NAVIGATING BANKING LIQUIDITY- FACTORS, CHALLENGES, AND STRATEGIES IN CORPORATE LOAN PORTFOLIOS

Abstract

This study examines the relationship between banking liquidity and corporate loans influenced by internal and external factors through central bank policies, regulations, business cycles, technology changes, loan covenants, and contracts.

Changes in central bank policies- monetary policy changes, discount rates, and QE, make bank liquidity partially predictable. Their effects can manifest through changes in borrowing, drawdowns, or interest rates, thus affecting the bank’s liquidity.

Regulatory changes, though rare, apply to all banks and usually have an extended duration for implementation, giving the bank time to adjust liquidity accordingly.

In contrast, the rapid and unforeseeable nature of technological advancements necessitates prudent risk planning within banks to prevent potential destabilization, as evidenced by the examples of Knight Capital in 2012 and RBS in 2015.

The impact of these factors on bank liquidity is predictable to a certain extent. The factors are much harder to manage when combined, because of the evolving nature of banking. This is especially true when a bank’s portfolio consists primarily of corporate loans.

Corporate loans and facilities pose the greatest challenge due to loan contracts/covenants and a shallow secondary market for corporate loans. This results in locked-down liquidity, causing that stress to permeate to other parts of the bank, when combined with the drawdown of OBS facilities.  

Loan contracts restrict banks from adjusting interest rates or selling loans.

The bank would benefit from a combined system that can identify the degree of correlation between the five essential factors as a combined system instead of individual elements.