لجنة مخاطر السوق والسيولة
Introduction
Liquidity is defined as the bank's ability to provide the required funds on an ongoing basis, either by obtaining new obligations, selling them, or benefiting from existing assets to target profits, especially in the long run. The liquidity management process is very important, as failure in liquidity management may lead to organizational problems with a material impact, exposure to reputational risks, and a decrease in the bank's credit rating.
Liquidity Management Goals
Liquidity management aims to ensure that resources are used wisely, responsibly and effectively managed at all times, and aims to finance commercial activities both in normal and abnormal market conditions.
- 1Maintaining a diversified funding base.
- 2Avoid excessive reliance on short-term liabilities such as bank deposits.
- 3Ensure the bank's ability to fulfill all its obligations upon maturity and maintain a safe limit of liquid assets without the need to liquidate assets at unfair prices or offer high interest rates.
General Principles of Liquidity Management
- 1Liquidity is measured by the bank's ability to provide the necessary funds when needed at a reasonable cost and with the lowest possible losses.
- 2The bank must be able to provide the necessary liquidity to fulfill all its obligations towards its customers and any other parties at any time.
- 3Cash flows — incoming and outgoing — are identified and matched within specific maturity periods to determine financing requirements expressed as a percentage of deficit or surplus.
Liquidity Sources
Liquidity sources are classified into two main groups:
Group 1: Asset-Based
Assets that may mature or can be liquidated without additional costs before maturity.
Group 2: Liability-Based
A variety of financing sources, either by borrowing or obtaining funds in another way.
The selection of funding sources depends on: costs and characteristics, the bank's ability to access liabilities markets, reasons for the required liquidity, and interest rate forecasts.
Types of Liquidity Risk
There are three types of liquidity risk that banks must monitor and manage effectively.
Evaluating and Measuring Liquidity
Liquidity can be measured through two approaches:
Cash Flow Approach
Useful for measuring short-term liquidity. Includes distribution of assets and liabilities over different maturity periods, where the gap represents cash inflows, outflows, and cumulative results give an indication of the bank's liquidity situation.
Stock Approach
Classifies assets into three categories: L1 (most liquid, cash or convertible within one day), L2 (liquid securities, liquidated within 2-5 days at reasonable cost), and L3 (credit lines available with the bank for short-term needs).
Liquidity Indicators and Ratios
| # | Ratio / Indicator |
|---|---|
| 1 | Loans to Total Assets |
| 2 | Loans to Deposits |
| 3 | Non-Performing Debt Ratio |
| 4 | Liquid Assets to Total Assets |
| 5 | Liquid Assets to Deposits |
| 6 | Liquid Instruments to Full Financial Investments |
| 7 | Borrowed Funds (Purchased Funds) to Total Assets |
| 8 | Borrowed Funds (Purchased Funds) to Liquid Assets |
| 9 | Inter-Bank Borrowing to Full Borrowing |
Warning Indicators & Contingency Plans
Every financial institution must have an emergency plan for liquidity management that clarifies alternatives to fill the deficit in liquidity and procedures to address crises.
Quantitative Warning Signs
- • Deposits are lower than prescribed rates
- • Increasing cost of sources of funds
- • Cumulative liquidity gaps
- • Increased concentration on both sides of the financial position
- • Significant drop in bank profits
- • Increase in non-performing debt portfolio
Qualitative Warning Signs
- • Low credit ceilings granted by banks
- • Decrease in asset quality
- • Decline in credit rating by international rating agencies
Liquidity According to Basel III
The global financial crisis in 2008 made it clear that liquidity is of great importance. The Basel Committee adopted two ratios:
1. Liquidity Coverage Ratio (LCR)
LCR = High-Quality Liquid Assets / Expected Net Cash Outflows (30 days) ≥ 100%
Represents highly liquid assets that can be converted into cash to cover expected cash flows during the next 30 days.
High-quality liquid assets must have:
- • Ease of evaluation
- • Low credit risk and market risk
- • Weak correlation with riskier assets
- • No restriction preventing disposal
- • Easily traded with an active market
2. Net Stable Funding Ratio (NSFR)
NSFR = Available Stable Funding / Required Stable Funding ≥ 100%
Represents the percentage of assets that must be supported by stable financing. Stable financing includes shareholders' equity and liabilities expected to be a good source of financing for more than one year.
Expected Impact on Banks
- • Will likely lead to a funding shortfall
- • Higher cost of financing
- • Lower availability of funding
- • Higher competition for deposits and stable long-term financing
- • Lower rate of return on capital accounts
Cash Flow Management
The bank must measure, monitor, and control cash flow and provide for maturity mismatches. The bank should conduct cash flow analyses based on stressful scenarios including limited bank crises and general market crises.
Stress Scenarios Should Include
- • Daily withdrawal rates for customer deposits
- • Payment of inter-bank deposits when due
- • Liquidation of securities with the central bank and sale of other bonds
- • Largest customers withdraw their deposits (e.g., the five largest customers)
Institutional Governance
Assets and Liabilities Committee (ALCO)
The Market Risk Department monitors liquidity risk through reports including: legal liquidity (daily), liquidity gap report, stress testing, loans-to-deposits ratio, qualitative assessment, concentration limits, and funding source concentrations.
Board of Directors
- • Approving the liquidity strategy and contingency plan
- • Setting management policy powers
- • Ensuring qualified staff for liquidity risk management
- • Reviewing violation reports
Executive Management
Senior management is responsible for liquidity risk management in accordance with risk tolerance levels approved by the Board of Directors.
Prepared by the Market Risk Group: Mohammed Swais, Anas Al Masry, Hanin Qaqeish, Maha Al Saeid, Yacoub Sawalha
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