Wednesday, January 28, 2009

Liquidity

Banks primary activity is to borrow short terms funds and lend long term, the mismatch between the banks short term liabilities (deposits) and its long term assets (loans) can lead to liquidity risk. Liquidity risk or asset and liability mismatch is one of the key factors that contributed to banking and financial crisis in the past. Liquidity risk at one bank can have contagion effect across the banking sector and affect the banking and financial system.

Since 2004 Mongolian banks have been asked to submit maturity mismatch report of assets and liabilities to Mongolbank (Bank of Mongolia) which enables to give an objective assessment of the liquidity risk in commercial banks. To effectively manage Mongolbank also approved regulation on “Calculating and controlling reserve requirements”. (minimum reserve requirements are 5%)

FSAP (Financial sector assessment program) is a joint program by World Bank and IMF to promote the soundness of financial systems in member countries. Mongolia started its participation in FSAP in 2007 and the program recommended to improve liquidity risk management in the commercial banks. Due to deepening financial intermediation and increased role of banks in the economy have resulted in an increase of deposits and decrease in liquid assets, to this end Mongolbank developed and approved “Liquidity management” guideline for banks.

The guideline is based on paper released from Basel Committee on Banking supervision“Sound practices for managing liquidity in Banking organizations”. The guideline provides basic recommendation on how to set up liquidity risk management framework, with quantitative and qualitative targets. Qualitative requirements mainly directed towards how banks should manage liquidity risk tailored specifically for the nature and complexity of each bank’s operations.

As for quantitative requirements the main objective is to fill in the gaps left by qualitative requirements, and also in case of liquidity crisis to take off some of the pressure on central bank which acts as lender of the last resort.

Source: Daily news, 2008.07.31, Bank of Mongolia.

Bank main source of funding is customer deposits and banks normally grant credits with longer maturities. The difference between the asset and liability maturities raises an issue of liquidity management. In spring many banks in Mongolia did not function normally. Almost all banks at one moment almost stopped or limited their lending operations to customers. Many banks were uncertain about their own and other banks future liquidity.

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