A Study on Liquidity Management on

Prime Bank Limited

A Study On Liquidity Management On Prime Bank Limited

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

-------------------------------------------On behalf of IFC Group

MBA 3rd Batch (2nd Semester)
Department of Management
(Team members name are in next page)

A Study On Liquidity Management On Prime Bank Limited

TEAM MEMBERS

SL No

Name

Roll No

Md. Mohsin Hossain

095179

Md. Mahabub Alam Manik

095255

Ishtiaque Ahmed

095253

Md. Robin Hasan

085788

Md. Abdullah Al- Mamun

095234

Sakti pada Mirdha

095218

Md. Idris

095215

Palash Mondal

095223

Nazmul Haque

095232

10

Sadiqur Rahman

095210

Remarks

A Study On Liquidity Management On Prime Bank Limited

INDEX

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

A Study On Liquidity Management On Prime Bank Limited

EXECUTIVE SUMMARY

A Study On Liquidity Management On Prime Bank Limited

1. INTRODUCTION
Liquidity management is undoubtedly one of the most crucial tasks of a bank.
The analysis in this study focuses on the liquidity situation of Prime Bank Limited
for the period of 2008 - 2010. Both short-term and long-term liquidity positions
have been taken into consideration. However, maturity-wise liquidity situation has
also been observed. To estimate the liquidity situation maturity-wise and total
liquidity gap have been calculated. Furthermore, this study also tries to examine
whether key performance indicators of these banks had any influence on liquidity
position during the period under study.
Any commercial bank is required to monitor and manage its liquidity position
effectively and cautiously. For Primes analysis, we have taken Prime Bank
Limited (Prime) in respect of maintaining liquidity position.
Prime Bank was created and commencement of business started on 17th April
1995. The sponsors are reputed personalities in the field of trade and commerce
and their stake ranges from shipping to textile and finance to energy etc. As a
fully licensed commercial bank, Prime Bank is being managed by a highly
professional and dedicated team with long experience in banking. Prime Bank
has already made significant progress within a very short period of its existence.
The bank has been graded as a top class bank in the country through
internationally accepted CAMELS rating. The bank has already occupied an
enviable position among its competitors after achieving success in all areas of
business operation. Prime Bank offers all kinds of Commercial Corporate and
Personal Banking services covering all segments of society within the framework
of Banking Company Act and rules and regulations laid down by central bank.
Diversification of products and services include Corporate Banking, Retail
Banking and Consumer Banking right from industry to agriculture, and real state
to software. Prime Bank, since its beginning has attached more importance in
technology integration.
Maintaining adequate liquidity is Primes strategic priority. Even though Prime
Bank achieved double-digit growth in its lending business, the Group was able to
A Study On Liquidity Management On Prime Bank Limited

maintain a liquid balance sheet. This was due to the strategy of building a longterm core deposit funding base of retail deposits to adequately fund its lending
business expansion. The injection of funds by issuing of subordinated bond of
BDT 2.5 billion and right share with premium of BDT 200 helped the bank to end
with a comparatively more liquidity. Prime Bank as a Group did not get much
involved in the stock market which was extremely volatile.
2. OBJECTIVE OF THE STUDY
The main objective of this study is to
-

Analyze liquidity position of prime bank limited

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

3. METHODOLOGY OF THE STUDY

In this study, at first we have calculated the net liquidity gaps 2008-2010. To
calculate net liquidity gap, we have collected maturity-wise information of both
assets and liabilities, which is segmented according to the following maturity
buckets:
-

Up to 1 month maturity
1-3 months maturity
3-12 months maturity
1-5 years maturity
More than 5 years maturity

With this information, we have calculated the net liquidity gap for each maturity
bucket from 2008 to 2010 by adding all the assets falling under that bucket and
then subtracting all the liabilities falling under that bucket from the assets of the
same maturity bucket.
That is
NLG = A - L
Where,
NLG = Net liquidity gap during a particular maturity bucket
A Study On Liquidity Management On Prime Bank Limited

A = Assets falling under a particular maturity bucket

L = Liabilities falling under a particular maturity bucket
Positive net liquidity gap implies that the bank has sufficient assets to satisfy the
liabilities of the same maturity bucket and negative net liquidity gap implies that
the liabilities exceed the assets for that particular maturity bucket. We found the
percentage of assets and liabilities held for each maturity bucket in respect of
total assets for the particular year. We have also calculated percentage of shortterm and long-term assets and liabilities for each of the year under discussion.
This provides a direction of liquidity situation of the concerned banks for the
years under discussion.

4. THEORETICAL FRAMEWORK:
Liquidity: Liquidity for a bank means the ability to meet its financial obligations as
they come due. Bank lending finances investments in relatively illiquid assets,
but it funds its loans with mostly short term liabilities. Thus one of the main
challenges to a bank is ensuring its own liquidity under all reasonable conditions.
Maturity: maturity or maturity date refers to the final payment date of a loan or
other financial instrument, at which point the principal (and all remaining interest)
is due to be paid.
Maturity gap: A measurement of interest rate risk for risk-sensitive assets and
liabilities. The market values at each point of maturity for both assets and
liabilities are assessed, then multiplied by the change in interest rate and
summed to calculate the net interest income or expense.
Asset liability management: In banking, asset and liability management is the
practice of managing risks that arise due to mismatches between the assets and
liabilities (debts and assets) of the bank.
Cash Reserve Requirement: The reserve requirement (or cash reserve ratio) is
a central bank regulation that sets the minimum reserves each commercial
bank must hold (rather than lend out) of customer deposits and notes. It is
normally in the form of cash stored physically in a bank vault (vault cash) or
deposits made with a central bank.
Statutory Requirement: The Statutory Requirement is a monetary policy
instrument available to manage liquidity and hence credit creation in the banking
A Study On Liquidity Management On Prime Bank Limited

system. It is used to withdraw or inject liquidity when the excess or lack of

liquidity in the banking system.
Stress testing: Stress testing is a form of testing that is used to determine the
stability of a given system or entity. It involves testing beyond normal operational
capacity, often to a breaking point, in order to observe the results.

5. LIQUIDITY MANAGEMENT ANALYSIS

Liquidity overview:

Table-1 Year-wise net liquidity gap of IBBL

Payable

2008
Receivabl
e

107.05

Up to 1
month
1-3months

Particular
s
Payable
on
demand

3-6
months
6
months-1
year
1-5 years
More
than 5
years

Total

GAP

Payabl
e

2009
Receivabl
e

2010
Payabl
e

Receiva
ble

1,833.89

1,726.84

7.97

603.59

595.6
2

1,028.46

1,028.4
6

10,910.0
0

1.82

-10,908.18

0.02

0.02

51.83

0.02

-51.81

271.55

50.00

-221.55

0.15

0.15

353.65

7.25

-346.39

100.00

100.00

100.00

100.0
0

27.58

16.36

-11.21

8.65

15.17

6.51

1,016.
90

0.15

1,016.7
5

81.69

-81.69

69.92

69.92

336.38

-336.38

-9,395.79

86.55

718.92

632.3
8

1,758.
76

1,035.88

-722.88

11,397.8
6

2,002.07

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

Table-2 Maturity analysis

Maturity analysis
Interest bearing assets

Below 1 year

1-5 Year

Above 5 year

Total

A Study On Liquidity Management On Prime Bank Limited

84,757

28,467

19,464

1,32,688

Non interest bearing

assets

8,203

1,450

10,457

20,110

Total assets

92,960

29,917

29,921

1,52,798

Interest bearing liabilities

60,016

23,840

20,511

1,04,367

Non interest bearing

liabilities

25,595

998

5,068

31,661

Total liabilities

85,611

24,838

25,579

1,36,028

Maturity gap

7,349

5,079

4,342

16,770

Cumulative gap

7,349

12,428

16,770

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

Required (%)

Maintained (%)
6
19

6.64
25.67

A Study On Liquidity Management On Prime Bank Limited

10

Way of liquidity management reporting: The liquidity statement of assets and

liabilities as on the reporting date has been prepared on residual maturity term as
per the following basis.
- Balance with other Banks and financial institutions, money at call and
short notice, etc. are on the basis of their maturity term
- Investments are on the basis of their respective maturity
- Loans and advances / investments are on the basis of their repayment
schedule;
- Fixed assets are on the basis of their useful lives
- Other assets are on the basis of their realization / amortization
- Borrowing from other Banks, financial institutions and agents, etc. are as
per their maturity / repayment terms
- Deposits and other accounts are on the basis of their maturity term and
past trend of withdrawal by the depositors
- Provisions and other liabilities are on the basis of their payment /
adjustments schedule.

6. LIQUIDITY RISK MANAGEMNT

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

11

C
L
F
T
u
i
a
q
n
m
l
u
d
e
l
i
d
n
R
r
g
i
t
s
y
R
k
i
r
s
i
k
s
k

Funding risk arises from the need to replace net outflows due to
unanticipated withdrawal/non-renewal of deposits.

Time Risk arises from the need to compensate for non-receipt of expected
inflows of funds i.e., performing assets turning into non-performing assets.

Call Risk arises due to crystallization of contingent liabilities. This may also
arise when a bank is not able to undertake profitable business
opportunities when it arises.

To this end, Prime maintains diversified and stable funding base comprising of
core retail, corporate and institutional deposits. It maintained sufficient liquid
assets for meeting the funding requirements. The principle responsibility of the
liquidity risk management of the bank rests with Treasury Division. Treasury
Division maintains liquidity based on historical requirements, current liquidity
position, anticipated future funding requirement, sources of fund, options for
reducing funding needs, present and anticipated asset quality, present and future
earning capacity, present and planned capital position. ALCO monitors the
liquidity management of Treasury by i) setting tolerance limit for cumulative cash
flow mismatches, ii) setting limit on loan to deposit ratio, iii) setting limits on
dependence on institutional deposits which are volatile in nature. From the
liquidity statement it can be seen that out of total deposit liabilities of Tk 124,519
million, contractual maturity of liability within 1 year is Tk 85,611 million. In the
liquidity statement it transpires that there is moderate positive gap in each
maturity buckets. So the cumulative gap is positive and pressure from liquidity is
minimal.
The Management Board defines Primes liquidity risk strategy, and in particular
Primes tolerance for liquidity risk based on recommendations made by Treasury
and the Capital and Risk Committee. At least once every year the Management
Board will review and approve the limits which are applied to the Group to

A Study On Liquidity Management On Prime Bank Limited

12

measure and control liquidity risk as well as the Banks long-term funding and
issuance plan.

Primes Treasury function is responsible for the management of liquidity and

funding risk of globally as defined in the liquidity risk strategy. Primes liquidity
risk management framework is designed to identify measure and manage the
liquidity risk position of the Group. Treasury reports the Banks overall liquidity
and funding to the Management Board at least weekly via a Liquidity Scorecard.
Primes liquidity risk management approach starts at the intraday level
(operational liquidity) managing the daily payments queue, forecasting cash flows
and factoring in Primes access to Central Banks. It then covers tactical liquidity
risk management dealing with access to secure and unsecured funding sources.
Finally, the strategic perspective comprises the maturity profile of all assets and
liabilities (Funding Matrix) and Primes issuance strategy.
Primes cash-flow based reporting system provides daily liquidity risk information
to global and regional management.
7. STRESS TESTING AND SCENARIO ANALYSIS
Prime use stress testing and scenario analysis to evaluate the impact of sudden
stress events on Primes liquidity position. The scenarios we apply have been
based on historic events,
Also incorporated are the lessons learned from the latest financial markets crisis.
They include the prolonged term money-market and secured funding freeze,
collateral repudiation, reduced fungibility of currencies, stranded syndications as
well as other systemic knock-on effects. The scenario types cover institutionspecific events (e.g. rating downgrade), market related events (e.g. systemic
market risk) as well as a combination of both, which links a systemic market
shock with a multi-notch rating downgrade.
Under each of these scenarios prime assume that all maturing loans to
customers will need to be rolled over and require funding whereas rollover of
liabilities will be partially impaired resulting in a funding gap. In addition we
analyze the potential funding requirements from off-balance sheet commitments
(e.g. drawings of credit facilities and increased collateral requirements) which
could materialize under stress. We then model the steps we would take to
counterbalance the resulting net shortfall in funding. Countermeasures would
include the Groups unencumbered business asset inventory, the available long
cash balance (over and above cash balances which form an integral part of

A Study On Liquidity Management On Prime Bank Limited

13

Primes existing clearing and settlement activities), as well as Primes strategic

liquidity reserve.
The asset liquidity analysis thereby forms an integral piece of stress testing and
tracks the volume and booking location within Primes consolidated business
inventory of unencumbered, liquid assets which we can use to raise liquidity via
secured funding transactions. Securities inventories include a wide variety of
different securities. As a first step, we segregate illiquid and liquid securities in
each inventory. Subsequently we assign liquidity values (haircuts) to different
classes of liquid securities. The liquidity of these assets is an important element
in protecting us against short-term liquidity squeezes.
In addition the bank maintains sizeable cash balances, primarily with central
banks, which are held in excess of the collateral which is required to support
Primes clearing activities in euro, U.S. dollars and other currencies around the
globe.
As a separate countermeasure we hold a dedicated strategic liquidity reserve
containing highly liquid and central bank eligible securities in major currencies
around the world to support Primes liquidity profile in case of potential
deteriorating market conditions. The volume of the strategic liquidity reserve is
the function of expected stress result. Size and composition are subject to
regular senior management review.
The most immediately liquid and highest quality items within the above three
categories are aggregated and separately identified as Primes Liquidity
Reserves. These Reserves comprise available cash and highly liquid
government securities and other central bank eligible assets. As of December 31,
2010 Primes Liquidity Reserves.
Stress testing is fully integrated in Primes liquidity risk management framework.
We track contractual cash flows per currency and product over an eight-week
horizon (which we consider the most critical time span in a liquidity crisis) and
apply the relevant stress case to all potential risk drivers from on balance sheet
and off balance sheet products. Beyond the eight week time horizon we analyze
on a quarterly basis the impact of a more prolonged stress period extending out
to twelve months, together with mitigation actions which may include some
change of business model. The liquidity stress testing provides the basis for the
banks contingency funding plans which are approved by the Management
Board.

A Study On Liquidity Management On Prime Bank Limited

14

Primes stress testing analysis assesses Primes ability to generate sufficient

liquidity under extreme conditions and is a key input when defining Primes target
liquidity risk position. The analysis is performed monthly.
Stress testing and scenario analysis plays a central role in Primes liquidity risk
management framework. This also incorporates an assessment of asset liquidity,
i.e. the characteristics of Primes asset inventory, under various stress scenarios
as well as contingent funding requirements from off-balance-sheet commitments.
The monthly stress testing results are used in setting Primes short-term
wholesale funding limits (both unsecured and secured) and thereby ensuring we
remain within the Boards overall liquidity risk tolerance.
Short-Term Liquidity: Primes reporting system tracks all contractual cash flows
from wholesale funding sources on a daily basis over a 12-month horizon. The
system captures all cash flows from unsecured as well as from secured funding
transactions. Wholesale funding limits, which are calibrated against Primes
stress testing results and approved by the Management Board, express Primes
maximum tolerance for liquidity risk. These limits apply to the respective
cumulative global cash outflows and are monitored on a daily basis. Primes
liquidity reserves are the primary mitigate against stresses in short-term
wholesale funding markets. At an individual entity level it may set liquidity outflow
limits across a broader range of cash flows where this is considered to be
meaningful or appropriate.
Unsecured Funding: Unsecured funding is a finite resource. Total unsecured
funding represents the amount of external liabilities which we take from the
market irrespective of instrument, currency or tenor. Unsecured funding is
measured on a regional basis and aggregated to a global utilization report. As
part of the overall Liquidity Risk Strategy, the management board approves limits
to protect Primes access to unsecured funding at attractive levels.

8. CONCLUSIONS:

A Study On Liquidity Management On Prime Bank Limited

15