A Study on Liquidity Management on Prime Bank Limited

A Study On Liquidity Management On Prime Bank Limited

LETTER OF TRANSMITTAL January 08, 2012 Dr. Tom Siller Colorado State University Fort Collins, CO 80524 Dear Sir, We are submitting to you the report, due January 08, 2012, as part of fulfilling the MBA degree. The report is for analyzing the liquidity position of Prime Bank limited. We are grateful to you for providing us such opportunity. This study enriched our knowledge. Sincerely,

-------------------------------------------On behalf of IFC Group MBA 3rd Batch (2nd Semester) Department of Management (Team members name are in next page)

TEAM MEMBERS

SL No 1

Name Md. Mohsin Hossain

Roll No 095179

Remarks

A Study On Liquidity Management On Prime Bank Limited

2 3 4 5 6 7 8 9 10

Md. Mahabub Alam Manik Ishtiaque Ahmed Md. Robin Hasan Md. Abdullah Al- Mamun Sakti pada Mirdha Md. Idris Palash Mondal Nazmul Haque Sadiqur Rahman

095255 095253 085788 095234 095218 095215 095223 095232 095210

INDEX

LETTER OF TRANSMITTAL TEAM MEMBERS EXECUTIVE SUMMARY

A Study On Liquidity Management On Prime Bank Limited

1. INTRODUCTION 2. OBJECTIVE OF THE STUDY 3. METHODOLOGY OF THE STUDY 4. THEORETICAL FRAMEWORK: 5. LIQUIDITY MANAGEMENT ANALYSIS 6. LIQUIDITY RISK MANAGEMNT 7. STRESS TESTING AND SCENARIO ANALYSIS 8. CONCLUSIONS:

EXECUTIVE SUMMARY

A Study On Liquidity Management On Prime Bank Limited

1. INTRODUCTION Liquidity management is undoubtedly one of the most crucial tasks of a bank. The analysis in this study focuses on the liquidity situation of Prime Bank Limited for the period of 2008 - 2010. Both short-term and long-term liquidity positions
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have been taken into consideration. However, maturity-wise liquidity situation has also been observed. To estimate the liquidity situation maturity-wise and total liquidity gap have been calculated. Furthermore, this study also tries to examine whether key performance indicators of these banks had any influence on liquidity position during the period under study. Any commercial bank is required to monitor and manage its liquidity position effectively and cautiously. For Primes analysis, we have taken Prime Bank Limited (Prime) in respect of maintaining liquidity position. Prime Bank was created and commencement of business started on 17th April 1995. The sponsors are reputed personalities in the field of trade and commerce and their stake ranges from shipping to textile and finance to energy etc. As a fully licensed commercial bank, Prime Bank is being managed by a highly professional and dedicated team with long experience in banking. Prime Bank has already made significant progress within a very short period of its existence. The bank has been graded as a top class bank in the country through internationally accepted CAMELS rating. The bank has already occupied an enviable position among its competitors after achieving success in all areas of business operation. Prime Bank offers all kinds of Commercial Corporate and Personal Banking services covering all segments of society within the framework of Banking Company Act and rules and regulations laid down by central bank. Diversification of products and services include Corporate Banking, Retail Banking and Consumer Banking right from industry to agriculture, and real state to software. Prime Bank, since its beginning has attached more importance in technology integration. Maintaining adequate liquidity is Primes strategic priority. Even though Prime Bank achieved double-digit growth in its lending business, the Group was able to maintain a liquid balance sheet. This was due to the strategy of building a longterm core deposit funding base of retail deposits to adequately fund its lending business expansion. The injection of funds by issuing of subordinated bond of BDT 2.5 billion and right share with premium of BDT 200 helped the bank to end with a comparatively more liquidity. Prime Bank as a Group did not get much involved in the stock market which was extremely volatile. 2. OBJECTIVE OF THE STUDY The main objective of this study is to

Analyze liquidity position of prime bank limited To understand the maturity wise liquidity position
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Liquidity risk management framework Ways of liquidity management Different forms of liquidity held

3. METHODOLOGY OF THE STUDY In this study, at first we have calculated the net liquidity gaps 2008-2010. To calculate net liquidity gap, we have collected maturity-wise information of both assets and liabilities, which is segmented according to the following maturity buckets: Up to 1 month maturity 1-3 months maturity 3-12 months maturity 1-5 years maturity More than 5 years maturity

With this information, we have calculated the net liquidity gap for each maturity bucket from 2008 to 2010 by adding all the assets falling under that bucket and then subtracting all the liabilities falling under that bucket from the assets of the same maturity bucket. That is NLG = A - L Where, NLG = Net liquidity gap during a particular maturity bucket A = Assets falling under a particular maturity bucket L = Liabilities falling under a particular maturity bucket Positive net liquidity gap implies that the bank has sufficient assets to satisfy the liabilities of the same maturity bucket and negative net liquidity gap implies that the liabilities exceed the assets for that particular maturity bucket. We found the percentage of assets and liabilities held for each maturity bucket in respect of total assets for the particular year. We have also calculated percentage of shortterm and long-term assets and liabilities for each of the year under discussion. This provides a direction of liquidity situation of the concerned banks for the years under discussion. 4. THEORETICAL FRAMEWORK:
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Liquidity: Liquidity for a bank means the ability to meet its financial obligations as they come due. Bank lending finances investments in relatively illiquid assets, but it funds its loans with mostly short term liabilities. Thus one of the main challenges to a bank is ensuring its own liquidity under all reasonable conditions. Maturity: maturity or maturity date refers to the final payment date of a loan or other financial instrument, at which point the principal (and all remaining interest) is due to be paid. Maturity gap: A measurement of interest rate risk for risk-sensitive assets and liabilities. The market values at each point of maturity for both assets and liabilities are assessed, then multiplied by the change in interest rate and summed to calculate the net interest income or expense. Asset liability management: In banking, asset and liability management is the practice of managing risks that arise due to mismatches between the assets and liabilities (debts and assets) of the bank. Cash Reserve Requirement: The reserve requirement (or cash reserve ratio) is a central bank regulation that sets the minimum reserves each commercial bank must hold (rather than lend out) of customer deposits and notes. It is normally in the form of cash stored physically in a bank vault (vault cash) or deposits made with a central bank. Statutory Requirement: The Statutory Requirement is a monetary policy instrument available to manage liquidity and hence credit creation in the banking system. It is used to withdraw or inject liquidity when the excess or lack of liquidity in the banking system. Stress testing: Stress testing is a form of testing that is used to determine the stability of a given system or entity. It involves testing beyond normal operational capacity, often to a breaking point, in order to observe the results.

5. LIQUIDITY MANAGEMENT ANALYSIS Liquidity overview:

Table-1 Year-wise net liquidity gap of IBBL

A Study On Liquidity Management On Prime Bank Limited

Particular s Payable on demand Up to 1 month 1-3months 3-6 months 6 months1 year 1-5 years More than 5 years Total

Payable 107.05 10,910.0 0 271.55 27.58 81.69 11,397.8 6

2008 Receivabl e 1,833.89 1.82 50.00 100.00 16.36 2,002.07

GAP 1,726.84 -10,908.1 8 -221.55 100.00 -11.21 -81.69 -9,395.79

Payabl e 7.97 8.65 69.92 86.55

2009 Receivabl e 603.59 0.02 0.15 100.00 15.17 718.92 595.6 2 0.02 0.15 100.0 0 6.51 69.92 632.3 8

2010 Payabl e 51.83 353.65 1,016.9 0 336.38 1,758.7 6

Receiva ble 1,028.46 0.02 7.25 0.15 1,035.88 1,028.4 6 -51.81 -346.39 1,016.7 5 -336.38 -722.88

The table 1 shows the short term liquidity gap of prime bank limited. Prime segments the total short term deposits and short term payable in different categories. By deducting the payable and receivable in short term nature prime calculates its liquidity gap. In 2008 it has net short term liquidity gap of 9,395 million. In 2010 it is reduced to 722 million.

Table-2 Maturity analysis Maturity analysis Interest bearing assets Non interest bearing assets Total assets Interest bearing liabilities Non interest bearing liabilities Total liabilities Maturity gap Cumulative gap

Below 1 year 57 03 60 16 95 11 49 49 84,7 8,2 92,9 60,0 25,5 85,6 7,3 7,3

1-5 Year 7 50 7 0 98 8 79 8 28,46 1,4 29,91 23,84 9 24,83 5,0 12,42

Above 5 year 64 57 21 11 68 79 42 70 19,4 10,4 29,9 20,5 5,0 25,5 4,3 16,7

Total 88 10 98 67 61 28 70 1,32,6 20,1 1,52,7 1,04,3 31,6 1,36,0 16,7

Table 2 shows the maturity gap of different years. Assets and liabilities are segmented into interest bearing and non interest bearing. From the liquidity statement it transpires that the cumulative gap is positive and pressure from liquidity is minimal. In order to meet the withdrawal demand Bank maintained adequate liquid assets as per regulation. The issuance of subordinated bond and injection of right share proceeds with premium significantly helped the bank to maintain sufficient liquidity.
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The liquidity policy of the bank has always been to carry a positive mismatch in the interest earning assets and interest bearing liabilities in the 1 to 30 days category. Primes liquidity remained at optimum levels during the year. The liquid assets ratio stood at 25.76% (required 19% of total demand & time deposits) in December 2010. The assets and liabilities committee (ALCO) of the bank monitors the situation and maintains a satisfactory trade-off between liquidity and profitability. Following CRR and SLR ratio was maintained as against the regulatory requirement.
Table-3 Reserve maintenance Cash Reserve Requirement Statutory Requirement

Required (%) 6 19

Maintained (%) 6.64 25.67

Way of liquidity management reporting: The liquidity statement of assets and liabilities as on the reporting date has been prepared on residual maturity term as per the following basis. Balance with other Banks and financial institutions, money at call and short notice, etc. are on the basis of their maturity term Investments are on the basis of their respective maturity

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 Loans and advances / investments are on the basis of their repayment schedule; Fixed assets are on the basis of their useful lives Other assets are on the basis of their realization / amortization Borrowing from other Banks, financial institutions and agents, etc. are as per their maturity / repayment terms Deposits and other accounts are on the basis of their maturity term and past trend of withdrawal by the depositors Provisions and other liabilities are on the basis of their payment / adjustments schedule.

6. LIQUIDITY RISK MANAGEMNT Liquidity risk is the risk to a bank's earnings and capital arising from its inability to timely meet obligations when they come due without incurring unacceptable losses. The liquidity risk of banks arises from funding long term assets by shortterm liabilities. Liquidity risk in banks manifest in different directions:

Funding risk arises from the need to replace net outflows due to unanticipated withdrawal/non-renewal of deposits. Time Risk arises from the need to compensate for non-receipt of expected inflows of funds i.e., performing assets turning into non-performing assets. Call Risk arises due to crystallization of contingent liabilities. This may also arise when a bank is not able to undertake profitable business opportunities when it arises. To this end, Prime maintains diversified and stable funding base comprising of core retail, corporate and institutional deposits. It maintained sufficient liquid assets for meeting the funding requirements. The principle responsibility of the liquidity risk management of the bank rests with Treasury Division. Treasury Division maintains liquidity based on historical requirements, current liquidity position, anticipated future funding requirement, sources of fund, options for reducing funding needs, present and anticipated asset quality, present and future earning capacity, present and planned capital position. ALCO monitors the liquidity management of Treasury by i) setting tolerance limit for cumulative cash flow mismatches, ii) setting limit on loan to deposit ratio, iii) setting limits on dependence on institutional deposits which are volatile in nature. From the liquidity statement it can be seen that out of total deposit liabilities of Tk 124,519
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million, contractual maturity of liability within 1 year is Tk 85,611 million. In the liquidity statement it transpires that there is moderate positive gap in each maturity buckets. So the cumulative gap is positive and pressure from liquidity is minimal. The Management Board defines Primes liquidity risk strategy, and in particular Primes tolerance for liquidity risk based on recommendations made by Treasury and the Capital and Risk Committee. At least once every year the Management Board will review and approve the limits which are applied to the Group to measure and control liquidity risk as well as the Banks long-term funding and issuance plan. Primes Treasury function is responsible for the management of liquidity and funding risk of globally as defined in the liquidity risk strategy. Primes liquidity risk management framework is designed to identify measure and manage the liquidity risk position of the Group. Treasury reports the Banks overall liquidity and funding to the Management Board at least weekly via a Liquidity Scorecard. Primes liquidity risk management approach starts at the intraday level (operational liquidity) managing the daily payments queue, forecasting cash flows and factoring in Primes access to Central Banks. It then covers tactical liquidity risk management dealing with access to secure and unsecured funding sources. Finally, the strategic perspective comprises the maturity profile of all assets and liabilities (Funding Matrix) and Primes issuance strategy. Primes cash-flow based reporting system provides daily liquidity risk information to global and regional management. 7. STRESS TESTING AND SCENARIO ANALYSIS Prime use stress testing and scenario analysis to evaluate the impact of sudden stress events on Primes liquidity position. The scenarios we apply have been based on historic events, Also incorporated are the lessons learned from the latest financial markets crisis. They include the prolonged term money-market and secured funding freeze, collateral repudiation, reduced fungibility of currencies, stranded syndications as well as other systemic knock-on effects. The scenario types cover institutionspecific events (e.g. rating downgrade), market related events (e.g. systemic market risk) as well as a combination of both, which links a systemic market shock with a multi-notch rating downgrade. Under each of these scenarios prime assume that all maturing loans to customers will need to be rolled over and require funding whereas rollover of liabilities will be partially impaired resulting in a funding gap. In addition we analyze the potential funding requirements from off-balance sheet commitments
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(e.g. drawings of credit facilities and increased collateral requirements) which could materialize under stress. We then model the steps we would take to counterbalance the resulting net shortfall in funding. Countermeasures would include the Groups unencumbered business asset inventory, the available long cash balance (over and above cash balances which form an integral part of Primes existing clearing and settlement activities), as well as Primes strategic liquidity reserve. The asset liquidity analysis thereby forms an integral piece of stress testing and tracks the volume and booking location within Primes consolidated business inventory of unencumbered, liquid assets which we can use to raise liquidity via secured funding transactions. Securities inventories include a wide variety of different securities. As a first step, we segregate illiquid and liquid securities in each inventory. Subsequently we assign liquidity values (haircuts) to different classes of liquid securities. The liquidity of these assets is an important element in protecting us against short-term liquidity squeezes. In addition the bank maintains sizeable cash balances, primarily with central banks, which are held in excess of the collateral which is required to support Primes clearing activities in euro, U.S. dollars and other currencies around the globe. As a separate countermeasure we hold a dedicated strategic liquidity reserve containing highly liquid and central bank eligible securities in major currencies around the world to support Primes liquidity profile in case of potential deteriorating market conditions. The volume of the strategic liquidity reserve is the function of expected stress result. Size and composition are subject to regular senior management review. The most immediately liquid and highest quality items within the above three categories are aggregated and separately identified as Primes Liquidity Reserves. These Reserves comprise available cash and highly liquid government securities and other central bank eligible assets. As of December 31, 2010 Primes Liquidity Reserves. Stress testing is fully integrated in Primes liquidity risk management framework. We track contractual cash flows per currency and product over an eight-week horizon (which we consider the most critical time span in a liquidity crisis) and apply the relevant stress case to all potential risk drivers from on balance sheet and off balance sheet products. Beyond the eight week time horizon we analyze on a quarterly basis the impact of a more prolonged stress period extending out to twelve months, together with mitigation actions which may include some change of business model. The liquidity stress testing provides the basis for the
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banks contingency funding plans which are approved by the Management Board. Primes stress testing analysis assesses Primes ability to generate sufficient liquidity under extreme conditions and is a key input when defining Primes target liquidity risk position. The analysis is performed monthly. Stress testing and scenario analysis plays a central role in Primes liquidity risk management framework. This also incorporates an assessment of asset liquidity, i.e. the characteristics of Primes asset inventory, under various stress scenarios as well as contingent funding requirements from off-balance-sheet commitments. The monthly stress testing results are used in setting Primes short-term wholesale funding limits (both unsecured and secured) and thereby ensuring we remain within the Boards overall liquidity risk tolerance. Short-Term Liquidity: Primes reporting system tracks all contractual cash flows from wholesale funding sources on a daily basis over a 12-month horizon. The system captures all cash flows from unsecured as well as from secured funding transactions. Wholesale funding limits, which are calibrated against Primes stress testing results and approved by the Management Board, express Primes maximum tolerance for liquidity risk. These limits apply to the respective cumulative global cash outflows and are monitored on a daily basis. Primes liquidity reserves are the primary mitigate against stresses in short-term wholesale funding markets. At an individual entity level it may set liquidity outflow limits across a broader range of cash flows where this is considered to be meaningful or appropriate. Unsecured Funding: Unsecured funding is a finite resource. Total unsecured funding represents the amount of external liabilities which we take from the market irrespective of instrument, currency or tenor. Unsecured funding is measured on a regional basis and aggregated to a global utilization report. As part of the overall Liquidity Risk Strategy, the management board approves limits to protect Primes access to unsecured funding at attractive levels.

8. CONCLUSIONS:

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