The Impact of Risk on Banking Business and on Socio-Economy

The core work of management is risk control. Risk control is the use of measures, techniques, tools, strategies, and operational programs to prevent, avoid, or minimize losses and unexpected impacts that may occur to the bank. There are risk control measures such as: Risk avoidance measures, loss prevention, loss reduction, risk transfer, risk diversification, information management, etc.

1.1.2.2.5 Risk financing

When risks occur, it is necessary to first monitor and accurately determine losses in assets, human resources, and legal values. Then, appropriate risk financing measures are needed. These measures are divided into two groups: self-overcoming risks and risk transfer.

1.1.3 Causes of risks in banking business

1.1.3.1 Group of causes related to the bank's management capacity

There are many reasons related to management capacity leading to risks in banking business. However, the lack of tight liquidity management leading to lack of payment capacity is the most important reason leading to risks for banks. In addition, lending and investing too recklessly also leads to risks, specifically in lending, banks concentrate too much capital on a certain business or economic sector, in investing, banks only focus on investing in a type of high-risk securities. And due to lack of understanding of the market, lack of information or incomplete information analysis, banks lend or invest inappropriately. In addition, there are also reasons due to illegal business activities, embezzlement, bank staff lacking professional ethics, weak professional qualifications, ... all of which are reasons leading to risks in banking business.

1.1.3.2 Group of causes related to customers

Causes from the customer side such as the customer borrowing capital lacks legal capacity, using the loan for the wrong purpose, ineffective, continuous loss of income channel, unsold goods... On the other hand, the customer's unreasonable capital management leading to lack of liquidity or the business owner borrowing capital lacks management capacity, embezzlement, fraud are also causes of risk for the bank.

1.1.3.3 Group of objective causes related to the business operating environment

There are many objective reasons such as natural disasters, fires, unstable security and political situations in the country and region. Or due to crisis, economic recession, inflation, imbalance in the international balance of payments leading to erratic exchange rates, unfavorable legal environment... also lead to risks in banking activities.

1.1.4 Impact of risks on banking operations and on socio-economy

In banking business, the first risk that affects is the possibility of causing loss of assets to the bank. Common losses are loss of capital when lending, increased operating costs, decreased profits, decreased asset value... Besides, risks reduce the reputation of the bank, the trust of customers and can lose the bank's brand. A bank that continuously makes losses, a bank that is often unable to pay can lead to a crisis of mass withdrawals by customers, and bankruptcy is the inevitable path. From there, it affects thousands of people who deposit money in the bank, thousands of businesses do not have their capital needs met... causing the economy to decline, prices to increase, purchasing power to decrease, unemployment to increase, causing social disorder and furthermore, leading to the collapse of a series of domestic banks.

In addition, the risks of banks also affect the world economy, because in the current conditions of integration and globalization of the world economy, the economy of each country is affected.

All countries depend on the regional and world economy. On the other hand, the relationship between currencies and investments between countries is developing very quickly, so banking risks in one country always directly affect the economies of related countries. This has been proven by the Asian financial crisis (1997), the South American financial crisis (2001-2002) and most recently the financial crisis in the US (2008).

1.2 Overview of bank liquidity risk management

1.2.1 The nature of liquidity risk

1.2.1.1 Concepts of liquidity

1.2.1.1.1 Liquidity:

Liquidity is the ability to access assets or funds that can be used to pay for things at a reasonable cost when the need for funds arises.

1.2.1.1.2 Liquidity risk

RRTK is the risk when a bank lacks funds or short-term assets that are viable enough to meet the needs of depositors and borrowers (Thomas.P.Fitch)

RRTK is the fluctuation in net income and market value of equity, arising from the difficulty of banks in immediately mobilizing available funds by borrowing or selling assets (Timothy W. Koch)

Thus, RRTK is a type of risk that appears in cases where banks lack the ability to pay, cannot promptly convert assets into cash, or are unable to borrow to meet the requirements of payment contracts.

1.2.1.1.3 Liquidity management:

Liquidity management is the effective management of the liquidity structure of assets and the good management of the portfolio structure of capital sources.

1.2.1.1.4 Liquidity supply:

Liquidity supply is the capital that increases the bank's funds, which is the source of liquidity for the bank.

1.2.1.1.5 Demand for liquidity is the demand for funds for the purposes of a bank that reduces the funds of that bank.

Table 1.1 Factors of liquidity supply and demand

Liquidity Supply S

Liquidity demand D t

1. Incoming deposits (S1)

2. Revenue from sales of services (S2)

3. Withdrawal of granted credit (S3)

4. Sale of assets in use and business (S4)

5. Other supplies (S5)

1. Customer withdraws deposits (D1)

2. Request for credit facilities (D2)

3. Repayment of non-deposit loans (D3)

4. Costs incurred in trading products and services (D4)

5. Payment of dividends to shareholders

East (D5)

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1.2.1.1.6 Net liquidity status:

Net liquidity position = Total liquidity supply – Total liquidity demand

(NLP t ) = (S1+ S2+ S3+ S4+ S5) – (D1 + D2 + D3 + D4 + D5)

Three possibilities can occur as follows:

 NLP t = 0: the bank is in a state of liquidity balance, this case is very rare in reality.

 NLP t >0: the bank is in a state of liquidity surplus

Due to the inefficient operation of the economy, banks cannot lend for investment. Within the scope of a bank, this is the work of not exploiting the full potential of assets, holding too many assets in direct or indirect forms that are not capable of generating profit (too large cash balance); or it could also be because the bank increases capital too quickly while not having an effective plan for capital use.

Managers must plan to invest surplus capital effectively (for example, buying previously sold secondary reserve securities, lending in the money market, depositing money at other credit institutions, etc.)

 NLP t <0: the bank is in a state of liquidity shortage

At that time, the bank will lose good investment opportunities that can bring profits to the bank, lose customers when they have to go to other banks to borrow. From losing customers to borrow capital will lead to losing customers to deposit, because of reducing the trust of depositors.

Managers must decide on appropriate funding sources and funding costs (for example, selling secondary reserves, borrowing overnight, borrowing from the State Bank of Vietnam, issuing large-denomination certificates of deposit to raise capital, mobilizing from the money market, etc.)

1.2.1.2 Causes of liquidity risk

1.2.1.2.1 Premise causes:

The first reason is the mismatch in the maturity of assets and liabilities. That is, banks mobilize and borrow capital with short terms, and at the same time circulate them to use for lending with longer terms. Therefore, many banks face a mismatch in the maturity of assets and liabilities. Rarely does the net cash flow on assets fit exactly to cover the net cash flow on liabilities. In fact, banks often have a significant proportion of liabilities that are characterized by having to be repaid immediately if the depositor has a need, such as demand deposits, term deposits that can be withdrawn before maturity, etc., so banks always face liquidity risk.

The second reason is the sensitivity of the main asset to changes in interest rates. When bank interest rates decrease (i.e. investment interest rates are higher than bank interest rates), many depositors withdraw their capital from the bank to invest in places with higher returns, while borrowers actively access credit because of lower interest rates. Thus, changes in interest rates simultaneously affect the flow of deposits as well as the flow of loans, and ultimately the liquidity of the bank.

Moreover, changes in interest rates also affect the market value of assets that banks can sell to increase liquidity, and directly affect the bank's borrowing costs in the money market.

The third reason is that banks must always meet liquidity needs perfectly. Liquidity problems or rumors of insolvency will reduce customers' confidence in the bank. One of the important jobs for bank managers is to always keep in close contact with customers with large deposit balances and customers with large unused credit lines to know their plans for when to withdraw money, and how much to withdraw so that appropriate liquidity plans can be made.

1.2.1.2.2 Causes from activities

Liability side: RRTK can arise at any time when depositors suddenly withdraw money, or force banks to borrow more or sell assets to meet liquidity needs. Of all asset groups, cash has the highest level of liquidity, so banks use cash as the first and direct means to meet liquidity needs. But cash does not bring interest income, so banks always tend to minimize assets in the form of cash. To earn interest, banks must invest in less liquid assets or in assets with long terms. However, some assets can only be converted into cash immediately at very low selling prices, thus threatening the ultimate solvency of the bank.

Asset-side causes: Risks arise in connection with credit commitments. A credit commitment allows the borrower to withdraw the loan at any time during its term. Once the credit commitment is made, the bank must ensure that there are enough funds to meet the needs of the customer, otherwise the bank faces risk.

1.2.1.3 The necessity of liquidity risk management

Rarely at any given time does the aggregate supply of payments equal the aggregate demand for payments. Therefore, banks must constantly deal with liquidity deficits or surpluses.

Besides, liquidity and profitability are two inversely proportional quantities: the more liquid an asset is, the lower its profitability is and vice versa; a highly liquid source of capital often has a high cost of capital mobilization, thus reducing the profitability when used for lending.

Recent studies have shown that the phenomenon of lack of liquidity, or deficit, is often one of the signs that a bank is in serious financial difficulty. The subsequent consequences may be that the bank gradually loses old deposits due to increasing withdrawal pressure, cannot attract new deposits due to the public's cautious attitude towards the bank, and some banks are in a state of reluctantly lending support because they have to mobilize capital at higher interest rates than lending rates, further reducing the bank's profits. The large-scale shortage of liquidity in some banks and becoming one of the causes of bankruptcy has confirmed that the liquidity problem cannot be ignored. Not only that, a bank's liquidity shortage will cause losses to the entire system. Because liquidity risk is widespread throughout the system, improving liquidity management capacity at each bank is a very important issue not only for each bank but also an urgent issue for the entire system.

Therefore, liquidity management is more important today than it was in the past, because some banks may be forced to close if they cannot meet their liquidity needs, even though they are technically still solvent. Moreover, liquidity management capacity is an important measure of the overall effectiveness of a bank in achieving its long-term goals.

1.2.2 Liquidity risk management content

1.2.2.1 General guidelines on liquidity management

Firstly, liquidity managers must constantly monitor the activities of the departments responsible for capital mobilization and use within the bank and coordinate the activities of these departments so that they are in harmony with each other.

Second, liquidity managers need to know in advance where and when depositors and borrowers intend to withdraw funds or replenish their deposits or repay loans.

Third, banks' liquidity needs and liquidity-related decisions must be analyzed on an ongoing basis to avoid perpetuating either surplus or deficit situations.

1.2.2.2 Market signals of liquidity risk

1.2.2.2.1 Public trust:

Banks will lose depositors because individuals and institutions fear that the bank does not have enough cash and may not be able to repay deposits.

1.2.2.2.2 Stock price fluctuations:

The bank's stock price fell, because investors realized that the bank was facing a liquidity crisis.

1.2.2.2.3 Applying a higher interest rate than the market:

When a bank applies an interest rate on deposits (deposits, bills, bonds) and accepts an unusually higher interest rate on loans than the market interest rate, or in other words, the bank accepts risks in the form of applying high borrowing costs because the bank is considered to be facing a liquidity crisis.

1.2.2.2.4 Loss on sale of assets:

If a bank is under pressure to sell assets in a hurry and is willing to take large losses to meet liquidity needs and the conversion of bank assets is frequent, the bank may be facing liquidity difficulties.

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