Liquidity risk management in commercial banks

In modern economy, the development of commercial banks plays an extremely important role in the provision and transfer capital process. Commercial banks are always faced with variety of risks. One of the most dangerous types of risk that could fast and widespread make the bank insolvent, losing its reputation and even lead to the breakdown of the whole bank system is liquidity risk. The issue of ensuring reasonable liquidity is considered as one of the most essential tasks that must be respected in a regular, continuous and complete manner. This dissertation will study general theory combining with investigating the current state of liquidity risk management in Vietnam commercial banks in the period of 2008 2015. Then, researcher would like to propose many solutions and recommendations in order to improve the effectiveness of liquidity management in Vietnams commercial banks in the coming time.

Liquidity risk management in commercial bank Evidence from commercial

banks in Vietnam (2008-2015)

Abstract

In modern economy, the development of commercial banks plays an extremely important role inthe provision and transfer capital process Commercial banks are always faced with variety ofrisks One of the most dangerous types of risk that could fast and widespread make the bankinsolvent, losing its reputation and even lead to the breakdown of the whole bank system isliquidity risk The issue of ensuring reasonable liquidity is considered as one of the mostessential tasks that must be respected in a regular, continuous and complete manner Thisdissertation will study general theory combining with investigating the current state of liquidityrisk management in Vietnam commercial banks in the period of 2008 - 2015 Then, researcherwould like to propose many solutions and recommendations in order to improve the effectiveness

of liquidity management in Vietnam's commercial banks in the coming time

Key words: Liquidity, risks management, commercial bank, liquidity demand, liquidity supply

In fact, banks encountered many difficulties while ensuring safety and the highest profit rate atthe same time in their operating process From the end of year 2007 and beginning of 2008,liquidity problem became a hot issue in Vietnam society The shortage of Vietnam dong in 2007made banks raised interest rates simultaneously while Vietnam State Bank must issue a tightenmonetary policy to decrease inflation It means that the shortage of liquidity or borrowing fromthe interbank with high interest rates could affect to commercial banks in particular and theeconomy in general.

Banks must prepare themselves the ability to manage liquidity under any circumstances in order

to invest money effectively, maximize profits as much as possible, reduce risks and avoid the risk

of bankruptcy Hence, ensuring a reasonable level of liquidity is considered as one of the mosturgent tasks that must be respected in a regular, continuous and complete manner In fact, thereare many studies in both theoretical and practical which investigating on liquidity riskmanagement with the aim of minimizing the risk to commercial banks Since late 2002, the BaselCommittee has issued regulations regulating the bank's risk management including liquidity risk

Along with it, the tools and methods of managing liquidity risk have been improved positively.However, due to the limited practical conditions and limited experience, the application ofcurrent international liquidity risk management standards to the operations of Vietnamesecommercial banks is not practical enough It still needs to be added many criteria to reflect the

whole picture of liquidity of commercial banks in Vietnam Hence, I chose the topic “Liquidity risk management in commercial bank - Evidences from commercial banks in Vietnam (2008-2015)" to study for my master's thesis.

I.1 Statement of the Problem

This dissertation is conducted in order to answer those questions below:

a Which principles apply to liquidity risk management?

b What is the current practice of liquidity risk management in commercial banks inVietnam and how are their risk management structures?

c What are the money market instruments of Vietnamese commercial banks available to

meet the liquidity needs of depositors?

d What factors affect Vietnam commercial banks in managing liquidity assets and

liabilities, their liquidity management methods?

e What are the liquidity risk mitigation measures?

I.2. Research objectives

In this dissertation, researcher will focus on studying general theory of liquidity risk andmanagement combining with current state of liquidity management in Vietnam commercialbanks in many recent years

Based on the survey information, the actual thesis, this dissertation has analyzed the liquidity risksituation and liquidity risk management at many commercial banks in Vietnam That couldreveal the causes of liquidity as well as factors affecting the liquidity management ability of

Vietnamese commercial banks It is the basis for proposing solutions to prevent and limitliquidity risk

I.3 Scope and limitation of the Study

Due to the limitation of research time (2007 – 2014), this dissertation will rely on many generaltheories as well as the annual reports of Vietnam commercial banks to investigate currentsituation of liquidity risk and liquidity risk management in Vietnam The limitation of thisresearch is only based on previous researches Because of time limitation, so researcher cannotcollect data in a direct way This dissertation is done in systematic from the problem formulation,research purposes, data collection, and data processing

There is no data has been manipulated and the research is not responsible to the other calculationbased on another data that might be different by the other institution

I.4 Significance of the Study

The results of this research are expected to provide benefits for:

b Provide convenience to determine which banks will be used to show maps based on the liquidityrisk management activities of commercial banks.

3 Bank

a This study shows the picture of current state of liquidity in commercial banks as well asproposing many solutions to manage liquidity risks which can be useful for banks to gain theirbenefit stably

b The author hopes the study will provide a positive impact by giving a better idea to reduce thebank’s weaknesses in managing liquidity risk

4 The researcher:

a This study is made to fulfil requirements to achieve a master’s degree

b Make better understanding about liquidity definition and factors that affect to liquidity incommercials

II.1. Overview of liquidity at commercial banks

2.1.1 Commercial bank

Commercial bank is one of the most important financial institutions in the economy It isconsidered as the principal lender for millions of consumers such as individuals, households,enterprises and most local government agencies In a commodity economy, at a given time, there

is always exists the fact that there are people who are temporarily own some money that stillhaven’t been invested, while there are people who need such amount of money (to meetconsumer demand or effective investments) and they can pay a fee to have the right to use thismoney According to the law of supply and demand, they will see each other and then all (thelender, the borrower, and social) benefits both, production and circulation are developed andimproved life Meet very diverse ways, and by the rise of commercial banks was born as a

necessity and an important way, the most popular (Jesswein, Kurt R, 2006)

Through the bank, the money can easily get an income that needs money can get the moneyneeded at a reasonable cost

It can be said that banks in particular and the banking and financial system in general areoccupying an important position and extremely sensitive in the economy, relating to theoperation of economic and social life.

More and more people are concerned to the activities of the bank, so what the bank is.According to the bank statement published in 23-5-1990 of the State Council of Vietnam

identified: "Commercial Bank is a monetary business organization that operates primarily and regularly receive deposits from customers with a responsibility in repaying that amount of money and use those amount to lend, make the discount and as a method of payment.” (Morris, 2002)

Banking activities are considered as currency trading activities and banking services, withregularly content is receiving deposits and using this amount to supply credit and paymentservices

2.1.2 Liquidity at commercial banks

2.1.2.1 Liquidity and the need for liquidity management

The basic function of the financial system is to provide liquidity One of the important tasks ofbank managers is ensuring liquidity and maintaining liquidity at a reasonable level for the bank

A bank is considered to have good liquidity if it can get the available funds at low cost at thetime the bank needs It means that bank has good liquidity when it has certain amount ofavailable capital at a reasonable scale, or a bank can quickly raise funds through credit or saleasset Unreasonable liquidity is the first sign which clearly show that bank is in financial trouble.Quantity of bank deposit is declined, reducing the money supply and forcing the bank to sellliquid assets gradually Other banks will not lend the problem bank without additional guarantees

or high interest rates This will lead to the decrease in income and threatening to the existence ofbanking institutions

Many banks believe that liquidity can be borrowed at the right time So they think that there is noneed to accumulate too much liquidity in the form of assets that easy to sell when needed at astable price In fact, shortages have occurred in recent years, notably the insolvency that has led

to bankruptcy in many major US banks in 2008 which proves that liquidity security is arequirement that cannot be overlooked

Liquidity management is therefore more important than ever because the bank may be closed if itfails to mobilize sufficient liquidity In 1997, because of the financial crisis, many banks in Asialose billions of dollars, panic customers, insolvent banks, bankruptcy or forced mergers USfinancial sector in 2008 combining with the collapse of big banks has indicated the importance ofensuring liquidity in the bank Hence, the commercial banks should focus on liquiditymanagement and raising high liquidity efficiency as a daily issue because it relates to theexistence and development of each bank and the whole system

2.1.2.2 Liquidity at commercial banks

Liquidity of assets: A bank manager is always concerned about the liquidity of each asset and

the asset portfolio The liquidity of each asset is the ability to convert assets into cash which ismeasured by time and cost The higher the time and cost of asset liquidity, the more likely it is toreflect the risk (loss) of converting assets into money over a specified period of time For a quicksale, the cost (or loss) is large This shows that the liquidity of an asset depends on many factorsand may change depending on each regions and countries

Banks hold asset portfolios with various kind of liquidity Asset structure with different liquiditycharacteristics creates a group of assets or total assets of liquidity Liquidity of portfolio assets ismeasured by the ratio of highly liquid assets to total assets (or on customer deposits at banks)

Liquidity Source: The bank mobilizes capital to create assets, including highly liquid assets.

Thus, the ability to mobilize contributes to payment ability of banks The liquidity of the source

is measured by time and cost which is used to expand the source The lower the time and the costare, the greater the liquidity of the source Actually, the liquidity of the source depends on manyfactors such as the distribution development of the financial market, the increase in the income ofthe population and the sensitivity of the income to the interest

Liquidity of a bank: The liquidity of a bank is the ability that bank can meet customer’s needs.

It is formed by the liquidity of the assets and the liquidity of the source It will be highly liquidwhen there are many liquid assets or are able to expand quickly with low cost or both, in linewith liquidity needs

Supply and Demand:

Liquidity supply is the ability of a commercial bank to provide money to meet customer’s needs,(liquid assets holding and mobilize ability) Liquidity supply in bank includes: deposits fromcustomers, sales of non-deposit services, repayment of customers' loans, loans from the monetarymarket

Liquidity demand is the payment demand of the bank's customer that the bank is obliged to meet.Liquidity includes legal claims and borrowing requirements of the client Liquidity needs of thebank include: Cash withdrawal from accounts, requests for loans from high quality creditinstitutions, repayment of non-deposit loans Cash and tax expenses appear in the production andservice process, payment of cash dividends

Liquidity risk: Liquidity risk is the loss that occurs when actual liquidity needs exceed the

expected liquidity At that level, bank must increase the costs to meet liquidity demand which

could lead to the decrease in bank's net income, at a higher level than the loss of liquidity thatwill lead to bankruptcy.

II.2. Liquidity Management

II.2.1. Liquidity management objectives and rules

II.2.1.1. Defining liquidity management objectives

Liquidity is directly related to the safety and profitability of the bank Therefore, maintainingliquidity is an important objective throughout the bank's operations In order to increase liquidity,costs must also increase and this can reduce the bank's income For example, if the bank holdsmore funds or liquidity increases, the bank's earnings will decline as a result of low, even profit-making funds such as cash in the bank In contrast, if the bank holds too little money, banks have

to raise funds in case of emergency, which makes interest payments are higher than usual Thiscan lead to the decrease in bank’s earnings Therefore, the bank's liquidity managementobjectives include:

- Ensure timely payment of bank at reasonable cost

- Predict liquidity risk and loss

II.2.1.2. Rules of liquidity management

Firstly, the liquidity manager must carefully observe activities of departments which relate to themobilization activities or use of funds in bank and must coordinate the operations of the liquiditymanagement department with those departments When the credit bureau issues a new credit line

to client, the liquidation manager must prepare for the ability to withdraw funds from this creditlimit Or if deposit department expect to sell large deposit certificates in the next few days, thisinformation must be immediately submitted to the liquidity management office

Second, the liquidator needs to know when and where the largest borrowers and the largestdepositors will withdraw funds or deposit more money This allows managers to better deal withthe occurrence of deficits and liquidity surplus.

Third, liquidity managers need to coordinate with senior manager to ensure that the objectivesand priorities for the liquidity problem are clear In recent years, the state of liquidity is always atop priority in the process of allocating funds It is clearly that the bank cannot manage the funds(mainly deposits) because amount of deposit money entirely depend on the public However, thebank can manage the use of capital In addition, the bank must maintain a required reserve ratio

at the central bank to meet its liquidity needs Bank must always be ready for withdrawalrequirements, so manage liquidity and invest a reasonable portion of capital into liquid assets atall times are always top priority Today, liquidity management plays an important supporting role

in the bank's core activities such as lending and providing other fee-based services Bank canmake profitable loans and the liquidity management office will be responsible for findingfinancing

Besides, liquidity needs must be constantly researched to avoid a surplus or liquidity shortage.Liquidity surplus means if bank does not invest additional capital, bank’s income will bereduced At the same time, liquidity shortages forced banks to respond quickly to avoid sellingassets or capital to meet liquidity needs

II.2.2. Content of Liquidity Management

II.2.2.1. Liquidity demand

a. Liquidity demand is the demand for available capital which primarily arises from two mainsources: the demand for withdrawals and demand for loans from customers In addition, loansfrom other banks or central banks also increase liquidity demand

Specifically, liquidity demand includes:

- Liquidity arising on the property side:

• Required reserves

• Demand for quality customer credit

- Liquidity arising from capital sources:

• Customers withdraw money

• Release of valuable paper

• Debt repayment

Liquidity is off balance sheet

• Payment of operating expenses, tax payment

+ Payment of dividends

b. Factors affect liquidity

First, the group of factors creates panic in depositors such as political instability, corruption.Second, the group of factors related to income and expenditure of customers such as incomelevel, population density and business

Third, the group of competitive factors in financial intermediaries such as deposit interest ratepolicy, credit policy of each organization

Fourth, groups of factors create the strength and prestige of the bank, such as officials,technology, market share, prestige etc

c. Liquidity demand management method

• Bank will analyze liquidity needs in the past

• Measure the relationship between the influence factors and liquidity needs to determinethe frequency and magnitude of liquidity needs

• Analyze and quantify liquidity demand for each type of deposit, each group of customersand each period of the year.

After analyzing the factors affecting the liquidity needs, the manager will identify the liquiditymanagement strategy by establishing a policy of conditions to stabilize liquidity needs Based onthis, ensure liquidity is ensured and income is maximized

II.2.2.2. Liquidity Supply

Liquidity supply arising from assets includes:

• Budget

• Customers refund credit

• Deferred payment from investment in securities

• Income from selling property

Liquidity arising from capital sources includes

• New deposit of customer

• Borrowing in the money market

• Release of valuable papers

Management of liquidity supply from asset-reserve strategies:

Banks must maintain the ability to meet the needs of demand payment of customers Liquiditysupply can be created from 2 criteria: maintain reserve and ability to mobilize

According to the internal control, it can meet the needs of payment of assets through strategicreserves This means that the retention of assets through asset management can provide liquidity

On the risk side, this means that the bank needs to create a suitable asset in terms of time,volume and structure of the source

Budget Analysis:

A bank usually meets the needs of customers by cash: cash in safes, deposits at the State Bankand other credit institutions If a customer has a savings deposit at a bank, bank will issue a cashfund to pay simply If a customer has a balance on his / her deposit account, signing a check ormoney order to pay to a customer at another bank, the bank will use the deposit at the State Bank

or the deposit at the institution credit to pay…If a customer wants to be paid but he/she has noenough money yet then the bank can lend (after the credit analysis) customers to pay Loans can

be in form of cash or transfer loans that are due (loans from the State Bank or the issuance ofbonds, banks pay in cash or transfer these activities are made with the aim of helpingcustomers make timely payment and investment activities

Factors that increase the decrease in budget and treasury policy: the budget (a part of the bank'sreserves) includes the bank's most liquid assets, which are regularly replenished from theincreased cash inflows Deposits, borrowings, debt collection, securities held by banks, etc arealso used frequently to pay deposits, loans, investments Increased or decreased funds may bedue to objective factors such as seasonality, business cycle and customer income, changes inmanagement regulations, or system or by the bank According to the reserve strategy which ispursued by bank, increasing the budget (as other conditions do not change) will reduce the bank'sincome Thus minimizing the budget (minimizing idle money) is the goal that banks mustpursue

Other reserves outside the budget

Bank executives are always looking for assets that can replace liquidity, while increasing thebank's profitability As the government bond market develops and the government'scommitments become more robust, government bonds become less risky and highly convertibleassets (nearly treasury) and yields higher than the budget This type of asset is classified as a

buffer between funds and credit.Other credit and securities items also have different liquidity.Discounts can be rediscounted at low cost, high-quality loans are out of date, or easy to sell, andmany short-term credits do increase the liquid properties.

Estimates of supply liquidity from assets

In order to respond effectively and promptly to the needs of customers, the bank needs tomaintain appropriate liquidity assets as the liquid assets only bring about a lucrative profit Assetliquidity to meet essential needs such as compulsory reserves, daily payments to depositors.Banks also have to hold liquid assets to "reserve" in cases of sudden changes in demandwithdrawn from the bank And in the third case, liquid assets are maintained for the purpose of

"attacking" - lending in case of necessity

The liquidity of assets is changed frequently: when the real estate market is vibrant, real estate ishighly liquid and vice versa When the SBV loosens monetary policy, the negotiable instrumentcan easily be discounted and vice versa Banks in different regions or countries, the liquidity ofassets is different Then analyzing and quantifying the liquidity of each asset is essential

The liquidity ratio needs to be maintained

Primary reserve / Total assets

(Primary reserves + secondary reserves) / Total assets

(Fund + liquidity securities) / Short-term deposits and loans

Primary Reserve / Credit

Banks should consider the appropriateness of each rate, selecting appropriate levels for eachperiod Banks also need to determine the total liquid assets to be held through liquidity needsanalysis The maturity date of the assets held together with the funds must meet legal reserverequirements (compulsory reserve) and demand for payment (liquid demand)

Reserve strategy and profitability

The bank's reserve strategy - maintaining liquidity and other liquidity assets - must always weighbetween liquidity and profitability The bank has to weigh the income that it has to give up in thepresent to maintain liquidity with possible future expenses to buy liquidity This considerationshould be based on the analysis and quantification of liquidity needs and the ability to providecurrent and future liquidity through liquidity of assets

Management of liquidity supply from capital sources or mobilization strategy:

With the development of the debt instruments market, banks can develop their mobilization tomeet their liquidity needs

Analysis of factors affecting time and cost of mobilization

Methods to meet the demand for liquidity from the source party depend heavily on the cost andtime of mobilization, ie, depending on the development of the source market A number offactors, from macroeconomic stabilization policy of the central bank and government, thedevelopment and competition of banks and other financial intermediaries in the country, regionand the world, the sensitivity The impact of the deposit on interest rates, banking networks, etc.,impacts a bank's ability to rapidly expand at a low cost

In general, banks set up a policy to mobilize and use cash flows to meet their expected credit andinvestment while maintaining liquidity at the required level The difficulty is theinappropriateness of the size and maturity of cash inflows to the needs of the bank Turning thematurity of cash inflows and outflows - that is, creating a maturity of depositors and borrowers -

is an important part of commercial banks' operations Banks may also be exposed to interest raterisk and liquidity risk Due to the maturity of the source and assets then bank will consider theholding of more liquid assets

Select the liquidity supply from the source

Central bank loans are often used to meet liquidity needs as interest rates are usually the lowest

in the lending interest rate bracket The interbank market rate is usually just higher than thecentral bank's interest rate, with simple borrowing procedures, largely based on the bank'sreputation For banks that are temporarily excess reserves, lending will bring higher returns.Borrow by issuing short-term notes such as certificates of deposit The interest rates of thesedebentures are usually higher than the term savings deposits but have a relatively fastmobilization period This type of paper usually focuses on businesses and high-income residents

To increase the attractiveness of debt paper, many banks have sought to re-establish the marketfor debt securities Banks can raise deposit rates to compete with other banks to mobilize more.This method is applied when the bank needs capital at a high cost Many banks use methods toexpand and diversify their depositors such as opening branches in different regions, differentcountries, offering a variety of deposits and services, increasing utility for people This is astrategy that meets the liquidity needs of the source structure itself

II.2.2.3. Combined management

The combined liquidity management strategy has become popular, based on maintainingliquidity of both assets and capital In general, large banks which close to the monetary center;tend to rely primarily on the liquidity of the source party while smaller banks, far from themonetary center, tend to maintain liquidity based on liquidity assets.

Moreover, most banks have made a compromise in their liquidity management policy, using bothliquid asset management and debt liquidity management to avoid many risks According to thecombined management strategy, part of the expected liquidity needs will be fulfilled by stockliquid assets (mainly securities and deposits at other banks) while the rest of liquidity needs will

be addressed by credit line agreements from correspondent banks or other lenders Cashrequirements will be solved mainly by borrowing The bank needs to plan for the demand forlong-term loans and capital used to meet this requirement It could be in form of short-term,long-term loans and securities, the assets will be converted into cash when liquidity requirementsappear

II.2.2.4. Liquidity Risk Measurement and Monitoring

Liquidity risk management is such an important and necessary issue to any banks In order toeffectively manage liquidity risk, banks need to set up an effective monitoring and measurementsystem That measurement system will help banks to anticipate liquidity risks and takepreventive measures in time to avoid the serious damage

Each bank has a different relation with their liquidity risk because liquidity scale also depends onsize and many different criteria such as: complexity of bank then each bank will seek suitablemeasurement techniques to manage liquidity risk For example: large banks often have large andstable deposits, while smaller banks often rely on deposits from large institutions In fact, evenwith abundant liquidity, banks still need the support of liquidity measurement and monitoring

tools to manage liquidity in crisis time and optimize return on their current funds There aremany liquidity measurement and monitoring techniques which are commonly used by banks,such as: Contingency Funding Plans, Cash Flow Projections, Liquidity Ratios and Limits,Internal Controls and Liquidity risks Those techniques will be analyzed specifically.

Contingency Funding Plans: In order to develop an efficient and comprehensive liquidity

management model, banking institutions need to come up with different scenarios ContingencyFunding Plan (CFP) contains many policies and procedures which could help bank to meet itsfunding needs in a managing liquidity risk at a reasonable cost CFP is used to predict future cashflows and other bank financial resources CFP should represent an estimate of balance sheet thatmay result from a liquidity or credit event to increase effectiveness CFP can provide an effectiveshort term and long term liquidity risk management model Besides, it also helps the financialinstitution to update the movements of liquidity regularly

Cash Flow Projections:

Banks often use cash flow measurement to determine their cash position Cash flow can estimatebank cash inflows and outflows, thus projecting a deficit and net surplus (GAP) over time

Banks need to distinguish clearly between the re-pricing gap report that measures interest raterisk and a behavioral gap report which takes into funding requirement of banks arising out ofdistinct sources on different time frames In order to compare cash inflows and outflows on a day

or specified period of time, bank need to construct a maturity ladder Banks, which rely on term funding, will primarily focus on managing liquidity on very short term while other banksmight actively manage their net funding requirement over a longer period Cash flow projectioncould estimate accurately bank’s flow of funds in short- term Those estimates will playimportant role as an indication of actions Moreover, bank will have opportunity to well - control

short-GAP with an analysis for distant periods Consequently, it is better for banks to apply short timeframes to measure near term exposures and longer time frames thereafter Banks should calculatedaily GAP for next one or two weeks, monthly Gap for next six month or a year and quarterlythereafter Those aspects below should be attention when making an estimation of cash flow.a) The funding requirement arising out of off- Balance sheet commitments also need to beaccounted for

b) Many cash flows associated with various products are influenced by interest rates or customerbehavior Banks need to take into account behavioral aspects instead of contractual maturity Inthis respect past experiences could give important guidance to make any assumption

c) Some cash flows may be seasonal or cyclical

d) Management should also consider increases or decreases in liquidity that typically occurduring various phases of an economic cycle

Liquidity Ratios and Limits:

Using ratios to determine liquidity is a method commonly used by banks The ratio used toquantify the liquidity is also varied Besides measuring liquidity, it also determines the limits forliquidity management However, ratios will be most useful when being used regularly andinterpreted taking into account qualitative factors

In order to accurately forecast liquidity, the bank needs to combine the analysis of informationrelating to borrowing capacity, ability to request early withdrawal, credit line, transaction size

It could be said that financial ratios is the foundation of asset-liability management decisions, abank's asset-liability managers should understand how a ratio is constructed, the range ofalternative information that can be placed in the numerator or denominator, and the scope ofconclusions that can be drawn from ratios Because ratio components as calculated by banks are

sometimes contradictory, ratio-based comparisons of institutions or even comparisons of periods

at a single institution can be deceptive

• Cash Flow Ratios and Limits

The failure of the bank to fulfill its payment obligations is considered as one of the most seriousrisks to liquidity Thus, cash flow ratios and limits attempt plays has a duty to measure andcontrol the volume of liabilities incurring during a specified period of time

• Liability Concentration Ratios and Limits

In order to preventing bank from depending on many providers or funding sources, liabilityconcentration ratios and limits are decided to apply

• Other Balance Sheet Ratios

There are many common ratios which are used by financial institutions to monitor current and

potential funding levels such as: total loans/total deposits, total loans/total equity capital,borrowed funds/total assets etc

Accounting estimates and Liquidity ratios:

In addition to the provisions on cash reserves, banks also need to set limits on the level ofliquidity risk within acceptable limits Limits should be reviewed and adjusted periodically.Besides, senior management of bank should analyze the strategies and activities of banks, whatbank have performed, earnings level, available fund to face potential losses, and acceptable risk.Balance sheet will reveal a level limitation that a bank should establish to manage liquidityeffectively In case limits cannot prevent a liquidity crisis, limit exceptions may be use as anindicator to excess risk or inadequate liquidity risk management However, most of the banksestimate liquidity based on the ratios on a specific date There are two types of liquidityindicators:

a) Asset based or Stored Liquidity Ratios, b) Liability based or Purchased Liquidity Ratios.a) Asset based or Stored Liquidity Ratios:

1) Cash position indicators = Cash + Deposits

Total Assets2) Liquid Securities Indicators = Govt Securities

Total Securities3) Risk less Assets Position = Cash+ Deposits+ Govt Securities

Total Assets4) Net Treasury Funds Position = Balance of Reserves with Central Bank

Total Assets5) Liquidity Assets Ratio = Cash+ Reserves+ Govt Securities

Total Assets6) Capacity Ratio = Net Loan + Lease or Rent

Total Assets7) Pledged Securities Ratio = Pledged Securities

Total Securities Holdingsb) Liability based or Purchased Liquidity Ratios:

1) Hot Money deposit = Withdraw able Hot Money Deposits

Total Hot Money Deposits2) Short- term Deposit to Assets= Short- term Deposits

Total Assets3) Short- time Investments to Sensitive Liabilities = Short- time Investments

Sensitive Liabilities

4) Deposits Brokerage Index = Brokerage deposits

Total Assets5) Core Deposits Ratio = Core Deposits

Total Assets6) Deposits Composition Ratio = Current Deposits

Term Deposits7) Transaction Deposits Ratio = Transaction Deposits

Non- transaction able Deposits

Internal Controls and Liquidity risks: If banks want to implement the policies as well as

procedure effectively, they must daily examine the process and various procedures In fact, thebigger and more complex the bank, the more they should do the examination Reviewers shouldverify the level of liquidity risk and management’s compliance with limits and operatingprocedures Any exception to that should be reported immediately to senior management / boardand necessary actions should be taken Senior management must update the current riskmanagement situation of the bank by receiving regular reports That will help senior predict thelevel and trend of the bank’s liquidity risk and figure out how much liquidity risk the bank isassuming

Convertibility of asset

Based on the analysis of the number of bankruptcies in the UK and US in the financial crisis of29-33, the authors of the theory argue that the number of British banks (mainly commercialloans) goes bankrupt were approximately with US banks (extending loans to real estate andconsumers) So, commercial loans also do not ensure liquidity safety for commercial banks when

the crisis occurs It is clear that the main problem for ensuring liquidity is the ability to generateincome of banks (increase their accumulation capacity) and the ability to convert assets With thedevelopment of the stock market, banks can have the necessary revenue when they meet theliquidity needs Thus, banks can completely make non-commercial loans while still ensuring theliquidity of banks.

II.2.3. Expected income theory

This theory assumes that asset receipts not only occur when assets are due but also over timethroughout the life of the asset For example, if the bank provides medium and long term loans,debt collection under multiple debt terms is expected to increase the liquidity of assets

This theory is an important foundation in the study of maturity of assets and capital, which is themain content to manage asset's liquidity Build debt recovery plan Expected earning of the asset

is a measure of the liquidity of the asset

II.2.4. Debt Management

This theory was formed in the mid-1960s associated with the formation of new mobilizationtools such as Certificates of Deposits (CDs) and the CD market that allowed large banks in pre-cash centers It is a bad thing to be able to mobilize a large amount of capital at a cheaper costthan the issuance of medium and long term bonds

Along with the development of the interbank market, banks are able to lend to each other on alarge scale, with low transaction costs This activity enhances the ability of commercial banks toborrow A bank with high creditworthiness (fast time, large scale, low cost) is highly liquid

In short, bank managers can maintain a portfolio of assets that is more profitable than liquidityand use new mobilization as the primary means to meet liquidity needs