A Linear Programming Model for Commercial Bank Liquidity Management

Abstract

The primary purpose of commercial bank liquidity management is to support other banking functions by maintaining reserves to meet unanticipated deposit withdrawals and an inventory of near cash funds to satisfy potential credit demands. Because of the substantial volume and the frequent turnover of assets and liabilities, liquidity management requires close attention to money market portfolio management as well as to the support of deposit and credit activities. The numerous constraints on such activity suggest that liquidity management may best be accomplished using mathematical programming. This paper describes the development of a practical and usable mathematical programming model for liquidity management in a medium to large commercial bank. Although there are differences in the models, the motivation for the application discussed here comes from Komar [7]. The bank has total assets of approximately $800 million and an investment portfolio (securities and federal funds sold) of approximately $200 million. Since the bank has had no prior experience with mathematical programming techniques, the model must be simple in order to insure that management understands and accepts it. While a simple model may abstract and oversimplify some real world complexities, the model discussed here can still improve liquidity management. The model is designed to help the manager make decisions by providing a comprehensive framework within which to evaluate alternative strategies.

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