Risk management in main risk types

Liquidity risk

Liquidity risk management framework

The nature of banking, investment and trading activities results in a continuous exposure to liquidity risk. Liquidity obligations arise from requirements to repay deposits, advance committed funds, and make interest and other expense payments. The group’s liquidity risk management framework is designed to identify, measure and manage the liquidity risk position to protect the group’s depositor base, maintain market confidence and ensure future growth. The group asset and liability committee (group ALCO) sets liquidity risk standards to ensure that the measurement, reporting, monitoring and management of the liquidity risks associated with Personal & Business Banking and Corporate & Investment Banking business activities across the group follow a common governance framework. Each bank within the group has an asset and liability committee (ALCO) to monitor compliance with group liquidity risk standards. Both the Africa ALCO and International ALCO report into the group ALCO, chaired by the group chief executive.

Approach to managing liquidity

Liquidity management within the group has several elements. These include:

• maintenance of a structurally sound balance sheet with restricted mismatches between anticipated inflows and outflows within different time buckets;
  
• maintenance of a portfolio of liquid and marketable assets over and above prudential requirements;
  
• daily and forecast cash flow management;
  
• implementation of long-term funding strategies;
  
• diversification of funding;
  
• undertaking of regular stress testing; and
  
• maintenance of adequate contingency plans.

The cumulative impact of these various elements is monitored on at least a monthly basis by the group’s ALCOs.

Structural requirements

Structural liquidity limits and guidelines are set to restrict the mismatches between cash inflows and outflows in different time buckets. These limits and guidelines are set by group ALCO and conform to international best practice.

Significant sources of structural liquidity are provided by term liabilities, portfolios of highly liquid assets, as well as core consumer and corporate customer deposits, mainly in the form of current and savings accounts. Although these deposits are mostly repayable on demand, or at short notice, diversification in terms of depositors, products and instruments assists in protecting against unexpected fluctuations.

By way of illustration, the one-month mismatch guideline is a maximum net liability outflow of 5,0%, taking behavioural profiles of depositors and borrowers into account. During 2005, the average one-month liquidity gap, as a percentage of total liabilities, was 1,1% for Domestic Banking and 0% for Corporate & Investment Banking International.

Domestic Banking also observes a ratio of long-term funding, defined as those deposits where the remaining term to maturity exceeds six months, to total funding. The ratio has actively been increased from 15,8% in December 2004 to 16,1% in December 2005, thereby further enhancing a structurally sound balance sheet.

Liquid and marketable assets

The group maintains a portfolio of highly marketable assets above the required statutory ratio that can easily be liquidated as protection against any unexpected interruption in cash flows. The average amount of surplus, unencumbered marketable assets in Domestic Banking was R22,3 billion in 2005 (2004: R18,8 billion).

Cash flow management and long-term funding strategies

To retain and generate adequate funding, the group has implemented cash flow management strategies. The daily management of funding is achieved by monitoring future cash flows to ensure cash requirements can be met. Monitoring and reporting take the form of cash flow projections, particularly over a short-term horizon.

Funding strategies, based on forecasted balance sheet structures, are used to anticipate and plan for future funding and structural liquidity requirements. The group is committed to maintain and increase core deposits, and improve the long-term maturity profile of the deposit portfolio. Securitisation represents a relatively small portion of the group’s funding strategy, but provides additional flexibility in Domestic Banking. During 2005, the group securitised R3,0 billion of vehicle loans and R4,5 billion of home loans.

Diversity of funding

Funding diversification and the constant monitoring of depositor concentrations are other key elements of liquidity management. Diversification is maintained across counterparty, instrument, industry sector and term. To ensure that a bank does not place undue reliance on a single entity as a funding source, limits are set on the amount of deposits accepted from any one entity and from the top-ten entities. Depositor concentrations and compliance to limits are reviewed at monthly ALCO meetings. In banking operations where depositor concentration levels periodically exceed the limits set at a group level, a portfolio of unencumbered marketable assets, in excess of prudential requirements, is held to mitigate the concentration risk and cater for the possibility of significant outflows.

Liquidity stress testing

The group’s asset and liability management functions develop and implement a process for subjecting anticipated cash flows to stress scenarios, to evaluate the impact of unlikely but plausible events on liquidity positions. The scenarios are based on historical events (such as the emerging market crisis of 1998) or modelled using hypothetical events such as a rating downgrade. The output of stress testing forms the basis of the group’s contingency funding plans.

Contingency plans

The group’s contingency funding plans comprise both quantitative and procedural elements. Quantitative elements include establishing the estimated value of funding sources under stress conditions, as well as selling assets under forced-sale conditions and adjusting the funding cost of liabilities. Procedural elements deal with roles and responsibilities at various levels of management, actions to be executed, as well as communication requirements, both internal (such as management information requirements) and external (such as communications with regulators).