Causes of recent liquidity crisis of banking sector

Liqui dity refers to the suppl y of the means of payments of an economy. In

Bangladesh, the totality of liquidity is indicated by what is called 'broad money' or M. !
shortage of money restricts demand by making it more di fficul t to engage i n
transactions. In"estment is particul arl y susceptible to li qui dity. #ow the mai n
causes of li quidi ty crisis of banki ng sector are gi "en below$
In the recent year, our country has e%perienced a decline in the "alue of &k
against '( currency which has created has huge liquidity crisis in the banking
sector. )or this reason our country has failed to collect ma%imum amount of '(
dollar required to open letter of credit *LC+ for local businessmen to import
essential commodities for the country. !s a result the importer is facing a se"ere
crisis in their business.
&he banks need to reser"e huge amount of money with the Bangladesh Bank as
it is mandatory for them to maintain the C,, and (L,. BB has recently
increased the rate of C,, and (L, as a result the problem of liquidity crisis has
been aggra"ated recently. &he central bank during last -ecember raised the
cash reser"e requirement *C,,+ by si% percent for commercial bank.
!s the increased percentage of C,, and (L, the commercial bank is
facing liquidity problem and for this reason to get rid of the problem this
banks are concentrated to generate more deposits. &o generate more
deposits they ha"e to increase the deposit rate which has a ad"erse effect in the
society.

.o"ernment credit from banking sector that would create e%tra burden to the
country/s banking sector and it creates more liquidity crisis in that sector. the
go"ernment has already borrowed &k 001 billion from the country/s banking
sector to met the e%isting budget deficit during last 01 months *2uly 101 to !pril
100+, while last year it repaid &k 34.5 billion loans. In the recent future the
commercial banks will be unable to pro"ide loan to the pri"ate sector.
If the bankers do not abide by the norms of the central bank and lend out money
un 6udiciously, there arises the problem with liquidity.

&he abnormal long7term finance and unsatisfactory reco"ery position of short7,
medium7 and long7term loans will ad"ersely affect the liquidity situation.
&he liquidity crisis of the banking sector has been accelerated by the increased
amount of inflation8 thus increasing the price of o"erall commodities for the
general people. &o keep peace with this inflationary effect, the people withdraw
their sa"ings from the banks and use this fund for their transactionary
e%penditure. !s a result the bank faces liquidity crisis.
&he reason of liquidity crisis, if any persisting in the financial sector may be the
non7reco"ery of loans. &he o"erall percentage of reco"ery of loan is "ery
alarming. By now the state7owned banks ha"e taken many steps to reco"er their
old loans but could not show any impro"ement. &he state7owned public limited
companies should gi"e due consideration to wai"er of interest. But the
businessmen or traders who failed to repay loans due to "arious reasons cannot
afford to bear the burden of huge interest and suit costs.

In yearly period, the commercial banks perform acti"ities of in"estment banks,
and for in"estment banks to also perform acti"ities of commercial banks *i.e. to
borrow short and to lend long+. !s a result there is a combination problem
of liquidity risk and credit risk and the problem becomes more uncontrollable and
se"ere.
9"ere%posure in deposit7lending ratio, credit to deposit ratio *C-,+ is causing the
liquidity crisis of the pri"ate commercial banks *:CBs+. Besides to make windfall
profit and engaged in unhealthy competition amongst the banks leading the
banking into a deep crisis. !lthough the Bangladesh Bank *BB+ has set 2une ;1
as deadline for bringing down to C-, to a rational le"el, still many of the pri"ate
banks are lagging behind to maintain it, according to a BB official.
,elationship of liquidity with the reser"e and call money rate$ <%cess reser"e
with Bangladesh Bank has been decreased by B-&41 billion in first si% months,
indicating an acti"e money market.
&he e%cess reser"e is hard cash deposited by banks in addition to cash reser"e
requirements, and it lies idle with the central bank and bears no return. ,epo and
re"erse repo rate were both raised by =1 basis points to >? and @? respecti"ely,
causing liquidity to drop. #ow we will see the graphical presentation of the
relationship of the e%cess reser"e and the liquidity of the banks.
Call money rate rose to double digit in -ecember 101 *)igure + mainly due to
increased demand for fresh funds in the inter7bank money market. &he demand
for fresh funds was slightly higher on the day following the increment of cash
reser"e requirement *C,,+ by the central bank to curb inflationary pressure on
the economy. 'nder the new rules, the commercial banks will ha"e to maintain a
C,, of >.11? instead of the pre"ious =.=? with the central bank from their total
demand and time liabilities on a bi7weekly basis.
&he proposed budget created a liquidity crisis in the banking sector due to its
o"er7reliance on domestic borrowing for implementing the annual de"elopment
program. If the go"ernment borrows hugely for implementing the !-:, the
industrial sector will not get enough loans from the banking system, which will
ultimately lead to a higher bank interest rate. In the budget for the ne%t fiscal
year, the go"ernment proposed bank borrowing of &k 03,5=4 crore for meeting
the deficit and spending in different sectors. ,aising the ta% at source to 0.=
percent from 1.@1 percent will hamper the country's e%ports.
Aow banks manage liquidity risk
Liquidity risk management is a crucial area of risk control that is not co"ered by the
original Basel II accord. Liquidity ,isk is the risk of not being able to meet obligations
when they come due because it cannot$
Liquidate assets or obtain adequate funding , this is called Bfunding liquidity riskB. <asily
unwind or offset specific e%posures without significantly lowering market prices because
of inadequate market depth or market disruptions, which is called Bmarket liquidity riskB.
&he dual definition of the liquidity risk helps in understanding the nature of the risks8
while funding liquidity risk focuses on company specific funding problems, market
liquidity risk describes general market liquidity disruptions. &he core of the liquidity risk
strategy of a commercial bank must include following main components8
,egular monitoring of net funding position and net funding gap of the bank8
&he &reasury monitors all maturing cash flows, replenishes e%isting funds as they
mature, monitors e%pected withdrawals from retail current and sa"ings accounts and
makes additional borrowings and regularly issues new debt.
-i"ersification of funding sources8
&he bank should posses well di"ersified funding sources including customer current
accounts credit balances, sa"ings and retail deposits and inter7bank deposits.
Broad portfolio of highly liquid assets8
&he bank has to maintain a broad portfolio of highly liquid or marketable assets that can
be easily used to obtain cash. &hese assets can pro"ide liquidity through repurchase
agreements or through sale.
Matching long term funding *o"er 0 months+.
)i%ed rate funding o"er 0 months andCor interest swaps *con"erting fi%ed rate liabilities
o"er 0 months in floating rate liabilities+.
(et up quantitati"e limits and the limit structure.
(et up clear crisis organiDation structure and escalation procedure.
&ested and up7to7date contingency funding plans8
&he contingency plans should address temporary and long7term liquidity disruptions
caused by a crisis. &hese plans ensure that all roles and responsibilities are clearly
defined.