Liquidity Ratio – What It Is and Why it Matters
When choosing an offshore bank, or indeed any bank, one of the key things to consider is the bank’s liquidity ratio. After all, anyone placing their assets in a bank account wants to know that it will remain safe, secure, and accessible at any time.
Unfortunately, not all banks have a favorable liquidity ratio. Find out more about what a liquidity ratio is, why it matters, and how offshore banks differ when it comes to total liquidity.
First, it’s important to define the concept of liquidity. Liquidity is the ability of assets to be bought or sold quickly. A home, for example, is not a liquid asset. It can’t be sold overnight. Even in the best-case scenario, it might take weeks for a home to transfer to a new owner.
Cash, on the other hand, is the best example of a liquid asset. It is immediately ready to be used to cover a debt or make a purchase. Cash is not the only liquid asset, but it’s the perfect example. Other assets that can boost liquidity include Treasury bonds (T-bonds) or corporate debt.
Both of these assets are backed by large institutions, such as the government or a multinational corporation. In many respects, they are just as secure as cash.
Defining the Liquidity Ratio
A bank’s liquidity ratio is the mathematical percentage of the bank’s total assets that it holds in liquid form, meaning cash or cash-like assets. A financial institution must have enough liquid assets to meet its short-term obligations. These include items such as withdrawals by customers, repayment of debts, funding new customer loans, etc.
There is both short-term and long-term liquidity to consider. It can happen that a political event, a government shutdown, or a currency jump makes investors apprehensive. That might mean that a significant percentage of account holders decide to move assets around. For these events, a bank needs to have a plan for short-term liquidity, perhaps over 30 days.
Long-term liquidity is more serious. If the market crashed, could a bank afford to return assets to all account holders? A liquidity ratio tells you whether or not a bank is prepared for these potential events.
Why Liquidity is Critical for Financial Institutions
As an individual investor or account holder, liquidity should matter to you. If a bank doesn’t have a substantial liquidity ratio, then it won’t be equipped to weather financial storms. In rare but serious cases, that could mean that you won’t be able to access your hard-earned assets when you need them most.
A bank run is when a large number of account holders withdraw cash from their accounts. While this is far from common, it has happened many times around the world. In 2001 and 2002, bank runs in Argentina and then neighboring Uruguay caused serious economic problems. In 2008, several bank runs in the United States caused financial institutions to be inoperable, requiring government assistance to prevent total bankruptcies.
There are many reasons why a bank run can happen. Sometimes, a mere rumor can get it started. A few skittish corporations could withdraw their assets and cause the collapse of a bank with virtually no notice. If there are no liquid assets left in a bank’s control, then it won’t be able to fill its ATMs with cash or allow account holders to withdraw large amounts of money.
For an account holder, that can be devastating. If you want to be sure that your money will be there for you when you need it most, be sure to choose a bank with a favorable liquidity ratio.
Government Regulations for Financial Liquidity
Virtually all major governments have regulations for their banks. This means that in order to operate as a financial institution, it must meet specific liquidity ratio requirements. However, these are not the same across the board. They can vary significantly from one country to the next.
Furthermore, they can change over time. When a nation goes through an economic crisis, it is common for their liquidity requirements to increase in response.
In Belize, as one example, banks are required by law to have liquidity rates of 24 percent or more. This is a standardized minimum, and every bank must adhere to that requirement to operate legally.
In contrast, the United States requires banks to have just one-third of that liquidity. On the surface, then, Belizean banks are a safer option if banks runs and long-term liquidity are serious concerns for you.
Institutional Liquidity Guidelines
Governmental liquidity ratio guidelines are just the bare minimum. Every institution can then choose to increase their liquidity to better protect their customers. At Caye International Bank, liquidity is twice what the Belizean government requires.
Going above the mandatory minimums can act as extra security for investors. If you’re putting your assets into an international bank, you need to know that it will always be accessible. An impressive liquidity ratio shows that banks are serious about providing long-term peace of mind to all account holders.
Weathering the Storm with the Right Bank
As an individual, there is little that you can do to prevent global banking crises. You can’t stop an election from happening, and you can’t control currency markets. You can, however, put a plan in place to weather these storms.
Planning ahead often includes placing assets in an offshore bank with ample liquidity. Opting for banks that go above and beyond the bare minimum can give you peace of mind and help you weather any stressful events that might negatively impact others.
A liquidity ratio isn’t just a small detail for a financial institution. It can be the difference between asset security and financial failure that impacts millions. At Caye International Bank in Belize, high liquidity is a priority, and many savvy investors choose the stability of Caye Bank to protect and grow their assets.
Contact Caye International Bank today to discuss how to secure your future with offshore banking.