Bank of Montreal 2004 Annual Report Download - page 68

BMO Financial Group Annual Report 200464
MD&A
Management’s Discussion and Analysis
Managing liquidity and funding risk is essential to maintaining
both depositor confidence and stability in earnings.
It is BMO’s policy to ensure that sufficient liquid assets and
funding capacity are available to meet financial commitments,
even in times of stress.
Our liquidity and funding risk management framework
includes:
•oversight by senior governance committees, including
the Liquidity and Funding Management Committee, RMC
and RRC;
•an independent oversight group within Corporate Treasury;
•independent process and internal control reviews by
Corporate Audit;
•
an RRC-approved limit structure to support risk management;
•effective processes and models to monitor and manage risk;
•strong controls over processes and models and their uses;
•a framework of scenario tests for stressed operating condi-
tions; and
•
contingency plans to facilitate managing through a disruption.
Data provided in this section reflect BMO’s consolidated posi-
tion. BMO subsidiaries include regulated and foreign entities,
and therefore movements of funds between companies in the
group are necessarily subject to the liquidity, funding and capi-
tal adequacy considerations of the subsidiaries as well as tax
considerations. Such matters do not materially affect BMO’s liq-
uidity and funding.
BMO’s liquidity and funding position remains sound
and there are no trends, demands, commitments, events or
uncertainties that are reasonably likely to materially impact
the position.
We actively manage liquidity and funding risk globally
by holding liquid assets in excess of an established minimum
amount at all times. Liquid assets include unencumbered,
high credit-quality assets that are marketable, can be pledged
as security for borrowings, or mature in a time frame that
meets our liquidity and funding requirements. Liquidity and
funding requirements consist of expected and potential cash
outflows. These arise from obligations to repay deposits
that are withdrawn or not renewed, and the need to fund asset
growth, strategic investments, drawdowns on credit and liquid-
ity facilities and purchases of collateral for pledging. Liquidity
and funding requirements are assessed under expected and
stressed economic, market, political and enterprise-specific
environments, and these assessments determine the minimum
amount of liquid assets to be held at all times.
In addition, we use two primary measures to evaluate
liquidity and funding risk. The first measure is the cash
and securities-to-total assets ratio. This measure provides
an assessment of the extent to which assets can be readily
converted into cash or cash substitutes to meet financial com-
mitments, as cash resources and securities are more liquid
than loans. The ratio represents the sum of cash resources
and securities as a percentage of total assets. BMO’s cash and
securities-to-total assets ratio at October 31, 2004 was 25.8%,
down from 29.1% at October 31, 2003. The decrease in the ratio
was primarily attributable to a decline in investment securities
and U.S. deposits with other banks in response to expectations
of rising interest rates.
Cash and securities totalled $68.5 billion at the end of the
year, down from $74.7 billion in 2003, while total assets
increased $8.7 billion to $265.2 billion.
Liquidity and funding risk is the potential for loss if BMO is unable to
meet financial commitments in a timely manner at reasonable prices
as they fall due. Financial commitments include liabilities to depositors
and suppliers, and lending and investment commitments.
Liquidity and Funding Risk
In addition to MVE and EV, simulations, sensitivity analysis,
stress testing and gap analysis, which is disclosed in Note 17 on
page 107 of the financial statements, are also used to measure
and manage interest rate risk.
Structural balance sheet earnings and value sensitivity to an
immediate parallel interest rate increase or decrease of 100 and
200 basis points is disclosed in the adjacent table. This sen-
sitivity analysis is performed and disclosed by many financial
institutions and facilitates comparison with our peer group.
Models used to measure structural market risk help forecast
how interest rates and foreign exchange rates may change
and predict how customers would likely react to the changes.
These models have been developed using statistical analysis
and are validated through regular model vetting and backtesting
processes and ongoing dialogue with the lines of business.
Models used to predict consumer behaviour are also used in
support of product pricing and performance measurement.
Structural Balance Sheet Earnings and Value Sensitivity
to Changes in Interest Rates ($ millions)*
(After-tax Canadian equivalent) As at October 31, 2004 As at October 31, 2003
Earnings Earnings
Economic sensitivity Economic sensitivity
value over the next value over the next
sensitivity 12 months sensitivity 12 months
100 basis point increase (224.3) 9.2 (202.3) 10.8
100 basis point decrease 183.7 (20.2) 142.7 (17.6)
200 basis point increase (470.4) 22.2 (431.8) 15.7
200 basis point decrease 332.3 (62.9) 181.2 (61.6)
*Exposures are in brackets and benefits are represented by positive amounts.