Navigating Banking Liquidity- Factors, Challenges and Strategies in Corporate Loan Portfolios

Abstract

Banks with a significant portfolio of commercial or corporate loans should pay close attention to the correlations between liquidity, loan pricing, and a specific combination of external and internal factors. This study highlights the combinations of these factors that significantly impact bank liquidity and, ultimately, solvency. The extensive body of literature that we scrutinized makes two major assumptions. The first assumption is that they consider the impact of these factors on a bank’s liquidity at an individual, isolated level.  The second assumption is that the bank portfolios are completely diversified. This traditional approach may not be suitable for larger banks with a significant portfolio of corporate loans or facilities. These banks may not conform to the assumption that their portfolio is completely diversified. Our study also indicates that unique combinations of these factors have a much more profound and distinct effect on the bank’s liquidity and vice versa. Corporate loans and facilities pose the most significant challenge due to loan contracts/covenants and a shallow secondary market for corporate loans. This results in locked-down liquidity, causing that stress to permeate to other parts of the bank, particularly when combined with the drawdown of OBS facilities.

When these internal factors are combined with multiple external factors, they cause unpredictable areas of stress on the least expected areas of the bank, forcing it to fail rapidly. This was proven in the case of RBS in 2015 and SVB in 2023. 

Banks that can identify correlations between these factors and stress-test these assumptions based on their portfolio size and diversification with specific importance to individual loan contracts would be better positioned to meet rapidly changing demands without impacting their liquidity or solvency. This paper aims to fill the research gap by analyzing the correlation of factors and the impact of that correlation on both liquidity and pricing of loans to corporates.