Liquidity Risk Management

Overview
Governance
Policies and procedures
Primary sources of funding
Loans to deposit ratio
Diversification policy on asset base and contingent liquidity risk management
Market turmoil and liquidity risk position
Market and liquidity risk reporting
Capital management

1 Overview

Liquidity risk relates to the risk of insufficient liquid assets to meet the Bank's obligation as they fall due or will have to meet the obligations at excessive costs.

This risk arises from mismatches in the timing of cash flows. Funding risk (a form of liquidity risk) arises when the liquidity needed to fund illiquid asset positions cannot be obtained at the expected terms and when required.

The objective of the Bank's liquidity risk management is to ensure that all anticipated funding commitments can be met when due and that access to funding sources is coordinated and cost effective.

2 Governance

BARAC and the full Board are responsible for the following:

Approval of liquidity risk management framework, policies, strategies, guidelines and philosophy
Providing Board oversight for the implementation of liquidity risk management policies
Approval of liquidity risk related limits for the Bank and subsidiaries.

The Assets & Liabilities Management Committee, made up of Executive Directors and other relevant Divisional Heads, is responsible for the following:

Review of policies relating to liquidity risk management
Recommendation of liquidity risk policies to the Board
Review of liquidity risk strategy and recommendation of same for Board approval
Provision of management oversight on the implementation of policies relating to liquidity risk
Monitoring of liquidity risk inherent in the maturities mismatch of the assets and liabilities
Development of policies, procedures, tools and systems for identifying, measuring, controlling and reporting liquidity risks
Ensuring compliance with statutory and regulatory requirements relating to liquidity risks
Review of and recommendations on liquidity risks related limits for approvals
Approving the stress scenarios and the assumptions of contingency funding plans.

Implementation of the Bank's market and liquidity risk management policies, procedures and systems is delegated to the Head of the Market and Liquidity Risk Management Department who reports to the ED/Chief Risk Officer.

The Bank maintains a well-articulated liquidity risk policy, which drives the level of liquidity risk exposures and determines business size and maturities.

3 Policies and procedures

The principal mechanism for implementing the Bank's liquidity policy is to maintain liquid assets to deposit ratio above the regulatory defined ratio of 25%.

The Bank's definition of liquid assets is more stringent than as defined by the Central Bank. While the apex bank admits federal government of Nigeria bonds as liquid assets, the Bank has stressed its liquid assets only to the portion of securities available for immediate sale and for which a deep and liquid market exists.

The liquidity ratio is interpreted in conjunction with cash flow projection and liability concentration ratios to measure the Bank's exposure to liquidity risk. The cash flow technique used is the maturity ladder which assesses all the Bank's cash inflows against its outflows to identify the potential for net shortfalls or net funding requirements.

In order to ensure compliance with liquidity levels, the Bank has pre-set liquidity gap limits. The liquidity and funding management process also includes the preparation of multicurrency balance sheets and assessing cash flows by major currencies and projecting cash flows under stress scenarios.

The Bank's use of concentration ratios prevents it from relying on limited number of depositors or funding sources.

Liquidity ratios

This is the level of liquid assets to total deposits. The level of holdings of liquid assets in the balance sheet reflects the prudent approach of the bank's liquidity policies and practice.

	Dec 2009	Mar 2009
Liquidity ratio	35.8%	47.5%

4 Primary sources of funding

The Bank's funding base consists of well-diversified corporate and retail deposits as well as interbank and other borrowings. Traditionally, the Bank has sought to attract lower-cost demand and savings deposits in order to keep its funding cost as low as possible and has attempted to minimise its reliance on higher cost time deposits as a significant source of funding. The Bank places considerable importance on the demand and savings deposits which form 73% of its funding base. Although these accounts are contractually repayable on demand, in reality, they are stable and have formed a core component of the Bank's liabilities. Also due to market perception of the Bank as one of the strongest banks in Nigeria, it enjoys a relatively lower cost time deposit base by attracting the retail segment whose principal consideration is the safety of their funds.

5 Loans to deposit ratio

The Bank emphasises the importance of core current and savings deposit accounts as a source of funds to finance lending to customers and discourage reliance on short-term wholesale funding (inter-bank borrowing and public sector fund). This is achieved by placing limits on the various Business Development Units of the Bank, which restrict their ability to increase loans and advances to customers without corresponding growth in current and savings deposit accounts. The pre-set loans to deposit ratio set and monitored by ALCO is 80%.

	Dec 2009 (N'million)	Mar 2009 (N'million)
Loans and advances to customers	1,022,486	684,107
Customer accounts	1,236,599	1,071,836
Advances to deposit ratio	82.69%	68.83%

6 Diversification policy on asset base and contingent liquidity risk management

The Bank maintains a large portfolio of tradable liquid assets in the form of Nigerian Treasury Bills and federal government of Nigeria bonds which are low in risk and can be converted in a short period of time or used to enhance the Bank's borrowing. The Bank also maintains a large portfolio of low risk assets which can be securitised and traded as off-balance sheet items. In addition, the Bank has put in place contingency funding arrangements with similar-sized Nigerian banks and maintains a standing credit facility with Central Bank of Nigeria, which can be accessed at short notice.

7 Market turmoil and liquidity risk position

The global financial crisis and margin lending related exposures by the banking industry continue to have adverse effects on the liquidity and funding risk profile of the banking industry. At systemic levels, these may be summarised as follows:

Cancellation of offshore credit lines to Nigerian banks.
Interbank funding cost increased as banks became reluctant to lend to each other, although this has been mitigated by CBN temporary guarantee of interbank deposits.
Many asset classes primarily considered to be liquid became illiquid.
Heavy loan loss provisioning induced by the result of CBN/NDIC Stress Test.
The difficulty of many banks to raise wholesale deposits at reasonable cost.

In specific terms, the Bank's exposure in margin lending is relatively insignificant to the size of its loan portfolio and, therefore, its liquidity position is unaffected. Also, the strain arising from the liquidity trapped in margin lending exposures is concentrated in the interbank market where FirstBank has been a dominant net placer of funds. The retail market from which the Bank derives its current and savings deposits is relatively unaffected. The desire by most customers for flight to safety and the Bank's market perception as a stronger Bank has impacted positively on the level of deposits.

The Bank's liquidity position on the local currency is very robust. In the period under review, growth in our deposit liabilities exceeded growth in risk assets. The Bank's focus this year will remain on liability generation which will be a necessary pre-condition for significant asset growth.

Foreign currency liabilities generally fund assets in the same currency and, where tenors differ, liquidity risks are generally adjudged fair.

8 Market and liquidity risk reporting

Various market and liquidity risk management reports are issued on a daily, fortnightly, monthly and quarterly basis as shown below:

Daily liquidity and market risk report: all ALCO members.
Fortnightly ALM and market risk report: ALCO meeting.
Monthly ALM and market risk report: ED, Risk and Mgt Control.
Quarterly ALM and market risk report: Board of Directors.

9 Capital management

FirstBank's capital management approach is driven by its strategy and organisational requirements, taking into account the regulatory and commercial environment in which it operates. It is the Bank's policy to maintain a strong capital base to support the development of its business and to meet regulatory capital requirements at all times.

Through its corporate governance processes, the Bank maintains discipline over its investment decisions and where it allocates its capital, seeking to ensure that returns on investment are appropriate after taking account of capital costs.

The Bank's strategy is to allocate capital to businesses based on their economic profit generation and, within this process, regulatory and economic capital requirements and the cost of capital are key factors.

FirstBank's capital is divided into two tiers:

Tier 1 capital comprises core equity tier 1 capital comprising ordinary shares, statutory reserves, share premium and general reserves. The book values of goodwill, intangible assets, unpublished losses and under provisions are deducted in arriving at core equity tier 1 capital.
Tier 2 capital comprises qualifying subordinated loan capital, preference shares, general provisions, debenture stock, minority and other interests in tier 2 capital and unrealised gains arising from the fair valuation of equity instruments held as available-for-sale. Tier 2 capital also includes reserves arising from the revaluation of properties and foreign reserves.

The Central Bank of Nigeria prescribed a minimum limit of 10% of total qualifying capital/total risk weighted assets as measure of capital adequacy of banks in Nigeria. Total qualifying capital consists of tier 1 and 2 capital less investments in unconsolidated subsidiaries and associates. The total risk weighted assets reflects only credit and counterparty risk.

The Bank achieved capital adequacy ratio of 21.33% at the end of the year; a marked reduction over the 30.01% recorded for the period ended December 2009. This is attributable to 49.46% increase in net loans and advances during the year. The Bank, as a policy, works to maintain adequate capital cover for its trading activities. Though regulatory requirement is 10%, FirstBank has a minimum internal target of 16%. Current position is closely monitored and reported fortnightly to the Assets and Liabilities Management Committee.

Capital adequacy

	Dec 2009	Mar 2009
Capital adequacy ratio	21.33%	30.01%
Capital composition:	N'mn	N'mn
Tier 1
Paid-up capital	14,504	12,432
Reserves	297,768	333,407
Tier 2
Long-term debt stock	35,473	35,042
Reserves	5,215	13,681
Capital utilisation:	352,960	394,562
Qualifying risk weighted assets	1,655,106	1,314,877

In June 2006, the Basel Committee on Banking Supervision published International convergence of Capital Measurement and Capital Standards, known as Basel II. Basel II is structured around three 'pillars': minimum capital requirements, supervisory review process and market discipline. Though there has been no regulatory requirement for banks in Nigeria to comply, FirstBank has embarked a on Basel II compliance project. The successful conclusion will allow the Bank's capital measurement to reflect market and operational risk exposures on the assets of the Bank.

The Bank's initiative is in tandem with regulatory actions which embraced the framework and accordingly set up a committee called the CBN/NDIC Committee on the new accord to oversee the adoption of the capital accord. The road map for implementation has been issued in a memorandum to the Bankers' committee on the implementation of the new capital accord in Nigeria.