Case 081Liquidity risk and ALMCore
A small finance bank's maturity ladder shows negative gaps of Rs 300 crore and Rs 250 crore in the first two weeks, against a Rs 400 crore tolerance on the cumulative negative gap within 14 days. Find the breach and propose fixes.
1The situation
Kostava Small Finance Bank's treasury builds a structural liquidity statement every day, slotting every inflow and outflow into time buckets. Today's net gaps, inflows less outflows, are minus Rs 300 crore in the 1 to 7 day bucket, minus Rs 250 crore in the 8 to 14 day bucket and plus Rs 400 crore in the 15 to 30 day bucket. The 15 to 30 day inflows include a Rs 250 crore treasury bill maturing on day 20.
The board's internal tolerance says the cumulative negative gap within 14 days must not exceed Rs 400 crore. The regulator sets its own tolerance limits by bucket; they are not used here, and the current figures should be confirmed with the regulator. The treasurer's first idea is a 7-day repo of Rs 200 crore.
2Your task
Is the bank in breach, by how much, and which fixes actually cure it?
Quick check
Where is the breach?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
The bank is Rs 150 crore over its tolerance: the cumulative gap reaches minus Rs 550 crore at 14 days against a limit of minus Rs 400 crore. No bucket breaches alone; the running total does. The 7-day repo does not cure it, because it brings cash in and takes it out inside the same fortnight. Funding that matures after day 14, or turning the Rs 250 crore day-20 treasury bill into cash now, does.
Step 1Why do liquidity limits sit on the cumulative gap?
Because cash short in week one is still short in week two unless something refills it. A household that is Rs 30,000 short on rent on the 5th and Rs 25,000 short on school fees on the 12th needs Rs 55,000 by the 12th, even if salary arrives on the 20th. The cumulative gapThe running total of inflows less outflows from today to the end of a bucket, which shows how much the bank must find from outside by that date. is what the bank must find from outside by a given day, so that is where a board sets the limit.
Step 2How big is the breach?
Add the buckets in order. Minus 300 by day 7, minus 550 by day 14, minus 150 by day 30. At day 14 the gap is Rs 550 crore, Rs 150 crore beyond the Rs 400 crore tolerance, even though the bank is only Rs 150 crore short over the whole month. The problem is timing, not size: the Rs 400 crore of inflows arrive a week too late.
Step 3Which fixes cure it, and why does the 7-day repo not?
Test each fix by asking where its cash comes in and where it goes out. A 7-day repo brings Rs 200 crore in today and sends Rs 200 crore out on day 7, so both legs sit inside the 14-day window and the cumulative gap at day 14 is unchanged at minus Rs 550 crore. A fix only counts if the money arrives inside 14 days and leaves after it.
| Fix | Cash in | Cash out | Cumulative gap at 14 days | Cures it? |
|---|---|---|---|---|
| Do nothing | -550 | No | ||
| 7-day repo, Rs 200 crore | Day 0 | Day 7 | -550 | No |
| 91-day certificate of deposit, Rs 200 crore | Day 0 | Day 91 | -350 | Yes, Rs 50 crore spare |
| Sell the day-20 treasury bill now, Rs 250 crore | Day 0 | Day 20 inflow gone | -300 | Yes, Rs 100 crore spare |
| Roll Rs 150 crore of day 8 to 14 bulk deposits to 45 days | Moves past day 14 | -400 | Just, no spare |
Choose between them on cost and on what they do to day 30. Selling the treasury bill costs almost nothing, but it only moves the Rs 250 crore inflow earlier; the month-end gap is unchanged. The 91-day issue costs a spread over the bill rate and keeps the bank covered past the month. A sensible answer uses the bill sale to cure today's breach and term funding to stop it recurring, and reports the breach to the asset liability committee either way. Then ask why the ladder has this shape: if the 8 to 14 day outflow is a few bulk deposits that always mature together, the fix is to spread their maturities.
Where candidates lose it
The common error is checking each bucket against Rs 400 crore, finding none over it, and declaring the bank compliant. The tolerance is on the cumulative gap; a candidate who misses that has missed the whole point of a ladder.
The second is accepting any borrowing as a fix. Short money that matures inside the window only shuffles cash within it; interviewers use the 7-day repo precisely to see whether you check both legs.
What the interviewer asks next
- Two bulk depositors in the 8 to 14 day bucket say they will not roll. Redo the ladder.
- Why might a regulator let marketable government securities sit in the first bucket whatever their maturity?
- How would you set the tolerance itself, rather than take it as given?
Company names and figures are illustrative.