LIQUIDITY RISK MANAGEMENT IN LIEN VIET COMMERCIAL JOINT STOCK BANK

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

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

VIETNAM NATIONAL UNIVERSITY, HANOI

SCHOOL OF BUSINESS

VAN THU HUONG

LIQUIDITY RISK MANAGEMENT

IN LIEN VIET COMMERCIAL JOINT STOCK BANK

Major: Business Administration

TABLE OF CONTENTS

ACKNOWLEDGEMENTS i

ABSTRACT ii

TÓM TẮT iv

LIST OF ABBREVIATIONS x

LIST OF TABLES xi

LIST OF FIGURES xii

INTRODUCTION 1

CHAPTER I: LITERATURE REVIEW 5

1.1 Commercial bank 5

1.1.1 Concepts 5

1.1.2 Products & services provided by commercial banks 6

1.1.3 Roles of commercial bank in economics 6

1.2 Risk management in Commercial Bank 7

1.2.1 Risk in commercial bank 7

1.2.2 Main risks in Commercial Bank 8

1.2.3 Risk Management in Commercial Bank 8

1.3 Liquidity Risk Management in Commercial Bank 10

1.3.1 Defining liquidity risk 10

1.3.2 Basel and Basel II requirements 12

1.3.3 International Framework for Liquidity Risk Management in Commercial Bank 16 1.3.3.1 Liquidity risk tolerance 18

1.3.3.2 Strategy & Policy 18

1.3.3.3 The responsibilities to manage liquidity risk 19

1.3.3.4 Liquidity Risk Management Process 21

1.3.3.5 Contingency Planning 25

1.3.3.6 Internal Audit 27

1.4 Liquidity risk in Vietnam Commercial bank system 27

1.4.1 Some typical events of liquidly risk in Viet Nam before year 2006 27

1.4.2 From the beginning of year 2006 to the end of year 2007: 28

1.4.3 From the beginning of year 2008 – the end of year 2008 29

1.4.4 From the beginning of year 2009 to the ending of year 2009 30

1.4.5 The first six months of year 2010 31

1.4.6 Summarized main reasons for liquidity crunch 32

1.5 State Bank of Vietnam regulations 33

1.6 Practices for liquidity risk management 37

1.6.1 The Hongkong and Shanghai Bank Corporation 37

1.6.2 Asia Commercial Bank 38

CHAPTER 2 LIQUIDITY RISK MANAGEMENT IN LIENVIETBANK 41

2.1 Overview on LienVietBank 41

2.1.1 Introduction 41

2.1.2 Business Results 44

2.1.3 Organization structure 44

2.2 Liquidity risk in LienVietBank 45 2.2.1 SBV’s regulations on liquidity ratios in the activities of credit institution

46

2.2.2 Supplies of Liquidity 47

2.2.2.1 Liquid Assets 48

2.2.2.2 Loans repayment 53

2.2.2.3 Total mobilized funds and chartered capital 55

2.2.3 Measurement of Liquidity risk via Gap Analysis 59

2.2.3.1 LienVietBank’s Liquidity Gap report in VND (see table 2-11) 60

2.2.3.2 LienVietBank’s Liquidity Gap report in USD (see table 2-12) 63

2.2.4 Assessment on current status of liquidity risk 65

2.3 General situation of risk management at LienVietBank 67

2.3.1 From establishment to end 2008 67

2.3.2 For the year of 2009 68

2.3.3 From the beginning of 2010 to now 69

2.4 Liquidity risk management in LienVietBank 69

2.4.1 Strategy and Policy 69

2.4.2 The responsibilities to manage liquidity risk 71

2.4.3 Process of liquidity risk management 74

2.4.4 Internal Audit 75

2.4.5 Contingency Plan 75

2.5 Assessment on liquidity risk management in LienVietBank 76

2.5.1 Achievements 77

2.5.2 Drawbacks on the current liquidity risk management in LienVietBank 78 2.5.2.1 Strategy and policy 78

2.5.2.2 Organization structure 78

2.5.2.3 Process of liquidity risk management and contingency plan 79

2.5.2.4 Management information system 79

2.5.2.5 Human resource 80

CHAPTER 3 RECOMMENDATIONS AND SOLUTIONS 82

3.1 Some petitions for LienVietBank 82

3.1.1 Building a culture of risk management in LienVietBank 82

3.1.2 Building Liquidity risk strategy and policy 84

3.1.3 Improving organizational structure 87

3.1.4 Building process of liquidity risk management 90

3.1.5 Building contingency plan 97

3.1.6 Improving management information system 99

3.1.7 Improving human resources 100

3.1.8 Action planning 102

3.2 Some petitions for SBV 107

3.3 Some petitions for Government 108

Conclusion 109

REFERENCE 110

Appendix 1 112

Appendix 2 113

Appendix 3 114

Appendix 4 115

LIST OF ABBREVIATIONS

ACB Asia Commercial Bank

ALCO Asset and Liability Committee

BOD Board of Directors

BOM Board of Management

CAR Capital Equity Ratio

LVB LienViet Commercial Joint Stock bank

NPLs Non performing loans

SBV State Bank of Viet Nam

Sacombank Sai Gon Thuong Tin bank

TCB Vietnam Technological and Commercial Joint stock bank VCB The Bank for Foreign Trade of Vietnam

LIST OF TABLES

Table 1-1: Products & services provided by commercial banks 6

Table 1-2: Summarized the principles of Basel 2 14

Table 1-3: International Framework for Liquidity Risk Management in Commercial Bank 17

Table 1-4: The differences between Decision No.457 and Circular 15 & 13 36

Table 2-1: Business Results - LienVietBank 44

Table 2-2: Comparison of the liquidity ratios 46

Table 2-3: The ratio of liquid assets to total assets 49

Table 2-4: Comparison of the ratio of liquid assets to total assets 50

Table 2-5: The average ratio of the component to liquid assets 51

Table 2-6: Comparison of the portion of the items out of liquid assets 52

Table 2-7: Some indicators of loans quality 54

Table 2-8: Comparison of loans quality by NPL ratio 55

Table 2-9: Comparison of LDR 55

Table 2-10: Mobilized funds from corporate and individuals of LienVietBank 57

Table 2-11: LienVietBank’s Liquidity Gap report in VND 62

Table 2-12: LienVietBank’s Liquidity Gap report in USD 64

Table 2-13: Summarize assessment on current status of liquidity risk in LienVietBank 65

Table 3-1: Recommendation for Process of liquidity risk management (content) 91

Table 3-2: Recommendation for Contingency plan sample 98

Table 3-3: Recommendation for Action planning 103

LIST OF FIGURES

Figure 1- 1: Three pillars of Basel II 13

Figure 2-1: Comparison of the ratio of liquid assets to total assets 50

Figure 2-2: Total mobilized funds of LVB 56

Figure 2-3: The number of accounts of incoming customer deposits 58

Figure 2-4: Rating liquidity risk management in LVB 77

Figure 3-1: Overview on chapter 3……… 81

Figure 3-2: Recommendation for Organization structure 87

Figure 3-2: Recommendation for Process of liquidity risk management (procedures) 95

INTRODUCTION

1 Necessity of the thesis

The nature of the bank is making a profit based on business risk In banking activities many types of risk exist (credit risk, liquidity risk, market risk, etc.) In Vietnam, the banking activities are often associated with credit risk However, liquidity risk, the type of risks that can immediately make a bank collapse is less focused, because if the banking activities took place on a normal schedule, the risk was not disclosed Only when a certain event happens to have a negative impact on the bank, then the liquidity risk is exposed, in the worst case, banks have no liquidity, leading to bankruptcy, and affecting the entire banking system

In Vietnam, liquidity risk can be a problem just say "old problem" was just a matter of "new problem" Calling it "an old problem" is because any bank manager knows about this kind of risk, understands the importance of it and they are also managing liquidity risk based on experience and traditional methods And calling it "a new problem" is because not many banks in Vietnam really understand it and find ways to reach new approaches to liquidity risk management by international standards Only after the events on the liquidity risk from 2006 through to now did banks begin to explore and consciously implement the management of liquidity risk, according to a scientific and more systematic method The starting point of that process must be derived from the banks which are fully equipped with theoretical knowledge about liquidity risk management

LienVietBank was established in April 2008, and in more than 2 years the bank has gained outstanding achievements in business results, but besides that, the issues of risk management are all complex The organizational structure is not stable, risk management personnel frequently change, the bank only cares about

credit risk management and pays no attention to risk management activities, particularly the management liquidity risk

And if there is a crisis similar to the liquidity crisis in 2008, the bank will face the enormous difficulty It is the reason why I decided to choose the topic

“Liquidity risk management in Lien Viet Commercial Joint Stock Bank” for my thesis

and periodic, science reviews

 Information gathered from direct observation as a person directly involved in activities related

The research methodology of the thesis is the combination of both qualitative and quantitative to analyze data and information, make comparisons, evaluations and conclusions on current situation of liquidity risk management in LienVietBank

The assessment focuses on the liquidity risk management in LienVietBank, due

to time constraint, limited analysis tools and the ability to approach data sources the research can not be analyzed fully and deeply all aspects of the problem

Thesis systematizes the basic knowledge of liquidity risk management in commercial bank, to apply this knowledge to assess liquidity risk and liquidity risk management in LienVietBank From there thesis contributes practical ideas

to LienVietBank to improve liquidity risk management, enhance competitiveness of LienVietBank in the market

TOPIC: “Liquidity risk management in LienViet Commercial Joint stock bank (LienVietBank)”

Introduction

Chapter 1: Literature Review

Chapter 2: Liquidity risk management in LienVietBank

Chapter 3: Recommendations and Solutions Conclusion

References

CHAPTER I: LITERATURE REVIEW

This chapter aims to answer the research questions about liquidity risk Firstly, definitions related to commercial bank, risk management in commercial bank Secondly and finally, definitions related to liquidity risk and liquidity risk management in commercial bank, expressing by Basel II and international framework for liquidity risk management

There is still much confusion about what exactly a commercial bank is And many definitions have been given by organizations "Commercial banks" can be defined based on: (1) Its function in the economy; (2) The services it offers to customers or (3) based on legal institutions that exist:

“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

1.1.2 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 banks1

Liability products

Represent liabilities of the bank, include checking and savings accounts, certificates of deposit and other types of deposit products

Asset 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

Electronic banking

Include the maintenance and expansion of 24-hour ATM networks, wire transfers and banking websites that allow consumers and business to obtain account information, open new accounts, order checks, transfer funds between accounts and make bill payments

Other Services

Include investment advisory services, corporate finance consulting, custodial services for estates and trusts, safekeeping of securities and other valuable items, and money transfer services

Commercial banks play an important role in economic development Economic development involves investment in various sectors of economy Commercial banks collect savings from the people and mobilize saving for investment in industrial project or making loans to individuals The investors borrow from banks to finance the projects Special funds are provided to the investors for the

completion of projects Commercial banks also represent a vital link in the transmission of government’s economic policies to the rest of the economy, when bank credit is scare and expensive, spending in the economy tends to slow and unemployment usually increase Or if interest rates are very high, the cost of bank credit will be high and this could be inflationary

Risk in a banking organization is possibility that the outcome of an action or event could bring up adverse impacts Such outcomes could either result in a direct loss of earnings/capital or may result in imposition of constraints on bank’s ability to meet its business objectives Such constraints pose a risk as these could hinder a bank's ability to conduct its ongoing business or to take benefit of opportunities to enhance its business

Banks often distinguish between expected and unexpected losses Expected losses are those that the bank knows with reasonable certainty will occur (e.g., the expected default rate of corporate loan portfolio or credit card portfolio) and are typically reserved for in some manner Unexpected losses are those associated with unforeseen events (e.g losses experienced by banks in the aftermath of nuclear tests, Losses due to a sudden down turn in economy or falling interest rates) Banks rely on their capital as a buffer to absorb such losses

Risks are usually defined by the adverse impact on profitability of several distinct sources of uncertainty While the types and degree of risks an organization may be exposed to depend upon a number of factors such as its size, complexity business activities, volume etc, it is believed that generally the

1

State Bank of Pakistan, (2002), Risk Management- Guideline for Commercial Banks & DFIs, page

1

banks face Credit, Market, Liquidity, Operational, Compliance/Legal/Regulatory and reputation risks Before overarching these risk categories, given below are some basics about risk Management and some guiding principles to manage risks in banking organization

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 arises from the potential that an obligor is either unwilling to perform

on an obligation or its ability to perform such obligation is impaired resulting in economic loss to the bank.1

Market Risk: It is the risk that the value of on and off-balance sheet positions of

a financial institution will be adversely affected by movements in market rates

or prices such as interest rates, foreign exchange rates, equity prices, credit spreads and/or commodity prices resulting in a loss to earnings and capital2

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: the risk of loss resulting from inadequate or failed internal

processes, people and systems or from external events The definition includes legal risk but excludes strategic and reputational risk.4

“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)”

The acceptance and management of financial risk is inherent to the business of banking and banks’ roles as financial intermediaries Risk management as commonly perceived does not mean minimizing risk; rather the goal of risk management is to optimize risk-reward trade-off Bank accepts risks that are uniquely part of the array of bank’s services

Risk management activities broadly take place simultaneously at following different hierarchy levels

Strategic level: It encompasses risk management functions performed by senior

management and board of director For instance definition of risks, ascertaining institutions risk appetite, formulating strategy and policies for managing risks and establish adequate systems and controls to ensure that overall risk remain within acceptable level and the reward compensate for the risk taken

Macro Level: It encompasses risk management within a business area or across

business lines Generally the risk management activities performed by middle management or units devoted to risk reviews fall into this category

Micro Level: It involves ‘On-the-line’ risk management where risks are actually

created This is the risk management activities performed by individuals who take risk on organization’s behalf such as front office and loan origination functions The risk management in those areas is confined to following operational procedures and guidelines set by management

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 3-4

 Anticipate adverse changes

 Be less vulnerable from negative environmental changes

 Increase competitive advantages

 Be able to gain the expertise to price risks and take opportunities.

1.3.1 Defining liquidity risk

"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

The Supply of Liquidity

 Incoming customer deposits

 Revenues from the sale of nondeposit services

 Customer Loan repayments

 Borrowing from the money market

 Selling assets

 Capital and Reserve

The Demand for Liquidity

 Customer deposit withdrawals

 Credit requests from quality loan customers

1

Source : Autorite Des Marches Financiers, (2009), Liquidity risk management guideline, page 7

 Repayment of nondeposit borrowing

 Operating expenses and payment of tax

 Payment of dividends by cash

Net liquidity position

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)

Implications of liquidity deficit:

 Offering higher rate of profit to deposits

 Shortage of financial resources to invest against commitments

 Loss of competitiveness

 Liquidity surplus: Net liquidity position <0 (Smaller than zero)

Implications of liquidity surplus:

 Underutilization of financial resources,

 Lower income and higher cost,

 Loss of competitiveness

Liquidity risk 1

Liquidity risk results from a financial institution’s difficulty or inability to honor its liquidity commitments in a timely manner at a reasonable cost Liquidity risk can also extend to a financial institution’s inability to take advantage of business opportunities and sustain the growth forecast in its strategic plan (strategic risk) due to a lack of liquidity or difficulty in obtaining funding at a reasonable cost

1

Source : Autorite Des Marches Financiers, (2009), Liquidity risk management guideline, page 7

Main causes of liquidity risk

Maturity mismatch Bank takes large amount of short term deposit and then make invest in long-term (maturity mismatch).The problem related to maturity mismatch situation is that bank hold an unusually high proportion of liability subject to immediate payment

 Sensitivity to rate change: rate of profit by other banks on deposits

rise/change of profit rate of deposit

 Loss of public confidence

 Unanticipated change in cost of capital

 Abnormal behavior of financial market

 Incorrect judgments and complacency

 Conversion of non-funded based limit into funded based

 Severe deterioration of assets quality

1.3.2 Basel and Basel II requirements

The Basel Committee on Banking Supervision is a committee of banking supervisory authorities that was established by the central bank governors of the Group of Ten countries in 1975 It consists of senior representatives of bank supervisory authorities and central banks from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the United Kingdom, and the United States It usually meets at the Bank for International Settlements in Basel, where its permanent Secretariat is located

Basel II is the second of the Basel Accords which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision Basel II uses a "three pillars" concept – (1) minimum capital

requirements (addressing risk), (2) supervisory review and (3) market discipline – to promote greater stability in the financial system

Figure 1- 1: Three pillars of Basel II

(Source: http://www.oenb.at/en/img/threepillars_tcm16-154242.jpg) The first pillar deals with maintenance of regulatory capital calculated for three

major components of risk that a bank faces: credit risk, operational risk and market risk Other risks are not considered fully quantifiable at this stage

The second pillar deals with the regulatory response to the first pillar, giving

regulators much risk, strategic risk, reputation risk, liquidity risk and legal risk, which the accord improved 'tools' over those available to them under Basel I It also provides a framework for dealing with all the other risks a bank may face, such as systemic risk, pension risk, concentration combines under the title of residual risk It gives banks a power to review their risk management system

The third pillar greatly increases the disclosures that the bank must make This

is designed to allow the market to have a better picture of the overall risk position of the bank and to allow the counterparties of the bank to price and deal

- Establish a robust liquidity risk

management framework that ensures it

maintains sufficient liquidity, including a cushion of unencumbered, high quality liquid assets, to withstand a range of stress events, including those involving the loss or impairment of both unsecured and secured funding sources

- Supervisors should assess the adequacy

of both a bank's liquidity risk management framework and its liquidity position

- Should develop a strategy, policies and

practices to manage liquidity risk in

accordance with the risk tolerance and to ensure that the bank maintains sufficient liquidity

- Should incorporate liquidity costs,

benefits and risks in the product pricing,

performance measurement and new product approval process for all significant business activities (both on- and off-balance sheet)

- Should have a sound process for

identifying, measuring, monitoring and controlling liquidity risk

- Should actively manage liquidity risk

exposures and funding needs within and across legal entities, business lines and currencies

- Should establish a funding strategy that

provides effective diversification in the sources and tenor of funding

- Should actively manage its intraday

liquidity positions and risks to meet

payment and settlement obligations on a timely basis under both normal and stressed conditions

- Should actively manage its collateral

positions, differentiating between

encumbered and unencumbered assets

- Should conduct stress tests on a regular

basis for a variety of institution-specific and market-wide stress scenarios

- Should have a formal contingency

funding plan (CFP)

- Should maintain a cushion of

unencumbered, high quality liquid assets

to be held as insurance against a range of liquidity stress scenarios

Public disclosure Principle 13 Should publicly disclose information on a

regular basis

The role of

supervisors

Principle 14,

15, 16, 17

- Supervisors should regularly perform a

comprehensive assessment of a bank’s

overall liquidity risk management framework and liquidity position

- Supervisors should supplement their regular assessments of a bank’s liquidity risk management framework and liquidity

position by monitoring a combination of

internal reports, prudential reports and market information

- Supervisors should intervene to require

effective and timely remedial action by a

bank

- Supervisors should communicate with

other supervisors and public authorities

1.3.3 International Framework for Liquidity Risk Management in

Commercial Bank 123456

Based on the seventeen principles of the Basel 2 on liquidity risk management, many commercial banks in the world have applied these recommendations on liquidity risk management at the banks There are differences in how the banks

to adapt to the characteristics of each bank, these banks are subject to a risk management framework common liquidity Its contents are summarized in the table 1-3 and presented concrete below

Independent review Guidance of

responsibilities

ALCO committee Measurement

Management Process Senior manager

Scenario and Stress

Identify back-up source funding

and infrastructure

INTERNATIONAL FRAMEWORK FOR LIQUIDITY RISK MANAGEMENT

(Source: Summarized by the author)

1.3.3.1 Liquidity risk tolerance

Risk tolerance is the measurement of a bank's willingness to suffer a decline (or repeated declines) in the value of investments (assets or capital) Banks must determine level of corporate risk tolerance and liquidity risk tolerance

1.3.3.2 Strategy & Policy

Financial institutions consider the importance of capital adequacy in managing liquidity risk and the potential impact of a liquidity crisis on their solvency Liquidity risk management strategy help the financial institution protect its capital, maintain marketplace confidence, take advantage of business opportunities and, finally, sustain its growth forecast

A liquidity risk management strategy should include:

 Capital adequacy in managing liquidity risk and the potential impact of a liquidity crisis on their solvency;

 The responsibilities to manage liquidity risk;

 Polices, processes and procedures to be implemented in order to identify, measure, monitor, mitigate and control liquidity risk

 The crisis contingency plan

 Internal Audit

The policy addresses the bank’s objective of protecting financial strength even for stressful events It prescribes the following minimum liquidity risk management requirements for banks:

 Provide clear guidance on the composition and role of the asset/liability committee or such other group responsible for managing liquidity;

 Establish approval processes to ensure adherence to liquidity risk

management processes;

 Establish liquidity ratio benchmarks

 Establish limits on the degree of concentrations to ensure diversification

of funding by origin and by term structure, for example, guarding against concentration by individuals or groups of depositors, types of deposit, sources of deposit, geographical, maturity period, and currencies; (5)

 Establish a framework for the composition of assets;

 Detail procedures for effectively managing domestic and foreign currency liquidity; and establish procedures to solve the problem that have internal control breaches;

 Regularly review of the deposit structure, include the volume and trend

of various types of deposits offered, maturity distributions of time deposits, interest rate paid on each type of deposit, prevailing market interest rate, limits on large time deposits, public funds, and non-resident deposits Review of alternate funding sources including stand-by facilities and lines of credit;

 Evaluate the acceptable mismatch in combination with currency commitments, for each currency individually and all currencies Set and regularly review limits on the size of cash flow mismatches over particular time horizons

1.3.3.3 The responsibilities to manage liquidity risk

 The Board of Directors

 Establishing and guiding the institution’s strategy and tolerance for liquidity risk

 Ensuring appropriate policies and procedures are established to guide the

management of the institution’s liquidity risk These policies and procedures should be reviewed periodically; at least annually

 Selecting senior managers with the authority, responsibility and competence to manage liquidity risk

 Monitoring the institution’s performance against the established liquidity risk profile

 Ensuring that liquidity risk is identified, measured, monitored and controlled

 Specifying the content and frequency of management’s liquidity reports

 Ensuring adherence to the lines of authority and responsibility that the board has established for managing liquidity risk

 Reviewing periodic management liquidity reports

 Reporting comprehensively on the liquidity management program to the board at least quarterly

 Role of Senior Management

 Implementing policies and procedures, i.e translating the board’s goals, objectives and risk tolerances into operating standards that are disseminated to staff

 Measuring and monitoring the liquidity needs of the institution on an ongoing basis

 Ensuring that liquidity is managed and controlled within the parameters

of the liquidity policy

 Establishing and utilizing a method for accurately measuring the institution’s current and projected liquidity needs

 Referring issues outside the scope of their authority to the ALCO

 Reporting periodically (at least monthly) to the ALCO

1.3.3.4 Liquidity Risk Management Process

 Identification of Liquidity Risk

Sources of risk relate to its balance sheet structure, off-balance sheet activities, exposure to other risks or market conditions For example:

 Inflows from the realization of assets (either upon maturity or at the time

of sale) are less than anticipated because of default risk or price volatility;

 Significant concentrations within the asset portfolio (e.g in relation to the distribution of exposures by counterparty, instrument type, geographical location or economic sector);

 Concentrations of funding sources or changing market conditions on the funding structure; concentration by individuals or groups of depositors, types of deposit, sources of deposit, geographical, maturity period, and currencies

Besides, loan commitments given by banks to their customer draw on liquidity Banks should be able to estimate and incorporate in their cash-flow projections the amount and timing of unused commitments (including those arising from

mortgage loans, retail overdrafts and credit cards) that will possibly be drawn; The direction and amount of cash flows for derivatives, options and other contingent items are affected by market interest rates, exchange rates and other special terms under the contract Banks should estimate such cash flows with care, having regard to the nature of individual transactions and market conditions; and

The unpredictable cash flow of the contingent liability embedded credit derivatives gives rise to liquidity demands It is expected that banks will undertake some scenario analysis to better establish the impact if the contingent liability is called upon

In summary, a financial institution should clearly identify its sources of liquidity risk as well as their impacts on its risk profile and liquidity position

 Measurement of Liquidity Risk

Analyze the liquidity positions in all of the major currencies in which they deal, both individually and all currencies, on a day to day basis for the shorter time horizons and over a series of specified time periods thereafter, including for more distant periods, in order to manage effectively and monitor the net funding requirements

 Liquidity Ratios:

- Liquid Assets to Total Assets

- Loans to Deposit

 Maturity Gap Analysis (MAP)

MAP is a simple technique for the measurement of liquidity risk, which also includes a note on the behavioral maturity of savings portfolios and its influence on maturity gap analysis Banks will calculate the gap between

assets and liabilities in terms of maturities If the maturity mismatch (GAP)

in any period (e.g., day, month, quarter) exceeds the limit allowed, the Asset/Liability Committee must take decisions to rectify the situation The basic steps are as follows:

- Choose time intervals used to analyze banking company liquidity

- Distributing assets and liabilities into appropriate time intervals

- Observing the Asset/Liability maturity profile

- Estimate the difference (positive or negative) between total assets and total liabilities pertaining to each time interval A negative mismatch

in the short-term may be cause for concern as it may indicate that the banking company is going to have problems funding, at a reasonable cost, all contractual obligations

 Scenario and Stress Testing

Scenario analyses and stress tests should focus on the following;

 Potential tightening or disruption of unsecured and secured loans markets;

 Prolonged unavailability of medium- and long-term funding sources (securitization, issuance of medium- to long-term securities, bonded debt, etc.) The simulation should reflect the correlation between short-term markets (interbank lending, repurchase and reverse repurchase agreements, etc.) and medium- to long-term markets The assumption that in the event of a crisis, a financial institution will ultimately be able

to rely on short-term funding may not be supported if the liquidity crisis undermines market confidence;

 Limits to the diversity of funding sources in the event of a crisis In a crisis situation, the securitization market may be completely frozen, the

bond market may be partially frozen and the interbank market may incur lower trading volumes and post shorter maturities The simulation should also assume that markets may be volatile in various foreign currencies simultaneously;

 The ability to convert liquidity from one currency to another during a crisis

 Monitoring of Liquidity Risk

Establishing and maintaining appropriate systems for monitoring liquidity risk Systems that produce liquidity reports should be linked to the bank’s core system and the data should reconcile with the bank’s financial data The liquidity management framework should provide the Board, senior management and other appropriate personnel with timely information on the liquidity position of the bank These reports should indicate breaches of limits or when the bank is approaching the limit and general compliance with the bank’s established policies and procedures Such systems need to be flexible enough to deal with various contingencies that may arise

 Mitigation of liquidity risk

 Holding an appropriate amount of liquid assets and diversify its sources

of financing Moreover, the financial institution should place importance

on its relations with funds providers The quality of these relations can be

a determining factor in times of crisis Identify the types, qualities and quantity of liquid assets it must hold in order to meet its liquidity requirements adequately base on such criteria:

- The market’s availability, the time to liquidate assets and the selling price;

- The percentage of total asset or net funding requirement;

- The currency of the assets; the maturity date, in view of a possible redemption or early sale;

- The possibility of pledging the assets as collateral to borrow funds or

as part of repurchase agreements;

- The concentration by type of asset, counterparty, geographic location and industry

 Diversification of financing sources, bank should analyze the various characteristics of its liabilities and their impact on its liquidity position in light of the following:

- The maturity date and volatility of liabilities;

- Percentage of holdings of secured and unsecured funding;

- The number of funds provider, the geographic location of the funds providers and their industry or area of activity

 Analyze the various conditions that apply to liabilities: (1) Liabilities that are stable even in times of crisis; (2) Liabilities likely to be withdrawn gradually after the first signs of a crisis; (3) Liabilities withdrawn immediately

 Securitization and repurchase agreements

1.3.3.5 Contingency Planning

 The contingency plan will follow scenarios (and for stress testing) The contingency plan should include early warning signs to signal a possible liquidity crisis and trigger implementation of the plan These indicators could include the following:

 Rapid asset growth, especially if funded with potentially volatile liabilities;

 Repeated breaching of internal and regulatory limits

 Significant decline in profitability, asset quality and overall financial condition of the institution

 Credit rating downgrade;

 Difficult to obtaining market funding or inability to access such funding; rising funding costs

 Going down or elimination of lines of credit granted to the institution by counterparties;

 Worsening in cash flow positions due to greater mismatching of maturities, particularly short-term maturities;

 Increase in deposit withdrawals for short-term periods;

 Changes in market conditions

 Effective contingency plans should include:

 Specific procedures to ensure timely and uninterrupted information flows

to senior management;

 Clear divisions of responsibility within management in a crisis;

 Action plans for altering the composition of assets and liabilities (i.e market assets more aggressively, sell assets intended to be held, raise interest on deposits etc.);

 An identification of back-up sources of funding, including unused credit lines, the circumstances in which they can be accessed, the amount expected and the priority attached to each alternative source of funds (i.e designate primary and secondary sources of liquidity);

 A classification of borrowers and trading customers according to their

importance to the institution in order to maintain customer relationships

 Identify the information and data necessary for decision-making and ensure they are available in a timely manner and on a continuous basis throughout the crisis;

 Plans and procedures for communicating with the media Determine the actions to be taken as regards clients, market participants, the media, compensation bodies and its regulatory agency; determine the potential impact of the actions to be taken on market perception, the reputation of the financial institution and its solvency;

 The contingency plan should be reviewed and updated regularly and also be tested to ensure that it is effective and appropriate

1.3.3.6 Internal Audit

Banks should use an independent review process to:

 Ensure that established policies and procedures are being followed;

 Ensure that procedures are achieving their objectives;

 Review the liquidity management process to identify any weaknesses;

 Ensure prompt corrective actions are taken

1.4.1 Some typical events of liquidly risk in Viet Nam before year 2006

Some events of liquidity risk occurred with the consequences are small and only affect a small number of banks, but have revealed signs of weakness and passivity of the Vietnamese banks in liquidity risk management

In Oct 2003, rumor had it Mr Pham Van Thiet, General Director of Asia Commercial Joint Stock Bank (“ACB”), had committed peculation and fled The bank’s depositors immediately demanded cash withdrawal As of 21:00

October 14, ACB had made payments to their customers totaling nearly VND700 billion, inclusive of USD16 million On October 15, the Governor of State Bank of Vietnam (“SBV”) Mr Le Duc Thuy had approved the discount limit of VND960 billion for ACB and at the same time denied such rumor Only with this support did ACB overcome the problem

On 22/07/2005, due to the fact that Phuong Nam Bank had lent to ineligible staff of 30 organizations in Soc Son District with estimated amount of nearly VND1 billion, customers flocked at the bank’s office to claim their money Phuong Nam Bank had to draw VND53 billion from its account with SBV At the end of the day, supported by SBV and Deposit Insurance of Vietnam (“DIV”), the bank had stopped the withdrawal

In July 2005, from hearsay that Ninh Binh Rural Joint Stock Bank had been involved in the USD10 million loan for the project of Nguyen Duc Chi who had been previously arrested, together with rumor of the disappearance of the bank’s director Mdm Nguyen Thi Hue, the public had swarmed the bank and drawn VND20 billion from their accounts The incident was quite a serious problem for this small-sized rural joint stock bank Eventually the attempt of DIV had ceased such withdrawal

1.4.2 From the beginning of year 2006 to the end of year 2007:

Business booming coupled with potential liquidity risk

As of the end of 2007, there were 80 banks in the local market including 5 owned banks, 37 commercial joint stock banks, 33 foreign bank branches and 5 joint venture banks This period also witnessed the breakout in the operation scale in the banking field In 2007 total assets of the banking system exceeded VND1,500 trillion or equivalent to 130% of the year’s GDP The annual growth

state-of credit and deposit activities was reported at very high rate state-of over 35% Particularly loan growth in 2007 increased by 53.89% against 2006, much

higher than the increase by 25.44% of 2006 over 2005 Fund mobilization in

2007 grew by 47.64% (2006: 36.53%)

Capital adequacy ratio (“CAR”) – an important criterion representing the repayment capacity of the bank’s term borrowings – had improved The average ratio for state-owned commercial banks had increased from 7% in 2006 to 9% in

2007 while the number for joint stock commercial banks stood at about 12% However, the banks faced potential risks, especially liquidity risk, in view that the bank lending to customer deposit ratio of the whole system stably stood at 90% (regional average was at 83%) Specifically a few banks whose ratio exceeded 100% were largely dependant in borrowings from interbank market

1.4.3 From the beginning of year 2008 – the end of year 2008

Liquidity risk occurred in severity and affected the safe operation of the entire banking system

Since early 2008 the global economy has been suffering from the worst crisis in history The impacts of this crisis together with the tightened monetary policy of SBV had Vietnam commercial banks facing serious issue in regard to liquidity:

 On 30.1.2008, SBV announced the upward adjustment of base lending rate from 8.25% per annum (“p.a.”) to 8.75%p.a., refinancing rate from 6.5%p.a

to 7.5%p.a and discount rate from 4.5%p.a to 6%p.a

 On 30.1.2008, SBV pumped VND12 trillion to meet banks’ liquidity requirement

 On 31.1.2008, SBV announced the offering of VND15 trillion for 2 weeks

 On 13.2.08, SBV announced the issuance of obligatory VND Treasury bill

on 17.3.08 totaling VND20.3 trillion at tenure of 364 days and coupon rate at 7.8%p.a to all 41 commercial banks

 On 19.2.08, interbank rate skyrocketed to 42%p.a

The potential risks previously forecasted had clearly exposed In order to meet liquidity requirement and to ensure operation security, commercial banks temporarily ceased lending, concentrated on debts collection and sought funds

to cover liquidity The race for funding had accelerated the average interest rate from 12%p.a to 18.6%p.a and distorted the interest rate curve where short term deposit rate became higher than long term deposit rate Some small banks’ operation became stagnant and those were categorized under special inspection The level of liquidity problem differed among commercial banks Small banks were more exposed to potential risks while big commercial banks, taking full advantage of their capital, assets and sound risk management capability, employed the funds rather efficiently, thus their liquidity risk was at relatively low level

By the end of 2008, as a result of drastic measures for liquidity management, liquidity position of Vietnam banking system had improved as could be seen from the static liquidity ratios as of the year end

1.4.4 From the beginning of year 2009 to the ending of year 2009

Liquidity risk in the commercial banking system continued but at lower levels thanks to the timely intervention of SBV

Year 2008 was an extremely difficult period for liquidity of banks as SBV tightened monetary policy to reduce inflation, and that time deposit rates had been pushed at up to 19% per year In 2009, the above scenario reoccurred but

at a lower level because the banks were more alert after the shortage in liquidity

in 2008

Early in 2009, affected by the financial crisis, banks had a large surplus of capital mobilization And State Bank asked banks to increase loan to

manufacturing sector at the same time the Government decided to support the interest rate on loans for manufacturing and business Due to low cost businesses could easier access to bank loans

The economy has hit a bottom at the first quarter of the year GDP increased by only 3.1% and then gradually recovered in the later quarters Accordingly, the demand for bank loans of enterprises increased, and growth of bank credit also increased by the same time, the risk of re-inflation was mentioned Credit growth in 2009 was 38%, quite far from the 30% target that SBV set Faced with the risk of re-inflation, SBV had in turn made the monetary tightening measures such as reducing the short-term funding for medium and long term financing ratio from 40% to 30%, increasing base rate from 7% to 8% after maintaining it for more than a year, and requiring banks to focus lending for production With the measures, the banks that took short-term funding for long-term financing or borrowed too much from the interbank market to provide for adjustment lending had to increase deposit rates to attract funds from corporate and individuals

From July to November, the commercial banks continued to raise VND interest rates for all tenures Highest interest rates subsequently went up to 9%, 10% and peaked up to 10.5% per year Interest rate curve was distorted when many banks applied a consistent high level of interest rates for most tenures

1.4.5 The first six months of year 2010

Banks overcame the most difficult period but there were still some indications

of the potential liquidity risk in banking activities

On 06/01/2010, SBV pumped about 15,000 billion through open market in order

to relieve stress issues on interest rates at commercial banks and reduce liquidity pressures on banks Immediately, the interbank interest rate decreased, one-week down to 11% per year, overnight interest rates still at 8.5% per year Whereas