Liquidity risk management : a comparative analysis on the core domestic banks in Malta

Abstract

The core objective of this research is to examine the extent of liquidity risk associated with financial institutions, particularly by comparing the core domestic banks in Malta, and evaluate their concurrent management of this risk. The banking sector is seen as an important source of financing for many businesses and organisations. In order to keep the integrity and reliability of the banking sector, information about risk and how fluctuations are managed have to be considered. One of the financial risks to be analysed is liquidity risk. Liquidity risk refers to the extra transactional cost, excessive loss of value and exorbitant stretches of time that banks have to face at the time of allocating liquidity to the third party when stipulated. Liquidity risk has to be managed and monitored effectively and cautiously. Liquidity Risk Management has become increasingly vital in the banking industry, especially with the recent financial meltdown and economic down-turn. It has become an integral part of the asset and liability management process. Liquidity risk does not need to be covered by equity but by a sufficient amount of liquid assets and securities. This might be a reason why the regulation of liquidity risk in banking is mainly concentrated on liquidity ratio-based financial constraints. Banks can be exposed to double-runs on assets and liabilities when providing liquidity to credit-line borrowers and depositors. It is an important task for banks to create effective policies and standards that are appropriate to measure and manage their liquidity positions on an on-going basis. In order to establish the liquidity risk of these domestic core banks, investigations will be undertaken on different liquidity ratios such as Current Ratio, Non- Interbank Lending, Return on Capital Employed and Debt-to-Equity Ratio amongst others. This study will be based on secondary data covering four years dating back from 2013 to 2015, whilst also taking data from 2009 as reference, this being the year after the global financial crisis. For this study, I am going to take both a qualitative and quantitative approach by distributing a set of questions to senior risk management employees for the comparative analysis of the domestic core banks and by doing a ratio analysis between the banks. This study will look at the banking regulations, more specifically on Basel II Pillar 3 which regulates market discipline. This pillar aims to complement the minimum capital requirements and supervisory review process by developing a set of disclosure requirements which will allow the market participants to measure the capital adequacy of an institution. One of the major aims is to enable market discipline to operate by the required domestic banks in Malta. They should disclose any details on the scope of capital, risk exposures, risk assessment processes, and the capital adequacy of the institution. Consequently, this study seeks to highlight the on-going liquidity risk condition of the domestic core banks and the importance of numerical indicators which will affect their liquidity risk level. A comparative analysis on the domestic core banks will also help to give a result on which bank is moving on the right track in terms of liquidity risk management.