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ASSETS LIABILITY MANAGEMENT IN BANK
INDEX
SR.NO TOPIC Page No.
1 Introduction 2-3
2 Basis Of Asset-Liability Management 4-63 Purpose And Objectives Of Assets Liability
Management
7-10
4 Significant Of Assets Liability Management 11-12
5 Scope Of Assets Liability Management 13-14
6 Components Of A Bank Balance Sheet 14-247 Techniques Of Assets Liability Management 25-27
8 Asset-Liability Management Approach 28-339 Assets Liability Management (ALM) System
In Bank- RBI Guidelines
34-46
10 Procedure For Examination Of Asset
Liability Management 47-5011 Study Of Assets Liability Management In
Indian Banks: Canonical Correlation
Analysis (Period – 1992-2004)
51-63
12 Conclusion13 Bibliography
CHAPTER 1
ASSETS LIABILITY MANAGEMENT
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Assets liability management has today become the most topical subject of any
financial institution. It encompasses the analysis and development of goals and
objectives, the development of long term strategic plans, periodic profit plans
and rate sensitivity management. In one way or another it has always been the
function or responsibility of Treasury and other financial/ strategic department
is being established and assets liability management department are being
formed within financial institution. These committees are often given
extraordinary powers regarding the mix and match of assets and liabilities and
have large influence in winding up activities which do not fit business strategy.
It is true that banks create both assets and liabilities in their day-to-day
operations, but it is also equally true that risk management in bank is keener to
manage their assets rather than their liabilities. In fact, for some time, bankers
were happy to keep an eye on their assets acquisition and treated the liability as
granted.
Of late, the mindset has changed and banks increasingly shown equal, if not
more, interest in liability management. In fact, bank’s main business is to
manage risk. Importantly, liquidity and interest risk management constitutes the
core business of banks.
To be more precise, banks are in the business of maturity transformation. They
accept deposits of different maturities and advance loan of different maturities.
Balancing and adjusting maturity period of deposits and loans from the core
business activity of banks.
If this activity of a bank is analyzed, one may observe that banks also transfer
the risk appetite of customers to each other through market operation.
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These activities of banks result in management of liquidity and interest risk in
their operations. In early day’s bank were mongering risks by having in-depth
knowledge of customers.
In day-to-day operation, it is inevitable for bank to face liquidity imbalance due to various reason.
CHAPTER 2
BASIS OF ASSET-LIABILITY MANAGEMENT
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Traditionally, banks and insurance companies used accrual system of
accounting for all their assets and liabilities. They would take on liabilities -
such as deposits, life insurance policies or annuities. They would then invest
the proceeds from these liabilities in assets such as loans, bonds or real
estate. All these assets and liabilities were held at book value. Doing so
disguised possible risks arising from how the assets and liabilities were
structured.
Consider a bank that borrows 1 Core (100 Lakhs) at 6 % for a year and lends
the same money at 7 % to a highly rated borrower for 5 years. The net
transaction appears profitable-the bank is earning a 100 basis point spread -
but it entails considerable risk. At the end of a year, the bank will have to
find new financing for the loan, which will have 4 more years before it
matures. If interest rates have risen, the bank may have to pay a higher rate
of interest on the new financing than the fixed 7 % it is earning on its loan.
Suppose, at the end of a year, an applicable 4-year interest rate is 8 %. The
bank is in serious trouble. It is going to earn 7 % on its loan but would have
to pay 8 % on its financing. Accrual accounting does not recognize this
problem. Based upon accrual accounting, the bank would earn Rs 100,000 in
the first year although in the preceding years it is going to incur a loss.
The problem in this example was caused by a mismatch between assets and
liabilities. Prior to the 1970's, such mismatches tended not to be a significant
problem. Interest rates in developed countries experienced only modest
fluctuations, so losses due to asset-liability mismatches were small or trivial.
Many firms intentionally mismatched their balance sheets and as yield
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curves were generally upward sloping, banks could earn a spread by
borrowing short and lending long.
Things started to change in the 1970s, which ushered in a period of volatile
interest rates that continued till the early 1980s. US regulations which had
capped the interest rates so that banks could pay depositors, were abandoned
which led to a migration of dollar deposit overseas. Managers of many
firms, who were accustomed to thinking in terms of accrual accounting,
were slow to recognize this emerging risk. Some firms suffered staggering
losses. Because the firms used accrual accounting, it resulted in more of
crippled balance sheets than bankruptcies. Firms had no options but to
accrue the losses over a subsequent period of 5 to 10 years.
One example, which drew attention, was that of US mutual life insurance
company "The Equitable." During the early 1980s, as the USD yield curve
was inverted with short-term interest rates sky rocketing, the company sold a
number of long-term Guaranteed Interest Contracts (GICs) guaranteeing
rates of around 16% for periods up to 10 years. Equitable then invested the
assets short-term to earn the high interest rates guaranteed on the contracts.
But short-term interest rates soon came down. When the Equitable had to
reinvest, it couldn't get even close to the interest rates it was paying on the
GICs. The firm was crippled. Eventually, it had to demutualize and was
acquired by the Axa Group.
Increasingly banks and asset management companies started to focus on
Asset-Liability Risk. The problem was not that the value of assets might fall
or that the value of liabilities might rise. It was that capital might be depleted
by narrowing of the difference between assets and liabilities and that the
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values of assets and liabilities might fail to move in tandem. Asset-liability
risk is predominantly a leveraged form of risk.
The capital of most financial institutions is small relative to the firm's assets
or liabilities, and so small percentage changes in assets or liabilities can
translate into large percentage changes in capital. Accrual accounting could
disguise the problem by deferring losses into the future, but it could not
solve the problem. Firms responded by forming assets-liability management
( ALM ) department to assess these assets-liability risk.
CHAPTER 3
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PURPOSE AND OBJECTIVES OF ASSETS
LIABILITY MANAGEMENT
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.
THUS, PURPOSE OF ASSETS LIABILITY MANAGEMENT
IS TO ENHANCE THE ASSET AND LIABILITIES AND
FURTHER MANAGE THEM. SUCH A PROCESS WILL
INVOLVE THE FOLLOWING STEPS:
I. Review the interest rate structure and compare the same to the
interest/product pricing of both assets and liabilities.
II. Examine the loan and investment portfolios in the light of the foreign
exchange risk and liquidity risk that might arise.
III. Examine the credit risk and contingency risk that may originate either
due to rate fluctuations or otherwise and assess the quality of assets.
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IV. Review, the actual performance against the projections made and
analyse the reasons for any effect on spreads.
The Assets Liability Management technique so designed to manage various
risk primarily aim to stabilize the short profits.
-Net Interest Income (NII)
-Net Interest Margin (NIM)
-Economic Equity Ratio
1. Net Interest Income (NII):
The impact of volatility on the short- term profit is measured by Net Interest
Income.
Net Interest Income = Interest Income – Interest Expenses.
2. Net Interest Margin (NIM):
Net Interest Margin = Net Interested Income / Average Total Assets.
Net Interest Margin can be viewed as the ‘spread’ on earning assets.
The net income of banks comes mostly from the spreads maintained between
total interest income and total interest expense. The higher the spread the
more will be the NIM.
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3. Economic Equity Ratio:
The ratio of shareholders funds to the total assets measures the shifts in the
ratio of owned funds to total funds. This fact assesses the sustenance
capacity of the bank.
OBJECTIVE OF ASSETS LIABILITY MANAGEMENT
At micro – level the objectives of Assets Liability Management are two
folds. It aims at profitability through Price Matching while ensuring liquidity
by means of maturity matching.
1. Price Matching basically aims to maintain spreads by ensuring that
deployment of liabilities will be at a rate higher than the costs. This exercise
would indicate whether the institution is in a position to benefit from rising
interest rates by having a positive gap (assets > liabilities) or whether it is in
a position to benefit from declining interest rates by a negative gap(liabilities
> assets).
2. Liquidity is ensured by grouping the assets/liabilities based on their
Maturing profiles. The gap in then assessed to identify future financing
Requirements. However, there are often maturity mismatches, which may to
a certain extent affect the expected result.
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CHAPTER 4
SIGNIFICANT OF ASSETS LIABILITY
MANAGEMENT
Why Do We Need Assets Liability Management? In simple terms- a
financial institution may have enough assets to pay off its liabilities. But
what if 50% of liabilities are maturing within 1 year but only 10% of assets
maturing within the same period. Though the financial institution has
enough assets, it may become temporarily insolvent due to severe liquidity
crisis.
Thus, ALM is required to match the assets and liabilities and minimize
liquidity as well as market risk.
Assets Liability Management views the financial institution as a set of
interrelationships that must be identified coordinated and managed as an
integral system. The primary management goal is the control of income and
expenses and the resulting net interest margins on ongoing basis.
Some Of Reasons for growing significance ASSETS
LIABILITY MANAGEMENT are:
1. Volatility
Deregulation of financial system changed the dynamics of financial markets.
The vagaries of such free economic environment are reflected in interest rate
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structures, money supply and overall credit position of the market, the
exchange rate and price level.
2. Product Innovation
The second reason for growing importance of ALM is rapid innovation take
place in financial product of bank. While there were some innovations that
came as passing fads, others have received tremendous response.
3. Regulatory Environment
At the international level, Bank for International Settlement (BIS) provides a
framework for banks to tackle the market risks that may arise due to rate
fluctuation and excessive credit risk. Central Bank in various countries
(including Reserve Bank of India) has issued frameworks and guidelines for
banks to develop Assets Liability Management policies.
4. Management Recognition
All the above – mentioned aspects forced bank management to give a
serious thought to effective management of assets and liabilities. A bank
shoul be in a position to relate and link the asset side with liability side. And
this calls for efficient Asset- Liability Management.
There is increasing awareness in the top management that banking is now a
different game altogether since all risks of the game have since changed.
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CHAPTER 5
SCOPE OF ASSETS LIABILITY MANAGEMENT
The scope of Asset Liability Management (ALM) must be clearly defined. It
has the purpose of formulating strategies, directing actions an monitoring
implementation thereof for shaping bank’s balance sheet that contributes to
attainment of the bank’s goals. Normally, in such context, the goals are,
a. To maximize or at least to stabilize the net interest margin and
b. To maximize or at least to protect the value or stock price, at an
acceptable level.
It is recognized that ALM addresses to the managerial tasks of planning,
directing and monitoring. The Treasury Department undertakes operational
tasks of executing the detailed strategies and actions. In any case, neither
ALM nor ALCO get associated, in any way, with the operational aspects of
funds management.
Managing risk / return trade off with in the ALM framework provided by ALCO is the task of Treasury and not ALM / ALCO.
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CHAPTER 6
COMPONENTS OF A BANK BALANCE SHEET
1. COMPONENTS OF LIABILITIES
LIABILITIES ASSETS
1. Capital
2. Reserve & Surplus
3. Deposits
4. Borrowings
5. Other Liabilities
1. Cash & Balances with RBI
1. Balance With Banks & Money at Call and Short
Notices
3. Investments
4. Advances
5. Fixed Assets
6. Other Assets
Contingent 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.
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2. Reserves & Surplus:
Components under this head include:
I. Statutory Reserve
II. Capital Reserves
III. Investment Fluctuation Reserve
IV. Revenue and Other Reserves
V. Balance in Profit and Loss Account
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
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III. Term Deposits
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
I. Borrowings outside India
5. Other Liabilities & Provisions:
It is grouped as under:
I. Bills Payable
II. Inter Office Adjustments (Net)
III. Interest Accrued
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IV. Unsecured Redeemable Bonds
(Subordinated Debt for Tier-II Capital)
V. Other (including provision)
1. 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
2. Balances With Banks And Money At Call & Short Notice
I. In India
i) Balances with Banks
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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
2. 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
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iii) Shares
iv) Debentures and Bond
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
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)
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ii) Covered by Bank/ Government Guarantees
iii) Unsecured
5. Fixed Asset:
I. Premises
II. Other Fixed Assets (Including furniture and fixtures)
6. Other Assets:
I. Interest accrued
II. Tax paid in advance/tax deducted at source (Net of Provisions)
III. Stationery and Stamps
IV. Non-banking assets acquired in satisfaction of claims
V. Deferred Tax Asset (Net)
VI. Others
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CONTINGENT LIABILITY
Bank’s obligations under LCs, Guarantees, and Acceptances on behalf of
constituents and Bills accepted by the bank are reflected under this heads.
BANKS PROFIT & LOSS ACCOUNT
A bank’s profit & Loss Account has the following components:
I. Income: This includes Interest Income and Other Income.
II. Expenses: This includes Interest Expended, Operating Expenses
and Provisions & contingencies.
COMPONENTS OF INCOME
1. Interest Earned
I. Interest/Discount on Advances / Bills
II. Income on Investments
III. Interest on balances with Reserve Bank of India and other inter-
bank funds
IV. Others
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2. Other Income
I. Commission, Exchange and Brokerage
II. Profit on sale of Investments (Net)
III. Profit/ (Loss) on Revaluation of Investments
IV. Profit on sale of land, buildings and other assets (Net)
V. Profit on exchange transactions (Net)
VI. Income earned by way of dividends etc. from subsidiaries and
Associates abroad/in India
VII. Miscellaneous Income
COMPONENTS OF 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.
V. Directors' Fees, Allowances and Expenses.
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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
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CHAPTER 7
TECHNIQUES OF ASSETS LIABILITY
MANAGEMENT
Asset liability management denotes the adaptation of the profit management
process in order to handle the presence of various constraint relating to the
commitments that figure in the liabilities of an institutional investor’s
balance sheet (commitments to paying pensions, insurance premium etc.).
There are, therefore, as many types of liability constraints as there are types
of institutional investor, and thus as many types of approaches to Assets
liability management.
ALM- type management techniques can be classified into several categories.
A first approach called cash-flow matching involves ensuring a perfect
match between the cash flows from the portfolio of assets and commitments
in the liabilities.
This technique, which provides the advantage of simplicity and allow, in
theory, for perfect risk management, nevertheless presents a number of
limitations. First of all, it will generally be impossible to find inflation-
linked securities whose maturity corresponds exactly to the liability
commitments. Moreover, most of those securities pay out coupons, which
lead to problem of reinvesting the coupons. To the extent that perfect
matching is not possible, there is a technique called immunization, which
allows the residual interest rate risk created by the imperfect match between
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the assets and liabilities to be managed in an optimal way. This interest rate
risk management techniques can be extended beyond a simple duration-
based approach to fairly general contexts. Including for example, hedging
non-parallel shifts in the yield curve, or to simultaneous management of
interest rate risk and inflation risk. It should be noted, however, that this
technique is difficult to adapt to hedging non-linear risk related to the
presence of options hidden in the liability structures.
Another, probably more important, disadvantages of the cash-flow matching
technique are that is that represented by the positioning that is extreme and
not necessary optimal for the investor in the risk/return space. In fact, we can
say that the cash-flow matching approach in ALM is the framework.
However, the lack of return, related to absence of risk premia, makes this
approach very costly, which leads to an unattractive level of contribution to
assets.
In a concern to improve the profitability of the assets, therefore to reduce
the level of contributions, it is necessary to introduce assets classes (stock,
government bonds and corporate bonds) which are not perfectly correlated
with the liabilities in to strategic allocation. It will then involve finding the
best possible compromise between the risk (relative to the liability
constraints ) there by taken on, and the excess return that the investor can
hope to obtain through the exposure to rewarded risk factor
Different techniques are then used to the optimize the surplus, i.e., the
excess value of the assets compared to the liabilities, in a risk/return space.
In particular, it is useful to turn to stochastic models that allow for a
representation of the uncertainty relating to a set of risk factors that impact
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the liabilities. These can be financial risk (inflation, interest rate, stocks) or
non financial risks (demographic ones in particular). When necessary, agent
behavior models are then developed which allows the impact on decisions
linked to the exerting of certain implicit options to be represented.
For example, an insured person cans (typically in exchange for penalties)
Cancel his/her life assurance contract if the guaranteed contractual rate
drops significantly below the interest rate level prevailing at date flowing the
signature of the contract, which makes the amount of liability cash flows,
and not just their current value, dependent on interest rate risk.
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CHAPTER 8
ASSET-LIABILITY MANAGEMENT APPROACH
ALM in its most apparent sense is based on funds management. Funds
management represents the core of sound bank planning and financial
management. Although funding practices, techniques, and norms have been
revised substantially in recent years, it is not a new concept. Funds
management is the process of managing the spread between interest earned
and interest paid while ensuring adequate liquidity. Therefore, funds
management has following three components, which have been discussed
briefly.
A. Liquidity Management
Liquidity represents the ability to accommodate decreases in liabilities and
to fund increases in assets. An organization has adequate liquidity when it
can obtain sufficient funds, either by increasing liabilities or by converting
assets, promptly and at a reasonable cost. Liquidity is essential in all
organizations to compensate for expected and unexpected balance sheet
fluctuations and to provide funds for growth. The price of liquidity is a
function of market conditions and market perception of the risks, both
interest rate and credit risks, reflected in the balance sheet and off-balance
sheet activities in the case of a bank. If liquidity needs are not met through
liquid asset holdings, a bank may be forced to restructure or acquire
additional liability under adverse market conditions. Liquidity exposure can
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stem from both internally (institution-specific) and externally generated
factors. Sound liquidity risk management should address both types of
exposure. External liquidity risks can be geographic, systemic or instrument-
specific. Internal liquidity risk relates largely to the perception of an
institution in its various markets: local, regional, national or international.
Determination of the adequacy of a bank's liquidity position depends upon
an analysis of it’s: -
• Historical funding requirements
• Current liquidity position
• Anticipated future funding needs
• Sources of funds
• Present and anticipated asset quality
• Present and future earnings capacity
• Present and planned capital position
As all banks are affected by changes in the economic climate, the monitoring
of economic and money market trends is key to liquidity planning. Sound
financial management can minimize the negative effects of these trends
while accentuating the positive ones. Management must also have an
effective contingency plan that identifies minimum and maximum liquidity
needs and weighs alternative courses of action designed to meet those needs.
The cost of maintaining liquidity is another important prerogative. An
institution that maintains a strong liquidity position may do so at the
opportunity cost of generating higher earnings. The amount of liquid assets a
bank should hold depends on the stability of its deposit structure and the
potential for rapid expansion of its loan portfolio. If deposit accounts are
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composed primarily of small stable accounts, a relatively low allowance for
liquidity is necessary
Additionally, management must consider the current ratings by regulatory
and rating agencies when planning liquidity needs. Once liquidity needs
have been determined, management must decide how to meet them through
asset management, liability management or a combination of both.
B. Asset Management
Many banks (primarily the smaller ones) tend to have little influence over
the size of their total assets. Liquid assets enable a bank to provide funds to
satisfy increased demand for loans. But banks, which rely solely on asset
management, concentrate on adjusting the price and availability of credit and
the level of liquid assets. However, assets that are often assumed to be liquid
are sometimes difficult to liquidate. For example, investment securities may
be pledged against public deposits or repurchase agreements, or may be
heavily depreciated because of interest rate changes. Furthermore, the
holding of liquid assets for liquidity purposes is less attractive because of
thin profit spreads.
Asset liquidity, or how "salable" the bank's assets are in terms of both time
and cost, is of primary importance in asset management. To maximize
profitability, management must carefully weigh the full return on liquid
assets (yield plus liquidity value) against the higher return associated with
less liquid assets. Income derived from higher yielding assets may be offset
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if a forced sale, at less than book value, is necessary because of adverse
balance sheet fluctuations.
Seasonal, cyclical, or other factors may cause aggregate outstanding loans
and deposits to move in opposite directions and result in loan demand, which
exceeds available deposit funds. A bank relying strictly on asset
management would restrict loan growth to that which could be supported by
available deposits. The decision whether or not to use liability sources
should be based on a complete analysis of seasonal, cyclical, and other
factors, and the costs involved. In addition to supplementing asset liquidity,
liability sources of liquidity may serve as an alternative even when asset
sources are available.
C. Liability Management
Liquidity needs can be met through the discretionary acquisition of funds on
the basis of interest rate competition. This does not preclude the option of
selling assets to meet funding needs, and conceptually, the availability of
asset and liability options should result in a lower liquidity maintenance
cost. The alternative costs of available discretionary liabilities can be
compared to the opportunity cost of selling various assets. The major
difference between liquidity in larger banks and in smaller banks is that
larger banks are better able to control the level and composition of their
liabilities and assets.
The ability to obtain additional liabilities represents liquidity potential. The
marginal cost of liquidity and the cost of incremental funds acquired are of
paramount importance in evaluating liability sources of liquidity.
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Consideration must be given to such factors as the frequency with which the
banks must regularly refinance maturing purchased liabilities, as well as an
evaluation of the bank's ongoing ability to obtain funds under normal market
conditions.
The obvious difficulty in estimating the latter is that, until the bank goes to
the market to borrow, it cannot determine with complete certainty that funds
will be available and/or at a price, which will maintain a positive yield
spread. Changes in money market conditions may cause a rapid deterioration
in a bank's capacity to borrow at a favorable rate. In this context, liquidity
represents the ability to attract funds in the market when needed, at a
reasonable cost vis-à-vis asset yield. The access to discretionary funding
sources for a bank is always a function of its position and reputation in the
money market
Although the acquisition of funds at a competitive cost has enabled many banks
to meet expanding customer loan demand, misuse or improper implementation
of liability management can have severe consequences. Further, liability
management is not risk less. This is because concentrations in funding sources
increase liquidity risk. For example, a bank relying heavily on foreign
interbank deposits will experience funding problems if overseas markets
perceive instability in U.S. banks or the economy. Replacing foreign source
funds might be difficult and costly because the domestic market may view the
bank's sudden need for funds negatively. Again over-reliance on liability
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management may cause a tendency to minimize holdings of short-term
securities, relax asset liquidity standards, and result in a large concentration of
short-term liabilities supporting assets of longer maturity. During times of tight
money, this could cause an earnings squeeze and an illiquid condition.
Also if rate competition develops in the money market, a bank may incur a high
cost of funds and may elect to lower credit standards to book higher yielding
loans and securities. If a bank is purchasing liabilities to support assets, which
are already on its books, the higher cost of purchased funds may result in a
negative yield spread.
Preoccupation with obtaining funds at the lowest possible cost, without
considering maturity distribution, greatly intensifies a bank's exposure to the
risk of interest rate fluctuations. That is why banks who particularly rely on
wholesale funding sources, management must constantly be aware of the
composition, characteristics, and diversification of its funding sources.
CHAPTER 9
ASSETS LIABILITYMANAGEMENT (ALM)
SYSTEM IN BANK- RBI GUIDELINES
1. Over the last few years the Indian financial markets have witnessed wide
ranging changes at fast pace. Intense competition for business involving both
the assets and liabilities, together with increasing volatility in the domestic
interest rates as well as foreign exchange rates, has brought pressure on the
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management of banks to maintain a good balance among spreads,
profitability and long-term viability. These pressures call for structured and
comprehensive measures and not just ad hoc action. The Management of
banks has to base their business decisions on a dynamic and integrated risk
management system and process, driven by corporate strategy. Banks are
exposed to several major risks in the course of their business - credit risk,
interest rate risk, foreign exchange risk, equity / commodity price risk,
liquidity risk and operational risks.
2. This note lays down broad guidelines in respect of interest rate and
liquidity risks management systems in banks which form part of the Asset-
Liability Management (ALM) function. The initial focus of the ALM
function would be to enforce the risk management discipline viz. managing
business after assessing the risks involved. The objective of good risk
management programmes should be that these programmes will evolve into
a strategic tool for bank management.
3. The ALM process rests on three pillars:
1. ALM information systems.
=> Management Information System.
=> Information availability, accuracy, adequacy and expediency.
2. ALM organization
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=> Structure and responsibilities.
=> Level of top management involvement.
3. ALM process
=> Risk parameters
=> Risk identification
=> Risk measurement
=> Risk management
=> Risk policies and tolerance levels.
4. ALM information systems
Information is the key to the ALM process. Considering the large network of
branches and the lack of an adequate system to collect information required
for ALM which analyses information on the basis of residual maturity and
behavioural pattern it will take time for banks in the present state to get the
requisite information. The problem of ALM needs to be addressed by
following an ABC approach i.e. analyzing the behavior of asset and liability
products in the top branches accounting for significant business and then
making rational assumptions about the way in which assets and liabilities
would behave in other branches. In respect of foreign exchange, investment
portfolio and money market operations, in view of the centralized nature of
the functions, it would be much easier to collect reliable information. The
data and assumptions can then be refined over time as the bank management
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gain experience of conducting business within an ALM framework. The
spread of computerization will also help banks in accessing data.
5. ALM Organization
1) a) The Board should have overall responsibility for management of risks
and should decide the risk management policy of the bank and set limits for
liquidity, interest rate, foreign exchange and equity price risks.
b) The Asset - Liability Committee (ALCO) consisting of the bank's senior
management including CEO should be responsible for ensuring adherence to
the limits set by the Board as well as for deciding the business strategy of
the bank (on the assets and liabilities sides) in line with the bank's budget
and decided risk management objectives.
c) The ALM desk consisting of operating staff should be responsible for
analyzing, monitoring and reporting the risk profiles to the ALCO. The staff
should also prepare forecasts (simulations) showing the effects of various
possible changes in market conditions related to the balance sheet and
recommend the action needed to adhere to bank's internal limits.
2) The ALCO is a decision making unit responsible for balance sheet
planning from risk - return perspective including the strategic management
of interest rate and liquidity risks. Each bank will have to decide on the role
of its ALCO, its responsibility as also the decisions to be taken by it. The
business and risk management strategy of the bank should ensure that the
bank operates within the limits / parameters set by the Board. The business
issues that an ALCO would consider, inter alia, will include product pricing
for both deposits and advances, desired maturity profile of the incremental
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assets and liabilities, etc. In addition to monitoring the risk levels of the
bank, the ALCO should review the results of and progress in implementation
of the decisions made in the previous meetings. The ALCO would also
articulate the current interest rate view of the bank and base its decisions for
future business strategy on this view. In respect of the funding policy, for
instance, its responsibility would be to decide on source and mix of
liabilities or sale of assets. Towards this end, it will have to develop a view
on future direction of interest rate movements and decide on a funding mix
between fixed vs. floating rate funds, wholesale vs. retail deposits, money
market vs capital market funding, domestic vs. foreign currency funding,
etc. Individual banks will have to decide the frequency for holding their
ALCO meetings.
3) Composition of ALCO
The size (number of members) of ALCO would depend on the size of each
institution, business mix and organizational complexity. To ensure
commitment of the Top Management, the CEO/CMD or ED should head the
Committee. The Chiefs of Investment, Credit, Funds Management /
Treasury (forex and domestic), International Banking and Economic
Research can be members of the Committee. In addition the Head of the
Information Technology Division should also be an invitee for building up
of MIS and related computerization. Some banks may even have sub-
committees.
4) Committee of Directors
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Banks should also constitute a professional Managerial and Supervisory
Committee consisting of three to four directors which will oversee the
implementation of the system and review its functioning periodically.
3. ALM Process
The scope of ALM function can be described as follows:
a) Liquidity risk management
b) Management of market risks (including Interest Rate Risk)
c) Funding and capital planning
d)Profit planning and growth projection
e)Trading risk management
The guidelines given in this note mainly address Liquidity and Interest
Rate risks.
6. Liquidity Risk Management
1. Measuring and managing liquidity needs are vital activities of commercial
banks. By assuring a bank's ability to meet its liabilities as they become due,
liquidity management can reduce the probability of an adverse situation
developing. The importance of liquidity transcends individual institutions, as
liquidity shortfall in one institution can have repercussions on the entire
system. Bank management should measure not only the liquidity positions
of banks on an ongoing basis but also examine how liquidity requirements
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are likely to evolve under crisis scenarios. Experience shows that assets
commonly considered as liquid like Government securities and other money
market instruments could also become illiquid when the market and players
are unidirectional. Therefore liquidity has to be tracked through maturity or
cash flow mismatches. For measuring and managing net funding
requirements, the use of a maturity ladder and calculation of cumulative
surplus or deficit of funds at selected maturity dates is adopted as a standard
tool.
2. The Maturity Profile as given in Appendix I could be used for measuring
the future cash flows of banks in different time buckets. The time buckets
given the Statutory Reserve cycle of 14 days may be distributed as under:
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 12 months
vi) Over 1 year and up to 2 years
vii) Over 2 years and up to 5 years
viii) Over 5 years.
3. Within each time bucket there could be mismatches depending on cash
inflows and outflows. While the mismatches up to one year would be
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relevant since these provide early warning signals of impending liquidity
problems, the main focus should be on the short-term mismatches viz., 1-14
days and 15-28 days. Banks, however, are expected to monitor their
cumulative mismatches (running total) across all time buckets by
establishing internal prudential limits with the approval of the Board /
Management Committee. The mismatch during 1-14 days and 15-28 days
should not in any case exceed 20% of the cash outflows in each time bucket.
If a bank in view of its asset -liability profile needs higher tolerance level, it
could operate with higher limit sanctioned by its Board / Management
Committee giving reasons on the need for such higher limit. A copy of the
note approved by Board / Management Committee may be forwarded to the
Department of Banking Supervision, RBI. The discretion to allow a higher
tolerance level is intended for a temporary period, till the system stabilises
and the bank is able to restructure its asset -liability pattern.
4. The Statement of Structural Liquidity may be prepared by placing all cash
inflows and outflows in the maturity ladder according to the expected timing
of cash flows. A maturing liability will be a cash outflow while a maturing
asset will be a cash inflow. It would be necessary to take into account the
rupee inflows and outflows on account of forex operations including the
readily available forex resources ( FCNR (B) funds, etc) which can be
deployed for augmenting rupee resources. While determining the likely cash
inflows / outflows, banks have to make a number of assumptions according
to their asset - liability profiles. For instance, Indian banks with large branch
network can (on the stability of their deposit base as most deposits are
renewed) afford to have larger tolerance levels in mismatches if their term
deposit base is quite high. While determining the to learn levels the banks
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may take into account all relevant factors based on their asset-liability base,
nature of business, future strategy etc. The RBI is interested in ensuring that
the tolerance levels are determined keeping all necessary factors in view and
further refined with experience gained in Liquidity Management.
5. In order to enable the banks to monitor their short-term liquidity on a
dynamic basis over a time horizon spanning from 1-90 days, banks may
estimate their short-term liquidity profiles on the basis of business
projections and other commitments. An indicative format for estimating
Short-term Dynamic Liquidity is enclosed.
7. Currency Risk
1. Floating exchange rate arrangement has brought in its wake pronounced
volatility adding a new dimension to the risk profile of banks' balance
sheets. The increased capital flows across free economies following
deregulation have contributed to increase in the volume of transactions.
Large cross border flows together with the volatility has rendered the banks'
balance sheets vulnerable to exchange rate movements.
2. Dealing in different currencies brings opportunities as also risks. If the
liabilities in one currency exceed the level of assets in the same currency,
then the currency mismatch can add value or erode value depending upon
the currency movements. The simplest way to avoid currency risk is to
ensure that mismatches, if any, are reduced to zero or near zero. Banks
undertake operations in foreign exchange like accepting deposits, making
loans and advance and quoting prices for foreign exchange transactions.
Irrespective of the strategies adopted, it may not be possible to eliminate
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currency mismatches altogether. Besides, some of the institutions may take
proprietary trading positions as a conscious business strategy.
3. Managing Currency Risk is one more dimension of Asset- Liability
Management. Mismatched currency position besides exposing the balance
sheet to movements in exchange rate also exposes it to country risk and
settlement risk. Ever since the RBI (Exchange Control Department)
introduced the concept of end of the day near square position in 1978, banks
have been setting up overnight limits and selectively undertaking active day
time trading. Following the introduction of "Guidelines for Internal Control
over Foreign Exchange Business" in 1981, maturity mismatches (gaps) are
also subject to control. Following the recommendations of Expert Group on
Foreign Exchange Markets in India (Sodhani Committee) the calculation of
exchange position has been redefined and banks have been given the
discretion to set up overnight limits linked to maintenance of additional Tier
I capital to the extent of 5 per cent of open position limit.
4. Presently, the banks are also free to set gap limits with RBI's approval but
are required to adopt Value at Risk (VAR) approach to measure the risk
associated with forward exposures. Thus the open position limits together
with the gap limits form the risk management approach to forex operations.
For monitoring such risks banks should follow the instructions contained in
Circular A.D (M. A. Series) No.52 dated December 27, 1997 issued by the
Exchange Control Department.
8. Interest Rate Risk (IRR)
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1. The phased deregulation of interest rates and the operational flexibility
given to banks in pricing most of the assets and liabilities have exposed the
banking system to Interest Rate Risk. Interest rate risk is the risk where
changes in market interest rates might adversely affect a bank's financial
condition. Changes in interest rates affect both the current earnings (earnings
perspective) as also the net worth of the bank (economic value perspective).
The risk from the earnings' perspective can be measured as changes in the
Net Interest Income (Nil) or Net Interest Margin (NIM). In the context of
poor MIS, slow pace of computerisation in banks and the absence of total
deregulation, the traditional Gap analysis is considered as a suitable method
to measure the Interest Rate Risk. It is the intention of RBI to move over to
modern techniques of Interest Rate Risk measurement like Duration Gap
Analysis, Simulation and Value at Risk at a later date when banks acquire
sufficient expertise and sophistication in MIS. The Gap or Mismatch risk
can be measured by calculating Gaps over different time intervals as at a
given date. Gap analysis measures mismatches between rate sensitive
liabilities and rate sensitive assets (including off-balance sheet positions).
An asset or liability is normally classified as rate sensitive if:
i) Within the time interval under consideration, there is a cash flow;
ii) The interest rate resets/reprises contractually during the interval;
iii) RBI changes the interest rates (i.e. interest rates on Savings Bank
Deposits, advances up to
Rs.2 lakhs, DRI advances Export credit, Refinance CRR balance, etc.)
In cases where Interest rates are administered; and
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iv) It is contractually pre-payable or withdrawal before the stated
maturities.
2. The Gap Report should be generated by grouping rate sensitive liabilities,
assets and off balance sheet positions into time buckets according to residual
maturity or next reprising period, whichever is earlier. The difficult task in
Gap analysis is determining rate sensitivity. All investments, advances,
deposits, borrowings, purchased funds etc. that mature/reprise within a
specified timeframe are interest rate sensitive. Similarly, any principal
repayment of loan is also rate sensitive if the bank expects to receive it
within the time horizon. This includes final principal payment and interim
installments. Certain assets and liabilities receive/pay rates that vary with a
reference rate. These assets and liabilities are reprised at pre-determined
intervals and are rate sensitive at the time of reprising. While the interest
rates on term deposits are fixed during their currency, the advances portfolio
of the banking system is basically floating. The interest rates on advances
could be reprised any number of occasions, corresponding to the changes in
PLR. The Gaps may be identified in the following time buckets:
i) Up to 1 month
ii) Over one month and up to 3 months
iii) Over 3 months and up to 6 months
iv) Over 6 months and up to 12 months
v) Over 1 year and up to 3 years
vi) Over 3 years and up to 5 years
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vii) Over 5 years
viii) Non-sensitive
3. The Gap is the difference between Rate Sensitive Assets (RSA) and Rate
Sensitive Liabilities (RSL) for each time bucket. The positive Gap indicates
that it has more RSAs than RSLs whereas the negative Gap indicates that it
has more RSLs. The Gap reports indicate whether the institution is in a
position to benefit from rising interest rates by having a positive Gap (RSA
> RSL) or whether it is in a position to benefit from declining interest rates
by a negative Gap (RSL > RSA). The Gap can, therefore, be used as a
measure of interest rate sensitivity.
4. Each bank should set prudential limits on individual Gaps with the
approval of the Board/Management Committee. The prudential limits should
have a bearing on the total assets, earning assets or equity. The banks may
work out earnings at risk, based on their views on interest rate movements
and fix a prudent level with the approval of the Board/Management
Committee.
5. RBI will also introduce capital adequacy for market risks in due course.
6. The classification of various components of assets and liabilities into
different time buckets for preparation of Gap reports (Liquidity and Interest
Rate Sensitivity) as indicated in Appendices I & II is the benchmark. Banks
which are better equipped to reasonably estimate the behavioral pattern,
embedded options, rolls-in and rolls-out, etc of various components of assets
and liabilities on the basis of past data / empirical studies could classify them
in the appropriate time buckets, subject to approval from the ALCO / Board.
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A copy of the note approved by the ALCO / Board may be sent to the
Department of Banking Supervision. Term), Bills Rediscounting, Refinance
from RBI / others, Repos and deployment of foreign currency resources after
conversion into rupees (unsnapped foreign currency funds) etc.
CHAPTER 10
PROCEDURE FOR EXAMINATION OF ASSET
LIABILITY MANAGEMENT
In order to determine the efficacy of Asset Liability Management one has to
follow a comprehensive procedure of reviewing different aspects of internal
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control, funds management and financial ratio analysis. Below a step-by-step
approach of ALM examination in case of a bank has been outlined.
STEP 1
The bank/ financial statements and internal management reports should be
reviewed to assess the asset/liability mix with particular emphasis on: -
• Total liquidity position (Ratio of highly liquid assets to total assets).
• Current liquidity position (Minimum ratio of highly liquid assets to
demand liabilities/deposits).
• Ratio of Non Performing Assets to Total Assets.
• Ratio of loans to deposits.
• Ratio of short-term demand deposits to total deposits.
• Ratio of long-term loans to short term demand deposits.
• Ratio of contingent liabilities for loans to total loans.
• Ratio of pledged securities to total securities.
STEP 2
It is to be determined that whether bank management adequately assesses
and plans its liquidity needs and whether the bank has short-term sources of
funds. This should include: -
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Review of internal management reports on liquidity needs and sources of
satisfying these needs.
Assessing the bank’s ability to meet liquidity needs.
STEP 3
The banks future development and expansion plans, with focus on funding
and liquidity management aspects have to be looked into. This entails: -
• Determining whether bank management has effectively addressed the
issue of need for liquid assets to funding sources on a long-term basis.
• Reviewing the bank's budget projections for a certain period of time in
the future.
• Determining whether the bank really needs to expand its activities.
What are the sources of funding for such expansion and whether there
are projections of changes in the bank's asset and liability structure?
• Assessing the bank's development plans and determining whether the
bank will be able to attract planned funds and achieve the projected
asset growth.
• Determining whether the bank has included sensitivity to interest rate
risk in the development of its long term funding strategy.
STEP 4
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Examining the bank's internal audit report in regards to quality and effectiveness in terms of liquidity management.
STEP 5
Reviewing the bank's plan of satisfying unanticipated liquidity needs by: -
• Determining whether the bank's management assessed the potential
expenses that the bank will have as a result of unanticipated financial
or operational problems.
• Determining the alternative sources of funding liquidity and/or assets
subject to necessity.
• Determining the impact of the bank's liquidity management on net
earnings position.
STEP 6
• Preparing an Asset/Liability Management Internal Control
Questionnaire which should include the following: -
• Whether the board of directors has been consistent with its duties and
responsibilities and included: -
• A line of authority for liquidity management decisions.
• A mechanism to coordinate asset and liability management decisions.
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• A method to identify liquidity needs and the means to meet those
needs.
• Guidelines for the level of liquid assets and other sources of funds in
relationship to needs.
CHAPTER 11
STUDY OF ASSETS LIABILITY MANAGEMENT IN
INDIAN BANK: CANONICAL CORRELATION
ANALYSIS ( PERIOD – 1992-2004)
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INTRODUCTION
Assets liability management (ALM) defines management of all assets and
liabilities of a bank. It requires assessment of various types of risks and
alerting the assets liability portfolio to manage risk.
Till the early 1990s, the RBI has done the real banking business and
commercial banks were mere executors of what RBI decided. But now, BIS
is standardizing the practices of banks across the globe and India is part of
this process.
The success of ALM, Risk Management of Assets and Liabilities. Hence,
these days, without proper management of assets and liabilities, the survival
is at stake.
A bank’s liabilities include deposits, borrowing and capital. On the other
side of the balance sheet are assets which are loans of various types which
banks make to the customer for various purposes. To view the two side of
bank’s balance sheet as completely integrated units. Has an intuitive appeal.
But the nature profitability of bank especially in terms of Net Interest
Margin (NIM).
ALM MODELS
Analytical models are very important for ALM analysis and scientific
decision making. The basic models are:
1. GAP Analysis Model
2. Duration GAP Analysis Models
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3. Scenario Analysis Model
4. Value-at-risk models
5. Stochastic Programming Model
Any of these models is being used by banks through their Asset Liability
Management Committee (ALCO). The executive Director and other vital
department heads ALCO in banks. There are minimum four members and
maximum eight members. It is responsible for Setting business policies and
strategies, Pricing assets and liabilities, Measuring risk, Periodic review,
Discussing new products and Reporting.
OBJECTIVE OF THE STUDY
Though Basel Capital Accord and subsequent RBI guidelines have given a
structure for ALM in banks, the Indian Banking system has not enforced the
guidelines in total.
Public Sector bank are yet to collect 100% of ALM data because of lack of
computerization all branches. With this background, this research aims to
find out the status of Asset Liability Management across all commercial
bank in Indian with the help of multivariate technique of canonical
correlation.
The discussion paper has following objective to explore:
• To study the Portfolio-Matching behavior of Indian Bank in terms of
nature and strengths of relationship between Assets and Liability.
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o To find out the component of Assets explaining variance in
liability and vice-versa.
o To study the impact of ownership over Asset Liability
Management in Bank
o To study impact of ALM on the profitability of different back-
groups.
METHODOLOGY
The study covers all scheduled commercial except the RBIs. The
period of the study was from 1992-2004. The banks were grouped
based on ownership structure the group were
1. Nationalized bank except SBI & Associates (19)
2. SBI and Associate (8)
3. Private Banks (30)
4. Foreign Banks (36)
RECLASSIFICATION OF ASSETS AND LIABILITIES
The assets and liabilities of a Bank are divided into various sub head. For a
purpose of the study, the assets were regrouped under six major heads and
the liabilities were regrouped under four major heads as shown in table
below. This classification is guided by prior information on the liquidity
– return profile of assets and the maturity- cost profile of liabilities. The
reclassified assets and liabilities cover in the study exclude ‘other assets’ on
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the asset side and ‘other liabilities’ on the liabilities side. This is necessary to
deal with the problem of singularity – a situation that produces perfect
correlation with in sets and make correlation between sets meaningless.
The relevant data has been collected from RBI website
TABLE 1 : RECLASSIFICATION OF ASSETSLiquid Assets Cash In Hand, Bal With Banks, Money At Call And Short Notice.
SLR Securities Govt. Securities And Other Approved Securities
Investments Other Than SLR Such As Shares, Debentures, Bond Subsidiaries
And Other.
Term Loans Term Loan
ShortTerm
Loans
Advance Not In TL – Bill Purchased And Discounted, Cash Credits,
Overdrafts And Loans
Fixed Assets Fixed Assets
TABLE 2: RECLASSIFICATION OF LIABILITIESNet Worth Capital, Reserves And Surpluses
Borrowings Borrowing From RBI, Banks, Other Fls From India And
Abroad
Short Term Deposits Demand Deposits And Savings Bank Deposits
Long Term Deposits All Deposits Not Included In Short Term
TABELE 3: LIQUIDITY-RETURN PROFILE OF ASSETS
Assets - Liquidity High Liquid Assets SLR Securities Short Term Loans
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Medium Investment Term Loans
Low
Fixed Asset
TABLE 4: MATURITY – COST PROFILE OF LIABILITIES
Near
Short Term Deposits
Borrowing
Liability Maturity
Medium Term Deposits
Far Net Worth
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CANONICAL CORRELATION ANALYSIS
Multivariate statistical technique, canonical correlation has been used to
access the nature and strength of relationship between the assets and
liabilities. To explore the relationship between assets and liabilities, we
could merely compute the correlation between each set of assets and each set
of liabilities. Unfortunately, all of these correlations assess the same
hypothesis – that assets influence liabilities.
The technique reduces the relationship in to a few significant relationships.
The essence of canonical correlation Measures the strength of relationship
between two sets of variables by establishing linear combination of variables
in one set and a linear combinations of variables in other set. It produces an
output that shows the strength of relationship between two variates as well
as individual variables accounting for variance in other set.
A=A1* (Liquid Assets) + A2* (SLR Securities) + A3* (Investment) + A4*
(Term Loan) + A5* (Short – Term Loans) + A6* (Fixed Assets)
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B= B1*(Net Worth) + B2* (Borrowings) + B3* (Short –Term Deposits)
+B4* (Loan- Term Deposits)
To begin with, A &B (called canonical variates) are unknown. The
technique tries to compute the values of Ai and Bi such that the covariance
between A & B is maximum.
TABLE 5: CANONICAL CORRELATION SUMMARY OF
OUTPUTForeign
Banks
Private bank nationalized SBI & Associate
R2 0.948 0.997 0.987 0.998
Canonical Loading
Assets 0.243 0.716 -0.046 0.237
LA 0.078 0.712 -0.328 0.744
SLR 0.314 -0.467 -0.662 0.858
Inv -0.469 -0.464 0.188 0.568
STL 0.268 0.461 0.747 -0.88
FA -0.903 -0.945 -0.728 0.644
Liabilities
NW -0.664 -0.948 -0.885 0.831
Bor 0.171 -0.523 0.593 -0.83
STD 0.498 0.972 0.126 -0.457
LTD -0.255 -0.201 0.007 0.964
Redundancy
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Asset 0.212 0.426 0.279 0.476
Liability 0.196 0.539 0.288 0.629
The first row (R2) is measure of the significance of the correlation. In this
case all the correlation is significant. The canonical loading is measure of the
strength of the association which means it is a present of variance linearly
shared by an original variable with one of the canonical varieties. A loading
greater than 40% is assumed to be significant. A negative loading indicates
an inverse relationship.
For example, for foreign bank, Fixed Assets (FA) under assets has a loading
of -0.903Net worth under liabilities has loading of -0.664. Since both are
negative, this means there is a strong correlation between FA and NW.
Similarly for foreign banks, we can observe that there is a strong negative
correlation between short-term deposit with both Term Loan and Fixed
Asset.
OBSERVATION
As per the summary table above, the canonical co-relation coefficients of
different set of banks indicate that different banks have different degree of
association among constituents of assets and liabilities. Bank-Groups can be
arranged in decreasing order of correlation:
o SBI and Associate
o Private Banks
o Nationalized Banks
o Foreign Banks
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Redundancy factors indicate how redundant one set of variables which gives
an idea about independent and dependent sets. This also gives an idea about
the fact whether the bank is asset-managed or liability-managed. Looking at
the redundancy factors, the independent and dependent sets for different
bank-group can be identified:
TABLE 6: CAUSE EFFECT RELATIONSHIPBank Independent Set Dependent Set
Foreign Liability Asset
Private Asset Liability
Nationalized Asset Liability
SBI & Associates Asset Liability
Other than Foreign bank groups, remaining three have assets as their
independent set this means during the study period (1992-2004), these banks
were actively managing assets and liability was dependent upon how well
the assets are managed. This is in perfect consonance with the micro
indicator.
FOREIGN BANKS
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The canonical function coefficient or the canonical weight of different
constituents in case of foreign banks Term Loans and Fixed Assets from
asset side Net Worth Short – term Deposit from liability side have
significant presence with following interpretation :
• Very strong co-relation between Fixed Asset and Net Worth.
• Strong negative correlation between short-term deposit with both
Term loan and Fixed Assets. This indicates –
o Proper using of short- term deposit.
o Not use for long- term assets or long term losses.
PRIVATE BANKS
In case of private bank all constituents’ of asset side Liquidate Assets, SLR
Securities, Short- term loans, investment, Term Loans, and Fixed Assets and
significantly explaining the co-relation while on liability side only Net
Worth and Short –Term Deposit are contributing. This shows how actively
these banks manage their assets to generate maximum return. This
relationship can be interpreted in the following ways:
• Very strong co-relation between FA and NW.
• Short- term deposit is used for Liquid Assets, SLR and Short –Term
Loans As defines above LA, SLR and STL – all are highly liquid
section of assets. So it is very prudent to employ short term deposits.
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ASSETS LIABILITY MANAGEMENT IN BANK
NATIONALIZED BANKS
In case of nationalized banks investment, short-term loan, fixed asset
contribute significantly in explaining asset part while net worth and
borrowings constituent of liability is major factor. The major interpretations
are:
• Very strong co-relation between FA NW.
• Nationalized banks use borrowing for Short-term loans.
• There is negative co-relation between Borrowing and Investment.
o More concerned with liquidity than profitability.
o Conservative strategy (in comparison to Private Banks).
o Good short-term maturity/liquidity management.
Nationalized Banks use a borrowing (which is never term maturity) for
Short- term a loan which is effective way of ALM.
SBI & ASSOCIATES
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ASSETS LIABILITY MANAGEMENT IN BANK
For SBI group all constitute of liability namely Net Worth, Borrowings
short-term deposit and long term deposit are significant while in assets side
SLR investment, Investment, Term loans and Fixed Assets are significant.
Following can be interpreted:
• Very strong correlation between FA and NW.
• Strong correlation between Borrowing and SLR.
• Correlation between Long term Deposits and ‘Term Loan, Investment
and SLR’.
o Short –term Deposits and Short-term liabilities are correlated.
o Most Conservative strategy.
o Over concerned with liquidity.
o Use long-term funds for Long as well as medium &short-term
loan.
CONCLUSION
Based on this decision above, it can be conclude that ownership and
structure of the banks do affect their ALM procedure. The discussion paper
concludes with following findings:
• Among all groups, SBI & association have best Assets-Liability
maturity pattern
• Other than Foreign Bank- all other banks can be called liability
manage banks.
• Across all banks, Fixed Assets and Net Worth are highly correlated.
• Private Banks are aggressive in profit generation.
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