liquidity risk management in banks case studyliquidity risk management at techcombank

1.3 International standards in management and supervision of liquidity risk 1.3.1 Basel’s principles for the management and supervision of liquidity risk After the market turmoil that

VIETNAM NATIONAL UNIVERSITY, HANOI

HANOI SCHOOL OF BUSINESS

PHAM THI THU HA

LIQUIDITY RISK MANAGEMENT IN BANKS

Case study: Liquidity risk management at Techcombank

Major: Business Administration

Code: 60 34 05

MASTER OF BUSINESS ADMINISTRATION THESIS

Supervisor: Dr Tran Phuong Lan

Hanoi, June 2012

i

ACKNOWLEDGEMENTS

First and foremost I offer my sincerest gratitude to Doctor Tran Phuong Lan for giving me the confidence to explore my research interests and the support throughout my thesis with her knowledge and enthusiasm

In particular, I can’t thank enough to ms Ho Thi Huong, director of Interest rate trading center at Techcombank for her help and support, specially for giving me opportunities to work directly in money market department that is in charge of managing bank’s daily liquidity so that I could study deeply on the research

I would also like thank my colleagues at Techcombank for their lively discussions and detailed guidance Ms Bui Thuy Nga, head of balance sheet management department, ms Le Phuong Mai, money market officer and Ms Nguyen Thi Minh Ngoc, assets and liabilities management officer, they all are so warmly and patient

in giving me their time and sharing their precious experiences Special thanks to Ms Tran Thi Hoa, fixed income dealer, she supported me much in daily work so that I could spend much time and focus on the thesis

I am so happy because my family always besides me I could feel so warm heart of

my mother and love of my husband for me, they encourage me much to study Master

of Business administration program and to complete this thesis

Hanoi, 06 June 2012

Pham Thi Thu Ha

ii

ABSTRACT LIQUIDITY RISK MANAGEMENT IN BANKS Case study: Liquidity risk management at Techcombank

Pham Thi Thu Ha MBA candidate, 2009 - 2011

School of Business – Vietnam National University, Hanoi

Supervisor: Dr Tran Phuong Lan

June 2012, 91 pages

Joining World Trade Organization (WTO) in 2006 brought to Vietnam not only opportunities but also many challenges in global competition One of the most challenging to Vietnam’s young economy is transformation process in financial and banking sector to comply with the WTO’s commitments These have made financial institutions and banks take best efforts to improve business efficiency and internal risk management process to meet step by step global acceptable standards and practices Since six years, Vietnam has taken many efforts to reform banking sector to enhance competition ability Domestic financial market has linked closer and closer

to international financial market Experience financial crisis occurring in US’s market in 2007, current public crisis in Europe, risk management become key focus

of global financial market Specially, liquidity risk management is essential to survive though crisis and to ensure durable development

This thesis focuses on studying standards and guidelines in liquidity risk management, including theory, management principles, measurements and management according to Basel Committee on Banking Supervision These have become international standards that many financial institutions in over the world apply for

iii

The study makes also clear understanding State bank of Vietnam’s regulations on stipulating prudential ratios in operations of credit institutions

Applying in fact, thesis also studies liquidity risk management at Techcombank, one

of most dynamic joint stock banks in Vietnam, according to business efficiency and its size Techcombank is also one pioneer bank in Vietnam financial market to study and implement global standards in banking management

By analyzing some strengths and weaknesses in liquidity risk management of Techcombank, thesis has proposed some solutions to improve Techcombank’s liquidity risk management, including solutions for daily management operation and also long term solutions

iv

TÓM TẮT QUẢN TRỊ RỦI RO THANH KHOẢN TRONG HOẠT ĐỘNG NGÂN HÀNG

Nghiên cứu: Một số giải pháp nâng cao hoạt động quản trị

rủi ro thanh khoản tại Ngân hàng Techcombank

Gia nhập Tổ chức thương mại thế giới (WTO) vào năm 2006, Việt Nam có những

cơ hội để phát triển, hội nhập nền kinh tế thế giới; đồng thời cũng đón nhận những thách thức to lớn trong cuộc cạnh tranh toàn cầu Một trong những thách thức lớn nhất của Việt Nam là việc cam kết tuân thủ các điều kiện và điều khoản liên quan đến hoạt động của lĩnh vực tài chính, ngân hàng Điều này khiến các tổ chức tài chính, ngân hàng phải thực sự nỗ lực để nâng cao hiệu quả kinh doanh cũng như đáp ứng các chuẩn mực quản trị rủi ro quốc tế trong cuộc cạnh tranh với các tổ chức tài chính toàn cầu

Sáu năm gia nhập WTO, cũng là khoảng thời gian Việt Nam có những bước tiến mạnh mẽ trong hoạt động của hệ thống ngân hàng Hoạt động của thị trường tài chính, ngân hàng trong nước đã gắn bó mật thiết với những diễn biến trên thị trường tài chính toàn cầu Trải qua cuộc khủng hoảng tài chính từ giữa năm 2007 với xuất phát điểm từ thị trường thế chấp của Mỹ, đến những vấn đề nan giải của cuộc khủng hoảng nợ công đang diễn ra tại Châu Âu hiện nay, vấn đề quản trị rủi ro trở thành tâm điểm của hệ thống tài chính toàn cầu, trong đó các nhà quản trị đặc biệt chú

đã trở thành chuẩn mực quốc tế cho hoạt động của nhiều tổ chức tài chính, ngân hàng trên toàn thế giới Đồng thời, đi cùng với những chuẩn mực này, luận văn cũng phân tích các thông lệ thị trường, các công cụ quản trị được chấp nhận rộng rãi trong hoạt động quản trị rủi ro thanh khoản

Nghiên cứu cũng tập trung vào quy định của Ngân hàng nhà nước Việt Nam trong việc áp dụng các chuẩn mực để đảm bảo an toàn trong hoạt động của các tổ chức tài chính, ngân hàng tại Việt Nam

Từ lý luận đến thực tiễn, luận văn đã phân tích hoạt động quản trị rủi ro thanh khoản tại Ngân hàng Techcombank, một ngân hàng thương mại cổ phần hàng đầu tại Việt Nam xét về quy mô và hiệu quả kinh doanh, cũng như việc đi đầu trong nghiên cứu, áp dụng các chuẩn mực quốc tế trong quản trị ngân hàng

Trên cơ sở phân tích các điểm mạnh và điểm yếu trong hoạt động quản trị rủi ro thanh khoản, nghiên cứu cũng đưa ra một số giải pháp nhằm cải thiện chất lượng hoạt động quản trị rủi ro thanh khoản tại Ngân hàng Techcombank, bao gồm các giải pháp ngắn hạn trong quản trị thanh khoản hàng ngày, cũng như các giải pháp nhằm cải thiện tình hình thanh khoản của Techcombank trong dài hạn

vi

TABLE OF CONTENTS

ACKNOWLEDGEMENTS i

ABSTRACT ii

TÓM TẮT iv

TABLE OF CONTENTS vi

LIST OF FIGURES ix

LIST OF TABLES x

LIST OF ABBRIVIATIONS xii

INTRODUCTION 1

CHAPTER 1: OVERVIEW OF LIQUIDITY RISK MANAGEMENT IN BANKS 2

1.1 Introduction of liquidity risk 2

1.2 Liquidity risk classification 3

1.3 International standards in management and supervision of liquidity risk 4 1.3.1 Basel’s principles for the management and supervision of liquidity risk 4

1.3.2 Liquidity measurement and management 6

1.3.3 Monitoring tools for liquidity risk management 9

1.4 State bank of Vietnam’s regulations on liquidity risk management 12

1.4.1 Capital adequacy ratio – CAR 14

1.4.2 Credit limits 14

1.4.3 Limits on capital contribution and share purchase 16

1.4.4 Ratio of granted credit to mobilized capital 17

1.4.5 Solvency ratios 17

vii

1.5 Conformity of State bank of Vietnam’s regulations to the international

standards in liquidity risk management 24

1.6 Lessons from other bank’s liquidity risk management process 25

1.5.1 Overview of liquidity risk management policy 26

1.5.2 Liquidity risk policy 26

CHAPTER 2: LIQUIDITY RISK MANAGEMENT 31

AT TECHCOMBANK 31

2.1 Techcombank overview 31

2.2 Process of Liquidity risk management at Techcombank 33

2.2.1 Liquidity risk measurement at Techcombank 33

2.2.2 BOD and BOM’s risk appetite on liquidity management at Techcombank 37

2.2.3 Techcombank’s liquidity risk management structure 37

2.2.4 Techcombank’s liquidity risk management flows 41

2.3 Assessments in liquidity risk management at Techcombank 70

2.3.1 Techcombank’s compliance toward Basel and SBV’s regulations 70

2.3.2 Strengths in liquidity risk managements 72

2.3.3 Weaknesses in liquidity risk management 77

CHAPTER 3: SOLUTIONS TO IMPROVE LIQUIDITY RISK MANAGEMENT AT TECHCOMBANK 80

3.1 Pursuing ambitious business strategy 80

3.2 Investing in information technology 82

3.3 Systemic document on liquidity risk management 83

3.4 Restructuring organization and developing HR 84

viii

3.5 Intelligent and flexible strategic in liquidity risk management 87 CONCLUSION 90 REFERENCES 91

ix

LIST OF FIGURES

Figure 2.1 Techcombank’s ALCO structure 38 Firgure 2.2 Techcombank’s Treasury structure under ALCO BSM 40 Firgure 2.3 Techcombank’s liquidity risk management process 42

x

LIST OF TABLES

Table 1.1 Credit limits on debt to clients 14

Table 1.2 Credit limits on debt to related clients 15

Table 1.3 Limits on financial leasing 16

Table 1.4 Limits on capital contribution and share purchase 16

Table 1.5: Ratio of granted credit to mobilized capital 17

Table 1.6: Overnight solvency ratio report 19

Table 1.7: 1 – 7 days solvency ratio report 21

Table 2.1: Financial highlights of Techcombank (2008 – 2011) 31

Table 2.2: 1-7 days solvency ratio for each currency 34

Table 2.3: Overnight solvency ratio for each currency 35

Table 2.4: Capital Adequacy Ratio 36

Figure 2.1 Techcombank’s ALCO structure 38

Firgure 2.2 Techcombank’s Treasury structure under ALCO BSM 40

Firgure 2.3 Techcombank’s liquidity risk management process 42

Table 2.5: Daily cash flows report 43

Table 2.6: VND Liquidity gap analysis 45

Table 2.7: USD Liquidity gap analysis 50

Table 2.8: Techcombank’s Solvency limits 55

Table 2.9: Techcombank’s Solvency ratio report at 28 and 29 March 2012 55

Table 2.10: Forecast daily solvency ratios report 57

Table 2.11: Liquidity stress testing modeling 60

xi

Table 2.12: Techcombank’s Liquidity stress testing in specific crisis 62 Table 2.13: Techcombank’s Liquidity stress testing in local market crisis 66 Table 3.1: Techcombank’s 2012 plan 81

xii

LIST OF ABBRIVIATIONS

S&D Sales and distribution division

Techcombank Viet Nam Technological and Commercial joint stock bank

1

INTRODUCTION

Risk is inherent in any business in general and in financial sector in particular It has become key focuses for managers and regulators since some recent decades, specially liquidity risk, after some recent global financial crisis After and after each crisis, regulators want to implement stricter regulations to prevent financial institutions from liquidity difficulties Financial institutions’ managers also pay much more attention to liquidity issues to ensure banks’ safe and durable development

The subject of thesis focuses on liquidity risk management This is nearly new and hot topic in Vietnam financial market, since State bank of Vietnam has just issued regulations on prudential ratios in 2010 and series of its amendment right after The regulations affect immediately banks’ balance sheet structure and also long term business orientation

It’s necessary to study on the subject to understand the international principles, measurement and management practices to apply adequately in Vietnam environment Thesis aims how to respond to local regulations of SBV and step by step implement international acceptable practices

Thesis studies case of Techcombank, one of most successful joint stock in Vietnam banking sector in the last decade Techcombank also is good example to make analysis because the bank has applied not only local regulations but also starting itself to set up internal requirements to reach international practices

2

CHAPTER 1: OVERVIEW OF LIQUIDITY RISK

MANAGEMENT IN BANKS

1.1 Introduction of liquidity risk

Risk occurs in any business in general and in banking sector in particular It can be said that banks run business in the most “sensitive” environment with special product of money Risks are any events that may negative impact on the bank business It can be classified in four types of risk in banking sector They are credit risk, market risk, operations risk, and liquidity

We almost know about the first three risks Credit risk is the risk that borrower fails

to repay a loan or other contractual obligation at right time and right amount, while market risk occurs day to day according change in price of financial assets And finally, operation risk arises from execution of business functions, is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events

They all three risks come directly from business But the last one is different, it is consequential risk It arises from underlying problems They can be endogenous or exogenous Endogenous problems are most often credit risk and, some times operation risk Exogenous problems are also result from market disruptions, sovereign downgrade and any other events that could impact bank’s business Liquidity is the ability of a bank to fund increases in assets and meet obligations as they come due, without incurring unacceptable losses This definition is broader than that concept that is only possession of cash or assets that can be readily converted into cash

Liquidity risk management nowadays has become one of most challenging to any financial managers Understanding the term, risk classification and measurement

3

that help managers well control the risk and lead business to achieve their targets and goals

1.2 Liquidity risk classification

Liquidity risk could arise from internal or external factors And level of liquidity risk, as well as the quantity of the available sources of liquidity, varies, depending

on circumstances and their duration In other words, specific circumstances define level of liquidity risk By understanding each specific circumstance, managers could sound understanding, measuring, and managing of liquidity risk

According to best practice in the financial market, liquidity risk is classified into three categories, including:

- Structural liquidity risk

- Contingency liquidity risk

- Market liquidity risk

Structural liquidity risk refers to the liquidity risk in the bank’s current balance sheet structure due to maturity transformation in the cash flows of each individual position This also called mismatch risk that results from both contractually and behavior driven cash flows

Contingency liquidity risk is the risk that future events may require a significantly larger amount of cash than a bank projects it will need It is the risk of not having sufficient funds to meet sudden and unexpected short term obligations Unexpected obligations can arise due to unusual deviations in the timing of cash flows or unexpected deposit withdrawals

Market liquidity risk refers to the inability to sell assets at or near the fair value Market liquidity risk may arise when a market disruption impairs the bank’s ability

to sell large positions or lower quality positions Market liquidity may also result from impaired access to the respective markets, for examples, after loss of reputation

4

Aggressive expansion and fast development of financial services increased competition for liabilities side These lead capital market changes that impact both the level of liquidity risk and the available tactics for managing risk Understanding liquidity risk sources and its trends are very important to prevailing adequate measurement and managing activities

1.3 International standards in management and supervision of liquidity risk

1.3.1 Basel’s principles for the management and supervision of liquidity risk

After the market turmoil that began in mid 2007, liquidity has become key focus of all managers in financial markets and the banking sector Basel Committee on banking supervision of BIS started to study deeply on liquidity issue, review issues already done in the year of 2000, and in February 2008, it published Liquidity Risk Management and Supervisory Challenges After more than a half year, principles for sound liquidity risk management and supervision was issued to guideline bank managers to implement liquidity risk management

This guidance of Basel Committee highlights seventeen principles for managing and supervising liquidity risk:

1.3.1.1 Fundamental principles for the management and supervision of liquidity risk

Principle 1: A bank should establish a robust liquidity risk management framework that ensures it maintains sufficient liquidity to deal with stress events It includes maintaining quality liquidity assets, their marketability and assessing depositors, access to secured and unsecured funding sources

1.3.1.2 Governance of liquidity risk management

Principle 2: Bank should establish risk appetite for its own business, including liquidity risk tolerance

1.3.1.3 Measurement and management of liquidity risk

Principle 5: Bank should establish a sound process for indentifying, measuring, monitoring and controlling liquidity risk

Principle 6: Bank should actively monitor and control liquidity risk

Principle 7: Bank should develop an effective and diversified funding strategy Principle 8: Bank should actively manage intraday liquidity position to meet all payments on timely basis under normal and stress conditions

Principle 9: Bank should actively manage collateral positions

Principle 10: Bank should conduct stress tests regularly for short term and bank case specific and market case specific After conducting stress test, bank could review and adjust liquidity risk strategy and policy do develop effective contingency plan Principle 11: Bank should have official contingency funding plan that defines strategies for liquidity shortfalls in emergency case

Principle 12: Bank should maintain a cushion of unencumbered assets, high quality liquid assets to withstand a range of stressed scenarios

1.3.1.4 Public disclosure

Principle 13: Bank should publicly and regularly disclose information so that market participants could know about the change in liquidity risk management framework and liquidity position

1.3.1.5 The roles of supervisors

Principle 16: Supervisors should intervene to require effective and timely remedial actions to ensure bank’s liquidity

Principle 17: Supervisors should communicate with regulators and other stakeholders to keep update and effectively cooperate regarding to supervision and overview of liquidity risk management

These principles guide not only bank managers to build up and conduct effectively liquidity risk management framework, but also regulators to implement adequately

to each country

The fundamental principles create general framework on liquidity risk management that work through all concepts and documents related to the issue After studying on risk liquidity risk from term to classification and management principles, we should move on how to measure and manage liquidity risk

1.3.2 Liquidity measurement and management

Liquidity risk management is essential for the long term viability of a bank It can

be said that it is the most challenging financial risk; not because managers do not understand well the risk, but because managers often take different approaches and the “flexible” adjustments depending on specific case of bank

But almost managers should agree in some common concepts and standards on measuring and managing liquidity risk

Basel Committee on banking supervision issued Basel III that guided two common standards to use in liquidity risk management They are Liquidity Coverage Ratio and Net Stable Funding Ratio

7

1.3.2.1 Liquidity Coverage Ratio (LCR)

100dayscalendar 30

next over theoutflows

cash net Total

assetsliquid

quality -

high of

LCR means minimum level of stock of high quality liquid assets that can be converted into cash to ensure bank’s liquidity during 30 calendar day time horizon LCR is expected to meet requirement for each common currency so that bank is ready to liquidity of each currency in daily operation

Stock of high quality liquid assets

This numerator requires bank maintain adequate limit of encumbered liquid assets

to meet its liquidity

These assets could be easily and immediately converted to cash at little or no loss of value This depends on specific stress scenarios, amount and also time frame It’s ideal if these assets are eligible at central bank for intraday liquidity and overnight operation

These assets involve characteristics as follows:

- Low credit risk and market risk

- Ease and certainty of valuation

- Low correlation with risky assets

- Listed on developed and recognized exchange market

- Active and sizable market

- Presence of committed market makers

- Low market of concentration

- Flight to quality

8

Bank should manage pool of these assets quite clear and separately with trading purpose The assets must be unencumbered to secure for any other transactions So that they are readily to immediately convert to cash to meet liquidity if any

Bank should also test regularly market condition to know exactly liquidity characteristic of assets

Basel III suggests classify these assets into level 1 and level 2 assets Level 1 assets include assets held at market value and not subject to haircut under LCR, such as: cash, central bank reserves, marketable securities guaranteed by sovereign, central bank, IMF,…Level 2 assets comprise no more than 40% of overall stock after haircuts such as corporate bonds and other securities that satisfy specific conditions

of Basel

Total net cash outflows

Total net cash outflows equals total expected cash outflows minus expected cash inflows in specific scenarios for 30 calendar days



Min - Outflows outflows

To manage cash outflows, bank should pay attention to products:

- Retail deposit run off

- Unsecured wholesale funding run off

- Secured wholesale funding run off

- And other additional requirements such as: derivative payables, loss of asset backed securities, downgrade triggers,

9

1.3.2.2 Net Stable Funding Ratio - NSFR

100funding

stableof

amount Required

fundingstable

ofamount

- Preferred stock with maturity that equal or greater than one year

- Liabilities with maturity that equal or greater than one year

- Portion of non maturity deposits or term deposits under one year but expected to remain with financial institutions when it due or under stress scenarios

- Portion of wholesales under one year but expected to remain with financial institutions when it due or under stress scenarios

Required amount of stable funding for assets and off balance sheet exposure is measured by using supervisor assumptions on the broad characteristics of liquidity profile of assets, off balance sheet exposures and other activities It is calculated as the sum of assets held and funded, multiplied by a specific required stable funding (RSF) Basel III also guides detailed compositions of asset categories and associated RSF so that financial institutions could easily apply

1.3.3 Monitoring tools for liquidity risk management

Besides these two standards in the section above, Basel III has guided series of monitoring tools as a framework for liquidity risk management But supervisors may need add supplement and develop this framework by using additional tools to capture liquidity risk adequate to their bank’s business environment

These tools include the five following:

- Market related monitoring tools

1.3.3.1 Contractual maturity mismatch

Contractual maturity mismatch defines gaps between contractual inflows and outflows for each time bucket This gap analysis helps managers know how much fund they need to raise up or surplus for each time bucket

The gaps are calculated by netting all inflows and outflows from all on balance sheet and off balance sheet items, mapped respectively to their maturities

Time bucket can be constructed for overnight, 7 days, 14 days, 1, 2, 3, 6 and 9 months, 1, 2, 3, 5 and beyond 5 years And the data collected for the gap report should at least at detailed categories as liquidity coverage ratio

Based on contractual gap, banks should make necessary assumptions to reflect specific bank case to forecast reasonable in and out cash flows so that the gaps produce report more useful information for managers

total s bank' The

ty counterpar

t significan each

from sourced s

liabilitie Funding

sheet balance

total s bank' The

strument product/in

t significan each

from sourced s

liabilitie Funding

11

List of asset and liability amounts by significant currency

These applications measure concentration of funding, to know how bank depends

on each significant counterparty or product/instrument One counterparty or product/instrument are considered as significant if aggregate amount of that counterparty or product/instrument count for more than 1% of total bank’s balance sheet

In order to capture the amount of structural currency mismatch, bank must provide a list of the amount of assets and liabilities in each significant currency To be consider as significant currency, aggregate liabilities in that currency must be counted for or more 5% of total liabilities

1.3.3.3 Available unencumbered assets

Available unencumbered assets are marketable as collateral in secondary market and/or eligible for central banks’ standing facilities

These assets are additional sources of bank’s liquidity Supervisors must know quantity and key characteristics of the assets for bank’s liquidity in emergency case, including secondary market condition (haircuts, aggregate amount, counterparty…) and central bank’s related policies for each period

1.3.3.4 Liquidity coverage ratio by significant currency

In order to better capture currency mismatch, bank should also monitor liquidity coverage ratio for each significant currency

currency

t significan each

in period day time 30

a over outflows cash

net Total

currency

t significan each

in asets liquid quality high

of Stock LCR

Currency

As the foreign currency LCR is a monitoring tool, not a standard, so it does not have an international minimum requirement, bank supervisors and managers should establish minimum level to monitor adequately to bank’s specific case and environment

12

1.3.3.5 Market related monitoring tools

High frequency market data with little or no time lag can be used as early warning indicators in monitoring potential liquidity difficulties

Supervisors could monitor following information to focus on liquidity issues:

- Market wide information

- Information on financial sector

- Bank – specific information

Basel III has guided principles, measurement standards and monitoring tools for liquidity risk management These have become international guidelines that implements more and more widely in over the world Each central bank studies and implements, adjusts if needed these guidelines into specific conditions of country

1.4 State bank of Vietnam’s regulations on liquidity risk management

Regulators always want to set up common standards to control the risks, stabilize macro environment, and ensure safe business, specially, in banking sector

By understanding the international standards in liquidity management, applying in the Vietnam position, state bank of Vietnam also issued the regulations on prudential ratios in operations of credit institutions; including the liquidity ratios The regulations are detailed in the following documents:

- Circular number of 13/2010/TT-NHNN dated May 20, 2010 of the State Bank of Vietnam stipulating prudential ratios in operations of credit institutions;

- Circular number of 19/2010/TT-NHNN of September 27, 2010, on amendment, supplement of several articles of the Circular No 13/2010/TT-NHNN dated 20 May 2010 of the Governor of the State Bank providing for the prudential ratios in activities of credit institutions;

13

- Circular number of 22/2011/TT-NHNN of August 30, 2011, on the amendment, supplement of several articles of the Circular No 13/2010/TT-NHNN dated 20 May 2010 of the Governor of the State Bank on prudential ratios in activities of credit institutions;

- Circular number of 33/2011/TT-NHNN of October 08, 2011, of the State Bank of Vietnam amending, supplementing some articles of the Circular No 13/2010/TT-NHNN dated May 20, 2010 of the State Bank of Vietnam stipulating prudential ratios in operations of credit institutions and regulations on lending by credit institutions to clients issued with the Decision 1627/2001/QD-NHNN dated December 31, 2001 of the governor

of the state bank

It is also called Circular number of 13, in brief These regulations refer to credit institutions operating in Vietnam, excluding the Social Policy Bank, the Vietnam Development Bank and grassroots people's credit funds Prudential ratios stipulated

in this Circular include:

- Capital adequacy ratio;

- Credit limits;

- Limits on capital contribution and share purchase;

- Ratio of granted credit to mobilized capital;

- Solvency ratio;

These five ratios attempt to manage bank’s operations in line of risk limit, to ensure the reasonable risk tolerance in each credit institution By complying with these regulations, each bank meets the common standards to reduce the risks in the business, including liquidity risk

We pass shortly the first four ratios and focus on the last one relating to liquidity management

14

1.4.1 Capital adequacy ratio – CAR

Individual capital adequacy ratio =

Own capital Total risk-weighted assets Banks must maintain CAR of 9% as individual and also consolidated capital adequacy ratio on the basis of consolidation of capital and assets of their own and their affiliated companies

1.4.2 Credit limits

In this term, SBV sets up the limits on loans, guarantees and discounts of valuable papers to financial institution

Some limits on debt to clients as following:

Table 1.1 Credit limits on debt to clients

2 Debts and guarantee amounts/Capital for single client 25%

4

Debts and outstanding guarantee amounts/Capital for a

A credit institution may not grant unsecured credits and credits under preferential conditions to enterprises which the credit institution holds the right to control, and shall comply with SBV’s restrictions:

15

Table 1.2 Credit limits on debt to related clients

1

Debts and guarantee amounts/Capital for an enterprise that

2

Debts and guarantee amounts/Capital for more than one

enterprise that credit institution has right to control 20%

3

Unsecured credit/Capital to financial institution's affiliated

In special cases, in order to perform socio economic tasks, if capital syndication abilities of credit institutions and foreign bank branches fail to meet loan or financial lease requirements of a single client, the Prime Minister may decide on specific loan or financial lease levels on a case-by-case basis

Limits on financial leasing

16

Table 1.3 Limits on financial leasing

1

Total financial leasing debts/Own capital of financial

2

Total financial leasing debts/Own capital of financial

leasing company for a group of related clients 50%

1.4.3 Limits on capital contribution and share purchase

Table 1.4 Limits on capital contribution and share purchase

1

Capital contribution and share purchase to an enterprise, an

investment fund, an investment project or another credit

institution/ Charter capital of the latter

(except founding affiliated company under law)

11%

2

Capital contribution and share purchase of a credit

institution and its subsidiaries, joint-venture companies and

associated companies in a single enterprise, investment

fund, investment project or another credit

institution/Charter capital of the latter

11%

3 Capital contribution and share purchase in all of its

affiliated companies/Charter capital and reserve fund 25%

4

Capital contribution and share purchase in all enterprises,

investment funds, investment projects or other credit

institutions and in its affiliated companies/ Charter capital

and reserve fund

40%

17

1.4.4 Ratio of granted credit to mobilized capital

Credit institutions must comply with all regulations on solvency ratio and other prudential ratios stipulated in the circular before and after of grant of credits

Table 1.5: Ratio of granted credit to mobilized capital

Grant of credit includes lending, financial leasing factoring, guarantee and discount

of valuable papers and negotiable instruments

Mobilized capital includes:

- Demand deposits and time deposits of individuals;

- Time deposits of organizations (excluding State Treasuries), including also those of other credit institutions and foreign bank branches:

- Loans provided by domestic organizations (excluding State Treasuries and loans provided by other domestic credit institutions) and loans provided by foreign credit institutions:

- Capital mobilized from organizations and individuals through issuing valuable papers

1.4.5 Solvency ratios

Solvency ratios (also called liquidity ratios) are important part in the Circular, it requires credit institutions maintain hardly solvency ratios including overnight

18

solvency ratio and 1-7 days solvency ratio in daily basis and currency basis (VND, USD, EUR, JBP)

The regulations impact strongly the bank operations and strategic assets allocation

It must establish the responsible unit to manage daily liquidity, and to cooperate the relating units in the bank to ensure the ratios in limits The unit is in charge of issuing, amending and updating internal liquidity management policy to comply with the limits

The Circular also requires the minimum contents to guide each credit institution to set up liquidity management policy:

- Responsibilities and rights of related units in managing solvency ratios

- IT system to support generating daily reports

- Solutions to temporary liquidity difficulties

- Adequacy allocation into high liquidity assets

- Applying adequacy models for liquidity stress test and scenario test

Solvency ratios

There are two solvency ratios: overnight and 1-7days solvency ratio

Overnight solvency ratio: minimum at 15%

Discounted value

1 Cash balance, book value of gold in

2

Cash balance and book value of gold

deposited at the State Bank

(excluding compulsory reserve

deposits)

100%

3

Positive difference between the

balance of demand cash deposits and

the book value of demand gold

deposits at other credit institutions

100%

4

Positive difference between the

balance of time cash deposits and the

book value of time gold deposits

which will become mature at other

credit institutions, excluding the

Social Policy Bank and the balance

of time cash deposits and the book

value of time gold deposits which

will become due of other credit

institutions at the credit institution

concerned;

100%

20

5

The book value of bonds or public

bonds issued or the payment of

which is guaranteed by the

Vietnamese Government,

governments or central banks of

OECD member states;

100%

6 The book value of treasury bills and

7

The book value of bonds issued by

local administrations, local financial

investment companies and the

Vietnam Development Bank;

100%

8 The book value of securities listed on

Vietnam-based stock exchanges;

< 5%

payable

9

The book value of other securities

and valuable papers accepted by the

State Bank for rediscount or

depositing and transaction in

monetary market operations

100%

1-7 days solvency ratio: minimum at 100%

Discounted value

A Total assets due in 7 subsequent days

1 The cash balance of the fund at the

2

The book value of gold at the end of

the previous day including gold

deposited at the State Bank and other

credit institutions;

100%

3

The balance of deposits at the State

Bank (excluding compulsory reserve

deposits) and demand deposits at

other credit institutions at the end of

the previous day;

100%

4

The balance of time deposits at other

credit institutions which will become

due in 7 subsequent days from the

following day

100%

5

Securities issued or the payment of

which is guaranteed and held by the

Vietnamese Government and

governments of OECD member

states at the end of the previous day;

95%

6

Value of securities issued or the

payment of which is guaranteed and

held by credit institutions operating

in Vietnam or by banks of OCED

member states at the end of the

previous day:

90%

22

7

The value of other securities listed

and held at the end of the previous

day;

85%

8

Outstanding secured loans and

financial leasing amounts, excluding

non-performing loans, which will

become due in 7 subsequent days

counting from the following day;

80%

9

Outstanding unsecured loans,

excluding non-performing loans,

which will become due in 7

subsequent days counting from the

The balance of demand deposits of

other credit institutions at the end of

the previous day;

100%

2

The balance of time deposits of other

credit institutions, organizations and

individuals which will become due in

7 subsequent days counting from the

following day;

100%

3

The average balance of demand

deposits of organizations (excluding

deposits of other credit institutions)

and individuals during 30 preceding

days counting from the previous day

The credit institution shall determine

this average balance as a basis for

calculation;

15%

23

4

Outstanding loans borrowed from the

Government and the State Bank

which will become due in 7

subsequent days counting from the

following day;

100%

5

Outstanding loans borrowed from

other credit institutions which will

become due in 7 subsequent days

counting from the following day;

100%

6

Outstanding valuable papers issued

by the credit institution which will

become due in 7 subsequent days

counting from the following day;

100%

7

The value of irrevocable lending

commitments to clients which will

become due for realization in 7

subsequent days counting from the

following day;

100%

8

The value of borrowing guarantee

commitments for clients which will

become due for realization in 7

subsequent days counting from the

following day;

100%

9

The value of payment guarantee

commitments, excluding the valued

guaranteed with cash, which will

become due for realization in 7

subsequent days counting from the

following day;

100%

10

Interests and charges which will be

come due each day in 7 subsequent

days counting from the following

24

To monitor the solvency capacity, credit institutions must set up monitoring table

to support the forecast at least in the next 30 subsequent days; and take any necessary actions to bring the ratios back to the limits The circular also requires reporting responsibilities of credit institutions to SBV if any difficulties and appropriate solutions, the change in internal policy so that SBV can apply reasonable measures, limits and supports

Liquidity risk management becomes very hot topic in recent years, not just because SBV issued the circular number 13 in the year of 2010, but it derives from management demand to face with fluctuant financial market from local to global market nowadays

Success or failure of each bank or financial institution depends much on risk management activities, including liquidity risk management Implementing successfully liquidity risk managing tools, adequate to Vietnam market condition is one of challenging that banks have to face with to achieve their targets and goals on the development way

1.5 Conformity of State bank of Vietnam’s regulations to the international standards in liquidity risk management

SBV has issued the Circular number of 13/2010/TT-NHNN in 2010, and a series of its amendments, governing liquidity risk in bank’s activities It’s the first time that SBV has applied and set up standards in liquidity risk management in the market This regulation is one of important step of SBV on the way of applying Basel II in Vietnam

The circular still exist many inappropriate points and obstacles when taking effect That is why right after the first version issued, banks could not implement and fully comply with regulations SBV had to review and edit the amendments of the circular

25

After two years, SBV has an overall plan of reviewing the Circular in 2012, to assess comprehensively the compliance of banks in Vietnam and efficiency of the circular before editing the circular

Approaching Basel II standards (published in 2004) requires banks in Vietnam to improve executive management ability, specially risk management It is still challenging to not only regulators but also banks in Vietnam to apply Basel II standards

Even though Basell II is considered as an important system to push reforming and strengthening management ability in bank, but recent worldwide financial crisis show many shortcomings of Basel II in current market One is requirement of liquidity cost

So, Basel III has been developed and agreed by members of Basel Committee in 2010-2011, scheduled to be introduced and implemented by members from 2012 to

2018 from partly to completely Basel III aims to strengthen the regulation, supervision and risk management of the banking sector, to meet new requirements Basel III is a comprehensive set of reform measures, focuses much on improving the banking sector's ability to absorb shocks arising from financial and economic stress, whatever the source and risk management and governance; and strengthening transparency and disclosures

1.6 Lessons from other bank’s liquidity risk management process

If liquidity risk management has been nearly a new topic to Vietnam financial markets since some recent years, but it’s very familiar to foreign banks because international financial institutions have applied international standards in liquidity management for a long time

We’ll take CitiGroup as a good example of liquidity risk management and study Citigroup’s liquidity risk management policy as comprehensive example

In liquidity risk policy, Citigroup has guided:

26

- Overview of liquidity risk policy

- Liquidity risk policy

- Risk management tools

- Roles and responsibilities of stakeholders

1.5.1 Overview of liquidity risk management policy

Through overview of liquidity risk management policy, Citigroup determines its objective, scope, target audience, owner, effective date, related policies and exceptions

The objective of this policy is to establish standards for defining, measuring, limiting and reporting liquidity risk in order to ensure the transparency and comparability of liquidity risk – taking activities

This policy applies to all of Citigroup, Inc (“Citi”) Newly acquired entities must immediately submit a plan for compliance with this policy for approval of the Head

of Citi risk oversight

The target audience for this policy is the local business Treasurers and their staff, corporate treasury and its staff, and their respective independent market risk managers

This policy or any changes and exceptions must be approved by the Head of corporate finance and Treasury and Head of Citi risk oversight

1.5.2 Liquidity risk policy

Citi sets up standards for measurement, reporting and management of liquidity risk

in order to ensure consistency across businesses stability in methodologies, and transparency of risk

This policy requires active ALCO in each country The Country ALCOs must have presentation from all businesses and legal vehicles The Citi country officer or Country Chief Executive Officer is designated as the chair of each country ALCO

27

The policy has covered the four following contents:

- Liquidity standards

- Funding and liquidity plan

- Risk management tools

- Maintain cash capital ratio of 120% at the aggregate bank and broker dealer level

1.5.2.2 Funding and liquidity plan

The local treasurers must prepare a Funding and Liquidity plan for every reporting entity that could be a country, geographic region or a legal entity, and have it endorsed by the Country ALCO It must then be approved by the Regional market risk manager and the Head of Corporate finance and Treasury The plan should refer to Guidelines for liquidity risk management and reporting for details

For frequency of reporting, reporting entities are classified into three groups: