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.
Philosophy
FirstBank will maintain an optimal level of liquidity through the active management of both assets and liabilities that will comply with regulatory requirements and optimise return on assets.
The following principles guide liquidity risk management across the Bank:
- The Bank shall be responsible for establishing a robust liquidity risk management framework that ensures it maintains sufficient liquidity to withstand a range of stress events.
- The Bank will clearly articulate a liquidity risk tolerance that is appropriate for its business strategy and its role in the financial system.
- ALCO shall develop strategies, policies and practices to manage liquidity risk in accordance with the risk tolerance and to ensure that the Bank maintains sufficient liquidity.
- The Bank shall incorporate liquidity costs, benefits and risks in its fund transfer pricing performance measurement and new product approval process for all significant business activities, thereby aligning the risk-taking incentives of individual business lines with the liquidity risk exposures their activities create for the Bank as a whole.
- The Bank shall have a sound process for identifying, measuring, monitoring and controlling liquidity risk. This process shall include a robust framework for comprehensively projecting cash flows arising from assets, liabilities and off-balance sheet items over an appropriate set of time horizons.
- The Bank shall establish a funding strategy that provides effective diversification in the sources and tenor of funding.
- The Bank shall assign ranking to funding sources depending on their level of stability (ranging from stable to volatile). For example, the most volatile funds are typically those funds supplied by depositors that could be quickly removed in the event of a crisis (e.g., overnight inter-bank funds in the Nigerian market).
- The Bank shall develop early warning indicators of liquidity risk to aid the prompt identification of liquidity risk such as concentrations either in assets or liabilities, deterioration in quality of credit portfolio and a large size of off-balance sheet exposure.
- The Bank shall have a formal contingency funding plan (CFP) that clearly sets out the strategies for addressing liquidity shortfalls in emergency situations.
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.
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.
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.
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.
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.