Home / Opinion / An easy way to understand why banks are nervous

An easy way to understand why banks are nervous

Intraday Liquidity is a term that would mystify some, but is one of the core issues of today as this is a liquidity crisis.

Liquidity
is the ability of a bank to meet its payment obligations by being able
to identify those assets that can be quickly converted to cash.

Intraday
Liquidity is therefore the money that the banks can identify throughout
the day (intraday) as they look at all the payments obligations that need to be
made between the various buyers and sellers of instruments and funds
that they are managing.

I finally had a light bulb switched on yesterday as I talked with a senior banker about the subject, as Intraday Liquidity is the core squeeze on the industry today.

To put this into context, most of the banks had more than enough liquidity to cover all the intraday payments and more until recently, so there was plenty of confidence in the system.

That trust and confidence disappeared as banks' ability to deploy liquidity dried up.  This is clearly evidenced by the fact that my banking friend and I were talking about payments, liquidity and confidence, and he drew this chart (double-click to see in large format, which is what you need):

Liquidity

What this shows is the billions of dollars (vertical axis) needed to be in play within the bank throughout a typical working day (horizontal axis) to cover all their payments due.

During that day, blocks of payments are demanded from the bank's clearing system and these demands must be met.

As I’m based in the UK, I put this in a UK context and the chart shows CHAPS Crest settlements at opening of day, followed by the first wave of faster payments for internet, telephone and standing order payments.  These are those that require the Faster Payments Service (FPS).

There’s a few BACS (Voca) and CLS (Continuous Linked Settlement) payments for direct debits, credit transfers and cross-border payments, and then there's a massive raft of CREST Delivery by Value (DBV) payments at end of day to cover securities lending and collateral transfers.

A typical day.

A problem today.

The problem is the red line.

The red line is the available liquidity in this bank's system to cover their exposures.

The assets that can be placed on transfer to cover the payments demands in the network.

This line is nose-diving throughout the day.

As can be seen, the red-line bounces down sharply early in the day as payment demands means that liquidity goes out of the bank. 

The line then totters around zero through the day, as the bank has no spare liquid assets to cover demands and finally, at the end of day, bounces sharply upwards because
the bank is receiving payments inwards to settle all their trades and demands with other banks.

This means that intraday, banks are being challenged by liquidity to meet all the payment demands outwards which, in past times, could have been covered by all of their
'spare' liquid assets. 

Today, there are none spare!

There is little liquidity – easily accessible liquid assets – in the bank to cover their throughout the day exposures. As a result, the banks have to backup payments through the day, and try to cope with them at end of day.

This is the dotted line which shows the bank's internal payments processing.  As liquidity within the bank nose-dives, payments queues rise.

Around 10:00, the outstanding payments in the queue peak because all assets have been allocated against the start of day payments, and it is not until the Crest DBV end of day payments that the monies return. 

As a result, the queue for payments peak means that general intraday payments the bank has to process wait until late in the day for payment.  The fact that liquidity is not there but the process to pay before end of day is still a prerequisite, has put a huge strain on internal bank systems and processing.

There's the rub of why bankers are nervous.  If you have no liquidity on the books, you cannot allocate capital and assets effectively.  You just sit squeezed tighter than a tin of salmon in a pilchard box.

This is the clearest chart I have seen to date to illustrate the strangulation of the markets, and thanks to my banking friend for explaining it in such a clear way.

About Chris M Skinner

Chris M Skinner

Chris Skinner is best known as an independent commentator on the financial markets through his blog, the Finanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal’s Financial News. To learn more click here…

Check Also

Where are all the women?

Despite there being many capable women in banking, finance and technology, it is surprising how …

  • Interesting graph,but there is more to the story.
    Liquidity is a symptom of that bankers problem. Ask him why he is illiquid?
    Liquidity simply means to invest less assets in loans and mortgages. That is a choice made by the bank to make revenue. If they do not, then the market kills them for having underutilised their assets.
    Then if we dig deeper the lack of capital at the bank means they have to fund their assets with relatively expensive (compared to capital) customer deposits. So no choice they must deploy as assets, ie loans and mortgages to make money.
    Banks are under capitalised, and overtrading – thats what produces the symptom descibe d above imho.

  • Chris Skinner

    True Colin,
    And useful additional insight as what we’re illustrating is the strain of the banks that are getting TARP and UK funding I believe …
    Chris

  • Chris Skinner

    True Colin,
    And useful additional insight as what we’re illustrating is the strain of the banks that are getting TARP and UK funding I believe …
    Chris

  • Phil Cantor

    The bogeyman’s £100bn vanishing trick – I’ve only just spotted this lovely graph but the interesting bit to me is the systemic view. Let’s say the “£Bn’s” in Chris’s graph is £10bn, so this typical bank starts out with £10bn and ends the day with £10bn but sinks intraday to £almost-none-bn before rising again, just in the nick of time. Now suppose there are ten banks all with this same, typical profile. The central bank (if it could get the data and by golly it is trying) will see £100bn vanish during the day only to reappear at the end of the day! Where has all the money gone?
    Of course, most of the money moves from one bank to another rather than being illiquidated, so probably the total liquid assets are still around somewhere in transit (in queues) – we hope. So how do we know whether to (over)react to the bogeyman £100bn vanishing trick?

  • Phil Cantor

    The bogeyman’s £100bn vanishing trick – I’ve only just spotted this lovely graph but the interesting bit to me is the systemic view. Let’s say the “£Bn’s” in Chris’s graph is £10bn, so this typical bank starts out with £10bn and ends the day with £10bn but sinks intraday to £almost-none-bn before rising again, just in the nick of time. Now suppose there are ten banks all with this same, typical profile. The central bank (if it could get the data and by golly it is trying) will see £100bn vanish during the day only to reappear at the end of the day! Where has all the money gone?
    Of course, most of the money moves from one bank to another rather than being illiquidated, so probably the total liquid assets are still around somewhere in transit (in queues) – we hope. So how do we know whether to (over)react to the bogeyman £100bn vanishing trick?