There are number of reasons for accepting to focus on this particular sector. Banks play an important role in the economy. With the change of financial environment over the last few decades it can be seen that it has led to a vital vulnerability towards liquidity risks. Followed by the worst financial turmoil ever, there are many questions to be asked. However it has merely been determined as a "liquidity crisis" one of the main drivers of the current financial crisis. Collapses of major Banks in UK and USA have given a significant pressure on financial markets as well as global economies.
Since 1988 regulators have paid a plenty of attention and have defined international standards for banks in the areas of market operational and credit risks. But they have ignored liquidity risk. Although some banks who failed to manage their liquidity positions during the financial crisis have passed the guidelines for managing liquidity risks by both Bank of International Settlements and the Institute of International Finance (Cuthber B.and Vander D. 2008).
After facing the worst crisis ever, most of the financial institutions, Central Banks and regulatory bodies declared to make liquidity as important as capital and to manage liquidity risks precisely (Blair-Ford S. 2009).
AIM AND OBJECTIVES
The area to be researched, examination of literature, the focus of individual bank's strategies and the requirements of regulatory bodies, it was a significant issue that the topic of most of theoretical and practical expense to be examined the importance of liquidity risk management. Also this topic has been discussed in existing studies and the formation of the objective is to analyse the banks strategies who performed well and who failed to perform during critical economic conditions. Collapse of Northern Rock, Lehman Brothers and Bear Sterns can be identified as poor management of liquidity in the banking industry (Heaney V. 2009). Collapses of these Banks have made a huge impact in developed countries financial markets and economies. Then it spreads to emerging markets and the global economy accordingly.
However, at the same time some other banks survived and performed well during the critical economic and financial conditions.
This research is being analysed the liquidity risk management strategies of performed banks and identifying banks with weak liquidity and contingency planning within the context of the bank's role within the financial system. Factors influenced on liquidity risks have also been considered.
At the same time this research is being discussed the responsibilities of Central Banks, (Federal Reserve, Bank Of England, and European Central Bank) and the other regulatory bodies such as Basel Committee and Financial Services Authority (FSA) in UK.
The objectives of the research are
The impact of bank stability, exposure to liquidity risk in critical economic conditions and strategies to be implemented in such conditions
The impact of economies, financial markets and the bank itself towards poor liquidity management
Disclosure requirement for banks towards liquidity risk strategies
The importance of a regulatory frame work within the banking industry towards managing liquidity risks.
The researcher is aiming to achieve by doing this research is to determine the importance of managing liquidity risks in the banking industry and the importance of the frame work in the perspective of regulatory bodies to minimise liquidity risk management.
LITERATURE REVIEW
3.1 What is liquidity management?
According to theory when liabilities exceed assets, there is an excess of funds which generates interest rates risk, while deficit leads the bank to long run commitments which existing resources do not entirely fund. Therefore there is a liquidity risk has generated by raising funds in the future to match the assets (Bessis J. p-139). Liquidity risk needs to be managed and according to Bessis J. (p-144) liquidity management is the continuous process of raising new funds. Although the theory suggests interest rates risks which is generated from the mismatch can be set off with forward hedges.
3.2 Importance of liquidity management in banking industry
Banks play an important role in the economy. Historically in 1930 and again 1970 multiple banking failures have been caused as a result of weak liquidity management (www.fsa.gov.uk). The banks approach and management of liquidity risk is one of key component in the "CAMELS" (Capital, Asset quality, Management, Earnings, Liquidity and Sensitivity) which is used to evaluate banks financial and management rating by US regulators ( Beaumier C.M. 2009). Also according to banking books banks borrow short term and lend long term and it increases three obvious risks, credit risk on the lending, long term interest rate risk and liquidity risk from the mismatch between the structure of assets and liabilities (www.fsa.gov.uk)
According to Jenkinson N. Executive director for financial stability, highlighted that the management of liquidity risk is a key counterpart to banks in their maturity transformation role. He identified that to hold a buffer of highly liquid assets as a defence.
3.3 What are the factors influencing liquidity risks?
In theory to determine liquidity risk it's essential to identified the associate other risks as market risks credit risks as well as off balancing risks such as contingent risks (Bessis Joel).
3.4 Disclosure requirement
Liquidity risk is the most cause of bank failure. If the liquidity risk is the reason for most banks failure then it's logically to assume that it attracts a high level of disclosure. Most of the past bank annual reports found the greatest attention has paid credit, market and operational risk. However the last risk that Basel's attention was liquidity risks (Blair-Ford S. 2009).
3.5 What is the most appropriate way to determine liquidity risks?
In literature, some of the writers argue it's worth the quantitative approach (ie: capital based approach, liquidity at risk LaR, Non-maturing assets and liabilities NomAL) rather than the qualitative approach to persuade liquidity. However the inadequate regulatory attention that liquidity has attracted has been qualitative. But there are some problems in availability of data and but banks should take sensible steps such as measuring its ability to bear a number of different liquidity scenarios (Cuthber B.and Vander D. 2008).
In practice almost for the first time, standardisation is a good news in measuring liquidity risk which is most of the regulators, practitioners are working within a common framework, on the other hand the bad news is there is a confusion, as an example most of the US bankers still use the technique of retrospective ratios to monitor liquidity risks (Matz L. 2010). Matz also explains the methods of Counterbalancing Capacity (CBC), "Buffer", "Forward liquidity exposure" (FCE) and "Survival Horizon" such as "Liquidity reserve" within the framework of liquidity risk. Stress testing procedures on liquid assets, Contingency Funding Plan (CFP), Key Risk Indicators (KRI) and Scenario Based Testing have also been identified as assessing the liquidity measurement.
3.6 Strategies to be implemented in liquidity risk management
According to Cuthber B. and Vander D. (2008) many liquidity risk managers have standard scenarios according to the bank's specific liquidity resources. Alternatively they look at the past (ie: Asian crisis) and Cuthber and Vander argue that it's not sufficient in analysing liquidity risk scenarios. Instead banks need to analyse their balance sheet structure to identify the more risky scenarios.
Waugh R. (the chairman of IIF Committee and President of Scotia Bank Canada) on market best practices contributes his belief, that risk management practices need to be tailored to each firm's business model and market participation. Each firm should determine its sensitivity to risk, and the best way to combine prudent risk management practices within its business strategy. At the same time he argues that even the firm's most prudent regulations cannot and will not guarantee avoidance of risk and therefore the regulations and supervision is needed implementing the best strategies. At the same time it is important that the firm needs to develop a strong risk culture, well understood and resilient liquid culture, and liquidity issues and costs should take into account in planning, product developing and decision making in multiple levels.
"Consequently more institutions are realising that liquidity risk measurements in the management perspective lends itself to use the scenario rather than stochastic" Additionally management should understand that the firms liquidity requirements according to market conditions as well as the nature of balance sheet itself. (Vander D. , liquidity specialist and the Co-founder of Liquidatum).
RESEARCH QUESTION/ HYPOTHESIS
What will be the impact on economy and financial markets if banks fail to manage liquidity risks?
Have the disclosure requirement been met by banks towards liquidity risks?
The banks that met disclosure requirements and followed the regulatory framework did perform over the weak economic conditions?
Have the Central Banks and regulatory bodies paid enough attention on liquidity risk management?
RESEARCH METHODOLOGY
Research design
This research can be identified as an explanatory research which is an issue that already known and have a description. To explain is the purpose of this research and it tries to determine the importance of liquidity risk management in banking industry.
Data collection
In this research, in order to meet its key objectives, secondary data have been identified as the most appropriate collection method. Documentary secondary data are often used in research projects and it includes Archival research, written documents ( i:e, books, journals, magazine articles, newspapers, notices, correspondence, reports to shareholders transcript of speeches and administrative and public records), non-written documents and so on. According to Bryman (1989) although the archival research has historical essence, it can refer to recent as well as historical documents (Lewis P. Saunders M. & Thornhill A. 2003). At the same time written documents are used to acquire qualitative data.
Analysis of data
Conduct a review of literature (using secondary as mentioned) of the following
liquidity management of financial institutions
responsibilities of Central banks
regulatory bodies
other economic and financial factors towards liquidity risk
Review risk profiles using annual reports of banks who manage their risks during critical conditions, comparing them with banks who failed.
Identify risk management strategies
Conclusion and recommendations
STRUCTURE AND PLAN
Abstract and Introduction - 1 week
Literature Review - 2 weeks
Research Methodology and Methods - 1 week
Analysis and interpretation - 2 weeks
Conclusion, recommendations and reference - 1 week
