Cash flow banking is a term used to describe the management of a bank’s cash flow. By managing a bank’s cash flow, it can be ensured that the bank has enough liquidity to meet its obligations. This is important for two reasons. First, banks are required by law to maintain a certain level of liquidity in order to ensure that depositors can be paid on demand. Second, if a bank does not have the liquidity to meet its obligations, there is a good chance that those circumstances will prevent it from lending money and earning income. If this happens, then the bank’s financial position will become very weak.
Managing Cash Flow: A Bright Outlook for Banks
The global economy has experienced significant turmoil in the recent past. As a result, many banks have struggled to maintain their cash flows. However, this situation may be turning around due to the actions of central banks in the U.S., Europe and China. By lowering interest rates to record lows, it has become much easier for banks to borrow money cheaply which can then be lent at high rates to other institutions. This will give them much needed cash flow, provided they make prudent lending choices.
Managing Cash Flow: The Importance of Liquidity
Banks are required by law to maintain a certain level of liquidity; this essentially means that they must keep the right amount of assets in easily accessible areas. Assets that can easily be sold or exchanged for cash are considered to be liquid assets. They include cash, short-term investments and government securities. By contrast, illiquid assets are long-term assets which cannot be turned into immediate cash (e.g. real estate). Banks must hold enough liquid assets to survive for at least 30 days if they experience a crisis. This is known as the liquidity coverage ratio (LCR).
Cash Flow Management: The Need to Measure Effectiveness
In order to make sure that banks are managing their cash flow effectively, it is important to measure what they are doing. One such way is by measuring the liquidity of the bank’s assets. The liquidity coverage ratio (LCR) is one measure of a bank’s liquidity. LCR is the percentage of a bank’s assets that are considered to be liquid. A higher LCR means that the bank is in a better position to meet its obligations.
Cash Flow Management: Conclusion
Banks are in a much better position today to manage their cash flows. This is due to the actions of central banks around the world, which have lowered interest rates to historic lows. By doing this, it has become easier for banks to borrow money cheaply and then lend it out at high rates. Banks that are able to manage their cash flow effectively will be in a much better position to continue lending in difficult markets.
