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A Comparative Analysis of a Conventional Bank and an Islamic Bank in Respect of Liquidity Management and Reprising Model.

Submitted to: Hasibul Alam Chowdhury Course Teacher Department of Banking University of Dhaka

Submitted by:

Department of Banking University of Dhaka

Date of Submission: 20th February, 2011

Introduction: This report is about the comparative analysis between a conventional bank and an Islamic bank in liquidity management for the period of 2005-2009. I also use the repricing model to compare between this two banks. In this study I will try to focus whether any significant differences exists in managing liquidity position of Islamic bank and conventional banks in Bangladesh. For our analysis, we have taken one bank from each category. That is AB Bank Limited as the conventional bank and Islami Bank Bangladesh Limited as the Islamic bank. For this assignment I have collected the annual reports of last five years mainly emphasis on liquidity statement of annual reports of this two banks.

Analysis of the liquidity position of the ABBL Measuring and managing the liquidity needs are vital for effective operation of commercial banks. By assuring a bank's ability to meet its liabilities as they become due, liquidity management can reduce the probability of an adverse situation developing. The importance of liquidity transcends individual institutions, as liquidity shortfall in one institution can have repercussions on the entire system. Bank managements should measure, not only the liquidity positions of banks on an ongoing basis, but also examine how liquidity requirements are likely to evolve under different conditions. In this report first I have calculated the liquidity gap of assests and liabilities of this bank in maturity bucket of Up to 1 month, 1-3 months, 3-12 months, 1-5 years, More than 5 years . I have also calculated the growth rate of AB Bank Limited for four years from 2006 to 2009. I have found that there is positive liquidity gap for the period under study. So it can be said that AB Bank Limited could satisfactorily maintain higher amount of assets than liabilities. It implies AB Banks ability to satisfy the liabilities as and when necessary. Net liquidity gap for AB bank limited has increased each year. But rate of growth gradually increased from 2006-2007 but decreased in the year 2008 and again increased in the year 2009. It indicates that during the period under study, AB bank got sufficient assets to satisfy the liabilities. These assets varied time to time. The positive growth of net liquidity gap indicates that the AB bank maintains this favorable situation throughout the period under study.

Analysis of the liquidity position of the IBBL: I have calculated the growth rate of IBBL for four years from 2006 to 2009. I have found that there is positive liquidity gap for the period under study. So it can be said that IBBL could satisfactorily maintain higher amount of assets than liabilities. It implies IBBLs ability to satisfy the liabilities as and when necessary. But rate of growth gradually decreased from 2006-2007, but dramatically increased from the year 2008 to 2009. It indicates that during the period under study, the assets decreased in 2007 than the year 2006. And in the year 2009 they ensured huge amount of assets to maintain a satisfactory liquidity position against their liabilities. Compared to the liabilities the assets always remained high in IBBL as the analysis shows a positive liquidity growth rate every year.

Comparative analysis of the liquidity position: the IBBL Vs. the AB Bank: In this section we will compare the liquidity situation of these two different types of banks from the perspective of net liquidity gap. We have calculated 5 year average net liquidity gap of the two banks on basis of maturity bucket. The calculation is given in the appendix. From the analysis, we have the following findings: a. The AB bank lacked appropriate up to 1 month maturity,1-3 month and 3-12 month maturity assets to a greater extent to satisfy the liabilities of the same maturity but the IBBL was able to manage more assets of that maturity to cover the liabilities of the same maturity. The IBBL performed better than the AB bank. That is, during the period under analysis, the IBBL managed liquidity situation of these three durations more efficiently than the ABBL. b. But in 1-5 year maturity case, the ABBL handled the liquidity situation more effectively than the IBBL c. again in More than 5 year maturity situation, the IBBLs liquidity performance was better. That is IBBL managed its liquidity situation more effectively than AB bank.

Table 4 summarizes the total liquidity gap and growth rate of this two bank from 2005 to 2009. If we consider the growth rate of total liquidity gap, we find that although the IBBL experienced higher amount of net liquidity gap than the AB bank, net liquidity gap of the AB bank

experienced more growth rate than the IBBL. It indicates that although IBBL is managing its liquidity situation better than the AB bank but AB bank is gradually improving its overall liquidity situation.

Repricing model of ABBL: Repricing gap is the difference between assets whose interest rates will be repriced of changed over some future period (rate sensitive assets) and liabilities whose interest rates will be repriced or changed over some future period (rate sensitive liabilities). I have shown the asset and liability repricing gap in table 1 in the appendix section where the assets and liabilities are categorized into different maturity buckets. I have used repricing model to point out Net Interest Income (NII) in terms of interest rate changes in different maturity buckets. NIIi = (GAPi ) Ri =(RSAi RSLi) Ri NIIi = Change in net interest income in the ith bucket. GAPi = Dollar size of the gap between the book value of RSA and RSL in maturity bucket i. Ri = Change in the level of interest rates impacting assets and liabilities in the ith buckets. The cumulative effects on the banks net interest income is determined by NIIi = (CGAPi ) Ri Interest rate sensitivity can also be expressed as a percentage of asset (A) (typically called the gap ratio. GAP Ratio = CGAP / Assets From my calculation of the year 2005 and 2007 I have found a negative cumulative gap (CGAP) between RSA and RSL which indicate that the AB bank had more liabilities than its assets. In this study I have assumed that the interest rate will increase by 1% in future. Because of future inflationary expectations I have shown increasing interest rate. So after calculation the NII of 2005 was -8007134 and 2007 was -7974419. It indicates that interest revenue from assets

increased in a lower rate than the interest expenses from the liabilities increased. So when, the RSA is less than RSL or the CGAP is negative then the relationship between interest rate and NII is negative. As the expected interest rate is in a rising mode so AB bank should maintain a positive CGAP which will make the NII positive. So AB bank should increase their rate sensitive asset against their rate sensitive liabilities. I have also calculated the gap ratio which tells us1. The direction of the interest rate exposure. 2. The scale of the exposure. In this case the AB bank has -2.42% gap ratio in 2005 and -1.25% in 2007 which indicate that the AB bank has more RSLs than RSAs in the one-year-and-less bucket. From my calculation of the year 2006, 2008 and 2009 I found positive cumulative gap (CGAP) between RSA and RSL which indicate that the AB bank had more assets than its liabilities. In this study I have assumed that the interest rate will increase by 1% in future. Because of future inflationary expectations I have shown increasing interest rate. So after calculation the NII of 2006 was 588041741, 2008 was 4016233431 and 2009 was 3623324517 . It indicates that interest revenue from assets increased in a higher rate than the interest expenses from the liabilities increased. So when, the RSA is more than RSL or the CGAP is positive then the relationship between interest rate and NII is positive. In this case the AB bank has 1.23% gap ratio in 2006, 4.78% in 2008 and 3.39% in 2009 which indicate that the AB bank has more RSAs than RSLs in the one-year-and-less bucket. Conclusion: In this analysis, we find that Islami Bank Bangladesh Limited (the IBBL) has performed better than the AB Bank in managing its liquidity position. Both in short term and long tern the average liquidity gap is managed more effectively by IBBL except the assets of 1-5 years maturity bucket. So we can say it should take steps to manage long term liquidity position more effectively. AB bank has positive liquidity gap in the long term but it has negative gap in the short term. So it should take necessary steps to manage a good liquidity position in the short term.

Appendix AB bank Limited Table 1

Parti cular s

2005

2006

2007

2008

2009

Up to 1 mont h 1-3 mont hs 3-12 mont hs 1-5 years More than 5 years Total

Liqui dity Gap 8635 0962 2 8301 8836 8 8929 8456 5 1220 0679 84 1107 5252 78 1526 8798 37

C Gap

863509 622 169369 7990 800713 425 419354 559 152687 9837

Liquid ity Gap 39160 5995 28943 1565 12690 79301 15165 27942 47819 3230

C Gap

Liquidity Gap 97923051 4 25098086 0

C Gap

Liquidity Gap 1356698 861

C Gap

Liquidit y Gap 311146 485

C Gap

391605 995 681037 560 588041 741 210456 9683 258276 2913

979230 514 728249 654 797441 923 373473 9584 451158 9265

13566 98861

311146 485

1208675 505

25653 74366

362034 719

673181 204

-69192269

1450859 065 1307909 730 1398363 186

40162 33431 53241 43161 67225 05347

295014 3313 288667 3214 357652 5201

362332 4517 650999 7731 100865 22932

45321815 07 77684968 1

25827 62912

45115892 65

6722505 347

100865 22932

Growth rate of the liquidity gap Growth rate of liquidity gap of the year 2006 = 2582762912 1526879837 /1526879837 * 100 = 69.15% Growth rate of liquidity gap of the year 2007 = 4511589265 2582762912 /2582762912 * 100 =74.68 % Growth rate of liquidity gap of the year 2008 = 6722505347 4511589265 /4511589265 * 100 =49.01 % Growth rate of liquidity gap of the year 2009 = 10086522932 6722505347 /6722505347 * 100 =50.04 %

AB BANK 2005 Changes in Net Interest Income NII 1 = (GAP 1) Ri = - 863509622 * 1% = - 8635096

NII 2 = (GAP 2) Ri = -830188368* 1% = -8301884 NII 3 = (GAP 3) Ri = 892984565 * 1% = 8929845 NII 4 = (GAP 4) Ri = 1220067984 * 1% = 1200680 NII 5= (GAP 5) Ri = 1107525278 * 1% = 11075253

CGAP = -800713425 NIIi = CGAP * Ri = -800713425 * 1% = -8007134 Rate Sensitive Assets = 2551658800 + 5451626899 + 15065790149 = 23069075848 Rate Sensitive Liabilities = 3415168423 + 6281815268 + 14172805584 = 23869789275

CGAP = One year rate sensitive assets One year rate sensitive liabilities = 23069075848 23869789275 = - 800713427 GAP Ratio = CGAP / Assets = - 800713427 / 33065402555 = -2.42% AB BANK 2006 Changes in Net Interest Income NII 1 = (GAP 1) Ri = -391605995* 1% = -3916060

NII 2 = (GAP 2) Ri = -289431565* 1% = -2894316 NII 3 = (GAP 3) Ri = 1269079301 * 1% = 12690793 NII 4 = (GAP 4) Ri = 1516527942 * 1% = 15165279 NII 5= (GAP 5) Ri = 478192230 * 1% = 4781922

CGAP = 588041741 NIIi = CGAP * Ri = 588041741*1%

= 5880417 Rate Sensitive assets = 4143424393 + 12323056314 + 18238866404 = 34705347111 Rate Sensitive Liabilities = 4535030389 + 12612487879 + 16969787103 = 34117305371 CGAP = 34705347111 34117305371 = 588041740 GAP Ratio = CGAP / Assets = 588041740 / 47989337222 = 1.23% AB BANK 2007 Changes in Net Interest Income NII 1 = (GAP 1) Ri = -979230514* 1% NII 2 = (GAP 2) Ri = 250980860 * 1% = 2509809 NII 3 = (GAP 3) Ri = -69192269* 1% = -691923 NII 4 = (GAP 4) Ri = 4532181507 * 1% = 45321815 NII 5= (GAP 5) Ri = 776849681 * 1% = 7768497 CGAP = -797441923 NIIi = -797441923* 1% = -9792305

= -7974419 Rate Sensitive Assets = 7793659471 + 13622628165 + 28371031313 = 49787318949 Rate Sensitive Liabilities = 8772889985 + 13371647305 + 28440223582 = 50584760872 CGAP = 49787318949 50584760872 = -797441923 GAP Ratio = CGAP / Assets = -797441923 / 63549864403 = -1.25%

AB BANK 2008 Changes in Net Interest Income NII 1 = (GAP 1) Ri = 1356698861 * 1% = 13566989 NII 2 = (GAP 2) Ri = 1208675505 * 1% = 12086755 NII 3 = (GAP 3) Ri = 1450859065 * 1% = 14508591 NII 4 = (GAP 4) Ri = 1307909730 * 1% = 13079097 NII 5= (GAP 5) Ri = 1398362186 * 1% = 13983622

CGAP = 4016233431

NIIi = CGAP * Ri = 4016233431 * 1% = 40162334 Rate Sensitive Assets = 15912731779 + 20814267718 + 38606580528 = 75333580025 Rate Sensitive Liabilities = 14556032918 + 19605592213 + 37155721463 = 71317346594 CGAP = 75333580025 71317346594 = 4016233431 GAP Ratio = CGAP / Assets = 4016233431 / 84053612585 = 4.78% AB BANK 2009 Changes in Net Interest Income NII 1 = (GAP 1) Ri = - 863509622 * 1% = - 8635096 NII 2 = (GAP 2) Ri = -1693697990 * 1% = -16936980 NII 3 = (GAP 3) Ri = 892984565 * 1% = 8929845

NII 4 = (GAP 4) Ri = 1220067984 * 1% = 1200680 NII 5= (GAP 5) Ri = 1107525278 * 1% = 11075253

CGAP = 3623324517 = 3623324517 NIIi = CGAP * Ri =3623324517 * 1% = 36233245 Rate Sensitive Assets = 1547832695 + 22533316027 + 36267369777 = 74279011999 Rate Sensitive Liabilities = 15167179710 + 22171281308 + 33317226464 = 70655687482 CGAP = 74279011999 70655687482 = 3623324517 GAP Ratio = CGAP / Assets = 3623324517/106912312383 = 3.39%

Islami Bank Bangladesh Ltd Table 2 Particular s Liquidit y Gap C Gap Liquid ity Gap Up to 1 Month 255786 70106 1-3 Months 156342 3608 255786 70106 100152 46498 3-12 Months 235239 62403 135087 15905 5843 3627 51 1727 6696 55 6458 8523 3 1-5 Years 101358 7804 124951 28101 2268 2649 51 More than 5 Years total 821574 1206 972061 3105 222157 41206 5350 3505 75 1000 7232 797 100072 32797 8122004 39 1184133 6254 18559903 58 140604919 79 249412 0344 2010554 3853 465688 2222 7169720 88 1265353 6693 56418171 6 122045016 21 141637 2707 1761142 3509 692514 7173 1269864 787 1193656 4605 87123455 3 116403199 05 618126 3811 1619505 0802 757103 2406 3007138 96 1066669 9818 59891448 84 107690853 52 520652 4178 1001378 6991 584336 2751 1036598 5922 1036598 5922 47799404 68 477994046 8 480726 2813 4807262 813 C Gap Liquidity Gap C Gap Liquidity Gap C Gap Liquidit y Gap C Gap 2005 2006 2007 2008 2009

1184133 6254

14060491 979

201055 43853