Liquidity risk management in banks case study

1.1 Introduction of liquidity risk 1.2 Liquidity risk classification 1.3 International standards in management and supervision of liquidity risk 1.3.1 Basel’s principles for the manage

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

1.1 Introduction of liquidity risk

1.2 Liquidity risk classification

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

1.3.2 Liquidity measurement and management

1.3.3 Monitoring tools for liquidity risk management

1.4 State bank of Vietnam’s regulations on liquidity risk

management

1.4.1 Capital adequacy ratio – CAR

1.4.2 Credit limits

1.4.3 Limits on capital contribution and share purchase

1.4.4 Ratio of granted credit to mobilized capital

1.4.5 Solvency ratios

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

international standards in liquidity risk management

1.6 Lessons from other bank’s liquidity risk management process

1.5.1 Overview of liquidity risk management policy

1.5.2 Liquidity risk policy

CHAPTER 2: LIQUIDITY RISK MANAGEMENT

AT TECHCOMBANK

2.1 Techcombank overview

2.2 Process of Liquidity risk management at Techcombank

2.2.1 Liquidity risk measurement at Techcombank

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

2.2.3 Techcombank’s liquidity risk management structure

2.2.4 Techcombank’s liquidity risk management flows

2.3 Assessments in liquidity risk management at Techcombank

2.3.1 Techcombank’s compliance toward Basel and SBV’s regulations 2.3.2 Strengths in liquidity risk managements

2.3.3 Weaknesses in liquidity risk management

CHAPTER 3: SOLUTIONS TO IMPROVE LIQUIDITY RISK

MANAGEMENT AT TECHCOMBANK

3.1 Pursuing ambitious business strategy

3.2 Investing in information technology

3.3 Systemic document on liquidity risk management

3.4 Restructuring organization and developing HR

3.5 Intelligent and flexible strategic in liquidity risk management

CONCLUSION

REFERENCES

School of Business – Vietnam National University, Hanoi

Supervisor: Dr Tran Phuong Lan 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

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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

CHAPTER 1: OVERVIEW OF LIQUIDITY RISK

MANAGEMENT IN BANKS 1.1 Introduction of 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 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 that help managers well control the risk and lead business to achieve their targets and goals

1.2 Liquidity risk classification

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

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

1.3.1.1 Fundamental principles for the management and supervision

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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

Principle 3: Bank should develop a strategy, policy and practices for managing liquidity risk according to bank’s risk appetite These should be reviewed regularly at least annually

Principle 4: Bank should develop an internal fund pricing system that includes liquidity costs, benefits and risks that products and services create for bank’s portfolio

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

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

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

1.3.2.1 Liquidity Coverage Ratio (LCR)

100dayscalendar 30

next over theoutflows

cash

net

Total

assetsliquidquality -

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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

1.3.2.2 Net Stable Funding Ratio - NSFR

100fundingstable

ofamount

Required

fundingstable

ofamount

5

NSFR is structured to ensure that long term assets are funded at least

a minimum amount of stable liabilities in relation to their liquidity risk profile

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

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sheetbalance total

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Funding

List of asset and liability amounts by significant currency

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

currency

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in period day time 30 a over outflows cash net Total

currency

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in asets liquid quality high of Stock LCR

Currency

6

Supervisors could monitor following information to focus on liquidity issues:

- Market wide information

- Information on financial sector

- Bank – specific information

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

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

in daily basis and currency basis (VND, USD, EUR, JBP)

Solvency ratios

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

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Overnight solvency ratio: minimum at 15%

1-7 days solvency ratio: minimum at 100%

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

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

1.6 Lessons from other bank’s liquidity risk management process

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:

- Overview of liquidity risk policy

- Liquidity risk policy

- Risk management tools

- Roles and responsibilities of stakeholders

1.6.2 Liquidity risk policy

1.6.2.1 Liquidity standards

1.6.2.2 Funding and liquidity plan

1.6.2.3 Risk management tools

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Now, the network of branches is more 300, covering 44 cities from North to South in Vietnam Techcombank is the first bank and unique up to now, received award of the pioneer in technological solutions in banking system in Vietnam With more than 7.500 staffs, Techcombank serves over 2 millions individuals and 60 thousands corporations

2.2 Liquidity management at Techcombank

1-7 days solvency ratio for each currency

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No Solvency Ratio 31-Dec-10 31-Dec-11 30-Mar-12

Regulatory Limit (100%)

Internal Trigger (110%)

Internal Target (115%)

1 1-7 days Solvency Ratio for VND 154.06% 145.47% 171.40% Complied Complied Complied

2 1-7 days Solvency Ratio for USD 159.84% 140.16% 118.60% Complied Complied Complied

3 1-7 days Solvency Ratio for EUR 146.70% 524.39% 224.40% Complied Complied Complied

4 1-7 days Solvency Ratio for GBP 1800.91% 2362.65% 2122.50% Complied Complied Complied

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1-7 days Solvency Ratio for other

currencies (*) 641.37% 2382.80% Complied Complied Complied

Overnight solvency ratio for each currency

No Solvency Ratio 31-Dec-10 31-Dec-11 30-Mar-12

Regulatory Limit (15%)

Internal Trigger (15.5%)

Internal Target (16%)

1 Overnight Solvency Ratio for VND 19.12% 20.15% 18.10% Complied Complied Complied

2 Overnight Solvency Ratio for USD 18.56% 22.02% 16.70% Complied Complied Complied

3 Overnight Solvency Ratio for EUR 28.62% 29.14% 24.90% Complied Complied Complied

4 Overnight Solvency Ratio for GBP 329.52% 681.44% 299.50% Complied Complied Complied

5

Overnight Solvency Ratio for other

currencies (*) 96.00% 112.00% Complied Complied Complied

(*) Other currencies included in solvency ratio for USD

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at Techcombank

Since very earlier, Techcombank’s BOD and BOM have clear view

in risk management in bank’s business and daily operations, including liquidity risk management Liquidity risk management is essential to the bank’s development Good liquidity creates stable environment for the bank’s business

This concept works through all Techcombank’s business, specially,

in credit activities Techcombank issued Risk appetite for financial institutions to assess and classify them into three categories:

- Not willing to deal

- Deal in controlling closely specific conditions

- Normal deal

In structure, Techcombank has two units responsible for managing liquidity risk management: Assets and Liabilities Committee and Treasury They work closely together and cooperate to ensure bank’s liquidity ALCO works directly with other business divisions to ensure bank’s liquidity policy that could be run through all business Treasury division is link between two markets: market of individuals and cooperates (market 1) and interbank market (market 2) to explore efficiently bank’s funding Under treasury, BSM also takes some duties of ALCO, to work and connect well between ALCO and Treasury

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process

Treasury operation officer

Branches/Trading desk to

BSM and MM officer

MM officer (in charge of

liquidity management)

Money market officer

MM officer (in charge of

liquidity management)

Money market officer

Financial officer

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Update Cash flows

at the beginning day

Inform funding IN/OUT

Update Cash flows position

Borrowing/Lending/Transfer

if needed

Forecast solvency ratios report

Improve solvency ratios report

if needed

Making solvency ratios report

Firgure 2.3 Techcombank’s liquidity risk management process

In daily basis, money market department takes care of managing, transferring and borrowing/lending if needed to ensure bank’s cash flows enough to meet the payment when it dues

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At the beginning of the day, treasury operations officer makes the Cash flows due report; it includes all contracts due

During the day, branches must inform BSM about the big cash flows

in and out the bank (sources almost from client’s savings, releasing credit, client payment activities,…); BSM sends the information to money market officer to prepare fund or lending fund if needed All transactions of treasury trading desk (foreign exchange, gold, bond, money market,…) must inform directly the deals occurring intraday to money market officer

And based the two data above, money market officer collects and inputs all deals occurring intraday including the cash flows from all branches and treasury’s trading desks by currency and by account

To manage the account balance, after balancing each account, officer transfers money between accounts or decides to borrow/lend to ensure the payable ability if needed

According to the SBV’s regulations, Techcombank must run the liquidity ratios at the limit of 100% for 1-7 days solvency and of 15% for overnight solvency ratio in each currency In fact, to enhance the liquidity, Techcombank has also applied higher requirements on solvency ratios through internal trigger and internal target

Techcombank’s Solvency limits

Solvency Ratio Regulatory

Limit

Internal Trigger

Internal Target 1-7 days Solvency Ratio 100% 110% 115%

Overnight Solvency Ratio 15% 15.5% 16%