary as funds flow into and out of the bank. For this reason no
formula can be so perfect as to displace completely the continuing need for
management's "educated" judgment in the local and special circumstances confronting his bank. It jl£ important, however, to reinforce judgment with some
formal guides. Wider use of the method described here should contribute toward
that end.
APPENDS B
Example of an Examiner's Comments
Concerning the
Excessive Liquidity Position
of a
Non-Money Market Bank
The bank, which has not borrowed for several years,
maintains what appears to be an excessive amount of liquid assets
at all times.
This excessively liquid position is not the result
of board policy, but stems rather from an apparent total absence
of effort on the part of management to employ profitably all
available funds.
During the year 1965, the reserve account balance
was in excess of required by a daily average of approximately
$125,000.
Because of the pressing demands of daily activities,
management admittedly maintains "a safe cushion" In the reserve
account so that it will not be forced to make a daily calculation
of the requirement.
The regular offers of a correspondent bank
to purchase excess Federal funds are always refused because the
reserve position is unknown*
In addition, the bank sold to a
correspondent bank mortgage participations aggregating about
$300,000 on June 1, 1965.
As of examination date, about $100,000
of the proceeds of this transaction had not been reinvested and
remained with the correspondent bank.
The elimination of these
excess balances would leave the bank still in a highly liquid
position, with about 20# of the investment account in Treasury bills
As standby liquidity protection, management has an open commitment
from the correspondent bank to purchase an unlimited amount of
this bank's mortgage portfolio.
The loss of potential earnings
inherent in a situation such as this was discussed with management.
APFEKDIX C
Example of an Examiner's Comments
Concerning the
Marginal Liquidity Position
of a
Non-Money Market Bank
Our formula indicates that the bank's liquidity position
has improved between examinations, primarily due to a shortening
of maturities of high-grade securities•
Total liquidity holdings
under two years now aggregate only about $1*5,000 less than
requirements over the same period.
However, if in computing this
formula, a few large public demand deposits were considered as
volatile (as indeed they appear to be) rather than vulnerable,
liquidity requirements for "under 1 year11 would be increased by
as much as $150,000.
The basic liquidity problem appears to stem
from the bank's failure to properly invest short-term public deposits
Cyclical increases of public funds in the spring and fall of each
year usually runoff rapidly at precisely the same time that loan
demands and other deposit withdrawals reach their cyclical peaks*
Without the additional public money, the bank's liquidity
holdings during these periods are hardly sufficient to cover the
seasonal demands*
This bank has been forced to borrow from the Federal
Reserve Bank regularly over the past few years.
Since last
examination, there were eight borrowing periods which totaled U6
days.
Average borrowings were $66,000 per day, and the bank's
reserve balance was deficient during three reporting periods.
Almost all borrowing occurred during periods of heavy public
C-2
deposit withdrawals with inadequate short-terra asset protection,
except for Government securities which the bank was reluctant to
sell.
Holdings of Treasury bills will now be increased in an
attempt to alleviate this problem in the future.
Management was
receptive to the suggestion that future short-term borrowing
requirements might be better satisfied in the Federal funds market,
or from correspondents rather than at the discount window*
APPENDIX D
Example of an Examiner's Comments
Concerning the
Adequate Liquidity Position
of a
Money Market Bank
This "bank continues a policy of maintaining a fully
invested position and, in so doing, operates close to the minimum
of liquidity requirements.
For the most part, management has been
able to operate satisfactorily because it has various means of
supporting its heavily invested position.
These means include
the bankfs correspondent relationship with about 1,500 banks
throughout the U.S., and various corporate, institutional and
municipal entities, which look to this bank for the investment of
their excess funds.
An important service offered correspondent
banks is the management of their reserve positions, which results
in this bank's heavy activity as a purchaser of Federal funds.
The bank also occasionally borrows heavily at the discount window
of the Federal Reserve Bank.
As a result, the bank's money
position desk maintains a close daily watch over the flow of funds
placed at its disposal.
It builds up heavy reserve deficits at
some time during each reserve period which are subsequently offset
by borrowed funds.
As a consequence, the bank generally maintains
its daily reserve position with a minimum average excess of one
million dollars or less over its required reserves.
Current projections of the bank's liquidity requirements,
over the second quarter of 19^5> have set a loan growth of about
$300 million.
The funds to support these projections are expected
D-2
to be generated primarily by increasing negotiable c/D!s by a
like amount.
It would appear, however, that if the bank for
some reason were unable to hold and/or attract additional c/D
growth, heavy pressures on the bank's money position may develop
such as have existed at times in prior years.
If such a situation
should arise, it may be necessary for the bank to liquidate a
portion of its municipal bond holdings and place additional
reliance upon borrowings to support its heavily invested position.
APEBMDIK E
Example of an Examiner's Comments
Concerning the
Tight Liquidity Position
of a
Money Market Bank
Comparing daily averages for
1961J.
with those of September
1966, deposits increased $1U6 million, borrowings increased $278
million, and securities decreased $29 million, for a total of
$^53 million which is the amount of loan increase during the same
period.
Therefore, an obvious conclusion would be that the major
portion of the loan expansion has been supported by borrowings,
mostly Federal runds.
Management has always contended that
borrowed funds were used primarily to support loans to non-money
market borrowers,
^or this reason alone, the bank's borrowing
activities can only be described as excessive, particularly since
a review of the bank's liquidity position shows that there has
been no reduction in lending activities and an appreciable decrease
in liquid assets to cover short-term needs.
Time C/D's totaled $1*52 million ($^02 million negotiable),
a decrease of about $150 million since last examination.
The
heavy runoff is attributed primarily to a tight money position of
corporate depositors and the more attractive yields in other
short-term investment instruments.
The bank's ability to borrow
Federal funds at more attractive rates has apparently detracted
from the desirability of generating additional c/D's or even
maintaining outstandings at the 1965 examination level.
It is
difficult to obtain any reliable estimate of how long the negotiable
E-2
C/D's will be carried and apparently no provisions have been made
for meeting a further runoff of these volatile-type deposits.
Average loans outstanding show a continual increase
since 1964 with the major increases occurring in term loans and
mortgages•
While management estimates term loan and mortgage
repayments of $212 million and $330 million, respectively, over
the next two years, unused commitments in both of these loan
categories aggregate about $433 million.
All of these commitments
will not be drawn down, but it is quite probable that the total
draw downs will exceed repayments in the next year.
Every effort
is reportedly being made by management to curtail the loan
expansion, with all new loan applications carefully screened to
determine how they can turn down requests without impairing
customer relationships.
Loans reached their highest level during
the past year.
Investment securities have been maintained at about
$6C0 million with $233 million in U.S. securities and the balance
primarily in tax exempts.
While the maturity distribution is
considerably less long-term than in other banks, liquidation of
securities to meet liquidity needs would result in sizable losses.
In connection with the above, attention is directed to
the fact that, while this bank was an infrequent borrower at
the discount window, the examiner was very much concerned over
the large volume of borrowings from other sources.
APPENDIX F
FORM FOR ANALYZING BANK CAPITAL
FR363
April 1956
(See Notes on Reverse Side)
BANK:
LOCATION:
DISTRICT NO.
BASED ON REPORT OF EXAMINATION AS OF
(Dollar Amounts tn Thousands)
AMOUNT OUTSTANDING
(1)
CAPITAL REQUIREMENT
Percent
PRIMARY AND SECONDARY RESERVE
47% of Demand Deposits i.p.c.
0%
Cash Assets
LIQUIDITY CALCULATION
%
36% of Time Deposits i.p.c.
100% of Deposits of Banks
Guar. Portion of CCC or V-loans
100% of Other Deposits
C o m Paper, Bnk Accept. &Brks* Lns
0.5%
U.S.GovtSecs:
*
100% of Borrowings
Allow, for spec, factors, if info,
Bills
available ( + o r - )
Certificates, etc. (to 1 yr.)
A. Total Provision for Liquidity
Other 0 * 5 yrs.) (Incl. Trees
Inv. Series A & B )
Other Sees. Inv. Rtngs 1 & 2 or
4.0%
B. Liquidity available from Prim, and
Secondary Res. ('ami outstanding" less
Equiv.(to3yrs.)
TOTALS
(2)
cap. required thereon)
MINIMUM RISK ASSETS
C. Liquidity to be provided from assets in
U^.Govt. Sees. (5-10 yrs.)
Groups 2 , 3 or 4 (zero if B equals or ex-
Ins. Portion FHA Rep. & Modr'n Loans
ceeds A, otherwise A less B)
Loans on Passb'ks, U.S. Sees, or CSV
Life ins.
D.
Short-term Municipal Loans
TOTALS
(3)
4%
in line 2)
E.
Liquidity to be provided from assets
in Groups 3 or 4 (zero if D equals or
exceeds C, otherwise C less D)
F.
Liquidity available from Intermediate
Assets (85% of "amt outstanding* in
line 3)
INTERMEDIATE ASSETS
U ^ . G o v t Sees. (Over 10 yrs.)
FHA and VA Loans
6%
TOTAL $
(4)
Liquidity available from Min. Risk
Assets (90% of "amt outstanding'
PORTFOLIO ASSETS (Gross of Res.)
Investments (not listed elsewhere)
u.
Loans (not listed elsewhere)
Liquidity to be provided from Portfolio
Assets (zero if F equals or exceeds E,
TOTALS
otherwise E less F)
* Plus 15% of 1st $100,000 of portfolio, 10% of noxt $100,000
and 5% of noxt $300,000.
(5)
FIXED, CLASSIFIED & OTHER ASSETS
Bk Prenu, Furn. & F i x t , Other Real Est.
Stocks & Defaulted Sees.
100%
50%
20%
0%
Assets Classified as "Doubtful*
Accruals, Fed. Res. Bk. Stock, Prep. Experu
_
TOTAL ASSETS $
Extra Capital Required on Any Assets in Groups 2 4
6.5% of line C
4.0% of line E
(6) ALLOWANCE FOR TRUST DEPT. (Amt equal to 300% of annual gross earnings of Department)
9.5% of line G
(7) EXTRA CAP. REQD. IF ANY ASSETS IN GROUPS 2 4 USED FOR LIQUIDITY (zero if line C in
Liquidity Calculation is zero, otherwise Total in line H)
H. Total Extra Cap. Req.
(8) ALLOW. FOR SPEC. OR ADDIT. FACTORS, IF INFO. AVAILABLE ( . or - )
(see notes on reverse side)
(9) TOTAL CAPITAL REQUIREMENT (1 thru 8)
(10)
ACTUAL CAP., ETC. (Sum of Cap. Stock, Surplus, Undiv. Profits, Res.forConting., Loan Valuation Res., Net unapplied Sec Valuation Res., Unallocated Charfe-offe,
and any comparable items) (Exclude Depreciation and Amortization Reserves)
I MORE than requirement (10 minus 9)
(11) AMOUNT BY WHICH ACTUAL IS: \
or
[ LESS thtn requirement (9 minus 10) ......
(12) RATIO OF ACTUAL CAPITAL, ETC. TO REQUIREMENT (10 divided by 9)
J-L
-$
NOTES REGARDING FORM FOR ANALYZING BANK CAPITAL
A thorough appraisal of the capital needs of a particular bank must take due occount of all relevant factors affecting the bank. These include
the characteristics of its assets, its liabilities, its trust or other corporate responsibilities, and its management-os well as the history and
prospects of the bank, its customers and its community. The complexity of the problem requires a considerable exercise of judgment. The group*
ings and percentages suggested in the Form For Analyzing Bank Capital can necessarily be no more than aids to the exercise of judgment.
The requirements indicated by the various items on the form are essentially "norms" and can provide no more than an initial presumption as to
the actual capital required by a particular bank. These "norms" are entitled to considerable weight, but various upward or downward adjustments
in requirements may be appropriate for a particular bank if special or unusual circumstances are in fact present in the specific situation. Such
adjustments could be made individually as the requirements are entered for each group of assets, but it usually is preferable, particularly for
future reference, to combine them and enter them as a single adjustment under Item 8, indicating on the Analysis Form or an attached page the
specific basis for each adjustment.
The requirements suggested in the Analysis Form assume that the bank has adequate safeguards and insurance coverage against fire, defalcation,
burglary, etc. Lack of such safeguards or coverage would place upon the bank's copital risks which it should not be called upon to bear.
ITEM (4) - PORTFOLIO ASSETS
Concentration or Diversification. - The extra requirement of 15% of the first $100,000 of portfolio, 10% of the next $100,000, and 5% of the next
$300,000, as specified in item 4, is a rough approximation of the concentration of risk (lack of diversification) which is likely in a smaller portfolio, and which is usually reflected in the somewhat larger proportion of capital shown by most banks with smaller portfolios. This requirement
is applied to all banks, but is naturally a larger portion of the total capital requirements of banks with smaller portfolios. However, a particular portfolio, whatever its size, may in fact have either more or less concentration of risk than other portfolios of similar size. If there is in
fact substantially greater or lesser concentration of risk in the portfolio assets of the particular bank-as for example dependence upon a smaller
or larger number of economic activities—it would be appropriate to increase or decrease requirements correspondingly.
Drafts Accepted By Bank. - When drafts have been accepted by the bank, ordinarily the customers' liability to the bank should be treated as
Portfolio Assets if the acceptances are outstanding, or the acceptances themselves should be so treated if held by the bank.
ITEM (5) - FIXED, CLASSIFIED, AND OTHER ASSETS
Rental Properties. - Bank premises, furniture and fixtures, and other real estate ore assigned a 100% requirement as a first approximation,
since these-assets usually are not available to pay depositors unless the bank goes into liquidation, and even then they usually can be turned
into cash only at substantial sacrifice. However, some properties which bring in independent income, such os bank premises largely rented to
others, may be more readily convertible intoxash by selling or borrowing on them, and in such situations it may be appropriate to reduce the
100% requirement by an amount equal to an assumed "sacrifice" value, such as, say, two or three times the gross annual independent income.
Stocks. - In the case of stocks, their wide fluctuations in price suggest a 100% requirement as a first approximation. However, in some cases
it may be appropriate to reduce the 100% requirement against a stock by an amount equal to an assumed "sacrifice" value, such as the lowest
market value reached by the stock in, say, the preceding 36 or 48 months.
Hidden Assets. - In some cases assets may be carried at book values which appear to be below their actual value, and may thus appear to
provide hidden strength. However, any allowance for such a situation should be made with great caution, and only after taking full account of
possible declines in values and the great difficulty of liquidating assets in distress circumstances.
ITEM (6) - ALLOWANCE FOR TRUST DEPARTMENT
Deposited Securities. - The requirement for the trust department should in no event be less than the amount of any securities deposited with
the State authorities for the protection of private or court trusts, since such securities are not available in ordinary circumstances to protect
the bank's depositors.
LIQUIDITY CALCULATION
Percentages of Deposits. - The provision for 47% liquidity for demand deposits of individuals, partnerships and corporations actually represents 33-1/3% possible shrinkage in deposits, plus 20% of the remaining 66-2/3%. 36% of time deposits i.p.c. represents 20%-shrinkage, plus
20% of the remaining 80%. In both instances, the provision for 20% liquidity for remaining deposits is to help the bank continue as a going
concern even after suffering substantial deposit shrinkage.
Among possible special factors to be considered in connection with the liquidity calculation would be concentration or diversification 'of
risk among deposits. This might be due to such things as dependence upon a smaller or larger number of economic activities, or preponderance of large or small deposits—large deposits usually being more volatile.
Liquidity Avoliable from Assets. — Liquidity available from primary and secondary reserves is assumed-to equal the amount of those assets
less only the regular capital required thereon, since the regular copital specified for these assets assumes forced liquidation. However, the
regular capital specified for other assets (i.e., those in Groups 2-4) is only a portion (approximately 40%) of that required for forced liquidation.
Therefore, in determining the liquidity available from such other assets, the omount of such other assets must be reduced by more than the regular specified capital.
Extra Copital Required. - This extra capital is to cover possible losses in forced liquidation of assets other than primary and secondary
reserves in case they had to be used to provide liquidity. The 4% indicated for Line E amounts to an automatic addition to the 6.5% that has
already been applied to Line C, and results in a total extra requirement of 10.5% of the liquidity to be provided from Intermediate Assets.
Similarly, the total extra requirement on the liquidity to be provided from Portfolio Assets is 20%. If trie same amounts of extra capital were
stated as percentages of the assets to be liquidated rather than of the liquidity to be provided, the percentages would be smaller, namely,
6% of Minimum Risk Assets, 9% of Intermediate Assets, and 15% of Portfolio Assets.
APPENDIX G
STATE OF NEW YORK
BANKING DEPARTMENT
IOO
CHURCH
STREET
NEW YORK 7, N.
Y.
G.RUSSELL CLARK
SUPERINTENDENT OF BANKS
Supervisory Circular Letter CB-14.
May 6, 1959
To the Institution Addressed:
PRIMARY LIQUIDITY
This Department has been studying a new approach to the
problem of primary liquidity of the state banks and trust companies
and similar types of institutions under its supervision. The basic
premise is that each bank should maintain an adequate amount of cash
and other assets which can be quickly converted into cash with a
minimum risk of loss to meet any foreseeable or potential deposit
decline or other cash needs without resort to borrowing except for
temporary purposes such as adjustment of reserve balances* Provision
should be made for the fluctuation of deposits, with appropriate consideration to concentrations in large balances and those of a temporary
nature*
To assist the Department in preparing statistics on this
subie~t, each institution is requested to analyze its deposits as of
the list business day of each month. If, however, your experience
shows that total deposits are usually at the lowest point during some
other part of the month, we recommend that a focal date within that
period be selected instead of the last business day,
A deposit segregation should be made each month, as at the
last business day or the focal date, as follows:
1. Date
2* Deposits of U.S. Government, states, and political
subdivisions (including time)
3. Deposits of other domestic and foreign banks
(including time)
U. Other demand deposits
5. Savings deposits
6* Other time deposits
7. Total deposits
G-2
May 6, 1959
The figures may be adjusted to the nearest thousand dollars. A record
should be retained by the bank covering at least the period between
examinations by this Department, and is to be made available to the
examiner. The executive officers will probably find it helpful to retain this record for a more extended period to enable them to study
seasonal trends and other pertinent factors affecting the liquidity
position.
If each institution will compute the aggregate difference
between the current total in each type of deposit with the lowest
monthly figure for the preceding twelve months, it should have a fair
estimate of the minimum amount of "primary reserves11 which it should
have available to meet its ordinary requirements. It is unlikely that
the "low" point in each of the deposit segregations will occur in the
same month of a yearly period, but any over-estimate due to such circumstances will provide a margin to cover unexpected developments. If,
however, the deposit level is lower than in the preceding year, further
study should be made of the causes, and a projection made of potential
future trends and liquidity requirements with special consideration to
deposits of a temporary nature, and to heavy concentrations of deposits
in a small number of accounts*
In addition to lieing prepared to meet potential deposit
losses, the institution should also make adequate provision to cover
its outstanding loan commitments, the ordinary seasonal credit requirements of its customers, projected new loan demands, and other factors
which may deplete its liquid assets.
The term "primary reserves" as used in the preceding paragraph
will consist of the following assets:
1. Cash, demand cash items, and balances due on demand
ffrom banks in excess of the reserves required to be
maintained against deposits,
2. Readily marketable securities maturing within two
years (at market values),
3. Loans to brokers and dealers in securities,
Um Bankers acceptances and prime commercial paper which
are readily marketable through brokers and dealers
in such paper, and
5. Federal funds sold.
0-3
May 6, 1959
Since reserves against deposits required by the Banking Law or
Federal Reserve regulations may not be drawn down without penalty for
deficiencies, only the excess reserves maintained, demand balances due
from nonreeerve depositaries, and demand cash items are allowed in this
formula. Securities maturing within two years are allowed at market
value. They can usually be disposed of with relatively moderate, if 11
any, loss. The other assets which are classified as "primary reserves
can also, as a rule, be quickly disposed of with minimum loss. While
some institutions may h#ld other assets of similar marketability and
quality to meet the qualifications of "primary reserves", for the sake
of uniformity only those listed above will be used for this purpose.
The Department intends to use the primary reserve formula as
a supervisory guide to supplement the quick asset ratio shown on
Schedule 2A of the examination report. Although the latter is useful
in revealing the proportion of assets intrinsically liquid in character,
the former will indicate to what extent immediate conversion to cash is
possible without interfering with the normal activities of the
institution.
Your cooperation is requested in facilitating the work of our
examiners in compiling these data.
Very truly yours,
E.H. Leete
Deputy Superintendent
of Banks
APPENDIX H
REGIONAL NEWSLETTER, Second National Bank Region, July, 1966
HOW'S YOUR LIQUIDITY ?
The present "tight-money11 market in which our banks are operating has led to increasing loan-to-deposit ratios and narrowing liquidity positions. While most bankers
are conversant with the rule-of-thumb standards relating to deposit ratios, we find that
many National bankers are unfamiliar with the method of computation and standards utilized by this Office in analyzing their liquidity position.
Since this is a topic of mutual interest, a copy of our form is shown below. Based
on our experience with the formula over the past two years, this Office makes a detailed
analysis of the asset structure when Net Liquid Assets to Net Deposits is 30 percent or
less.
It will be noted that the formula eliminates the market value of pledged bonds but
does include municipal and corporate securities as a source of liquidity.
We would appreciate receiving the views and comments of bankers with respect to the
merit of the guidelines.
LIQUIDITY ANALYSIS FORM
Cash and Due From Banks
Market Value - Unpledged Bonds
Market Value of Excess Pledged Bonds
Federal Funds Sold
Subtotal
Less: Borrowings
Federal Funds Purchased
_ _ _
Required Reserves
Net Liquid Assets
_______
Total Deposits
00
_______
Less Secured Deposits
,
Net Deposits
(B)
X of Net Liquid Assets
to Net Deposits (A JL- B)
-3-
APPENDIX I
PAGE 1
APPLICATION OF FORMJLAS
Sample Bank
Balance Sheet
(in thousands of dollars)
Cash & Due From
Banks
Reserves With FRB
And Cash Items in
Process
Investment Account*
U.S. Government
Municipals
Other Securities
Loans & Discounts
Less Val. Res.
291
241
532
967
766
26
1,759
3,947
63
Fixed Assets
Other Assets
3,884
63
14
6,252
Total Assets
*Maturity Distribution (Par Value)
Under 1 year
1 - 2 years
2 - 5 years
Over 5 years
1.772
Deposits
Demand
I.P.C.
U.S. Government
States & Municipals
Other
Time
I.P.C.
Cert, of Dept.
(non. neg.)
States & Municipals
Others
(Total Deposits)
Other Liabilities
Book Capital Funds
774
57
568
__59
1,458
3,892
19
237
52
Total Liabilities
Securities pledged to secure
deposits total $405 (Par Value)
4,200
(5,658)
53
541
6,252
APFEHKDC I
PAGE 2
Ratios
Loan to deposit ratio
68. e
Liquid assets to liability ratio
11.*
Cash & due from banks
Brokers & dealers loans
U.S. Government Securities
(Up to 2 yr. maturities)
291
0
350
Total deposits
Less: Cash items
Reserves at FRB
5,658
241
541
0
Less borrowings
5,417
New York State's Quick Asset Ratio
Cash, due from banks,
exchanges and demand items
Unpledged Securities
(Mkt. value)
Loans sec. by readily
marketable collateral
41.4$
532
1,756
286
Total Quick Assets
Less: Secured deposits
and borrowings
2,574
Net Quick Assets
2,217
Total Liabilities
Less: deposits and
borrowings secured
by pledge of assets
357
Net Liabilities
5,711
_35I
APPENDIX I
PAGE 3
New York Liquidity Formula
Sample Bank
Requirements
Deposit Liquidity
Demand deposits
Volatile
Vulnerable
Large
(-)Volatile
Residual
Total
(-)Large
Time deposits
Volatile
Large
Residual
Total
Less Vol. &
Vul.
Under
1 year
Amount
60
88
638
20
760
10
55
654
96
3,491
5
1-2 years
2-5 years
53
698
60
128
1,458
698
76
53
20
131
4,200
709
115
106
Deposit Requirements
259
251
Portfolio Liquidity
Seasonal loan demand
Unexpected demand
Projected loan increase
70
90
68
100
100
100
70
90
194
Portfolio Requirements
Aggregate Requirements
t
0
300
293
25J.
Under
1 year
1-2 years
2-5 years
Holdings
Liquidity Instruments Held
Excess reserves and correspondent balances
High-grade securities maturing in
Under 1 year
1 - 2 years
2 - 5 years
127
229
192
491
APPENDIX I
PAGE 4
-2-
Net Liquidity
Aggregate Holdings
Less borrowings
(a) Net Holdings
(b) Aggregate Requirements
$ excess (+) or deficit (-)
Liquidity Index ((a) * (b))
Under
1 year
1-2 years
2-5 years
356
192
491
0
300
+ 56
192
293
491
251
(-)ioi
+240
119
66
196
355
Consolidated Index
(c)
Weight
Under 1 year
1-2 years
2-5 years
Net
Holdings
1,019
1,150
2 x
1 x
•5 x
Consolidated Index
((e) «- (d))
NOTE:
Liquidity Requirements
113
For examiner's comments relating to this bank's liquidity position
and borrowings, see Exhibit D.
FORM FOR ANALYZING BANK CAPITAL
FR 363
April 1956
APFEEDIX I
PAGE 5
(See Notes on Reverse Side)
SAMPLE BANK
BANK:
LOCATION:
BASED ON REPORT OF EXAMINATION AS OF
DISTRICT NO.
(Dollar Amounts tn Thousands)
(1)
Amu*
Percent
PRIMARY AND SECONDARY RESERVE
Cash Assets
5 32
S
OX
47% of Demad Deposits i.p.c.
36^
J _
1 , U27
3 8 * of T i m Deposits i.p.c
100K of Deposits of Banks
Guar. Portion of CCC or V-loans
921
1 0 « of Other Deposits
Comm. Paper, Bnk Accept. & Biles' Lns
0.5%
U.S. Govt. Sees*
*
1
100% of Borrowings
Allow, for spec, factors, if info,
200
Bills
available ( f o r - )
2 , 712
A. Total Provision for Liquidity
Other 0 - 5 yrs.) (Incl.Treas
535
Inv. Series A & B )
Other Sees. Inv. R t n g s l & 2 or
177
Equiv. (to 3 yrs.)
TOTAL $
(2)
LIQUIDITY CALCULATION
CAPITAL REQUIREMENT
AMOUNT OUTSTANDING
1
28
4.0%
Liquidity available from Prim, and
Secondary Res. (*amt outstanding* less
29
MINIMUM RISK ASSETS
cap. required thereon)
C.
235
U.S. Govt. Sees. (5-10 yrs.)
B.
—
1,
U15
1,
297
Liquidity to be provided from assets in
Groups 2 . 3 or 4 (zero if B equals or exceeds A, otherwise A less B)
Ins. Portion FHA Rep. & Modr'n Loans
Loans on Passb'ks, U.S. Sees, or CSV
85
Life ins.
D.
Short-term Municipal Loans
320
TOTAL $
13
4%
INTERMEDIATE ASSETS
U.S. Govt Sees. (Over 10 vrs.)
nk
FHA and VA Loans
2/rk
TOTAL $
(4)
F.
6%
10
288
in line 2)
E.
(3)
Liquidity available from Mm. Risk
Assets (90% of "amt outstanding"
Liquidity to be provided from assets
in Groups 3 or 4 (zero if D equals or
exceeds C, otherwise C less D)
1 , 009
Liquidity available from Intermediate
Assets (85% of 'amt. outstanding* in
line 3)
1*8
PORTFOLIO ASSETS (Gross of Res.)
Investments (not listed elsewhere)
Loans (not listed elsewhere)
TOTAL $
612
3,353
3.965
G. Liquidity to be provided from Portfolio
Assets (zero if F equals or exceeds E,
10%*
861
otherwise E less F)
* Plu» 15% of 1st $100,000 of portfolio, 10% of noxt $100,000
anA 5% af naxt S300 000
(5)
FIXED, CLASSIFIED & OTHER ASSETS
6k
Bk Prem., Fum. & Fixt., Other Real Est.
Stocks & Defaulted Sees.
lOfiSC
6k
50%
29
*3
Extra Capital Required on Any Assets in Groups 2-4
Used for Liquidity
Assets Classified as "Loss"
59
Assets Classified as "Doubtful"
20%
Assets Classified as "Substandard"
TOTAL ASSETS $
Ik
6.252
(6)
ALLOWANCE FOR TRUST DEPT. (Amt equal to 300% of annual gross earnings of Department)
(7)
EXTRA CAP. REQD. IF ANY ASSETS IN GROUPS 2 4 USED FOR LIQUIDITY (zero if line C in
ALLOW. FOR SPEC. OR ADDIT. FACTORS, IF INFO. AVAILABLE ( , or - )
(9)
TOTAL CAPITAL REQUIREMENT ( 1 thru 8)
4.0t of M M E
ko
9.5* of line G
82
206
Liquidity Calculation is zero, otherwise Total in line H)
(8)
8 If
ML
206
(see notes on reverse side)
(10)
f
825
ACTUAL CAP., ETC. (Sum of Cap. Stock, Surplus, Undiv. Profits, Res. for Contuig., Loan Valuation Res., Net unapplied Sec Valuation Res., Unallocated Charge-offs,
and any comparable items) (Exclude Depreciation and Amortization Reserves)
1
M0RE than requirement (10 minus 9)
or
LESS thin requirement (9 minus 10)
(12) RATIO OF ACTUAL CAPITAL, ETC. TO REQUIREMENT (10 divided by 9)
-1221
73
PAGE 5
National Bank's Liquidity Formula
Sample Bank
Cash and Due From Banks
532
Market Value - Unpledged Bonds
)
)
)
Market Value of Excess Pledged Bonds
Federal Funds Sold
0
Sub total
Less:
1,396
1,928
Borrowings
0
Federal Funds Purchased
0
Required Reserves
319
319
Net Liquid Assets
1,609
Total Deposits
5,658
Less:
Secured Deposits
Net Deposits
360
5,298
# of Net Liquid Assets to
Net Deposits
(A 7 B)
(A)
30-3#
(B)
@FedFRASER