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2.5 Management of Liquidity Risk
The lack of liquidity is one of the main reasons that cause a commercial bank in insolvency, and liquidity problem also triggers many financial crises to happen.18
In western countries the theory of liquidity management of commercial banks has developed from theory of asset management in 1960s to theory of liabilities management in 1970s and then evolved into theory of asset and liability management in 1980s.
In general, the significance of sufficient liquidity is to demonstrate that the bank is capable to pay debts, the bank is capable to grant loans to customers, the bank can avoid selling asset at a sacrifice, and the bank can reduce risk premium paid for borrowed funds (Chou, 2008).
Theory of asset and liability management emphasizes on comprehensive management on bank’s assets and liabilities, because both assets and liabilities are sources of liquidity. In China the government implements assets-liabilities ratios control to achieve the goal of liquidity management of commercial banks.
According to article 39 of 〈 Law of the People’s Republic of China on Commercial Banks〉, commercial banks shall abide by following provisions when giving loans to customers:
1. The capital adequacy ratio may not be lower than 8%.
2. The ratio of the outstanding of loans to the outstanding of deposits (Loan-to-deposit ratio) may not exceed 75%.
3. The ratio of the balance of floating assets to the balance of floating liabilities (Liquidity ratio) may not be lower than 25%.
18 In 2008 liquidity problems caused some famous and large banks in USA went bankruptcy then resulted in global financial tsunami, e.g. Lehman Brothers Holdings Inc.
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4. The ratio of the outstanding of loans granted to the same borrower to the balance of the capital of the commercial bank (Loans to single largest customer) may not exceed 10%.
Table 2-16 shows afore-mentioned assets-liabilities ratios of SOCBs from 2007 to 2009, only capital adequacy ratio is excluded because it is relevant to the international norm—Basel II and therefore it will be discussed hereinafter in Section 2.6, as for other three indicators, the five SOCBs all conformed to the regulatory requirements and each indicator will be discussed separately as below.
Liquidity ratio is used to measure the ability of a bank to repay short-term debt, the higher ratio means a bank has better solvency, in 2009 CCB had the highest liquidity ratio of 49.63%, the second was BOC with ratio of 45.3%, the third was ABC with ratio of 40.99%, while BOCOM has the lowest ratio of 28.02%; however, if the ratio is too high that might reflect the efficiency of capital use of the bank is not good enough and could further affect profitability.19
Loan-to-deposit ratio is another measure of liquidity which is calculated by dividing loan balance by deposit balance, the higher figures denote lower liquidity.
From 2007 to 2009 the average Loan-to-deposit ratio of ABC was the lowest one, the figure was 57.25%, and the second lowest was ICBC with average figure of 57.4%.
During the same period the figures of ICBC and BOCOM have increased year by year, expansion of banking business might result in rising Loan-to-deposit ratio.
Percentage of ‘‘Loans to single largest customer’’ denotes the degree of concentration of credit risk; once the largest customer default on paying loans that will definitely cause the bank suffer a heavy loss, according to the regulation the ratio must lower than 10%.20
19 Liquidity ratio is calculated by dividing the balance of current assets by the balance of current liabilities.
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In 2007 ABC’s annual report did not reveal the ratio of ‘‘Loans to single largest customer’’, but the figures from 2008 to 2009 showed that ABC had the highest degree of concentration on lending to its major customer, and ratios of rest SOCBs were between 2% and 4%.
In addition to the percentage of ‘‘Loans to single largest customer’’, ratio of the outstanding of loans granted to top ten single customers to the net capital of the commercial bank (Loans to top 10 largest customers) is also an indicator to examine borrower concentration of a bank. In 2009 among peers BOC had the highest degree of concentration on lending to its major customers and ratios of rest four SOCBs were between 18% and 23%.
Table 2-16: Regulatory Indicators of SOCBs in China—2007~2009
Unit: %
Note: 1. Liquidity ratio of BOCOM included current assets and liabilities of local and foreign currencies, while Liquidity ratio of other SOCBs is based on RMB current assets to RMB current liabilities.
2. NA indicates no data available.
Source: ICBC, CCB, BOC, ABC, and BOCOM, Annual Report, 2009.
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Furthermore, there are other liquidity ratios commonly used to evaluate commercial banks, such as ‘‘Net Loans/Total Assets’’, ‘‘Net Loans/ (Deposits and Short-term Funding)’’ and ‘‘Liquid Assets/ (Deposits and Short-term Funding)’’.
Table 2-17 summarizes above three ratios of SOCBs from 2007 to 2009.
‘‘Net Loans/Total Assets’’ indicates what percentage of assets of the bank is tied up in loans, and the higher ratio reflects the less liquid the bank will be. From 2007 to 2009 this ratio of SOCBs were between 40% and 60%, in 2009 BOCOM had the highest ratio of 57.69%, and BOC ranked the second with figure of 54.84%.
Table 2-17: Indicators of Liquidity of SOCBs in China—2007~2009
Unit: %
Bank ICBC CCB BOC ABC BOCOM
Item Year 2007 2008 2009 2007 2008 2009 2007 2008 2009 2007 2008 2009 2007 2008 2009
Net Loans/
Total Assets 45.57 45.46 47.38 48.24 48.75 48.77 45.98 45.88 54.84 51.06 42.98 45.16 51.31 48.41 57.69
Net Loans/
(Deposits and Short-term
Funding)
50.11 49.98 51.65 53.09 53.55 53.13 54.38 53.49 61.70 46.37 46.66 48.90 57.35 53.33 63.11
Liquid Assets/
(Deposits and Short-term
Funding)
17.43 21.35 18.02 5.00 5.18 24.80 14.97 18.76 11.59 17.51 20.01 26.36 19.15 24.22 22.71
Source: B ankscope, http://bankscope.bvdep.com/ip.
‘‘Net Loans/ (Deposits and Short-term Funding)’’ is similar to Loan-to-deposit ratio, higher figure reflects lower liquidity, from 2007 to 2009 this ratio of SOCBs were in the range between 46% and 64%, and in 2009 BOCOM also had the highest figure of 63.11% among others.
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‘‘Liquid Assets/ (Deposits and Short-term Funding)’’ is a deposit run off ratio and looks at what percentage of customer and short term funds could be met if they were withdrawn suddenly, the higher this percentage the more liquid the bank is and less vulnerable to a classic run on the bank. By 2008 CCB had lowest figure around 5% but the ratio up nearly 19% to 24.8% in 2009; nevertheless, in the same year ABC had the highest of 26.36% among SOCBs.