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Procedia Economics and Finance 32 (2015) 1188 – 1198

Emerging Markets Queries in Finance and Business

Liquidity Risk Management in Post-Crisis Conditions

(XJHQLD$QD0DWLúa, * , Crenguìa Alina Matièb
a
Dimitrie Cantemir Christian University Bucharest, Faculty of Economic Sciences,
56 Teodor Mihali Street, Cluj-Napoca, 400591, Romania
b
Agency ManagerBT Cluj-Napoca

Abstract

Liquidity risk management, often called "water of life" in the banking system needs to be addressed by banks with more
rigors, given the current financial environment. This implies a better diversification of the funding sources, longer average
debt maturities in order to reduce some gaps between assets and liabilities, creating liquidity reserves based on immediately
attainable assets. This paper focuses on stress-testing scenarios, performing an empirical study on tracking and limiting
liquidity risk in Romania compared to the European banking system, starting from the premise that one of the most
important elements of the financial crisis is the liquidity crisis in the credit institutions. The paper presents a selection and
analysis of measures to improve the crisis and not least, the implementation of liquidity scenarios, applicable to the various
stages of the crisis.

©©2015
2015The Published
Authors. Published by Elsevier
by Elsevier Ltd.B.V. This is an open
Selection and access
peer article
reviewunder the CC
under BY-NC-ND license
responsibility of Emerging Markets
(http://creativecommons.org/licenses/by-nc-nd/4.0/).
Queries in Finance and Business local organization.
Selection and peer-review under responsibility of Asociatia Grupul Roman de Cercetari in Finante Corporatiste

Keywords: liquidity risk management; solvency risk;

1. Introduction

The main purpose of bank management is to ensure the functioning of financial and banking institutions
under the conditions of a competitive market and the role of performance and risk management primarily aims
to maximize profits while maintaining an acceptable level of risk. Thus, performance and risk management is

* Corresponding author. Tel.: +40 723-205-526.

E-mail address: [email protected].

2212-5671 © 2015 The Authors. Published by Elsevier B.V. This is an open access article under the CC BY-NC-ND license
(http://creativecommons.org/licenses/by-nc-nd/4.0/).
Selection and peer-review under responsibility of Asociatia Grupul Roman de Cercetari in Finante Corporatiste
doi:10.1016/S2212-5671(15)01496-3
 Eugenia Ana Matiş and Crenguța Alina Matiș / Procedia Economics and Finance 32 (2015) 1188 – 1198 1189

characterized as a major area of banking, representing the fundamental objective of a bank’s activity. The
historical development of the theory of risk management in banks was characterized by a certain inconsistency
and lack of consensus, many commercial banks remaining dependent to the tradition that the concept of risk is
only associated to credit risk. Given the current financial and economic context, from our point of view the
most important risks, but not the only ones, are solvency risk, liquidity risk, interest rate risk, currency risk and
country risk.
Therefore, although the literature has grown, in many ways risk management is a science which is still in an
early stage. Reality forces us to broaden initial perspectives, context in which practical experience carries a
definitive role. The new basic philosophy of the managerial act in commercial banks must be focused not only
on reducing risk, but especially on assuming them in an intelligent manner.
Regarding liquidity risk, it is the most important financial market risk and it is defined as a situation where
the bank does not have adequate liquidity to meet its financial obligations. Liquidity risk becomes a threat
when a bank cannot predict the demand for new loans or deposit withdrawals. The primary source of liquidity
is the liquid assets that can be sold immediately for a price as close to the nominal value as possible. The
essential task of bank managers is to estimate and properly cover the liquidity needs of the bank. On a long
term, the bank’s profitability can also be negatively affected if the bank holds in its portfolio too many liquid
financial assets compared to its needs. On the other hand, too little liquidity can create financial problems,
especially for small banks, being even capable of generating bankruptcy. Maintaining an adequate level of
liquidity in all banks is also extremely important in order to minimize systemic risk, which is due the risk of
contagion through interbank settlements.
Commercial banks lined up to the requirements of the supervisory bank, according to which each credit
institution must develop its own plan for tracking and limiting liquidity risk. The alternative financing plan is
an important part of the liquidity risk management process, including scenarios that are applicable to the post-
crisis period and a set of measures to improve the situation. This plan must be prepared and maintained by each
financial institution, providing a framework for solving liquidity problems both on the short run and on the long
run. The use of this alternative financing plan is related to the process of managing liquidity and it is concerned
with specific issues in cases of liquidity crisis. The Operational Liquidity Committee is responsible for
recommending the pronouncement of the crisis situation to the Asset and Liability Committee (ALCO) which
will take into account the information on the evolution of the triggering indicators.
Taking into account the fact that the length of a crisis has a huge impact on whether the bank's liquidity is
affected, the following two timeframes were defined and analyzed separately: short-term (1 month) and long
term (1 year). For each mentioned scenario, we have the following levels according to the way the situation is
perceived:
x The internal perception applies in particular to individual crises, when only the concerned knows about the
existence of liquidity problems based on indicators and information from inside the bank. At this level, it
would be easier for the bank to attract additional resources at a reasonable cost;
x The external perception when the entire market knows the liquidity difficulties in times of crisis. At this
level it will be more difficult to attract additional resources at a reasonable cost, regardless of the type of
crisis: individual or market one.

2. Determining the liquidity position of the bank in case of liquidity crisis through cash flow

Internal and external triggering factors, signal developments that indicate a potential problem of liquidity for
the bank. Therefore, the result of their level and evolution analysis can motivate the activation of the alternative
financing plan. According to the internal perception, estimates about the future refer to the result of the
estimated lei and foreign currency cash flows as well as the outcome of the net five days cash flow across the
1190 Eugenia Ana Matiş and Crenguța Alina Matiș / Procedia Economics and Finance 32 (2015) 1188 – 1198

bank. Indicators for the present or past situation refer to the funds raised from non-bank customers and
indicators that reflect the structure of the balance sheet (liquidity ratios).
According to external perception, the following are taken into account:
x macroeconomic indicators of inflation, current account deficit, RON/EUR exchange rate, the M3 money
supply (consisting of actual currency, demand deposits and time deposits, certificates of deposit, till receipts,
treasury bills, medium term savings accounts and other assets with a lower degree of liquidity);
x rating qualifiers for Romania and for the bank;
x indicators of the bank’s unfavorable performance evolution, the worsening of the reported performance
(profit and loss);
x indicators showing unusual developments, disturbing for the monetary market, such as the sharp rise in
interest rates and margins (the difference between the monetary policy and the central bank overnight
ROBID);
x indicators of the monetary and capital markets functionality.

If during the monitoring process the responsible unit will register an overtaking of one or both of the two
warning levels for the monitored triggering indicators, this will be immediately communicated to the
Operational Liquidity Committee (OLC) and the Administration of Assets and Liabilities, which will determine
the gravity of the situation and convene for an extraordinary meeting to review the latest developments and
take measures to improve the situation.
The necessary measures contain a series of reports on the bank's liquidity, required by regulators and
creditors and reports necessary to monitor liquidity. The daily cash flow report is based on estimating the
bank’s current account balance opened with the Romanian National Bank and includes receipts and payments
resulting from monetary and securities transactions, interbank foreign exchange transactions, cash transactions,
estimates on LORO account transactions and customer operations as well as other transactions.
x In cases of crisis liquidity, the lei estimated cash flow will be adapted to the new conditions, by the
following: pessimistic estimates on customer transactions, including cash;
x delays in interbank settlements;
x negative effects arising from customer foreign currency transactions.

Given the higher liquidity risk, one will have to maintain a higher reserve of liquidity than usual when
taking liquidity management decisions (investments, investment commitments). If cash flow indicates a daily
liquidity deficit, it should not exceed the volume of the eligible assets portfolio, accepted by the supervisory
authority.
The daily cash flow report is based on the bank's NOSTRO account balances and it includes receipts and
payments resulting from monetary and securities market transactions, interbank foreign exchange market
transactions, cash, bilateral financing and syndicated loans as well as other transactions. Cash flow situation
simulations for various liquidity crisis scenarios are very important because they contain a list of options and a
set of appropriate solutions for each case.

3. Monitoring and limitation procedures for liquidity risk in the current financial context

Credit institutions have developed their own procedures for monitoring and limiting liquidity risk which
encompass provisions on the following elements:
x more restrictive internal limits in the case of the liquidity ratio;
x establish and monitor the thresholds in order to control the high liquidity risk of each person separately;
x the bank's own liquidity indicators;
x the information system on liquidity for bank management.
 Eugenia Ana Matiş and Crenguța Alina Matiș / Procedia Economics and Finance 32 (2015) 1188 – 1198 1191

3.1. Restrictive internal limitations for liquidity ratios

If the minimum limit of the liquidity ratios on each maturity bucket (established by National Bank of
Romania No.1/2001) is 1, it is recommended that banks maintain a margin of 10-20% above the cumulative
level set by the NBR for the first cumulative two maturity buckets (remaining maturity up to 3 months). This
margin is necessary because excess liquidity registered on each maturity bucket, except for the last one, is
added to the actual liquidity associated with the next maturity bucket, thus becoming a prerequisite for
obtaining an appropriate indicator for higher maturity buckets, while in the first bucket (up to 1 month) and
optionally the second one (up to 3 months), the banks should have a higher than necessary effective liquidity.

3.2. Establishing and monitoring limits for the surveillance of high liquidity risks in relation to a single
individual

This monitoring process is carried out by taking into account the specifications set by the Supervisory
Authority, according to which the high liquidity risk in relation to one individual is the liquidity risk to any
individual, group of individuals or businesses, whose value is at least 10 % of the liability’s value. If the
liquidity risk in relation to one individual exceeds 15% of the liability, the necessary liquidity will be calculated
by recording the maturity at sight liabilities and those representing sight deposits at their carrying amount. In
order to monitor the high liquidity risk in relation to one individual and considering the domestic economic
environment, the key individuals and businesses in relation to which banks record liquidity risks are monitored
in order to comply with the limits enforced by the NBR’s Norm No.1/2001. Therefore liquidity risks in relation
to a single individual are monitored, for exposures exceeding 100 million lei and liquidity risks to a single legal
entity for exposures above the level of 300 million lei.

3.3. Bank’s own liquidity ratios

The specialized body handling the bank’s credit risk control calculates and monitors the following indicators
of immediate liquidity, both for each of the EUR, USD and GBP currencies as well as cumulatively for the
RON equivalent:
x liquidity ratio calculated as the ratio of the assets liquid up to 7 days and the sight deposits of the bank’s
individual customers;
x liquidity ratio calculated as the ratio of the assets liquid up to 7 days and the sight deposits of bank
customers, individuals and legal entities, including correspondent accounts of other banks in the concerned
bank (LORO);
x liquidity ratio calculated as the ratio of the assets liquid up to 7 days and the total current accounts and term
deposits of bank’s customers, individuals;
x liquidity ratio calculated as the ratio of the assets liquid up to 7 days and the total current accounts and term
deposits of bank customers, individuals and legal entities, including correspondent accounts of other banks
in the concerned bank.

The situation is transmitted to the National Bank of Romania through an immediate liquidity indicator
(calculated according to the requirements of the National Bank of Romania), calculated as a ratio, as follows:

cash  NOSTRO accounts  bank deposits  government bonds

IL
deposits attracted from other banks/nonbanking clients  creditlines  LORO accounts
1192 Eugenia Ana Matiş and Crenguța Alina Matiș / Procedia Economics and Finance 32 (2015) 1188 – 1198

3.4. The information system on liquidity for bank management

In order to provide information on bank liquidity, a number of reports are requested and developed, among
which: current account statement, the statement of minimum reserve requirements and interbank assets and
liabilities; report on the daily progress of funds raised from non-bank customers; a report on market trends; as
well as the report on market liquidity risk.

3.5. Liquidity limits and analyses

Lately, foreign banks active in Romania focused their efforts on improving liquidity management standards
taking into account the experience gained during the crisis by the parent bank. They have implemented the
following analyses and liquidity limits, tailored to the specifics of the Romanian market: short-term liquidity
limit (the limit is calculated based on the 5 days net flow), the liquidity limit based on stress-testing scenarios,
the long-term limit concerning the intragroup financing.
The short-term liquidity limit – In the case of a liquidity crisis, short-term pressures are why the bank
decided to implement a standard short-term liquidity limit on a group level. The short term limit refers to the
net five days flow that must be covered by an eligible collateral pool, separate for each main currency: local
currency (RON) and EUR. There are two major criteria to be taken into account in calculating the daily value
of the collateral for the short-term liquidity limit. These two criteria are availability and eligibility of securities.
In short, the limit of short-term liquidity needs to be calculated and monitored daily for each of the two
currencies, RON and EUR.
The liquidity limit based on scenarios and "stress-testing". In order to measure liquidity risk, banks have
developed various analytical models, based on different scenarios, showing their ability to cope with different
types of liquidity crisis. This offers a dynamic image of the bank’s liquidity according to different scenarios of
liquidity crises and the time horizon of the analysis. There are five liquidity scenarios, on each asset and
liability balance sheet position:
There are three sets of assumptions established for the scenarios are set:
x Normal activity (Ordinary Course of Business): no internal or external problems;
x Individual crisis (Name Crisis):
Individual slight crisis – image moderated (Mild Name Crisis): decrease in profits and/or negative outlook;
Severe individual crisis – image severe (Severe Name Crisis): decrease in rating scores by at least two units;
x Market Crisis:
Mild Market Crisis: mild recession, mild political crisis;
Severe Market Crisis: banking crisis, deep, long and severe recession.

The impact of the liquidity crisis largely depends on its duration. A prolonged moderate liquidity crisis may
have similar effects to a short term severe crisis. Therefore, the scenarios take into account two timelines: one
month or one year.
There are three sets of assumptions established for the scenarios are set:
x Assumptions underlying the core and the secondary activity: what proportion of a class of products is
represented by the core business;
x Assumptions regarding the renewal: what percentage of a class of products will be renewed in terms of the
considered time horizon and scenarios;
x Sale or transformation in collateral and early withdrawals: what percentage of a class of products can be sold
or used as collateral (on the asset side) or withdrew early (on the liability side) before maturity taking into
account the time horizon and the considered scenarios.
 Eugenia Ana Matiş and Crenguța Alina Matiș / Procedia Economics and Finance 32 (2015) 1188 – 1198 1193

The long term limits on intra-group financing applies only if the bank does not comply with the limit set by
the scenario for a year. This means that the average period to maturity of the long-term intergroup financing
must be at least equal to the maturity average and the average demand for advanced reimbursements of long
term securities issued by the parent bank.

4. Analysis of the Romanian liquidity situation compared to the situation of the banking system
registered in the European Union

Following the problems of the Euro zone banks, the ECB has taken measures to support lending through a
series of unconventional measures intended to support financing and credit flows conditions, well above what
could have been achieved only by reducing ECB interest rates. This approach has been adapted to the financial
structure of the euro area economy and the specific situation of the global financial crisis. The set of measures
focused on banks, since they are the financing primary source for the real economy in the Eurozone. Therefore,
it committed itself to provide liquidity to the Eurozone banks, at a fixed interest rate for all refinancing
operations, in return for some adequate collaterals it extended the refinancing operations maturity, from three
months before the crisis, up to one year it extended the list of assets accepted as collateral and provided
liquidity in foreign currency (mainly U.S. dollars).

Fig. 1. Months EUREPO, EURIBOR and OIS

The adopted unconventional measures were developed in such as a way as to be easily canceled as the
situation normalizes. The main objective of the measures was to mitigate the adverse effects exerted by
malfunctioning monetary markets on the liquidity situation of euro area solvent banks. Also, the measures were
intended to support credit flows to companies and households.
1194 Eugenia Ana Matiş and Crenguța Alina Matiș / Procedia Economics and Finance 32 (2015) 1188 – 1198

As a result of the sustainable support offered to lending and the strong reduction in key ECB interest rates
during the period October 2008 - May 2009, interest rates on the money market and those charged by banks on
loans, declined significantly. The sustainable support given to lending continued to significantly improve the
liquidity situation in the market, while helping to mitigate the risks associated with financing. During 2012,
conditions in the euro area monetary markets were still affected by the sovereign debt crisis.

Fig. 2. ECB interest rate and overnight interest rate

In July 2012 the Governing Council decided to reduce the key ECB interest rates by 25 basis points. The
decrease to 0% of the interest rate on the deposit facility occurred in the context where the short-term yields on
money market were at a level close to zero and a series of transactions - particularly on the guaranteed market
segment - were running negative interest rates. EONIA continued to place above zero. The resort to deposit
facilities declined as a result of the yield decreasing to 0%, given that many counterparties have opted for
keeping the surplus amounts in excess of the minimum reserves in the current account.
After the two long-term refinancing operations (LTROs) with a three years maturity timeframe, the liquidity
excess summed up approximately 810 billion EUR. Excess liquidity in the financial system of the euro area
peaked at 813 billion EUR in March 2012, but afterwards it steadily decreased while banks started to early
repay the three year loans they received from ECB. In late December 2012, it was about 615 billion EUR.
Because of these large volumes of liquidity, the overnight interest rate (EONIA) remained very close to the rate
on deposit facilities at the end of December 2012, which is about 62 basis points lower from the interest rate on
the main refinancing operations.
In October 2013 the ECB data shows that excess liquidity in the financial system in the euro area fell to 187
billion euros. It is the lowest level since December 2011 and also the first time that excess liquidity has dropped
below 200 billion euros after the ECB has injected more than 1,000 billion euros in long-term refinancing
programs (LTRO) in 2011 and 2012.
The liquidity needs are determined by the sum of minimum required reserves, the availabilities that exceed
the level of these reserves and find themselves in the current accounts of the credit institutions held by the ECB
 Eugenia Ana Matiş and Crenguța Alina Matiș / Procedia Economics and Finance 32 (2015) 1188 – 1198 1195

and the autonomous liquidity factors influencing the availabilities in the credit institutions current accounts, but
which are not under the direct control of the liquidity management mechanisms within the Euro system.
However, at some point, the preference for liquidity in banks, which has been brought by the crisis to
abnormally high levels will decrease. Then the banks will start to use excess reserves, which today are stocked
at the central bank, to credit the real sector and to finance various financial operations. When this happens,
central banks will have to increase the short-term interest rate. For this, they will need to sell securities
available on their balance sheets in unprecedented amounts in order to keep inflation at relatively low levels.

Fig. 3. Factors underlying the structure of liquidity in the Eurozone (2012)

Regarding the Romanian banking sector it continued to be well protected against various unfavourable
developments that have occurred both locally and internationally during this period. Firstly, the level and
quality of its own funds remained in the corresponding parameters:
x Ack the solvency ratio was maintained at an appropriate level (14.7% in June 2013), significantly above the
regulatory minimum (8%);
x their own funds consist mainly of good and very good quality items (1st level own funds ratio was 13.6% in
June 2013);
x the central bank decided to keep their prudential filters for calculating their own funds and the prudential
indicators during 2013 (thus de facto solvency indicators continue to be about 4% higher than the reported
levels) and will be gradually abandoning these filters during the implementation of additional capital
requirements of Basel III (range 2014-2017).

The situation on the international financial markets experienced a relative relief, but it also included short
periods of risk aversion revival. Prospects remain affected by uncertainties amid a globally disappointing
economic growth and the uncertainty about the possible developments in capital flows when major central
banks will begin to phase out the extensive unconventional monetary policy measures implemented to date.
Regarding financial support programs for countries facing severe financial problems they have been perfected.
1196 Eugenia Ana Matiş and Crenguța Alina Matiș / Procedia Economics and Finance 32 (2015) 1188 – 1198

Moreover, the European Stability Mechanism was tested during the Cyprus crisis, the government of the
country having received financial aid of 10 billion euros (of which 9 billion through MES) to cover the
financing needs of the Cypriot economy: financing budget deficit, medium and long term debt payments and
recapitalization of the financial institutions.
Events in Cyprus did not have an important impact on the financial markets in Romania. In the Romanian
banking sector, the crisis reflected only in the Cypriot-owned banks (their share in the total assets of the
domestic banking sector was 1.4% in August 2013) and the household and business deposits fluctuations were
normal. On the contrary, the Romanian economy has seen a significant improvement of the macroeconomic
framework in relation to the European countries of the region. Growth in the region was generally negative in
2012, except for Poland (1.9 percent), Bulgaria (0.8 percent) and Romania (0.7 percent). For 2013, the
European Commission forecasts indicate Romania as having the most alert economic growth in the region, with
a continuous consolidation process and maintaining public debt at a relatively low level.
The European Central Bank continued to significantly contribute to reducing the risk of a disorderly
development of credit conditions in the EU. The main measures implemented in this regard are:
x introduction of the purchase of sovereign bonds on the secondary market (Outright Monetary Transactions
in September 2012);
x continuing the refinancing programme by full acceptance of the amounts including longer-term refinancing
operations (repo with a three months maturity);
x expanding the list of eligible instruments accepted as collaterals for refinancing operations;
x reducing the policy rate to 0,5 percent (in May 2013).

Regarding the liquidity risk, the central banks in the countries of origin of the Romanian banking capital,
injected significant amounts in their financial systems in order to resume lending and financial market
functionality. The highest amount was injected by the Netherlands (EUR 17.755 million), being followed by
Italy (EUR 13.199 million). Liquidity provided by the countries of origin of the parent banks operating in
Romania have had the following impact on equity of Romanian subsidiaries and on their external liabilities:

Fig 4. Liquidity provision by authorities in countries of origin and its effects on financing in Romania during the crisis (EUR million)
Source: RNB

However, the global economic crisis is expected to generate more losses worldwide. IMF estimates show
that this could total about 4,000 billion dollars, of which two thirds would be localized in credit institutions. A
 Eugenia Ana Matiş and Crenguța Alina Matiș / Procedia Economics and Finance 32 (2015) 1188 – 1198 1197

decrease in business activity internationally and the materialization of losses will contagiously generate
implications for the domestic banking sector and the real economy in Romania.
The deposits attracted from companies and households continued to be the main source of funding for banks
(51.3 % of total liabilities at the end of August 2013), 4 % increase in comparison to the same period of the
previous year, amid the ongoing increasing trend in domestic savings. In late August 2013, the share of external
financing in total liabilities of the banking system was 21.3%, down with 3.5% from June 2012. The value
however, continues to be above the average of the region; the external funding has decreased by about 3.4
billion euros in the first half of 2013 compared to the same period last year. Emphasizing the dynamics of this
adjustment, although it induce reductions in the external debt of the private sector is likely to create a risk of
constraints on the real sector, especially given the accelerated reduction of parent company – subsidiary credit
lines including over a period of low risk aversion towards emerging markets exposures (January-May 2013).
The high percentage of external financing with medium and long term maturities has the effect of reducing
liquidity risk. The orderly but significant reduction of external funding has led to a gradual increase in the
average maturity of funds attracted from parent banks, getting in August 2013 at over 23 months.

Fig 5. Evolution of the external liabilities

5. Conclusions

With regard to liquidity risk management, the financial crisis was a real stress-testing for credit institutions.
By applying suitable measures to improve the liquidity crisis situation, the necessary results are yielded with
high efficiency. The proposal and the applying of the following measures will increase the capacity and
efficiency of liquidity crisis management: REPO transactions with banks and customers, optimizing the use of
funding commitments through collaboration between business lines to identify projects eligible for trade
facilities, optimizing the financing activity within banking groups, transfer of assets within the group
companies, issuing bonds, selling the loans to other banks. The following activities must be taken into account:
trading on the financial markets, municipal and corporate bonds, belonging to business lines, cash in the branch
network and funds registered in the Nostro accounts. If the local capital market registers a lack of liquidity, one
should sell portfolio securities on a long time horizon and in low volume transaction. If the crisis turns out to be
1198 Eugenia Ana Matiş and Crenguța Alina Matiș / Procedia Economics and Finance 32 (2015) 1188 – 1198

long lasting, the bank should consider the monetization of the less liquid assets like fixed assets, loans or
equity.

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