Importance of maintaining liquidity and enhancing financial capacity

A company’s financial strategy is developed, keeping in mind certain constants and changes in the ever-inconsistent economy. With an unprecedented crisis never announces itself beforehand, companies have to look well beyond their traditional credit sources for maintaining free cash reserves. Liquidity Investment solutions provide clients an operationally efficient way to set pre-defined investment parameters to meet their liquidity management objectives. The inadequacy of liquidity causes the market value to crash and has important practical implications as well. Investment Banks dealing in Liquidity and Debt Restructuring have to fine-tune the balance between cash inflows and outflows to maintain a healthy fluidity between operations. Funding liquidity refers to the ability of a financial intermediary to raise cash on demand within a brief notice.

Investment banks and fund managers have the duty to diligently manage such difficulties to meet an investor’s redemption frequencies. But maintaining many cash-reserves is also bad as it drags down returns. Funding liquidity refers to the ability of a financial intermediary to raise cash on demand within a brief notice, it is merely now maintaining a tripartite of balance among factors like holdings, liabilities, and market. Banks and institutional investors normally invest in a variety of assets with varying degrees of liquidity. Implying they can pay out investors willing to redeem or opt-out. Also, these investors also enjoy Liquidity Premium- which is the additional value gained from holding long term illiquid assets.

One of the primary aims of liquidity management is to avoid situations where illiquid assets are forced to be sold on high discounts, to meet the cash crunch on the business faces.

RBI in its recent circular in 2019 has published liquidity risk management guidelines (LRM) mainly focusing on NBFC sectors. The circular focused on aligning responsibilities on management, CFO’s as a foolproof model around liquidity risk is not yet in place. NBFCs rely on brief term funding and high-interest rates. This circular sets forward a regime, post-IL&FS scam, alters the maturity profile and mismatches associated with different brackets.

Value creation is important in liquidity structuring, often associated with capital risk, which is the balance between availability of cash and its efficient use. The creation of values is mainly done through management and financiers working together. Methods include improved product pricing, reduction of capital cost, and enhanced risk planning and performance.

Excellent practices suggesting using pre-emptive tools like analysing investor behaviour, cost protection methods like swing pricing, etc. Also, Asset protection; preserving fairer values upon sale, segregating specific assets for better management ensuring value preservation. Since liquidity touches on many aspects of investment management from asset allocation to rebalancing policy, managers and companies should scrutinize their liquidity profile. Fund managers and investment banks have a high threshold to satisfy their liquidity and investor interest. Commonly used methods are:

- Liquidity analysis

- Stress Testing

- Deferred Redemptions

- Fund Suspension

Placing a successful aversion to an approaching Liquidity Crisis it is very significant to have investments in a variety of sectors, sound internal control, and developing market-specific scenarios to gauge sensitivity, etc. It is therefore essential to adjust the parameters and threshold values of a risk monitoring tool to peer group specific levels to assure a top level of reliability of the monitoring system. Businesses having a liquidity cushion may survive and plan flexibly to gain lost opportunities and would deem to have a considerable competitive advantage. Close management and careful fine-tuning of the liquidity risk framework are essential to help the firm survive in extreme stress and optimize assets without undue strain in less stressed conditions.