A DI with the following balance sheet (in millions) expects a net deposit drain of $15 million.

Questions and Problems Liquidity risk, as a result of heavier-than-anticipated liability withdrawals or loan commitment exercise, is a common problem faced by FI managers. Well-developed policies for holding liquid assets or having access to markets for purchased funds are normally adequate to meet liability withdrawals. However, very large withdrawals can cause asset liquidity problems that can be compounded by incentives for liability claim holders to engage in runs at the first sign of a liquidity problem.

These incentives for depositors and life insurance policyholders to engage in runs can push normally sound FIs into insolvency. Mutual funds are generally able to avoid runs because liabilities are marked to market so that losses are shared equally among liability holders. Since such insolvencies have costs to society as well as to private shareholders, regulators have developed mechanisms such as deposit insurance and the discount window to alleviate liquidity problems. We discuss these mechanisms in detail in Chapter 19.

Summary Assets Liabilities and Equity Cash $10 Deposits $68 Loans 50 Equity 7 Securities 15 Total assets $75 Total liabilities and equity $75 Show the DI’s balance sheet if the following conditions occur:

a. The DI purchases liabilities to offset this expected drain.

b. The stored liquidity management method is used to meet the expected drain