BUSINESS, MANAGEMENT AND EDUCATION
ISSN 2029-7491 print / ISSN 2029-6169 online
2012, 10(2): 186–204
doi:10.3846/bme.2012.14
BANK LIQUIDITY RISK: ANALYSIS AND ESTIMATES
Meilė Jasienė1, Jonas Martinavičius2, Filomena Jasevičienė3,
Gražina Krivkienė4
Vilnius University, Saulėtekio al. 9, LT-10222 Vilnius, Lithuania
E-mails: 1meilute.jasiene@ef.vu.lt; 2jonas.martinavicius@ef.vu.lt;
3ilomenaak@gmail.com (coresponding author); 4grazina.krivkiene@gmail.com
Received 31 October 2012; accepted 21 November 2012
Abstract. In today’s banking business, liquidity risk and its management are some
of the most critical elements that underlie the stability and security of the bank’s
operations, proit-making and clients conidence as well as many of the decisions
that the bank makes. Managing liquidity risk in a commercial bank is not something new, yet scientiic literature has not focused enough on different approaches
to liquidity risk management and assessment. Furthermore, models, methodologies or policies of managing liquidity risk in a commercial bank have never been
examined in detail either.
The goal of this article is to analyse the liquidity risk of commercial banks as well
as the possibilities of managing it and to build a liquidity risk management model
for a commercial bank.
The development, assessment and application of the commercial bank liquidity
risk management was based on an analysis of scientiic resources, a comparative
analysis and mathematical calculations.
Keywords: liquidity risk, bank risks, commercial banks, liquidity ratios, obligatory reserves, liquidity risk mamagement.
Reference to this paper should be made as follows: Jasienė, M.; Martinavičius, J.;
Jasevičienė, F.; Krivkienė, G. 2012. Bank liquidity risk: analysis and estimates,
Business, Management and Education 10(2): 186–204.
http://dx.doi.org/10.3846/bme.2012.14
JEL classiication: G21.
1. Introduction
Liquidity risk is a critical component of all risks that affect the activities of a bank.
Banks must assess their liquidity risk at all times and during periods of economical
recession in particular. The article appraises the importance of risk to economy, its
inluence on the banking sector and identiies the risks that commercial banks face.
Moreover, it assesses the signiicance of liquidity risk, analyses ways to manage it as
well as the development of the liquidity ratio and the obligatory reserves requirement in
Lithuania. A model to manage the liquidity risk in a commercial bank has been designed
and used to assess the liquidity in one commercial bank controlled by a foreign bank.
Copyright © 2012 Vilniaus Gediminas Technical University (VGTU) Press Technika
www.bme.vgtu.lt
Business, Management and Education, 2012, 10(2): 186–204
Different authors demonstrate varying understanding of risk in a commercial bank.
Some sources state that risk is the probability of losses resulting from the unforeseen
impact of both external and internal factors affecting the bank.
By rendering inancial services to the public, a commercial bank creates added value
for its shareholders. To attain this goal, the resources available and the risks arising have
to be managed in the most effective way possible. Banks handle inancial resources entrusted to them by deposit-holders and invest the moneys striving to earn the maximum
proit obtainable at an acceptable level of risk. When it comes to managing its risks, a
commercial bank has to consolidate risk management, creating a uniform process since
all risks and methods to manage it are interrelated.
One of the main objectives of a bank is to choose the best ratio of risk level and
proitability. In banking, risk usually implies a threat that the bank might lose some of its
resources, income, run higher costs whilst performing some of its inancial operations.
However, taking risks in the business of a bank does not always entail losses. Eficient
risk management in a bank could provide the backbone for a successful business of
the bank. Every bank faces a whole of different risks in the process of its operations,
(Cooper 2007). Liquidity risk is one of the most important risks that banks face, since
problems with liquidity may eventually lead to insolvency issues.
The commercial bank liquidity risk management model that the authors introduce in
this article permits assessing how successful a commercial bank manages its liquidity
risk. An assessment of a commercial bank’s liquidity risk creates a possibility to see the
gaps in managing such a risk and to improve the way the liquidity risk that the bank
faces is managed.
2. Conception and meaning of liquidity risk
Why is liquidity risk management so important? During the recent inancial crisis, although many banks had posted adequate levels of capital, they still experienced dificulties because they failed to manage their liquidity properly. Post-crisis, the higher cost
of liquidity, larger funding spreads, higher volatility and reduced market conidence are
driving inancial institutions to allocate more resources to improving their liquidity risk
management capabilities (BoL 2011).
One should begin analysing risks with the conception of risk in its broadest sense.
Even though a lot of authors provide slightly varying deinitions of risk, generally risk
can be assumed to be an expression of a probable event as a value. Risk is the perceived
loss that is often measured by the possibility of unfavourable choice, which is expressed
as probability. An economist may see this probability as a ratio that indicates a possible
loss of proit and the occurrence of losses (BIS 2009).
G. Kancerevyčius (2009) notes that risk occurs when the probabilities of potential
results are known, uncertainty arises when the probabilities of different possible results
are not known. This is what distinguishes risk from uncertainty.
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So, based on a literary analysis, one can infer that risk is a probability, which shows
that actual proitability will differ from the one that has been planned. The higher this
probability is, the higher risk is faced. However, we cannot see risk only as an indicator
of substantial losses. Accepting additional risks may lead to extra proit, and the higher
the risk, the higher proit can be expected. In conclusion, the meaning of risk in economy can be perceived both as a probability of losses and an opportunity to operate under
uncertain conditions and make higher income by accepting a higher degree of risk.
By rendering its services to the public, a commercial bank generates added value
for its shareholders. This requires managing the resources available and any risks that
may arise in the most effective way possible. Banks handle inancial resources entrusted
to them by deposit-holders and invest the moneys striving to earn the maximum proit
obtainable at an acceptable level of risk Valvonis (2009)Many different methods exist to
manage every type of risk. When it comes to managing its risks, a commercial bank has
to consolidate risk management, creating a uniform process since all risks and methods
to manage it are interrelated.
There are three main types of risks that can be identiied: market risk, credit risk
ir and operational risk (Crouhy, Galai, Mark 2007). This classiication of bank risks
sum up the risks that banks incur, yet it does not embrace one of the key types of risks
that a bank faces, which is liquidity risk. A. Gaulia and I. Mačerinskienė (2006) further
expand the classiication of risk as established in the Basel rules of capital adequacy
by adding liquidity risk.
Fig. 1. Banking risk (Source: created by authors)
J. Bessis (2008) identiied six principal types of risk such as credit risk, interest rate
risk, market risk, liquidity risk, operational risk ir foreign exchange risk. Authors of the
current banks risk is relected in Fig. 1. The scientist has added other types of risks to
the ones mentioned above. Other risks may concern country risk, regulation risk and
so on.
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According to the classiication of banking risks introduced by foreign economists
Timothy W. Koch and S. Scott MacDonald (2006), market risk can be generally said to
consist of three lesser risks: stock price risk, interest rate risk and foreign exchange risk.
Timothy W. Koch and S. Scott MacDonald (2010) identiied six types of risks. These
are credit risk, liquidity risk, market risk, operational risk, reputation risk and legality
risk. These risks go hand in hand with capital risk, which is perceived as a risk that the
investor will lose all or part of their funds.
So, a commercial bank is affected by a plenitude of different risks. Many authors
identify various risks that commercial banks face, yet the differences among them are
not essential.
Liquidity risk is one of the most critical risks that banks run. Adequate management
of liquidity may minimise the probability that serious problems will arise in future. In
fact, the issue of liquidity is not limited to just one bank. A low liquidity ratio in one
inancial institution could affect the entire system. It is liquidity risk that may play the
deinitive role in the case of a bankruptcy of a bank. At a time of economic recession,
the liquidity of a bank is a guarantee for the bank’s inancial stability (Brunnermeier,
Lasse 2009).
Liquidity is the ability of a bank to fund increases in assets and meet obligations
as they come due, without incurring unacceptable losses (BIS 2008). The fundamental
role of banks in the maturity transformation of short-term deposits into long-term loans
makes banks inherently vulnerable to liquidity risk, both of an institution-speciic nature and that which affects markets as a whole. Virtually every inancial transaction or
commitment has implications for a bank’s liquidity. Effective liquidity risk management
helps ensure a bank’s ability to meet cash low obligations, which are uncertain as they
are affected by external events and other agents’ behaviour (CEBS 2009).
The European Central Bank (ECB 2009) deines liquidity risk as the ability of a bank
to inance increases in assets and meet payment obligations when due. However, this
deinition does not relect the extent of liquidity quite correctly. This extent is important when it comes to unforeseen utilisation of credit facilities, withdrawal of deposits,
premature repayments of loans and/or payments of interest.
The rules for estimating the liquidity ratio as approved by the Bank of Lithuania
describe the liquidity of a bank as the bank’s ability to honour its obligations on time,
fully and without interruptions.
T. P. Fitch (2006) deined liquidity in his dictionary of banking terms as the ability
of an institution to meet its obligations. In banking, this term stands to include the ability of a bank to meet the demands of deposit holders who wish to withdraw their funds
and to satisfy the needs of willing borrowers.
Banks are a vital part of the global economy, and the essence of banking is assetliability management, liquidity, gap and funding risk management as well (Choudry
2007, 2009, 2010, 2012). Liquidity risk is the risk that a banking business will have
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M. Jasienė et al. Bank liquidity risk: analysis and estimates
insuficient funds to meet its inancial commitments in a timely manner. The too key
elements of liquidity risk are short-term cash low risk and long-term funding risk The
long-term funding risk includes the risk that loans may be available when the business
requires them or at acceptable cost. All banking businesses need to manage liquidity
risk to ensure that they remain solvent.
Market and funding liquidity risks compound each other as it is dificult to sell
when other investors face funding problems and it is dificult to get funding when the
collateral is hard to sell. Liquidity risk also tends to compound other risks. If a trading
organization has a position in an illiquid asset, its limited ability to liquidate that position at short notice will compound its market risk. Suppose a irm has offsetting cash
lows with two different counterparties on a given day. If the counterparty that owes
it a payment defaults, the irm will have to raise cash from other sources to make its
payment. Should it be unable to do so, it too will default. Here, liquidity risk is compounding credit risk.
Accordingly, liquidity risk has to be managed in addition to market, credit and other
risks. Because of its tendency to compound other risks, it is dificult or impossible to
isolate liquidity risk. In all but the most simple of circumstances, comprehensive metrics
of liquidity risk do not exist. Certain techniques of asset-liability management can be
applied to assessing liquidity risk. A simple test for liquidity risk is to look at future net
cash lows on a day-by-day basis. Any day that has a sizeable negative net cash low is
of concern. Such an analysis can be supplemented with stress testing. Look at net cash
lows on a day-to-day basis assuming that an important counterparty defaults.
3. Management of liquidity risk in Lithuanian banks
To achieve better management of liquidity risk, the Bank of Lithuania has set a
liquidity ratio for Lithuanian commercial banks to comply with.
The liquidity ratio: the relationship between the liquid assets and current liabilities
of a bank may not be lower than 30 per cent.
where:
L = LA: CL × 100%, L ≥ 30%,
L is the liquidity ratio,
LA is the liquid assets,
CL is the current liabilities.
The Bank of Lithuania has also established the following concepts:
Liquidity buffer is liquid assets suficient to meet an additional need for liquid assets that may arise during the designated survival period of a bank under unfavourable
conditions according the most probable scenario. The liquidity buffer is a short-term
component of the liquidity counterbalance capacity.
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Survival period is a short-term period established by a bank, when the bank can
ensure continuity of its business and meet all of its obligations when they are due according to the established worst-case scenarios, without attracting additional cash lows
and avoiding the necessity to sell its assets at a loss.
Net funding gap is the negative difference, which results from subtracting the expected monetary disbursements amount from the anticipated monetary revenues amount.
Banks must manage their liquidity buffers by making sure that it will be available
to them should unfavourable circumstances arise, with no legal, regulatory or operating
restrictions imposed on the application of such assets. Banks should steer clear of high
concentrations of securities and other liquid assets.
Obligatory reserves are another important requirement that facilitates managing and
safeguarding the liquidity of commercial banks. Requirements for obligatory reserves
are the requirements of the central bank for commercial banks to have a particular
amount of their identiied liabilities covered with liquid assets. Said portion is known
as the obligatory reserve ratio. The obligatory reserve requirement applies to maintain
the liquidity of the banking system as well as a higher degree of stability in the interest
rates on the monetary market.
Currently, obligatory reserves of the Bank of Lithuania must total 4 per cent of
the bank’s existing liabilities (BoL 2008. Considered the most liquid form of assets,
obligatory reserves clearly assure a higher degree of liquidity and shock-resistance of
the banking system, however they do nothing to protect deposits held with commercial
banks due to the simple fact that the amount of such deposits normally exceeds the
extent of the reserves by a dozen or so times.
The recent international inancial crisis has underlined the importance of managing liquidity risk. The requirements for liquidity risk management have never been
standardised on an international scale before (Jasevičienė 2012). That in mind, both the
requirements of the CRD IV directive and Basel III set forth new standards for liquidity
risk management as well. The standards shall consist of two indicators. The liquidity
coverage ratio (LCR) is estimated as the ratio between the liquidity buffer and the net
funding gap. The minimum required LCR is expected to be that of 100 per cent. The
Lithuanian banking system is currently aligned with this ratio. The net stable funding
ratio (NSFR) is the ratio between the existing long-term liabilities and the required
long-term liabilities, the latter amount established on the basis of the available longterm assets. The NSFR’s function is to harmonise the structure of long-term assets and
liabilities. So far, banks do not completely comply with this requirement but are planning to achieve full compliance by the time the CRD IV directive is in place. During
the second quarter of 2012 the amount of banks’ liquid assets – balances of accounts,
debt securities, cash – dropped, yet the liquidity ratio of the banking system remained
unchanged and still stood at 39.8 per cent (Fig. 2).
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Fig. 2. Dynamic liquidity ratio percentage
(Source: Bank of Lithuania 2012 (created by authors))
This ratio remained intact because the maturities of inancial resources held with
banks were growing shorter and, according to the rules for calculating the liquidity ratio,
these resources were recorded as liquid assets. Bearing in mind that the possibilities
for the banks operating in Lithuania to attract funds during the crisis varied, and so did
their strategies to manage liquidity as well as the structures of their liquid assets, for the
purposes of analysis of banks’ liquidity we can identify two groups of banks: subsidiary
banks and branches of foreign banks, and banks that do not have a parent bank.
During the second quarter, the liquidity ratio of the group of banks that do not have
a parent bank and are more vulnerable to liquidity shocks continued to decline and was
lower than that of the subsidiary banks’ group. Banks that do not have a parent bank
manage their liquidity and comply with the requirements by making their own liquidity buffers and harmonising the maturities of assets and liabilities, and their liquidity is
largely affected by luctuations of the deposit volume. Most (54.3 per cent) of the liquid
assets of these banks are investments into debt securities, whereas liquid balances of
bank accounts make up slightly over 11 per cent of the liquid assets. The liquidity of
subsidiary banks is becoming increasingly centralised, and as a result the formation of
their liquidity buffers is formed and compliance to ratios is enforced by coordinating
decisions and actions with the parent bank, considering the entire parent bank group.
Liquidity risk management holds a certain amount of relevance for banks due to an
absence of balance between the maturities of assets and liabilities within the banking
system (Fig. 3).
Since the main type of business of banks operating in Lithuania is lending operations, the majority (59.5 per cent) of their assets is invested for periods extending
beyond one year. Stable long-term sources of inancing account for nearly half of the
(32.4 per cent) amidst banks’ liabilities, and therefore banks inance their long-term
investments with short-term liabilities, which are being constantly renewed. As mentioned above, considering the risk of liquidity that stems out of the misbalance between
assets and liabilities, the EU is planning to introduce a net stable funding ratio (NSFR),
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which shall be used to determine the minimum amount of long-term liabilities required
to cover the amount of long-term assets of a bank. Even though this ratio is scheduled
to appear in the EU in 2018, banks should start looking for inancial resources with
extended maturities and strive for a better balance between their assets and liabilities
in terms of their maturities already. Still, banks that do not have a parent bank will be
facing challenges in prolonging the maturities of their liabilities, as such banks have
dificulties in attracting long-term funds on the local market even at higher interest
rates, however this prolongation of liability maturities may have a negative impact on
the proitability igures of subsidiary banks as well.
Fig. 3. Assets and liabilities by maturity dynamics
(Source: Bank of Lithuania 2012 (created by authors))
According to the data available for July 1, 2012, most banks have an adequate liquidity buffer to compensate for the net funding gap. As estimated by the banks, the
liquidity buffer totalled LTL 16.9 billion compared to the net funding gap of LTL 7.1
billion, which means that the banks’ liquidity buffer was 2.4 times bigger than the required loor value. The suficient coverage of the net funding gap in the banking system
is driven by parent banks, which include unused loans from foreign holding institutions
into their liquidity buffer. The liquidity buffer of banks that do not have a parent bank
on July 1, 2012 was just slightly bigger than their net funding gap.
The liquidity buffer required to secure short-term liquidity of banks under unfavourable conditions can be estimated, and the ratio can be compared for different banks
with a higher degree of precision by using the liquidity coverage ratio (LCR), which
by deinition approximates liquidity buffer, yet is uniform for all inancial institutions.
Although the EU is planning to introduce this ratio in 2015, voluntary pilot calculation
of the LCR across all eight banks doing business in Lithuania began in early 2012.
According to the information available for July 1, 2012, judging by the new requirements to be implemented (some of them are more rigid than those applied to estimating
the liquidity buffer, for instance, deining inancial instruments that can comprise the
buffer in a very conservative fashion), the LCR of banks is a little lower and compliance
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to it would entail a lower liquidity buffer than the ratio estimated on the basis of banks’
reports. During the second quarter, the pilot LCR of banks improved slightly and, as of
July 1, 2012, stood at 143 per cent (BoL).
The European Banking Authority (EBA 2012) is also actively involved in analysing and appraising the liquidity status of EU banks. According to the EBA (which has
divided banks into two groups), at end of December 2011, the average LCR of Group
1 was 72.1%, with country results ranging from 25.6% to 122.9%. The shortfall is
estimated at €1066.8 bn, of which 77.1% is represented by 3 countries. Only 9 banks,
accounting for 20.5% of the Group 1, have an LCR ratio above 100%.
Fig. 4. LCR and NSFR ratio (Sourse: EBA 2012)
More than 80% of the holdings of LCR eligible liquid assets are Level 1 assets,
which implies that on average the 40% cap on level 2 assets has a limited impact, while
some countries are signiicantly affected. In total, 24 banks face a reduction in Level 2
assets of about €53 bn due to the cap on liquid assets. Group 2 LCR has signiicantly
improved, now at 90.9%, on average. About 44% of the Group 2 banks (i.e. 49 of 111
banks) already meet the regulatory minimum requirement, with little difference between
large and small banks. The shortfall of liquid assets is also reduced, to €101.7 bn.
Concerning the NSFR, Group 1 banks report an average ratio of 93.4%, resulting in a
shortfall of available stable funding of €1.1 trillion. Group 2 banks show very similar
results, with an average NSFR of 93.6%. (Fig. 4).
4. Liquidity risk management model of a commercial bank
Following the analysis of scientiic literature and the legislation of the Republic of
Lithuania and the Bank of Lithuania that was presented in the theory part, we designed a
model for managing liquidity risk in commercial banks (Fig. 5). This liquidity management model is based on theoretical ways to manage liquidity risk and the contemporary
banking practice.
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Liquidity risk management of a bank
Short-term
liquidity plannig
Long-term
liquidity
plannig
Liquidity rao of the bank of Lithuania
Forecast of liquidity need
Assurance of obligatory reserve
Deposits and loans forecast
Shot-term liquidity limits realizaon
Analyses of liquidity gap
Long-term liquidity limits realizaon
Fig. 5. Liquidity risk management model of a commercial bank
(Source: compiled by the authors based on Bessis 2008; Kancerevyčius 2009)
Assessment of liquidity risk in a commercial bank can be split into management of
short- and long-term liquidity. The management of short-term liquidity of a bank covers
a period of one month. Short-term liquidity of a bank can be managed in line with the
liquidity ratio prescribed by the Bank of Lithuania as well as the internal short-term
liquidity indicators of the bank.
Long-term liquidity management consists of managing a bank’s liquidity over a period of one year (Kancerevyčius 2009). Management of long-term liquidity can be based
on forecasting and satisfying the need for liquidity. Analysing the liquidity gap and assessing long-term liquidity ratios is equally important.Gap analysis allows you to see the
differences between assets and debt liabilities both at present and at any given moment
in future (Bessis 2008). A positive difference indicates that assets will exceed liabilities
and shareholders’ equity over the period of analysis. That means that the amount of assets during a respective period will be higher than that of liabilities. Whereas a negative
difference will mean that, over the period of analysis, liabilities will exceed assets. This
means that there will be a deicit of assets during a particular period. A zero difference
indicates that the amount of assets precisely covers the amount of liabilities.
So, this model of managing a commercial bank’s liquidity risk allows judging the
success with which the commercial bank handles its liquidity risk. Assessment of the
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liquidity risk of a commercial bank creates a possibility to pinpoint weaknesses in liquidity risk management and to manage the liquidity risk of the commercial bank with
more eficiency.
Fig. 6. Assets of a bank controlled by a foreign bank by maturity as of the 31st of
December, 2011 (%) (Source: compiled by the authors based on a bank`s controlled
by a foreign bank inancial year 2011 report)
5. The valuation of the liquidity risk of a bank controlled by a foreign bank
For the purposes of this analysis, we have chosen a universal commercial bank controlled by a foreign bank, which offers the entire range of banking services to private
and business clients.
Before applying the liquidity risk management model to analyse the management of
short- and long-term liquidity risk of the bank, we should carry out an analysis of the
bank’s assets and liabilities by maturity.
Notably, as of December 31, 2011 the majority of the subject bank’s assets were
long-term assets with maturity of 1 to 3 years (16.27 per cent) and over 3 years (37.23
per cent). The bank’s short-term assets with maturity of under 1 month accounted for
16.41 per cent of all assets, and assets with maturity of up to 3 month made 19.13 per
cent of the bank’s assets (Fig. 6).
The largest portion (36.52 per cent) of the liabilities of the bank controlled by a foreign bank consists of liabilities with maturity of 1 to 3 years. The subject bank’s shortterm liabilities with maturity of under 1 month amounted to 33.39 per cent of its total
liabilities, and liabilities with maturity of under 3 months accounted for 39.62 per cent
of the liabilities (Fig. 7). The liabilities of the bank controlled by a foreign bank with
maturity of up to 1 year amounted to one-half (50.26 per cent) of the bank’s liabilities.
Therefore, considering the structure of the assets and liabilities of the bank controlled by a foreign bank by maturity, we can conclude that the short-term assets of
the bank account for 37.65 per cent of its total assets, and short-term liabilities with
maturity of under 1 year make up one-half (50.26 per cent) of its total liabilities.
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Fig. 7. Liabilities of a bank controlled by a foreign bank by maturity as of the 31st of
December, 2011 (%) (Source: compiled by the authors based on a bank`s controlled
by a foreign bank inancial year 2011 report)
5.1. Valuation of short-term liquidity risk
As we have already mentioned, liquidity risk management can be classiied as shortterm liquidity management and long-term liquidity management.
The liquidity risk management model presented in the methodology if this work
will be applied and appraised on the basis of an example of one currently operating
bank controlled by a foreign bank. The application of the liquidity risk management
model should begin with an analysis of short-term liquidity management. According to
the methodology of the research, short-term liquidity management should be based on
compliance to the liquidity ratio established by the Bank of Lithuania and the internal
liquidity limits of the bank.
To make sure it maintains its liquidity, every bank must irst of all comply with
the liquidity ratio prescribed by the Bank of Lithuania. According to the information
provided in the inancial statements of the bank controlled by a foreign bank, the bank
fully complied with the liquidity ratio established by the Bank of Lithuania (Fig. 8). The
bank has to compute this ratio following the rules for calculating the liquidity ratio as
approved by the Bank of Lithuania. The liquidity ratio of a bank, i.e. the ratio between
the bank’s liquid assets and current liabilities may not be below 30 per cent (BoL 2008).
During the period covered by our analysis (2003–2011), the liquidity ratio of the
bank controlled by a foreign bank was above the 30 per cent requirement. The higherthan-required liquidity ratio of the bank controlled by a foreign bank is evidence to
the fact that the bank had suficient reserves of liquid assets and was inancially stable
as far as liquidity risk is concerned. The liquidity increase in 2011 was the product of
the increase in the amount of the bank’s current liabilities driven by the bankruptcy of
another bank. As a result, the subject bank reported surplus liquidity at the end if 2011.
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Fig. 8. Change of liquidity values 2003–2011 of a bank which is under control of the foreign
bank (%) (Source: compiled by the authors based on a bank`s controlled by a foreign bank
inancial year 2003–2011 reports)
Another important facet of managing and assessing short-term liquidity is the liquidity limits set by the bank. The short-term liquidity of the bank controlled by a foreign
bank was appraised on the basis of the short-term liquidity indicators suggested within
the framework of our liquidity management model.
The immediate liquidity limit, which shows the amount of demand deposits held
in cash in this case is 10.53 per cent. The amount of cash within the total of deposits
held with the bank controlled by a foreign bank is 6.26 per cent. The ratio between
the aggregate amount of liquid inancial resources and the deposits held with the bank
indicates that the bank holds 41.11 per cent of the deposits in liquid form. This ratio
has probably increased as a result of the growth of the deposits portfolio. In theory,
the recommended value under economic recession should be between 30 and 40 per
cent (Table 1).
It should be noted that the difference between the liquid assets and short-term liabilities of the bank controlled by a foreign bank is negative. That means that the short-term
liabilities of the bank are completely covered with long-term assets. The overall liquidity ratio shows that 18.82 per cent of the assets of the bank controlled by a foreign bank
are liquid assets. In our particular case, the ratio is below the recommended threshold.
It is dificult to interpret the value of this ratio explicitly, because it is estimated only
with reference to the bank’s assets and does not relect the demand for liquidity in the
bank controlled by a foreign bank.
The deposit sensitivity ratio indicates that demand deposits account for 59.44 per
cent of all deposits held with the bank controlled by a foreign bank (Table 1). In this
case, this ratio is relatively high, making the bank sensitive to deposit withdrawals.
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Table 1. The valuation of the short-term liquidity indicators of a bank controlled by a foreign
bank (Source: compiled by the authors based on a bank`s controlled by a foreign bank inancial
year 2011 report; Koch, MacDonald 2006)
Short-term liquidity indicators
1
2
3
4
5
6
7
Calculated ratios and values
322 421 / 3 060 599 =
0.1053 × 100% = 10.53%
322 421 / 5 149 173 =
Share of cash in bank’s deposits
0.0626 × 100% = 6.26%
Share of all liquid funds in bank’s 2 117 000 / 5 149 173 =
deposits
0.4111 × 100% = 41.11%
2 117 000 / 11 242 806 =
Overall liquidity ratio
0.1882 × 100% = 18.82%
3 060 599 / 5 149 173 =
Deposit sensitivity ratio
0.5944 × 100% = 59.44%
2 117 000 – 4 727 680 =
Bank’s liquidity
–2 610 680
Shall of all liquid funds in
2 117 000 / 3 060 599 =
demand deposits
0.6917 × 100% = 69.17%
Immediate liquidity limit
Recommended limits
in the period of
economic recession
11–15%
till 5%
30–40%
30–40%
30–40%
Positive, negative
30–50%
In our case, the share of all liquid funds in demand deposits is 69.17 per cent. This
ratio indicates the extent to which the amount of liquid assets of the bank controlled by
a foreign bank secures demand liabilities. In this case, the indicator exceeds the established loor of the ratio by quite a margin.
So, considering the short-term liquidity indicators depicted in the 2011 inancial
statements of the bank controlled by a foreign bank, we can conclude that not every
ratio is within the recommended limits. Notably, the bank in question has a parent company and therefore commands an excellent opportunity to attract inancing resources at
a minimum price. This means that in the event of a liquidity crisis the bank could look
forward to support from the parent institution. This opportunity minimises the bank’s
sensitivity to liquidity risk. As a result, we can say that liquidity risk management in
the bank controlled by a foreign bank is less conservative.
Considering the short-term liquidity ratios of the bank controlled by a foreign bank,
we would suggest that, at the time of economic recession, the bank should increase the
share of liquid assets within its total assets base.
5.2. Valuation of long-term liquidity risk
After we have inished our analysis of the short-term liquidity of the bank controlled
by a foreign bank, we should move on to examining its long-term liquidity. The type of
analysis that is relevant for the purposes of managing and assessing the liquidity risk
of a commercial bank is gap analysis.
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The aggregate liquidity gap of the bank controlled by a foreign bank as of December
31, 2011 can be compared with the aggregate gap of the bank’s liquidity as of December
31, 2010.
As you can see from the table, the overall liquidity gap over a 1–3 period was negative and stood at LTL 3,695,669 thousand (Table 3). As of December 31, 2010, the
aggregate liquidity gap of the bank was also negative and amounted to LTL 4,014,408
thousand (Table 2). For periods of over 3 years, just like the net liquidity gap, this gap
became positive and on December 31, 2011 amounted to LTL 313,470 thousand (Table
3). As of December 31, 2010, the aggregate liquidity gap of the bank controlled by a
foreign gap over a period longer than 3 years was negative and stood at LTL 371,751
thousand (Table 2). The positive liquidity gap shows that, during the period under investigation, the bank controlled by a foreign bank had more assets than liabilities and
shareholders’ equity. When it comes to analysing the total liquidity gap of the bank
controlled by a foreign bank, we can state that for all periods covered in our study the
liquidity gap in the bank controlled by a foreign bank was negative (Table 2). This
means that the bank had more liabilities than assets during all of the periods covered
in our analysis.
Table 2. The liquidity gap analyses of a bank controlled by a foreign bank by the 31st of
December, 2010 (thousand litas) (Source: compiled by the authors based on a bank`s controlled
by a foreign bank inancial year 2010 report)
610 768
Under 1
month
676 922
629 849
6-12
months
981 691
Over 3 Undeined
Total
years
term
2 480 740 4 188 539 1 234 275 11 299 584
496 800
2 583 548
1 992 329
1 367 711
514 311
1 061 224
2 372 055 545 882
(1 972 780) (1 315 407) (870 911)
115 538
(79 533)
108 685
On demand
Total assets
Total
liabilities
and equity
Liquidity
gap
Cumulative
liquidity gap
1-3 months 3-6 months
1-3 years
862 524
3 642 657 371 751
(1 972 780) (3 288 187) (4 159 098) (4 043 560) (4 123 093) (4 014 408) (371 751) 0
11 299 584
-
Table 3. The liquidity gap analyses of a bank controlled by a foreign bank by the 31st of December,
2011 (thousand litas) (Source: compiled by the authors based on a bank`s controlled by a foreign bank
inancial year 2011 report)
On demand Under 1 1-3 months 3-6 months 6-12 months 1-3 years Over 3 Undeined
Total
month
year
terms
1 021 899 306 742
620 712
1 465 009 1821 986 4 185 502 995 923 11 242 806
Total assets 825 033
Total
700 863
650 885
544 912
173 363
33 242 806
liabilities
3 082 107 672 059
4 106 191
1 309 393
and equity
Liquidity
(2 257 107) 349 840
(394 121) (30 173)
920 097
(2 284 205) 4 009 139 (313 470) gap
Cumulative
(2 257 107) (1 907 267) (2 301 388) (2 331 561) (1 411 464) (3 695 669) 313 470 0
liquidity
gap
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Additional liquidity indicators are relevant for the purposes of managing long-term
liquidity risk in a commercial bank as well. The additional long-term liquidity ratios
that we suggest in our liquidity risk management model are used to assess the long-term
liquidity of the bank controlled by a foreign bank (Table 4).
Table 4. The valuation of the long-term liquidity indicators of a bank controlled by a foreign
bank (Source: compiled by the authors based on a banks` which is under control of the foreign
bank 2011 year inancial report; Koch, MacDonald 2006)
1
2
3
4
Long-term liquidity indicators
Loans to deposits
Ratio for the stable portion of
liabilities
Ratio of liabilities equity
coverage
Long-term liquidity ratio
Calculated ratios and values
8 882 706/ 5 149 173 = 1.72
4 659 592 / 11 242 806 =
0.4144 × 100% = 41.44%
1 308 552/ 9 94 2543 =
0.13170 × 100% = 13.17%
6 007 488 / 4 282 554 = 1.40
Recommended limits
about 1
The higher the value
1/10–1/25
Not less than 1
The ratio between loans and deposits in the subject bank shows that the bank has
issued loans 1.72 times more than it has attracted deposits. We can say that deposits are
not the only and principal source of inance for the bank controlled by a foreign bank.
The bank procures its funding from the parent bank, through issues of debt securities
or from loans on the banking market.
In our particular case, the ratio for the stable portion is 41.11 per cent. This indicator
relects the stable part of the liabilities. Since for the bank controlled by a foreign bank
this ratio is quite high, we are safe to say that the liquidity of the bank is good. The
ratio of liabilities equity coverage displays the bank’s ability to cover its liabilities with
equity. In this case, the ratio is 13.17 per cent, meaning that only a small portion of the
liabilities of the bank controlled by a foreign bank is covered with the bank’s equity.
The long-term liquidity ratio shows that the amount of the bank’s long-term assets is
1.4 times the amount of its equity and long-term liabilities.
So, considering the long-term liquidity ratios that we found in the inancial statements of the bank controlled by a foreign bank, we can conclude that the bank manages
its long-term liquidity.
The liquidity risk management model that we developed was successfully applied
in the case of the bank controlled by a foreign bank. The commercial bank liquidity
risk management model allows appraising the short- and long-term liquidity of a bank,
identify weaknesses in liquidity risk management and develop recommendations. On
the basis of the hands-on application of this model, we can say that the bank in question
manages its liquidity risk however at the end of 2011 it was faced with surplus liquidity.
After we conducted our analysis of the development of the requirements of the
liquidity ratio and obligatory reserves for commercial banks, we are now able to see
that at the time of economic recession banks, and especially those that do not have
any parent bank, should increase the share of liquid assets across their asset base by
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acquiring T-bills or other liquid assets. Should a bank feel the need for liquid resources,
the author of this article should suggest raising funds through selling liquid assets or by
attracting liabilities. The bank should uphold competitive interest rates on time deposits
and organise ad campaigns to attract deposits.
6. Conclusions
After we have discussed and analysed the importance and management of liquidity
risk that commercial banks incur, developed a commercial bank liquidity management
model, and analysed how this model can be applied in practice by drawing on the case
of one commercial bank controlled by a foreign bank, we can conclude that risk is
deined by the notion of duality. Risk is a probability that relects the chance to lose
proit and run losses against earning additional proits. The concept of risk is integral to
uncertainty. Scientists diverge on this relationship. There are two identiiable stances on
the relationship between risk and uncertainty. One of them deines those two concepts
as being identical, whilst the other one draws a distinct line between them. Commercial
banks face different risks. The main types of risk that banks run, such as liquidity risk,
credit risk and market risk are distinguished by all authors. It should also be said that all
risks are mutually interrelated, regardless of the number of identiiable risks. Liquidity
risk is a principal type of risks that banks face. Having analysed the notions of risk that
different authors present, we can sum up that the liquidity risk of a bank is risk that the
bank will be unable to meet its obligations when due as a result of shortage of liquid
funds and will therefore suffer losses after a sharp decline in the amount of inancial
resources and an increase in the price of new funding to cover up previous debts. The
main goal of managing liquidity risk is to ensure as proitable operation of the bank as
possible, by maintaining a suficient level of liquidity buffer to safeguard stable business
of the bank. Effective management of liquidity provides a backbone for earning maximum proit at a certain liquidity risk level. Having discussed the methods to manage
liquidity, we can conclude that the diversity of ways to manage liquidity is immense.
The underlying liquidity management methods are based on managing the bank’s assets
and liabilities at a certain moment in time. Liquidity demands can be identiied using
methods of deposit structure and cash low reporting. The method of deposit structure
and the method of cash low reporting augment one another. The irst method embraces
a thorough analysis of the structure of deposits accepted by the bank. The second method supplements the irst one and covers the possibilities to withdraw deposits as well as
the demand for credit. Assessment of liquidity risks in the bank is based on managing
short-term (up to one month) and long-term (one-year) liquidity. Short-term liquidity of
the bank is managed in line with the liquidity ratio requirement prescribed by the Bank
of Lithuania by securing a required amount of obligatory reserves and complying with
short-term liquidity ratios as well as the limits that apply to them. Long-term liquidity
management relies on forecasting the need for liquidity, deposit and loan lows, meeting the need for liquidity, liquidity gap analysis and assessment of long-term liquidity
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indicators. Liquidity gap analysis has revealed a mismatch between the bank’s assets
and liabilities by maturity. The Bank of Lithuania has placed an exclusive focus on managing liquidity risk as well. The stress testing analysis has shown that banks are rather
successful in managing their liquidity. Having conducted analysis of the liquidity gap
in one bank we can state that the net liquidity gap for each demand at the close of 2011
was LTL 2,257,107 thousand in the negative. The total liquidity gap for a period of one
to three years was minus LTL 3,695,669 thousand. For periods longer than 3 years, the
net liquidity gap of the bank was LTL 4,009,139 thousand, whilst the aggregate liquidity gap was LTL 313,470 thousand. During the economic recession, the bank that we
analysed ensures coverage of loans outstanding with long-term liabilities and capital
and complies with the recommended limits of additional long-term liquidity indicators.
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Meilė JASIENĖ. Doctor Social Science, Professor, Vilnius University. Research interests: theory of
banking, inancial markets.
Jonas MARTINAVIČIUS. Doctor Social Sciences, Associate Professor, Vilnius University. Research
interest: statistical theory, statistycal methods.
Filomena JASEVIČIENĖ. Doctor Social Sciences, Vilnius University. Research interests: banking,
the ethics of banking.
Gražina KRIVKIENĖ. Master of Sciences in Economics, Vilnius University. Research interests:
banking risk, assets and liability management.
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