Work sheet #1 Liquidity Risk

Market and liquidity risk Committee

 

Introduction :

Liquidity is defined as the bank’s ability to provide the required funds (liquidity) on an ongoing basis, either by obtaining new obligations, selling them, or benefiting from existing assets , 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 and may result in exposure to reputational risks and may also lead to a decrease in the bank’s credit rating and other negative effects, and that liquidity management is a complex dynamic process Procedures, as well as the bank’s assets and liabilities, are affected by various economic factors, such as changes in interest rates and exchange rates, as well as market liquidity.

Liquidity management goals:

Liquidity management aims to ensure that resources are used wisely, responsibly and effectively managed at all times, and aims to finance its commercial activities both in normal and abnormal conditions in the market. The main objective of the financing and cash liquidity strategy is as follows:

• Maintaining a diversified funding base.
• Avoid excessive reliance on short-term liabilities such as bank deposits.
• Ensure the bank’s ability to fulfill all its obligations upon maturity and maintain a safe limit of assets that guarantee its ability to fulfill its obligations upon request without confusion or loss and thus without the need to liquidate its assets at unfair prices or to offer high interest rates to attract new deposits.

Therefore, the main objectives of the liquidity policy are to reach an ideal position for liquidity and avoid concentration of funds that may put the bank in the possibility of liquidity problems, in addition to working on developing a contingency plan for liquidity in case of crises.

General principles of liquidity management:

• Liquidity is measured by the bank’s ability to provide the necessary funds when needed at a reasonable cost and with the lowest possible losses.
• The bank must be able to provide the necessary liquidity to fulfill all its obligations towards its customers and any other parties at any time and to take advantage of opportunities to enhance profitability in addition to preserving the bank’s reputation, image and name of the bank.
• The cash flows – incoming and outgoing – are identified and matched with each other within specific maturity periods to determine the financing requirements in each period expressed as a percentage of deficit or surplus.

Liquidity sources:

Liquidity sources are classified into two main groups, the first includes assets that may mature or can be liquidated without additional costs before maturity, and the second group is a variety of financing sources that are either by borrowing or obtaining funds in another way (the figure below shows the sources of liquidity) The process of selecting funding sources depends on the following:

• Costs and characteristics of various sources of liquidity.
• The bank’s ability to access the liabilities markets (to obtain deposits).
• The reasons for our need for the required liquidity
• Interest rate forecasts

Types of Liquidity Risk:

There are three types of liquidity risk, as shown in the figure below:

Evaluating and measuring liquidity:

Liquidity can be measured either through the cash flow approach method or the stock approach method. The first method is useful for measuring short-term liquidity and includes the distribution of assets and liabilities over different maturity periods, and the gap between assets and liabilities in different time periods represents cash inflows, cash outflows and the gap The cumulative results in different periods give an indication of the bank’s liquidity situation and conditions.

Cumulative maturity gap:

It represents the difference between assets that mature within a specified period of time and liabilities that mature within the same period. The second method includes classifying assets into three categories (L1, L2, and L3). Prudent management of liquidity requires maintaining a balanced mix between the three classifications to face any liquidity pressures, which are as follows:

• L1 is the most liquid asset, which is either in the form of cash or can be converted into immediate cash within one day.
• L2 are liquid securities which can be liquidated within 2-5 days at a reasonable cost.
• L3 consists of lines of credit available with the bank or firm commitments made by other banks to our bank account for short term needs.

In addition, the bank should conduct a more in-depth assessment of market conditions, including detailed scenario analysis, including various market factors, past trends, behavioral studies on interest rate-sensitive assets and liabilities, and develop a clear methodology for managing liquidity gaps.

Liquidity Analysis:

There are many other methods for analyzing the bank’s liquidity situation, including:

Monthly analysis and review of deposits, in particular:

• Range of fluctuations and changes.
• Any regular increases to accounts.
• Determining the extent of concentration in deposits.
• Methods of dealing with deposits upon maturity.

Monitoring and Control of Cash and Liquid Assets:

• Determine the assets that are considered liquid according to the type of currency.
• Minimum limits of assets that must be maintained.
• Maximum limits for treasury bills.

Liquidity indicators and ratios:

• Loans to total assets
• Loans to deposits
• Non-performing debt ratio
• Liquid assets to total assets
• Liquid assets to deposit
• Liquid instruments to full financial investments
• Borrowed funds (Purchased Funds) to total assets
• Borrowed funds (Purchased Funds) to liquid assets
• Inter-bank borrowing to full borrowing

Warning indicators and developing contingency plans for crises:

Every financial institution must have an emergency plan for liquidity management, which shows the various alternatives to fill the deficit or shortage in liquidity, and so that it clarifies an emergency plan for the bank’s liquidity in which it is clarified how to face the possibilities of liquidity shortage and the procedures used to address the liquidity crises that it is exposed to and access to the available alternatives, and so that The bank has sufficient cash liquidity to face emergencies resulting from liquidity, in addition to meeting the needs of customers in light of the liquidity crisis. Liquidity crises, which requires the need to rely on a variety of different sources to compensate for the shortfall in liquidity.

There are warning indicators that must be prepared in advance, and then an emergency plan must be activated or prepared to face liquidity crises when they occur, whether in internal events.

The emergency plan is based on the following:

• Determining the minimum liquidity for the bank in order to fulfill its urgent obligations.
• Obtaining additional resources, whether from the local or foreign market.

These warning indicators are divided into two parts, the first is quantitative and the second is qualitative, and they are as follows:

Quantitative warning signs such as:

• Deposits are lower than the prescribed rates.
• Increasing the cost of sources of funds.
• Cumulative liquidity gaps.
• Increased concentration on both sides of the financial position.
• A significant drop in the bank’s profits.
• An increase in the bank’s non-performing debt portfolio.

Specific warning signs such as:

• Low credit ceilings granted by banks.
• A decrease in the quality of assets. –
• Decrease or possible decline in the credit rating of the bank by international rating agencies.

Liquidity according to Basel III:

The global financial crisis in 2008 made it clear that the issue of liquidity is of great importance in the work of the global financial and banking system and the markets as a whole. This thing was enshrined by the Basel Committee by expressing its desire to reach a global standard for liquidity, as it adopted two ratios: The first is for the short term and is known as the liquidity coverage ratio (LCR). It is calculated by attributing the highly liquid assets held by the bank to the 30-day volume of its cash flows. This ratio aims to make the bank self-satisfy its liquidity needs in the event of a crisis. As for the second ratio, it is for measuring liquidity in the medium and long term, and its aim is to provide the bank with stable financing sources for its activities (NSFR).

First: Liquidity Coverage Ratio

This percentage represents highly liquid assets that can be converted into cash to cover the expected cash flows to the bank during the next 30 days.

First: Liquidity Coverage Ratio = high-quality liquid assets >= 100%

The expected net cash outflows within 30 days.

This percentage consists of the value of high-quality liquid assets under specific stress conditions, and high-quality liquid assets carry the following specifications:

First: the basic characteristics:

• Ease of evaluating these assets.
• These assets carry low credit risk and market risk.
• Correlation is weak with riskier assets.
• There is no restriction or attachment that prevents the bank from disposing of it.

Second: Market specifications:

• It can be traded easily and there is an active market for it.

Third: operational requirements:

• Manage these portfolios
• Not using it to hedge other positions
• Determining the bank for an entity responsible for liquidity risk management

The value of net cash flows issued under a specific scenario, for the following items:

• Withdrawing a specific part of the deposits of individuals.
• Loss of a specific part of corporate deposits.
• Loss of a specific part of the short-term financing.
• Requirements as a result of a decrease in the bank’s rating.
• An increase in price fluctuations in the market (for guarantees, financial instruments, and derivatives).
• Exploitation of unused ceilings for facilities

Second: Net Stable Funding Ratio:

It represents the percentage of assets that must be supported by stable financing.

Available amount of stable financing ≤ 100%

Amount of stable financing required Stable financing:

It represents part of shareholders’ equity and liabilities that are expected to be a good source of financing for a period of more than one year.

The expected impact of the new liquidity ratio on banks:

• It will most likely lead to a funding shortfall
• High cost of financing
• Low availability of funding
• High competition for deposits and stable long-term financing.
• Low rate of return on capital accounts.

Cash flow management

The bank must measure, monitor and control the cash flow and follow up and provide for cases of maturity mismatches, provided that the bank has appropriate systems and procedures for:

• Determine net financing requirements on a daily basis
• Conducting cash flow analyzes based on stressful scenarios
• Analysis of flows according to the following scenarios:

• Limited crisis in the bank
• General market crisis

Through these scenarios, a hypothetical percentage of draining resources and maturity of assets is determined:

• Setting a Money runoff rate
• The exit of funds and the maturity of assets according to the contractual date

It should include the following scenarios:

• 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.
• The largest customers withdraw their deposits (for example, the five largest customers).

Maintaining an appropriate balance of high-quality liquid assets is considered as a source of rapid liquidity generation in order to meet the bank’s needs for funds in cases of distress, which requires the existence of a pre-approved liquidity emergency plan in order to activate it in times when the bank faces liquidity crises, in addition to the necessity that the bank has a strategy Liquidity is approved for liquidity management, in which the basis for the acquisition and quality of liquid assets is determined, and the following matters must be taken into consideration when determining those assets:

• Market depth
• Exposure level to those tools
• Credit rating for those tools Credit rating
• Maturity date for those instruments
• Time for liquidation

The bank must maintain a good level of funding sources characterized by diversity and stability (liabilities), taking into account the lack of concentration in those sources by taking into account the following:

• due date
• The extent of concentration in those sources
• The cost of obtaining these resource.

Institutional Governance

The bank must comply with the liquidity ratio approved by the Central Bank (legal liquidity) in order for the bank to fulfill its obligations according to their due date.

Assets and Liabilities Committee

The Market Risk Department monitors the Bank’s liquidity risk through reports presented to the ALCO Committee, through the following reports and ratios:

• Report the legal liquidity on a daily basis and calculate the average percentage during the month and the lowest and highest percentage during the month
• Liquidity gap report
• Stress testing
• The ratio of loans to deposits
• Qualitative assessment of liquidity risk
• Concentration limits
• Concentrations of sources of funds

Board of Directors

• Approving the liquidity strategy, liquidity contingency plan and policies related to liquidity risks.
• Setting the powers for the various management policies
• Ensuring that there is a qualified staff to manage liquidity and manage liquidity risks
• Violation reports

Executive management supervision

• Senior management is responsible for liquidity risk management in accordance with risk tolerance levels approved by the Board of Directors and the powers granted to them.

Done By Market Risk Group,

1. Mohammed Swais
2. Anas Al Masry
3. Hanin Qaqeish
4. Maha Al saeid
5. Yacoub Sawalha