bank risk management liquidity risk management in vietnam commercial banks

A INTRODUCTION I RATIONALE OF STUDY Evidently, commercial bank is very crucial to every country’s economic growth In recent years, Vietnam commercial bank has succeeded in fighting inflation, securing monetary stability, boosting economic growth, etc.However, in the trend of economic integration, commercial banks in Vietnam are facing more and more risk due to the fierce competition of other foreign credit institution Hence, the bank’s risk management is becoming more and more important and requires immediate attention from commercial bank’s managers as well as bank’s operator Out of the many risks that commercial banks have to face, liquidity risk might be the most specific risk and have huge impact on the bank’s performance II STRUCTURE OF STUDY This report will consist of parts: Literature review, Findings and analyses of liquidity risk and liquidity risk management and finally reach the conclusion and giving some recommendations for the concern Due to the limited time and resources, the research might have many shortcomings, so we are looking forward to Dr Nguyen Thu Thuy’s comments and recommendations to be able to improve our knowledge and skills for further research Principles of Banking Group B LITERATURE REVIEW I DEFINITION For commercial banks, liquidity risk is very typical, the reason is that the vast majority of bank capital is mobilized capital that can be withdrawn before maturity date Liquidity risk happens when the changes in secondary market become a problem for the transformation of the bank’s asset into cash to meet financial demands and this can be caused by the increase in the cost or time of the transactions The loss that the bank has to suffer is the additional cost for finding other sources of fund If the bank cannot make immediate payments, it will lead to the decrease in the number of depositors or even worse, bankruptcy Lending is the primary investment activity of the bank so as a financial intermediary, it needs to maintain its ability to make payment or in other words, maintain its liquidity We would like to list some detailed examples of liquidity risk: + In the 1970s, the commercial banks in developed countries lended hundreds of billions of dollars to developing countries In the 1980s, those loans became insolvent Debt crisis took place in many countries, especially Latin America Consequently, many of those banks were unable to pay the depositors, suffered losses and then went out of business + In the 1990s, Japanese securities firms were in a dilemma due to the collapse of realestate market and security market The commercial banks that supplied funds for those firms could not reclaim the loan and pay the depositors During the same period, some credit unions suffered losses and caused bank run, which led to continuous collapses Principles of Banking II Group CHARACTERISTICS Liquidity risk is the most typical risk faced by commercial banks There are three main reasons: + The capital the banks raise has high degree of liquidity The main source of bank’s capital is from call deposit The withdrawal date and the amount to withdraw can be an obstacle in banking’s management + The bank’s asset usually has lower degree of liquidity than the bank’s liabilities The asset of the bank comes from loans The quantity and due date are usually agreed and fixed in credit contracts and it is very rare for the bank to receive the payment before the due date Moreover, if the customers are in need of capital and their projects are workable, the banks will make loans When an immediate demand for cash arises, the banks usually have to bid their asset The asset with higher liquidity often brings lower revenue and is rarely in the possession of banks Meanwhile, the banks not want to bid the one with huge revenue due to difficulties in transaction and exposure to high risk In addition, the market for bank’s asset does not develop + Banking activities is often based on credibility Basically, all banks can offer the same services However, choices of banks to deposit or to take out a loan or to use payment services rely much on their “name” Hence, if there is any rumor which can hurt the bank’s reputation, illiquidity risk is likely to happen III MEASUREMENT OF LIQUIDITY The criteria to evaluate the liquidity risk comes from liquidity measurement It include: Asset liquidity rate, deposit liquidity rate, liquidity gap, and payment index Principles of Banking a Group Liquidity rate These rates are used to compared the liquidity of current asset, short-term deposit & loan and credit The higher rate there is, the lower liquidity rate for commercial bank There are many indexes that the bank can use to evaluate its liquidity and liquidity risk - Asset liquidity rate 1: In which: + ALR 1: Asset liquidity rate + TLA : Total liquidity assets + TA : Total assets + PR: Primary reserve + SR: Secondary reserve How to determine which is the primary and which is the secondary reserve relies on the financial situation and business ability of each bank and the regulation of every country Normally, TLA, PR, SR can be calculated by the following formulas: In which: + C: Cash Principles of Banking + DD1: Demand deposit + TD1: Term deposit + GSS : Government short-term securities + CSS: Convertible short-term securities + CL: Convertible loans - Asset liquidity rate 2: Asset liquidity rate is based on the the primary reserve of the bank In which: + ALR: Asset liquidity rate - Deposit liquidity rate This rate is based on the short-term deposit and borrowing of the bank In which: + DLR : Deposit liquidity rate + SD: Short-term deposit + SB: Short-term borrowing Group Principles of Banking Group This rate reflects the liquidity rate of short-term deposit and borrowing - Credit liquidity rate In which: + CLR: Credit liquidity rate + O: Outstanding loan This rate shows the liquidity per unit of credit that the bank provides b Liquidity gap Liquidity gap shows the gap between the liquidity supply and liquidity demand Negative liquidity gap indicates liquidity risk Liquidity gap is calculated by a formula: In which: + LG: Liquidity gap + LS: Liquidity supply + LD: Liquidity demand Principles of Banking Group When Liquidity supply is higher than liquidity demand, which means that Liquidity gap is positive, the bank has more cash than required therefore the bank is able to make payment and the liquidity risk is quite low On the other hand, when the liquidity supply is lower than the Liquidity demand, Liquidity gap is negative, the bank does not have enough cash to make payment and therefore, the liquidity risk is very high Besides the above rates, banks can use other rate to evaluate its liquidity Many banks estimate the liquidity demand based on solely experience and the industry average ratio So some other rates can be used in liquidity management: + The higher rate means that the bank has better ability in making immediate payment + The higher this ratio, the lower the liquidity IV LIQUIDITY RISK MANAGEMENT a Management of liquidity demand The liquidity demand includes: Withdrawal on demand of the depositors, corporation or  organizations  Credit demand of customer for online payment  Loan payment when it is due  Interest payment for deposit and loan Principles of Banking Group The liquidity demand should be estimated beforehand based on some factors that can affect the liquidity demand in short run and liquidity trend in long run b  The rumor that can badly affect bank’s reputation  Information about depositor’s income,savings and consumption  The policy and interest rates of other credit institutions  The reputation of the bank itself Liquidity risk management by applying liquidity management theories - Commercial loan theory: The commercial loan theory states that the liquidity of a bank can be maintained by focusing on short-term self-liquidating productive loans to business organizations Basically these loans are working capital used to expedite the process of money making for those organizations Short-term productive loans mean higher debt recovery ability for debt collector because the borrower always have stable income or revenue so there is little risk of bad debt However, the are some noticeable defects of this theory: + Short-term loan comes with lower interest rate which means lower revenue for banks + Undiversified loan maturity could threaten the customer’s loyalty as they can turn to another bank for more diversified services If all bank pursue the same rules, then it may reduce the money supply, making it impossible for existing debtors to repay the debt at maturity + Do not consider the relative stability of bank deposit This characteristic can allow commercial bank to expand its capital for a long period of time without losing liquidity Principles of Banking - Group Shiftability theory The theory states that the liquidity of a bank can be maintained if the bank continue a substantial amount of assets that can be moved to other banks for cash without any loss of material These assets can include: stock of company with good financial and business situation, government bonds, good quality loan (Mortgage loan) This theory has positive elements of truth and can motivate term lending by banks However, this theory fail to consider some other factors like the economic conditions or when there is a run on the bank, etc - Anticipated income theory: The liquidity of a bank is not only measured by the transformation of its asset After many analysis of the bank liquidity on the viewpoint of cash flow, it is concluded that the repayment of the borrower does not occur when the debt matures but rather during the entire time of borrowing The medium or long term loan often comes with a mortgage from a customer and the mortgage will be used and depreciated If the borrowers borrow money for long-term good, the loan should be repaid by the future earnings of the borrower in installments rather giving lump sum at the maturity of the loan in order to increase the liquidity of the asset This theory did not deny the commercial loan theory or the shiftability theory but emphasize on the potential of receiving debt payment with the borrower’s income rather than relying solely on the mortgage The theory does not affect how the bank wants to invest and prevents the banking from having to face with the question of how to deal with the mortgage it is holding Overall, it significantly increase the liquidity of the bank Principles of Banking - Group The liabilities management theory: This theory was formed in the mid-1960s of the 20th century, attached to the formation of a new mobilization tool, the certificate of deposit and the CD market In addition to the traditional borrowing of central banks and other commercial banks, the CD allows large central banks to mobilize large amounts of capital at a short time, at a cheaper cost issuing medium and long term bonds In addition, the development of an international and regional interbank market allows banks around the world to borrow from one another on a large scale, with low transaction costs and less affected by the policy of Central bank of each country This operating environment increases the ability of commercial banks to borrow According to the authors, if a bank has a high ability to borrow, its liquidity is also high Bank managers can maintain a portfolio of assets that are more profitable than liquidity and use new deposits as the main method to meet liquidity needs Principles of Banking 10 Group C FINDINGS AND ANALYSES I OVERVIEW OF ASIA COMMERCIAL BANK (ACB) Asia Commercial Joint Stock Bank (ACB) was established on 19 May 1993 and began operations in June 1993 From that time, ACB has experienced a rapid rise and achieved many milestones ACB was actually the first bank in Vietnam to issue Mastercard and Visa international debit card In 1997, ACB implemented a two-year training program on banking operations conducted by foreign bankers and banking specialists, to make sure that the bank was wellequipped It also signed an agreement with the premier UK financial institution Standard Chartered Bank to receive comprehensive technical assistance The bank has also been awarded two Labor Medals by the Vietnamese government (in 2006 and in 2008), as well as being recognised by several prestigious institutions as a fine financial institution in Vietnam The Bank provides consumer and corporate commercial banking services, including deposits, corporate and consumer lending, as well as trade financing It is also involved in capital and money markets at interbank level, along with treasury activities, commodities financing and international clearing and settlement Through its subsidiaries and affiliates, the Bank provides investment banking services, such as securities brokerage, custody and underwriting services, along with corporate advisory services Other activities include gold bar manufacturing and asset management II ASIA COMMERCIAL JOINT STOCK BANK (ACB)’S CASE OF LIQUIDITY RISK In early 2003, ACB was still in effective business The profit in the first months of 2003 of this bank increased by 20% compared to that of the same period in 2002 (reaching approximately Principles of Banking 11 Group 170 billion) ACB was very popular and trusted by domestic customers and foreign ones trust when they deposit money Therefore, the rumor of "General Director of ACB, Pham Van Thiet escaped" caused a "shock" to people in Ho Chi Minh City, especially those who are depositors in the bank Here are some key developments of the incident: - At the beginning of October 2003, the first rumor about the General Director of ACB began to flee - About a week later, on Sunday (October 12) and Monday (October 13), the rumor became widespread among people in Ho Chi Minh City - On October 14, 2003, the tension reached its "peak" when thousands of people rushed to withdraw their money at the headquarters of ACB on Nguyen Thi Minh Khai Street and its branch at 30 Mac Dinh Chi ( District - Ho Chi Minh City) At these two locations, the population was so crowded that it flooded the road,causing heavy traffic congestion hours Thankfully, the appearance in front of a large number of people of the State Bank of Vietnam Governor Le Duc Thuy beside the General Director Pham Van Thiet and representatives of the City Government was the most powerful rejection of rumor - Over the next day, October 15, despite the fact that great withdrawal continued, the press agencies together with the individuals and authorities simultaneously had news and articles with a view to rejecting the false information Therefore by the end of the day, the situation calmed down Customers started to send deposits back to ACB On October 16, the incident was almost eliminated Principles of Banking 12 Group - After a week, everything was back to normal ACB restored all activities Even at that time, the number of depositors was much greater than that before the incident It can be seen that the reason for placing ACB in the context of liquidity risk in this case stems from an external reason which is a “false rumor” (CEO of ACB fled) that led to a massive withdrawal of money This makes it difficult for banks to use market instruments to regulate bank liquidity effectively This incident only happens in a very short time (about days) but it is extremely serious Without the positive, synchronized and reasonable measures, the risk of a domino effect in the whole banking industry (people will withdraw money at all banks) would have been totally possible At that time, the consequences would be hard to imagine On August 21, 2012, Vietnam financial market in general and Asia Commercial Bank (ACB) in particular were unprecedentedly shocked by the news that "Bau" Kien - Nguyen Duc Kien, the former Vice Chairman of the Association Co-founder of ACB had been arrested for investigation of economic misconduct The serious impact of this incident was immediately shown Within just days, 5.6 billion USD of the capitalization of Vietnam stock market evaporated, not to mention the series of declining sessions that followed Trillions of VND was withdrawn from ACB in just a few days The wind and waves struck ACB continuously Three days after Bau Kien was arrested, Mr Ly Xuan Hai - the former General Director of ACB was also arrested Below is analysis of financial indicators: Principles of Banking 13 Group Index Quarter 3rd, 2013 Quarter 3rd, 2012 H3 6% 22% In the third quarter of 2013, cash accounted for a very small proportion, which proved that the bank did not have enough cash to meet the immediate liquidity demand, this index was lower than 10% so if there was a large and unexpected need for liquidity, the bank would certainly have to borrow in the money market with high interest rates The fact that proves this claim is that in 2012 Kien was arrested and in 2013, the bank had to resolve issues related to “Bau Kien” Index Quarter 3rd, 2013 Quarter 3rd, 2012 H4 92% 96% As we are concerned, credit is considered to be a low liquidity asset, but credit balance accounted for over 90% of total assets, indicating that banks were quite illiquid There was a downward trend with very small degree, which showed that the risk of liquidity risk was not much reduced Index Quarter 3rd, 2013 Quarter 3rd, 2012 Principles of Banking H6 14 18% Group 11% From the above data, we see that ACB bank actively held a number of securities to ensure its liquidity, thereby showing that the bank was creating its liquidity but not much Index Quarter 3rd, 2013 Quarter 3rd, 2012 H8 7% 38% Through analyses, we can see that in 2013, ACB was no longer in the safe range (