Kenneth R. Szulczyk
borrowers, who will pay high interest rates and are not likely to default on their loans. Then,
banks purchase securities that have high returns, are liquid, and have low default risk. If
depositors begin withdrawing funds, the banks can sell the liquid securities and pay the
depositors’ withdrawals. Liability management is banks cannot force customers to open
checking and savings accounts. Thus, banks are limited in these funding sources. However,
banks use financial instruments, such as certificates of deposits, Eurodollars, federal funds
market, and repurchase agreements. Currently, banks have few restrictions in raising funds.
Illustrating liquidity risk for your bank, we show your bank’s balance sheet below. The
Federal Reserve requires your bank to hold 10% of deposits as required reserves. Thus, your
bank has enough funds to meet depositors’ withdrawals.
Your Bank
Assets Liabilities
Required reserves $10 million
Excess reserves 10 million
Loans 80 million
Securities 10 million
Deposits $100 million
Bank Capital 10 millionDepositors withdraw $10 million that decreases deposits by $10 million. Bank pays the
funds from excess reserves, equaling $10 million. Consequently, this bank has met withdrawal
demands. Both bank deposits and excess reserves decrease by $10 million, shown in the T-
account below:
Your Bank
Assets Liabilities
Required reserves $10 million
Excess reserves 0 million
Loans 80 million
Securities 10 million
Deposits $90 million
Bank Capital 10 millionDepositors withdraw another $10 million, and the bank pays the withdrawals from required
reserves. Both deposits and required reserves decrease by $10 million, shown in the T-account
below
Your Bank
Assets Liabilities
Required reserves $0 million
Excess reserves 0 million
Loans 80 million
Securities 10 million
Deposits $80 million
Bank Capital 10 million