Research - V4.0

ASSESMENT OF LIQUIDITY RISK MANAGEMENT
(A case study of Bank of Abyssinia)
Prepared by:
 Samrawit Faris
 Selam Gebrewold
 Helen Bereda
Advisor: Robel Y.
17th Sept, 2021
Addis Ababa, Ethiopia

ASSESMENT OF LIQUIDITY RISK MANAGEMENT
(A case study of Bank of Abyssinia)
Prepared by:
 Samrawit Faris
 Selam Gebrewold
 Helen Bereda
A RESEARCH PAPER SUBMITTED FOR THE PARTIAL

FULFILLMENT OF THE BACHELOR OF ARTS IN ACCOUNTING
AND FINANCE
Advisor: Robel Y.
17th Sept, 2021
Addis Ababa, Ethiopia

Acknowledgement
First and for most, we would like to thank our God for this all chance he gave us Next, we
would like to extend our heart full gratitude to our advisor, Mr. Robel Y. for the good advice
and constructive comments he had been giving. He devoted his time to follow up each of our
paper. Our heartily thanks go to our families who have a great support in our life and for their
moral and material support. Last but not the least we would like to extend our thanks to Bank
of Abyssinia managerial staff and employees in Head office.
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Contents
Acknowledgement..................................................................................................................................i
List of Tables.........................................................................................................................................iv
Acronym................................................................................................................................................v
Abstract................................................................................................................................................vi
CHAPTER ONE........................................................................................................................................1
1. INTRODUCTION.................................................................................................................................1
1.1 Background of the study..............................................................................................................1
1.2 Background of the organization...................................................................................................3
1.3 Statement of the problem.........................................................................................................3
1.4 Research questions......................................................................................................................5
1.5 Objectives of the study................................................................................................................5
1.5.1 General objective..................................................................................................................5
1.5.2 Specific objective..................................................................................................................5
1.6 Significance of the study..............................................................................................................5
1.7 Scope of the study.......................................................................................................................5
1.8 Limitations of the study...............................................................................................................6
1.9 Research methodology................................................................................................................6
1.9.1 Research design....................................................................................................................6
1.9.2 Research participants and population..................................................................................7
1.9.3 Data collection procedure....................................................................................................7
1.9.4 Sampling and sampling technique........................................................................................7
1.9.5 Analysis of data and interpretation......................................................................................8
1.10 Organization of the paper..........................................................................................................8
CHAPTER TWO.......................................................................................................................................9
2. REVIEW LITERATURE..........................................................................................................................9
2.1 Concept of liquidity and Liquidity Risk.........................................................................................9
2.2 Bank liquidity.............................................................................................................................10
2.3 Risk............................................................................................................................................11
2.4 Banking risks..............................................................................................................................12
2.4.1 Liquidity risk........................................................................................................................12
2.4.2 Interest rate risk (IRR).........................................................................................................13
2.4.3 Market risk..........................................................................................................................13
2.4.4 Default or credit risk...........................................................................................................13
ii
2.4.5 Operational risks.................................................................................................................13
2.5 Sources of liquidity risk..............................................................................................................13
2.5.1 Lack of cash flow management...........................................................................................14
2.5.2 Inability to obtain financing................................................................................................14
2.5.3 Unexpected economic disruption.......................................................................................14
2.5.4 Profit crisis..........................................................................................................................14
2.6 Measuring liquidity....................................................................................................................14
2.6.1 Analysis of financial ratio....................................................................................................15
2.6.2 Cash flow forecasting..........................................................................................................15
2.6.3 Capital structure management...........................................................................................16
2.7 Implementing liquidity risk........................................................................................................16
2.8 Liquidity risk management process...........................................................................................16
2.9 Theoretical review.....................................................................................................................18
2.9.1 Shift ability theory...............................................................................................................18
2.9.2 Anticipated theory..............................................................................................................18
2.9.3 Liquidity Preference Theory................................................................................................19
2.10 Empirical review......................................................................................................................19
2.11 Research gap............................................................................................................................23
CHAPTER THREE..................................................................................................................................24
3. Data Presentation, Analysis, and interpretation..............................................................................24
3.1 Background of respondents.......................................................................................................24
3.2 Information about liquidity risk management policy, liquidity risk management structure, and
contingency plans............................................................................................................................26
3.3 Information about major challenges the bank faced during implementation of the policies and
standard formulations.....................................................................................................................28
3.4 Information about liquidity position as per liquidity risk indicator............................................29
Analysis of Interview session...........................................................................................................31
CHAPTER FOUR....................................................................................................................................33
4. CONCLUSION AND RECOMMENDATION..........................................................................................33
4.1 CONCLUSION.............................................................................................................................33
4.2 RECOMMENDATIONS................................................................................................................34
Reference............................................................................................................................................36
Appendix.............................................................................................................................................39
iii
List of Tables
Table 3. 1 respondent background......................................................................................................23

Table 3.2 responses on liquidity risk management contingent plans..................................................25
Table 3.3 responses on major challenges............................................................................................27
Table 3. 4 responses on liquidity risk standards and control mechanisms..........................................28
iv
Acronym
BOA – Bank of Abyssinia
RBS – Risk-based supervision.
NBE – National bank of Ethiopia
ROA – Return on Assets
ROE – Return on Equity
v
Abstract
This study was assigned to assess the liquidity risk management practice in Bank of
Abyssinia. In preparing this research both primary and secondary data were used. The
primary data were collected through questionnaires which were held in both open ended and
close ended techniques and interviews to the bank liquidity risk management team, whereas,
Secondary data has been obtained from the website and literatures. The researcher used
judgmental sampling for the selection of the sample. And the data collection through the
questionnaires and interview were organized and analyzed, then tabulation in the form of
tables and interpretation were made. The result of the study indicated that the major
challenges that the bank faces in the liquidity risk management are unexpected withdrawal of
deposits and seasonal fluctuation in funding sources. On the basis of findings of the study,
conclusion and recommendations are made in light of assessment of liquidity risk
management.
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CHAPTER ONE
1. INTRODUCTION
1.1 Background of the study
In simple terms, liquidity is a measure of a company`s ability to cover its obligations to
creditors who demand funds at inconvenient times. In other words, if liquidity is not properly
handled, a company may experience illiquidity and even go bankrupt or suffer loss. No
manager wants to lead a company to this situation. That is main reason why companies have
to be aware of liquidity risk management. Managers must be prepared to adjust to negative
economic conditions and potential changes in order to remain competitive and avoid
damaging the company`s image and relationship with stakeholders. (Hawawini, G.; Vialler,
C. 2007). Liquidity can also be used to characterize a firm`s cash or near-cash asset; the more
liquid the more liquid asset a corporation has, the better its liquidity. Liquidity ratios are a
type of financial ratio that measures a company`s liquidity. One such ratio is the current ratio
which determines a company’s ability to pay short term debts as they come due (Van Ness,
2009).
Banks are financial intermediaries that transmit excess money to the economy's deficit sector
in the form of long-, and short-term loans. Banks make saving and capital generation easier in
the economy. The Bank for International Settlements (BIS) defines liquidity as a bank's
ability to support asset growth and meet commitments when they become due without
suffering unacceptable losses, according to BIS (2008). As a result, banks play a critical role
in the maturity transformation of short-term deposits into long-term loans, posing a liquidity
risk. As a result, banks must maintain an ideal level of liquidity in order to maximize profit
while also meeting their obligations (Alemayehu,2016), and should be prepared to deal with
shifting monetary policy which influences general liquidity trends as well as their own
transactional needs and short-term borrowing repayment. (Akhtar, 2007).
Because one of its primary social functions is maturity transformation, often known as time
intermediation, banks have always been vulnerable to liquidity risk. To put it another way,
they take demand deposits and other short-term money and re-lend them at longer maturities.
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As a result, banks can lend the funds for extended periods of time with a reasonable certainty
that the deposits will be available or that equal deposits can be secured from others as needed,
possibly with a minor increase in deposit rates ( Tsignesh, 2012).
According to (Santomero, 1997), banks are in the risk industry. They take on variety of
financial risks when providing financial service, one of which is liquidity risk. Because of
their ability to supply market intelligence, transaction efficiency, and funding capabilities,
market participants seek out the service of this financial institution. The bank does not bear
all of the risks associated with its primary activities, such as those concerning its own balance
sheet and basic lending and borrowing. Banks require liquidity to pay creditors, cover
unplanned withdrawals, pursue alternative investment opportunities, and adjust to changes in
loan demand and commitments.
Banks as credit institutions also frequently convert typically short-term liquid liabilities in to
long-term illiquid assets. Banks supply liquidity to consumers with liquidity demand on order
to smooth consumption and investment but they are also vulnerable to liquidity hazard (Webb
David C., 2000).
Liquidity risk is a common byproduct of banking operations. Because of bank normally

collects short-term deposit and loans long-term, the difference in maturities creates liquidity
risk and a
cost of liquidity. the time profile of the predicted sources and uses of funds can reflect the
bank`s liquidity condition and banks should manage liquidity gaps within acceptable limits.
The rationale for liquidity risk management is that because the time or the amount of the cash
outlays are uncertain, a financial institution must be prepared with enough cash to meet its
obligations. (Kiyotaki and Moore., 2008). Thus, the aim of this study is to assess how BOA is
managing liquidity risk.
A bank having outstanding asset quality, strong profitability and sufficient capital may fail if
it does not retain appropriate, which is why liquidity risk management has become one of the
most important success determinants for banks. (Crow, 2009).
This research looks at how the Bank of Abyssinia manages risk by measuring the liquidity
risk using the liquidity ratio and examining current management practices for managing the
bank's liquidity risk.
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1.2 Background of the organization
The Bank of Abyssinia (BOA) was created with its current name on February 15, 1996,
ninety years to the day after Emperor Menelik established the historically significant Bank of
Abyssinia.
In terms of shareholders, workers, customers, and branch expansion, the bank has made
significant improvement in recent years. Currently, the bank has 2,226 shareholders, 6,000
staff, and over 5,000,000 customers, with 600 offices spread over the country. Customers can
take advantage of a variety of services provided by the bank, including a savings account, a
youth-targeted savings program, gift savings accounts, on-site services, safe deposit boxes,
foreign money transfers, and so on. Furthermore, with an authorized capital of 5.5 billion.
The Bank of Abyssinia's vision is to carry on the tradition of Ethiopia's first bank, via
constant innovation and the provision of quality financial systems. The bank's objective is to
deliver a broad range of local and international banking services using trained and motivated
staff and cutting-edge technology. As a result, the focus of these papers is on the current level
and developments of liquidity, as well as their relationship to the performance of the Bank of
Abyssinia.
1.3 Statement of the problem

The nature of banking business demands that banks invest systematically in asset with
varying degrees of liquidity. On a global consolidated basis there is a better understanding of
how banks manage their liquidity. Banks must be able to control their stability and manage
risks in order to reap the benefit of a well-organized banking system. Liquidity risks refers to
the possibility that a bank will be unable to meet its depositors` communicates. It is one of the
most pressing concepts that banks face today. (Jenkinson,2008). However, in today’s
competitive and open economic system, with strong external influences and sensitive market
actors, maintain a defensive liquidity risk posture and management is extremely tough.
(Siddiqi,2008). Liquidity risk management is a crucial component of any financial
institution`s overall risk management framework, particularly in the financial services
industry. (Majid,2003). Banks, as financial institution must manage liquidity demand and
supply in an acceptable manner in order to run their business securely, maintain good
relationship with stakeholders and avoid liquidity crisis. (Ismal,2010).
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The incapacity of a bank to accept decreases in liabilities or fund growth in assets is known
as liquidity risk. Illiquidity refers to a bank's inability to access adequate cash at a fair cost,
either through raising liabilities or quickly converting assets. When banks don't have
adequate liquidity, they can't get the funds they need from debt without converting assets into
liquidity at a reasonable cost. In extreme circumstances, a lack of liquidity might lead to a
bank's bankruptcy. Following it, a loss in finance liquidity resulted in significant suffering
(Berehanu 2015).
One of the most important issues to address in order to make a progress is how to ensure that
banks successfully balance their liquidity management in order to remain stable while still
providing liquidity to the market. Policymakers will strive to maintain the country`s sold
economic growth while keeping unemployment and inflation low. In the case of asset
liquidity risk, banks manage liquidity through concentrations and relative market size
portfolios as well as diversification, credit lines or other backup funding and limiting cash
flow gaps. Because the behavior of multiple market participants in a stress scenario must now
also be taken into account liquidity risk management has become increasingly sophisticated.
There are internal and external sources of liquidity risk. Accordingly, banks specific (internal
factors) such as, bank size, risk, non-performing loan (NPL) and banks external factors
(macroeconomic factors) such as, GDP, financial policy of the country, inflation and
financial crisis (Lucchetta, 2007).
Commercial banks in Ethiopia maintain extra liquidity in their accounts, according to studies
by Worku (2006) and Semu (2010) on the factors that influence bank performance and
profitability. However, commercial banks are currently experiencing a severe liquidity
constraint, which is affecting their day-to-day operations.
Andebet (2016) conducted a study on the performance of private commercial banks in

Ethiopia before and after the National Bank of Ethiopia (NBE) issued a directive on April 4,
2011, requiring private commercial banks to hold 27 percent of gross loan extensions in a 5-
year bill with a 3% annual interest rate. The current state of the bank of Abyssinia's liquidity
management practice is investigated in this study.
Starting from 2019-2021 liquidity has risen due to certain wars and covid-19 pandemic. The
covid-19 pandemic has made liquidity a pressing issue for banks. So, the researcher tried to
assess how BOA is managing liquidity risk.
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1.4 Research questions
 What is the liquidity risk contingency plan in BOA?
 What are the major challenges of liquidity risk management in BOA?
 What looks like the liquidity position of BOA as per the key per liquidity risk
indicator?
1.5 Objectives of the study

1.5.1 General objective
The general objective of this study is to assess the liquidity risk management in the case of
Abyssinia bank.
1.5.2 Specific objective

 To evaluate the liquidity risk contingency plan of the company.
 To assess the major challenges of liquidity risk management of the company.
 To examine the liquidity position of the company as per liquidity risk indicator.
1.6 Significance of the study
The major benefits of this study will be the following:

 It might help to provide relevant and valuable information to decision makers
including managers, investors, depositors and creditors.
 It might help the Abyssinia bank to know how effective they are in managing
liquidity risk.
 It will give an insight about the liquidity risk management in Abyssinia bank.
 It can also assist other researchers in their research and explanations. In addition, it
benefits the financial sector of the economy as well as society as a whole.
1.7 Scope of the study

There is major risk in banking business or banking risks such as interest risk, market, default
or credit risk, operational risk and liquidity risk. This study assesses only about the liquidity
risk management. In conducting this research, we used analytical type of research because we
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add value in existing research. Due to manageability and accessibility difficulty the scope of
the study was limited to employees of Addis Ababa Head Office of BOA.
1.8 Limitations of the study

The research study was not free from limitations. There were some issues which has hindered
the full attainment of the study objectives. Some of the limitations the researchers faced
constitutes:
 Difficult to inspect all aspects of the company related to liquidity
 Lack of transparency although in few of the employees by misunderstanding the
study objective
 Financial constraint to go very regularly and collect the data in detail.
1.9 Research methodology

This section describes the methodology undertaken in relation to justification of the research
design, data sources and collection methods, sampling techniques and method of data
analysis and presentation.
1.9.1 Research design

Research design is a master plan or conceptual structure within which research is conducted.
It facilitates the smooth sailing of the various research operations, thereby making research as
efficient as possible yielding maximum information with minimal expenditure of effort, time
and money (Kothari, 2004). The researcher used non-probabilistic sampling design called
judgmental sampling technique where the researcher selected units to be sampled based on
his/her professional judgment. It enabled the researcher to describe the current liquidity risk
management practice, liquidity position and performance the bank considered in this stud
Mixed method research represents research that involves collecting, analyzing and
interpreting, quantitative and qualitative data in a single study or in a series of studies that
investigate the same underlying phenomenon. (leech N,onwuegbuzie A, 2008)
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1.9.2 Research participants and population
To collect adequate information related to the investigation, the investigators relied on
employee working on BOA head office staff. From the total population the researcher took
three departments that are directly related to the subject matter. From the risk and compliance
department, all the experts working in that department were 7, and from the finance
department and cheque clearance officers, which were working there were 6. The rest 7
experts working in treasury department were selected purposively. The researcher selected 20
employees as a sample size.
1.9.3 Data collection procedure

To fulfill the purpose of the study, the researcher used both primary and secondary data.
Primary data was collected by distributing a hard copy questionnaire to the selected
respondents at BOA. The questionnaire method as instrument of data collection was used
because it provided wider coverage to the sample and also facilitated collection of large
amounts of data.
Secondary data was collected from different bank's documents, manuals on employees on
risk management, website, and different books and research articles in the study area.
1.9.4 Sampling and sampling technique

There are two types of sampling methods:
• Probability sampling-involves random selection, allows us to make statistical
inferences about the whole group.
• Non-probability sampling- involves non-random selection based on
convenience or other criteria allowing us to easily collect initial data.
The researcher used non probability sampling design which is called judgmental
sampling technique, where the researcher selected units to be sampled based on his/her
professional judgment. How it came to completion was by collecting data from the
selected sample area from BOA and analyzing the responses from the questionnaire. A
sample questionnaire was presented to BOA staff at head office. The first step in
sampling is to decide on an appropriate sample size. There are no strict rules for
selecting a sample size. One can make a decision based on the objectives of the project
time available, budget and the necessary degree of precision.
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1.9.5 Analysis of data and interpretation
Data analysis and interpretation is used to extract useful information from the data and taking
the decision based on the data analysis. The researchers classified the data appropriately for
interpretation. To analyze and interpret the data obtained from the questionnaire, a
quantitative technique is used as Percentage, and organized in tabulated form.
1.10 Organization of the paper

The research paper is divided in to four chapters. The first chapter comprises reports, the
introduction and research methodology conducted. The second chapter is a literature review,
that is a general explanation of the subject. The third chapter is discussion, analysis and
interpretation of the responses from questionnaire and interview. Finally, the fourth chapter is
conclusion and recommendations.
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CHAPTER TWO
2. LITERATURE REVIEW
2.1 Concept of liquidity and Liquidity Risk

Liquidity risk is the possibility that over a specific time period, the bank will become unable
to settle obligations with immediacy (Drehmann and Nikolaou, 2009). It is a risk arising from
a bank’s inability to meet its obligations when they come due without incurring unacceptable
Losses. This risk can adversely affect both banks’ earnings and the capital and therefore, it
becomes the top priority of a bank’s management to ensure the availability of sufficient funds
to meet future demands of providers and borrowers at reasonable costs.
Banks need liquidity to meet deposit withdrawal and to fund loan demand. The variability of
loan demand and deposit a banks liquidity need. Bank has adequate liquidity when it can
obtain sufficient funds either by increasing liabilities or by converting assets, promptly and at
a reasonable cost. The price of liquidity is a function of market conditions and market
perception of the risks, both interest rate and credit risk reflected banks’ balance sheet
activities. If liquidity needs are not meet through liquid asset holdings. Banks may be forced
to restructure or acquire additional liability under adverse market condition. (Allan, J., Booth,
P., Verrall, R., & Walsh, D. 1998).
There are many factors that affect banks own liquidity and in turn affect the amount of
liquidity they can create. These factors have a varying degree of influence on the balance
between liquidity risk and liquidity creation or a bank’s liquidity management. A bank’s
assets and liabilities play a central role in their balancing of liquidity risk and creation. A
bank’s liabilities include all the banks sources of funds. Banks have three main sources of
funds: deposit accounts, borrowed funds and long-term funds. The amounts and sources of
funds clearly affect how much liquidity risk a bank has and how much liquidity it can create.
The easier a bank can access funds the less risk it has and the higher amount of funds it holds
the more liquidity it can create, if willing to do so. Deposit accounts are made up of
transaction deposits also known as demand deposits, savings deposits, time deposits, and
money market deposit accounts. The borrowed funds of a bank come from loans from other
banks via the Federal Funds market, loans from the Federal Reserve Bank, repurchase
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agreements and Eurodollar borrowings. The longer-term sources of funds for banks are bonds
that banks issue and bank capital. Therefore, these two liabilities are major factors of a bank’s
liquidity risk. Demand deposit accounts give banks a larger cash base and thus are a form of
liquidity. Undrawn credit lines are a liquidity risk that is off the balance sheet; companies
with established credit lines can borrow from banks when they need it and thus decrease a
bank’s liquidity (jeff Madura, 2007). The second is that the banks that face the most liquidity
pressures and have more cash outflow than inflow will have to sell assets. In this situation
most other banks will be facing increased liquidity pressures and there will be only a few
banks in the market to buy these assets. This lack of liquidity in the market can lead to fire
sales of assets. This means the company looking to sell the assets will have to offer them at a
large discount because it needs the cash now due to liquidity pressure. Therefore, in crisis
periods banks holding more liquidity will be able to both grow in new business and take over
business of other banks by buying their assets at low prices. By purchasing assets at fire sale
prices banks that are the purchaser stand to make a great deal of profit (Acharya., Shin.,
&Yorulmazer, 2009). Banks via the Federal Funds market, loans from the Federal Reserve
Bank. Banks liquidity management is the process of generating funds to meet contractual or
relationship between those banks must meet. Effective liquidity management serves five
important functions:
• It demonstrates the market place that the bank is safe and therefore capable of
repaying its borrowing.
• It enables the bank to avoid sale the unprofitable sale of asset. This function permits
banks to avoid sale of asset.
• The lower the size of the default risk premium the bank must pay for funds. Banks
with strong balance sheet will be perceived by the market places as being liquid and
safe such as banks will be able to buy fund at risk premium reflecting their perceived
credit worthiness.
2.2 Bank liquidity

Liquidity is the ability of a bank to fund increases in asset and meet obligation as they come
due, without incurring unacceptable losses. The fundamental role of banks in the maturity
transformation of short-term deposit in to long loans makes the bank inherently vulnerable to
liquidity risk, both of an institution specific nature and that which affects market as a whole.
The market turmoil that begins in mid-2007 G.C re-emphasis the importance of liquidity to
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the functioning of financial market and the banking. Liquidity is a financial institution
capacity to meet its cash and collateral obligation without incurring unacceptable losses.
Adequate liquidity is dependent upon the institutions ability to efficiently meet both expected
and unexpected cash flow and collateral needs without adversely affecting either daily
operation or the financial condition of the institution (Jenkinson,2008).
It is also a risk not having sufficient current assets (cash and quickly saleable securities) to
satisfy current obligations of depositors especially during the time of economic stress.
Therefore, without required liquidity and funding to meet obligations, a bank may fail.
(Pandey, 2010) posits that liquidity is current assets which should be managed efficiently to
safeguard the firm against the risk of illiquid. Lack of liquidity in extreme situations can lead
to the firm’s insolvency. He further state that conflict exists between liquidity and
profitability. If the firm does not invest sufficient fund in current assets, it may become
illiquid which is risky. It may lose profitability if some idle current assets do not earn
anything. Hence, insufficient liquidity is one of the major reasons of bank failure. Liquidity is
necessary to enable banks providing funds on demand and credits needed by customers which
are associated with the default risk.
2.3 Risk
Before getting into the subject of risk management we need to first define what risk means
and illustrate the types of risks that are recognized by the scholars of the subject. In reviewing
the subject matter of risk management, the concept of corporate governance and the
principles that lie behind it will be discussed. But first what is “risk”?
“The etymology of the word “Risk” can be traced to the Latin word “Rescum” meaning Risk
at Sea or that which cuts. Risk is associated with uncertainty and reflected by way of charge
on the fundamental/ basic i.e., in the case of business it is the Capital, which is the cushion
that protects the liability holders of an institution.” (Raghavan, 2003). From this we can
imply that “risk” is intended to show the likelihood of occurrence of a negative situation that
we do not wish to see realized.
Risk is the potential that a chosen action or activity will lead to a loss (undesirable outcome).
All businesses face the threat of risk in their investment as it is dependent on the returns to be
had in the future, which is uncertain as to what could happen, thus rendering itself to risk.
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Mostly, risk and uncertainty are confused and used interchangeably which is wrong as the
two are different. This leads us to clearly define the similarity and difference between the
two. On the other hand, risk to a banker means the perceived uncertainty connected with
some event related to the banking business. For example: will borrowers’ default on loans;
will new business fall; will the price of assets in an investment portfolio fall; will the bank
suffer losses from a change in long-term interest rates; is lending profitable? (Allan et al,
1998).
Types of risk:
• Funding risk- needs to replace net outflow due to an anticipated withdrawal of

deposit arises
• Time risk- needs to compensate for non-receipt of expected inflows of funds

arises due to temporary problem in recovery and time involved in managing
liquidity.
• Call risk- crystallization of contingent liabilities and inability to undertake

profitable business opportunities when desirable arises due to swaps and
option conversion of non-fund-based limit to fund based.
2.4 Banking risks

The major risks in banking business or banking risks are listed below (David. B Bell):
• Liquidity risk
• Interest rate risk
• Market risk
• Default or credit risk and
• Operational risk
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2.4.1 Liquidity risk
The liquidity risk of banks arises from funding of long-term assets by short term liabilities,
thereby making the liability subject to rollover or refinancing risk. Funding liquidity risk is
defined as the inability to obtain funds to meet cash flow obligations.
2.4.2 Interest rate risk (IRR)

IRR is the exposure of a bank’s financial condition to adverse movement in interest rates,
interest rate risk refers to potential impact on net interest income or net interest margin or
market value of equity (MVE) caused by unexpected changes in market interest rates, interest
rate risk can take different forms. IRR can be viewed in two ways: its impact is not the
earnings of the bank or its impact on the economic value of the bank’s assets, liabilities and
OBS positions.
2.4.3 Market risk

Market risk is the risk of adverse deviation of the market-to-market value of trading portfolio,
due to market movements, during the period required to liquidate the transactions. This
results from adverse movements in the level or volatility of the market prices of interest rate
instruments, equities, commodities and currencies. Market risk also referred to as price risk.
Price risk occurs when assets are sold before their stated maturities. In the financial market,
bond prices and yields are inversely related.
2.4.4 Default or credit risk

Credit risk is the most simply defined as the potential of a bank borrower or counterparty to
fail to meet its obligations in accordance with agreed terms. For most banks loans are the
largest and most obvious source of credit risk.
2.4.5 Operational risks

Operational risk is the risk of loss resulting from inadequate or failed internal processes,
people and systems or from external events. Strategic risk and reputation risk are not party of
operational risk.
Operational risk may loosely be comprehended as any risk which is not categorized as market
or credit risk. Scope of operational risk is very wide. It includes fraud risk, documentation
risk, competence risk, model risk, cultural risk, external event risk, legal risk and regulatory
risk.
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2.5 Sources of liquidity risk
Liquidity risk is a risk that a bank will not have sufficient cash to meet its financial
commitments in a timely manner. As business go about the process of measuring and
maintain liquidity risk. cThey need to be alert for common sources of that risk. These sources
include (Joe wijira, 2020).
2.5.1 Lack of cash flow management

Cash flow management gives a bank good visible into potential liquidity challenges and
opportunities cash flow is the bloodline of all business without proper management of cash
flow, a bank will increase its exposure to unnecessary liquidity risk. Moreover, a bank
without healthy and well managed cash flow will face uphill battle to remain profitable,
attract potential investors and to be visible in the long run.
2.5.2 Inability to obtain financing

A history of late debt repayment without loan covenant requirement they translate into
additional challenges when attempting to secure financing. Therefore, it is imperative that
bank have a good relation and regular communication with lenders. The inability to obtain
funding at all or to obtain it at competitive rates and acceptable term increase liquidity risk.
2.5.3 Unexpected economic disruption

At the start of 2020, the stock market was at its all-time and few people expected the world
would be so hard it by covid-19. The adverse economic impact of this global pandemic was
swift.
2.5.4 Profit crisis

A profit crisis will not only see a decline in its profitability margins and remain in operation.
It will need to start dipping into cash reserves. Failure to stop a continuous cash burn will
eventually deplete cash reserves, with the bank inevitably facing a liquidity crisis.
2.6 Measuring liquidity

One of the key elements of measuring and maintaining liquidity risk is the ability to identify
the warning signs of liquidity crisis. Beyond the identification of these signs, a bank must
also be able to measure risk magnitude so that it can take immediate and appropriate actions
14 | P a g e
to stop a downward spiral. The measuring methods are analysis of financial ratio, cash flow
forecasting and capital structure management.
2.6.1 Analysis of financial ratio

Good liquidity measure means performing financial ratio analysis, understanding what these
ratios means and taking the necessary best course of action. Financial ratio provides a bank
with current indicators of liquidity risk based on its past performance, allowing it to make the
required financial and operational tweaks to ensure it attains desired future financial and
operational outcome. Analysis of financial ratio includes quick ratio and current ratio.
2.6.1.1 Quick ratio

Measures how well a bank can meet its short-term financial obligation. It’s calculated as:
current asset −inventory

Quick ratio =
current liability
• Quick ratio > 1 means the banks are able to its current and above that it’s in a profit
generating situation.
• Quick ratio < 1 means the banks don’t have enough liquid assets to pay its current
liabilities.
• Quick ratio = 1 means the banks have the exact liquid asset to pay its current
liabilities.
2.6.1.2 Current ratio

Just like quick ratio current ratio measures the liquidity level of a bank and its ability to use
ort-term assets to repay sort-term obligation. It’s calculated as:
current asset
Current ratio =
current liability
• Current ratio > 1 means the bank have enough capital meet its short-term obligation
and also able to generate profit.
• Current ratio < 1 means the bank does not have enough capital to meet its short-
term obligation.
• Current ratio = 1 means that have enough capital to meet its short-term obligations.
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2.6.2 Cash flow forecasting
Importantly, management must have good visibility into potential liquidity difficulties and
opportunities. That said, it is always prudent for bank to maintain and revise their cash flow
forecasts, crisis or no crisis measuring and maintain sort-term liquidity risk is particularly
critical for a bank that as large transaction volume. Longer term cash flow forecasts can be
used to support the strategic objective of the bank and provide financial detail for lenders.
2.6.3 Capital structure management

Debt is usually the cheapest source of financing given that debt as a lower cost of funding
than equity and is also tax-deductible for a bank. To measure liquidity risk due to over-
leverage, a bank should look to see if it as enough liquidity to pay its debt interest and
principal.
2.7 Implementing liquidity risk

Implementing a risk management requires that responsibilities and accountabilities for
carrying out the program be determined and assigned. The organizational structure and
incentive system should be aligned with the goals and objectives of the risk management
program. Those responsible for carrying out the program should have the necessary abilities
to implement the strategy. Managerial competencies in organizational behavior, team
leadership and change management will also be required to implement a risk management
strategy. Responsibilities and accountabilities for implementing a strategy should be clear to
all public servants, objectives, strategies and processes should be well documented and
available to stakeholders.
A good risk manager would have the following attributes:
 A proactive attitude toward dealing with the risk and ability to undertake
prudent experimentation.
 An ability to admit and learn from mistakes.
 An ability to recognize one’s own biases and assumption.
 An ability to work in inter-disciplinary and cross-functional teams.
 An ability to recognize the role of science in risk management and recognize
and deal with uncertainty.
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2.8 Liquidity risk management process
The liquidity management process first begins with the Board of Directors (BOD) of a firm
establishing a liquidity management policy which will serve as a guideline for all the
employees in the firm. The Basel committee as banking supervisory body, has provided at
least three requirements for a BOD to carry out which are summarized briefly below.
First of all, there is the need for the BOD to understand the liquidity risk profile of
their organization, bearing in mind their internal and external business environment, in order
to be able to determine their tolerance limit. Again, there is the need for the BOD to
determine and approve the appropriate strategies, policies and liquidity risk management
practices which they intend to adopt for their operations. And finally, the BOD also needs to
relate the content of this policy to the senior management and then guide them in order
to implement it (Basel Committee, 2008).Policies are written statements which show an
institution’s commitment to pursue certain goals and objectives, by setting standards and
courses of action. They are intended to clearly specify the institution’s mission, values and
principles, as well as defining how daily activities are to be carried out. (Kimathi et al.,
2015).
With the above requirements having been settled, the policies now must contain the specific
goals and strategies of managing the liquidity of the firm (both in the short-term and
long-term). As a matter of fact, these policies are meant to clearly define the roles and
responsibilities of the entities involved the liquidity management process, which include
asset and liability management policies as well as the firm’s affiliation with other
financial institutions and regulators at large. Thus, it behooves the BOD to collaborate with
the appropriate expertise like the CEO, risk managers and regulators in order to formulate an
effective policy which takes into account the business environment of the firm. (Kumar, T.,
&Yadav, G. C., 2013).
Furthermore, in the liquidity management process, an effective information system is key, in

supporting the entire process. An effective information system allows institutions to monitor,
report and control its liquidity risk exposure, thereby determining its funding needs. An
effective information system, as explained by the Basel Committee, consists of two players,
namely, the decision makers in charge of the liquidity management of the institution, and
decision followers, who are found at the operational level. Thus, information on liquidity
17 | P a g e
management passes from the decision makers, through the senior managers down to
the subordinates who implement and also report to the superiors (Diamond and Rajan, 2010).
To add to that, the Basel Committee also prescribes that banks and other related institutions
ought to have an internal control system to help maintain the soundness of their
liquidity management process. Internal control consists of the processes effected by an
institution’s board of trustees, and other relevant personnel, to achieve specific goals such as
effectiveness and efficiency of operations, reliability of financial reporting, and compliance
with regulations (University of Delaware, 2012).This internal control system could be
assigned to an Asset-Liability Committee (ALCO), which is normally a risk management
committee in a bank or lending institution comprising senior managers, and with the goal
of evaluating, monitoring and approving risk management practices (Singh and Tandon,
2012), thus bridging the gap between the top and bottom hierarchy of the institution. The
internal control system is primarily intended to audit or review the liquidity management
process of the institution, evaluating its liquidity position as well as proposing new
enhancements to the BOD when necessary (ICAEW, 1999; Council, F. R, 2014; Basel
Committee, 2008).
2.9 Theoretical review

The major objective of Abyssinia bank is to create liquidity while remaining financially
stable. There are a number of ways bank manage their liquidity risk. This section examines
three theories that are demand relevant to research topics. The theories include; shift ability
theory, anticipated theory and liquidity preference theory.
2.9.1 Shift ability theory

The shift ability theory of bank liquidity was propounded by (H.G. moulton, 1960). who
asserted that if the commercial banks maintain a substantial amount of assets that can be
shifted on to the other banks for cash without material loss in case of necessity, then there is
no need to rely on maturities. According to this view, an asset to be perfectly shift able must
be immediately transferable without capital loss when the need for liquidity arises.
2.9.2 Anticipated theory

The anticipated theory was developed by (H.V. prochanow, 1994) on the basis of the
practice of extending term loans. According to this theory regardless of the nature and
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character of a borrowers business the bank plans the liquidation of the term loan from the
anticipated income of the borrower. A term loan is for a period exceeding one year and
extending to less than five year. The bank puts restrictions on the financial activities of the
borrowers while granting this loan. At the time of granting loan the bank takes into
consideration not only the security but the anticipated earning of the borrower. Thus, the loan
by the bank gets repaid out of the future income of the borrower.
2.9.3 Liquidity Preference Theory

(Keynes, 1960). postulated that the need to retain cash is influenced by speculative,
precautionary and transactions motives and interest rate is the payment for parting with cash.
Rate of interest according to the theory is established by the assessment of projected needs
for money and the amount of money available for satisfying the projected needs. Money
required for speculative, precautionary and transactions needs, amounts to the aggregate
demand for liquidity. Liquidity preference refers to the quantity of cash an individual/
institution would want to retain in a given point in time.
(Appelt, 2016). argued that the concept of interest rate as proposed by liquidity preference
theory is lacking in consistency. The interest rate as a measure of reluctance to renounce
liquid cash cannot simultaneously constitute the price which brings in to balance the desire to
retain cash with the supply of cash resources.
(Appelt, 2016). further stated that the subject of exchange relations in disregarded in relation
to the concept of interest rate and the demand for money.
2.10 Empirical review

Bordeleau and Graham (2010) offered empirical findings for a panel of Canadian and
American banks from 1997 to 2009 addressing the relationship between liquid asset holdings
and profitability. In brief, the findings revealed that there is a nonlinear relationship between
profitability and liquid assets held by banks; nevertheless, there is a limit beyond which
retaining more liquid assets reduces a bank's profitability, everything else being equal. This
result is conceptually compatible with the premise that financing markets compensate a bank
for retaining liquid assets to some extent, hence lowering its liquidity risk. However, the
opportunity cost of maintaining such very low yielding liquid assets on the balance sheet can
eventually offset this benefit. Simultaneously, the estimation findings show that the
relationship between liquid assets and profitability is influenced by the bank's business plan
19 | P a g e
as well as the risk of financing market challenges. According to the experts, adopting a more
traditional business model, such as deposit and loan-based banking, allows a bank to
maximize revenues while maintaining a lower quantity of liquid assets.
(Kaitibiet al., 2018). studied the link between efficient management of credit risk and
profitability of banks in Sierra Leone. The researchers studied one of the commercial banks
for the period 2010 – 2014. Ratios and chats were adopted to examine the association that
existed between the outcome and response parameters. The study established that efficient
credit management considerably influenced financial returns of commercial banks during the
period of the case study.
(Vodova, 2011). aimed to identify important factors affecting commercial banks liquidity of
Czech Republic. In order to meet its objective, the researchers considered bank specific and
macroeconomic data over the period from 2001 to 2009 and analyzed them with panel data
regression analysis by using EViews 7 software package. The study considered four firm
specific and eight macroeconomic independent variables which affect banks liquidity. The
expected impact of the independent variables on bank liquidity was: capital adequacy,
inflation rate and interest rate on interbank transaction/money market interest rate were
positive and for the share of non-performing loans on total volume of loans, bank
profitability, GDP growth, interest rate on loans, interest rate margin, monetary policy
interest rate/repo rate, unemployment rate and dummy variable of financial crisis for the year
2009 were negative whereas, the expected sign for bank size was ambiguous (+/-). The
dependent variable (i.e., liquidity of commercial banks) was measured by using four liquidity
ratios such as liquid asset to total assets, liquid assets to total deposits and borrowings, loan to
total assets and loan to deposits and short-term financing.
(Vodova, 2011). revealed that bank liquidity was positively related to capital adequacy,
interest rates on loans, share of non-performing loans and interest rate on interbank
transaction. In contrast, financial crisis, higher inflation rate and growth rate of gross
domestic product have negative impact on bank liquidity. The relation between the size of the
bank and its liquidity was ambiguous as it was expected. The study also found that
unemployment, interest margin, bank profitability and monetary policy interest rate/repo rate
have no statistically significant effect on the liquidity of Czech commercial banks,
(Tirualem,2009), stress on the impact of liquidity on performance of banks, the
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existence of standardized liquidity risk management strategy(practice) and the impact of
the directives of NBE on the performance of commercial banks in Ethiopia. To conduct
the study, descriptive method was employed. Purposive sampling was used in the
selection of each bank and the respondents from the respective bank. Thus, a total of 30
respondents participated to the sources of primary data for the study. Data were collected
through questionnaire, interview and annual reports of each commercial bank. The data
collected from primary and secondary sources were organized using tables and graphs
interpretation was made on the data using quantitative and qualitative methods. The
findings of the study revealed that there is no uniform (standardized) liquidity risk
management policy and procedure in the banking industry which is for all
commercial banks in Ethiopia. Finally, recommendations were forwarded based on the
major findings so as to improve the liquidity risk management practice of commercial
banks in Ethiopia. (Alemayehu Fekadu, 2016).
Research is to identify the factors significant to explain Ethiopian commercial

Banks liquidity. This study has categorized the independent factors into bank specific
factors and macroeconomic factors. The bank specific factors include Bank Size, Capital
Adequacy, Profitability, Non-Performing Loans, and Loan Growth while the
macroeconomic factors include Gross Domestic Product, General Inflation and National
bank Bill. The panel data was used for the sample of eight commercial banks in Ethiopia
from 2002 to 2013 year and estimated using Fixed Effect Model (FEM), data was present
by using descriptive statistics and the balanced correlation and regression analysis for
liquidity ratios was conducted. The findings of the study show that capital strength and
profitability had statistically significant and positive relationship with banks’ liquidity. On
the other hand, loan growth and national bank bill had a negative and statistically
significant relationship with banks’ liquidity. However, the relationship for inflation, non-
performing loans, bank size and gross domestic product were found to be statistically
insignificant. The study suggests banks must have increase their outreach to tens of
millions of people by openings up more and more branches every year through country, and
have significantly improve their banking service by introducing new product and services
like Agent banking, Mobile banking and Internet Banking through the application of modern
technology. (Andebet Mulualem Zewdu, 2016).
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This study aimed at comparing the performance of Private commercial banks in Ethiopia
during pre and post Bill Periods. i.e 2008-2011 and 2012-2015 years. The study used
quantitative research approach and secondary financial ratio analysis for six private
commercial banks. Profitability performance, liquidity performance and asset quality
performance of the banks were assessed to compare pre and post bill periods
performance of the private banks. Purposive sampling was used to select samples from the
total population. The study used trend analysis using graphs for each of the variables in
the study to observe the trend on them throughout the observation period. A paired t-
test is employed to test the hypothesis that the means of the two periods are same on the
eight variables. As a result of hypothesis test it was found there is statistically
significant difference between the two periods in respect to profitability measures of
Return of Equity (ROE), Cost to Income(C/I) ratio, and Net interest margin (NIM). In
addition statistically significant difference between the two periods is observed in the
Liquidity measure of Liquid asset to deposit (LAD) ratio and asset quality measure of loan
reserve to total loan (LRTL) ratio. The study reveal statistically insignificant difference
between the two periods in respect to Return on Asset(ROA) and liquidity measure
of Loan to Deposit(LD) ratio and Loan to total asset(LTA) ratios. Finally, the study had
recommended on further research in bank performance and regulatory requirements in
private banking business.
(Mekebub, 2016). the main objective of this study was to identify the determinants of
liquidity of private commercial banks in Ethiopia. In order to achieve the research
objectives, data was collected from a sample of six private commercial banks in Ethiopia
over the period from 2000 to 2015. Bank specific and macroeconomic variables were
analyzed by using the balanced panel fixed effect regression model. Bank’s liquidity is
measured in three ratios: liquid asset to deposit, liquid asset to total asset and loan to deposit
ratios. The findings of the study revealed that, bank size and loan growth has negative and
statistically significant impact on liquidity; while non- performing loans, profitability and
inflation have positive and statistically significant impact on liquidity of Ethiopian private
commercial banks. However, capital adequacy, interest rate margin, real GDP growth
rate, interest rate on loans and short- term interest rate have no statistically significant
effect on the liquidly of Ethiopian private commercial banks.
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(Shukla J., and muchem E, 2017). studied the nexus between management of liquidity and
financial performance of commercial banks in Rwanda. Fourteen commercial banks were
randomly selected for the purpose of the study. Multiple regression technique was adopted to
establish the nexus between management of liquidity in the financial returns of commercial
bank of in Rwanda. The study concluded that holding more liquid assets as compared to total
assets would lead to lower returns to commercial bank in Rwanda and the effect is significant
at 5%.
2.11 Research gap

The liquidity and its impact have been used in the majority of the empirical studies shown
above on profitability and performance measurement, and identify liquidity
factors. Studies according to the sources given above, commercial banks' liquidity is
influenced by bank-specific factors like the bank's size, profitability, capital sufficiency, and
risk-related characteristics, and macroeconomic factors like variation of interest rates and
indicators of inflation. There are also few studies that appear to incorporate elements that
determine liquidity as an explanatory variable for bank profitability, which is traditionally
assessed by ROA and ROE. However, those publications do not focus on this area of the
study.
All of the studies mentioned used quantitative techniques, and most of them used combined
quantitative and qualitative techniques. However, this study attempts to fill the gap by
demonstrating the bank's practice using mixed approach, which employs both quantitative
and qualitative techniques, and demonstrates how the internal management handles liquidity.
Furthermore, this study aimed to illustrate only the bank-specific factors and a detailed
analysis of the case of Bank of Abyssinia. This will assist each and every bank in evaluating
its liquidity management practices in order to monitor and maintain an acceptable level of
liquidity while avoiding the risk of a bank's excess or deficit.
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CHAPTER THREE
3. Data Presentation, Analysis, and interpretation

This chapter deals with data analyses, presentation and interpretation which were conducted
from sample responses. Questionnaire were distributed to 20 Bank of Abyssinia employees,
From the risk and compliance department, all the experts working in that department is 7 and
from the finance department and cheque clearance officers, which are the total number
working there is 6 and the rest 7 experts working in treasury department, selected purposely
using convenient judgmental sampling method. Out of these 20 questionnaires, 18 were
completed and collected as a result of this the response rate is 90%. Generally, the collected
data is analyzed as follows.
3.1 Background of respondents
Table 3. 1 respondent background
Respondents
No Percentage
1. Sex
Male 12 66.67%
Female 6 33.33%
Total 18 100 %
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2. Educational level
College diploma 2 11.11%
BA/BSC degree 10 55.55%
Master degree 4 22.22%
Other 2 11.11%
Total 18 100%
3. work experience
Below 2 years 3 16.67%
2-4 Years 3 16.67%
4-6 Years 8 44.44%
Above 6 Years 4 22.22%
Total 18 100%
4. Position in the bank
Junior officer 3 16.67%
Senior officer 4 22.22%
Managerial 9 50%
Non-clerical 2 11.11%
Total 18 100%
Sources: questionnaire, (2021)
Table 3.1 shows background of the respondent which includes Four (4) classes that are sex,
educational level, years of services in the organization and position in the bank. As it can be
seen the above table the sex range, 12(66.67%) of the respondents are Male and 6(33.33%) of
the respondent are Female. This shows Majority of the respondent were Male. 2(11.11%) of
the respondent are had qualification of college diploma, 10(55.55%) had qualification B.A
Degree, 4(22.22%) of the respondent had qualification of Master degree and 2(11.11%) of the
25 | P a g e
respondent have other qualifications. This shows that majority of the respondent had B.A
Degree.
From the total number of the respondent 3(16.67%) had less than 2 years of experience,
3(16.67%) had 2-4 years of experience, 8(44.44%) had 4-6 years of experience, and also
4(22.22%) of the respondents had more than 6 years of experience in the bank sector. This
shows that majority of the respondents had 4 to 6years of experience. This implies that since
average of the respondents are experienced, they are efficient in managing the liquidity risk
in the bank’s context.
Finally, this table shows position in the organization 3(16.67%) of the respondent were Junior
officers, 4(22.2%) were Senior officers, 9(50%) were in managerial staff, 2(11.11%) were
non-clerical. This shows Majority of the respondent were at management position in the
bank. This implies that there is segregation of duties in the bank thus leading the bank to
perform the task properly.
3.2 Information about liquidity risk management policy, liquidity

risk management structure, and contingency plans
Table 3.2 responses on liquidity risk management contingent plans
No of respondents and percentage

Strongly Disagree Neutral Agree Strongl Total
Disagree y Agree
1. The risk & compliance 0 (0%) 0 (0%) 2 14 2 18
management sub-committee (11.11 (77.7 (11.11 (100
of the board of directors %) 8%) %) %)
oversees the implementation
of the risk management
policy.
2. The company board of 0 (0%) 0 (0%) 0 (0%) 2 16 18
directors properly (11.1 (88.89 (100
understands the nature of the 1%) %) %)
bank liquidity & assigning
responsibility to a different
level for managing liquidity
26 | P a g e
risk.
3. The senior management of 0 (0%) 0 (0%) 0 (0%) 0 18 18
the company strive in (0%) (100%) (100
evaluating the design & %)
implementation of an
appropriate liquidity risk
management system and
standards liquidity risk
reporting and monitoring
process
4. The senior management of 0 (0%) 0 (0%) 0 (0%) 0 18 18

the bank established policies (0%) (100%) (100
to clearly set the purpose, %)
objectives and goals of
liquidity management.
Sources; questionnaire, (2021)
As shown in the above table 3.2 question number one (1) indicate that the majority
14(77.78%) and 2(11.11%) of the respondents answered that the board of directors oversees
the implementation of the liquidity risk policies of the bank, while the remaining 2(11.11%)
of the respondents were neutral. From question number one, the researchers concluded that
the board has strong hierarchy of controlling the implementation of the policies.
Question number two (2) shows that the majority 16(88.89%) and 2(11.11%) of the
respondents answered that the board of directors have understood well the nature of the bank
to predict the risk levels and assign responsibility hierarchy. This implies the skill and
proficiency of the bank’s board staff on risk management, and a reliability on them to adopt
more efficient policies in the bank.
Question number (3) indicates that all 18(100%) of the respondents answered that the senior
management staff of the bank regularly examines the formulation and implementation of the
policies and the standards. This builds up confidence and reliability on the procedures of
implementation, and easily fill possible gaps.
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Question number (4) indicates that all 18(100%) of the respondents answered that the senior
management staff of the bank have set clear policies to determine the goals of the liquidity
risk management activities. From this, the researchers concluded that the bank has principles
to make every individual to be aware of the policies and the implementation goals.
3.3 Information about major challenges the bank faced during

implementation of the policies and standard formulations.
Table 3.3 responses on major challenges

Disagree y Agree
1. There are challenges that 0 (0%) 0 (0%) 3 14 1 18
hinder effective (16.67 (77.7 (5.56%) (100
implementation of liquidity %) 8%) %)
risk management in the bank.
2. The bank annually adopts a 0 (0%) 0 (0%) 0 (0%) 10 8 18
new way to offset the (55.5 (44.44 (100
increasing cost of operations 6%) %) %)
in order to prevent liquidity
risk.
3. The bank’s liquidity 0 (0%) 0 (0%) 0 (0%) 12 6 18
management system involves (66.6 (33.33 (100
consistency and clear 7%) %) %)
communication, even during
difficult scenarios.
4. The bank builds a liquidity 0 (0%) 0 (0%) 0 (0%) 12 6 18

dashboard to comply with the (66.6 (33.33 (100
need to monitor their liquidity 7%) %) %)
position on a real-time basis.
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14(77.78%) and 1(5.56%) of the respondents approved those critical challenges were
identified in the implementation procedures, while the remaining 3(16.67%) of the
respondents were neutral. From the above table the researchers concluded that the board is
confronting challenges from the liquidity risk management.
respondents answered that the bank regularly adopts new ways to enhance the
implementation and reduce liquidity risk. This implies the bank’s diligence to fill gaps in the
current policies and implementation procedures.
Question number (3) indicates that the majority 12(66.67%) and 6(33.33%) of the
respondents answered that bank’s liquidity risk management system involves consistency and
strong communication in the implementation procedures to survive difficult scenarios or
unpredicted events. This implies the bank has greater possibility of surviving in sudden crisis.
respondents answered that bank has a dashboard to monitor and analyze the liquidity level,
the implementation effectiveness and the progress of improving the policies. This implies the
bank has real-time monitoring to track every stage of the implementation and interpret the
results.
3.4 Information about liquidity position as per liquidity risk

indicator
Table 3. 4 responses on liquidity risk standards and control mechanisms

Disagree y Agree
1. The bank has clear 0 (0%) 0 (0%) 0 (0%) 14 4 18
procedure for identifying, (77.7 (22.22 (100
monitoring, measuring and 8%) %) %)
controlling liquidity risk.
2. The bank has inflow 0 (0%) 0 (0%) 3 10 5 18
against the outflow and (16.67 (55.5 (27.78 (100
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liquidity value of its asset to %) 6%) %) %)
identify the potential for
future net funding shortfalls.
3. The bank's liquidity risk 0 (0%) 0 (0%) 2 12 4 18
measurement options are (11.11 (66.6 (22.22 (100
adequate. %) 7%) %) %)
4. The bank sets a limit to 0 (0%) 0 (0%) 0 (0%) 12 6 18

control the liquidity risk (66.6 (33.33 (100
exposure and vulnerabilities. 7%) %) %)
14(77.78%) and 4(22.22%) of the respondents answered that the bank adopted clear
procedures to identify liquidity risks, implement the policies and monitor operations. From
the question number one, the researchers concluded that the board is working hard on
monitoring procedures for the policy implementation.
respondents answered that the bank has inflow against the outflow to identify its capability
considering funding shortfalls in the future. The remaining 3(16.67%) were neutral.
Question number three (3) shows that the majority 12(66.67%) and 4(22.22%) of the
respondents answered that the bank has adequate options and capability to measure its
liquidity risk, while the remaining 2(11.11%) were neutral. From this the researchers
concluded that the bank secured several alternatives to measure its liquidity level. It helps
explore more vulnerable sides and areas that need to be improved.
respondents answered that bank has set a limit to its liquidity in order to control risk
exposure. It is concluded that this limit helps minimize vulnerability to unexpected crisis and
uncontrollable scenarios.
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Analysis of Interview session
Question 1. What are the main causes of liquidity risk in the bank, and how is it
identified?
The liquidity risk management staff said that the potential factors that have been leading to
liquidity risks, although some are not too critical are:
 Negative trend in significantly increased risk in product concentration on either assets
or liability, such as deterioration in quality of credit portfolio
 A decline in earnings performance
 Rapid asset growth funded by volatile large deposit, and
 A large size of off-balance sheet exposure and Customs trend of withdrawal
The staff also said that Bank of Abyssinia regularly works to trace and spot its liquidity risk
in a continuous routine using different techniques. The bank introduced liquidity risk
management system that is managed by regular supervision, well defined warning signals and
proper implementation of the policies. The risk identifying procedure incorporates the use of
liquidity risk measurement tools, setting limits, adoption of strong MIS.
Question 2. What tools and standards does the bank employ to assess its liquidity
level?
One of the member staff in the liquidity risk management said that liquidity level
measurement of the bank is performed through continuous review of liquidity status to ensure
the presence of reliable procedure by the body responsible for risk management. The factors
considered and standards adopted by the bank to measure its liquidity level are, Liquidity
concentration ratios and limits like percentage of core deposit to total deposit and percentage
of foreign deposit to liquid asset, liquidity risk indicators like loan to deposit percentage and
liquid asset to total asset ratio, Maturity gap analysis, and Stress testing
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Question 3. What are the bank's strength and weakness when it comes to
managing liquidity risk?
According to the response from the managerial staff, the bank has a practice of continuously
developing its framework and periodically manage liquidity risk exposure. The bank also has
a good policy and strategy towards handling liquidity. The weak sides, as stated by the staff,
that the bank should work on are the concentration of total deposit of the bank in customers
as they are the major depositors, and periodic fluctuation of its funding sources.
Question 4. Is there a plan in place for when there is uncertainty or an

unexpected crisis?
The liquidity risk management staff said that there is contingency plan during unexpected
crisis. The bank has a practice of predicting every possible risk exposure using the tools and
mechanisms mentioned before. Based on the findings, the staff prepares survival paths for the
scenarios that are likely to occur, and also defines warning signals for them. To point out
some scenarios from previous experience of the bank, concentration in either asset liability,
decline of deposit or sudden withdrawals, and false transactions, are the major ones.
Therefore, the bank has its own liquidity risk management policy and procedure. It is
essential for supervisors to address liquidity risk as thoroughly as other major risks. From the
data obtained the bank has timely reporting and monitoring of liquidity risk. Furthermore,
the strategy covers both normal course action and crisis situation. The aim of liquidity
supervision and regulation is to reduce the frequency and severity of banks’ liquidity
problems, in order to lower their potential impact on the financial system. But there is no
specific period to revised it according to the current situation. though there is policy and
procedure to monitor the liquidity risk the bank should timely and periodically review in
order to be competitive with the current situation.
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CHAPTER FOUR
4. CONCLUSION AND RECOMMENDATION

This chapter discusses the conclusions that are drawn from the findings of the study, and
based on this, the researcher gives recommendations. This study indicates that:
 BOA has liquidity risk management policy and procedure which is approved by the
board of directors of the bank. Other units are also involved in executing the liquidity
risk management policy and procedure which include senior management, asset and
liability committee, and risk management and control department. These bodies have
their own hierarchical roles in the liquidity risk management system.
 there is excess liquidity considered and this is because of some mismatch of inflows
and outflows of funds which is caused by low economic growth and absence of
adequate financial instruments in the country. s
 there is lack of standardized liquidity risk management in the banking industry instead
the bank adopts its own liquidity policies and procedures. The NBE issues directives
regarding liquidity and reserve requirements. Since there’s no illiquidity in the bank,
it can be observed that the directives and other controls of NBE do not affect the
banks’ performance but the underdeveloped economy of the county.
4.1 CONCLUSION
This study revealed the practices of Bank of Abyssinia in liquidity risk management.
Accordingly, a number of conclusions can be drawn from the results.
 Bank of Abyssinia experience unexpected withdrawal of depositors, and

management’s grant for credit in order to maximize profit due to high demand for
loan of customers affects the bank’s liquidity performance.
 The bank experience significant seasonal fluctuation in its funding sources.
33 | P a g e
 The bank has reliable and well-organized contingency plan which is applicable when
there is unexpected situation happened. This reduced the effect of risk factors and
possibilities significantly.
 The managerial staff adopts strategy and procedure towards managing and measuring
the liquidity risk of the bank. But the periodicity and revision still have to be
improved in order to consistently stay firm respect to the current challenges.
Therefore, from the above discussion it is possible to conclude that the liquidity risk handling
practices of Bank of Abyssinia are good, being still reminded of the above-mentioned
weaknesses that demands a quick fix.
4.2 RECOMMENDATIONS
Based on the findings, the researchers came up with the following possible recommendations
to policy makers, the banks, and the government in order to overcome the challenges, and
reduce the effect of liquidity risk occurrences in the context of Bank of Abyssinia.
 Multiplicity of funding sources is an important aspect in banking industry. The bank

should conduct extensive studies to overcome the limited capability of funding
sources.
 The NBE should contribute a lot and work in collaboration with banks by facilitating
the establishment of secondary markets to widen the scope and options of funding.
 The NBE should revise its liquidity risk management policies regularly and
overwatches the policy adoption and implementation at the bank’s level, strengthen its
staff capacity and adopt RBS, risk-based supervision.
 Although the bank has a good practice of contingency plan giving better attention to
possible spots, working hard on it will improve the capability of reaching more
potential risk possibilities and intensify the bank’s resistance to survive such scenarios
without unnecessary loss.
 More researchers should be encouraged to conduct studies on this area. This will
actually benefit both the bank and the policy makers to adopt efficient policies and
conduct effective implementations.
 Liquidity risk management is the responsibility of a bank. A bank should build a solid
liquidity risk management system that guarantees it has adequate liquidity, including a
liquidity buffer.
34 | P a g e
 Liquidity risk management is the responsibility of a bank in general. A bank should
build a solid liquidity risk management system that guarantees it has adequate
liquidity, including a liquidity buffer. Liquid assets that are unencumbered and of
good quality, and also that can tolerate a variety of stress situations, such as those
involving the loss of both unsecured and secured funding options. Supervisors should
evaluate the situation regarding adequacy of a bank's liquidity risk management
strategy and its internal controls. If a bank's liquidity situation is inadequate, they
should act quickly, and to safeguard depositors and reduce potential damage, either
area should be used.
Reference
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Appendix
St. MARY’S UNIVERSITY
Department of Accounting and Finance
The aim of this questionnaire is to collect information for research to be conducted on the
challenge and prospects of liquidity risk management in the case of Bank of Abyssinia, at
Head office by Samrawit Faris, Selam Gebrewold, and Helen Bereda, who are undergraduate
student of Accounting and Finance at St. Mary’s University. Your cooperation in providing
genuine response to the following questions is highly important for the success of this study.
It is prepared only for academic purposes and your response will be kept confidentially.
Thank you in advance for your cooperation.
Instructions:
 Do not write your name
 Please use a tick mark (✔) to choose your best response to the close-ended questions
 Write your answer on the space provided for open-ended questions

 Attempt all questions
Background Information
1. Sex
38 | P a g e
Male Female
2. Educational level
College diploma Master Degree
BA/BSC degree Other
3. Over all experience in the bank
Below 2years 4-6 years
2-4 years Above 6 years
4. Position in the bank
Junior officer Senior officer
Managerial Non-clerical
General questions
1. Does the bank have clear liquidity risk management policy and procedure?
Yes No
2. If yes, does it pass through periodic revisions?
Yes No
3. If yes, how often do you perform the revision?
6 months
1 year
2 years
Other
4. Does the bank apply stress tests on liquidity?
Yes No
5. Does your bank has predefined warning signs for occurrence liquidity crises?
Yes No
6. If yes, what types of scenarios are in use as signals?
7. Does your bank meet the requirements of NBE regarding liquidity?

As expected,
Over liquid
Deficient
Other
39 | P a g e
Information about liquidity risk management policy, procedure
framework and liquidity risk management structure
(N.B 1 - Strongly Disagree, 2 - Disagree, 3 - Neutral, 4 - Agree, 5 - Strongly Agree)
1 2 3 4 5
1. The risk & compliance management sub-

committee of the board of directors oversees
the implementation of the risk management
policy.
2. The company board of directors properly

understands the nature of the bank liquidity
& assigning responsibility to a different
level for
managing liquidity risk.
3. The senior management of the company

evaluating the design & implementation of
an appropriate liquidity risk management
system and standards liquidity risk reporting
and monitoring process
4. The senior management of the bank

established policies to clearly set the purpose,
objectives and goals of liquidity management.
Information about major challenges faced in implementation the

liquidity risk management of the bank
40 | P a g e
1 2 3 4 5
1. There are challenges that hinder effective

implementation of liquidity risk management in
the bank.
2. The bank annually adopts a new way to

offset the increasing cost of operations in
order to prevent liquidity risk.
3. The bank’s liquidity management system

involves consistency and clear communication,
even during difficult scenarios.
4. The bank builds a liquidity dashboard to

comply with the need to monitor their
liquidity position on a real-time basis.
Information about liquidity position as per liquidity risk indicator.

1 2 3 4 5
1. The bank has clear procedure for identifying,

monitoring, measuring and controlling liquidity
risk.
2. The bank has inflow against the outflow and

liquidity value of its asset to identify the
potential for future net funding shortfalls.
3. The bank's liquidity risk measurement

options are adequate.
41 | P a g e
4. The bank sets a limit to control the liquidity
risk exposure and vulnerabilities.
INTERVIEW
This interview session with the liquidity risk management body is aimed to collect
information about the liquidity risk management practices in the context of Bank of
Abyssinia. We would like to thank you in advance for your cooperation.
1. What are the main causes of liquidity risk in the bank, and how is it identified?
2. What tools and standards does the bank employ to assess its liquidity level?
3. What are the bank's strength and weakness when it comes to managing liquidity
risk?
4. Is there a plan in place for when there is uncertainty or an unexpected crisis?
42 | P a g e

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ASSESMENT OF LIQUIDITY RISK MANAGEMENT

(A case study of Bank of Abyssinia)

17th Sept, 2021

Addis Ababa, Ethiopia

(A case study of Bank of Abyssinia)

A RESEARCH PAPER SUBMITTED FOR THE PARTIAL

17th Sept, 2021

Addis Ababa, Ethiopia

Table 3. 1 respondent background......................................................................................................23

RBS – Risk-based supervision.

NBE – National bank of Ethiopia

ROA – Return on Assets

ROE – Return on Equity

Liquidity risk is a common byproduct of banking operations. Because of bank normally

1.3 Statement of the problem

Andebet (2016) conducted a study on the performance of private commercial banks in

1.5 Objectives of the study

1.5.2 Specific objective

1.6 Significance of the study

The major benefits of this study will be the following:

1.7 Scope of the study

1.8 Limitations of the study

1.9 Research methodology

1.9.1 Research design

1.9.3 Data collection procedure

1.9.4 Sampling and sampling technique

1.10 Organization of the paper

2.1 Concept of liquidity and Liquidity Risk

2.2 Bank liquidity

• Funding risk- needs to replace net outflow due to an anticipated withdrawal of

• Time risk- needs to compensate for non-receipt of expected inflows of funds

• Call risk- crystallization of contingent liabilities and inability to undertake

2.4 Banking risks

• Interest rate risk

• Default or credit risk and

2.4.2 Interest rate risk (IRR)

2.4.3 Market risk

2.4.4 Default or credit risk

2.4.5 Operational risks

2.5.1 Lack of cash flow management

2.5.2 Inability to obtain financing

2.5.3 Unexpected economic disruption

2.5.4 Profit crisis

2.6 Measuring liquidity

2.6.1 Analysis of financial ratio

2.6.1.1 Quick ratio

current asset −inventory

2.6.1.2 Current ratio

2.6.3 Capital structure management

2.7 Implementing liquidity risk

A good risk manager would have the following attributes:

Furthermore, in the liquidity management process, an effective information system is key, in

2.9 Theoretical review

2.9.1 Shift ability theory

2.9.2 Anticipated theory

2.9.3 Liquidity Preference Theory

2.10 Empirical review

Research is to identify the factors significant to explain Ethiopian commercial

2.11 Research gap

3. Data Presentation, Analysis, and interpretation

3.1 Background of respondents

Table 3. 1 respondent background

College diploma 2 11.11%