Regulations on management of liquidity in banks

1. General provisions

1.1. These Regulations have been developed in accordance with the Laws of the Republic of Azerbaijan on the Central Bank of the Republic of Azerbaijan and on Banks, other legislative acts of the Republic of Azerbaijan, regulations of the Central Bank of the Republic of Azerbaijan (hereinafter – the Central Bank), as well as best international practices and standards.
1.2. These Regulations set minimum requirements with respect to internal liquidity risk and liquidity management policies, procedures and guidelines for commercial banks and local branch offices of foreign banks (hereinafter – banks) operating in the Republic of Azerbaijan.
1.3. Every bank should develop and put in place liquidity risk identification, evaluation and management of their operations and activities. Credit, market, operating and other risks affecting liquidity should also be considered when developing such policies, procedures and guidelines.
1.4. Bank's liquidity management policy, procedures and guidelines should be developed by the Management Board with appropriate committees, and approved by the Supervisory Board.
1.5. The approved policy, procedures and guidelines of the bank should documented and communicated to relevant business units and employees.
1.6. Policies, procedures and guidelines should be reviewed at least once a year.

2. General definitions of liquidity and liquidity risk

2.1. Liquidity is the bank's ability to fulfil its balance and off-balance sheet liabilities (hereinafter – liabilities), effectively manage changes that occurred and/or are expected in attracted sources of funding, as well as finance asset growth as planned without additional expenses.
2.2. Liquidity risk is the risk of failure to perform planned and contingency obligations in a timely and effective manner, and a decline in bank's ability to access additional liquid funds, as well as to dispose of its assets promptly with minimum losses.
2.3. Maturity breakdown for liquidity analysis is the division of assets and liabilities with the same maturities.
2.4. Liquidity gap is a maturity mismatch between assets and liabilities. When assets are above or below liabilities, a positive or negative liquidity gap arises.

3. Classification of liquid assets and liabilities

3.1. Liquidity of an asset is determined by the time required to turn it into a highly liquid assets, and possible losses that may arise.
Assets are classified in the following liquidity categories:
3.1.1. Highly liquid assets — this category includes cash in the national and hard currencies, securities issued by the government of Azerbaijan and the Central Bank, mortgage-backed securities issued by the Azerbaijan Mortgage Fund under the Central Bank, required reserves held with the Central Bank in excess of the norm, correspondent accounts with the Central Bank, as well as all domestic and highly rated foreign banks, and «overnight» deposits.
3.1.2. Medium liquid assets — this category includes interbank market short-term financial instruments, deposits held with domestic and foreign banks, other financial institutions, bankable metals, securities issued by domestic banks, governments and central banks of member countries of the Organization for Economic Cooperation and Development (OECD), as well as investment-grade and repo securities, up to 30 day loans.
3.1.3. Low liquid assets — this category includes assets that cannot be converted into highly liquid assets within a short period of time with minimum losses (other loans, except loans categorized as medium liquid assets, other securities, except securities categorized as highly and medium liquid assets, fixed assets, equity investments, etc.).
3.2. Liquidity of a liability is determined by likelihood of fulfilment of the liability, as well as the liability owner's right to demand to withdraw his/her assets from the bank. The higher the probability of withdrawal demands and rights is, the higher the liquidity of liabilities is. Liabilities are classified into the following liquidity categories:
3.2.1 Highly liquid (current) liabilities — this category includes all current accounts, including correspondent accounts and overnight deposits of banks; demand deposits, term liabilities with 30 day maturity or less (including securities issued by the bank), matured liabilities, contractually unrestrained and irrevocable lines of credit opened.
Debt funds attracted from the Central Bank are not included in highly liquid (current) liabilities.
If a matured liability is not claimed and is considered extended under the contract between the parties, such a liability is not included in the highly liquid (current) category.
3.2.2. Medium liquid assets — this category includes liabilities from 30 to 365 days (including securities issued by the bank), debt obligations with maturity over a year, but with a contractual entitlement for the creditor to claim early/premature payment.
3.2.3. Low liquid assets —include liabilities with maturity over 365 days.

4. Liquidity risk and liquidity risk management internal policies and procedures

4.1. In light of the bank's overall strategy, the liquidity management policy should specify the structure, maturity and management methods of bank's assets and liabilities, diversity and stability of financing sources, approach to liquidity management in various currencies, range of bank products, asset realization assumptions, etc.
4.2. The liquidity management policy may authorize bank's branch offices, subsidiary companies and banks to manage their own liquidity, within the limits set by the management.
4.3. Every bank should develop internal liquidity management procedures, in consideration of the nature and complexity of its operations. Such procedures should provide comprehensive coverage of its activities giving rise to liquidity risk and the liquidity management process and be followed in implementing the liquidity policy.
4.4. Bank's internal liquidity management procedures should identify the business unit or executive officer responsible for controlling the bank's consolidated liquidity position in a centralized manner, the business unit's or the officer's powers and reporting, as well as reporting procedures and interactions with other business units of the bank.

5. Liquidity management

5.1. Banks should form a liquidity management process to cover at least the following areas of management and control of various areas of their business:
5.1.1. on asset management:

• monitor correspondent account balances;
• monitor the scope of lending;
• monitor loan portfolio quality;
• monitor interest rates on loans;
• monitor the bank's securities portfolio;
• monitor repo securities;
• monitor assets pledged as collateral;
• monitor marketable fixed and other illiquid assets to maintain an adequate level of liquidity.

5.1.2. on liabilities management:

• monitor the size of funds attracted by the bank, in consideration of recent trends, seasonal factors, interest rate sensitivity and other macroeconomic factors;
• monitor the size of deposits (including deposits of banks and other legal entities, overnight transactions);
• monitoring maturities of deposits and other liabilities;
• regularly monitor and support relations with creditors of bank's main liabilities;
• monitor concentrations of sources of liabilities, considering the type of liability, the creditor and the location;
• monitor off-balance sheet liabilities.

5.2. Liquidity gap analysis. Banks should carry out liquidity gap analysis at least once a month as follows, in light of the nature of bank's operations, structure and composition of assets and liabilities, historic trends in their dynamics, as well as seasonal and other factors:
5.2.1. Maturities used for internal gap analysis should cover at least instant, 1-7, 8-15, 15-30, 30 days to one year monthly periods, as well as 1-2, 2-3, 3-5 years and over 5 years periods annually. Banks may use shorter periods for the above listed maturity breakdown, if necessary.
5.2.2. Maturity breakdown of assets and liabilities should be based on related terms specified in underlying agreements, conservative approach to asset sales opportunities, assumptions on dynamics of borrowed funds. Gap analysis should consider only principal amounts of assets and liabilities (excluding interest).
5.2.3. Bank's cash funds in national and foreign currencies should be assigned in full to the ‘instant’ maturity. Assets such as correspondent accounts held with the Central Bank and other banks, assets like ‘overnight' deposits held with banks, correspondent accounts of other banks held with the bank, demand deposits of legal entities and individual, liabilities like ‘overnight’ deposits of banks may be assigned in full to ‘instant’ maturity or distributed among several maturities calculated in accordance with the criteria defined by the bank for each type of assets/liabilities. Such criteria should be based on statistics of past periods and analysis of historic trends.
5.2.4. When conducting a gap analysis, banks may assign term liabilities to appropriate maturities or to the real liquid extent of their value. The real liquid amount of the bank's liquidity in an appropriate maturity is the part thereof in that period that is highly likely to be executed, in the bank's judgment. To define the real liquid amount of liabilities banks should use appropriate criteria for each type of liabilities, statistics of past periods and analysis of historic trends. To ensure that the criteria are adequate, bank's management should regularly review them.
5.2.5. Past due loans, fixed assets, intangible assets, equity investments, other termless assets and capital elements should be assigned to the last (the longest term) maturity in gap analysis.
5.2.6. to control foreign currency denominated liquidity position, banks should conduct a separate gap analysis for foreign exchange, specify the Manat equivalent in the maturity breakdown schedule, as well as evaluate the overall foreign exchange demand.
Considering outcomes of the gap analysis of foreign exchange, banks should regularly monitor their ability to access borrowings on foreign markets, availability of appropriate currency sources on the domestic market, prompt convertibility of one currency to another, exchange rate fluctuations and possible adverse effects on underlying assets.
5.2.7. Gap analysis should include an analysis of individual and cumulative negative liquidity gaps and comparison against the limits set by banks in accordance the requirements herein.
5.2.8. Findings of gap analysis should be properly documented and reported to the management. Decisions on relevant measures to be taken according to findings of the gap analysis should be developed by bank’s authorized person/business unit and submitted to the Management Board for approval.
5.3. Instant liquidity ratio requirement. Every bank should maintain the ratio of average daily price of highly liquid assets to average daily price of highly liquid (current) liabilities at least at the rate of 30 percent.
Liabilities with maturity of 8 to 30 days (including securities issued by the bank) classified as highly liquid (current) liabilities are not included in the calculation of the bank's instant liquidity ratio.
If a bank has past due liabilities to creditors and depositors (including all debts to the Central Bank and other banks), the bank is deemed to have breached the instant liquidity ratio, whether the bank is in compliance with the instant liquidity ratio or not.
5.4. Limit setting. Bank's internal procedures should set at least the following limits to provide a liquidity level adequate in relation to the bank's size (assets, capital, customer base, operations), nature and financial position:

• limit for the ratio of the cumulative negative liquidity gap of at least 0-7, 0-30, 0-90, 0-180, 0-365 and over a year maturity to total assets;
• maximum amount of bank's liabilities per creditor or a group of related creditors (individuals and legal entities, banks, international and other financial institutions), or the maximum ratio to total liabilities;
• maximum ratio of annual principal payments on all liabilities with maturity over one year to total liabilities.

Bank's internal procedures should determine limit compliance procedures, including procedures for removal of incompliance, as well as frequency of comparing actual liquidity indicators against the limits established. Limits set in bank's internal procedures should be regularly reviewed to ensure that the bank's current and projected liquidity position is adequate.
Any instances and causes of limit violation should be documented and reported to the management. Bank's procedures should include measures to be taken to modify bank's liquidity management procedures depending on the extent of violation of limits.
5.5. Analysis of liquidity ratios. Banks should determine procedures for evaluating and comprehensively analyzing the liquidity position and demand for liquid funds, as well as for presenting analysis and evaluation findings to the management. Banks may use the following liquidity ratios in addition to the requirements and limits set in Items 5.3 and 5.4 herein for liquidity analysis:

• Ratio 1: Ratio of highly liquid assets to total assets.
• Ratio 2: Ratio of current assets to highly liquid (current) liabilities (current liquidity ratio). Current assets include, in addition to highly liquid assets, any assets with maturity 30 days or less.

A decline in ratios 1 and 2 indicates a reduction in high quality assets, or bank's excessive reliance on volatile sources of funding normally used for short-term. Such a reduction does not only indicate deterioration of the liquidity condition, but may also indicate acceptable changes in the financing strategy.

• Ratio 3: Ratio of highly liquid (current) liabilities to total assets. This ratio measures the level of financing of assets from short-term liabilities. If this ratio is high, it indicates bank's high dependence on unstable sources of funding.
• Ratio 4: Ratio of highly liquid (current) liabilities to total liabilities. This ratio evaluates the scope of funds that might leave the bank at early signs of problems. If a bank has large amount of highly liquid liabilities, it should have a more stringent emergency/contingency liquidity plan.
• Ratio 5: Ratio of loans to deposits. Loans in this ratio include net loans to customers other than interbank loans (less possible loan loss reserves), and deposits are deposits of customers held with the bank, other than deposits of other banks. This ratio measures the extent to which the bank finances the loan portfolio. An increased ratio indicates the bank's greater reliance on unstable sources of funding (e.g., short-term borrowings).
• Ratio 6: Ratio of pledged securities to total securities. This ratio indicates the percentage of securities pledged as collateral which cannot be used to cover liquidity needs.
• Ratio 7: Ratio of total funds attracted on domestic financial markets to total funds attracted on foreign markets. This ratio is designed for regulating concentration of funds attracted by the bank from domestic and foreign markets.
• Ratio 8: Ratio of total demand deposits and stable balances of correspondent accounts of banks to total liabilities. This ratio identifies what portion of total liabilities are demand deposits and stable balances of correspondent accounts. A stable balance means the amount that has remained in and has not been withdrawn from the account for one year.

5.6. Early warning system. Banks should have an early warning system and procedures that analyze possible critical situations, identify increased risks of adverse changes in the liquidity position and increased need for additional funding.

The early warning system should consist of regularly monitored quantitative and qualitative criteria and cover at least the following criteria:

• excessive growth of low liquid and/or illiquid assets, especially assets funded from highly liquid liabilities;
• increasing concentration of assets and liabilities by types;
• increase in liquidity gaps;
• reduction of average weighted maturities of liabilities;
• regular proximity of limits established, failure to comply with internal and prudential limits;
• dramatic decline in bank's profitability indicators, deterioration of asset quality and overall financial position;
• price decline of bank's shares, bonds and other securities;
• increasing funding costs;
• bank's creditors requiring additional security;
• closure of lines of credit opened for the bank;
• deposit run-off, including unmatured deposits;
• difficulties in attracting long-term funding;
• difficulties in placing short-term liabilities;
• public information that may have adverse impact on the bank;
• decline of ratings assigned by rating agencies;
• deterioration of bank's reputation.

5.7. Stress-test and scenario analysis. To project the bank's liquidity position effectively, the bank should stress-test its liquidity position at least once a month.
The stress-test scenario should be developed taking account of various criteria such as assumptions associated with the bank and the nature of its operations (types of bank transactions and products, sources of funding), current and project market conditions, as well as effects of ratings assigned by international rating agencies.
When conducting a stress-test, it should be remembered that contractual amounts of term assets and liabilities do not necessarily reflect their real liquid value.
Stress-test assumptions may include:

• Stress-test for assets:
• non-timely repayment or delinquency of loans (liquidity risk rising in connection with credit risk);
• the Central Bank revises reserve requirements;
• reduction in bank's liquid assets;
• market value of liquid assets changes.
• Stress-test for liabilities:
• holders of term liabilities withdraw their funds prematurely;
• reduction in funds in current and correspondent accounts;
• currency of customer deposits changes;
• large deposit run-off;
• early revocation of funds from banks and other financial institutions;
• line of credit agreement breached (early termination, contractual amounts not allocated in full or in time).
• Assumptions affecting assets and liabilities:
• interest rates change;
• inflation rate fluctuates;
• exchange rate fluctuates drastically.

Liquidity stress-tests may be carried out at foreign branch offices, subsidiary companies and subsidiary banks of the bank separately in accordance with bank's predetermined procedures. In this case, stress-test findings should be reported to the bank's head office.
Banks should develop ‘the worst case’, ‘the best case’ and ‘probable’ scenarios of development of liquidity position changes and, considering the above assumptions, separate criteria should be developed for each scenario.
Each scenario should be applied to all balance and off-balance sheet items. Any changes in these items should be analyzed and considered in bank's liquidity and financial performance projections.
Assumptions used in stress-tests should be subject to approval by the bank's appropriate committee. Stress-tests and scenario analysis findings should be presented to the bank's management and other relevant employees of the bank.
The bank's appropriate committee should prepare and the Supervisory Board approve decisions for making necessary changes to the bank's strategic plan, as well as limits and liquidity management rules and procedures based on stress-tests and scenario analysis findings.
5.8. Emergency/contingency liquidity plan. Banks should have a plan (hereinafter – the contingency plan) that determines procedures for accessing liquid funds and turning assets into liquid funds with minimum losses in cases of emergency to ensure continuous and undisrupted operation of the bank.
This plan should be developed in consistency with the bank's structure, nature of operations, risk profile, scope of operations, region of business. The contingency plan should, considering the bank's needs for liquid funds, as well as important payments for the bank and their priority in execution, clearly identify potential sources of funding in cases of unexpected shortage of liquid funds, funds that the bank would be realistically able to acquire, required timeframes and associated costs.
The contingency plan should be developed in conjunction with a number of the bank's related business units (Risk Management Committee, Treasury, Asset and Liabilities Management Committee, Information Technologies, Payment Systems and Financial Service) and approved by the Supervisory Board. The plan should identify emergency response procedures and a clear division of related duties and powers.
The contingency plan should be reviewed and approved at least once a quarter, in consistency with the current situation. Assumptions used in the plan should be stress-tested to ascertain that the plan is up to date.
The contingency liquidity management plan should include:

• size and composition of funds considered the most stable among attracted funds;
• from the standpoint of likelihood of reduction of sources of funding attracted by the bank due to unexpected liquidity deficit, classification of such funding sources;
• term and termless liabilities expected to decrees immediately as soon as early signs of unexpected liquidity deficit arise;
• bank's sources and ability to raise additional funding, including additional capital (in consideration of prudential norms and internal limits and other requirements);
• expected maximum period of time required to restore undisrupted operation of the bank if unexpected liquidity deficit arises.

The plan should identify assets that may be used as security or disposed of immediately.
5.9. Diversification of sources of funding. Banks should diversify their funding sources depending on the nature of their operations, type of products and markets they operate in. Funding sources should be diversified as follows

• by various types of deposits;
• by use of other various types of attracted funds (e.g., commercial securities issued by the bank) as security of bank's liabilities, other than deposits;
• by various types of depositors/creditors (individuals and legal entities, the Central Bank, other government agencies, banks and other financial institutions, etc.);
• by geographic location, country, region.

To ensure that components of diversification are adequate in relation to existing conditions, they should be reviewed at least once a quarter.
5.10. Collateral management. If additional funding is required for balance and off-balance sheet operations, assets usable as collateral should be regularly monitored. Banks should ensure that no legal, regulatory or internal limitations exist as far as immediate use of such assets with as little loss as possible.
5.11. Liquidity of branch offices. Bank's internal procedures should identify the requirements on liquidity of branches, liquidity management procedures and liquidity position reporting system, in consideration of their scope and nature of operations.
The branch office liquidity management system should cover liquidity requirement planning in light of bank-established maturities, as well as procedures for interaction with the bank's head office and other branch offices to provide and/or increase the branch office's liquid funds.

6. Reporting system and submission of reports

6.1. Internal reporting system. The bank's management should receive regular and, in emergencies, immediate liquidity status reports.
The bank's reporting system should cover liquidity management processes noted in Item 5 herein. In addition, the reporting system should also contain the following information to inform the bank management as well as other authorized employees:

• liability concentration data: largest providers of funds/liability holders, their lines of business and geographic distribution, type of resources (current account, term deposit, interbank loan), amount of funds, interest rate and other details;
• list of the most marketable assets;
• list of assets currently pledged as collateral and, if additional funding is required, may be pledged as collateral or refinanced in future;
• recovery of loans and other liabilities, future fixed asset acquisition and long-term investment financing plan (internal) and projections (considering external impacts);
• value of various resources for return on assets and bank transactions (current and projected values for funding sources);
• regular reports for evaluation of current market conditions, as well as bank's ability to access market and sell assets as quickly as possible to ensure diversification of liabilities.

6.2. Management Information System (MIS). Banks should develop and put in place an adequate information system to:

• measure, monitor and control liquidity risk on a daily basis;
• determine and modify maturities for analysis of liabilities;
• check compliance with procedures and limits established;
• monitor trends of liquidity indicators;
• develop various reports in the format defined in regulatory requirements and internal policies.

The MIS should be able to monitor the dynamics of the criteria identified in the early warning system and alert the bank management if any indicator reaches a critical level.
The MIS should allow calculation of the liquidity position for each currency, as well as the total liquidity position for all currencies used by the bank.
The MIS-generated reports should be regularly presented to the bank's Supervisory Board, Management Board and relevant employees.
6.3. Internal control of liquidity risk management. Bank's internal controls should ensure that the liquidity management processes are adequately controlled. The main component of internal control is the regular independent evaluation of the liquidity management system and presentation of requirements to make necessary changes in this system. Findings of such evaluations should be properly documented and reported to the bank management.
6.4. Reporting to the Central Bank. Banks should prepare their liquidity position reports, including maturity breakdown and instant liquidity reports in accordance with the format and procedure requirements of the prudential reporting system and presented to the Central Bank as part of prudential reports.
6.5. Delivery of data to users. Banks should disclose their liquidity risk details to users in accordance with Central Bank's related regulations. In addition, the bank's own policy may provide for additional disclosures on the bank's stability.