ISLAMI BANK BANGLADESH LIMITED

TREASURY & FUND MANAGEMENT DIVISION

INTERNATIONAL BANKING WING
HEAD OFFICE, DHAKA

M.C Memo: Date: June 21, 2009

Sub: Fund and Liquidity Management-keeping in view of existing Liquidity
Position and Possibility of Short-Term Investment.

Liquidity management is an crucial part of asset-liability & risk management framework

of the Banking industry, failure to address the issue may lead to dire consequences,
including instability of the Bank. It is a process of making properly & timely bridge of
Bank’s sources & uses of funds at reasonable cost at all times. For Islamic financial
institutions, liquidity management is a big challenge due to limited development of the
Islamic money market to raise and deployment of funds to/from the inter-Bank money
market (Wholesale market) and Global Market. Whereas the money market is an
important component of the liquidity management framework as it is the first avenue to
manage liquidity of the Bank.

1. Accessing the liquidity Position of the Bank :

a) Maintenance of CRR
b) Maintenance of SLR
c) Cash Flow cum Balance sheet
d) Key management ratios & interpretations:
e) Inter-Bank FX & MM position
f) IBBL Money Market Position

2. Measuring the risk related to Liquidity of the Bank :

a) Risk related to Local Currency Liquidity
b) Risk related to Foreign Currency liquidity.
3. Managing the Liquidity risk/Liquidity management

Sl Sources of funds BDT Sl Uses of funds BDT Net

(Million) (million) liquidity
Liquidity represents the quality and marketability of the assets and liabilities, in absence
of which bank will be exposed to a great deal of risk. Banks liquidity Management is the
process of generating funds to meet contractual or relationship obligations at reasonable
prices at all times. It includes …
• Ability of bank to meet maturating liability.
• Ability of the bank to attract deposit, meets its commitments
• Ability of matching the maturity of assets & liabilities daily.
• Coping with any short term pressures
• To meet liquidity needs and obligations to ensure the smooth running of business.
• Forecasting cash need and providing for these needs in the most cost-effective
way.
• Reduces the adverse situation developing in the Market

• Supply and Demand of liquidity:

The following sources of liquidity and supply come together to determine each bank’s
net liquidity position at any moment of time.
Supplies of liquidity come from Demand for Banks liquidity arise from
• Customers deposit • Customers Deposit withdrawal
o Mudaraba Deposits • Uses for CRR & SLR
o Al wadiha deposit • Investment to Customers
o Sundry deposit o Bai murabaha
o Bills payable o Bai Mujjal
o Contingent deposits o HPSM
(security ,NRD,NRT) o Musharaka
• Revenues from the sale of Non o Bai us Sarf
deposit services o Quard – Hasana
• Customers Investment/loan o Mudarabaha
repayments o Bai Salam
• Sale of Banks asset o Bai istisna
• From Money Market ( through o Ijara
BGIIB). • Repayment of Non deposit
• Capital & reserve borrowings
 • Operating expenses & tax
incurred in producing & selling
services
• Payment of Dividends
• To Money Market(Through
BGIIB)

• Liquidity Risk:
Liquidity risk includes both the risk of being unable to fund its portfolio of assets at
appropriate maturities and rates and the risk of being unable to liquid a position in a
timely manner at reasonable prices.
• Causes of Liquidity Risk:
• Liquidity Shortage:-Total Demand for Liquidity > total supply of liquidity
o Implications of liquidity deficit:
• Offering higher rate of profit to deposits
• Shortage of financial resources to invest against commitments
• loss of competitiveness

• Liquidity surplus :-Total Supply of liquidity > total demand for Liquidity
o Implications of liquidity surplus:
• underutilization of financial resources,
• lower income and higher cost,
• loss of competitiveness

• Why face/sources of liquidity problem:

• Maturity mismatch” Bank takes large amount of short term deposit and
then make invest in long-term (maturity mismatch).The problem
related to maturity mismatch situation is that bank hold an unusually
high proportion of liability subject to immediate payment
• Sensitivity to rate change: When rate of profit by other banks on
deposits rise/ Change of Profit rate of deposit
• Loss of Public Confidence
• Unanticipated change in cost of capital
• Abnormal behavior of financial Market
• Incorrect judgments and complacency
• Conversion of Non-funded based limit into funded based
• Severe deterioration of assets quality
 • Key Issues in liquidity management in Islamic Banking

No lender of Last resort

Different shariah interpretation

No Islamic Money Market

Absence of Islamic secondary market

Slow development in Islamic financial instruments

Small no. of participants

• Assessing & Managing Liquidity of Islamic Banking

• Sources & uses of funds basis:
o Net liquidity/Fund Position: The Banks are to prepare daily position of
funds considering total deposits, total Investments, investment in shares &
approved securities, Balance with Bangladesh Bank, CRR, SLR, Balance
with Sonali Bank as an agent of Bangladesh Bank, Cash in tills, Balance
in FC clearing A/cs,, Deposits with others Banks (Short & term Deposit)
etc to work out net surplus/shortage of fund on daily basis to assess the
liquidity /Investbale funds of the Bank.

o Maturity Profile Mismatch

A key issue that banks need to focus on is the maturity of its assets and
liabilities in different tenors. A typical strategy of a bank to generate revenue
is to run mismatch, i.e. borrow/takes deposit short term and lend/investment
longer term. However, mismatch is accompanied by liquidity risk and
excessive longer tenor Investment against shorter-term deposits would put a
bank’s balance sheet in a very critical and risky position.
To address this risk and to make sure a bank does not expose itself in
excessive mismatch, a bucket-wise (e.g. next day, 2-7 days, 7 days-1 month,
1-3 months, 3-6 months, 6 months-1 year, 1-2 year, 2-3 years, 3-4 years, 4-5
years, over 5 year) maturity profile of the assets and liabilities is prepared to
understand mismatch in every bucket.

We know that all of the shorter tenor assets and liabilities will not come in or
go out of the bank’s balance sheet. As a result, banks prepare a forecasted
balance sheet where the assets and liabilities of the nature of current, overdraft
etc. are divided into ‘core and non-core’ balances, where core is defined as the
portion that is expected to be stable and will stay with the bank; and non-core
to be less stable. The distribution of core and non-core is determined through
historical trend, customer behavior, statistical forecasts and managerial
judgment; the core balance can be put into over 1 year bucket whereas non-
core can be in 2-7 days or 3 months bucket.

o Maximum Cumulative Outflow (MCO): The MCO is for Business and

measures. Under normal conditions, the day-to-day management of
liquidity relies on the effective control of cash flow. Maximum cumulative
outflow (MCO) guidelines control the net outflow (inflow from asset
maturity minus outflow from liability maturity) over the following
periods: overnight, one week and one month. The MCO includes…
 Review funding requirements
 Estimation of retail business
 Realistic Estimation of expected change of assets/liabilities with
resulting need to manage the bank’s aggregate cash
requirements(Including CRR & SLR)
 Cash flows from settlements of foreign exchange transactions
 Intraday exposures arising from settlements of the daily clearing
system.
 The ability to raise cash by selling marketable assets
 Investment and deposit must be forecasted for a given period
 The estimated change of deposit and investment must be calculated
 Computation of bank’s net liquidity funds, surplus or deficit
 o Undrawn commitments:
A bank’s liquidity is very much vulnerable to undrawn commitments by
customers. Undrawn commitments may be unutilised by not drawing an
sanctioned limits of customers or any investment/loan commitments, which
has not been drawn by customers. Customers have the right to ask for these
funds at any point in time and the bank is obligated to pay the customer. Thus
a ceiling should be set on a bank’s commitments to customers. The undrawn
commitment guideline may be established which relates the maximum level of
undrawn commitments to the bank’s remaining unused wholesale borrowing
capacity. These measures are to ensure that the banks are able to raise funds in
order to meet customers’ demands for drawing on lines that they have granted
to them.

• Comparative study of other bank/General market condition

o Rate of growth in new deposit
o Rate of growth in investment
o Specific Bank Crises
o General market crises
o Over the chosen time frame

• Liquidity ratio indicator: Banks also estimate its liquidity needs based on ratio.

• Investment/Loan Deposit Ratio: Investment/Loan deposit ratio, typically

calculated as the ratio of /investment/loans against deposits, is the most common
way to see a bank’s liquidity position. In an ideal scenario, loan deposit ratio
should not exceed 80%-85% (after keeping required for statutory requirements).
However, a bank may decide to invest in inter bank to manage its surplus
funds. But excessive Investment/lending (a high Investment/Loan Deposit Ratio)
may expose a bank in serious liquidity and interest rate risk as the market liquidity
may tighten any time.

• Medium Term Funding Ratio: Banks typically make money by running

mismatches, that is, by taking short term and /Investing lending long term.
However, short term deposits may go out of the bank upon maturity, whereas a
bank cannot call back long term Investment/lending. Thus a bank has to find the
right combination for longer term mismatch. Medium term funding ratio is
calculated as the ratio of liabilities with a contractual maturity of more than one
year to assets with a contractual maturity of more than one year. This ratio is
 intended to highlight the extent to which we are dependent on being able to roll
over short term deposits in order to fund medium term assets.

• Comparative study of other bank/General market condition

o Rate of growth in new deposit
o Rate of growth in investment
o Specific Bank Crises
o General market crises
o Over the chosen time frame

• Liquidity measuring & management : signal from Market reaction :

o Public Confidence and withdrawal risk
o Propaganda against Islamic banking
o Stock price behavior
o Inability to meet investors commitments against sanctions due to liquidity
crunch
o Lower rate of profit against deposit
o Rate of growth in new deposit

• Deposit management
o In case liquidity shortage :Introduce new (increased) customer rates to encourage
deposit accretion and emphasize need to focus on account profitability
o In case of Liquidity surplus : Exploring new opportunities to invest funds
• Choice of right mode of investment to secure investment
• Role of ALCO: ALCO has to take responsibility in managing liquidity position
on continuous basis by bringing desired changes in the composition of assets and
liabilities.

• Settling different limits : Bank Management set limits to ensure liquidity and
these limits should be reviewed:
o The cumulative cash flow mismatch(net funding requirements as
percentage of total assets) over particulars periods
o Liquid assets as a pct of short term liabilities
o Limit on investment to deposit ratio (Should be 80-85%
 (The AD ratio should be 80%-85%. However, the Loan Deposit ratio of the
bank should go upto 110%.
The Loan Deposit ratio = Loan/(Deposit+Capital+Funded Reserve)
The ratio will be fixed based on the bank’s capital, Bank’s reputation in the
market and overall depth of the money market. )
o Limit on investment to capital ratio(single exposure )
o Minimum liquidity provision to be maintained to sustain operation
o Counterparty limits for local and foreign bank for local and FC
• Medium Term Funding Ratio (MTF): The MTF of a bank should not be
less than 30%. The ideal scenario should be 45%. Given, the overall scenario
of current market, it will be suitable to move towards the MTF limit of 45% as
we progress.

• Maximum Cumulative Outflow: MCO upto I month bucket should not

exceed 20% of the balance sheet assets volumes.

• Local Regulatory Compliance?Central Bank Compliance:

Banks operating in Bangladesh are required to maintain credit balance with the
Central Bank minimum 5% of time and Demand Deposits as CRR and the
accounts must not be overdrawn and 5 % as SLR on total deposits or eligible
securities like Bangladesh Govt Islamic Investment Bond.

Regulation Parameter/Formula Comprising

Cash reserve 5% of liabilities Lcy cash at Central Bank

Liquidity reserve 5% of liabilities Cash in Tills

Fcy balance with Central Bank
Lcy balance with Central Bank
Selected Govt Bonds

• Capital Adequacy

Banks operating in Bangladesh are required to maintain a minimum capital at

10% of total risk weighted assets.The need to adopt the best international
practices, given the globolisation of economies and businesses. As you are aware
 of “Basel Committee on Banking Supervision” and the emphasis on maintaining
the Capital Adequacy commensurate to exposure or risk on balance sheet. The
new “Basel Capital Accord” stipulates that “ Banks must hold capital
commensurate with the level of interest rate risk they undertake”.
• Large Exposures
Banks operating in Bangladesh are required to restrict their lending to any large
single relationship to 15 %( Funded) & non funded 20% of their capital and with
the approval of Central Bank it can be increased to 100% of their capital

• Liquidity Test for Contingencies/Stress liquidity/

The major risk a bank runs is liquidity risk. Under any circumstances a bank has
to honor its commitments. As a result, it has to make sure that enough liquidity is
available to meet fund requirements in situations like liquidity crisis in the
market, policy changes by central bank, a name problem of the bank etc. So, a
bank’s balance sheet should have enough liquid assets for meeting contingencies.
any crisis situation.
Liquid assets can be as follows:
• Back up liquidity
• Specific Government Securities.
• Selling Fcy from forex open position limit to generate Lcy liquidity
• Specific FDRs encashment