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VIETNAM NATIONAL UNIVERSITY, HANOI SCHOOL OF BUSINESS VAN THU HUONG LIQUIDITY RISK MANAGEMENT IN LIEN VIET COMMERCIAL JOINT STOCK BANK MASTER OF BUSINESS ADMINISTRATION THESIS Hanoi - 2010 VIETNAM NATIONAL UNIVERSITY, HANOI SCHOOL OF BUSINESS VAN THU HUONG LIQUIDITY RISK MANAGEMENT IN LIEN VIET COMMERCIAL JOINT STOCK BANK Major: Business Administration Code: 60 34 05 MASTER OF BUSINESS ADMINISTRATION THESIS Supervisors: 1. Dr. Chu Thanh 2. MBA Ha Nguyen Hanoi - 2010 TABLE OF CONTENTS ACKNOWLEDGEMENTS......................................................................................i ABSTRACT............................................................................................................ii TÓM TẮT.............................................................................................................. iv LIST OF ABBREVIATIONS.................................................................................. x LIST OF TABLES .................................................................................................xi LIST OF FIGURES...............................................................................................xii INTRODUCTION................................................................................................... 1 CHAPTER I: LITERATURE REVIEW .................................................................. 5 1.1. Commercial bank ......................................................................................5 1.1.1 Concepts................................................................................................ 5 1.1.2 Products & services provided by commercial banks .............................. 6 1.1.3 Roles of commercial bank in economics ................................................6 1.2. Risk management in Commercial Bank.....................................................7 1.2.1. Risk in commercial bank .......................................................................7 1.2.2. Main risks in Commercial Bank ............................................................ 8 1.2.3. Risk Management in Commercial Bank.................................................8 1.3. Liquidity Risk Management in Commercial Bank................................... 10 1.3.1. Defining liquidity risk.......................................................................... 10 1.3.2. Basel and Basel II requirements........................................................... 12 1.3.3. International Framework for Liquidity Risk Management in Commercial Bank 16 1.3.3.1. Liquidity risk tolerance .................................................................... 18 vi 1.3.3.2. Strategy & Policy............................................................................. 18 1.3.3.3. The responsibilities to manage liquidity risk .................................... 19 1.3.3.4. Liquidity Risk Management Process ................................................ 21 1.3.3.5. Contingency Planning ...................................................................... 25 1.3.3.6. Internal Audit................................................................................... 27 1.4. Liquidity risk in Vietnam Commercial bank system ................................ 27 1.4.1. Some typical events of liquidly risk in Viet Nam before year 2006...... 27 1.4.2. From the beginning of year 2006 to the end of year 2007: ................... 28 1.4.3. From the beginning of year 2008 – the end of year 2008 ..................... 29 1.4.4. From the beginning of year 2009 to the ending of year 2009 ............... 30 1.4.5. The first six months of year 2010......................................................... 31 1.4.6. Summarized main reasons for liquidity crunch .................................... 32 1.5. State Bank of Vietnam regulations .......................................................... 33 1.6. Practices for liquidity risk management................................................... 37 1.6.1. The Hongkong and Shanghai Bank Corporation .................................. 37 1.6.2. Asia Commercial Bank........................................................................ 38 CHAPTER 2. 2.1. LIQUIDITY RISK MANAGEMENT IN LIENVIETBANK .... 41 Overview on LienVietBank..................................................................... 41 2.1.1. Introduction ......................................................................................... 41 2.1.2. Business Results .................................................................................. 44 2.1.3. Organization structure ......................................................................... 44 2.2. Liquidity risk in LienVietBank................................................................ 45 2.2.1. SBV’s regulations on liquidity ratios in the activities of credit institution vii 46 2.2.2. Supplies of Liquidity ........................................................................... 47 2.2.2.1. Liquid Assets................................................................................ 48 2.2.2.2. Loans repayment .......................................................................... 53 2.2.2.3. Total mobilized funds and chartered capital.................................. 55 2.2.3. Measurement of Liquidity risk via Gap Analysis ................................. 59 2.2.3.1. LienVietBank’s Liquidity Gap report in VND (see table 2-11)..... 60 2.2.3.2. LienVietBank’s Liquidity Gap report in USD (see table 2-12)...... 63 2.2.4. Assessment on current status of liquidity risk ...................................... 65 2.3. General situation of risk management at LienVietBank........................... 67 2.3.1. From establishment to end 2008 .......................................................... 67 2.3.2. For the year of 2009............................................................................. 68 2.3.3. From the beginning of 2010 to now ..................................................... 69 2.4. Liquidity risk management in LienVietBank........................................... 69 2.4.1. Strategy and Policy .............................................................................. 69 2.4.2. The responsibilities to manage liquidity risk........................................ 71 2.4.3. Process of liquidity risk management................................................... 74 2.4.4. Internal Audit ...................................................................................... 75 2.4.5. Contingency Plan ................................................................................ 75 2.5. Assessment on liquidity risk management in LienVietBank .................... 76 2.5.1. Achievements ...................................................................................... 77 2.5.2. Drawbacks on the current liquidity risk management in LienVietBank 78 2.5.2.1. Strategy and policy ....................................................................... 78 viii 2.5.2.2. Organization structure .................................................................. 78 2.5.2.3. Process of liquidity risk management and contingency plan ......... 79 2.5.2.4. Management information system.................................................. 79 2.5.2.5. Human resource............................................................................ 80 CHAPTER 3 RECOMMENDATIONS AND SOLUTIONS ................................. 82 3.1 Some petitions for LienVietBank ............................................................ 82 3.1.1 Building a culture of risk management in LienVietBank...................... 82 3.1.2 Building Liquidity risk strategy and policy ......................................... 84 3.1.3 Improving organizational structure ...................................................... 87 3.1.4 Building process of liquidity risk management .................................... 90 3.1.5 Building contingency plan ................................................................... 97 3.1.6 Improving management information system ........................................ 99 3.1.7 Improving human resources............................................................... 100 3.1.8 Action planning ................................................................................. 102 3.2. Some petitions for SBV............................................................................. 107 3.3. Some petitions for Government ................................................................. 108 Conclusion .......................................................................................................... 109 REFERENCE...................................................................................................... 110 Appendix 1.......................................................................................................... 112 Appendix 2.......................................................................................................... 113 Appendix 3.......................................................................................................... 114 Appendix 4.......................................................................................................... 115 ix LIST OF ABBREVIATIONS ACB Asia Commercial Bank ALCO Asset and Liability Committee BOD Board of Directors BOM Board of Management CAR Capital Equity Ratio HR Human Resource LVB LienViet Commercial Joint Stock bank NPLs Non performing loans SBV State Bank of Viet Nam Sacombank Sai Gon Thuong Tin bank TCB Vietnam Technological and Commercial Joint stock bank VCB The Bank for Foreign Trade of Vietnam x LIST OF TABLES Table 1-1: Products & services provided by commercial banks ............................... 6 Table 1-2: Summarized the principles of Basel 2................................................... 14 Table 1-3: International Framework for Liquidity Risk Management in Commercial Bank...................................................................................................................... 17 Table 1-4: The differences between Decision No.457 and Circular 15 & 13 .......... 36 Table 2-1: Business Results - LienVietBank.......................................................... 44 Table 2-2: Comparison of the liquidity ratios......................................................... 46 Table 2-3: The ratio of liquid assets to total assets ................................................. 49 Table 2-4: Comparison of the ratio of liquid assets to total assets .......................... 50 Table 2-5: The average ratio of the component to liquid assets.............................. 51 Table 2-6: Comparison of the portion of the items out of liquid assets................... 52 Table 2-7: Some indicators of loans quality ........................................................... 54 Table 2-8: Comparison of loans quality by NPL ratio ............................................ 55 Table 2-9: Comparison of LDR ............................................................................. 55 Table 2-10: Mobilized funds from corporate and individuals of LienVietBank...... 57 Table 2-11: LienVietBank’s Liquidity Gap report in VND .................................... 62 Table 2-12: LienVietBank’s Liquidity Gap report in USD..................................... 64 Table 2-13: Summarize assessment on current status of liquidity risk in LienVietBank ........................................................................................................ 65 Table 3-1: Recommendation for Process of liquidity risk management (content)... 91 Table 3-2: Recommendation for Contingency plan sample .................................... 98 Table 3-3: Recommendation for Action planning ................................................ 103 xi LIST OF FIGURES Figure 1- 1: Three pillars of Basel II...................................................................... 13 Figure 2-1: Comparison of the ratio of liquid assets to total assets......................... 50 Figure 2-2: Total mobilized funds of LVB............................................................. 56 Figure 2-3: The number of accounts of incoming customer deposits...................... 58 Figure 2-4: Rating liquidity risk management in LVB ........................................... 77 Figure 3-1: Overview on chapter 3………………………………………………... 81 Figure 3-2: Recommendation for Organization structure ....................................... 87 Figure 3-2: Recommendation for Process of liquidity risk management (procedures) .............................................................................................................................. 95 xii Ket-noi.com Ket-noi.com kho kho tai tai lieu lieu mien mien phi phi INTRODUCTION 1 Necessity of the thesis The nature of the bank is making a profit based on business risk. In banking activities many types of risk exist (credit risk, liquidity risk, market risk, etc.). In Vietnam, the banking activities are often associated with credit risk. However, liquidity risk, the type of risks that can immediately make a bank collapse is less focused, because if the banking activities took place on a normal schedule, the risk was not disclosed. Only when a certain event happens to have a negative impact on the bank, then the liquidity risk is exposed, in the worst case, banks have no liquidity, leading to bankruptcy, and affecting the entire banking system. In Vietnam, liquidity risk can be a problem just say "old problem" was just a matter of "new problem". Calling it "an old problem" is because any bank manager knows about this kind of risk, understands the importance of it and they are also managing liquidity risk based on experience and traditional methods. And calling it "a new problem" is because not many banks in Vietnam really understand it and find ways to reach new approaches to liquidity risk management by international standards. Only after the events on the liquidity risk from 2006 through to now did banks begin to explore and consciously implement the management of liquidity risk, according to a scientific and more systematic method. The starting point of that process must be derived from the banks which are fully equipped with theoretical knowledge about liquidity risk management. LienVietBank was established in April 2008, and in more than 2 years the bank has gained outstanding achievements in business results, but besides that, the issues of risk management are all complex. The organizational structure is not stable, risk management personnel frequently change, the bank only cares about 1 credit risk management and pays no attention to risk management activities, particularly the management liquidity risk. And if there is a crisis similar to the liquidity crisis in 2008, the bank will face the enormous difficulty. It is the reason why I decided to choose the topic “Liquidity risk management in Lien Viet Commercial Joint Stock Bank” for my thesis. 2 Research Objective The aim of the research is to analyze and assess the current status of liquidity risk management in LienVietBank and to propose appropriate recommendations to enhance the efficiency in liquidity risk management in LienVietBank. The thesis therefore aims to achieve the following objectives:  Systemize the basic theoretical problem about liquidity risk and liquidity risk management in commercial banking.  Identifying and assess current situations of liquidity risk and liquidity risk management in LienVietBank.  Propose recommendations and solutions to enhance the efficiency in liquidity risk management in LienVietBank. 3 Research Scope For the purpose and requirement of an MBA graduate thesis, the thesis only focuses on liquidity risk and liquidity risk management in Lien Viet Commercial Joint stock bank. 4 Information sources  Statistic data gathered at LienVietBank (financial statements, official releases of LienVietBank).  Data from other sources such as other banks, books, internet, related journals 2 Ket-noi.com Ket-noi.com kho kho tai tai lieu lieu mien mien phi phi and periodic, science reviews.  Information gathered from direct observation as a person directly involved in activities related. 5 Research Methodology The research methodology of the thesis is the combination of both qualitative and quantitative to analyze data and information, make comparisons, evaluations and conclusions on current situation of liquidity risk management in LienVietBank. 6 Limitation The assessment focuses on the liquidity risk management in LienVietBank, due to time constraint, limited analysis tools and the ability to approach data sources the research can not be analyzed fully and deeply all aspects of the problem. 7 Expected result Thesis systematizes the basic knowledge of liquidity risk management in commercial bank, to apply this knowledge to assess liquidity risk and liquidity risk management in LienVietBank. From there thesis contributes practical ideas to LienVietBank to improve liquidity risk management, enhance competitiveness of LienVietBank in the market. 8 Thesis structure TOPIC: “Liquidity risk management in LienViet Commercial Joint stock bank (LienVietBank)” Introduction Chapter 1: Literature Review Chapter 2: Liquidity risk management in LienVietBank 3 Chapter 3: Recommendations and Solutions Conclusion References 4 Ket-noi.com Ket-noi.com kho kho tai tai lieu lieu mien mien phi phi CHAPTER I: LITERATURE REVIEW This chapter aims to answer the research questions about liquidity risk. Firstly, definitions related to commercial bank, risk management in commercial bank. Secondly and finally, definitions related to liquidity risk and liquidity risk management in commercial bank, expressing by Basel II and international framework for liquidity risk management. 1.1. 1.1.1 Commercial bank Concepts There is still much confusion about what exactly a commercial bank is. And many definitions have been given by organizations. "Commercial banks" can be defined based on: (1) Its function in the economy; (2) The services it offers to customers or (3) based on legal institutions that exist: “A financial institution that accepts demand deposits and makes loans and provides other services for the public”1. “A full-service institution that offers customers deposit, payment and credit services, in addition to other financial services”2. “A financial intermediary which collects credit from lenders in the form of deposits and lends in the form of loans”.3 Finally, there is a definition “commercial bank” still used by many nations today: The bank that sells deposits and makes loan to businesses and individual4. 1 Source: wordnetweb.princeton.edu/per1/webwn 2 Source: arcuclesbase.com 3 Source: http://www.investorglossary.com/commercial-bank.htm 4 Source: S.Rose, Peter and C.Hudgins, Sylvia, (2008), Bank management & Financial Services, page 6 5 1.1.2 Products & services provided by commercial banks Commercial banks offer many types of products and services which can be summarized as below: Table 1-1: Products & services provided by commercial banks1 Products & Services Content Represent liabilities of the bank, include checking and Liability products savings accounts, certificates of deposit and other types of deposit products Represent the primary assets of the banks, these Asset Products products normally take the form of personal and business loans, mortgages, auto loans and credit cards Include the maintenance and expansion of 24-hour ATM networks, wire transfers and banking websites Electronic banking that allow consumers and business to obtain account information, open new accounts, order checks, transfer funds between accounts and make bill payments Include investment advisory services, corporate Other Services finance consulting, custodial services for estates and trusts, safekeeping of securities and other valuable items, and money transfer services 1.1.3 Roles of commercial bank in economics Commercial banks play an important role in economic development. Economic development involves investment in various sectors of economy. Commercial banks collect savings from the people and mobilize saving for investment in industrial project or making loans to individuals. The investors borrow from banks to finance the projects. Special funds are provided to the investors for the 1 Source: John B.King, 2010, Ehow contributor journal 6 Ket-noi.com Ket-noi.com kho kho tai tai lieu lieu mien mien phi phi completion of projects. Commercial banks also represent a vital link in the transmission of government’s economic policies to the rest of the economy, when bank credit is scare and expensive, spending in the economy tends to slow and unemployment usually increase. Or if interest rates are very high, the cost of bank credit will be high and this could be inflationary. 1.2. 1.2.1. Risk management in Commercial Bank Risk in commercial bank1 Risk in a banking organization is possibility that the outcome of an action or event could bring up adverse impacts. Such outcomes could either result in a direct loss of earnings/capital or may result in imposition of constraints on bank’s ability to meet its business objectives. Such constraints pose a risk as these could hinder a bank's ability to conduct its ongoing business or to take benefit of opportunities to enhance its business. Banks often distinguish between expected and unexpected losses. Expected losses are those that the bank knows with reasonable certainty will occur (e.g., the expected default rate of corporate loan portfolio or credit card portfolio) and are typically reserved for in some manner. Unexpected losses are those associated with unforeseen events (e.g. losses experienced by banks in the aftermath of nuclear tests, Losses due to a sudden down turn in economy or falling interest rates). Banks rely on their capital as a buffer to absorb such losses. Risks are usually defined by the adverse impact on profitability of several distinct sources of uncertainty. While the types and degree of risks an organization may be exposed to depend upon a number of factors such as its size, complexity business activities, volume etc, it is believed that generally the 1 State Bank of Pakistan, (2002), Risk Management- Guideline for Commercial Banks & DFIs, page 1 7 banks face Credit, Market, Liquidity, Operational, Compliance/Legal/Regulatory and reputation risks. Before overarching these risk categories, given below are some basics about risk Management and some guiding principles to manage risks in banking organization. 1.2.2. Main risks in Commercial Bank Banks face a number of risks in order to conduct their business, and there have been four main risks faced by commercial banks include: Credit risk arises from the potential that an obligor is either unwilling to perform on an obligation or its ability to perform such obligation is impaired resulting in economic loss to the bank.1 Market Risk: It is the risk that the value of on and off-balance sheet positions of a financial institution will be adversely affected by movements in market rates or prices such as interest rates, foreign exchange rates, equity prices, credit spreads and/or commodity prices resulting in a loss to earnings and capital2. 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. 3 Operational Risk: the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. The definition includes legal risk but excludes strategic and reputational risk.4 1.2.3. Risk Management in Commercial Bank1 1 State Bank of Pakistan, (2002), Risk Management- Guideline for Commercial Banks & DFIs, page 5 2 State Bank of Pakistan, (2002), Risk Management- Guideline for Commercial Banks & DFIs, page 17 3 Source: Basel Committee on Banking Supervision, (2008), Principles for sound liquidity risk management and supervision, page 1 4 Source: Bank for International Settlements, Sound Practices for the Management and Supervision of Operational Risk, ,page 2 8 Ket-noi.com Ket-noi.com kho kho tai tai lieu lieu mien mien phi phi “Banks are in the Business of Managing Risk, Pure and Simple, that is the Business of Banking” (Walter Wriston, Chairman an CEO Citicorp 19701984)” The acceptance and management of financial risk is inherent to the business of banking and banks’ roles as financial intermediaries. Risk management as commonly perceived does not mean minimizing risk; rather the goal of risk management is to optimize risk-reward trade-off. Bank accepts risks that are uniquely part of the array of bank’s services. Risk management activities broadly take place simultaneously at following different hierarchy levels. Strategic level: It encompasses risk management functions performed by senior management and board of director. For instance definition of risks, ascertaining institutions risk appetite, formulating strategy and policies for managing risks and establish adequate systems and controls to ensure that overall risk remain within acceptable level and the reward compensate for the risk taken. Macro Level: It encompasses risk management within a business area or across business lines. Generally the risk management activities performed by middle management or units devoted to risk reviews fall into this category. Micro Level: It involves ‘On-the-line’ risk management where risks are actually created. This is the risk management activities performed by individuals who take risk on organization’s behalf such as front office and loan origination functions. The risk management in those areas is confined to following operational procedures and guidelines set by management. What Benefits of risk management in Banking?  Protect the bank from unexpected failures, loss, damage 1 Source: State Bank of Pakistan, (2002), Risk Management- Guideline for Commercial Banks & DFIs, page 3-4 9  Anticipate adverse changes  Be less vulnerable from negative environmental changes  Increase competitive advantages  Be able to gain the expertise to price risks and take opportunities. 1.3. Liquidity Risk Management in Commercial Bank 1.3.1. Defining liquidity risk "Liquidity" refers to a financial institution’s capacity to meet its current and anticipated liquidity obligations as they come due, without incurring considerable losses.1 The Demand for and Supply of Liquidity2 The Supply of Liquidity  Incoming customer deposits  Revenues from the sale of nondeposit services  Customer Loan repayments  Borrowing from the money market  Selling assets  Capital and Reserve The Demand for Liquidity  Customer deposit withdrawals  Credit requests from quality loan customers 1 Source : Autorite Des Marches Financiers, (2009), Liquidity risk management guideline, page 7 2 Source: S.Rose, Peter and C.Hudgins, Sylvia, (2008), Bank management & Chapter 11: Liquidity and Reserve Management: Strategies and Policies 10 Financial Services, Ket-noi.com Ket-noi.com kho kho tai tai lieu lieu mien mien phi phi  Repayment of nondeposit borrowing  Operating expenses and payment of tax  Payment of dividends by cash Net liquidity position The following sources of liquidity and supply come together to determine each bank’s net liquidity position at any moment of time: Net liquidity position = Supplies of liquidity – Demand of liquidity  Liquidity Shortage: Net liquidity position > 0 (greater than zero) Implications of liquidity deficit:  Offering higher rate of profit to deposits  Shortage of financial resources to invest against commitments  Loss of competitiveness  Liquidity surplus: Net liquidity position <0 (Smaller than zero) Implications of liquidity surplus:  Underutilization of financial resources,  Lower income and higher cost,  Loss of competitiveness Liquidity risk1 Liquidity risk results from a financial institution’s difficulty or inability to honor its liquidity commitments in a timely manner at a reasonable cost. Liquidity risk can also extend to a financial institution’s inability to take advantage of business opportunities and sustain the growth forecast in its strategic plan (strategic risk) due to a lack of liquidity or difficulty in obtaining funding at a reasonable cost. 1 Source : Autorite Des Marches Financiers, (2009), Liquidity risk management guideline, page 7 11
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