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Analyzing Your Current Liquidity Position

Although effective liquidity management requires looking ahead at expected future cash flows, it is also necessary to have an initial understanding of the bank’s current position.

Typically, when evaluating this current liquidity position we start by constructing ratios that communicate the inherent liquidity on the asset side of the balance sheet as well as the potential funding sources. A traditional asset liquidity measurement is the Loans to Deposits ratio. It is designed to depict the percentage of deposit funding that is "tied-up" in the loan portfolio which is not normally considered to be very liquid. The AFS Security to Total Asset ratio is a complimentary measure to the Loans to Deposits ratio. It communicates the percentage of assets that could be readily converted to cash in a liquidity crunch (pledging requirements and individual security market values within the portfolio would potentially affect the true "availability" of the portfolio).

On the liability side, the ratio of Total Deposits to Total Assets is another traditional liquidity measure that indicates the broad "reliable" base of funding for the bank. Although this ratio establishes how much of the bank’s assets are funded by deposits, rather than borrowed funds or equity, it falls short in helping to understand the nature of the deposits deemed to be reliable. In conjunction with this measure, the Purchased Funds to Earning Assets ratio assists in recognizing the nature of funding sources. By definition, Purchased Funds include large CDs, public CDs, foreign deposits, brokered CDs, fed funds purchased, repurchase agreements, and other short-term borrowings (e.g. S-T FHLB advances). Used together, these two measures could reveal that although a bank might be funding 90% of assets via deposits, if the Purchased Funds ratio is 45% it's a strong indicator that most of the bank’s deposits are, on the surface, not necessarily considered reliable. Certainly, these two measures can give a clearer indication of the bank’s potential future funding position by better identifying the nature of the funding sources already employed and depended on by the bank.

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