VIETNAM NATIONAL UNIVERSITY, HANOI SCHOOL OF BUSINESS VAN THU HUONG LIQUIDITY RISK MANAGEMENT IN LIEN VIET COMMERCIAL JOINT STOCK BANK MASTER OF BUSINESS ADMINISTRATION THESIS... VIE
LITERATURE REVIEW
Commercial bank
There is still confusion about what exactly a commercial bank is, and organizations offer several definitions Generally, these definitions can be categorized into three criteria: the bank’s function in the economy, the services it provides to customers, and the legal institutions that govern it By examining a bank’s economic role, its range of customer services (deposits, loans, payments), and the applicable legal framework, we gain a coherent, SEO-friendly understanding of what constitutes a commercial bank.
“A financial institution that accepts demand deposits and makes loans and provides other services for the public” 1
“A full-service institution that offers customers deposit, payment and credit services, in addition to other financial services” 2
“A financial intermediary which collects credit from lenders in the form of deposits and lends in the form of loans” 3
Finally, there is a definition “commercial bank” still used by many nations today: The bank that sells deposits and makes loan to businesses and individual 4
1 Source: wordnetweb.princeton.edu/per1/webwn
3 Source: http://www.investorglossary.com/commercial-bank.htm
4 Source: S.Rose, Peter and C.Hudgins, Sylvia, (2008), Bank management & Financial Services, page 6
1.1.2 Products & services provided by commercial banks
Commercial banks offer many types of products and services which can be summarized as below:
Table 1-1: Products & services provided by commercial banks 1
Represent liabilities of the bank, include checking and savings accounts, certificates of deposit and other types of deposit products
Represent the primary assets of the banks, these products normally take the form of personal and business loans, mortgages, auto loans and credit cards
This strategy focuses on the ongoing maintenance and expansion of 24-hour ATM networks, wire transfer services, and online banking platforms to serve both consumers and businesses around the clock By enabling access to account information, opening new accounts, ordering checks, transferring funds between accounts, and making bill payments, these banking websites deliver secure, convenient financial management and an improved user experience across channels.
Include investment advisory services, corporate finance consulting, custodial services for estates and trusts, safekeeping of securities and other valuable items, and money transfer services
1.1.3 Roles of commercial bank in economics
Commercial banks are a cornerstone of economic development, converting savings into productive investment They collect public savings and mobilize them for financing industrial projects and personal loans, acting as crucial financial intermediaries Investors borrow from banks to fund these ventures, often supported by specialized funds and financing facilities designed to promote project finance By channeling savings into investment, commercial banks help drive growth across various sectors of the economy.
Commercial banks are a vital conduit for transmitting government economic policies to the broader economy When bank credit is scarce and expensive, spending slows and unemployment tends to rise Conversely, very high interest rates keep the cost of credit high, which can create inflationary pressures.
Risk management in Commercial Bank
Risk in a banking organization is the possibility that the outcome of an action or event could produce adverse impacts, such as direct losses of earnings or capital or constraints that prevent the bank from achieving its business objectives These constraints can hinder ongoing operations and limit the bank's ability to conduct business or seize opportunities to enhance its performance and growth.
Banks distinguish between expected losses and unexpected losses Expected losses are those the bank can forecast with reasonable certainty—for example, the expected default rate of a corporate loan portfolio or of a credit card portfolio—and they are typically reserved for in advance Unexpected losses come from unforeseen events, such as a sudden downturn in the economy or a fall in interest rates, and can also arise from dramatic events like nuclear tests Banks use capital as a buffer to absorb these losses.
Risks are typically defined by the adverse impact they can have on profitability arising from multiple sources of uncertainty The types and intensity of risk to which an organization is exposed depend on factors such as its size, complexity, business activities, and transaction volume; however, it is generally understood that risk emerges across several domains—market, credit, operational, liquidity, and regulatory—and that the overall effect on profitability hinges on effective identification, measurement, and mitigation of these uncertainties.
1 State Bank of Pakistan, (2002), Risk Management- Guideline for Commercial Banks & DFIs, page
Banks face a spectrum of risk types, including credit, market, liquidity, operational, compliance/legal/regulatory, and reputational risk Before outlining these risk categories, this article covers the fundamentals of risk management and provides guiding principles for effectively managing risk in banking organizations.
1.2.2 Main risks in Commercial Bank
Banks face a number of risks in order to conduct their business, and there have been four main risks faced by commercial banks include:
Credit risk is the potential that a borrower or counterparty will be unwilling or unable to fulfill an obligation, or that its ability to do so will deteriorate, resulting in economic losses for the bank It covers the risk of default, delayed payments, or reduced repayment capacity, all of which can erode loan returns and capital Effective management involves assessing creditworthiness, monitoring financial health, and applying controls such as credit limits, collateral, and diversification to protect the bank’s earnings.
Market risk is the potential for adverse changes in the value of a financial institution’s on- and off-balance sheet positions caused by movements in market rates and prices Such movements—encompassing interest rates, foreign exchange rates, equity prices, credit spreads, and commodity prices—can reduce earnings and capital, highlighting the need for robust measurement and management of exposure across both sides of the balance sheet.
Liquidity Risk : Liquidity is the ability of a bank to fund increases in assets and meet obligations as they come due, without incurring unacceptable losses 3
Operational risk is the risk of loss arising from inadequate or failed internal processes, people, and systems, or from external events The definition explicitly includes legal risk but excludes strategic and reputational risk, focusing the scope on day-to-day operational failures and external shocks rather than broader decisions or damage to reputation.
1.2.3 Risk Management in Commercial Bank 1
1 State Bank of Pakistan, (2002), Risk Management- Guideline for Commercial Banks & DFIs, page 5
2 State Bank of Pakistan, (2002), Risk Management- Guideline for Commercial Banks & DFIs, page 17
3 Source: Basel Committee on Banking Supervision, (2008), Principles for sound liquidity risk management and supervision, page 1
4 Source: Bank for International Settlements, Sound Practices for the Management and Supervision of
“Banks are in the Business of Managing Risk, Pure and Simple, that is the
Business of Banking” (Walter Wriston, Chairman an CEO Citicorp 1970- 1984)”
Financial risk management is an inherent part of banking and of banks’ roles as financial intermediaries Rather than simply minimizing risk, effective risk management seeks to optimize the risk–reward trade-off to create value for customers and shareholders Banks accept risks that are intrinsic to the breadth of services they provide, applying disciplined approaches to identify, price, and manage those risks within their risk appetite.
Risk management activities broadly take place simultaneously at following different hierarchy levels
Strategic level risk management is performed by senior management and the board of directors, encompassing the definition of risks, determination of the institution’s risk appetite, and the formulation of strategies and policies for managing risk, while also establishing robust systems and controls to ensure that overall risk remains within acceptable limits and that the potential rewards justify the risk taken.
Macro-level risk management encompasses risk oversight within a defined business area or across multiple business lines This level typically includes risk review activities conducted by middle managers or by units dedicated to risk assessment and monitoring, coordinating the identification, evaluation, and mitigation of risks at an organizational scale.
Micro-level risk management centers on on-the-line risk, where risks are actively created by frontline activities It encompasses risk-management duties carried out by individuals who take risk on the organization’s behalf, such as front-office staff and loan-originations teams In these areas, risk controls are bounded by the operational procedures and guidelines set by management, guiding day-to-day actions and ensuring alignment with the organization’s risk framework.
What Benefits of risk management in Banking?
Protect the bank from unexpected failures, loss, damage
1 Source: State Bank of Pakistan, (2002), Risk Management- Guideline for Commercial Banks & DFIs, page
Be less vulnerable from negative environmental changes
Be able to gain the expertise to price risks and take opportunities.
Liquidity Risk Management in Commercial Bank
"Liquidity" refers to a financial institution’s capacity to meet its current and anticipated liquidity obligations as they come due, without incurring considerable losses 1
The Demand for and Supply of Liquidity 2
Revenues from the sale of nondeposit services
Borrowing from the money market
Credit requests from quality loan customers
1 Source : Autorite Des Marches Financiers, (2009), Liquidity risk management guideline, page 7
2 Source: S.Rose, Peter and C.Hudgins, Sylvia, (2008), Bank management & Financial Services , Chapter 11: Liquidity and Reserve Management: Strategies and Policies
Operating expenses and payment of tax
Payment of dividends by cash
The following sources of liquidity and supply come together to determine each bank’s net liquidity position at any moment of time:
Net liquidity position = Supplies of liquidity – Demand of liquidity
Liquidity Shortage: Net liquidity position > 0 (greater than zero)
Offering higher rate of profit to deposits
Shortage of financial resources to invest against commitments
Liquidity surplus: Net liquidity position