Introduction

Banks play a central role in all modern financial systems. To perform it effectively, banks must be safe
and be perceived as such. The single most important assurance is for the economic value of a banks
assets to be worth significantly more than the liabilities that it owes. The difference represents a cushion
of capital that is available to cover losses of any kind. However, the recent financial crisis underlined
the importance of a second type of buffer, the liquidity that banks have to cover unexpected cash
outflows. A bank can be solvent, holding assets exceeding its liabilities on an economic and accounting
basis, and still die a sudden death if its depositors and other funders lose confidence in the institution.
What is liquidity at a bank?
Liquidity at a bank is a measure of its ability to readily find the cash it may need to meet demands upon it.
Liquidity can come from direct cash holdings in currency or on account at the Bangladesh Bank Reserve.
More commonly it comes from holding securities that can be sold quickly with minimal loss. This
typically means highly creditworthy securities, including government bills, which have short-term
maturities. Indeed if their maturity is short enough the bank may simply wait for them to return the
principal at maturity. Short-term, very safe securities also tend to trade in liquid markets, meaning that
large volumes can be sold without moving prices too much and with low transaction costs.
However, a banks liquidity situation, particularly in a crisis, will be affected by much more than just this
reserve of cash and highly liquid securities. The maturity of its less liquid assets will also matter, since
some of them may mature before the cash crunch passes, thereby providing an additional source of funds.
Or they may be sold, even though this incurs a potentially substantial loss in a fire sale situation where the
bank must take whatever price it can get. On the other side, banks often have contingent commitments to
pay out cash, particularly through lines of credit offered to its retail and business customers. Of course,
the biggest contingent commitment in most cases is the requirement to pay back demand deposits at any
time that the depositor wants.
How much liquidity is enough?
Since liquidity comes at a cost, a bank faces a trade-off between the safety of greater liquidity and the
expense of obtaining it. This makes it difficult to answer the question of how much liquidity is enough.
Worsening the difficulty is the complexity of the financial system and the challenge of predicting its
future state and therefore the probability and severity of future cash crunches. Banks try to ensure that
they have sufficient liquidity to meet all relevant regulatory requirements, plus a buffer to reduce the
likelihood that liquidity falls below these thresholds and triggers a regulatory or market response or
creates constraints on the banks actions. In a similar way, they try to ensure that they have sufficient
liquidity to avoid a downgrade from the credit rating agencies to a level below the banks target rating,
although there always remains the option of accepting a lower rating. More sophisticated banks also try to
hold the probability of a crippling liquidity crisis to below some fraction of a percent each year, based on
their internal modeling.
What are the new liquidity requirements?
In the Basel III rules, regulators have, for the first time, designed global standards for the minimum
liquidity levels to be held by banks. Prior to this there were a few countries that had quantitative

minimum requirements, but the large majority, including the US, relied on subjective regulatory judgment
as to when liquidity levels were so low that a bank should be forced to remedy them. In practice, very
little was done to force banks to shore up liquidity. The Basel III liquidity rules, which will be phased in
starting in 2015, rely on two minimum ratios.
The first is a Liquidity Coverage Ratio which is a kind of stylized stress test to ensure that a bank
would have the necessary sources of cash to survive a 30-day market crisis. It appears that 30 days was
chosen as the relevant period because it was viewed as long enough for central banks and governments to
take the necessary emergency measures to calm a widespread market crisis of liquidity.
The second is the Net Stable Funding Ratio which tries to ensure that a banks assets would be
adequately supported by stable funding sources. The idea is to keep banks from engaging in excessive
maturity transformation or doing it in too risky a manner.
Supervisors around the globe are also instituting formal stress test procedures to ensure that banks have
sufficient liquidity to handle specific difficult economic and financial environments. In the US, the Fed
has instituted the Comprehensive Liquidity Analysis and Review, starting in late 2012 for a few of the
largest banks. This is a multi-step process that includes bank-run stress tests using their own models, with
guidance and feedback from the Fed, as well as review of the governance and decision-making processes
at the bank relevant to liquidity management.

Figure 1 Phase-in arrangements for Basel III implementation in Bangladesh

How does the Liquidity Coverage Ratio work?

The LCR is calculated by dividing the banks level of high quality liquid assets by the projected cash
claims over the next 30 days. Basel III specifies what will be considered high quality liquid assets. Very
safe, very liquid assets, including government bonds and cash held at central banks, are considered to be
Level 1 assets. Safe and liquid assets of other types, including specified categories of private securities,
are considered to be in Level 2 and are subject to haircuts of up to 50% on their value to represent the
potential loss in a fire sale during a time of crisis. Level 2 assets may constitute no more than 40% of the
total. An assumption is also made as to what percentage of assets maturing in the 30 day period will be
rolled over, since some assets are tied to ongoing business relationships and would be difficult to
completely run off.
Basel III also specifies what percentage of liabilities with an indefinite maturity, such as demand deposits,
will be assumed to run off. In practice, retail deposits tend to be sticky and not to move, especially
when they fall within the deposit guarantee limits, and therefore little run-off is assumed from them.
Corporate deposits are less sticky and are assumed to run off in greater volume. Assumptions are also
specified about draw downs of cash through lines of credit and other instruments where banks have
promised to loan money up to certain limits if requested. Crisis times tend to result in many of these lines
being drawn down.
Banks will be required to maintain LCRs of 100% or more; that is, to have sources of cash more than
sufficient to cover their expected outflows over the assumed 30-day crisis period. However, the Basel
Committee has indicated that national regulators should have the flexibility to allow the ratio to fall below
100% when a bank or the system is in trouble. That said, banks in normal times will almost certainly
target a ratio above 100% in order to maintain a safety buffer to protect them from potential regulatory
actions. They will also be loath to fall below 100% even in a time of crisis, although circumstances may
force them to do so. Financial markets will react similarly and may substantially penalize banks that open
themselves up to regulatory actions by allowing their ratio to decline to near or below 100%.
How can banks achieve adequate liquidity?
Banks can increase their liquidity in multiple ways, each of which ordinarily has a cost, including:

Shorten asset maturities

Improve the average liquidity of assets
Lengthen liability maturities
Issue more equity
Reduce contingent commitments
Obtain liquidity protection Shorten asset maturities.

This can help in two fundamental ways. First, if the maturity of some assets is shortened by enough that
they mature during the period of a cash crunch, then there is a direct benefit. Second, shorter maturity
assets generally are more liquid.

What is liquidity for a bank?

Liquidity refers to how quickly and cheaply an asset can be converted into cash. Money (in the form of
cash) is the most liquid asset. Assets that generally can only be sold after a long exhaustive search for a
buyer are known as illiquid. The degree to which an asset or security can be bought or sold in the market
without affecting the asset's price. Liquidity is characterized by a high level of trading activity. Assets that
can be easily bought or sold are known as liquid assets. The ability to convert an asset to cash quickly
also known as Marketability. The ability of an asset to be converted into cash quickly and without any
price discount. There is no specific liquidity formula; however liquidity is often calculated by using
liquidity ratios. It is safer to invest in liquid assets than illiquid ones because it is easier for an investor to
get his/her money out of the investment. Examples of assets that are easily converted into cash include
blue chip and money market securities. For banks, liquidity management is about getting a fine return on
cash which they may need at short notice. They do this by borrowing and lending between each other using either money market securities or deposits and loans - in what is called the interbank market. Just as
the interbank market allows commercial banks to engage in liquidity management, Central Banks also use
money markets to manage their reserves, and in doing so can affect prevailing money market rates. This is
commonly achieved by manipulating the one market segment over which they have direct control, the
Treasury bill market. High liquidity means there is a lot of money because interest rates are low, and so
capital is easily available. However, a liquidity glut can develop if there is really too much money looking
for too few investments. This is usually a precursor to a recession, as more of this capital becomes
invested in bad ventures.
Liquidity for a bank means the ability to meet its financial obligations as they come due. Bank lending
finances investments in relatively illiquid assets, but it fund its loans with mostly short term liabilities.
Thus one of the main challenges to a bank is ensuring its own liquidity under all reasonable conditions.
Core liquidity: Cash and other financial assets that banks possess that can easily be liquidated and paid
out as a part of operational cash flows. Examples of core liquidity assets would be cash, government
bonds and money market funds. Banks typically use forecasts to anticipate the amount of cash that
account holders will need to withdraw, but it is important that banks do not over-estimate the amount of
cash and cash equivalents required for core liquidity because unused cash left in core liquidity cannot be
used by the bank to earn increased returns.
Liquid Asset: An asset that can be converted into cash quickly and with minimal impact to the price
received. Liquid assets are generally regarded in the same light as cash because their prices are relatively
stable when they are sold on the open market.
Cash Position: The amount of cash that a company, investment fund or bank has on its books at a specific
point in time. The cash position is a sign of financial strength and liquidity. In addition to cash itself, it
will often take into consideration highly liquid assets such as certificates of deposit, short-term
government debt and other cash equivalents.
Money market: The money market is better known as a place for large institutions and government to
manage their short-term cash needs. However, individual investors have access to the market through a
variety of different securities.

Liquidity cushion: A reserve fund for a company or person is containing money market and highly liquid
investments. This is a cushion used by large and small investors. By maintaining cash reserves in money
market instruments, unexpected demands on cash don't require the immediate sale of securities.
Current asset: A balance sheet account that represents the value of all assets that are reasonably expected
to be converted into cash within one year in the normal course of business. Current assets include cash,
accounts receivable, inventory, marketable securities, prepaid expenses and other liquid assets that can be
readily converted to cash. In personal finance, current assets are all assets that a person can readily
convert to cash to pay outstanding debts and cover liabilities without having to sell fixed assets.
Current liability: A company's debts or obligations that are due within one year. Current liabilities appear
on the company's balance sheet and include short term debt, accounts payable, accrued liabilities and
other debts.
Maturity mismatch: The tendency of a business to mismatch its balance sheet by possessing more shortterm liabilities than short-term assets and having more assets than liabilities for medium- and long-term
obligations. How a company organizes the maturity of its assets and liabilities can give details into the
liquidity of its position.
What is liquidity Management?
Cash and liquidity management is about forecasting the companys cash needs to run its businesses and
then managing the group wide cash flows, short-term borrowings and cash in the most efficient manner to
ensure that those cash needs can be met. With the help of IT and communications systems, cash can be
pooled internationally and used to best advantage. Funding and liquidity needs are intimately connected
with understanding and managing working capital and the payments and cash reporting systems to best
advantage. Some ratios can be used to analyze the liquidity position of a bank.
(a) Liquidity ratios: A class of financial metrics that is used to determine a company's ability to pay
off its short-terms debts obligations. Generally, the higher the value of the ratio, the larger the
margin of safety that the company possesses to cover short-term debts.
Current Ratio: A liquidity ratio that measures a company's ability to pay short-term obligations. This
ratio is mainly used to give an idea of the company's ability to pay back its short-term liabilities (debt and
payables) with its short-term assets (cash, inventory, receivables). The higher the current ratio, the more
capable the company is of paying its obligations. Also known as "liquidity ratio", "cash asset ratio" and
"cash ratio".

Current Ratio =

Currents Assets
Current Liabilities

Total debt-to-asset: A metric used to measure a company's financial risk by determining how much of the
company's assets have been financed by debt. Calculated by adding short-term and long-term debt and
then dividing by the company's total assets.

Total debt Total Assets=

Short term debt+ Long term debt

Total Assets

(b) Trend Analysis: An aspect of technical analysis that tries to predict the future movement of a
stock based on past data. Trend analysis is based on the idea that what has happened in the past
gives traders an idea of what will happen in the future. There are three main types of trends:
short-, intermediate- and long-term.
Liquid Assets of a Bank:
An asset that can be converted into cash quickly and with minimal impact to the price received. Liquid
assets are generally regarded in the same light as cash because their prices are relatively stable when they
are sold on the open market. For an asset to be liquid it needs an established market with enough
participants to absorb the selling without materially impacting the price of the asset. There also needs to
be a relative ease in the transfer of ownership and the movement of the asset. Liquid assets include most
stocks, money market instruments and government bonds. The foreign exchange market is deemed to be
the most liquid market in the world because trillions of dollars exchange hands each day, making it
impossible for any one individual to influence the exchange rate. Cash and other financial assets that
banks possess that can easily be liquidated and paid out as part of operational cash flows. Examples of
core liquidity assets would be cash, government bonds and money market funds. Banks typically use
forecasts to anticipate the amount of cash that account holders will need to withdraw, but it is important
that banks do not over-estimate the amount of cash and cash equivalents required for core liquidity
because unused cash left in core liquidity cannot be used by the bank to earn increased returns.

Cash in hand: Amount of money of a bank, which stay in hand of that bank to meet recent needs.
Generally, bank keeps enough money in hand. As a result liquidity risk is minimized.
Items in the process of collection: Some amount of money which keeps in the process of making
cash.
Reserve in Bangladesh Bank: Every schedule bank has reserve requirement where every bank
keeps 5% money on his total capital to the Bangladesh Bank. If a bank needs of money, he can
withdraw money from BBs reserve amount.
Balance with other banks: Every commercial bank has an account in other commercial banks
such as customer. If a bank needs of money, he can withdraw money from his account. As a result
liquidity risk is minimized.

Characteristics of Liquid Assets:

There are three characteristics involved in liquid assets, which are ready market, stable price and
reversible.
a) Ready Market: A liquid asset must have a ready market so that it can be converted into cash
without delay.
b) Stable Market: Liquid asset must have a reasonable stable price so that no matter how quickly
the asset must be sold or how large the sale is the market is deep enough to absorb the sale
without a significant decline in price.
c) Reversible: The seller can recover his or her original investment with little risk of loss.

Types of Liquidity:
There are several types of liquidity in banking sectors in our country which are immediate liquidity,
short-term liquidity, long-term liquidity, contingent liquidity, economic cyclical liquidity.
a) Immediate liquidity: When cash money is needed to pay in Cheques to demandable customers, it
is called immediate liquidity.
b) Short-term liquidity: Short-term liquidity is used to meet the monthly liquidity requirements.
Based on the types of clients and on the seasonal variability, the necessity of these types of
liquidity can vary.
c) Long-term liquidity: Long-term liquidity is required to meet the cash demand for replacement of
fixed assets, retirement of the redeemable preferred shares or debentures and to acquire new fixed
assets and technical know-how.
d) Contingent liquidity: It arises depending on the happening of some unexpected events. It is
difficult to guess this unexpected situation but not impossible though the amount cannot be
exactly predicted. Contingent liquidity is also required to face the adverse situations created by
big bank robbery, fraud, arson or other accidents.
e) Economic cyclical liquidity: Based on good or bad economic situation, the supply of bank
deposit and the demand for loan varies. Due to this variation, the liquidity demand also varies.
But it is very difficult to identify the extent of such variation. Generally, difficult national and
international events such as political instability, war, the pressure created by the different interest
groups relating to the banking activities are the causes of economic cyclical liquidity needs.
Liquidity Risk:
Liquidity risk is the current and prospective risk to earnings or capital arising from a banks inability
to meet its obligations when they come due without incurring unacceptable losses. Liquidity risk
includes the inability to manage unplanned decreases or changes in funding sources. Liquidity risk
also arises from the failure to recognize or address changes in market conditions that affect the ability
to liquidate assets quickly and with minimal loss in value.
Sources of liquidity risk:

Incorrect judgment and complacency

Unanticipated change in cost of capital
Abnormal behavior of financial markets
Range of assumptions used
Risk activation by secondary sources
Break down of payments system
Macroeconomic imbalances

Central Banks Liquidity Management:

The liquidity management of a central bank is defined as the framework, set of instruments and
especially the rules the central bank follows in steering the amount of bank reserves in order to control
their price (i.e. short term interest rates) consistently with its ultimate goals (e.g. price stability). The note
presents a basic theory of liquidity management in a framework of substantial reserve requirements and
averaging, focusing on the relationship between quantities (central bank balance sheet items) and
overnight rates and the involved signal extraction problems. Some elements of a normative theory of
liquidity management are suggested.
The purchase, sale and rediscount of bill of exchange and promissory notes drawn on and payable in
Bangladesh are also included in the activity of the bank. The bank acts as the lender of last resort for the
government as well as for the country's scheduled banks. All scheduled banks are required to maintain a
minimum reserve with the Bangladesh Bank. The present statutory liquidity reserve (SLR) requirement is
18.5% of total demand and time liabilities, 5.5% of which is to be maintained as cash reserve ratio (CRR),
and the rest 13% as approved securities. The SLR requirement for Islamic banks is 10% and they are to
keep 5.5% of this reserve as CRR and the rest 5.5% in approved securities.
Bangladesh Bank runs a Deposit Insurance Scheme established under the Deposit Insurance Ordinance
1984. The objective of the scheme is to safeguard the deposits of the customers with both local and
foreign deposit money banks doing business in Bangladesh. The deposits amounting up to Tk. 100,000 of
all customers in a scheduled bank are insured under the scheme. All scheduled banks in Bangladesh are
required to be members of the scheme and pay premium on their deposits at a rate determined by the
Bangladesh Bank from time to time. Bangladesh Bank accumulates the premiums in the Deposit
Insurance Fund.

Particulars
Cash (in hand)
Particulars
Deposits

2015
2,391.18
2015
194,825.10

2014
2,340.06
2014
204,837.73

2013
2,683.87
2013
201,907.14

2,800.00
2,683.87

2,700.00
2,600.00
2,500.00
2,400.00

2015
2,391.18

2,340.06

2,300.00
2,200.00
2,100.00
Cash (in hand)

2014
2013

206,000.00

204,837.73

204,000.00

201,907.14

202,000.00
200,000.00

2015

198,000.00
196,000.00

2014

194,825.10

2013

194,000.00
192,000.00
190,000.00
188,000.00
Deposits

Particulars
2015
Loans, advances and
151,864.53
lease / investments
Particulars
2015
Borrowings
from
other
10,442.20
banks
12,000.00

2014
147,366.65

2013
153,588.76

2014
7,668.88

2013
3,858.26

10442.2

10,000.00
7668.88

8,000.00

2015

6,000.00
3858.26

4,000.00

2014
2013

2,000.00
0.00
Borrowings from other banks

156,000.00
153,588.76

154,000.00
152,000.00

151,864.53
2015

150,000.00
148,000.00

2014
147,366.65

146,000.00
144,000.00
Loans, advances and lease / investments

2013

Particulars
Borrowings
banks

from

2015
10,442.20

other

2014
7,668.88

2013
3,858.26

Liquidity Gap
27,000.00
26,415.03
26,000.00
25,000.00

24,460.71

24,000.00

23,029.61

23,000.00
22,000.00
21,000.00
0.5

1.5

2.5

3.5

Cash Reserve Requirement (CRR) and Statutory Liquidity Ratio (SLR)

Cash Reserve Requirement and Statutory Liquidity Ratio have been calculated and maintained in
accordance with section 33 of Bank Companies Act, 1991 and MPD circular nos. 01 & 02, dated June 23,
2014 and December 10, 2013 & DOS circular no. 1 dated 19 January 2014. The Cash Reserve
requirement on the Banks time and demand liabilities at the rate of 6.5% has been calculated and
maintained with Bangladesh Bank and 13% Statutory Liquidity Ratio for conventional banking and
5.50% Statutory Liquidity Ratio for Islamic banking, excluding CRR, on the same liabilities has also been
maintained in the form of treasury bills, bonds and debentures including FC balance with Bangladesh
Bank. Both the reserves maintained by the Bank are in excess of the statutory requirements, as shown
below:
Particulars

Amount in Taka

a) Cash Reserve Requirement

Required reserve
Actual reserve maintained (note-3a.2)
Surplus / (deficit)
b) Statutory Liquidity Ratio
Required reserve
Actual reserve maintained- (note-3a.5)
Surplus / (deficit)

2015
13,236,417,440
14,336,197,689
1,099,780,249

2014
13,100,234,670
13,528,018,067
427,783,397

25,422,733,180
64,877,278,167
39,454,544,987

25,077,954,010
74,077,853,175
48,999,899,165

Total required reserve

Actual reserve held
Total surplus

38,659,150,620
79,213,475,856
40,554,325,236

38,178,188,680
87,605,871,241
49,427,682,561