Financial Risk Manager Part 2
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- Two financial entities are confronting distinct funding difficulties. Bank A, a mid-sized regional bank, is concerned about meeting its legal reserve requirements on a daily basis and seeks alternative solutions to this challenge. On the other hand, Bank B, a small community bank, is experiencing an unexpectedly large shortfall in the renewal of its long-term certificates of deposit (CDs) due to increased competition for retail deposits in its local market. Historically, Bank B has relied on stable CDs to fund its home mortgage portfolio. Considering the timing and availability of non-deposit funds, what would be the most appropriate funding strategy for each of these organizations?
- Two financial entities are confronting distinct funding difficulties. Bank A, a mid-sized regional bank, is concerned about meeting its legal reserve requirements on a daily basis and seeks alternative solutions to this challenge. On the other hand, Bank B, a small community bank, is experiencing an unexpectedly large shortfall in the renewal of its long-term certificates of deposit (CDs) due to increased competition for retail deposits in its local market. Historically, Bank B has relied on stable CDs to fund its home mortgage portfolio. Considering the timing and availability of non-deposit funds, what would be the most appropriate funding strategy for each of these organizations?
Explanation:
The correct answer is C. Bank A should fund today's shortfall in legal reserves through the Fed Funds Market and Bank B should fund its CD shortfall through borrowing from the Federal Home Loan Banks Advances Program. The bank can match fund its mortgages against the Advance Program funding term.
Bank A is facing a shortfall in legal reserves for the day, which is a short-term liquidity issue. The Fed Funds Market is an appropriate source for addressing short-term liquidity needs because it allows banks to borrow and lend reserves overnight. This market provides immediate access to funds, which is crucial for Bank A to cover its reserve requirements for the day.
Bank B, on the other hand, is experiencing a shortfall in long-term CD renewals due to competition for retail deposits. This is a longer-term funding issue, and the Federal Home Loan Banks (FHLB) Advances Program is a suitable solution. The FHLB offers longer-term, low-cost funding that can be used to match the term of the bank's mortgage portfolio. By borrowing from the FHLB, Bank B can secure stable, long-term funding to replace the lost CD funding.
The other options are not as suitable for the specific funding needs of each bank. Option A involves borrowing from the wholesale deposit market and Eurocurrency deposit market, which are more expensive and less stable sources of funding compared to the Fed Funds Market and FHLB Advances Program. Option B suggests using the commercial paper market and Federal funds market, but these are not ideal for the long-term funding needs of Bank B. Option D proposes issuing debentures and using the commercial paper market, which may not provide the immediate or long-term funding required by the banks.
In summary, the most appropriate funding response for each institution is to utilize the Fed Funds Market for Bank A's short-term liquidity needs and the Federal Home Loan Banks Advances Program for Bank B's longer-term funding requirements. This approach addresses the specific timing and availability of non-deposit funds for each bank's unique situation.