Asset Liability Management -

7/29/2019 Asset Liability Management -

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Riddhi Gala 01

Sunil Kewalramani 05

Vikram Shah 70Laxmikar Naidu 75

Sanjeev Gawda 76

Ajay Deshpande 80

Asset LiabilityManagement in Banks


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Components of a

Bank Balance sheetLiabilities Assets

1. Capital

2. Reserve & Surplus3. Deposits

4. Borrowings

5. Other Liabilities

1. Cash & Balances with

RBI2. Bal. With Banks &

Money at Call and Short

Notices

3. Investments4. Advances

5. Fixed Assets

6. Other Assets

Contingent Liabilities


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Components of Liabilities

1. Capital:

Capital represents owners 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 includes:

I. Statutory ReservesII. Capital Reserves

III. Investment Fluctuation Reserve

IV. Revenue and Other Reserves

V. Balance in Profit and Loss Account


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3. Deposits

This is the main source ofbanks funds. The deposits are

classified as deposits payable on demand and time. Theyare reflected in balance sheet as under:

I. Demand Deposits

II. Savings Bank Deposits

III. Term Deposits


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4. Borrowings

(Borrowings include Refinance / Borrowings from RBI,

Inter-bank & other institutions)

I. Borrowings in India

i) Reserve Bank of India

ii) Other Banksiii) Other Institutions & Agencies

II. Borrowings outside India


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5. Other Liabilities & Provisions

It is grouped as under:I. Bills Payable

II. Inter Office Adjustments (Net)

III. Interest Accrued

IV. Unsecured Redeemable BondsV. Others(including provisions)


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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


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2. Balances With Banks And Money At Call & ShortNotice

I. In India

i) Balances with Banks

a) In Current Accountsb) 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


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3. InvestmentsA major asset item in the banks balance sheet. Reflectedunder 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


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4. AdvancesThe most important assets for a bank.A. i) Bills Purchased and Discounted

ii) Cash Credits, Overdrafts & Loans

repayable on demandiii) Term Loans

B. Particulars of Advances :

i) Secured by tangible assets

(including advances against Book Debts)

ii) Covered by Bank/ Government Guarantees

iii) Unsecured


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5. Fixed AssetI. 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

Banks obligations under LCs, Guarantees,

Acceptances on behalf of constituents and

Bills accepted by the bank are reflectedunder this heads.


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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.


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ALM-MIS

Management Information System

Information availability, accuracy, adequacy and expediency

ALMorganisation

Structure and responsibilities ALCO Committee

Level of top management involvement

ALMprocess

Risk parameters

Risk identification

Risk measurement Risk management

Risk policies and tolerance levels


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ALCO

Senior management including CEO shouldbe responsible for ensuring adherence to the

limits

Decision making unit responsible for- Strategic Management of interest & liquidity rates

- Balance sheet planning- Product pricing for both deposits and advances

- Monitoring the results & progress

- Funding mix


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Scope of ALM

Liquidity risk management

Management of market risks (including Interest Rate Risk)

Funding and capital planning

Profit planning and growth projection

Trading risk management


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Significance ofALM

Volatility

Product Innovations & Complexities

Regulatory Environment

Management Recognition


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Purpose & Objective of ALM

An effective Asset Liability Management Techniqueaims 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 ration.

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)


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Liquidity Management

Banks liquidity management is the process

of generating funds to meet contractual or

relationship obligations at reasonable pricesat all times.

New loan demands, existing commitments,

and deposit withdrawals are the basiccontractual or relationship obligations that a

bank must meet.


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Funding Avenues

To satisfy funding needs, a bank mustperform one or a combination of thefollowing:

a. Dispose off liquid assets

b. Increase short term borrowings

c. Decrease holding of less liquid assetsd. Increase liability of a term nature

e. Increase Capital funds


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Categories of liquidity risk

Funding Risk

- Need to replace net outflows due to

unanticipated withdrawals/non-renewal Time Risk

- Need to compensate for non-receipt of

expected inflows of funds Call Risk

- Crystallization of contingent liability


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Statement Of Structural Liquidity

Places all cash inflows and outflows in thematurity 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 toexceed 20% of outflows

Shows the structure as of a particular date


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Statement of Structural Liquidity

As per RBI guidelines issued for ALM implementation forBanks in 1999, there are 8 time buckets T-1 to T-8 classified

respectively as follows

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


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An Example of Structural Liquidity

Statement1-14Days 15-28Days 30 Days-3 Month 3 Mths -6 Mths 6 Mths -1Year 1Year - 3Years 3 Years -5 Years Over 5Years Total

Capital 200 200

Liab-fixed Int 300 200 200 600 600 300 200 200 2600

Liab-floating Int 350 400 350 450 500 450 450 450 3400

Others 50 50 0 200 300

Total outflow 700 650 550 1050 1100 750 650 1050 6500

Investments 200 150 250 250 300 100 350 900 2500

Loans-fixed Int 50 50 0 100 150 50 100 100 600

Loans - floating 200 150 200 150 150 150 50 50 1100Loans BPLR Linked

100 150 200 500 350 500 100 100 2000Others 50 50 0 0 0 0 0 200 300

Total Inflow 600 550 650 1000 950 800 600 1350 6500

Gap -100 -100 100 -50 -150 50 -50 300 0

Cumulative Gap -100 -200 -100 -150 -300 -250 -300 0 0

Gap % to Total O -14.29 -15.38 18.18 -4.76 -13.64 6.67 -7.69 28.57


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Strategies

To meet the mismatch in any maturity bucket, thebank has to look into taking deposit and invest itsuitably 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 of1-29 days of Rs 200 crores and rest matching withother out flows.


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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 safetyand soundness of the bank.


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Managing Interest Rate Risk

Balance Sheet Adjustments

Changing portfolio as interest rate changes

OFF Balance sheet adjustments

- Using off balance sheet derivatives like

interest rate swaps and futures


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Measuring Interest Rate

Sensitivity

Gap Analysis

Duration Gap Analysis


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GAP ANALYSIS

Gap is defined as the difference between the rate sensitive

assets and rate sensitive liabilities maturing within a

specific time period.

Gap = RSARSL

Gap Change in

Interest Rate

Change in

NII

Positive RSA > RSL Increase Increase

Positive RSA > RSL Decrease DecreaseNegative RSA < RSL Increase Decrease

Negative RSA < RSL Decrease Increase

Zero RSA = RSL Increase No Change

Zero RSA = RSL Decrease No Change


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ExampleLet us consider an XYZ Bank for which the maturity

pattern of Assets and Liabilities as on a particular date, say31.03.2004 is given


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Problems with Gap Analysis

Time Horizon

Repricing of the assets / liabilities

Correlation with market

Assuming correlation with the market as 1

Focus On NII

Focusing more on NII rather than Shareholders wealth


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Duration Gap Analysis

DurationWeighted average time to receive all cash flows

from a financial instrument (expressed in years)

Duration GapDifference between duration of a banksassets and liabilities

It is a measure of interest rate sensitivity that explains how

changes in interest rate affect the market value of banksassets and liabilities and in turn net worth.


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Duration Gap Change in Interest

Rate

Change in Net

Worth

Positive Increase Decrease

Positive Decrease Increase

Negative Increase Increase

Negative Decrease Decrease

Zero Increase No Change

Zero Decrease No Change

Duration gap, Interest rates and changes in net worth


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Example

Duration of a 3-year loan with 12% as rate of simple interest

and having market value is Rs.700 is calculated as follows

Duration=Total Cumulative Returns/Market Value (MV) of

loan=1883.04/700 = 2.69 yrs


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Example

Duration Gap (DG) for the following assets and liabilities of

an organization, if the value unit is Rupees (INR) andduration is in years


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Here Total Assets (TA) = 100 + 700 + 200 = 1000 and

Total Liabilities (TL) = 620 + 300 = 920 (Without Equity)DA = Weighted average of Duration of all Assets

= [ MV(Ai) x DAi ] / TA for i = 1 to m; where Ai is the i th

asset out of m assets

= [700*2.69+200*4.99] /1000= 2.88 yrs

DL = Weighted average of Duration of Liabilities

= [ MV(Lj) x DLj ] / TL for j = 1 to n; where Lj is the j th

liability out of n liabilities

= [620*1+300*2.81] /920= 1.59 yrs

Duration GAP (DG) = DA- [TL/TA] DL = 2.88 - 1.59

[920/1000] = 1.42 years


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Problems with Duration Gap

Analysis

Immunization

Isolation of the market value of equity to interest rate

changes will be effective only if interest rate for all

maturity securities shift up or down by exactly the same

amount.

Duration Drift


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THANK YOU

Asset Liability Management -

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