Aug 24, 2022
7 mins read
The business community has taken the biggest hit from the ups and downs of the economy in recent times. More and more companies are going out of business, selling off assets, or simply abandoning their locations.
Target liquidation has been the last step for many of these companies. If a company has debts, a liquidator can determine how much money it can make by selling off its assets. But liquidation can take several forms and is not always the same. Some companies go into liquidation voluntarily, while others are simply evaluated by a team of liquidators.
The term "member's voluntary liquidation" is used to describe the first kind of liquidation. In a voluntary liquidation, the stockholders, shareholders, or partners of a corporation have decided to sell off their holdings in order to pay off their ever-mounting debts. However, the amount of predicted liquidation is more than the amount of debt to be paid off, so in this sort of liquidation, the spirit of volunteerism is present. In plainer terms, the shareholders are not total losers if they liquidate because they will still make some money.
Creditor-initiated liquidation is another category. During an orderly liquidation, the company's owners retain control over the winding down procedure. One key distinction between this group and the first is that there is no voluntarism involved; rather, they have no choice but to sell up their possessions to settle their debts.
Further, in this scenario, the sum of their debts is equal to or greater than the value of their liquidated assets. No good comes from it; it's a dead end. If the value of the assets is insufficient to pay off the loan, then there may be remaining deficits. Because of this quality, creditor-voluntary liquidation has replaced all other forms to become the standard.
Compulsory liquidation is the third and last type of bankruptcy classification. As the name implies, the liquidation of the assets is not a voluntary or intentional action on the part of the owners. This form results from a bankruptcy or insolvency declaration by a business and subsequent court order. This occurs when the company is unable to pay off its debts in any other way. The court also appoints liquidators to determine how much of the company's assets can be salvaged in the event of its demise.
If a company believes it will never be able to pay off its debts or if it simply wants to maximize its profits before shutting down, liquidating its assets is a viable option (at least if it is taken before the court takes action to do so). They may be spared the difficulty and social disgrace of being forcibly liquidated in this way. However, the best course of action for a business is to avoid incurring debt in the first place, as this will help you avoid the aforementioned possibilities that could cause the demise of your company.
Key Issues in the Management of Liquidity Risk
This is the continuation of a series on Liquidity Risk management. My first piece, titled "Managing Liquidity Risk - The 2007 Crisis," addressed the widespread liquidity issues confronted by financial institutions all over the world starting in the summer of 2007. These issues were harbingers of the present financial crisis. After that, I dove into the topic of Liquidity Risk Management and looked back on the events of that summer to see what led to the extreme strain on so many banks.
The crisis exposed the fact that vital concerns had been neglected. During its 2008 review of the situation, the "Basel Committee on Banking Supervision" offered additional advice in areas such as;
banks' tolerance for liquidity risk,
sustain adequate levels of cash flow,
the division of a bank's liquidity costs, advantages, and hazards
identifying and evaluating all potential threats to liquidity,
The Stress Test,
emergency savings strategies,
managing the danger of running out of cash during the course of the day, and
disclosure to the public as a technique of encouraging market discipline.
Here I discuss the recommendations found in the "Liquidity Risk Management and Supervisory Challenges" report published by the Basel Committee in February 2008.
Seventeen separate "principles" have been laid out to provide this direction. This set of guiding ideas has been organized into five broad classes. At this point, I'd like to address how I plan to approach categories and the underlying ideas that they may or may not share.
Liquidity risk management and oversight are fundamental idea
This is built on a single premise that makes the bank responsible for handling all liquidity-related issues. To achieve this goal, the bank must take several important steps, such as instituting a rigorous system for managing risk and making sure there's enough cash on hand to cover any transactions that may arise. According to the same premise, bank regulators must make sure each bank has a solid plan in place for dealing with its own unique liquidity risk.
Management and governance of liquidity risk
There are three guiding ideas presented here. In each case, the answer depends on the bank's tolerance for liquidity risk. It is the responsibility of the bank's board of directors to assess and approve all matters pertaining to liquidity at least once a year, and this includes determining a level of required liquidity to match the bank's business strategy. Principle 3 addresses the importance of considering the bank's liquidity when pricing products and approving any new products.
The evaluation and control of liquidity risk
Getting into the "meat" of the proposal. It consists of eight separate tenets. I'll go over each of these rules in turn.
Financial institutions need a reliable method to detect, quantify, track, and manage their own liquidity risk.
In order to succeed, financial institutions need to have a global, proactive stance toward liquidity. This means businesses have to coordinate the risks they face and the money they spend across all their divisions, countries, and corporate structures. In addition, businesses must take into account the constraints imposed by law, regulation, and practicality on the transfer of cash among their many corporate units.
Banks need to ensure they can raise sufficient funds quickly from a variety of sources, thus it's important for them to spread their funding around.
It is critical for banks to aggressively manage their intraday (as opposed to overnight) liquidity to ensure that they have enough cash on hand to satisfy their obligations when they come up. Also, a bank needs to prepare for this scenario under both ideal and adverse circumstances.
Careful management of collateral is also required, as is the distinction between collateralized and unencumbered assets.
The system should be put through a variety of stress tests on a regular basis. This is crucial since it will show whether or not the bank can meet its liquidity needs and stick to its usage targets.
A formal emergency liquidity plan should be in place for the bank. Responsibility and reporting structures should be made crystal clear. The strategy should also be tested frequently.
In addition, banks must keep certain of their assets in a readily usable form such as cash or other liquid assets, free of any liens or other restrictions. There can be no restrictions on how these resources are used.
Openness to the Public
Simply put, a bank should be transparent about its liquidity and risk management practices on a regular basis so that the market may draw its own judgment.
The function of the bank regulator is the focus of the final four principles. In the first place, it is crucial that regulators keep tabs on the bank's risk management system and liquidity levels. In addition, they need access to other data, such as internal reports and market data. Managers have a responsibility to intervene when they notice issues and see that they are resolved quickly.
Moreover, supervisors must maintain open lines of communication with their counterparts in other countries as well as with public agencies such as central banks. This is to guarantee efficient communication and coordination for monitoring liquidity risk management. This dialogue must take place frequently and at regular hours. As the level of stress rises, so too must the urgency with which information is shared.
The purpose of disseminating this advice is to provide the first solace and invite discussion. I will discuss the "hows," "whys," and "what to look for" of putting some of these principles into practice in a future piece.