Module A - Asset Liability Management

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CAIIB-RISK MANAGEMENT- ASSET LIABILITY MANAGEMENT – MODULE A

G.R.RAO, Faculty, IIBF

204/08/23

BANKING BUSINESS ON 26.09.2008

figures in croresDEMAND DEPOSITS 4,96,673

TERM DEPOSITS 29,45,465 34,42,138

LOANS, CC,OD 24,36,890

BILL FINANCE 1,05,577 25,42,467

CASH : DEPOSIT RATIO = 9.91

CREDT: DEPOSIT RATIO =73.86

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BANKING BUSINESS Contd...

C R R : 9

S L R : 25

TOTAL 34

HOW BANKS MANAGE

CREDIT & CASH TOTALLING 83.77 % OF DEPOSITS

BORROWING TO DEPOSITS: 11.74 %

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PRESENT DAY PRORITIES

NET PROFIT WHICH IS OPERATING PROFIT - PROV. & APPROPRIATIONS

OPERATING PROFIT

(OP) =INT. INC. + OTH. INC.

NET.INT. INC.(NII) ALSO CALLED SPREAD = INT. (EARNED – SPENT)

O.P. = (INT. EARNED – INT.SPENT)

- OTHER (EXPNS. – INC.)

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NII AND NIM

BANKS WILL BE INTERESTED IN NIM AND WOULD LIKE TO SEE IT GROW

NIM MANAGEMENT IS MAINLY ASSET AND LIABILITY MANAGEMENT

IT MANAGES ASSETS AND LIABILITIES TO IMPROVE NIM UNDER A GIVEN RISK FRAME WORK

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ASSET LIABILITY MANAGEMENT

ENSURE ACCEPTABLE NII / NIM AND LONG TERM IMPROVEMENT IN NET WORTH FOR A GIVEN RISK LEVEL

INCLUDES PLANNING, ACQUIRING AND DEPLOYING FUNDS FOR ABOVE PURPOSE

IT IS ONGOING PROCESS OF FORMULATING, MONITORING, REVISING AND FRAMING STRATEGIES RELATED TO ASSETS AND LIABILITIES

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ALM Contd…

ENCOMPASSES MANAGEMENT OF

LIQUIDITY AND INTEREST RISKS AVOIDS VOLATILITY, HELPS PRODUCT

INNOVATION AND COMPLIANCE OF REGULATIONS

IN REGULATED ENVIRONMENT IT IS

DAY TO DAY FUND MANAGEMENT FUNCTION ONLY

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ALM Contd.. FROM BALANCE SHEET ANGLE

RESERVE MAINTENANCE LIABILITY MANAGEMENT ASSET MANAGEMENT INVESTMENT MANAGEMENT CAPITAL MANAGEMENT LIQUIDITY MANAGEMENT

FROM P&L ANGLE SPREAD MANAGEMENT

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ALM- FUNDS MANAGEMENT

INCOME ON FUNDS LENT SHOULD BE MAXIMUM

EXPENSES ON FUNDS BORROWED SHOULD BE REASONABLE

ENNSURING FUND AVAILABILITY IS LIQUIDTY MANAGEMENT

AT REASONABLE COST IS INT. MGMT

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LIQUIDITY MANAGEMENT

TO ENSURE SUPPLY OF NEEDED FUNDS FOR EXISTING BUSINESS AND NEW

BUSINESS TAKE CARE OF MIS-MATACHES IN

MATURITIES OF ASSETS & LIABILITIES PROJECTS FINANCIAL STRENGTH TO

SOCIETY AND BANKING SYSTEM WHICH IN TURN ENABLES EASY AVAILABILITY OF FUNDS AT REASONABLE COST

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HOW LIQUIDITY GETS AFFECTED

DUE TO REGULATORY CHANGES DUE MARKET CHANGES BOTH

EXISTING AND POTENTIAL DUE TO CUSTOMERS’ ACTIONS DUE TO CRYSTALLISATION OF

CONTINGENT LIABILITIES DUE TO NPAs BIG FRAUDS

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LIQUIDITY MANAGEMENT

ESTIMATION OF SIZE AND TIME OF FUND REQUIREMENTS CORRECTLY

PLANNING APPROPRIATELY IN ADVANCE CONSIDERING COSTS AT DIFFERENT TIMES

ACQUIRE FUNDS AT OPTIMUM COSTS

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LIQUIDITY MANAGEMENT

WHY CASH FLOW ESTIMATES CAN GO WRONG DECREASE IN ANTICIPATED

REALISATIONS BOTH PRINCIPAL & INT. INCREASE IN NPA LEVELS BEYOND

ESTIMATES SUDDEN SPURT IN ASSET BEYOND

BANK’S CONTROL

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LIUQUIDITY MANAGEMENT

TYPES OF RISKS IN LIQUIDITY MGMT FUNDING RISK

NEED TO PROVIDE FUNDS FOR UNEXPECTED OUTGOINGS TIME RISK

NEED FOR COMPENSATING NON REALISED SOURCES CALL RISK

CRYSTALLISATION OF CONTINGENCIES

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FOREIGN CURRENCY LIQUIDITY MANAGEMENT- PROCESS

FINALISE STRATEGY (QUALITY& QUANTITY) FOR EACH CURRENCY OF EXPOSURE

STIPULATE LIMITS FOR TOLERANCES REG. MISMATCHES IN DIFFERENT TIME BANDS LOAN TO DEPOSIT AND LOAN TO CAPITAL LIQUID ASSETS TO ST LIAB.

MEASURE, MONITOR AND MANAGE LIQUIDITY

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LIQUIDITY MANAGEMENT

IDENTIFICATION OF PRIMARY AND SECONDARY RESOURCES

DIVERSIFICATIONOF RESOURCES CRISIS SCENARIO STUDIES CONTINGENCY PLANNING

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DIFFERENT APPROACHES TO LIQUIDITY MANAGEMENT

STOCK APPROACH & FLOW A PPROACH IN FLOW APPROACH INFLOWS AND

OUTFLOWS ARE MEASURED FOR DIFFERENT TIME BUCKETS AND UNDER DIFFERENT SCENARIOS LIKE

NORMAL TIMES, BANK SPECIFIC CRISIS AND SYSTEMIC CRISIS AND FUNDING AVENUES IDENTIFIED

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RBI GUIDELINES GROUP LIKELY INFLOWS AND

OUTFLOWS INTO DIFFERENT TIME BUCKETS AND PRESCRIBING MAX MISMATCH IN NEAR TERM BUCKETS

1 DAY 5% 2-7 DAYS 10%

8-14 DAYS 15%5-28 DAYS 20%PERCENTAGES ARE MAX. FOR RESPECTIVE TIME BUCKET

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INTEREST RISK MANAGEMENT RISK OF INT. INC. GETTING AFFECTED DUE TO EXTERNAL FACTORS ONLY MARKET INTEREST RATES AND REGULATORY INTEREST RATES IMPACT WILL BE ON BOTH ADVANCES

AND INVESTMENTS LIQUIDTY AND INTEREST RISK ARE NOT

EXCLUSIVE NOT ALL ASSETS OR LIAB. WILL BE

IMPACTED

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INTEREST RISK MANAGEMENT

GAP OR MISMATCH RISK IT IS RISK DUE TO FUNDING OF

ASSETS WHICH WILL REPRICE IN DIFFERENT PERIOD FROM THAT OF LIABILITIES

BASIS RISK DUE TO DIFFERENT IMPACT ON

ASSETS AND LIABILITIES IN THE SAME TIME BUCKET

2104/08/23

INTEREST RISK Contd…

EMBEDDED OPTION RISK INHERENT RIGHT WITH AN ASSET OR

LIABILITY FOR REPRICING YIELD CURVE RISK OR RATE LEVEL

RISK DUE TO CHANGES INITIATED BY

REGULATOR/ MARKET FORCES VOLATILITY RISK

SUDDEN VOLATILITIES IN MARKT. MORE IN CASE OF BORROWED FUNDS

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MEASUREMENT OF INTEREST RISK

GAP METHOD AND ANALYSIS GROUP RATE SENSITIVE ASSETS AND

LIABILITIES INTO DIFFERENT BUCKETS STUDY THE IMPACT OF INTEREST CHANGES

BOTH POSITIVE AND NEGATIVE ON THE NIM

DURATION METHOD MODIFIED DURATION METHOD SIMULATION APPROACH

STATIC AND DYNAMIC SIMULATION

2304/08/23

GAP ANALYSIS

GAP IS + VE IF ASSETS > LIABILITIES

Δ NII = GAP * Δr ( CHANGE IN INT. RATE)

NIM = NII / EARNING ASSETS(EA)

GAP * Δr = ΔNIM * EA = NIM* EA * ΔC

ΔC IS ACCEPTABLE CHANGE IN NIM

WORKING BACKWARDS YOU CAN ARRIVE AT THE ACCEPTABLE GAP FOR AN ACCEPTABLE ΔC

2404/08/23

LIMITATIONS IN GAP METHOD

GAP MAY NOT BE AMENABLE TO CHANGE TO SUIT DESIRED ΔC

PRESUMES THAT BOTH ASSETS AND LIAB. WILL BE UNIFORMLY IMPACTED

DOESNOT TAKE INTO ACCOUNT TIME VALUE OF CASH FLOWS

WHEN THERE IS SIGNIFICANT CHANGE EVEN THOSE WHICH ARE NOT TO BE REPRICED WILL BE REPRICED

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ADJUSTED DURATION

IN THIS METHOD ASSETS AND LIABILITIES ARE GROUPED DEPENDING UPON THEIR EXTENT OF LIKELY IMPACT AND NOT INTO TIME BUCKETS BY ASSIGNING DIFFERENT WEIGHTS

RATE ADJ. GAP = ∑ WAI* AI – ∑ WLI*LI

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MODIFIED DURATION

MODIFIED DURATION (MD) IS USED TO STUDY THE CHANGE IN PRICE OF AN ASSET DUE TO A CHANGE IN INTEREST RATE

MD = D/ (1+ r) AND PC = - MD* Δ r / 100 PC IS CHANGE IN PRICE AND Δ r IS

CHANGE IN INTEREST RATE IN BASIS POINTS AND THIS IS USEFUL ONLY IN CASE OF SMALL CHNGES IN INTEREST RATES

2704/08/23

MANAGEMENT OF FOREX RISK

TRANSACTION EXPOSURE CURRENCY RISK IN SPECIFIC FOREX

TRANSACTION BETWEEN EXECUTION AND SETTLEMENT

TRANSLATION EXPOSURE CURRECNY RISK INVOLVED AT THE

TIME OF REPORTING TRANSACTIONS AT THE END OF ACCOUNTING YEAR TO H.O.

OPERATING EXPOSURE

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FOREX RISK MGMT. TOOLS

FORWARDS FUTURES-CURRENCY OPTIONS SWAPS MONEY MARKET INSTRUMENTS

MONEYMARKETINSTRUMENTS CAN BE USED LIKE A FORWARD CONTRACT INMGMT. OF FOREX RISK

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RISK MGMT. IN DEALING ROOM

OPEN POSITION OVERNIGHT AND DAY LIGHT LIMITS STOP LOSS LIMITS CAP ON SIZE OF TRANSACTION

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TWO PRACTICAL PROBLEMS ON DURATION ANALYSIS

1. ASSETS AND LIABILITIES OF FMG FINANCES ALONGWITH THEIR DURATION AND INTEREST RATRES ARE AS PER GIVEN TABLE. IDENTIFY RISK SENSITIVEGAP AND NIM. DURING AFORECASTING PERIOD OF 1YEAR IF INTEREST RATES FALL BY 2 % WHAT WOULD BE IMPLICATION ON NIM

2. ABC BANK HAS EARNING ASSETS AMNOUNTING TO Rs 1980 CRORES AND THEIR NIM IS 4%. MANAGEMENT’S POLICY SAYS THAT A 2.5% DEVIATION FROM NIM IS ACCEPTABLE. BANK FORECASTS THAT INTEREST RATES WOULD INCREASE BY 0.75% DURING NEXT12 MONTHS. WHAT SHOULD BE THE GAP OF THE BANK IF THEY HAVE TO BE WITHIN THE GIVEN RANGE OF NIM

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OBJECTIVE QUESTIONS1. THE NEED TO REPLACE NET OUTFLOWS

DUE TO UNANTICIPATED WITHDRAWAL OF DEPOSITS IS KNOWN AS ---------RISK.

2. THE NEED TO COMPENSATE FOR NON-RECEIPT OF EXPECTED INFLOWS OF FUNDS IS CLASSIFIED AS -----RISK.

3. CALL RISK ARISES DUE TO CRYSTALLISATION OF ------.

4. MATURITY LADDERS ENABLES THE BANK TO ESTIMATE THE DIFFERENCE BETWEEN-----AND------IN PREDETERMINED PERIODS.

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OBJECTIVE QUESTIONSQ. THE INSTITUTION IS IN A POSITION TO BENEFIT

FROM RISING INTEREST RATES WHEN ASSETS ARE ……………THAN LIABILITIES.A. LESSER.B. GREATERC. EQUAL D. HALF.

Q. THE LIQUIDITY RISK ARISING OUT OF UNANTICIPATED WITHDRAWAL OR NON RENEWAL OF DEPOSITS IS CALLED AS A. FUNDING RISK.B. TIME RISK.C. MARKET RISKD. OPERATIONAL RISK.

3304/08/23

OBJECTIVE QUESTIONSQ.LIQUIDITY RISK ARISING OUT OF CRYSTALLIZATION

OF LIABILITIES AND CONVERSION OF NON FUND BASED LIMITS TO FUND BASED LIMITS IS KNOWN AS

A. CALL RISK.B. TIME RISK.C. OPERATIONAL RISK.D. MARKET RISK.Q. STOCK APPROACH OF MEASURING AND MANAGING

LIQUIDITY RISK AND FUNDING REQUIREMENTS IS BASED ON

A. LEVEL OF ASSETS AND LIABILITIES AND BALANCE SHEET EXPOSURE ON A PARTICULAR DATE.

B. BASED ON STOCKS PLEDGED TO BANK IN CASH CREDIT ACCOUNT

C. STOCK OF INVESTMENTS OF BANK.D. NONE OF ABOVE.

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OBJECTIVE QUESTIONSQ. UNDER GAP METHOD THE NET FUNDING

REQUIREMENT IS CALCULATED BASED ON

A. RESIDUAL MATURITIES OF ASSETS AND LIABILITIES.B. ACTUAL MATURITIES OF ASSETS AND LIABILITIES C. BOTH THE ABOVE.D. NONE OF ABOVE. 

Q. CASH INFLOWS ARISE FROM MAINLY:A. MATURING ASSETS.B. MATURING LIABILITIES.C. MATURING OFF BALANCE SHEET EXPOSURE.D. MATURING TIME DEPOSITS.

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OBJECTIVESQ. IF THERE IS SIGNIFICANT DEFICIT OBSERVED SAY AFTER 30

DAYS PERIOD OPTION AVAILABLE FOR BANK IS TO

A. ACQUIRE AN ASSET MATURING ON THAT DAY.B. RENEW OR ROLL OVER A 30 DAY LIABILITY.C. ACQUIRE A LIABILITY MATURING AFTER 30 DAYS.D. NONE OF ABOVE. Q. PRESENTLY NUMBER OF SUB DIVISIONS IN 1-14 DAYS TIME BUCKET FOR STRUCTURAL LIQUIDITY ARE

A. FOUR.B. THREEC. FIVE .D. NONE OF ABOVE.

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OBJECTIVESQ. CAPITAL , RESERVES AND SURPLUS ARE SLOTTED

IN WHICH TIME BUCKET IN STRUCTURAL LIQUIDITY STATEMENT:A. OVER 5 YEARS.B. OVER 3 YEARS.C. OVER 1 YEAR.D. OVER 6 MONTHS.

Q. SAVING AND CURRENT DEPOSIT MAY BE TREATED AS VOLATILE PORTION UPTO A. 10% AND 15 % RESPECTIVELY.B.20% AND 30% RESPECTIVELY.C. 30% AND 40% RESPECTIVELY.D. NONE OF ABOVE

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OBJECTIVESQ. WHAT IS BASIS RISK:

A. RISK THAT INTEREST RATE OF DIFFERENT ASSETS AND LIABILITIES MAY CHANGE IN DIFFERENT MAGNITUDES IS CALLED BASIS RISK.

B. RISK RELATING TO BASIS ON WHICH LOAN IS SANCTIONED.C. RISK RELATED TO YIELD CURVE.D. NONE OF ABOVE.

Q. ONE OF THE STRATEGIES FOR REDUCING THE ASSET OR LIABILITY SENSITIVITY COULD BE :

A. INCREASE FLOATING RATE INSTRUMENTS.B. INCREASE FIXED RATE INSTRUMENTS.C. NONE OF ABOVE.D. ALL THE ABOVE.

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OBJECTIVES 

Q. HIGHER THE DURATION IMPLIES THAT A GIVEN CHANGE IN THE LEVEL OF INTEREST RATES WILL HAVE A. LARGER IMPACT ON ECONOMIC VALUE.B. SMALLER IMPACT ON ECONOMIC VALUE.C. NO IMPACT.D. NONE OF ABOVE.

 Q. DURATION WILL BE HIGHER IF

A. LONGER THE MATURITY DATE OR SMALLER THE PAYMENTS THAT OCCUR BEFORE MATURITY ( COUPON PAYMENTS)

B. SHORTER THE MATURITY AND HIGHER THE PAYMENTS THAT OCCUR BEFORE MATURITY ( COUPON PAYMENTS)

C. NONE OF ABOVE. D. ALL THE ABOVE.

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OBJECTIVESQ. SHORT TERM DYNAMIC LIQUIDITY STATEMENT RELATE

TOA. MONITORING LIQUIDITY ON DYNAMIC BASIS OVER A TIME

HORIZON OF 1-90 DAYS.B. MONITORING LIQUIDITY ON DYNAMIC BASIS OVER A TIME

HORIZON OF 7-90 DAYS.C. MONITORING LIQUIDITY ON DYNAMIC BASIS OVER A TIME

HORIZON OF 28-90 DAYS.D. NONE OF ABOVE. Q. IN STATEMENT OF INTEREST RATE SENSITIVITY :A. ONLY RUPEE ASSETS AND LIABILITIES AND OFF BALANCE

SHEET POSITIONS SHOULD BE REPORTED.B. ALL ASSETS AND LIABILITIES SHOULD BE REFLECTED.C. ONLY FOREIGN CURRENCY ASSETS AND LIABILITIES

SHOULD BE REFLECTED.D. NONE OF ABOVE.

4004/08/23

THANQ

WISH U ALL SUCCESS IN EXAM