Liquidity being one of the most critical dimensions of a commercial bank, its management (planning and controlling) carries paramount importance not only to the bank concerned, but also to the regulatory body and other stakeholders. In practice, our regulatory body, i.e. Bangladesh Bank is much concerned about liquidity measurement, evaluation, monitoring, and reporting at regular intervals pursuing Basel III guidelines. Bangladesh Bank has been publishing annually a special report titled Financial Stability Report since 2010 wherein information on financial sector liquidity is also inserted.
Bangladesh Bank assesses the liquidity condition of the banking sector adopting some specific measures namely, Call money rate, Advance-Deposit Ratio (ADR), Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR). All the scheduled banks are required to report regularly as per Basel III guidelines. Apart from reporting, it is mandatory for the banks to maintain Cash Reserve Requirement (CRR) and Statutory Liquidity Ratio (SLR) according to the standards set by Bangladesh Bank. CRR and SLR are both expressed in terms of ratio and now composed of 5.5 per cent and 13 per cent respectively of total time and demand liabilities of each scheduled bank.
It is to be pointed out that the liquidity condition of our banking organisations is measured to ascertain whether the actual scenario satisfies the central bank requirements on the one hand, and to examine the possibility of meeting the demands of the bank customers (depositors for withdrawals and loanees) on the other. As regards liquidity analysis of our banks, a couple of issues relating to the cash flows of deposit and its interest which have so far been left unfocused should be brought to light. In fact, pointing to a new approach to measuring liquidity is the prime objective of ongoing discussion.
What is bank liquidity needs to be spelt out first. Liquidity is the ability to fund increases in assets and meet obligations as they come due without incurring unacceptable losses (Basel Committee on Principles for Sound Liquidity Risk Management and Supervision, September 2008).In easier terms, liquidity of a bank is a measure of its ability to readily find the cash it may need to meet demands upon it (Elliot, D.J., The Brookings Institution, June 23, 2014).Viewed thus, we can in our own context explain that bank liquidity refers to the capacity of a bank ( i.e. having cash or liquid assets) to meet grossly the following needs:
- Regulatory compliance ( maintaining CRR and SLR)
- Depositors 'claims for withdrawals
- Loan requests
- Purchase of non-financial assets
- Repayment of borrowed money
An analysis of the definition and currently used measures of bank liquidity cited above unveils the fact that they have been developed basically using balance-sheet approach, i.e., focusing upon asset and liability items (off-balance sheet items also considered in NSFR). Do we ever think of liquidity in terms of meeting operating expenses including interest on deposit and borrowing? Arguably interest payment is to be made from interest earned on loans and investments. Interest is charged on unclassified loans and directly credited to interest income account. Can this interest so credited be treated as realised to the extent of 100 per cent? If it is counted as 100 per cent realised, it is just presumptive, not factual, because a period of at least three months (as per BB's classification guidelines) elapses after a loan has turned overdue and then such loan is classified. The said overdue period for first classifying may in practice extend to about six months. Is there any categorical record system whereby one can know exactly the interest charged on the classified loans during that gap period between being first overdue and being classified?
Most possibly the facet of loan profile with respect to the aforesaid elapsed period for which interest needs to be computed plus pre-overdue period's interest charged may remain out of the bank's knowledge and perception since the bank is normally sure that interest income entries are always properly done as per classification circular. As a result of such perception of the bank or concerned officials, the case of unrealised interest from unclassified loans lies totally unobtrusive. Since no analytical record is kept, nothing is known with certainty about the size of unrealised interest while it is very essential to be aware of. We cannot perceive any problem of cash shortfall or poor liquidity that is likely to be caused by the amount of unrealised interest because the cash balance and other liquid assets the bank holds are not segregated and earmarked based on their different sources of origination.
As regards deposit, there exist two enigmas. One is about how much of deposit grows as a cash inflow as it is observed that deposit may increase by either fresh cash inflows or interest crediting and by both. The other is the amount of interest credited to deposit accounts but not withdrawn by depositors. The ratio between additional net cash deposit and additional deposit by interest crediting is highly significant. Greater proportion of net cash deposit directly helps to resolve liquidity shortfall. Contrarily, the unwithdrawn interest does not involve any cash outflow; rather it eases the pressure on liquidity. However, our limitation is that the banks are not yet equipped with sufficient knowledge of the enigmas to improve the quality of their liquidity analysis.
Existing liquidity measures are vital no doubt. But they are inadequate because they mainly serve the needs of the regulatory body and the customers of the banks, not those of innovative decision-making of the banks ignoring any analysis on the nature of deposit flows and some hidden profit and loss items that influence liquidity in a subtle way. Therefore the application of both balance-sheet approach and profit and loss account approach is crucial to the search for some new measures. Otherwise, liquidity measurement would remain relatively imperfect and ineffective.
Haradhan Sarker is ex-Financial Analyst, Sonali Bank & retired Professor of Management.
