Liquidity risk management in banks case study

VIETNAM NATIONAL UNIVERSITY, HANOI HANOI SCHOOL OF BUSINESS PHAM THI THU HA LIQUIDITY RISK MANAGEMENT IN BANKS Case study: Liquidity risk management at Techcombank Major: Business Administration Code: 60 34 05 MASTER OF BUSINESS ADMINISTRATION THESIS Supervisor: Dr Tran Phuong Lan Hanoi, June 2012 TABLE OF CONTENTS ACKNOWLEDGEMENTS ABSTRACT TÓM TẮT TABLE OF CONTENTS LIST OF FIGURES LIST OF TABLES LIST OF ABBRIVIATIONS INTRODUCTION CHAPTER 1: OVERVIEW OF LIQUIDITY RISK MANAGEMENT IN BANKS 1.1 Introduction of liquidity risk 1.2 Liquidity risk classification 1.3 International standards in management and supervision of liquidity risk 1.3.1 Basel’s principles for the management and supervision of liquidity risk 1.3.2 Liquidity measurement and management 1.3.3 Monitoring tools for liquidity risk management 1.4 State bank of Vietnam’s regulations on liquidity risk management 1.4.1 Capital adequacy ratio – CAR 1.4.2 Credit limits 1.4.3 Limits on capital contribution and share purchase 1.4.4 Ratio of granted credit to mobilized capital 1.4.5 Solvency ratios 1.5 Conformity of State bank of Vietnam’s regulations to the international standards in liquidity risk management 1.6 Lessons from other bank’s liquidity risk management process 1.5.1 Overview of liquidity risk management policy 1.5.2 Liquidity risk policy CHAPTER 2: LIQUIDITY RISK MANAGEMENT AT TECHCOMBANK 2.1 Techcombank overview 2.2 Process of Liquidity risk management at Techcombank 2.2.1 Liquidity risk measurement at Techcombank 2.2.2 BOD and BOM’s risk appetite on liquidity management at Techcombank 2.2.3 Techcombank’s liquidity risk management structure 2.2.4 Techcombank’s liquidity risk management flows 2.3 Assessments in liquidity risk management at Techcombank 2.3.1 Techcombank’s compliance toward Basel and SBV’s regulations 2.3.2 Strengths in liquidity risk managements 2.3.3 Weaknesses in liquidity risk management CHAPTER 3: SOLUTIONS TO IMPROVE LIQUIDITY RISK MANAGEMENT AT TECHCOMBANK 3.1 Pursuing ambitious business strategy 3.2 Investing in information technology 3.3 Systemic document on liquidity risk management 3.4 Restructuring organization and developing HR 3.5 Intelligent and flexible strategic in liquidity risk management CONCLUSION REFERENCES LIQUIDITY RISK MANAGEMENT IN BANKS Case study: Liquidity risk management at Techcombank Pham Thi Thu Ha MBA candidate, 2009 - 2011 School of Business – Vietnam National University, Hanoi Supervisor: Dr Tran Phuong Lan INTRODUCTION Risk is inherent in any business in general and in financial sector in particular It has become key focuses for managers and regulators since some recent decades, specially liquidity risk, after some recent global financial crisis After and after each crisis, regulators want to implement stricter regulations to prevent financial institutions from liquidity difficulties Financial institutions’ managers also pay much more attention to liquidity issues to ensure banks’ safe and durable development The subject of thesis focuses on liquidity risk management This is nearly new and hot topic in Vietnam financial market, since State bank of Vietnam has just issued regulations on prudential ratios in 2010 and series of its amendment right after The regulations affect immediately banks’ balance sheet structure and also long term business orientation It’s necessary to study on the subject to understand the international principles, measurement and management practices to apply adequately in Vietnam environment Thesis aims how to respond to local regulations of SBV and step by step implement international acceptable practices Thesis studies case of Techcombank, one of most successful joint stock in Vietnam banking sector in the last decade Techcombank also is good example to make analysis because the bank has applied not only local regulations but also starting itself to set up internal requirements to reach international practices CHAPTER 1: OVERVIEW OF LIQUIDITY RISK MANAGEMENT IN BANKS 1.1 Introduction of liquidity risk Liquidity is the ability of a bank to fund increases in assets and meet obligations as they come due, without incurring unacceptable losses This definition is broader than that concept that is only possession of cash or assets that can be readily converted into cash Liquidity risk management nowadays has become one of most challenging to any financial managers Understanding the term, risk classification and measurement that help managers well control the risk and lead business to achieve their targets and goals 1.2 Liquidity risk classification According to best practice in the financial market, liquidity risk is classified into three categories, including: - Structural liquidity risk - Contingency liquidity risk - Market liquidity risk 1.3 International standards in management and supervision of liquidity risk 1.3.1 Basel’s principles for the management and supervision of liquidity risk 1.3.1.1 Fundamental principles for the management and supervision of liquidity risk Principle 1: A bank should establish a robust liquidity risk management framework that ensures it maintains sufficient liquidity to deal with stress events It includes maintaining quality liquidity assets, their marketability and assessing depositors, access to secured and unsecured funding sources 1.3.1.2 Governance of liquidity risk management Principle 2: Bank should establish risk appetite for its own business, including liquidity risk tolerance Principle 3: Bank should develop a strategy, policy and practices for managing liquidity risk according to bank’s risk appetite These should be reviewed regularly at least annually Principle 4: Bank should develop an internal fund pricing system that includes liquidity costs, benefits and risks that products and services create for bank’s portfolio 1.3.1.3 Measurement and management of liquidity risk Principle 5: Bank should establish a sound process for indentifying, measuring, monitoring and controlling liquidity risk Principle 6: Bank should actively monitor and control liquidity risk Principle 7: Bank should develop an effective and diversified funding strategy Principle 8: Bank should actively manage intraday liquidity position to meet all payments on timely basis under normal and stress conditions Principle 9: Bank should actively manage collateral positions Principle 10: Bank should conduct stress tests regularly for short term and bank case specific and market case specific After conducting stress test, bank could review and adjust liquidity risk strategy and policy develop effective contingency plan Principle 11: Bank should have official contingency funding plan that defines strategies for liquidity shortfalls in emergency case Principle 12: Bank should maintain a cushion of unencumbered assets, high quality liquid assets to withstand a range of stressed scenarios 1.3.1.4 Public disclosure Principle 13: Bank should publicly and regularly disclose information so that market participants could know about the change in liquidity risk management framework and liquidity position 1.3.1.5 The roles of supervisors Principle 14: Supervisors should regularly make comprehensive assessment of overall liquidity position and framework Principle 15: Supervisors should supplement assessments of liquidity risk management framework by monitoring a combination of internal reports, prudential reports and market information Principle 16: Supervisors should intervene to require effective and timely remedial actions to ensure bank’s liquidity Principle 17: Supervisors should communicate with regulators and other stakeholders to keep update and effectively cooperate regarding to supervision and overview of liquidity risk management 1.3.2 Liquidity measurement and management 1.3.2.1 Liquidity Coverage Ratio (LCR) Stock of high - quality liquid assets  100 Total net cash outflows over the next 30 calendar days LCR means minimum level of stock of high quality liquid assets that can be converted into cash to ensure bank’s liquidity during 30 calendar day time horizon 1.3.2.2 Net Stable Funding Ratio - NSFR Available amount of stable funding  100 Required amount of stable funding NSFR is structured to ensure that long term assets are funded at least a minimum amount of stable liabilities in relation to their liquidity risk profile 1.3.3 Monitoring tools for liquidity risk management 1.3.3.1 Contractual maturity mismatch Contractual maturity mismatch defines gaps between contractual inflows and outflows for each time bucket This gap analysis helps managers know how much fund they need to raise up or surplus for each time bucket 1.3.3.2 Concentration of funding This metric aims to define sources of wholesale funding that could impact significant to institution when they are withdrawn Some of the practical applications in manage concentration of funding: Funding liabilitie s sourced from each significan t counterparty The bank' s total balance sheet Funding liabilitie s sourced from each significan t product/instrument The bank' s total balance sheet List of asset and liability amounts by significant currency 1.3.3.3 Available unencumbered assets Available unencumbered assets are marketable as collateral in secondary market and/or eligible for central banks’ standing facilities 1.3.3.4 Liquidity coverage ratio by significant currency Foreign Currency LCR  1.3.3.5 Stock of high quality liquid asets in each significan t currency Total net cash outflows over a 30 day time period in each significan t currency Market related monitoring tools Supervisors could monitor following information to focus on liquidity issues: - Market wide information - Information on financial sector - Bank – specific information 1.4 State bank of Vietnam’s regulations on liquidity risk management 1.4.1 Capital adequacy ratio – CAR Own capital Individual capital adequacy ratio = Total risk-weighted assets Banks must maintain CAR of 9% as individual and also consolidated capital adequacy ratio on the basis of consolidation of capital and assets of their own and their affiliated companies 1.4.2 Credit limits In this term, SBV sets up the limits on loans, guarantees and discounts of valuable papers to financial institution 1.4.3 Limits on capital contribution and share purchase 1.4.4 Solvency ratios Solvency ratios (also called liquidity ratios) are important part in the Circular, it requires credit institutions maintain hardly solvency ratios including overnight solvency ratio and 1-7 days solvency ratio in daily basis and currency basis (VND, USD, EUR, JBP) Solvency ratios There are two solvency ratios: overnight and 1-7days solvency ratio Overnight solvency ratio: minimum at 15% 1-7 days solvency ratio: minimum at 100% To monitor the solvency capacity, credit institutions must set up monitoring table to support the forecast at least in the next 30 subsequent days; and take any necessary actions to bring the ratios back to the limits 1.5 Conformity of State bank of Vietnam’s regulations to the international standards in liquidity risk management 1.6 Lessons from other bank’s liquidity risk management process We’ll take CitiGroup as a good example of liquidity risk management and study Citigroup’s liquidity risk management policy as comprehensive example In liquidity risk policy, Citigroup has guided: - Overview of liquidity risk policy - Liquidity risk policy - Risk management tools - Roles and responsibilities of stakeholders 1.6.1 Overview of liquidity risk management policy 1.6.2 Liquidity risk policy 1.6.2.1 Liquidity standards 1.6.2.2 Funding and liquidity plan 1.6.2.3 Risk management tools 1.6.2.4 Management reporting CHAPTER 2: LIQUIDITY MANAGEMENT AT TECHCOMBANK 2.1 Techcombank overview Techcombank, Vietnam Technological and Commercial Joint - stock Bank, was established on September 27th, 1993 It started business with the registered capital of only VND 20 billion, and after more than 18 years of development, it grows to … 2.2.2 BOD and BOM’s risk appetite on liquidity management at Techcombank Since very earlier, Techcombank’s BOD and BOM have clear view in risk management in bank’s business and daily operations, including liquidity risk management Liquidity risk management is essential to the bank’s development Good liquidity creates stable environment for the bank’s business This concept works through all Techcombank’s business, specially, in credit activities Techcombank issued Risk appetite for financial institutions to assess and classify them into three categories: - Not willing to deal - Deal in controlling closely specific conditions - Normal deal 2.2.3 Techcombank’s liquidity risk management structure In structure, Techcombank has two units responsible for managing liquidity risk management: Assets and Liabilities Committee and Treasury They work closely together and cooperate to ensure bank’s liquidity ALCO works directly with other business divisions to ensure bank’s liquidity policy that could be run through all business Treasury division is link between two markets: market of individuals and cooperates (market 1) and interbank market (market 2) to explore efficiently bank’s funding Under treasury, BSM also takes some duties of ALCO, to work and connect well between ALCO and Treasury 10 2.2.3.1 Assets and Liabilities Committee Structure of ALCO Techcombank’s ALCO structure 2.2.3.2 Treasury divisions Besides the function of trading, Treasury is also in charge of managing liquidity risk in daily basis to meet all requirements set up by ALCO Techcombank’s Treasury structure under ALCO 11 2.2.4 Techcombank’s liquidity risk management process Liquidity risk management In charge process Treasury operation officer Branches/Trading desk to BSM and MM officer MM officer (in charge of liquidity management) Money market officer MM officer (in charge of liquidity management) Money market officer Financial officer 12 Update Cash flows at the beginning day Inform funding IN/OUT Update Cash flows position Borrowing/Lending/Transfer if needed Forecast solvency ratios report Improve solvency ratios report if needed Making solvency ratios report Firgure 2.3 Techcombank’s liquidity risk management process In daily basis, money market department takes care of managing, transferring and borrowing/lending if needed to ensure bank’s cash flows enough to meet the payment when it dues 13 At the beginning of the day, treasury operations officer makes the Cash flows due report; it includes all contracts due During the day, branches must inform BSM about the big cash flows in and out the bank (sources almost from client’s savings, releasing credit, client payment activities,…); BSM sends the information to money market officer to prepare fund or lending fund if needed All transactions of treasury trading desk (foreign exchange, gold, bond, money market,…) must inform directly the deals occurring intraday to money market officer And based the two data above, money market officer collects and inputs all deals occurring intraday including the cash flows from all branches and treasury’s trading desks by currency and by account To manage the account balance, after balancing each account, officer transfers money between accounts or decides to borrow/lend to ensure the payable ability if needed According to the SBV’s regulations, Techcombank must run the liquidity ratios at the limit of 100% for 1-7 days solvency and of 15% for overnight solvency ratio in each currency In fact, to enhance the liquidity, Techcombank has also applied higher requirements on solvency ratios through internal trigger and internal target Techcombank’s Solvency limits Regulatory Limit Internal Trigger Internal Target 1-7 days Solvency Ratio 100% 110% 115% Overnight Solvency Ratio 15% 15.5% 16% Solvency Ratio 14 Techcombank’s Solvency ratio report at 28 & 29 March 2012 1-7 days Solvency Ratio for each currency 28-Mar 29-Mar Regulatory Limit (100%) 1-7 days Solvency Ratio for VND 154.8% 157.9% Complied Complied Complied 1-7 days Solvency Ratio for USD 131.0% 133.5% Complied Complied Complied 1-7 days Solvency Ratio for EUR 193.4% 171.8% Complied Complied Complied 1-7 days Solvency Ratio for GBP 2041.3% 2132.5% Complied Complied Complied 1-7 days Solvency Ratio for other currencies 2050.0% 2596.0% Complied Complied Complied No Solvency Ratio 15 Internal Trigger (110%) Internal Target (115%) Overnight Solvency Ratio for each currency 28-Mar 29-Mar Regulatory Limit (15%) Overnight Solvency Ratio for VND 18.7% 19.3% Complied Complied Complied Overnight Solvency Ratio for USD 17.7% 20.5% Complied Complied Complied Overnight Solvency Ratio for EUR 23.6% 21.0% Complied Complied Complied Overnight Solvency Ratio for GBP 289.8% 302.6% Complied Complied Complied Overnight Solvency Ratio for other currencies 112.1% 110.2% Complied Complied Complied No Solvency Ratio 16 Internal Trigger (15.5%) Internal Target (16%) We see all the limits are complied, including the SBV’s limits and Techcombank’s internal limits at the day of 31, March 2012 If any ratio breaks, finance division will inform treasury and meet to discuss reasons and solutions to bring the ratios in the line, right after when it comes… At the end of morning, money market officer makes the forecast liquidity report of the day This forecast bases on: - MCO report at the previous day; - All the transactions occurring intraday; - Any assumes if needed (basing on market condition) - Besides daily liquidity risk management as SBV’s regulation, Techcombank also step by step studies and applies international standards such as stress and scenario test, contingency liquidity plan,…but these activities are not made regularly, only once or twice time in the past But it is very valuable for next implementations in the future 2.3 Assessments in liquidity risk management at Techcombank 2.3.1 Techcombank’s compliance toward Basel and SBV’s regulations Since very earlier, from the strategic and open vision on liquidity risk management of BOD and BOM to actual daily business, Techcombank always complies fully with all SBV’s regulations on the prudential ratios in credit institutions’ operations including all five ratios: - Capital adequacy ratio; - Credit limits; - Limits on capital contribution and share purchase; - Ratio of granted credit to mobilized capital; - Solvency ratio; 17 According to Basel’s regulations on liquidity risk management, Techcombank now only studies and runs some of monitoring tools of Basel: - Daily contractual maturity mismatch (MCO): Techcombank prepares only contractual contracts, not dynamic one So information may be not useful for liquidity management purpose because it does not reflect forecast potential liquidity of bank respective to each stress scenario in the future - Concentration of funding: Techcombank not yet makes full reports according to Basel to update and monitor funding concentration Concentration of funding has not been assessed in details to know the bank’s dependence level on significant counterparty, product or currency The reports provide now only the list of some big fund providers so BSM check their plan of withdraw to prepare fund - Available unencumbered assets: Techcombank has just started to make unencumbered assets report for liquidity purpose only since second quarter in 2012 But it has not yet issued any documents to guide which assets are classified into this kind sources of liquidity It’s now only based on government bond’s daily report - LCR by significant currency: Techcombank has not yet prepared that kind of LCR reports - Market related monitoring tools: update the information on market, specially in financial sector and bank environment keeps very important to assess and forecast bank’s liquidity position Techcombank’s BOD and BOM encourage strongly these activities, but in fact, it is not efficiently worked The reports are separated and not focused on the liquidity subject 2.3.2 Strengths in liquidity risk managements 18 2.3.2.1 Good reputation Understanding that reputation is a precious asset of any enterprise, specially in banking sector, Techcombank pays much attention to build and develop their own brand name The success makes Techcombank’s reputation, in turn, reputation creates the opportunities and advantages to lead Techcombank to new success Good reputation helps Techcombank much in managing risk, including liquidity management It creates stability in cash flows; Techcombank gets huge savings from individuals and enterprises, and it continues to increase time by time; Techcombank also gets big access in interbank market Foreign banks and state own banks give Techcombank huge clean and collateral line in interbank It supports strongly efficient liquidity management process, if any difficulties 2.3.2.2 Efficient business and risk management strategy Techcombank strengthens the foundation of risk management division by building on existing established practices and develop it through human resources professionals who are regularly equipped with updated and modern risk management knowledge With the support of IT system, risk management best practices are now step by step implemented across the whole bank, in every business division 2.3.2.3 Pioneer in information technology Modern IT allows Techcombank provide new products and services to customers It creates strong competitive advantages in banking system Techcombank always the first banks in providing such modern and useful services to customers with new IT solutions In aspect of liquidity management, core system tracks every transaction in whole bank, so all data are available to make liquidity management report as SBV’s requirement and internal report as required This also is SBV’s requirement to ensure the availability of data to meet the management purpose 19 2.3.2.4 Vision in liquidity management In very earlier, Techcombank’s BOD and BOM recognized the role of liquidity management in medium and long term of development strategy BOD and BOM assigned specialized units in the banks in charge of liquidity management, ALM and treasury system Beside SBV’s regulation, Techcombank has also applied stricter requirement in liquidity management To ensure the bank’s compliance, early warning system was established by ALM 2.3.2.5 Human resources Focusing on people, consider staffs as one bank’s precious asset, Techcombank has been organizing many useful training courses on shore and offshore to improve staffs’ knowledge, skills and to update new tools in liquidity management 3.1.1 Weaknesses in liquidity risk management 3.1.1.1 Lack of documented systemic liquidity management policy There have not yet issued systemic documented liquidity management policy It exists now only draft version, based on meeting minutes, or agreements between divisions in the banks In long term, it could damage the bank’s liquidity if bank does not set up the systemic documents on liquidity management 3.1.1.2 Availability of IT system IT is one of the strength of Techcombank, but it is also one weak point Investing in core banking in very earlier, but with the fast development of Techcombank, IT system now has begun overload 20 In risk management aspect, Techcombank has been setting up tools to managing risk on system It focuses mostly on credit risk; little for market risk and operation risk but none for liquidity risk 3.1.1.3 Efficient Analysis Reporting system Techcombank has not yet build specialized module for liquidity report to recognize the change in solvency ratios intraday and to make report at the end of day This makes deviation from the actual and forecast report; so the bank must take any solutions back date to bring the ratios in line only after break 3.1.1.4 Structural organization ALM, BSM and Money market department now are responsible for managing bank’s liquidity risk But almost daily activities are run by Money market department – one trading unit in the bank, while BSM and ALM are two specialized units that take care liquidity risk but they are not active in daily work These make mixed structure between trading purpose and liquidity management purpose CHAPTER 3: SOLUTIONS TO IMPROVE LIQUIDITY RISK MANAGEMENT AT TECHCOMBANK 3.1 Pursuing ambitious business strategy A ambitious business strategy brings good position for liquidity risk management Restructuring whole Vietnam economy with the start of bank sector has been a highlight of the year 2011 It brings opportunities and also challenges to each bank, including Techcombank In fact, the restructuring process prefers the efficient big banks This chance gives Techcombank good opportunity to breakthrough to be leading enterprise in Vietnam 3.2 Investing in information technology Techcombank should invest in software or developing module from core banking system, specialized in liquidity risk management to meet development demand This new software allows Techcombank to do: 21 - Daily solvency ratio report at the end of day as SBV’s regulation - Update solvency position intraday: to forecast solvency ratios and take any necessary actions to keep the ratios in the SBV’s and Techcombank internal’s limit - Core MCO and dynamic MCO reports at the end of the day - Stress test and scenario test (as the assumption inputs of ALM) - FTP management, Fund transfer pricing across each product of business units 3.3 Systemic document on liquidity risk management BOD and BOM’s strategic vision on risk management is one of the strength of Techcombank It favors specialized units to have power to manage smoothly bank’s liquidity But the concept of top team is not enough Techcombank needs also to complete the document system related to liquidity management issue from policy in general and guidelines in details 3.4 Restructuring organization and developing HR Techcombank should restructure more clearly not only in nominal but also in actual business, all the structure and management process should be documented 22 3.5 Intelligent and management flexible strategic in liquidity risk To be successful in liquidity risk management, besides setting up the policy as above, Techcombank should also develop an intelligent and flexible strategic in liquidity risk management, this strategy could base on: - Techcombank’s situation and position, itself - Vietnam financial market’s characteristics and macro economic policies - Global financial market’s influence 23 CONCLUSION Liquidity risk management becomes key focus for bank’s managers and regulators in fluctuant financial markets nowadays The thesis studies international standards in liquidity risk management and SBV’s regulations for financial institutions that operate in Vietnam From theories to fact, thesis makes analysis the situation of liquidity risk management at Techcombank, one of most the most successful joint - stock banks in Vietnam during the last decade Based on the research and analysis of Techcombank’s situation, author gives some recommendations to improve the bank’s liquidity risk management I hope thesis could contribute a little to subject of liquidity risk management, a very new and interesting topic that needs to be discussed and developed more and more in Vietnam context Despite the best effort to fulfill the thesis, it exist inevitable shortcomings due to author’s knowledge and experience Thus, feedbacks and comments on the thesis are precious to author to deeper study in the next future 24 ... categories, including: - Structural liquidity risk - Contingency liquidity risk - Market liquidity risk 1.3 International standards in management and supervision of liquidity risk 1.3.1 Basel’s principles... ABBRIVIATIONS INTRODUCTION CHAPTER 1: OVERVIEW OF LIQUIDITY RISK MANAGEMENT IN BANKS 1.1 Introduction of liquidity risk 1.2 Liquidity risk classification 1.3 International standards in management. .. Strengths in liquidity risk managements 2.3.3 Weaknesses in liquidity risk management CHAPTER 3: SOLUTIONS TO IMPROVE LIQUIDITY RISK MANAGEMENT AT TECHCOMBANK 3.1 Pursuing ambitious business strategy