Ministry of education and science of Russian Federation

Baikal State University of Economics and Law

Faculty of Banking and Finance

Research Proposal

Performed by Mantatova Aryuna, MBF-15

Submitted to Bakhmatova T.G., Ph.D.

Irkutsk, 2015 Abstract

This work investigated the impact of liquidity management on the profitability of banks in Russia. The work is necessitated by the need to find ways of increasing sufficiency of liquidity management in Russian banking industry. Three banks were randomly selected to represent the entire banking industry in Russia. Liquidity management is defined by the structure of bank assets such as cash assets, loans and securities. The relationship between the structure of bank assets and bank profitability defined with help of regression analysis to test the hypothesis. The results of this study have shown that it’s important for banks to find optimal structure of assets that allow to avoid lack of liquidity and it’s excess. In this case the effective liquidity risk management leads to the rising of bank profitability.

Introduction

Banks have to deal with different risks during their activity in order to performance as a profitable and sustain organization. The fundamental role of banks is being financial intermediaries transform short-term deposits (liabilities) into long-term loans (assets) and this makes banks vulnerable to liquidity risk.  The transformation process creates asset and liability maturity mismatches on banks’ balance sheet that must be actively managed with available liquidity. Liquidity risk management is a key banking function and an integral part of the asset and liability management process. It’s important for banks analyze whether their liquidity risk management is effective or not in order not to lose their license and to get profit.

Literature review

One of the most important parts of commercial bank management system is correctly chosen strategy in the circumstances of a changing environment. Strategy gives a possibility to look into the future of the commercial bank, forecast its goals, areas, scale and potential operational results in relation to resource sources and expenses. In the article “Some Quantitative Aspects of Stability Management Strategy in a Bank” written by Sksonova and Solojova in Procedia - Social and Behavioral Sciences journal in 2012, the authors analyze the parameters of Latvia's commercial bank operations with a goal to prove that the stability of commercial bank system depends on how successfully commercial bank managed profitability and liquidity parameters as well as implemented asset management strategy. This article characterizes the contours of the optimal stability strategy for banks with an emphasis on banks operating in the transition economies. This paper proposed a management strategy of separating asset portfolios into distinct groups and ensuring that each type of asset portfolio is backed by a liability with a corresponding time profile. In addition, the role of the overall bank's strategy on the market was analyzed and it was shown how it relates to the decisions on asset allocation. The author distinguishes three types of asset transformation, which banks use in the process of their operation: quantitative, qualitative and time. Quantitative transformation is transforming comparatively small deposits into significant amounts of money (assets), which is necessary to finance large enterprises. Qualitative transformation is used to decrease asset risks. Resources attracted by the bank (liabilities) are placed using diversified asset portfolios, which means increased safety both for the assets and the liabilities. Apart from that banks perform constant monitoring of the borrowers, which also decreases risks of losing the assets. In context of creating optimum asset portfolio, the time asset transformation has a special meaning. Generally asset time transformation is transforming short-term deposits into medium and long-term loans, which can destroy bank's current liquidity. This risk can be partially decreased, using short-term interbank loans and derived instruments of financial markets (swap, futures etc.). Effective asset time transformation occurs, when the assets being placed are fully backed with liabilities with corresponding time stability. Apart from that, the interest rate, which a bank is paying for attracting liabilities, is connected with the interest rate, which it gets from its assets. Banks have to follow changes in real liabilities with different time stability closely (ideally - every day), in order to implement timely measures of their asset portfolio transformation to maintain current liquidity. The results of the research underline that that banks should maintain their liquidity by optimizing cash flow and the structure of assets and liabilities. In this case the tasks of bank management are managing the cash flow, improving the structure and quality of assets and liabilities, controlling liquid assets and forecasting the liquidity position of a bank.

In the article “Bank Liquidity Risks: Analysis and Estimates” written by Meilė Jasienė, Jonas Martinavičius, Filomena Jasevičienė, Gražina Krivkienė in Buisness, Management and Education journal in 2012 it is analyzed the importance and management of liquidity risk that commercial banks incur, developed a commercial bank liquidity management model, and analyzed how this model can be applied in practice by drawing on the case of one commercial bank controlled by a foreign bank. After analyzing the notions of risk that different scientists present, authors sum up that the liquidity risk of a bank is risk that the bank will be unable to meet its obligations when due as a result of shortage of liquid funds and will therefore suffer losses after a sharp decline in the amount of financial resources and an increase in the price of new funding to cover up previous debts. The main goal of managing liquidity risk is to ensure as profitable operation of the bank as possible, by maintaining a sufficient level of liquidity buffer to safeguard stable business of the bank. Effective management of liquidity provides a backbone for earning maxi­mum profit at a certain liquidity risk level. The underlying liquidity management methods are based on managing the bank's assets and liabilities at a certain moment in time. Liquidity demands can be identified using methods of deposit structure and cash flow reporting. The first method embraces a thorough analysis of the structure of deposits accepted by the bank. The second meth­od supplements the first one and covers the possibilities to withdraw deposits as well as the demand for credit. Assessment of liquidity risks in the bank is based on managing short-term (up to one month) and long-term (one-year) liquidity. As a result of study the author offer a model of managing both short- and long-term liquidity. Short-term liquidity of the bank is managed in line with the liquidity ratio requirement prescribed by the Central bank by securing a required amount of obligatory reserves and complying with short-term liquidity ratios as well as the limits that apply to them. Long-term liquidity management relies on forecasting the need for liquidity, deposit and loan flows, meet­ing the need for liquidity, liquidity gap analysis and assessment of long-term liquidity indicators

Liquidity risk may arise from the inability of a bank to provide liquidity as stipulated in the contracts, either to investors or depositors, this being extremely well underlined in the context of the recent global financial crisis. In the article “Banks liquidity risk analysis in the new European Union member countries: evidence from Bulgaria and Romania” written by Roman and Sargu in Procedia - Social and Behavioral Sciences journal in 2014, the aim of the research is to evaluate the liquidity risk of the banks operating in Bulgaria (11 banks) and Romania (15) in the context of the EU ascension process. In order to achieve this authors have investigated the role and impact that a series of financial indicators for the capital adequacy, assets quality, management quality and profitability have on the liquidity risk of the banking institutions, the analyzed period is 2003-2011. The ascension to full time members of the European Union of Bulgaria and Romania has had a tremendous effect on these countries banking systems, determining a series of changes both in the operating strategies and also in the market dynamics. The research shows that the joining in the European Union by Bulgaria and Romania has lead to an increase of the number of foreign owned bank in the two countries. It also leads to an increase of the capital adequacy ratio. These two evolutions have lead to additional demands from the shareholders for the banks to increase their returns either through more profitable investments or by increasing the volume of revenue generating assets and implicitly decreasing the volume of liquid assets. On the other hand the ratio of impaired loans plays also a decisive role in the way in which the banking institutions operating in Bulgaria and Romania are managing their liquidity. This is directly influenced by the policies adopted by the Central Banks of the two countries; hence the different connection that exists between the liquidity indicators and the ratio of impaired loans to gross loans in the case of the Bulgarian and Romanian banks respectively. The obtained results underline that the capital adequacy ratio and the ratio of impaired loans to gross loans have a statistically significant impact on the liquidity risk of the banks operating in Bulgaria and Romania.

The literature on the determinants of liquidity risk is relatively scarce, in general, the empirical researches being focused mostly on the case of the advanced economies. For example, the research of Bonfim and Kim “Liquidity risk in banking” written in 2012 highlights how a sample of European and North American banks manage liquidity risk, over the period 2002-2009. In particular, using regression analysis based on panel data, the authors con­sider three different measures of liquidity risk and attempt to understand whether banks tend to take more risks in a crisis period and if they follow similar strategies in these periods. The authors also identify the determinants of liquidity risk. The results highlight that the type of relationship between liquidity risk and size, performance and the ratio between loans and deposits depends on the type of liquidity risk measure used. Bank size generally has a positive impact on bank liquidity, while the performance measure has an ambiguous relationship with li­quidity risk. The results provide important insights for regulators, suggesting that banks have a collective behavior in the pre-crisis period, reflected in a global deterioration of liquidity indicators and that collective risk taking incentives are focused mainly among the largest banks worldwide.

The work “The Impact of Liquidity Management on the Profitability of Banks in Nigeria” written by Sunny Obilor Ibe in Journal of Finance and bank Management in 2013 investigated the impact of liquidity management on the profitability of banks in Nigeria. The work is necessitated by the need to find solution to liquidity- management problem in Nigerian banking industry. Three banks were randomly selected to represent the entire banking industry in Nigeria. The proxies for liquidity management include cash and short term fund, bank balances and treasury bills and certificates, while profit after tax was the proxy for profitability. Elliot Rothenberg Stock (ERS) stationary test model was used to test the run association of the variables under study while regression analysis was used to test the hypothesis. Treasury bills and certificates have a significant impact on bank profitability and bank balance has also an influence on bank profitability. The research shows that there is a significance positive relationship between cash (and short term fund) and profit after tax. The result of this study has shown that liquidity management is indeed a crucial problem in the Nigerian banking industry. The study therefore recommends that banks should engage competent and qualified personnel in order to ensure that right decisions are adopted especially with the optimal level of liquidity and still maximize profit.