Asset Liability Management
in Banks
[Module A]
Live Interactive Learning Session- 16-04-2007
Presentation by S P Dhal, Faculty Member,
SPBT College
Components of a
Bank Balance sheet
Liabilities
Assets
1.
2.
3.
4.
5.
1.
2.
Capital
Reserve & Surplus
Deposits
Borrowings
Other Liabilities
Cash & Balances with RBI
Bal. With Banks & Money at
Call and Short Notices
3. Investments
4. Advances
5. Fixed Assets
6. Other Assets
Contingent Liabilities
Components of Liabilities
1.Capital:
Capital
represents
owner’s
contribution/stake in the bank.
- It serves as a cushion for depositors and
creditors.
- It is considered to be a long term sources
for the bank.
Components of Liabilities
2. Reserves & Surplus
Components under this head includes:
I.
II.
III.
III.
IV.
Statutory Reserves
Capital Reserves
Share Premium
Revenue and Other Reserves
Balance in Profit and Loss Account
Components of Liabilities
3. Deposits
This is the main source of bank’s funds. The
deposits are classified as deposits payable on
‘demand’ and ‘time’. They are reflected in
balance sheet as under:
I.
Demand Deposits
II. Savings Bank Deposits
III. Term Deposits
Components of Liabilities
4. Borrowings
(Borrowings
include
Refinance
/
Borrowings from RBI, Inter-bank & other
institutions)
I. Borrowings in India
i) Reserve Bank of India
ii) Other Banks
iii) Other Institutions & Agencies
II. Borrowings outside India
Components of Liabilities
5. Other Liabilities & Provisions
It is grouped as under:
I.
II.
III.
IV.
V.
Bills Payable
Inter Office Adjustments (Net)
Interest Accrued
Unsecured Redeemable Bonds
(Subordinated Debt for Tier-II Capital)
Others(including provisions income tax,
TDS, Interest Tax, Provisions etc.)
Components of Assets
1. Cash & Bank Balances with RBI
I. Cash in hand
(including foreign currency notes)
II. Balances with Reserve Bank of India
In Current Accounts
In Other Accounts
Components of Assets
2. BALANCES WITH BANKS AND MONEY AT CALL &
SHORT NOTICE
I. In India
i) Balances with Banks
a) In Current Accounts
b) In Other Deposit Accounts
ii) Money at Call and Short Notice
a) With Banks
b) With Other Institutions
II. Outside India
a) In Current Accounts
b) In Other Deposit Accounts
c) Money at Call & Short Notice
Components of Assets
3. Investments
A major asset item in the bank’s balance sheet.
Reflected under 6 buckets as under:
I. Investments in India in : *
i) Government Securities
ii) Other approved Securities
iii) Shares
iv) Debentures and Bonds
v) Subsidiaries and Sponsored Institutions
vi) Others (UTI Shares , Commercial Papers, COD &
Mutual Fund Units etc.)
II. Investments outside India in **
Subsidiaries and/or Associates abroad
Components of Assets
4. Advances
The most important assets for a bank.
A. i) Bills Purchased and Discounted
ii) Cash Credits, Overdrafts & Loans
repayable on demand
iii) Term Loans
B. Particulars of Advances :
i) Secured by tangible assets
(including advances against Book Debts)
ii) Covered by Bank/ Government Guarantees
iii) Unsecured
Components of Assets
5. Fixed Asset
I.
Premises
II.
Other Fixed Assets (Including furniture and fixtures)
6. Other Assets
I.
II.
III.
IV.
V.
VI.
Interest accrued
Tax paid in advance / tax deducted at source
(Net of Provisions)
Stationery and Stamps
Non-banking assets acquired in satisfaction of claims
Deferred Tax Asset (Net)
Others
Contingent Liability
Bank’s obligations under LCs, Guarantees,
Acceptances on behalf of constituents and Bills
accepted by the bank are reflected under this
heads.
It also includes Un-called part of Partly Paid
Investment.
Banks Profit & Loss Account
I.
II.
A bank’s profit & Loss Account has
the following components:
Income: This includes Interest Income
and Other Income.
Expenses: This includes Interest
Expended, Operating Expenses and
Provisions & contingencies.
Components of Income
1. INTEREST EARNED
I.
II.
III.
Interest/Discount on Advances / Bills
Income on Investments
Interest on balances with Reserve Bank
of India and other inter-bank funds
IV. Others
Components of Income
2. OTHER INCOME
I.
II.
III.
IV.
V.
VI.
VII.
Commission, Exchange and Brokerage
Profit on sale of Investments (Net)
Profit/(Loss) on Revaluation of Investments
Profit on sale of land, buildings and other
assets (Net)
Profit on exchange transactions (Net)
Income earned by way of dividends etc. from
subsidiaries and Associates abroad/in India
Miscellaneous Income
Components of Expenses
1. INTEREST EXPENDED
I.
II.
III.
Interest on Deposits
Interest on Reserve Bank of India / Inter-Bank
borrowings
Others
Components of Expenses
2. OPERATING EXPENSES
I.
Payments to and Provisions for employees
II.
Rent, Taxes and Lighting
III.
Printing and Stationery
IV.
Advertisement and Publicity
V. Depreciation on Bank's property
VI.
Directors' Fees, Allowances and Expenses
VII.
Auditors' Fees and Expenses (including Branch Auditors)
VIII.
Law Charges
IX.
Postages, Telegrams, Telephones etc.
X.
Repairs and Maintenance
XI.
Insurance
XII.
Other Expenditure
Provisions & Contingencies
• Provision Made for:
- Bad & Doubtful debts
- Taxation
- Depreciation/Diminution in value of
Investment
- Other Provisions
Assets Liability Management
It is a dynamic process of Planning,
Organizing & Controlling of Assets
& Liabilities- their volumes, mixes,
maturities, yields and costs in order
to maintain liquidity and NII.
Financial Intermediation-Qualitative Asset
Transformation
• Liquidity and payment intermediation
– Liquid deposits vs illiquid credits
• Maturity intermediation
– Short-term deposits vs long-term credits
• Denomination intermediation
– Small-denomination deposits vs large credits
• Diversification intermediation
– Investors have a claim against a well-diversified
portfolio
• Information intermediation
– FIs acquire information about the borrowers, provide
them with funds, and monitor their performance
– Incentives for monitoring: rents or reputation
Significance of ALM
•
•
•
•
•
Volatility
Product Innovations & Complexities
Integration of Markets
Regulatory Environment
Management Recognition
Purpose & Objective of ALM
An effective Asset Liability Management Technique
aims to manage the volume, mix, maturity, rate
sensitivity, quality and liquidity of assets and
liabilities as a whole so as to attain a predetermined
acceptable risk/reward ratio.
It is aimed to stabilize short-term profits, long-term
earnings and long-term substance of the bank. The
parameters for stabilizing ALM system are:
1.
Net Interest Income (NII)
2.
Net Interest Margin (NIM)
3.
Economic Equity Ratio
RBI DIRECTIVES
• Issued draft guidelines on 10th Sept 1998.
• Final guidelines issued on 10th
implementation of ALM w.e.f. 01.04.99.
Feb’99
for
• To begin with 60% of asset & liabilities are covered;
100% from 01.04.2000.
• Initially Gap Analysis was applied in the first stage of
implementation.
• Disclosure to Balance Sheet on maturity pattern on
Deposits, Borrowings, Investment & Advances w.e.f.
31.03.01
Liquidity Management
Bank’s liquidity management is the process
of generating funds to meet contractual or
relationship obligations at reasonable prices
at all times.
New loan demands, existing commitments,
and deposit withdrawals are the basic
contractual or relationship obligations that a
bank must meet.
Adequacy of liquidity position for
a bank
a.
b.
c.
d.
e.
f.
g.
h.
Analysis of following factors throw light on a
bank’s adequacy of liquidity position:
Historical Funding requirement
Current liquidity position
Anticipated future funding needs
Sources of funds
Options for reducing funding needs
Present and anticipated asset quality
Present and future earning capacity and
Present and planned capital position
Factors that may affect a bank’s liquidity include:
•
•
•
•
•
•
•
A decline in earnings
An increase in Non-Performing assets
Deposit concentration
A down grading by Rating Agencies
Expanded Business Opportunity
Acquisitions
New Tax initiatives
Funding Avenues
To satisfy funding needs, a bank must perform
one or a combination of the following:
a.
b.
c.
d.
e.
f.
Dispose off liquid assets
Increase short term borrowings
Decrease holding of less liquid assets
Increase liability of a term nature
Securitization of Assets
Increase Capital funds
Types of Liquidity Risk
• Liquidity Exposure can stem from both
internally and externally.
• External liquidity risks can be geographic,
systemic or instrument specific.
• Internal liquidity risk relates largely to
perceptions of an institution in its various
markets: local, regional, national or
international
Other categories of liquidity risk
• Funding Risk
- Need to replace net outflows due to
unanticipated withdrawals/non-renewal
Arises due to:
• Fraud Causing substantial loss
• Systemic risk
• Loss of Confidence
• Liabilities in Foreign Currencies
Other categories of liquidity risk
• Time Risk
- Need to compensate for non-receipt of
expected inflows of funds
Arises due to:
- Severe deterioration in asset quality
- Standard assets turning into NPA
- Temporary Problem in recovery
- Time involved in managing liquidity
Other categories of liquidity risk
• Call Risk
- Crystallization of contingent liability
Arises due to:
- Conversion of non-fund based limit to fund
based limit
- Swaps and Options
Measuring & Managing Liquidity
Risk
Steps necessary for managing liquidity
risks in Banks
1. Developing a structure for managing
liquidity risk
2. Setting tolerance level and limit for
liquidity risk
3. Measuring and Managing Liquidity Risk
Setting tolerance level and limit for
liquidity risk
Limits could be set on the following lines:
1.
2.
3.
4.
5.
6.
Cumulative cash flow mismatches over particular period taking
conservative view of marketable liquid assets
Liquid assets as percentage of short-term liabilities
A limit on Loan to deposit ratio
A limit on loan to capital ratio
Primary sources for meeting funding needs should be quantified
Flexible liquidity provision to be maintained to sustain
operations
Measuring and Managing
Liquidity Risk
Measuring and Managing funding requirement can
be done through two approaches:
1. Stock Approach
2. Flow Approach
Stock Approach
This Approach is based on the level of assets
and liabilities as well as Off-Balance sheet
exposures on a particular date.
1. Ratio of Core Deposit to total Assets:
Core Deposit/Total Asset: More the ratio better it is
because core deposit treated to be the stable source of
liquidity.
2. Net Loans to Total deposits Ratio:
Net Loans/Total Deposit: It reflects the ratio of loans
to Public Deposits or core deposits. Lower the ratio is
the better.
Stock Approach
3. Ratio of Time Deposit to Total Deposits:
Time Deposits/Total Deposits:
Higher the Ratio better
4. Ratio of Volatile liabilities to total assets
Volatile Liabilities/Total Assets
Lower the Ratio the Better
5. Ratio of Short Term Liabilities to Liquid
Assets:
Short Term Liabilities/Liquid Assets:
Lower the Ratio the better
Stock Approach
6. Ratio of Liquid Assets to Total Assets:
Higher the Ratio the better
7. Ratio of Short Term Liability/Total Assets:
A lower ratio is desirable
8. Ratio of Prime Asset to Total Asset:
Higher the ratio the better
9. Ratio of Marketable liability to total asset:
Lower the ratio better
N.B>Indian Banks do not follow this approach
Flow Approach
The Frame work for assessing and
managing bank liquidity through flow
approach has three major dimensions:
1. Measuring and Managing net funding
requirements
2. Managing market access, and
3. Contingency Planning
Statement of Structural Liquidity
All Assets & Liabilities to be reported as per
their maturity profile into 8 maturity Buckets:
i.
1 to 14 days
ii. 15 to 28 days
iii. 29 days and up to 3 months
iv. Over 3 months and up to 6 months
v. Over 6 months and up to 1 year
vi. Over 1 year and up to 3 years
vii. Over 3 years and up to 5 years
viii. Over 5 years
STATEMENT OF
STRUCTURAL LIQUIDITY
• Places all cash inflows and outflows in the
maturity ladder as per residual maturity
• Maturing Liability: cash outflow
• Maturing Assets : Cash Inflow
• Classified in to 8 time buckets
• Mismatches in the first two buckets not to
exceed 20% of outflows
• Shows the structure as of a particular date
• Banks can fix higher tolerance level for other
maturity buckets.
An Example of Structural Liquidity
Statement
15-28
1-14Days Days
Capital
Liab-fixed Int
Liab-floating Int
Others
Total outflow
Investments
Loans-fixed Int
Loans - floating
300 200
350 400
50 50
700 650
200 150
50 50
200 150
Loans BPLR Linked
100 150
Others
50 50
Total Inflow
600 550
Gap
-100 -100
Cumulative Gap -100 -200
Gap % to Total Outflow
-14.29 -15.38
30 Days- 3 Mths - 6 Mths - 1Year - 3 3 Years - Over 5
3 Month 6 Mths
1Year
Years
5 Years Years
200 600 600 300 200
350 450 500 450 450
0
550 1050 1100 750 650
250 250 300 100 350
0 100 150 50 100
200 150 150 150 50
200 500 350 500 100
0
0
0
0
0
650 1000 950 800 600
100 -50 -150 50 -50
-100 -150 -300 -250 -300
18.18
-4.76
-13.64
6.67
-7.69
200
200
450
200
1050
900
100
50
100
200
1350
300
0
28.57
Total
200
2600
3400
300
6500
2500
600
1100
2000
300
6500
0
0
ADDRESSING THE MISMATCHES
• Mismatches can be positive or negative
• Positive Mismatch: M.A.>M.L. and Negative
Mismatch M.L.>M.A.
• In case of +ve mismatch, excess liquidity can
be deployed in money market instruments,
creating new assets & investment swaps etc.
• For –ve mismatch,it can be financed from
market borrowings (Call/Term), Bills
rediscounting, Repos & deployment of foreign
currency converted into rupee.
STRATEGIES…
• To meet the mismatch in any maturity
bucket, the bank has to look into
taking deposit and invest it suitably
so as to mature in time bucket with
negative mismatch.
• The bank can raise fresh deposits of
Rs 300 crore over 5 years maturities
and invest it in securities of 1-29 days
of Rs 200 crores and rest matching
with other out flows.
Maturity Pattern of Select Assets & Liabilities of A Bank
Liability/Assets
I. Deposits
a. Up to 1 year
b. Over 1 yr to 3 yrs
c. Over 3 yrs to 5 yrs
d. Over 5 years
II. Borrowings
a. Up to 1 year
b. Over 1 yr to 3 yrs
c. Over 3 yrs to 5 yrs
d. Over 5 years
III. Loans & Advances
a. Up to 1 year
b. Over 1 yr to 3 yrs
c. Over 3 yrs to 5 yrs
d. Over 5 years
Iv. Investment
a. Up to 1 year
b. Over 1 yr to 3 yrs
c. Over 3 yrs to 5 yrs
d. Over 5 years
Rupees
(In Cr)
15200
8000
6700
230
270
450
180
00
150
120
8800
3400
3000
400
2000
5800
1300
300
900
3300
In Percentage
100
52.63
44.08
1.51
1.78
100
40.00
0.00
33.33
26.67
100
38.64
34.09
4.55
22.72
100
22.41
5.17
15.52
56.90
Interest Rate Sensitivity Analysis
• Structural Liquidity Statement is the
basis for IRS analysis. All off balance
sheet items are excluded except Repos,
Reverse Repos and SWAPs.
• Non-sensitive assets / liabilities are
shifted to non-sensitive bucket (like
Capital, Reserves, Fixed Assets etc).
• A perception of likely interest rate
scenario is formed. Accordingly, repricing effect is assessed for all RSA /
RSL.
• Rate sensitive gaps are assessed from
the analysis.
STATEMENT OF
INTEREST RATE SENSITIVITY
• Generated by grouping RSA,RSL & OFFBalance sheet items in to various (8)time
buckets.
RSA:
• MONEY AT CALL
• ADVANCES ( BPLR LINKED )
• INVESTMENT
RSL
• DEPOSITS EXCLUDING CD
• BORROWINGS
Balance Sheet looked at from Interest Rates:
Balance Sheet Items
Whether
Interest
bearing
Fixed /
Floating Rate
Remarks
Liabilities
Capital
No
Reserves & Surplus
No
Deposits
- Current Deposits
No
- Savings Deposits
Yes
- Term Deposits
Fixed
Yes
Fixed
Yes
Fixed
Yes
Generally
Fixed
Yes
Fixed
Discretionary pricing
for High Value deposits
& Inter bank items
Borrowings
- From within India
- From Outside India
Sometimes, floating,
linked to LIBOR
Other Liabilities
- Interest Payable
- Subordinated Debts
Yes
- Others
NO
Fixed
In a few cases, this is
floating rate item
Balance Sheet looked at from Interest Rates:
Balance Sheet Items
Whether
Interest
bearing
Fixed /
Floating Rate
Remarks
Assets
Cash on Hand
Balances with RBI
No
Interest only on CRR
withdrawn since
24-06-2006
No
Balances with Other
Banks
- in current accounts
- Call money,
Reverse Repo etc
Investments
No
Yes
Fixed
Yes
Fixed
Loans and Advances
Yes
Fixed /
Floating
Fixed Assets
No
Other Assets
No
However, shares etc do
not earn interest
MATURITY GAP METHOD
(IRS)
•
•
•
•
THREE OPTIONS:
A) RSA>RSL= Positive Gap
B) RSL>RSA= Negative Gap
C) RSL=RSA= Zero Gap
IRS & Interest Rate Scenario
Impact of Interest Rate Changes on NII
Rising Interest Stable Interest Falling Interest
Rate Scenario Rate Scenario Rate Scenario
Negative Mis Matches in IRS
Adverse
No Impact Favourable
Mis Match in IRS is NIL
No Impact No Impact No Impact
Positive Mis Matches in IRS Favourable No Impact
Adverse
Interest Rate Risk Management
• Interest Rate risk is the exposure of a bank’s
financial conditions to adverse movements
of interest rates.
• Though this is normal part of banking
business, excessive interest rate risk can
pose a significant threat to a bank’s earnings
and capital base.
• Changes in interest rates also affect the
underlying value of the bank’s assets,
liabilities and off-balance-sheet item.
Interest Rate Risk
• Interest rate risk refers to volatility in Net
Interest Income (NII) or variations in Net
Interest Margin(NIM).
• Therefore, an effective risk management
process that maintains interest rate risk
within prudent levels is essential to safety
and soundness of the bank.
Sources of Interest Rate Risk
• Interest rate risk mainly arises from:
–
–
–
–
–
–
Gap Risk
Basis Risk
Embedded Option Risk
Yield Curve Risk
Price Risk
Reinvestment Risk
Measurement of Interest Rate Risk
• Gap Analysis- Simple maturity/re-pricing
Schedules can be used to generate simple
indicators of interest rate risk sensitivity of both
earnings and economic value to changing interest
rates.
- If a negative gap occurs (RSA<RSL) in given
time band, an increase in market interest rates
could cause a decline in NII.
- conversely, a positive gap (RSA>RSL) in a
given time band, an decrease in market interest
rates could cause a decline in NII.
Interest Rate Risk
• The risk that the returns on funds to be reinvested will
fall below the originally anticipated returns.
0
0
Liabilities
Assets
1 year
2 years
Measurement of Interest Rate Risk
• Duration Analysis: Duration is a measure
of the percentage change in the economic
value of a position that occur given a small
change in level of interest rate.
MARKET RISK: Measure, Monitor & Manage
– Value at Risk
Value-at-Risk
Value-at-Risk is a measure of Market Risk,
which measures the maximum loss in the
market value of a portfolio with a given
confidence
VaR is denominated in units of a currency
or as a percentage of portfolio holdings
For e.g.., a set of portfolio having a current
value of say Rs.100,000- can be described
to have a daily value at risk of Rs. 5000- at
a 99% confidence level, which means there
is a 1/100 chance of the loss exceeding Rs.
5000/- considering no great paradigm shifts
in the underlying factors.
It is a probability of occurrence and hence is
a statistical measure of risk exposure
The Success of ALM rests of
effective existence of:
• ALM Information System
- Management Information System (MIS)
- Information Availability, Accuracy,
Adequacy and expediency
• ALM Organization
• ALM Process
ALM Information System
• Information is key to the ALM Process
• Due to varied nature of business focus among
Public/Private/Foreign Banks, uniform practice of
ALM System not feasible
• Data Accuracy, Quality & timeliness are key to
ALM information system
• Banks with wide geographical reach and manual
system required to follow ABC Approach so as to
cover maximum assets and liabilities for analyzing
their behaviour.
• The level of computerization, use of Core Banking
Solution will ease the ALM Information System.
ALM Organization
• ALCO Committee
– Should be headed by CEO/CMD or ED
– Members include head of Investment, Credit, Funds
& Treasury (Fx & Domestic), International Banking
and Economic Research can be members. In
addition, head of IT should also be an invitee for
building up of MIS/Computerization.
– The Management Committee of the Board or any
other specific Committee constituted by the Board
should oversee the implementation of system &
review its functioning periodically.
ALM Process
• The Scope of ALM functions can be
described as follows:
- Liquidity Management
- Management of Interest Rate Risk/Market
Risk
- Funding & Capital Planning
- Profit planning and Growth Projections
- Trading Risk Management
SUCCESS OF ALM IN BANKS :
PRE - CONDITIONS
1. Awareness for ALM in the Bank staff at all
levels–supportive Management & dedicated
Teams.
2. Method of reporting data from Branches/ other
Departments. (Strong MIS).
3. Computerization-Full computerization,
networking.
4. Insight into the banking operations, economic
forecasting,
computerization,
investment,
credit.
5. Linking up ALM to future Risk Management
Strategies.
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