State Bank of India

SUMMER INTERNSHIP & RESEARCH PROJECT 2010 ON

LIQUIDITY RISK MANAGEMENT

SMALL AND MEDIUM ENTERPRISES DEPARTMENTBANGALORE

SUBMITTED BY: - NEETHU BAHULEYAN

ENROLLMENT NO: - 09MMA4109

UNDER THE SUPERVISION AND GUIDEANCE OF: - Prof. BRR

ACADEMIC YEAR: - 2009-2011

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DECLARATION

I Neethu Bahuleyan hereby declare that the “Summer Internship” report

submitted in partial fulfillment of the requirement of Post Graduate Diploma in

Business management to MIME Leaders in Management & Entrepreneurship

under the guidance and supervision of Dr. BRR, MIME is my original work and

not submitted for the award of any other degree, diploma, fellowship or other

similar titles or prizes.

DATE:

PLACE: Bangalore

SIGN:

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ACKNOWLEDGEMENT

It is my proud privilege to release the feelings of my gratitude to several persons

who helped me directly or indirectly to conduct this project work. I express my

heart full indebtness and owe a deep sense of gratitude to my faculty guide Dr.

BRR, Professor, MIME Leaders in management and Entrepreneurship, Bangalore,

for his invaluable guidance in this endeavor. I sincerely thank them for his

suggestions and help to prepare this report.

I am extremely thankful to the Dean and faculties of the Institute for their

coordination and cooperation and thankful for organizing summer internship

training for students.

I express deep sense of gratitude to my company guide Mr. Ramakrishna, Deputy

General Manager of SBI, for offering suggestions and help in successfully

completing my project. They have been a constant source of inspiration and

motivation.

Thanking you

Date: NEETHU BAHULEYAN

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INDEX

Sr No. Particulars Page

No.

1. ABSTRACT

2. INTRODUCTION TO THE STUDY

2.1 Introduction

2.2 Framework for measuring and managing liquidity

2.3 Measuring and managing net funding requirements:

3. OBJECTIVES AND METHODOLOGY

3.1 Objectives

3.2 Methodology

3.3 Literature review

3.4 Explanation of concepts

4. INDUSTRY PROFILE

4.1 Introduction

4.2 Post Independence

4.2 Nationalization

4.3 Liberalization

4.5 Current Situation

4.6 Regional Banks

4.7 Recent Developments

4.8 Government Regulations

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5. COMPANY PROFILE

5.1 History

5.2 Key area of operations

5.3 Management

5.4 SWOT Analysis

5.5 Competitors and other players

5.6 Awards

5.7 Products

6. ANALYSIS

6.1 Statement of interest rate sensitivity

6.2 Maturity gap method

6.3 Observations of the study

7. RECOMMENDATIONS

8. CONCLUSIONS

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1. ABSTRACT:

Today in the banking sector every bank nationalized or private are striving to

reach the pinnacle. Though in the national scenario the Govt./Nationalized banks

are leading bank in the metropolitan context the private banks are leading both in

business as well as service.

STATE BANK OF INDIA has built its leadership by making itself as India’s

largest commercial bank having largest retail lender with great brand image, high

market capitalization and also to find place in the fortune global 500 list.

The Broad objective of the project is to identify the liquidity risks faced by the

banks and Classification of assets and liabilities into different time buckets as per

RBI guidelines issued for liquidity management in banks. Analysis of liquidity

risk through Cash Flow Approach Method

This study is basically divided into eight major parts. The first part of the report

includes the introduction to the study. The second part deals with the banking

Industry. The third part includes the Introduction of State bank of India.

The fourth part is analysis then recommendations and conclusions.

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2. INTRODUCTION TO THE STUDY

2.1INTODUCTION TO LIQUIDITY RISK MANAGEMENT:

Banks are in the business of maturity transformation. They lend for longer time

periods, as borrowers normally prefer a longer time frame. But their liabilities are

typically short term in nature, as lenders normally prefer a shorter time frame

(liquidity preference). This results in long-term interest rates typically exceeding

short-term rates. Hence, the incentive for banks for performing the function of

financial intermediation is the difference between interest receipt and interest cost

which is called the interest spread. It is implicit, therefore, that banks will have a

mismatched balance sheet, with liabilities greater than assets in short term, and

with assets greater than liabilities in the medium and long term. These

mismatches, which represent liquidity risk, are with respect to various time

horizons. Hence, the concern of a bank is to maintain adequate liquidity

Liquidity risk is the potential inability to meet the bank's liabilities as they

become due. It arises when banks are unable to generate cash to cope with a

decline in deposits or increase in assets. It originates from the mismatches

in the maturity pattern of assets and liabilities. Measuring and managing

liquidity needs are vital for effective operation 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.

Analysis of liquidity risk involves the measurement of, not only the

liquidity position of the bank on an ongoing basis but also examining how

funding requirements are likely to be affected under crisis scenarios. Net

funding requirements are determined by analyzing the bank's future cash

flows based on assumptions of the future behavior of assets and liabilities

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that are classified into specified time buckets and then calculating the

cumulative net flows over the time frame for liquidity assessment.

Future cash flows are to be analyzed under "what if" scenarios so as to

assess any significant positive/ negative liquidity swings that could occur

on a day-to-day basis and under bank specific and general market crisis

scenarios. Factors to be taken into consideration while determining liquidity

of the bank's future stock of assets and liabilities include: their potential

marketability, the extent to which maturing assets /liability will be renewed,

the acquisition of new assets/liability and the normal growth in

asset/liability accounts.

Factors affecting the liquidity of assets and liabilities of the bank cannot always be

forecast with precision. Hence, they need to be reviewed frequently to determine

their continuing validity, especially given the rapidity of change in financial

markets.

The liquidity risk in banks manifest in different dimensions:

Funding Risk — need to replace net outflows due to unanticipated

withdrawal/non- renewal of deposits (wholesale and retail);

Time Risk — need to compensate for non-receipt of expected inflows of

funds, i.e., performing assets turning into non-performing assets; and

Call Risk — due to crystallization of contingent liabilities and inability to

undertake profitable business opportunities when desirable.

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2.2 FRAMEWORK FOR MEASURING AND MANAGING LIQUIDITY

Measuring and managing liquidity needs are vital for effective operation 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 managements should measure not only the

liquidity positions of banks on an ongoing basis, but also examine how

liquidity requirements are likely to evolve under different assumptions.

Experience shows that assets like government securities and other money

market instruments, which are generally treated as liquid could also become

illiquid when the market and players are unidirectional. Therefore, liquidity

has to be tracked through maturity or cash flow mismatches.

The framework for assessing and managing bank liquidity has three dimensions:

1. Measuring and managing net funding requirements

2. Managing market access and

3. Contingency planning.

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2.3 MEASURING AND MANAGING NET FUNDING REQUIREMENTS:

The first step towards liquidity management is to put in place an effective

liquidity management policy, which, inter alia, should spell out the funding

strategies, liquidity planning under alternative scenarios, prudential limits,

liquidity reporting/reviewing, etc. Liquidity measurement is quite a difficult

task and can be measured through stock or cash flow approaches. The key

ratios, adopted across the banking system are: loans to total assets, loans to

core deposits, large liabilities (minus) temporary investments to earning

assets (minus) temporary investments, purchased funds to total assets, loan

losses/net loans, etc.

While liquidity ratios are the ideal indicators of liquidity of banks operating

in developed financial markets, the ratios do not reveal the intrinsic

liquidity profile of Indian banks which are operating generally in an illiquid

market. Experiences show that assets like government securities, other

money market instruments, etc., commonly considered as liquid have

limited liquidity as the market and players are unidirectional. Thus, analysis

of liquidity involves tracking of 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. The maturity profile

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,

which are generally treated as liquid may be distributed as under:

1. 1 to 14 days

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2. 15 to 28 days

3. 29 days and up to 3 months

4. 3 months and up to 6 months

5. 6 months and up to 1 year

6. 1 year and up to 3 years

7. 3 years and up to 5 years

8. Above 5 years.

The investments in SLR securities and other investments are assumed as

illiquid due to lack of depth in the secondary market and are, therefore,

required to be shown under the respective maturity buckets, corresponding

to the residual maturity. However, some of the banks may be maintaining

securities in the `Trading Book', which are kept distinct from other

investments made for complying with the Statutory Reserve Requirements

and for retaining relationship with customers. Securities held in the

`Trading Book' are subject to certain preconditions like:

1. Clearly defined composition and volume;

2. Maximum maturity/duration of the portfolio is restricted;

3. The holding period not to exceed 90 days;

4. Cut-loss limit prescribed;

5. Defeasance periods (product-wise) , i.e., time taken to liquidate the position

on the basis of liquidity in the secondary market are prescribed;

6. Marking to market on a daily/weekly basis and the revaluation gain/loss

charged to the profit and loss account, etc.

Banks which maintain such `Trading Books' and comply with the above

standards are permitted to show the trading securities under 1-14 days, 15-

28 days and 29-90 days buckets on the basis of the defeasance periods. The

Board/ALCO of the banks should approve the volume, composition,

holding/defeasance period, cut loss, etc., of the `Trading Book' and copy of

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the policy note thereon should be forwarded to the Department of Banking

Supervision, RBI.

Within each time bucket, there could be mismatches depending on cash

inflows and outflows. While the mismatches up to one year would be

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 mismatches (negative gap) during 1-

14 days and 15-28 days in normal course may not exceed 20% of the cash

outflows in each time bucket. If a bank, in view of its current asset-liability

profile and the consequential structural mismatches, needs higher tolerance

level, it could operate with higher limit sanctioned by its Board

/Management Committee, giving specific reasons on the need for such

higher limit.

The Statement of Structural Liquidity (Annexure I) 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 also be

necessary to take into account the rupee inflows and outflows on account of

Forex operations. 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 a large branch network

can (on the stability of their deposit base as most deposits are rolled-over)

afford to have larger tolerance levels in mismatches in the long-term, if

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their term deposit base is quite high. While determining the tolerance

levels, the banks 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.

"In order to enable banks to monitor their short-term liquidity on a dynamic

basis over a time horizon spanning from 1-90 days, they may estimate their

short-term liquidity profiles on the basis of business projections and other

commitments for planning purposes."

3. OBJECTIVES AND METHODOLOGY OF THE STUDY:

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Though Basel Capital Accord and subsequent RBI guidelines have given a

structure for Liquidity Management and Asset Liability Management (ALM) in

banks, the Indian banking system has not enforced the guidelines in total. The

banks have formed Asset-Liability Committees (ALCO) as per the guidelines; but

these committees rarely meet to take decisions.

Taking this as a base, this research is done to find out the status of Liquidity

Management in State Bank of India with the help of "Cash Flow Approach"

methodology for controlling liquidity risk. To achieve the main purpose, the

following objectives are set forth:

3.1OBJECTIVES

To identify the liquidity risks faced by the banks.

Classification of assets and liabilities into different time buckets as per RBI

guidelines issued for liquidity management in banks.

Analysis of liquidity risk through Cash Flow Approach Method.

3.2METHIDOLOGY:

The study covers SBI's data for evaluation. The relevant data have been collected

from the published annual report of the bank for the period from March 2010.

In order to have effective liquidity management, bank need to undertake periodic

funds flow projections, taking into account movements in non-treasury assets and

liabilities [fresh deposits, maturing deposits (and maturing) and new term loans].

This enables forward planning for Cash Reserve Ratio (CRR) and Statutory

Liquidity Ratio (SLR) maintenance.

3.3CASH RESERVE RATIO:

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A scheduled bank is under the obligation to keep a cash reserve called the

Statutory Cash Reserve, with the Reserve Bank of India (RBI) under Section 42 of

the Reserve Bank of India Act, 1934. Every scheduled bank is required to

maintain with the Reserve Bank an average daily balance equal to least 3% of its

net demand and time liabilities. Average daily balances mean the average of

balances held at the close of business on each day of the fortnight. The Reserve

Bank is empowered to increase the rate of Statutory Cash Reserve from 3% to

20% of the Net Demand and Time Liabilities (NDTL). The rate of CRR in March

2010 was 5.75%.

Liabilities of a Scheduled bank exclude:

Its paid-up capital and reserves

Loans taken from the RBI or IDBI or NABARD

The aggregate of the liabilities of a scheduled commercial bank to the State

Bank or its subsidiary bank, any nationalized bank or a banking company or

a cooperative bank or any financial institution notified by the Central

Government in this behalf shall be reduced by the aggregate of the

liabilities of all such banks and institutions to the concerned scheduled

bank.

Thus, the entire amount of interbank liability for the purpose of Section 42 is

excluded and the net liability of a scheduled bank to the entire banking system,

(i.e., after deducting the balance maintained by it with all other banks from its

gross liabilities to them) will be deemed to be its liabilities to the system.

The objective of maintaining a minimum balance with RBI is basically to ensure

the liquidity and solvency of the scheduled banks. Every reporting fortnight starts

on a Saturday, or, if it is a holiday, the next working day and ends on the following

second Friday (Thursday or the previous working day if Friday is a holiday).

Branches send their data to their Head Office. Preliminary NDTL returns are due

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to the RBI in seven days of the close of a reporting fortnight, while final returns

must reach in 21 days.

The NDTL statement in Form A is prescribed by the RBI. There is a fixed format

in which branches send data to the CRR/SLR cell responsible for the RBI returns.

3.4STATUTORY LIQUIDITY RATIO:

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Section 24(2A) of Banking Regulation Act, 1949, requires every banking

company to maintain in India in Cash, Gold or Unencumbered Approved

Securities or in the form of net balance in current accounts maintained in

India by the bank with a nationalized bank, equivalent to an amount which

shall not at the close of the business on any day be less than 25% or such

other percentage not exceeding 40% as the RBI may from time to time, by

notification in the Gazette of India, specify, of the total of its demand and

time liabilities in India as on the last Friday of the second preceding

fortnight, which is known as SLR. At present, all Scheduled Commercial

Banks are required to maintain a uniform SLR of 25% of the total of their

demand and time liabilities in India as on the last Friday of the second

preceding fortnight which is stipulated under Section 24 of the RBI Act,

1949.

RBI can enhance the stipulation of SLR (not exceeding 40%) and advise

the banks to keep a large portion of the funds mobilized by them in liquid

assets, particularly government and other approved securities. As a result,

funds available for credit would get reduced.

All banks have to maintain a certain portion of their deposits as SLR and

have to invest that amount in these Government securities.

Government securities are sovereign securities. These are issued by the RBI

on behalf of the Government of India, in lieu of the Central Government's

market borrowing program.

3.5 THE TERM GOVERNMENT SECURITIES INCLUDE:

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1. Government Dated Securities, i.e., Central Government Securities

2. State Government Securities

3. Treasury Bills.

The Central Government borrows funds to finance its fiscal deficit. The

market borrowing of the Central Government is raised through the issue of

dated securities and 364 days Treasury Bills, either by auction or by

floatation of fixed coupon loans.

In addition to the above, Treasury Bills of 91 days are issued for managing

the temporary cash mismatches of the government. These do not form part

of the borrowing program of the Central Government.

Based on the required CRR and SLR per day, the treasury department of

the bank ensures that sufficient balance is maintained in the Reserve Bank

(at its different branches). The fund manager calculates on a daily basis the

RBI balances based on opening RBI balances and taking into account

various inflows and outflows during the day. The fund manager takes the

summary of inflows and outflows and the net effect is added to/subtracted

from the opening RBI balances. By this method, an RBI balance of all the

14 days is arrived at. For instance, on the opening day of the fortnight, if

there is an anticipated surplus, banks can generally lend it at an average,

subject to subsequent inflows/outflows. Conversely, for a shortfall, the

bank may borrow the required amount in call/repo/Collateralized

Borrowings and Lending Obligations (CBLO) markets on a daily basis.

Successful functioning of the funds department depends mostly on the

prompt collection of information from branches/other departments

regarding the inflow and outflow of funds. The information should also be

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collected accurately and collated properly/correctly. Improper maintenance

of liquidity and CRR position by the fund manager may lead to either a

default or an excess which does not earn any interest for the bank.

3.6 MANAGING MARKET ACCESS:

Apart from the above cash flows, banks should also track the impact of

prepayments of loans, premature closure of deposits and exercise of options built

in certain instruments which offer put/call options after specified times. Thus, cash

outflows can be ranked by the date on which liabilities fall due, the earliest date a

liability holder could exercise an early repayment option or the earliest date on

which contingencies could be crystallized.

The difference between cash inflows and outflows in each time period, the excess

or deficit of funds becomes a starting point for a measure of a bank's future

liquidity surplus or deficit, at a series of points of time. Banks should also consider

putting in place certain prudential limits, as detailed below, to avoid liquidity

crisis:

Cap on interbank borrowings, especially call borrowings

Purchased funds vis-à-vis liquid assets

Core deposits vis-à-vis Core Assets, i.e., CRR, SLR and Loans

Duration of liabilities and investment portfolio

Maximum Cumulative Outflows across all time bands

Commitment Ratio — track the total commitments given to

corporate/banks and other financial institutions to limit the off-balance

sheet exposure; and

Swapped Funds Ratio, i.e., extent of Indian Rupees raised out of foreign

currency sources.

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Banks should also evolve a system for monitoring high-value deposits (other than

interbank deposits), say Rs. 1Cr, or more to track the volatile liabilities. Further,

the cash flows arising out of contingent liabilities in normal situation and the

scope for an increase in cash flows during periods of stress should also be

estimated. It is quite possible that market crisis can trigger substantial increase in

the amount of draw downs from cash credit/overdraft accounts, contingent

liabilities like letters of credit, etc.

The liquidity profile of the banks could be analyzed on a static basis, wherein the

assets and liabilities and off-balance sheet items are pegged on a particular day and

the behavioral pattern and the sensitivity of these items to changes in market

interest rates and environment are duly accounted for. Banks can also estimate the

liquidity profile on a dynamic way by giving due importance to:

Seasonal pattern of deposits/loans;

Potential liquidity needs for meeting new loan demands, unavailed credit limits,

potential deposit losses, investment obligations, statutory obligations, etc.

3.7CONTINGENCY PLANNING:

All banks are required to produce a Contingency Funding Plan (CFP).

These plans are to be approved by ALCO, submitted annually as part of the

Liquidity and Capital Plan, and reviewed quarterly. The preparation and the

implementation of the plan may be entrusted to the treasury.

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CFP are liquidity stress tests designed to quantify the likely impact of an

event on the balance sheet and the net potential cumulative gap over a 3-

month period. The plan also evaluates the ability of the bank to withstand a

prolonged adverse liquidity environment. At least two scenarios require

testing: Scenario A, a local liquidity crisis, and Scenario B, where there is a

nationwide problem or a downgrade in the credit rating if the bank is

publicly rated.

The bank's CFP should reflect the funding needs of any bank managed

mutual fund whose own CFP indicates a need for funding from the bank.

Reports of CFPs should be prepared at least quarterly and reported to

ALCO.

If a CFP results in a funding gap within a 3-month time frame, the ALCO

must establish an action plan to address this situation. The Risk

Management Committee should approve the action plan.

At a minimum, CFPs under each scenario must consider the impact of

accelerated run off of large funds providers.

The plans must consider the impact of a progressive, tiered deterioration, as

well as sudden, drastic events.

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Balance sheet actions and incremental sources of funding should be

dimensioned with sources, time frame and incremental marginal cost and

included in the CFPs for each scenario.

Assumptions underlying the CFPs, consistent with each scenario, must be

reviewed and approved by ALCO.

The Chief Executive/Chairman must be advised as soon as a decision has

been made to activate or implement a CFP. The Chief Executive or the Risk

Management Committee may call for implementation of a CFP.

The ALCO will implement the CFP, amending it with the approval of the

Risk Management Committee, where necessary, to meet changing

conditions; daily reports are to be submitted to the Treasury Head,

comparing actual cash flows with the assumptions of the CFP.

3.8FOREIGN CURRENCY LIQUIDITY MANAGEMENT:

For banks with an international presence, the treatment of assets and

liabilities in multiple currencies adds a layer of complexity to liquidity

management for two reasons. First, banks are often less well-known to

liability holders in foreign currency markets. Therefore, in the event of

market concerns, especially if they relate to a bank's domestic operating

environment, these liability holders may not be able to distinguish rumor

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from fact as well or as quickly as domestic currency customers. Second, in

the event of a disturbance, a bank may not always be able to mobilize

domestic liquidity and the necessary foreign exchange transactions in

sufficient time to meet foreign currency funding requirements. These issues

are particularly important for banks with positions in currencies for which

the foreign exchange market is not highly liquid in all conditions.

Banks should, therefore, have a measurement, monitoring and control

system for liquidity positions in the major currency markets in which they

are active. In addition to assessing their aggregate foreign currency liquidity

needs and the acceptable mismatch in combination with their domestic

currency commitments, banks should also undertake separate analysis of

their strategies for each currency individually. When dealing in foreign

currencies, a bank is exposed to the risk that a sudden change in foreign

exchange rates or market liquidity, or both, could sharply widen the

liquidity mismatches. These shifts in market sentiment might result, either

from domestically generated factors or from contagion effects of

developments in other countries. In either event, a bank may find that the

size of its foreign currency funding gap has increased. Moreover, foreign

currency assets may be impaired, especially where borrowers have not

hedged foreign currency risk adequately. The Asian crisis of the late 1990s

demonstrated the importance for banks to closely manage their foreign

currency liquidity position on a day-to-day basis.

The particular issues to be addressed in managing foreign currency liquidity

will depend on the nature of the bank's business. For some banks, the use of

foreign currency deposits and short-term credit lines to fund domestic

currency assets will be the main area of vulnerability, while for others; it

may be the funding of foreign currency assets with domestic currency. As

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with overall liquidity risk management, foreign currency liquidity should be

analyzed under various scenarios, including stressful conditions.

3.3 LITERATURE REVIEW

1. The article explains that in the year 2003 the Mortgage Backed Securities

Clearing Corporation (MBSCC) and the Government Securities Clearing

Corporation (GSCC) merged into the Fixed Income Clearing Corporation

(FICC) under the Depository Trust Clearing Corporation (DTCC) umbrella.

FICC continually searches for cost-effective ways to provide increased

liquidity, risk management and other dynamic processes that help firms

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operate more efficiently as well as expand the population of firms that can

take advantage of these benefits. This paper will outline the motivations,

customer needs, regulatory interests and market dynamics behind these

initiatives, the benefits they will bring to the industry and the progress they

have made so far. In addition, the author has addressed some of the

challenges that currently face the industry and how FICC, along with its

members and partners, is fashioning solutions for those as well.

2. Developed countries and is becoming increasingly relevant for corporate

firms in India. This paper examines the practices and policies of foreign

exchange risk and interest rate risk management followed by the corporate

firms in India. The study reveals that Indian firms are aware of the risk

management techniques and many of them are using the same to manage

various risks. However, all the risks are not managed and the type of

ownership control significantly influences the usage of the techniques to

manage exchange rate risk and interest rate risk. 'Exposures are not large

enough' is the most widespread and prominent reason for not managing

risks. Risks inherent in derivatives are a significant reason in making the

firms using risk management techniques. The prominent barriers hindering

the routine use of derivatives are monitoring and evaluating the risk of

derivatives, pricing, valuing and accounting in conjunction with credit and

liquidity risk. About two-fifths of the firms are risk averse but do not hedge

their full exposure. A majority of the firms follow cost-center approach

towards risk management. Ownership has been observed to be a significant

determinant of firms' strategy towards risk management. While a majority

of foreign controlled firms and private sector business group firms can be

characterized as partial hedgers, the majority of the public sector firms

belong to the category of negligible hedgers. In sum, the adoption of risk

management techniques is still in infancy. It is desirable that decision

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makers and managers review their risk management practices afresh and

devise anticipatory and proactive policies in order to have competitive

advantages internationally.

3. Financial and insurance theories explain that large widely-held corporations

manage corporate risks if doing so is cost-effective to reduce frictional

costs such as taxes, agency costs and financial distress costs. A large

number of previous empirical studies, most in the U.S., have tested the

hypotheses underlying corporate risk management with financial derivative

instruments. In order to quantify corporate hedge demand, most previous

studies have used the ratio of principal notional amount of derivatives to

company size, although they recognize that company size is not an

appropriate proxy for financial risk. This paper analyzes the interest-rate-

risk hedge demand by Australian companies, measured through the ratio of

principal notional amount of interest rate derivatives to interest-rate-risk

bearing liabilities. Modern panel data methods are used, with two panel

data sets from 1998 to 2003 (1102 and 465 observations, respectively).

Detailed information about interest-rate-risk exposures was available after

manual data collection from financial annual reports, which was only

possible due to specific reporting requirements in Australian accounting

standards. Regarding the analysis of the extent of hedge, their measurement

of interest-rate-risk exposures generates some significant results different

from those found in previous studies. For example, this study shows that

total leverage is not significantly important to interest-rate-risk hedge

demand and that, instead, this demand is related to the specific risk

exposure in the interest bearing part of the firm's liabilities. This study finds

significant relations of interest-rate-risk hedge to company size, floating-

26

interest-rate debt ratio, annual log returns, and company industry type

(utilities and non-banking financial institutions).

4. The article deals with the development of an efficient asset/liability

management (ALM) process at the bank. ALM is one of the most important

functions for creating an optimal risk/reward trade-off in community

banking. The successful implementation of the ALM process is the

differentiating factor with regard to profitability among community banks.

Frequently, ALM is narrowly considered as market risk or interest rate risk

management. The committee responsible for managing the balance sheet is

called the Asset/Liability Management Committee (ALCO). The role of

ALCO is to manage assets, liabilities and capital along with managing

balance sheet risk.

5. The article explains how building connections between stress-testing and

contingency planning work in the liquidity risk management at financial

institutions. Three lines of defense employed by institutions to address

liquidity risk are key risk indicators, contingency planning and scenario-

based stress testing. Uses of scenario-based stress testing are tactical risk

management decisions, identification of potential weaknesses and

vulnerabilities, contingency planning process, and setting limits and

comparing forecasted risk exposures to the risk limits

6. The article focuses on the challenges faced by banks on their compliance

with the rules that concern liquidity risk management which were

established by regulators such as the Basel Committee on Banking

Supervision, Committee of European Banking Supervisors and the Great

Britain Financial Services Authority (FSA). It states that the primary

challenge that confronts some banks is the need to understand the

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requirements of the regulators despite the inconsistency of the rules that

each of them imposed. It adds that the requirements to use the stress tests

and calculate the liquidity buffer in the measurement of liquidity risk offer

a challenge among banks. Moreover, despite the rules provided by

regulators in liquidity risk management, many banks still failed to meet the

requirement.

7. The article discusses the significance of liquidity risk management as a

regulation for credit control firms in Great Britain. The author noted how

Chief Executive Hector Sants of the Financial Services Authority (FSA)

stressed the importance of liquidity risk like a capital for managing of

firms. The author presented issues surrounding FSA's guidance for liquidity

policies such as the systems and controls requirements and contingency

funding plan.

4. INDUSTRY PROFILE

4.1 INTRODUCTION

Banks in India as modern senses emerged only till 18th century. During the time of

the American Civil War, the supply of cotton to Lancashire stopped from

28

Americas. At that time some banks were opened, which functioned as entities to

finance industry, including speculative trades in cotton. Most of the banks opened

in India during that period could not survive and failed because of the high risk

which came with large exposure to speculative trades in cotton. In India in the year

1786, The General Bank of India was the first bank to come into existence in India

and then in the year 1870 which is almost after a century The Bank of Hindustan

became the 2nd bank in India.

In India at least 94 banks failed during the years 1913 to 1918. This was really a

turbulent time for the world as a whole and the banking sector in India specially.

This was the period which witnessed the First World War (1914-1918). Since then

through the end of the Second World War (1939-1945), and two years thereafter

until India achieved independence, were very challenging period for Indian

banking. The years of the First World War were turbulent, and it took toll on many

banks which simply collapsed despite the Indian economy gaining indirect boost

due to war-related economic activities. There were at least 106 numbers of banks

which downed shutters during that period. Following is a table giving year wise

closed banks’ detail during the period:

YearsNumber of Banks

that failed

Authorised capital

(Rs Lakhs)

Paid-up Capital

(Rs. Lakhs)

29

1913 12 274 35

1914 42 710 109

1915 11 56 5

1916 13 231 4

1917 9 76 25

1918 7 209 1

4.2POST-INDEPENDENCE:

The partition of India bought about a social unrest throughout India in 1947. Riot

and chaos ruled. The most adversely impacted provinces were the Punjab and

West Bengal. So did the economies of both these provinces. As a result, the

banking activities had remained paralyzed for months. Till then the banking sector

was wide open and there were almost no regulation. Most of the promoters were

30

private players. With Independence, things started changing. Rather the

independence marked the end of a regime of the Laissez-faire for the Indian

banking. The new government initiated a process of playing an active role in the

economy of the nation. The Industrial Policy Resolution adopted by the

government in 1948 was the first step towards it. The resolution opted for a mixed

economy. This resulted into greater control and involvement of the state in

different segments of the economy, more so, in the sensitive sectors including

banking and finance. The important banking regulatory steps were as follows:

In 1948, India's central banking authority the Reserve Bank of India got

nationalized, and it became an institution owned by the Government of India.

With the enactment of the Banking Regulation Act in 1949, the Reserve Bank of

India (RBI) got empowered "to regulate, control, and inspect the banks in India."

The Banking Regulation Act also provided that no new bank or branch of an

existing bank may be opened without a license from the RBI, and no two banks

could have common directors.

Interestingly, despite these provisions, control and regulations, almost all banks in

India except the State Bank of India, continued to be owned and operated by

private persons. However, the situation changed dramatically with the

nationalization of major banks in India on 19th July, 1969.

4.3NATIONALISATION:

From Independence, it took some years for the banking sector to mature. By

1960s, the Indian banking industry did occupy an important position to facilitate

the development of the Indian economy. Moreover, it did employ a quantum

volume which could affect national economy. It resulted in a debate about the

possibility to nationalize the banking industry. At that point, during the annual

31

conference of the All India Congress Meeting, in a paper entitled "Stray thoughts

on Bank Nationalization", Indira Gandhi, the-then Prime Minister of India

expressed the intention of the GOI favouring nationalisation. The paper was

received with positive enthusiasm. Thereafter, in a swift and sudden move, the

GOI issued an ordinance and nationalised the 14 largest commercial banks with

effect from the midnight of July 19, 1969. The decision was even termed as a

"masterstroke of political sagacity" by non other than a leader of the stature of

Jaypraksh Narayan. Then, within the next fortnight of issuing the ordinance, the

Parliament passed the Banking Companies (Acquisition and Transfer of

Undertaking) Bill. The bill finally received the presidential approval on 9th

August, 1969.

In 1980, there came the second phase of nationalisation of 6 more commercial

banks. The reason forwarded for this was to have more control of credit delivery

by the government. By the time, GOI effectively got hold of 91% control of the

total banking business of India.

Till 1990s, all nationalised banks grew at a pace of around 4%, similar to the

average growth rate of the Indian economy.

4.4LIBERALIZATION:

Since the launch of the economic liberalisation and global programme in 1991,

India has considerably relaxed banking regulations and opened the financial

sector for foreign investment. India is also committed to further open the

banking sector for foreign investment in pursuance to its commitment to the

World Trade Organsation(WTO)

32

Licenses were issued to a small number of private banks, such as Global Trust

Bank (the first of such new generation banks to be set up)which later

amalgamated with Oriental Bank of Commerce, UTI Bank(now re-named as

Axis Bank), ICICI Bank and HDFC Bank. These banks also came to be known

as New Generation tech-savvy banks because of their improved service

condition and their extensive use of IT in the operations.

This move instigated competition, resulting increased efficiency and

performance and did a lot of good to the banking sector. The rapid growth in

the economy of India, again as a result of liberalisation, also did help transform

the sector to this new look. The new situation shifted many goal posts. Till

then, the widely used method of 4-6-4 (Borrow at 4%; Lend at 6%; Go home at

4) of functioning by the banks become redundant. Technology, competition,

change in customer behaviour, macro-economic conditions, government

policies, resultant of all together ushered a new modern, efficient and

innovating banking environment in India. People started receiving more from

the banks and also constantly started demanding more. Retail banking boom

can be attributed to this phenomenon.

With the second phase of economic reforms, the next stage for the Indian

banking has been setup with the proposed relaxation in the norms for Foreign

Direct Investment, where all Foreign Investors in banks may be given voting

rights which could exceed the present cap of 10%. It’s notable that FDI

permissible limit, at present, has gone up to 49% with some restrictions.

33

4.5CURRENT SITUATION:

Today, the banking sector in India is fairly mature in terms of supply,

product range and reach. As far as private sector and foreign banks are

concerned, the reach in rural India still remains a challenge. In terms of

quality of assets and capital adequacy, Indian banks are considered to have

clean, strong and transparent balance sheets relative to other banks in

comparable economies in its region. The Reserve Bank of India is an

autonomous body, with minimal pressure from the government. The stated

34

policy of the Bank on the Indian Rupee is to manage volatility but without

any fixed exchange rate. Till now, there is hardy any deviation seen from

this stated goal which is again very encouraging.

With passing time, Indian economy is further expected to grow and be

strong for quite some time-especially in its services sector. The demand for

banking services, especially retail banking, mortgages and investment

services are expected to grow stronger. Therefore, it is not hard to forecast

few M&As, takeovers, and asset sales in the sector. Consolidation is going

to be another order of the day.

The significant change in the policy and attitude that is currently being seen

is encouraging for the banking sector growth. In March 2006, the Reserve

Bank of India allowed Warburg Pincus, a private foreign investor, to

increase its stake in Kotak Mahindra Bank to 10%. Notably, this is the first

time that a foreign individual investor has been allowed to hold more than

5% in a private sector bank since 2000. Earlier, The RBI in 2005

announced that any stake exceeding 5% by foreign individual investors in

the private sector banks would need to be vetted by them.

“Currently, India has 88 scheduled commercial banks (SCBs) - 28 public

sector banks (that is with the Government of India holding a stake), 29

private banks (these do not have government stake; they may be publicly

listed and traded on stock exchanges) and 31 foreign banks. They have a

combined network of over 53,000 branches and 17,000 ATMs. According

to a report by ICRA Limited, a rating agency, the public sector banks hold

over 75 percent of total assets of the banking industry, with the private and

foreign banks holding 18.2% and 6.5% respectively.”

35

Despite the current global slowdown, despite the fear of US economic

recession, despite the volatility of Indian stock markets, every informed

observer is more or less optimistic about the 8% to 10% growth per annum

for the Indian economy till the next few years. Therefore, it can safely be

said that the banking industry in India will only surge ahead in coming

years. We can also expect to see many other sea changes in terms of their

operations, funding and structures. As they say, this is just the beginning!

India has a strong and vibrant banking sector comprising state-owned

banks, private sector banks, foreign banks, financial institutions and

regional banks including cooperative banks, rural banks and local area

banks. In addition there are non-banking financial companies (NBFCs),

housing finance companies, Nidhi companies and chit fund companies.

As monetary authority of the country, the Reserve Bank of India (RBI)

regulates the banking industry and lays down guidelines for day-to-day

functioning of banks within the overall framework of the Banking

Regulation Act, 1949, Foreign Exchange Management Act, 1999 and

Foreign Direct Investment (FDI) policy of the government state owned

banks.

The Indian banking sector is dominated by 28 state-owned banks which

operate through a network of about 50,000 branches and 13,000 ATMs.

The State Bank of India (SBI) in the largest bank in the country and along

with its seven associate banks has an asset base of about Rs. 7,000 billion

(approximately US$150 billion).

36

The other public sector banks are Punjab National Bank, Bank Of Baroda,

Canara Bank, Bank Of India, IDBI Bank.

The public sector banks have overseas operations with Bank of Baroda

topping the list with 51 branches, subsidiaries, joint ventures and

representative offices outside India, followed by SBI (45 overseas

branches/offices) and Bank of India (26 overseas branches/offices). Indian

banks, including private sector banks, have 171 branches and offices

abroad.

SBI is present in 29 countries, Bank of Baroda in 20 countries and Bank of

India in 14 countries.

Private sector banks India has 29 private sector banks including nine new

banks which were granted licenses after the government liberalised the

banking sector. Some of the well known private sector banks are ICICI

Bank, HDFC Bank and IndusInd Bank and the latest Yes Bank has recently

entered the private sector bank. In terms of reach the private sector banks

with an asset of over Rs 5,700 billion (about US$124 billion) operate

through a network of 6,500 branches and over 7,500 ATMS.

Foreign banks As many as 29 foreign banks originating from 19 countries

are operating in India through a network of 258 branches and about 900

ATMs. With total assets of more than Rs 2,000 billion (about 44 billion US

dollars) they are present in 40 centers across 19 Indian states and Union

Territories. Some of the leading international banks that are doing brisk

business in India include Standard Chartered Bank.

37

Foreign banks operating in India:

1. ABN-AMRO Bank N.V. (24 branches)

2. Abu Dhabi Commercial Bank Ltd. (2 branches)

3. Arab Bangladesh Bank Ltd. (1 branch)

4. American Express Bank (7 branches)

5. Antwerp Diamond Bank N.V. (1 branch)

6. Bank International Indonesia (1 branch)

7. Bank of America (5 branches)

8. Bank of Bahrain & Kuwait (2 branches)

9. Bank of Nova Scotia (5 branches)

10. Bank of Tokyo-Mitsubhai UFJ Ltd. (3 branches)

11. BNP Paribas (8 branches)

12. Bank of Ceylon (1 branch)

13. Barclays Bank Plc. (1 branch)

38

14. Calyon Bank (5 branches)

15. Citi Bank N.A. (39 branches)

16. Shinhan Bank (1 branch)

17. Chinatrust Commercial Bank (1 branch)

18. Deutsche Bank (8 branches)

19. DBS Bank (2 branches)

20. HSBC Ltd. (45 branches)

21. JP Morgan Chase Bank N.A. (1 branch)

22. Krung Thai Bank Public Co. Ltd. (1 branch)

23. Mizuho Corporate Bank Ltd. (2 branches)

24. Mashreq Bank PSC (2 branches)

25. Oman International Bank SAOG (2 branches)

26. Standard Chartered Bank (81 branches)

27. Sonali Bank (2 branches)

28. Societe General (2 branches)

39

29. State Bank of Mauritius (3 branches) The Netherlands-based ING Group has

taken over the management of the Indian private sector Vysya Bank Ltd. in

October 2002 and is operating as ING Vysya Bank Ltd.

4.6REGIONAL BANKS:

Rural areas in India are served through a network of Regional Rural Banks, urban

cooperative banks, rural cooperative credit institutions and local area banks. Many

of these banks are not doing well financially and the government is currently

engaged in restructuring and consolidating them. Local area banks were of recent

origin as on March 31, 2006 four such banks were operating in the country.

Financial institutions in India have seven major state-owned financial institutions

which include Industrial Development Bank of India, Industrial Financial

40

Corporation of India, tourism Finance Corporation of India, Exim Bank, Small

Industries Development Bank of India, National Bank for Agriculture and Rural

Development and National Housing Bank. These institutions provide term loans

and arrange refinance. These are also specialized institutions like the power

Finance Corporation, Indian Railway Finance Corporation, Infrastructure

Development Finance Company and state-level financial corporations.

India also has a vibrant NBFC sector comprising 13,000 NBFCs that are registered

with the RBI and fund activities like equipment leasing, hire purchase etc. Out of

the total about 450 NBFCs are allowed by the RBI to collect funds from the

public. Large NBFCs have an asset base of about Rs 3,000 billion

4.7 RECENT DEVELOPMENTS:

State Bank of India has acquired 76% stake in Giro Commercial Bank, a

Kenya bank.

Bank of Baroda is planning to acquire a bank in Africa to consolidate its

presence in the continent.

Canara Bank is helping Chinese banks recover their huge non-performing

assets.

ICICI banks is in the process of taking over Sangli Bank, a private sector

bank in Maharashtra.

41

The RBI has recently allowed the commonwealth Bank of Australia,

Banche Popolari uniote S.c.r.l (based in Italy), Vneshtorgbank (Russia trade

bank), Prmsvyazbank (Russian commercial bank), Banca Popolare Di

VIcenza (Italian bank), Monte Dei Paschi Di Siena (Italian bank) and

Zurcher Kantonalbank (Swiss bank) to set up representative office in India.

4.8GOVERNMENT REGULATIONS:

Even though banking companies are registered under the companies Act, 1956

they are regulated by the RBI which grants license to companies for operating a

bank , operating branches and ff sit ATMs, fixes statutory liquidity ratio (SLR)

and cash reserve ratio , and lays down other conditions for day-to-day operations.

The RBI permission is also needed for board level appointments in banks. With

regard to interest rates, individual banks are free to fix rates with the expectation

of savings bank rate which is decided by the RBI. The individual banks are free to

fix lending rates.

42

5. COMPANY PROFILE

43

State Bank of India (SBI), Mumbai Main Branch

5.1HISTORY

The state Bank of India was established in 1955, its predecessor, the Imperial

Bank of India, was established in 1921, as a result of the amalgamation of the

three banks including Bank of Bengal, Bank of Bombay and Bank of Madras.

Since 1973, the bank has been involved in a non-profit activity called commodity

service banking. All the branches and administrative offices throughout the

country sponsor and participate in a large number of welfare activities and social

causes. State Bank of India opened its first offshore banking unit (OBU) in 2003.

The bank entered into an agreement with western union’s Kouni Travels to offer

inward remittance facilities in 2005. During2006, the bank faced huge disruptions

in its services on account of a week long strike by over 200,000 employees,

demanding upward revision of their pension benefits. Later the same year, the

44

bank announced that it would securitize 25-30% of its loan assets over the next

few years as an alternative source of funds. The bank also announced that it would

increase its overseas presence and would set up 60 new overseas offices in two

years.

SBI entered into wealth management and financial planning services to clients

who have INR0.5million or more in their accounts. SBI announced plan to roll out

banking services in 50,000 unbanked villages by March 2010. In2009, the bank

announced that got a full banking license from the regulator, the Dubai Financial

Services Authority.

5.2KEY AREAS OF OPERATIONS

The business operations of SBI can be broadly classified into the key income

generating areas such as National Banking, International Banking, Corporate

Banking, & Treasury operations.

45

5.3MANAGEMENT

The bank has 14 directors on the Board and is responsible for the management of

the Bank’s business. The board in addition to monitoring corporate performance

46

also carries out functions such as approving the business plan, reviewing and

approving the annual budgets and borrowing limits and fixing exposure limits. Mr.

O. P. Bhatt is the Chairman of the bank. The five-year term of Mr. Bhatt will

expire in March 2011. Prior to this appointment, Mr. Bhatt was Managing Director

at State Bank of Travancore. Mr. Bhatt has more than 30 years of experience in the

Indian banking industry and is seen as futuristic leader in his approach towards

technology and customer service. Mr. Bhatt has had the best of foreign exposure

in SBI. We believe that the appointment of Mr. Bhatt would be a key to SBI’s

future growth momentum. Mr. T S Bhattacharya is the Managing Director of the

bank and known for his vast experience in the banking industry. Recently, the

senior management of the bank has been broadened considerably. The positions of

CFO and the head of treasury have been segregated, and new heads for rural

banking and for corporate development and new business banking have been

appointed. The management’s thrust on growth of the bank in terms of network

and size would also ensure encouraging prospects in time to come.

47

5.4SWOT ANALYSIS

State Bank of India (SBI) is the leading commercial bank in India, offering

services such as retail banking, commercial banking, international banking and

treasury operations. Low cost CASA and reduced reliance on bulk deposits help

the bank reduce the cost of funds and thus improve profitability, but increasing

competition and tepid global interbank market could affect the bank’s market

share and financial performance.

48

STRENGTHS WEAKNESS

The largest public sector bank in

India and also one of the world’s

top 100 banks in the world

Low cost CASA and reduced

reliance on bulk deposits

Prudent lending practices helping

control NPAs

Compared to foreign banks in

India, SBI’s

overseas presence is minuscule

Susceptible to political

interventions

OPPORTUNITIES THREATS

New licenses and approvals

likely to expand revenue and

profits

Investments in information

technology will decrease

transaction costs of SBI

Growth in general insurance

industry will help SBI to increase

the market share

SBS merger further hastens SBI

and its

associate banks merger and

helping defend its leadership

position

Opening of banking sector

in2009 will cause intense

competition

Teid global interbank lending

could derail overseas expansion.

49

5.5COMPETITORS AND OTHER PLAYERS:

TOP PERFORMING PUBLIC SECTOR BANKS

Andhra Bank

Allahabad Bank

Punjab National Bank

Dena Bank

Vijaya Bank

TOP PERFORMING PRIVATE SECTOR BANKS

HDFC

ICICI Bank

AXIS Bank

Kotak Mahindara Bank

Centurion Bank of Punjab

TOP PERFORMING FOREIGN BANKS

Citi Bank

Standard Chartered

HSBC Bank

ABN AMRO Bank

American express

50

5.6 AWARDS

5.7DIFFERENT PRODUCTS OF SBI

51

DEPOSIT LOANS CARDS DIFFERENT CREDIT CARDS

Savings

Account

Home

Loans

Consumer

Cards

SBI international

card

Life Plus

Senior Citizens

Savings

Account

Loan

Against

Property

Credit Card SBI Gold Cards

Fixed Deposits Personal Loans Travel Card SBI Gold Master

Cards

Security deposits Car Loan Debit Card Partnership Cards

Recurring

Deposits

Loan Against

Securities

Commercial Card SBI employee

Cards

Tax- Saver Fixed

Deposits

Two Wheeler

Loan

Corporate Card

Salary Account Preapproved Loan Prepaid Card

Advantage

Woman Savings

account

Retail Asset Purchase Card

Rural savings

account

Farmer Finance Distribution Card

People’s Saving

Account

Business

Installment Loans

Business Card

Freedom Savings

Account

Flexi Cash Merchant Services

6. ANALYSES

52

MATURITY GAP ANALYSIS FOR LIQUIDITY RISK (SHORT TERM) THROUGH CASH FLOW APPROACH (MARCH 200010)

1 to 14 Days

15 to 28 Days

29 days to 3 Months

Over 3 Months to 6 Months

Over 6 Months up to 1 Year

Over 1 Year up to 3 Years

Over 3 Years up to 5 Years

Over 5 Years

Deposits 31,596.91 14,592.93 37,853.31 56,627.41 86,114.19 1,81,909.61 1,02,864.77 1,78,420.51

Borrowings 2,985.88 5,531.82 10,490.96 8,523.60 4,384.83 9,173.88 3,052.88 30537.79

FCL 4,319.68 9,152.31 14,704.28 15,303.10 14,831.34 17,878.41 6,550.34 1,677.01

Total Cash outflow(a)

38902.47 29,277.06 63,048.55 80,454.11 105,330.36 208,961.90 112,467.99 210,635.31

Loans & Advances

30,886.76 8,026.04 33,299.25 26,620.89 19,452.19 2,40,706.90 42,276.20 84,900.05

Investments 7,505.92 4,494.75 21,733.42 7,848.99 6,777.18 32,238.61 60,331.76 1,24,504.50

FCA 4,319.68 9,152.31 14,704.28 15,303.10 14,831.34 17,878.41 6,550.34 1,677.01

Total Cash(b)

77,918.80 38,851.45 117,740.48 91,696.97 75,344.24 290,823.92 157,984.84 211,081.56

Gap(b-a) 39,016.33 9,574.39 54,691.93 11,242.86 -29,986.12 81,862.02 45,516.85 446.25

Cumulative Gap

55,456.95 65,031.34 119,723.27 130,966.13 100,980.0 182,842.03 228,358.88 228,805.13

Total Assets

9,64,432.08 9,64,432.08 9,64,432.08 9,64,432.08 9,64,432.08 9,64,432.08 9,64,432.08 9,64,432.08

Gap to Total Assets (%)

5.750 6.743 12.41 13.58 10.47 18.95 23.68 23.72

6.1STATEMENT OF INTEREST RATE SENSITIVITY

53

Generated by grouping RSA, RSL & OFF-Balance sheet items in to various (8)

time buckets.

RSA:

A) Money at call

B) Advances

C) Investment

RSL:

A) Deposits

B) Borrowings

6.2MATURITY GAP METHOD

Three options:

A) RSA>RSL= Positive Gap

B) RSL>RSA= Negative Gap

C) RSL=RSA= Zero Gap

6.3OBSERVATIONS OF THESTUDY

54

From the year ending March 31, 2000, banks are required to disclose the maturity

patterns of loans and advances, investments in securities, deposits and borrowings,

and foreign currency assets and liabilities. The data of the year ending March 31,

2010 has been used to conduct a Cash Flow Approach (short-term maturity gap)

analysis of assets and liabilities for different maturity buckets.

The analysis of net funding requirements involves the construction of a

maturity ladder and the calculation of cumulative net excess or deficit of

funds at selected maturity dates. This is called "Cash Flow Approach" to

liquidity management.

A maturity ladder of an 8 time bucket is used to compare SBI's future cash

inflows to its future cash outflows. Evaluating whether a bank is

sufficiently liquid depends in large measure on the behavior of cash flows

under different scenarios, such as normal conditions (going concern

scenario) or a bank specific crisis (the bank's liabilities cannot be rolled

over or replaced and will have to pay higher at maturity) or general market

crisis (liquidity affects all the banks or one or two markets).

For evaluation of Cash Flow Approach, 1-14 days bucket, 15-28 days time

bucket and 29-90 days time buckets have been taken as the relevant time

frames for active liquidity management as it does not generally extend to

more than a few weeks. Since the SLR/CRR maintenance period is 14 days,

meaningful information is arrived at by a short time horizon which is

stacked by many short periods (ranging up to 3 months by every week).

55

In the year 2010, there was a positive gap in short-term liquidity, i.e., up to

6 months. Its short-term cash outflow was less than cash inflow which

means that SBI maintained a sound liquidity position, as shown in the table.

Other than in the bucket of 6 months to 1 year liquidity position shows

positive cumulative gap throughout its time. So its short-term liquidity was

maintained and during this period, SBI had a sound liquidity position.

There was a negative gap between 6 months to 1 year (Rs. 29,986.12). But

at the end, i.e., in the 5 years ad above it had a positive cumulative gap

which shows that its medium-term liquidity risk could be maintained.

Percentage of negative gap to cash out flow was 5.75 % in 1-14 days time

bucket, 6.74%in 15-28 days time bucket, 12.41% 29 to 3 months, 13.58%

3months to 6 months, 10.47% 6 months to 1 year, 18.95% 1 year to 3 years,

23.68%3 years to 5 years, 23.72% 5 years.

Here RSA > RSL so it’s a positive gap.

56

6.4LIQUIDITY MANAGEMENT IN BANKS: THE CASH FLOW

APPROACH:

Liquidity has been defined as the ability of an institution to replace liability run

off and fund asset growth promptly and at a reasonable price. Maintenance of

superfluous liquidity will, however, impact profitability adversely. It can also be

defined as the comprehensive ability of a bank to meet liabilities exactly when

they fall due or when depositors want their money back. This is a heart of the

banking operations and distinguishes a bank from other entities.

Measuring and managing the liquidity needs are vital for effective operation 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. By measuring the liquidity positions of banks on an ongoing

basis, banks can examine how liquidity requirements are likely to evolve under

different conditions.

57

7. RECOMMENDATIONS

A bank should set limits to control its liquidity risk exposure and

vulnerabilities. A bank should regularly review such limits and

corresponding risk escalation procedures. Limits should be relevant to the

business in terms of its location, complexity of activity, nature of products,

currencies and markets served.

A bank should design a set of indicators to identify the emergence of

increased risk or vulnerabilities in its liquidity risk position or potential

funding needs. Such early warning indicators should identify any negative

trend and cause an assessment and potential response by management in

order to mitigate the bank’s exposure to the emerging risk.

Market access is critical for effective liquidity risk management, as it

affects both the ability to raise new funds and to liquidate assets. Senior

management should ensure that market access is being actively managed,

monitored and tested by the appropriate staff.

A bank should actively manage its intraday liquidity positions and risks to

meet payment and settlement obligations on a timely basis under both

normal and stressed conditions and thus contribute to the smooth

functioning of payment and settlement systems.

58

8. CONCLUSION:

Mismatches can be positive or negative

Positive Mismatch: M.A.>M.L. and Negative Mismatch M.L.>M.A.

In case of +ve mismatch, excess liquidity can be deployed in money market

instruments, creating new assets & investment swaps etc.

For –ve mismatch, it can be financed from market borrowings (Call/Term),

Bills rediscounting, Repo & deployment of foreign currency converted into

rupee.

To meet the mismatch in any maturity bucket, the bank has to look into

taking deposit and invest it suitably so as to mature in time bucket with

negative mismatch.

59

BIBLIOGRAPHY

1. www.ebscohost.com 2. www.rbi.org.in 3. www.statebankofinda.com

4. Basel Committee report

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