Adulrahman alkahtani
CHAPTER 1
INTRODUCTION AND RESEARCH METHODOLOGY
The dissertation presents a detailed evaluation of liquidity risk and crisis in banking and financial institutions. Moreover, it also explores the liquidity risk management strategies in Saudi Arabia. In order to support the discussion the dissertation discusses two Saudi Islamic banks i.e. Al-Rajhi bank and Albilad bank and their risk management strategies.
Background
The crisis of funding in any bank caused by the internal or external crisis confronted by the bank. Internal problems include risks such as operational and credit risk however, external problems involve market risks, country risks etc and liquidity risk arises as the consequence of all the internal and external problems of the bank. The bank should have optimized liquidity in order to avoid liquidity risks that can cause failure of the bank. Therefore, liquidity risks management is required for a bank to operate on a long term basis. Liquidity risk is of crucial importance when considering it with respect to a bank and it is regarded as one of the most challenging risks in banking and financing sectors. The term challenging is not due to the fact that it is misunderstood by the management of bank but because of the reason that the managers have to utilize different tools and instruments in order to deal with it and this can result in confusion related to liquidity risk management.
With the evolution of Islamic banking which provides with the banking solutions and financial services that are in compliance with the rules and regulations of Shariah, there is an increased trend of providing Islamic banking services not only in most of the Muslim countries but also in other countries around the world. Like the conventional banking system and financing institutions, Islamic banks face and confront liquidity risks and crises as well. There is very critical need of effective and efficient liquidity risk management in order to combat with the liquidity problems and crisis by monitoring, regulating, mitigating, and reporting liquidity issues in systematic manner.
Aims and Objectives
The aim of this research in Islamic finance is to explore and evaluate the liquidity risk and crisis in Islamic finance and banking industry putting especial emphasis on Saudi Islamic Banks such as Al-Rajhi Bank and Albilad Bank. It also reviews the processes and practices involved in liquidity risk and crisis management with regard to Al-Rajhi Bank and Albilad Bank, Saudi Arabia.
The research also has the objective of developing a comprehensive understanding of liquidity, liquidity risk, its impact in terms of banking and financial institutions and the liquidity risk and crisis management. It also clarifies the idea about the theory and principles of Islamic banking. Moreover it also accentuates on liquidity risk issues and crisis and on the effective management of these risks and crises with regard to the practices of Islamic banking. It also conducts a statistical analysis in order to evaluate and analyze the issues and problems related to liquidity risk management in practices and operations of Al-Rajhi bank and Albilad bank. It also presents the reflection on the empirical findings in order to generalize the concept of liquidity risk and crisis and the liquidity risk management in Saudi Arabia with respect to Islamic banking.
Research Questions
(i) What are the main and distinguishing characteristics of liquidity risk and its management in Islamic banking(ii) What kind of financial techniques and instrument can be used to apply liquidity risk management for Islamic banking system(iii) How are Al-Rajhi bank and Albilad bank managing their liquidity risk
Research Methodology and Method
This section discusses research methodology, research design, and research method proposed for this research dissertation.
Research Methodology
The major aim of methodology is to devise the research in a manner that it gives the comprehensive understanding of the objects of research and answer the research questions in a very understandable manner. The aims and objectives of this research dissertation could be met in number of ways. The research propagation could be systematic, random and direct. The systematic research starts from the very beginning and tells the back ground of the problem. It then accentuates on the problem, the reasons behind the problem, and what effects does the problem put on the system under consideration. Then the research propagates towards the solution of the problem and then makes an analysis if the proposed solution is implementable or not. The systematic approach is known to provide the best of understanding. However, with the random approach the research follows a random trial and discusses different significant details randomly without interlinking different topics of discussion. This approach does not give result as effective as that of the systematic methodology. While the direct approach just discusses the problem and its solution without shedding light on background of the problem, its scope, and effectiveness of the proposed solutions.
Research Design
The research in this dissertation is carried out in a stepwise manner that makes the nature of research design systematic and procedural. This design follows the systematic methodology of research dissertation. The design starts with the introduction that involves the background of the issue and its impact on the system under consideration. Then it defines the aims and objective of the research dissertation. It also sheds light on the research questions that the research dissertation would answer and clarify the concepts mentioned in the research questions. Then, it discusses the concepts of liquidity risks and crises and liquidity risk management in conventional banking. Then, it introduces the concept of Islamic banking and liquidity risk management in Islamic banking. Moreover, it discusses two Saudi banks and their operations and performances in terms of liquidity risks and crises management.
Research Method
In order to develop a research that provides complete and clear understanding of the research statement it is necessary to compile the research in a manner well understood by the reader i.e. in a systematic manner by developing connections between different phases and topics of research dissertations. The research methods accentuates on the discussion of liquidity risk management and its significance with regard to conventional banking around the world. The research then introduces conceptualization of Islamic banking, the manner it is different from conventional banking, and the ways it is more effective and efficient than conventional banking. It also focuses on developments and trends of Islamic banking and financing institutions in Saudi Arabia.
Limitations and Difficulties
The fact that every Islamic bank utilizes different instruments in order to deal with the financial implications and liquidity risks and crises, made it difficult to gather the generalized idea of situation of Islamic banking in Saudi Arabia. Moreover, the increased development and growth of Islamic banking has become such a vast field that it created difficulties in carrying out the comprehensive understanding of Islamic banking throughout the world and particularly in Saudi Arabia. In addition to these limitations, difficulties arose because of the limited availability of primary sources in order to carry out the extended research for this topic.
Overview of Research
The research encompasses all the major discussions and topics necessary in order to develop the comprehensive understanding of liquidity risk management and crises. It starts with the background of the problem of liquidity risks, its causes, and the effects on the performances and operations of banking and financial institutions in chapter one. Then in chapter two, it precedes one step further and discusses the impact of liquidity risks and its management in conventional banking and financial institutions. Then in chapter three, it accentuates on the Islamic banking and liquidity risk management with regard to it. In order to make the research more specific the liquidity risk management in Islamic banking is discussed with respect to Saudi Arabia in chapter four. In chapter five, the paper sheds light on two Islamic banks of Saudi Arabia (Al-Rajhi Bank and bank Al Bilad) and the manners in which they fulfill their liquidity requirement, confronts the liquidity crises, and manage the liquidity risks. Chapter six makes the conclusion for this research paper.
Chapter 2
LIQUIDITY RISKS AND LIQUIDITY RISK MANAGEMENT IN CONVENTIONAL BANKING A LITERATURE REVIEW
Liquidity risk is the possibility of loss to the earnings of any bank which results from either the inability to fulfill its responsibilities and duties or funding the increment in assets of the bank as it come down without undergoing unaccepted price or losses. Liquidity risk also originates when the bank fails to identify or deal with the variability in market situations that can put disastrous impact on the banks ability to liquefy the assets promptly having the minimum loss in value of any asset.
Liquidity risk is one of the significantly potential risks for conventional banks. It originates when the insufficiency of liquid assets arises in meeting its obligations and responsibilities. In situations like these that banks usually fulfill their liquidity needs and requirements from market. Nevertheless situations of getting funded with the help of market depend on the state of liquidity in market and the liquidity of the borrower bank. In accordance with that, the bank short of liquidity may need to go for the transaction at high costs that results in losses of earnings or in even worse situation it can also lead to the failure of operation of the bank when it shows inability in undertaking transactions at the prevailing market rates.
Banks that undergo exposing of large off-balance sheets or the banking bodies that depends greatly on the huge deposits of large corporations have the potential of having a liquidity risk of very high level. Moreover, there exists a significant potential of liquidity risk for banks that experience a quick and exponential growth in assets. Liquidity risk in any bank induces never comes alone it also make rooms for other substantially potential risks as credit risk and market risks. The reason behind the triggering of other risk factor by one risk factor i.e. liquidity risk is the fact that financial risks are mutually inclusive and progress in one risk factor can induce development in other factors as well. For example, an increment in credit risk of a bank results in increment of liquidity risk as well. Moreover, if management fails to estimate properly the effect of liquidity while starting a new business then it would induce greater strategic risk for banks.
Early Warning Indicators of Liquidity Risk
An inchoate liquidity exercise may initially get noticed in the financial monitoring system of the bank as a course of negative slope with significantly potential long-run results for profits or capital. This part accentuates on some of the early warning indicating factors that not always
result in a liquidity deficit nonetheless have significant potential to set the liquidity problem on fire. As a result, the management has to keep check for these indicators and analyze it further as to nip the evil liquidity problem in the bud. These warning indicators include
A negative slope or tremendous increment of risk with regard to any business
The concentrated state of assets and liabilities
Declension of quality in credit functions
Quick development of assets funded by huge temporary deposits
Large size exposing of off-balance sheet
Degenerating the arbitrator rating about bank
Liquidity risk management in conventional banks also focuses on the manner in which meeting of funding needs and requirements are satisfied. It includes recognizing the market the bank has accessed for funding, identifying the type of these markets, making evaluation about the current and future utilization of market funds by banks and monitoring signals of eroding of confidence.
Board and Senior Management Oversight
In order to establish an effective and efficient liquidity management the banks have a well-informed board, able management, expert staff, effective systems and efficient and strategic procedures. The duty of the board is to make comprehensive understanding of the liquidity risks attached to the bank and setup effective tools in order to mitigate these risks. Moreover, it should have an efficient risk management framework that can face even the worst of unequal liquidity situations. In general, the responsibilities of board include proper positioning of banks direction of strategies, to make appointment of efficient and talented staff, continuous monitoring of liquidity risks and banks performance against it, and ensuring that liquidity risk is undergoing proper identification, monitoring, and control.
Liquidity Risk Strategy
The board defines liquidity risk strategy as to clearly address the policies on specific issues related to liquidity risk and its management. These strategies include
Assets and Liabilities Proportion
The strategy for liquidity risk management in conventional banking highlights the right proportion of assets and liabilities as to do effective maintenance of liquidity. Asset and liability management is effective in terms of managing the liquidity risk as to prevent the higher slope of costs that transform the asset and liability stats from maximized profits and gains to increased liquidity risks.
Making Liabilities Stable and Diversified
In many situations concentration of funds take place when immediate withdrawal of funds or assets depends on only one factor, this leads to an increased liquidity risk. Therefore, the strategy in order to manage liquidity risk is thus designed as to make sure that bank has diverse sources of funding in daily liquidity needs.
Making the Accession to Inter-Bank Market Possible
The inter-bank market can play a significant role in terms of the liquidity risk therefore the strategic policy takes this situation into consideration as well because in hard times accessing inter-banks markets gets tedious and costly as well.
Liquidity Risk Management Process
There always exists the need of liquidity risk management processes in order to perform identification, measurement, monitoring, and controlling the liquidity risks and exposures. In order to identify the liquidity associated risks properly it is necessary to realize the possible present and future liquidity exposures.
Management Information System
An efficient management information system is necessary to make calculated decisions related to liquidity risk management. The prime concern in this regard is the fact that information should be readily accessible for daily liquidity management and controlling the risks associated to it. MIS promotes the appropriate consolidation of data, its comprehensiveness, and making it focused and readily available. Generally, the reports generated by banks allows the MIS to do effective liquidity monitoring during the times of peace and crisis, the only difference is the fact that during the crisis managers would be needed to produce reports in a more frequent manner. Moreover, the banks focus on appropriate and timed flow of information through the system in a systematic as to ensure effective management of liquidity risks.
Measuring and Monitoring Liquidity Risk
In order to perform appropriate management of liquidity risk it is necessary for banks to have an efficient and effective measurement and monitoring system. These days the conventional banks focuses more on constituting systems, enabling banks to foresee liquidity risk before time as to take appropriate precautionary measurements and thus, avoiding any significant or non significant losses. It is obvious that liquidity risks affect different banks with different intensity depending on the size of banks and nature of its businesses therefore the needs for measuring and monitoring liquidity risks are served accordingly.
Contingency Funding Plans
Contingency funding plan is basically a combination of strategic policies and systematic procedures that plays the role of basic draft or design that guides the bank in meeting its funding requirements within time and at minimal cost. It serves as the savior for banks in the times of crisis. The contingency funding plan holds its basis on cash flows in time to come and the funding sources for a bank under the worst market situations. The plan can render an effective outline and framework in order to manage liquidity risk for both short and long term market situations. Moreover, it aids in ensuring that the bank can perform effective management in situations like significant fluctuations and steep changes in liquidity.
Contingency funding plan is equally useful for both everyday liquidity risk management and emergency liquidity management. For every day liquidity risk management scenario, contingency plan makes sure that the bank is ready to confront any of the liquidity problems and serves as an add-on to the current liquidity management system. In this situation, the contingency funding plan ensures maintenance of sufficient liquid assets, measuring and monitoring funding needs in different situations, and effective management of making funding sources accessible. On the other hand, the liability strategy involves particular procedural policies as pricing procedure, assistance in case of crisis, early redemption policy, utilization of discount window etc. A good contingency funding plan is not exhausting at all as the banks understand its significance and invest due time and efforts in setting this plan.
Cash Flow Projections
At the elementary stage, banks use the measurements of cash flow in order to analyze its cash situation. The cash flow projection calculates the net deficit or net profit by utilizing the net inflow and outflow of bank over a certain time period. One most significant example of cash flow projection is already discussed in this paper under contingency funding plan. Another significant tool in this regard is the maturity ladder that is practicable in comparing the inflow and outflow of cash not only in daily businesses but also over substantial time span.
For short period of time, the calculation of banks funding flow is obviously more accurate moreover these calculations holds more significance as they indicate the steps to be taken spontaneously while managing liquidity risks. In addition to that, for longer time periods a very clear advantage for banks would be the fact that it would have ample time to do effective GAP management before it solidifies. Similarly banks utilize shorter spans of frames to do measurement of relatively near exposition risks.
Liquidity Ratios and Limits
Conventional bank utilizes numerous ratios in order to measure liquidity. These ratios are useful when creating limits or margins for effective liquidity risk management. Nonetheless, the ratios would not be of any significance without regular and substantially considered quality factors these ratios are always valid when used with more quality oriented information about lending capability for instance, likeliness of increased withdrawals before time, decrement in credit, decrement in size of transaction, decrement of funds accessible by the bank etc. But these ratios are of pivotal importance as the decisions related to any asset or liability management holds their basis on the existence of these financial ratios. Therefore, conventional banks around the world understand the importance and significance of these financial ratios. This is one of the main reason that every bank management personnel has knowledge about the construction of these ratios, other significant information that can be utilized as substitutes, and the significance of results derived from these ratios. Many a times these ratios can end up in ambiguous results as the components or factors in denominator or numerator are not always constant hence, banks takes special care in this regard while making comparisons of different quantity frames. The paper discusses some of the most commonly used ratios in terms of liquidity risk management.
Ratio of cash Flow and Limits
One of the most significant causes of serious liquidity risk originates from the banks inability to invest an increasing liability. The ratios of cash flow and limits try to perform measurement and controlling of the size of liabilities increment within a particular time span.
Concentration of Liability Ratios and Limits
These ratios are useful in preventing a bank from depending on too less sources of funds. The limits in these ratios are generally represented as either a fraction of liquid assets or the original amount.
Other Balance Sheet Ratios
Total lending total depositions, total lending total equity capital, borrowed funds total assets etc are some of the common examples of ratios found within banks in order to continue monitoring present and future levels of funds.
In addition to these limits and requirements, the bank management performs establishment of margins and limits on the type and quantity of liquidity risk it wants to presume. These margins undergo consistent reviews, revisions, and adjustments as to cope up with changing liquidity risk situations. While putting limits to exposition of risk, management considers the appropriateness of strategic policies and procedural activities of bank, its history of operations, height of earnings, capital accessible as to recover from losses, and the capability of tolerating risk. Setting limits or margins does not prevent from liquidity risk and crisis but it is very helpful in before time indication of potential liquidity risks and problems.
Internal Controls
In order to effectively implement the strategic policies and procedures, banks constitutes revision processes that make sure the compliancy of different procedures and margins appointed by the management. Independent bodies perform the review process on regular basis, and the complexity of review is directly proportional to the size of bank. The reviewers perform verification of quantity of liquidity risks and the compliancy of management with these margins and operational procedures.
Monitoring and Reporting Exposition of Risks
The management takes reports on the height, intensity, and nature of the liquidity risk of bank at least once in three months. A latest trend in this regard is that of incremental reporting it enables the liquidity monitoring via series and sequence of elementary liquidity reports during normal situations however, ratchets not only in frequency but also in information included in report during crisis. These reports play an effective role in indicating to the management about the liquidity situation and the managements performance in confronting the liquidity risks.
Chapter 3
LIQUIDITY RISKS AND ITS MANAGEMENT IN ISLAMIC BANKING
The notion of Islamic Banking has gained significant importance in several countries of the world. In many countries like Pakistan and Iran complete adoption of Islamic Banking has taken place according to the laws and regulations of Shariah. However other countries like UAE, Malaysia, Saudi Arabia, Kuwait, etc offers Islamic Banking along with conventional banking. This is achievable either by opening the branches or windows of Islamic banking in conventional banks or by establishing distinguished and separate banks under the umbrella of Islamic rules and regulations that particularized in Islamic finance. The services of Islamic finance and banking involves an incrementing range of sub-organizations as commercial banks, investment banks, and different insurance and investment companies nonetheless, banks still hold the credit for being the prime financial service providers in most of the Islamic countries.
With regard to Islamic banking, liquidity risk is a very substantial risk that comes into existence due to the limited availability or complete unavailability of instruments and facilities such as money market tools and lender of last resort (LOLR) services that are compatible with Islamic laws and prevent liquidity risks to affect bank as well. The latest conceptualization of murabahah and tawarruq in many countries of the world has emerged as a very innovative solution to liquidity risk management. These concepts have gained utmost significance as the tools and instruments for Islamic banking in order to perform effective and efficient management of liquidity risks.
Liquidity management is one of the most prime concerns in the banking sector. Customer deposits their funds in a bank with utmost confidence that it can perform the withdrawal any time it wants. The capability of bank to disburse these funds is of great importance as all the business of the bank relies on this particular ability and failure in doing so can cause disastrous results. Generally, liquidity implies to the capability of trading instruments readily at reasonable cost with regard to the prevailing demand and supply situations depending upon the depth, width, and resiliency of the market at minimized operating cost. A liquid asset is the asset who complete present worth is realizable and that can be converted into buying power in comparison to other product, commodities, goods, and services. Cash or funds are perfectly liquid assets and this is the reason that they are the most effective and efficient mean of depositions, investments, and transactions around the world. The significance of liquidity holds no other parallels as the shortage or deficit of liquidity in any banking institution can induce reverberation that causes damage. Thus, it is very critical and significant for Islamic banks to employ an appropriate and calculated strategic policy in order to achieve enough and adequate funding quickly and that too at very reasonable operating costs.
The issue of liquidity risk is also critical to Islamic banking that perform holding of non-liquid assets when the liabilities pertaining to it are in the liquid form, and have the assets in hands whose value is not predictable while giving the guarantee of value of the liabilities. AS Islamic Banking systems adopt the same organizational structure and properties as that of the conventional banks, they are prone to liquidity risks and crisis as well. The significant mismatching between the two factors of deposition and investment financing opens up the doors of Islamic banking for liquidity crisis. On the contrary, if the bank focuses too much on maintaining liquidity as to prevent the liquidity crisis results in considerable losses in terms of business profitability to the bank. Hence, the only solution for Islamic banks in this regard is to maintain equal balance between the goals of maintaining safety and achieving profitability and this is the most significant point in management of liquidity crisis in Islamic banking as well.
One of the most significant examples of mechanisms used for the management of liquidity risks and the risks associated to it is that of the Inter-bank Moment market (IIMM). This conceptualization was first introduced in Malaysia and since then it is one of the most commonly used instrument used in this regard. Its basic aim is to enable the Islamic banks with ease and option for funding and making adjustments in profiles in no time and thus performing the maintenance of funds. This setup is very essential in order to encourage and elevate constancy in the bank. The most significant aspect of this instrument is the fact that it renders the platform for Islamic banking in order to do effective and efficient management of liquidity risks and crisis without challenging the laws, rules, and regulations of Shariah. In order to establish and develop a vivacious, fully effective and efficient IIMM it is necessary to create the wide scope of creative and innovational instruments related to Islamic finance and banking and the substructure to appreciate and encourage active trade activities in order to make enhancement in depth and width of the market.
Although liquidity risks are dangerous for banks following Islamic finance as well however, according to a theory the risk is minimal as compared to other conventional banks at present. Islamic banks have relatively less exposure which results in less instable systems. The ideal Islamic banking model involves the balance sheet of the bank that accentuates on the profit-loss sharing not only in terms of assets but also with regard to liabilities as well. In these situations, it appears that the depositors or funders who have shared potential risks with their bank in terms of liabilities would get affected by any negative steep in terms of asset in the balance sheet of the bank. It implies that any crisis arising for the bank is not only confronted by the bank but the depositors and the investors have their share of bad impacts as well. The actual value of the assets pertaining to the bank is the value of the funder or depositors assets. Therefore, Islamic banking has appeared as one good substitute for the conventional banking with some real positive add-ons attached to it and the reason behind this statement is the fact that that Islamic banking system is more robust and provides greater stability as compared to the conventional banking system around the world.
Nevertheless, the practices and operations of Islamic banking around the world are found to be too different in many significant ways from the theoretical concepts of Islamic finance and banking visualized by the experts and scholars belonging to the Islamic world. The practices dont focus on strict divvying up gains and losses with funders and depositors, the process of distributing gains even if there are no or low gains that results in deteriorations which in turn put stress on the assets or equity of depositors. Moreover, in Islamic banking most of the situations are based on retail deposition principles and program for both current and savings that are the results of different contracts Wadiah Yad Dhamanah i.e. guaranteed safekeeping or Al-Qard i.e. loan. These are the rules and schemes that are the guaranteed primary agreements regardless of the gainfulness with regard to its asset. The persisting exercise of presenting hibah i.e. gift at the price equal to the price of return on depositions proposed by conventional banks and it deteriorate the perfect and ideal structure of Islamic banking. As a result, Islamic banks fall back to other lines of fixed return tools. The other instruments involve murabahah i.e. cost plus sale, bai bithaman ajil i.e. postponed or deferred payment sale, bai al-salam i.e. purchasing with postponed delivery, bai al-istisna i.e. accredited manufacturing, and ijarah i.e. leasing and many other similar instruments directed at concrete and fastened profits.
One major consideration for which Islamic banks face great criticism for not setting preference level for long termed developmental projects over short-spanned projects desired to achieve rapid profits. This particular aspect is more close to that of the conventional banks that prioritize short-spanned projects and investments as banks operate on the grounds of small deposits and reserves and therefore, it has the ability to liquefy its assets in a very rapid manner in case of crisis and different requirements. This short spanned design of the Islamic banks around the world become more pronounceable with the account of predominant position of contracts and agreement that have their ground on debt or fixed return policies such as murabahah and leasing with respect to the assets in the balance sheet of Islamic banks. The design of depositions with respect to liabilities that is not appropriate for long-term projects that further focuses on the resistance of Islamic banks to in order to participate in long-spanned projects. Therefore, from the viewpoint of necessity, the functions of Islamic bank are not very different from conventional banking.
One of the most significant approaches to effective liquidity management is the capability of a bank to approach to secondary market as that of capital market and IIMM. The IIMM usually implies to borrowing and lending processes for annual or biannual spans of time. This international money market has emerged as the platform for finance organizations and governmental bodies in order to perform management of short-spanned liquidity requirements. Therefore, banks usually anticipate managing liquidity not only with respect to the assets but also in terms of liabilities of the balance sheet. Moreover, banks also expect to maintain the active participation in international money markets. They consider these markets as the origin for discretional skills with respect to short-spanned funds on grounds of interest-rate competition. Interest-rate competition is a process that can assist banks in fulfilling their liquidity requirements.
There are numerous short-spanned liquidity tools and techniques in conventional banking and formal money-markets that render different offers for returns and investments. These tools involve treasury bills, deposits certificate, and agreements of repurchasing, acceptance of banks, commercialized papers and money deposits regarding international banking. All these techniques have dissimilar properties relating to the maturity spans that are very diverse. In short, IIMM permits surplus banks to carry funds to deficit banks utilizing numerous instruments and therefore performing the maintenance of funds and liquidity risk, which is essential step in promotion of stability in the banking system. Nonetheless, most of these tools utilized in inter-bank money market necessarily hold its basis on interest. Hence, the development and establishment of an executable Islamic money market with instruments that share compliancy with Shariah. This is necessary for the polished development of the banking industry.
The early endeavors in overcoming the crisis of liquidity management focused on creation of short-spanned and long-spanned debt tools that are in accordance with and in compliancy with the laws and regulations of Shariah. This was apparent in some legal jurisdictions by issuing of various Islamic finance tools and techniques that are equally good for long-termed and short-termed bindings in order to fulfill the liquidity management needs and investment requirements of Islamic banking organizations around the world. Another very significant and substantial instruments and techniques that are utilized in managing the short-spanned liquidity crises and problems in Islamic world, particularly in the Gulf and Middle Eastern regions is that of Commodity Murabahah.
Another significant point with regard to Islamic banking is the fact that it performs the tracing of number of depositors or investors in bank. One manner to perform this is when established rate of return is more than the Islamic rate of return, how many of the Islamic funds it takes to be moved into conventional funds. It will be beneficial for the bank due to impact of liquidity reversal, caused by this technique. This is done by creating special task forces, team or working groups to supervise, regulate or control, analyze and monitor the significance of liquidity risks and crisis towards the bank. The process begins by keeping track of flow of liquidity to the expected mismatch between the asset and the liquidity. This sets up a policy internal to the bank and linked to the partners of the business, and to design the procedural strategy in order to detect the liquidity crisis. The process is continued until the design of bureaucracy connected to the banks strategy face unanticipated liquidity requirement.
One major practice in this regard is the preparation of cash or liquidity in reserve for particular situations. Islamic banks require liquidity in order to perform execution of regular and random transactions. The regular transactions implies to the daily operation of the bank whereas the random transactions refers to the two specific situations, first situation is the fact when random transactions are estimated or predicted while the second category in this regard refers to the random and the unpredictable liquidity requirements. The predictable random liquidity requirements involve the Islamic banks duty to render different services. On the other hand, the unpredictable and random liquidity requirements are the result of sudden liquidity shortage.
Chapter Four
ISLAMIC BANKING IN SAUDI ARABIA DEVELOPMENTS AND TRENDS
The chapter analyzes the history of Islamic banking in Saudi Arabia. It also accentuates on the present situation in terms of Islamic finance in the kingdom. Moreover, it performs the detailed study of developments and trends found within the country with regard to Islamic Financial Institution and their practice in Saudi Arabia.
A very significant in banking operations holding its ground on Shariah i.e. Islamic Banking arose in many parts of the world and especially in Saudi Arabia. Theoretically, the rules and regulations of Islamic banking are in accordance with the Islamic principles of Halal and haram i.e. a Muslim can do the trading or investment in any business that is allowable (Halal) in Islam and cannot take part in any business activity that is non-permissible (Haram) is Islam. Haram activities generally involve businesses that are unlawful and unethical for example, gambling, prostitution, drugs, alcohol, and many other businesses like this. The main consideration in this regard is the classification of the interests being charged on different funds in accordance with Shariah.
Saudi Arabia shares and enjoys rich history in terms of Islamic banking not only in Saudi Arabia but also in different parts of the worlds. Prince Mohammad Bin Faisal of the kingdom was the founder of Islamic Banks in many Arab countries like Egypt and Sudan. Al-Baraka Bank is also the result of endeavor of Saudi businessman Sheikh Saleh Kamal, this banks has its branches spread in different parts of the world. In 1984, Al Rajhi Bank took a bold step in seeking the Islamic Banking license in Saudi Arabia. At that point of time, Al Rajhi bank was already one of the largest financial groups in the kingdom but it wanted its recognition as an Islamic Financial and Banking institution. Now, the institution has become as the largest Islamic finance organization in the world with total assets exceeding 10 billion. It also enjoys the position being the most successful bank of Saudi Arabia, utilizing the fruits of Islamic Banking with over 300 branches, over 450 cash dispensers, and about 3000 sale facilitation centers.
Competitiveness with regard to retail markets has alleviated to a higher level in present times. In the era of 1970s and 1980s there used to be the situations where Islamic banks had to compete with the conventional banking systems and generally there used to be only one Islamic bank serving the needs of whole nation or country. Though it made the position of these singles bank significantly monopolistic, however even then the performance of such banks was not very satisfactory as there was no awareness about the Islamic banking according to the rules and regulations of Shariah. On the other hand, the customers who wanted to deal with their investments and deposits in an Islamic manner had no option but to use services of these single Islamic banks. In Saudi Arabia, Al Rajhi Bank has enjoyed this practical monopoly since the year 1985. The prime mover of this amazing development in Islamic Banking in Saudi Arabia with respect to the supply side is the rising number of financial bodies rendering solutions that are in accordance with Shariah.
Along with the recent Islamic finance organizations and Islamic banks that came into existence, there is another very significant and emergent trend found among the conventional banking institutions to transform their operations and practices to the services and operations that are in compliancy with Shariah. This increment in services of Islamic banking across the kingdom has resulted in two major impacts. The first one is the fact that with the increased count of service providers in market, the level of public awareness with respect to the services in accordance with Shariah has reached to a very high level. This situation in Saudi Arabia is very satisfactory as compared to other countries of the world where the level of public awareness about Shariah compliant services of Islamic banking is tremendously low. The second major impact in this regard is the fact that due to the excessive competitiveness in market that has resulted from a greater quantity of service providers has consequence in the improvement of services, its innovation and the service charges. This is one of the most positive points of Islamic banking that has significantly increased the importance of Islamic finance not only in the eyes of Muslims but in the minds of non Muslims as well.
By the decade of 1990, the competitiveness for Islamic bankingg took a new turn as the conventional finance and banking institutions began opening Islamic windows which the proceeded to the opening of dedicated Islamic banking branches. These developments did not stop here as the banks that did not used to support the Islamic investments and Islamic accounts financing began to render Islamic funds to their conventional banking customers. The example of this scenario in Saudi Arabia is of the National Commercial Bank that started offering a range of Islamic managed funds that were proposed for screening to be in compliance with Shariah.
Moreover, the National Commercial bank that holds the credit for being the largest bank of the Kingdom of Saudi Arabia has developed an International Trade Fund that holds its operation on the basis of Murabahah. The working includes the collection of funds by marketing units to investors where the units are the representation of investment of funds. The resources collected by these funds find their way in utilization in the banking transactions that are based on the principles of Murabahah by buying products, commodities, goods, and services from providers and then trading them to purchasers on a the grounds of deferred payment. The profits and gains collected from this process go into the fund by incrementing the value of each unit. These funds necessarily render short-spanned business as the maximum allowed time for any business transaction is twelve months.
With regard to the absolute size, Saudi Arabia still enjoys the largest and the most liquid market for Islamic financing than any country in the world whether it is in terms of bridge financing or starting public offering. Saudi Arabia has the largest Islamic banking service that includes the Murabahah services worth 1.6 billion out of the total banking finances of 2.32 billion which was done for the most prominent GSM Company in Saudi Arabia in October 2004. The development and growth of Islamic banking is Saudi Arabia is increasing by exponential rates in a mercurial manner. The banking sector in the kingdom is formulating at very rapid pace which is basically derived by a briskly-developing market demand for products and services that are in accordance with Shariah and encourages and promoted by a very prominent and significant regulating agency, the Saudi Arabian Monetary Agency (SAMA).
The kingdom of Saudi Arabia has always acted as a herald in order to support and encourage the banks in Saudi Arabia to do offering of such services that are in compliant with Shariah and needed by the Saudi Markets. This is the main reason that all banks in kingdom offer a range of services that are in accordance with the rules and regulation of Shariah and with higher quality finance engineering stipulations under the monitoring and supervisory of well known and authentic Shariah committees and well reputed and talented finance personnel. In terms of providing support to these endeavors, the kingdom accentuates on helping the professionals and personnel to excel in the field of Islamic Banking. To serve this purpose, SAMAs IOB has rendered various programs, services, courses, trainings, and symposia in context of development, selling, and monitoring services and products that are in accordance with Shariah. The count of bankers who extracted benefits from these programs is above 6000 that took participation in almost 400 sessions over the last few years. These efforts have greatly alleviated the rate of development of Islamic Banks in Saudi Arabia and that too without deteriorating the compliancy with Islamic Shariah or the engineering perspective and flexibility required by an emergent and active market.
Out of the eleven banks of Saudi Arabia whose reports were evaluated at the end of business year 2006, three banks were known to carry out all their business operation and financial activities in a manner that was in compliance with the rules and regulations of Shariah. Therefore, all of the investments and depositions are in accordance with Shariah as well. These three banks are Al-Rajhi Bank, Al-Jazira Bank, and Albilad Bank. Almost all of the Saudi Banks reveal the kinds of services and facilities they utilize in that are in accordance with the Shariah principles. These services and facilities include their profiles and portfolios Al Rajhi and Albilad banks exhibit remarkable difference and distinction in the kinds of instruments they use for the extension of credit. But the most commonly found instrument in all the Saudi banks is that of Murabahah.
Another significant point in this regard is the fact that industry of Islamic financial service is in complete integration with international and global financial markets and at the same time, performing the maintenance and regulation of its distinct nature and innovative services. The Islamic banking industry in Saudi Arabia utilizes the same levels of supervision and control as that of the conventional banks or other financial institutions. Any violation of standard practices or procedural application done by Islamic banks does not only cause hindrance in their operations and services but also serve as obstruction to the acceptance of their services in global financial markets. For this purpose the Saudi Government focused on establishing the Islamic Financial Services Board (IFSB) in order to encourage the cause of establishing and developing the financial services and products industry in accordance with the rules and regulations of Shariah. The board makes sure that the Islamic banking in kingdom is qualified discreetness and transparence by adopting various existing or new policies and strategies that are in compliancy with principles and procedures of Islamic banking.
The performance of the board has been remarkable ever since its establishment and it has made remarkable endeavors in issuance of international standards regulating Islamic Banking through numerous committees and groups. Setting and establishing these standards helps in building up a concrete structure for creating strong and dynamic banking practices that are capable of competing with the global financial institutions. Another significant performance of the board is making endeavors in order to organize and manage different symposiums and training sessions for promoting and raising awareness level of common people with respect to the nature of Islamic banking. The latest data and statistics depicts the assets of total assets size of Islamic banks crossed the range of 800 billion at the end of year 2009. Analysts have expected these assets to increase and exceed the boundaries of 1 trillion after 2010. Moreover, the trend in issuing Islamic Sukuk has experienced increment as well and has exceeded by 100 billion by the year 2009.
Another development in context of Islamic banking in Saudi Arabia is the creation of Saudi Arabian Monetary Agency. The agency has the job of exerting continuous efforts and endeavors towards promoting public awareness and emphasizing on significance of application of international standards that result in helping in management of risks, enhancement of competitive environment, and creating firm entities. Hence, it also promotes different training sessions and conferences whose sole objective is to provide a comprehensive understanding of Islamic Finances standard in Saudi Arabia in terms of capital sufficiency, liquidity and other risks management, regulating review procedure, systems of corporate governance, transparence and markets behavior, etc. These objectives are the basic block and the constituents of fundamental base for ensuring well-being, stability, and adequateness of the system of Islamic banks and financial institutions.
Chapter Five
EVALUATING LIQUIDITY RISK AND EXPLORING LIQUIDITY RISK MANAGEMENT STRATEGIES IN SAUDI ISLAMIC BANKS
This section discusses, analyzes, and evaluates liquidity risk and explores the strategies, processes, and operations of liquidity risk management in Saudi Islamic banks. The discussion is particular to two very significant and substantial Islamic banks of Saudi Arabia, The Al Rajhi Bank and bank Albailad.
Evaluation of Liquidity Risk Management in Al-Rajhi Bank
This section discusses the liquidity risk with regard to the Al Rajhi bank of Saudi Arabia and its procedural process and operational strategies in order to deal with liquidity risk management and crisis.
Al Rajhi bank- Introduction
Al Rajhi banks hold the credit for being the largest Islamic bank not only in the kingdom but in the world as well. It also holds the position of being the most significant investment corporation in Saudi Arabia. Moreover, the Al Rajhi group is also regarded as one of the major stock companies in Saudi Arabia with highest capital of Saudi Riyal 6.75 billion. The bank has its head office in Riyadh, the capital of the kingdom. However, the services of the bank are not limited to the boundaries of Saudi Arabia as the bank has extended its services over the national boundaries and have several branches in Malaysia as well. The banking, investment, trading, and financial operations of Al Rajhi bank started in the year in 1978 and since then, it has covered a long journey filled with outstanding developments and excellent customer satisfaction. The capital base of Al Rajhi bank over the years flourished from SR 750 million to SR 1.5 billion, then to Saudi Riyal 2.25 billion, which then reached to SR 4.5 billion in march 2005, then to SR 6.75 billion in March of 2006, and then to SR 13.50 billion in March 2007.
As to maintain its performance in the banking sector in the increased competitiveness in Islamic financial institutions around the world, AL Rajhi bank has lately launched its branches in Malaysia as well and hence, stepping into the world of international Islamic banking. The bank has been strictly abiding by the standards it has set in accordance with the rules and regulations of Shariah. This mode of banking that is in compliance with Islamic principles has played a very significant and substantial role in order to bridge the ultimate gap between two very important factors. These two important factors are the latest and the modern demands and requirements of financial business situations and the basic principles and intrinsic value of Islam. It is necessary to bridge the gap between these two factors as to ensure sound development and proper growth of Islamic financial industry in presence of the global standards of international conventional banking.
Risk Management in Al Rajhi Bank
One of the detrimental and qualitative factors in evaluating the performance of the bank is the risk positioning of the bank on the risk scale and the risk management of various risks that are most likely to affect the performance of the bank. The significance of effective risk management can be judged by the current global concerns related to liquidity and credit risks in the international market. In this respect, Al Rajhi bank has strong and effective procedural strategies that make significant changes in corporate work, improves control and risk management operations, alleviates the standards of transparency in financial reporting, Put positive impact on concentration of credit risk and management of liquidity crises. Al Rajhi bank favors the strategies or plans that intend to set the market risk appetite to a conservative limit as to minimize the risks as much as possible. One significant point in this regard is to improve the risk positioning of the bank regardless of the fact that Islamic banking is stronger as compared to the conventional banking when it comes to withstand the damaging shocks not only on the assets side but with regard to the liabilities of the bank as well.
Al Rajhi banks has adopted significant, effective and efficient positive steps in order to strengthen the strategies related to risk management, procedural policies, instruments controlling the risks and the banks culture. The operation of risk management system has undergone a considerable enhancement in size, improvement in operations, widening in scope, and significant strengthening in stature of the organization. These developments have resulted in ultimate edge that Al Rajhi enjoys over the other contemporary Islamic banks across the globe. Analyzing the financial reports in the later section, we would come to the result that the performance of Al Rajhi Bank with respect to the risk management has turned out to be steady and satisfactory during the recent years.
One important consideration in this respect is the fact the risk positioning of the bank has undergone weakening due to higher concentration of market risks and crises. This happens in situations such as credit exposures in particular to the corporate banking book and this is one of the issues confronted by many of the Saudi banks including Al Rajhi bank. Nonetheless, the retail profile of Al Rajhi bank has more of a chondritic nature. The fact that the local economy is governed my comparatively less number of corporate giants, therefore the effect of concentration is a constant limitation for all the banks. Moreover, in spite of being an international player, the functioning of Al Rajhi is more directed towards the domestic banking that is the function of Saudi Arabias economy. However, on the other dimension of the banks balance sheet, concentrations risks confront certain constraints because of the fact that the significant portion of funds and funding sources belong to the retail market which are not concentrated at all. Another positive feat is the fact that Al Rajhi bank does not bank on a fixed number of retail clients. That is how risk management system of the bank has undergone significant improvement in past few years.
Though the bank confronts concentration risks when it comes to the shareholding architecture and structure however, under the supervision and monitoring of SAMA, most of the share holders, and the management board, Al Rajhi bank has significantly fortified its compliancy operations, the substructure of coordinated governance, and risk management system for the last one year. It is a matter of fact that concentration risks are common to every bank in the kingdom the strategy of Al Rajhi bank in order to deal with these risks is to limit these risks by adding extra capital charges as determined by the banks standard policy and translated by SAMA. Moreover, market risks confront constraint, liquidity risks are significantly monitored, and the operational risks are under strong scrutiny.
The risk management system of Al Rajhi bank is very concrete in comparison to its peers. Experts regard the system as independent, well-developed, well-maintained, well-staffed and capable of covering all significant and related risks classifications around the world. This has resulted in significantly low risk appetite of the bank that implies to the fact that the bank employs and operates mostly in plain vanilla mediation and investment financing that avoids composite, unknown, and out of the world dealings and transaction. However, some of the corporate giants and large Saudi organizations are still the exceptions. The main portfolio of Al Rajhi bank is under domination of credit risk as it has undergone adoption of an ultimately centrally focused culture in evaluating and rating risks.
During the past, the risk management system of Al Rajhi bank in terms of its liquidity risk has been limited by being an Islamic bank as it enables the bank to do utilization of money markets and investing in government security businesses governed by interest, Nonetheless, in collaboration with SAMA in the year 2002, the bank did create a new tool that matches to the government security businesses and is also in compliancy with rules and regulations of Shariah. By making huge investment in their tools and instruments, Al Rajhi made effective and remarkable improvement in its liquidity management. During the recent times, Al Rajhi bank has also given tremendous strength to the networking system of counter-party banks, has made increments in its exposure to the positioning of Murabahah with other banks, and has extended and enhanced the Murabahah funding profile of maturity.
Al Rajhis liquidity position has remained appropriate for many years however it has encountered a decline in the year 2008. Liquidity management is one the hardest tasks for Islamic banks because of the fact that mostly the instruments or tools utilized for liquidity management share the grounds with interest either with respect to the money market or with regard to the security market which of course is against the Shariah principle. Hence, the investment profile of Al Rajhi bank stays small in comparison to the fundamental money market, placements holding its basis on Murabahah, and funds exposures. SAMA has made the design that repeats the culture and conduct of fixed income securities that are in accordance with Shariah. While on the other hand, the continuity of funds of the bank suffers misbalance as the bank enjoys no refunding from market if it exceeds a specified range.
Though we completely roger that a significant portion of clients depositions are remain stable most of the time however, like other Islamic banks Al Rajhi bank is not free of the reputation risk, as long-termed funding are beneficial in mitigating the reputation risk. Moreover, it would promote international extension and aid in addressing issues like maturity mismatches and threats of increased income sensitiveness to margin shocks.
Analyzing The Liquidity Risk Related Developments And Trends In Al Rajhi Bank
In context of performance in the kingdom, Al Rajhi bank stays at an average scale. The culture of bank has made improvement and is getting synchronized with customers expectation from bank of this good reputation. Despite of having an Islamic business model the bank need some supervising authority. Moreover, Al Rajhi enjoys being the first Islamic bank to open in publically as per Pillar 3 in 2008. In short, credit risks are lowered, funding stays short-termed, assets get wide, liquidity management instruments share limited accessibility, significant part of balance sheet is maintained by bank, and financial statements undergo international auditing.
Moreover, Al Rajhi bank has a concrete funding visibility the bank enjoys gains from a large number of clients deposits that finance loans, enabling the bank to keep substantial short termed liquid assets. The concentration in depositions confronts constraints as client fixes almost 75 of assets and liabilities. The remaining amount is for direct investment by clients that is the only money that has value and a long-spanned debt as well. Though, most of the depositions are short-spanned but have effective roll over record, bank is prone to risk of transformation because of funding long-spanned loans and short-spanned depositions. The quick increment in corporate loan book has given significant boost to broader maturity mismatches. The bank has just begun dealing with the cases of broader access to long-spanned funds. Moreover, situations in market have stopped this procedural strategy for the predictable future.
The position of liquidity is satisfactory however it still is hard for Al Rajhi bank to do effective management as it exhibits a lack in accessing different substitutes of asset classes in order to mitigate excessive liquidity. As the bank is forbidden to deal in fixed-income securities therefore it has the setup for dealing with short-spanned especial placements with SAMA. Moreover, AL Rajhi banks has the permission to do withdrawal from SAMA up to 75 of the total size of such short-spanned liquidity requirement which is also the proportion permissible for conventional repo dealings, therefore setting limits on the dependability over interbank market. In addition to that, Al Rajhi holds an extra liquidity buffer as short-spanned bank placements.
Measuring liquidity risk through financial ratios (liquidity ratio)
Liquidity Ratios200820072006200511.720.228.835-Table for liquidity ratios for Al Rajhi bank.
EMBED Excel.Chart.8 s
- Figure to show the devilments and trends in liquidity ratios.
200920082007Liquidity Ratios for first quarter9.6210.2910.9Liquidity Ratios for first half
8.99.7710.5Liquidity Ratios for second half9.210.211.7-Table for quarterly liquidity ratios.
Liquidity Indicators
2008
2007
2006
2005
2004Net Investment () Customer Deposits114.9794.6393.2593.0666.63Net Investment () Total deposits109.1991.9789.0488.7165.50Average Net Investments () Average Customer Deposits106.1994.0193.1680.7762.73Average Net Investment () Average Assets76.6666.6566.7661.2149.26Liquid Assets () Total Assets11.7426.6929.8327.1342.97Customer Deposits () Total Deposits94.9797.1995.4895.3398.30Customer Deposits Shareholders Equity (Times)4.623.803.645.215.98Due from Banks () Due to Banks14.69334.87377.16176.4978.58Fig- Liquidity Indicators of Al Rajhi Bank
Liquidity Ratios200820072006200520042003Customer deposits Funding base93.7695.4093.3997.1998.3798.81Total loans Customer deposits87.3893.2992.7388.5963.3151.69Total LoansCustomer deposits long-term funds71.3473.9572.5275.4155.8145.48Customer Loans (net) assets (adj)63.1566.0963.3065.0646.7737.69-Table for funding and liquidity ratios
EMBED Excel.Chart.8 s
-Figure to show trends and developments in funding and liquidity ratios5.1.3.2 Assessing the structure of deposits in terms of liquidity risk. Table of deposits types (current account-saving accounts-investment deposits-margin accounts- profit equalization provision)
Current accountSaving accountInvestment depositsMargin accountsProfit equalisation provision Total andTotal andTotal andTotal andTotal and20089.317,7892,256,9072,987,5671,945,3989,161,12020078,472,4792,046,5832,572,8591,739,2856,892,78020067,974,2851,875,2852,183,2451,458,8427,027,810
EMBED Excel.Chart.8 s
Figure to show the trends and developments in deposits.5.1.3.3 Assessing the maturity structure of assets and liabilities.
This section asses and analyzes the maturity structure of assets and liabilities with respect to the year 2008, 2007, and the year 2006. The tables show an increasing trend in structure of assets and liabilities. The bank has shown increased and improved performances during the recent years that has bore potential benefits for the bank.
2008
2007
2006
Evaluation of Liquidity Risk Management in Bank Albilad
This section discusses the liquidity risk with regard to the bank Albilad of Saudi Arabia and its procedural process and operational strategies in order to deal with liquidity risk management and crisis.
Bank Albilad- Introduction
Bank Albilad is a joint venture of a Saudi stock company whose establishment took place in November, 2004 with the huge corporate capital of 300 million. Bank Albilad is one of the most esteemed bank that offers financial solutions and products that are in compliance with the rules and regulations of Shariah and Islamic principles in order to meet the expectations and inspirations of the clients, employees, and shareholders. The bank values honesty and integrity as one of the most practiced virtue in the culture and regards it as practicing the highest and most reputed moral and ethical standard. It also accentuates on honoring commitment with the clients, employees, and shareholders. The policy of the bank is exercising transparency and adopting the apex of equality in every dealing and transaction with banks clients, employees, and share holders. Another significant point in this regard is the aiming towards the achievement of complete customer satisfaction by making comprehensive understanding of clients requirements and responding to it perfectly. The bank calls the team-work its strength and regards it as the most competitive advantage over its contemporaries. The bank is committed towards never ending learning, brainstorming, and sharing. It believes in empowering its own people, promoting the culture of accountability, fostering and recognizing team-work at every stage of organizational success. Albilad is committed towards rendering a safe and healthy culture and takes pride in participating and supporting different humanistic causes.
The head office of Bank Albilad is situated in Riyadh, the capital of Kingdom of Saudi Arabia. Bank Albilad looks forward to perform expansion of its branches all over the kingdom, moreover it seek to render services of women banking as well. Bank Albilad renders all banking and financing products and services that are compatible with the Islamic principles and are in accordance with the rules, regulations and concepts of Shariah at all levels of the organization. Bank Albilad principally deals with Islamic banking and business finance products, retail banking and financing services and investment products and services.
Risk Management In Bank Al Bilad
Since the year 1988, the bank has been following the rules of capital adequacy for Islamic finance and banking services that holds its basis on recommendations of Basel I. Basel I is a comprehensive and compatible group of rules and regulations under the supervision of the bank of International Settlement (BIS). Basel I is the comprehensive and compatible collection of rules and regulations that had the intentions of making the capital need more independent of the risk and integrate the impact of off-balance sheet activities and operations. The set of rules had the objective of creating more transparent and homogeneous rules for Islamic banks with regard to the international banking.
Nonetheless in June 2006, novel, distinct and minimized set of rules and regulations were implemented by SAMA, The novel regulations holds its basis on the recommendations of Basel II which was also issued under supervision of Board of International Settlement (BIS). The major areas as required for regulation includes widened risk management especially to that of liquidity risk management, tractability, and increased and enhanced risk predisposition.
The bank has the aim of standing as a stable and strong financial service provider having greater insight and ability of being transparent in risk management. The mission statement of the bank lies in adopting the best and highest international standards, strategies, policies, and practices with regard to the effective risk management. Bank Albilad utilizes significant resources in developing strategies and instruments that prove to be valuable in supporting and carrying out this mission vision. Consequently, the bank has developed significant and efficient expertness in issues related to risk management. Risk management is a procedural process that operates severally from the other business sectors and units of the bank. It has the objective of promoting a concrete, efficient and effective risk management environment by abiding by a comprehensive group of procedures and operations that goes under the design process as to carry out effective identification, measurement, monitoring and risk exposures. The management board and senior managers are included in the development of the risk procedures, and operations and the repeated supervision and regulation of the risk management process. These risk management processes and procedures are matter of extreme importance and extra examination not only by neutral board of Shariah but auditors internal and external to organization and the supervisors and regulators of bank as well. These practices assist in strengthening and fortifying the processes and practices related to risk management in Bank Albilad.
Albilad accentuates on the management of numerous substantial and critical risks. These risks include the credit risk which is simply the risk related to losses due to the failure of different parties in meeting their part of responsibilities or obligations. These risks also involve market risks which are due to the varying of value of assets and liabilities with respect to the changing situations of market. One of the major concerns of risk management in Albilad bank is the risk of excess or shortage of liquidity these are the risks when the liquidity or liquid assets of the banks are unable to fulfill the requirements of the bank. Another risk factor that the risk management takes care of the risk of losses due to the deficiency or error in fulfillment of processes and procedures internal to the bank, human or system mistakes, or the processes external to the bank.
The risk management group apportions significant resources in order to ensure that the ongoing processes are in compliance with the limits of credit and to monitor its credit profile. The management group has a concrete reporting cyclic system in order to make sure that the related and relevant parts of management body that involves the board, the senior management, and the executives, share the transparent information regarding the developments, latest trends, and growth rates in the credit profile, non-operating loans etc.
Bank Albilad utilizes not only the conventional method for the purpose of risk management however it also makes effective usage of advanced risks controlling instruments for measuring and monitoring the risks as market risks, liquidity risks, credit risks, operating risks, concentration boundaries, risk of economical valuation in order to perform the measurement of risks and its exposures. These methods or processes of measuring and monitoring the risks involves efficient reporting system in order to notify the senior management about the risks, effective reporting operations to SAMA and performing the daily management of the risks in the different units of the bank Albilad.
Analyzing The Liquidity Risk Related Developments And Trends in Bank Albilad
Liquidity risk is the risk that the bank confronts when it is unable to fulfill its requirements when needed at the very nominal and acceptable market price. The measurement of this kind of risks takes place by making match of assets and liabilities that hold their basis on the balance sheets of the bank. Liquidity risk risks are risks of losses that occur due to disproportionate increment of the funding costs of bank, the decrement or losses of funds that limits the bank from setting up new businesses, and the lack of funding sources that obstructs the bank from fulfilling its obligations and requirements.
Liquidity management in Bank Albilad holds its basis on monitoring and management of operating and architectural liquidity risks in numerous conditions. The management of operational liquidity risks has the primary objective of making sure that the bank always enjoys optimum liquidity or liquid asset in short spans in order to perform absorption of the devastating and dangerous impacts of dealings and transaction made in the bank.
The procedural and strategic policies in order to deal with the liquidity risk in bank Albilad are determined as the portion of market risk policies. Moreover, one of the significant developments in this regard is the liquidity contingency plan whose proper implementation has taken place with the aim of ensuring that the bank has done optimized preparation for taking alternative steps in case of occurrence of any liquidity risks or crises. It is the most fundamental part of the business strategy of the bank to evaluate and presume risks with regard to its liquidity, the strategic policies and procedure for Bank Albilad were designed for defining in terms of the banks appetite for negative funding. In the process of liquidity risk management Bank Albilad differentiates between the liquidity risks in local and the risks in extraneous currencies. The department of market risk shares the responsibilities of assuring that the bank is in compliance with the risk range of operational liquidity and quickening the breaching reports to the senior management. The major business and risk committees and stakeholders gets report on the liquidity of bank on the normal basis. In addition to that, the committee for assets and liabilities management evaluates the development and trends in terms of banks liquidity and the long-spanned funding plans in a consistent manner.
When it comes to the efficient and effective management of liquidity risks subjected for short-term that management of bank Albilad holds the primary aims and objectives of making sure that the bank always has a significant amount of liquidity buffer that can perform the absorption of shocks or imbalances caused by net impact of transactions already done and anticipated changes. These calculations are done by taking into the consideration the holding and possessing of the liquid assets by the Bank Albilad.
Another important trend while perform the effective management for the risks and crises attached to the long-spanned liquidity risk is taking structural liquidity of the bank Albilad into consideration. As a matter of fact, the structural liquidity risk management holds its basis on considering the mismatches occurred in the liquidity associated to bank in a long term manner. The liquidity risk management for long term basically possesses the aims and objectives of ensuring that the bank does not develop the needs and requirements of large funding in future in an inexpedient manner. Determination of the structural liquidity is the most significant trend in managing liquidity risks for long-term and it becomes even more substantial when the bank starts planning about the activities and procedures related to funding and pricing. The management of structural liquidity risks and crises by Bank Albilad is done by managing, supervising, and regulating the structural liquidity risks while taking the gap report into consideration. The gap report holds its basis on a collapse and breakdown of the assets, liabilities, and other off-balance sheet items pertaining to the books of accounts of bank Albilad that happens due to the reason of maturity of these accounts. In order to meet this purpose, Bank Albilad utilizes the fixed and already set maturity time period that originates by dint of different contracts and agreements. Being a significant and substantial part of the management of bank Al Bilad pertaining to the liquidity risks and crisis, the liquidity state and position in the gap report is classified into numerous variables for example, foreign exchange, product, business area and different units belonging to the organization. Along with the other valuable and extremely important the trend of these informative gap reports depict the fact that the bank Albilad possesses an extra structural liquidity that dominates in local currency mode.
Another significant development and trend in this regard is the analysis in which the liquidity scenario is reviewed in bank Albilad. The bank gives various effective and efficient stress tests in order to perform appropriate measurement of the banks immediate liquidity risk and for ensuring that the bank has a certain significant and optimized response time in order to deal with the situations that gives rise to potential risks and crises. The effective scenario analysis not only includes the specific crises and risks of the bank however it also involves the general market crises and risks. In addition to that, Albilad bank monitors, controls and regulates the variegation of different products, commodities, goods, services, currencies, maturities and the counter parties of sources that fund, ensuring that the bank has a concrete and fortified funding base. This strong funding base is most likely to protect the bank in the most possible extent when the market come across monetary crises or come under pressure.
Measuring Liquidity Ratios Through Financial Ratios
This section measures the liquidity risk through financial ratios. The most significant financial ratio in this regard is the ratios of current ratio, quick ratio, and liquidity ratio. The section also includes the table for liquidity ratios for Albilad bank. It includes figure to show the developments and trends in current and liquidity ratios, table for quarterly liquidity ratios, table for funding and liquidity ratios, figure to show trends and developments in funding and liquidity ratios (four ratios)which is 1-customer deposits funding base 2- total loans customer deposits 3- total loans customer deposits long term funds 4- customer loans assets .
Measuring liquidity risk through financial ratios current ratio and liquidity ratio
2008200720062005Liquidity Ratio ()39.0960.0910.9134.58Current Ratio ()43.2364.4917.6443.68 -Table for liquidity ratios for bank Albilad
- Figure to show the developments and trends in current and liquidity ratios.
200920082007Liquidity Ratios for first quarter28.3837.9258.30Liquidity Ratios for first half22.6535.8955.43Liquidity Ratios for second half29.8338.0056.67-Table for quarterly liquidity ratios.
-Table for funding and liquidity ratios.
Liquidity Ratios200820072006200520042003Customer deposits Funding base91.7090.3889.3987.2988.2285.29Total loans Customer deposits85.3289.3984.2982.4869.2855.29Total LoansCustomer deposits long-term funds75.2973.2870.2869.3857.2843.28Customer Loans (net) assets (adj)64.2863.9061.3862.3844.2830.45
EMBED Excel.Chart.8 s
-Figure to show trends and developments in funding and liquidity ratios(four ratios)which is 1-customer deposits funding base 2- total loans customer deposits 3- total loans customer deposits long term funds 4- customer loans assets .
5.1.3.2 Assessing the structure of deposits in terms of liquidity risk. Table of deposits types (current account-saving accounts-investment deposits-margin accounts- profit equalization provision)
Current accountSaving accountInvestment depositsMargin accountsProfit equalisation provision Total Total Total Total Total 20081,345,2922,839,283927,2781,098,790243,57120071,084.2742,139,293837,268982,937241,3492006947,2841,729,279792,279910,670220,964Table developments and trends in the deposit types
EMBED Excel.Chart.8 s Figure to show developments and trends in deposit types5.1.3.3 Assessing the Maturity Structure of Assets and Liabilities
This section asses and analyzes the maturity structure of assets and liabilities with respect to the year 2008, 2007, and the year 2006. The tables show an increasing trend in structure of assets and liabilities. The bank has shown increased and improved performances during the recent years that has bore potential benefits for the bank.
2008
2007
2006
Liquidity Ratios for first quarter20092008200720.3828.9238.30-Table for quarterly liquidity ratios.
Chapter Six
CONCLUSION
The paper concludes with the discussion of liquidity risk and its effective management with respect to the Islamic banking. It shows the main and distinguishing features of liquidity risks such as its origin in Islamic banking institutions. The causes of liquidity risks in Islamic banking is the consequence of very limited or rare accessibility of tools and instruments that are in compatibility with the rules and regulations of Islamic Shariah. These tools and instruments can be the money market tools, lender of last resort services etc. The Islamic concepts of Murabahah and tawarruq in countries around the world have appeared to be very significant instruments in managing liquidity risks and crises in an effective and efficient manner. Liquidity risks and crises can result in devastating situations for Islamic banks like any other conventional banking institution. Therefore, the policies and strategies for effective management of liquidity problems is one of the most significant considerations for Islamic banking and financial institutions. The research have shown that in order to perform the effective management of liquidity risk, the Islamic bank should maintain a right balance of liquidity in the institution as both too much and too less of liquidity results in undesirable situations for the bank. Another important financial technique is utilizing the inter-bank money market that allows the Islamic banks to adjust the profiles in shortest time possible and thus resulting in rapid management of funds. The technique of profit-loss sharing is another major point in reducing the liquidity risks of Islamic banks as compared to the conventional bank around the world. The utilization of tools and instruments as to deal with the liquidity risks and crises is different in different parts of the world these tools include Murabahah i.e. cost plus sale, al Qard i.e. loan, hibah, Wadiah Yad Dhamanah i.e. guaranteed safekeeping, bai bithaman ajil i.e. postponed or deferred payment sale, bai al-salam i.e. purchasing with postponed delivery, bai al-istisna i.e. accredited manufacturing, and ijarah i.e. leasing etc. The liquidity management of Al Rajhi bank was restricted due to the fact that Islamic banking allows the bank to utilize money markets and invest in interest based government security business. Therefore, Al Rajhi developed a new tool for dealing with liquidity risks in collaboration with SAMA that is in accordance with the rules of Shariah.
This new tool utilized by Al Rajhi bank is making big investments in implementing the tools for managing liquidity risks and thus controlling the liquidity risks effectively. Moreover, Al Rajhi bank deal with liquidity risk and crises by holding an additional liquidity buffer or liquidity shock absorber in the form short-time placements of bank. On the other hand, Al Bilad bank takes care of liquidity risks and crises by effectively monitoring and managing the operational as well as architectural liquidity. The bank keeps an eye on the mismatches occurred in liquidity associated with the Islamic banking and financial services and accentuates on maintain an optimum liquidity level for both short and long term operations. When it comes to the comparison of two both the banks in terms of liquidity ratios, Al Rajhi bank has performed significantly well as its liquidity ratios calculations are better than Banl Al Bilad.
Categories:
0 comments:
Post a Comment