Hitting the Tough Shots - MIT Sloan School of Management

More documents

Recommendations

Info

Continued from page 5 problem, and want to solve it. Our students want to make a difference, and this want, along with a culture that ignores barriers is what drives students here to be so entrepreneurial.” Aulet elaborated on the theme of cross-campus collaboration. “The more collisions of great minds we can create at MIT the better,” he said. “The MIT Entrepreneurship Center, for example, was designed from the beginning to serve all fi ve schools across MIT, and promote education between the schools.” The MIT $100K will start the next phase of its competition with the Executive Summary Contest, announcing its winners in February 2010, followed by the Business Plan Contest, where more than $350,000 in cash and prizes will be awarded to aspiring entrepreneurs. For more on the MIT $100K, please visit: http://www.mit100k.org/ When a Liquidity Diet for Banks Makes Sense MIT Sloan researcher’s model tells banks how to avoid running out of cash From the MIT Sloan Media Relations Offi ce The balance sheets of many of the big banks that failed or teetered on the brink in the fi nancial crisis actually looked fi ne. On paper, their assets were suffi cient to cover liabilities. Their problem was liquidity. At the end of each day, banks must have suffi cient liquid assets to meet demands. If they don’t, the bank heads for failure, which is what happened at Bear Stearns and other Wall Street institutions in the fall of 2008. Liquidity vanished as apprehension about default spread, and banks were afraid to lend to each other. Sebastian Pokutta, a lecturer in operations research and statistics at MIT Sloan, has developed a mathematical model that banks can use to organize their global liquidity operations so they have suffi cient liquidity to avoid a repeat of what happened in the crisis. The model, which Pokutta developed with Christian Schmaltz of the Frankfurt School of Finance and Management, tells large banks when they need to open local liquidity centers in outlying subsidiaries. These centers can generate liquidity almost immediately, while waiting for a transfer from a distant headquarters can take hours or even be impossible when headquarters is in a different time zone and happens to be closed at a crucial time. “A liquidity center provides relatively cheap and immediate liquidity,” Pokutta said. Liquidity centers are staffed by traders who can quickly execute overnight loans with other banks or sell off assets to generate cash when demand is likely to exceed liquid assets. “If you don’t have a liquidity center in place, the only immediate liquidity available is expensive central bank funds. Cheap liquidity has to be ordered in advance from a distant location and is only available with a delay.” Pokutta said. “One might say that a liquidity center is an option on cheap and immediate liquidity.” Opening a liquidity center can be costly for a bank, since staff must be hired, trained, and equipped. Pokutta’s model identifi es the conditions under which opening such a center would be a wise move for a bank. It turns out that the opening of a center becomes more attractive when demand uncertainty increases. Continued on page 7 6
Continued from page 6 Most large banks today have only a handful of liquidity centers, even though the banks have subsidiaries operating in countries around the globe. “Banks today are spread out over time zones, countries, jurisdictions, and foreign exchange zones,” Pokutta said. “Sometimes offi cials have to sign off on transfers. People did not think about this before the crisis, but now we know this situation is dangerous.” Before moving to their academic posts, Pokutta and Schmaltz used to work together at a large fi nancial risk management fi rm. They decided to use their fi rst-hand experience and academic training to create a model that simulates a large bank with subsidiaries in countries and regions around the world. The model incorporates the many variables that affect a bank’s risk of running short of liquidity, as well as the cost of opening a center. Accounted for in the model are such things as the liquidity uncertainty, transferability constraints, currency fl uctuations, and country instability. In testing the model, Pokutta and Schmaltz discovered that the key factor in whether a bank should open a liquidity center is the volatility of demand a bank faces for liquid assets. This fi nding contradicts a widespread assumption in the banking industry that the total amount of demand for liquidity is the main reason to open a center. “For a very long time people thought that the expected demand was what would tell you whether you needed to do this,” Pokutta said. “It turns out that the volatility aspect is much more important.” He likens it to ordering pizza for a party of 20 friends. The host might assume that each person would eat two slices and would order pizza with 40 slices plus a few extra. But if the host has no idea how much each person will eat, then it would be good to have a pizza shop nearby with fast delivery. Before the fi nancial crisis, banks did not pay a great deal of attention to liquidity management, according to Pokutta. They focused instead on their investments, loans, and other so-called “profi t centers” in the bank. Since the crisis, banks and regulators are paying more attention to liquidity, according to Pokutta. He believes events would have unfolded differently in the fall of 2008, if banks had dedicated more resources to understanding liquidity risk more clearly. “It should not happen that a bank with a good balance sheet fails,” he said. “Failures caused by liquidity problems are unnecessary defaults.” Brunel Lecture Series This year’s talk in the Brunel Lecture Series on Complex Systems, which will be presented by Charles Ferguson, Director/Producer/Writer of Inside Job (new documentary about the causes of the 2008 fi nancial meltdown; watch trailer here). His lecture, entitled, “The Financial Crisis, the Recession, and America’s Future: A Systemic Perspective” will begin at 4:00 p.m. at MIT, in 54–100. The MIT Engineering Systems Division (ESD), which sponsors the Brunel Lecture, is an interdisciplinary academic unit that spans most departments within the School of Engineering, as well as all fi ve schools within MIT. ESD faculty, researchers, and students tackle real-world challenges using approaches from engineering, management, and social sciences. For more details about this event and Ferguson visit: http://events.mit.edu/event.html?id=13566016&da te=2010/11/9. 7
Page 1 and 2: Schoolwide News Hitting the Tough S
Page 3 and 4: Continued from page 2 Earlier this
Page 5: Collapsible Air Freight Crate Wins
Page 9 and 10: 15 DEGREES ALUMNI NEWS & UPDATES Fi
Page 11 and 12: SUSTAIN- ABILITY@ SLOAN Get Ready f

Hitting the Tough Shots - MIT Sloan School of Management

You also want an ePaper? Increase the reach of your titles

Delete template?

Save as template?