ASSET LIABILITY MANAGEMENT IN BANKSPresented by: Teena George

Asset Liability Management

Asset Liability can be defined as a mechanism to address the risk faced by a bank due to mismatch between assets and liabilities either due to liquidity or change in interest rates.

ALM policy framework focuses on bank profitability and long term viability.

Maturity matching of assets and liabilities across various time horizons.

`ALM aims to manage the volume, mix, maturity, rate sensitivity, quality and liquidity of assets and liabilities as a whole so as to attain 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

Evolution

Pre liberalisationVery less competition in banking sectorMain focuses on asset management

Post liberalisationDeregulation of interest ratesNon recognition of income on accrual basisHigh off balance sheet exposureHigh Competition

Need for ALM

Globalization of financial markets Deregulation of interest rates Diversification of ALM products’ Healthy competition in banking sector Multi-currency Balance Sheet Integration of markets Narrowing of NIM/NII

Components of a Bank Balance Sheet

Liabilities

Assets

1. CapitalS2. Reserve & Surplus3. Deposits4. Borrowings5. Other Liabilities

1. Cash & Balances with RBI2. Bal. With Banks & Money

at Call and Short Notices3. Investments4. Advances5. Fixed Assets6. Other Assets

ALM Objectives

Liquidity Risk Management. Interest Rate Risk Management. Currency Risks Management. Profit Planning and Growth Projection.

Tools used by banks for ALM ALM information systems

ALM Organization

ALM Process

ALM Information Systems

Usage of Real Time information system to gather the information about the maturity and behavior of loans and advances made by all other branches of a bank

ABC Approach : analysing the behaviour of asset and liability products making rational assumptionsThe data and assumptions can thenbe refined

ALM OrganizationThe board should have overall responsibilities and should set the limit for liquidity, interest rate, foreign exchange and equity price risk

The Asset - Liability Committee (ALCO) ALCO, consisting of the bank's senior

management (including CEO) should be responsible for ensuring adherence to the limits set by the Board

The role of ALCO includes product pricing for both deposits and advances, desired maturity profile of the incremental assets and liabilities,

It should review the results of and progress in implementation of the decisions made in the previous meetings

ALM Process

Risk Parameters

Risk Identification

Risk Measurement

Risk Management

Risk Policies and Tolerance Level

Categories of Risk

Credit Risk Market Risk Operational Risk

Transaction Risk Commodity risk Process risk

Portfolio risk Interest Rate risk Infrastructure risk

Settlement risk Forex rate risk Model risk

Equity price risk Human risk

Liquidity risk

But under ALM risks that are typically managed are….

Currency Risk

Liquidity Risk

Interest Rate Risk

Liquidity Risk

The risk that the institution might not be able to generate sufficient cash flow to meet its financial obligations

EFFECTS OF LIQUIDITY CRUNCH Risk to bank’s earningsReputational riskContagion effectLiquidity crisis can lead to runs on institutions

Statement of Structural Liquidity

All Assets & Liabilities to be reported as per their maturity profile into 10 maturity Bucketi. 1 dayii. 2-7 days iii. 8-14 daysiv. 15-28 daysv. 29 days and upto 3 months vi. Over 3 months and upto 6 months vii. Over 6 months and upto 1 year ‘viii. Over 1 year and upto 3 yearsix. Over 3 years and upto 5 years x. Over 5 years

RBI GUIDELINES ON STRUCTURAL LIQUIDITY STATEMENT

Main focus should be on the short-term mismatches viz., 1day,2-7 days,7-14 days and 15-28 days. Maturing Liability: Cash Outflow

Maturing Assets : Cash Inflow

The negative gap during 1day,2-7 days,7-14 days and 15-28 days time-buckets should not exceed 5%,10%,15% and 20 %

The SSL may be reported to RBI, once a month, as on the third Wednesday of every month.

Liability mismatchOutflows are more than inflows. Managing the situation is based on time availability. Short term borrowing Availing finances and discounting facilities from other banks, RBI etc. Sell securities, shares etc

Asset mismatchIt occurs when inflows are more than outflows. The excess money should be deployed in profit generating avenues like: Government bonds and securities Shares of good companies Any other legal investments

Structural liquidity statement Time bucket 1 day 2-7 days

8-14 days

15-28 days

29 days -3m 3m-6m 6m-1yr 1yr-3yr 3yr-5yr Over 5 yr

Inflows 403.84 319.22 348.58 362.52 751.79 630.27 645.81 2281.06 731.66 2530.76

Outflows 96.72 378.22 307.3 218.01 669.71 1358.9 1124.37 3053.03 469.22 1015.84

Cumulative Outflow 96.72 474.94 782.24 1000.25 1669.96 3028.86 4153.23 7206.26 7675.48 17664.63

Gap 307.13 -59.01 41.28 144.51 82.08 -728.63 -478.56 -771.96 262.44 1514.92

Cumulative gap 307.13 248.12 289.4 433.91 515.99 -212.63 -691.19 -1463.16 -1200.72 0

Gap as % to outflow 317.56 -15.6 13.43 66.29 12.26 -53.62 -42.56 -25.29 55.93 149.13

Cumulative gap as % of cumulative

outflow 317.56% 52.24% 37% 43.38% 30.90% -7.02% -16.64% -20.30% -15.64% 0%

Limit by RBI(%) -5% -10% -15% -20%

Internal tolerance limit(%) -25% -30% -35% -35% -35% -10%

Analysis of liquidity risk positionGap =Inflow-OutflowValue of Gap<0 is called negative gapMismatch = (Negative gap/Outflow)x100

Decision RuleMismatch in the time buckets 1day,2-7ddays,8-14days greater than 5%,10% and 20% implies liquidity risk is higher

Mismatch in any time buckets is greater than bank’s internal tolerance limit in the corresponding time buckets implies existence of liquidity risk in those time buckets.

Interest Rate Risk (IRR)

The risk where changes in market interest rates might adversely affect a bank's financial condition.

Excessive interest rate risk can pose a significant threat to a bank’s earnings and capital base

Interest rate risk refers to volatility in Net Interest Income (NII) or variations in Net Interest Margin(NIM)

NIM = (Interest income – Interest expense) / Earning assets

Sources of Interest Rate Risk

Interest rate risk Analysis

Traditional Gap analysis is considered to be a suitable method to measure the Interest Rate Risk.

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:within the time interval under consideration, there is a cash flow;the interest rate resets/reprices contractually during the interval; it is contractually pre-payable or withdrawable before the stated maturities;It is dependent on the changes in the Bank Rate by RBI

Interest rate risk statement

The interest rate gaps may be identified in the following time buckets:

i. 1-28 days ii. 29 days and upto 3 months iii. Over 3 months and upto 6 months iv. Over 6 months and upto 1 year v. Over 1 year and upto 3 years vi. Over 3 years and upto 5 years vii. Over 5 years

IMPACT ON NII

Gap Interest rate Change

Impact on NII

Positive Increases Positive

Positive Decreases Negative

Negative Increases Negative

Negative Decreases Positive

Findings

Liquidity Risk Management

There are no mismatches above the prudential limit in the short term buckets i.e. 1st day, 2-7days and 8-14days in all the years from 2010 to 2014. These are the critical time buckets as per RBI norms

In 2010 and 2011, bank has enough assets to meet customer demands while in 2012,2013 and 2014 outflows are greater than inflows.

Negative mismatches are there in some time buckets of all the years. Since they are within the internal tolerance level set by bank ,these mismatches are manageable.

Interest Rate Risk Management

The bank would benefit from falling interest rates in some time buckets while others, the bank would benefit from rising interest rates.

The interest rate analysis shows that some of the time buckets are liability sensitive which shows an increase in NII if the interest rate goes down.The bank is asset sensitive when interest rate goes down.

Suggestions

If assets are more, Repay high cost call money and creditors Government bonds and securities Shares of good companies Any other legal investments

If liabilities are more, Short term borrowing Diminish excess cash balance at the branches Availing finances and discounting facilities from other banks, RBI etc. Sell securities, shares etc

Conclusion

ALM technique aims to manage the volume mix, maturity, rate sensitivity, quality and liquidity of assets and liabilities as a whole to attain a predetermined acceptable risk or reward ratio.

The ALM system of Dhanlaxmi bank is found to be effective one as the liquidity risk and the interest rate risks are maintained within the RBI limits.

In short, ALM helps in enhancing the asset quality, quantifying the risk associated with assets and liabilities and controlling them. So a proper ALM system must be implemented in every banks for the effective functioning of a bank which reduces the exposure of risk chances in banks.

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