Presentation by S P Dhal, Faculty Member, SPBT College

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Asset Liability Management in Banks
Module A
Live Interactive Learning Session

• Presentation by S P Dhal, Faculty Member, SPBT
  College

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Components of a Bank Balance sheet
Contingent Liabilities
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Components of Liabilities

• 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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Components of Liabilities

• 2. Reserves Surplus
• Components under this head includes
• I. Statutory Reserves
• II. Capital Reserves
• III. Investment Fluctuation Reserve
• IV. Revenue and Other Reserves
• V. Balance in Profit and Loss Account

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Components of Liabilities

• 3. Deposits
• This is the main source of banks funds. The
  deposits are classified as deposits payable on
  demand and time. They are reflected in
  balance sheet as under
• I. Demand Deposits
• II. Savings Bank Deposits
• III. Term Deposits

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Components of Liabilities

• 4. Borrowings
• (Borrowings include Refinance / Borrowings from
  RBI, Inter-bank other institutions)
• I. Borrowings in India
• i) Reserve Bank of India
• ii) Other Banks
• iii) Other Institutions Agencies
• II. Borrowings outside India

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Components of Liabilities

• 5. Other Liabilities Provisions
• It is grouped as under
• I. Bills Payable
• II. Inter Office Adjustments (Net)
• III. Interest Accrued
• IV. Unsecured Redeemable Bonds
• (Subordinated Debt for Tier-II Capital)
• V. Others(including provisions)

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Components of Assets

• 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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Components of Assets

• 2. BALANCES WITH BANKS AND MONEY AT CALL SHORT
  NOTICE
• I. In India
• i) Balances with Banks
• a) In Current Accounts
•   b) In Other Deposit Accounts
• ii) Money at Call and Short Notice
• a) With Banks
•   b) With Other Institutions
• II. Outside India
• a) In Current Accounts
• b) In Other Deposit Accounts
• c) Money at Call Short Notice

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Components of Assets

• 3. Investments
• A major asset item in the banks balance sheet.
  Reflected under 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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Components of Assets

• 4. Advances
• The most important assets for a bank.
• A. i) Bills Purchased and Discounted
• ii) Cash Credits, Overdrafts Loans
• repayable on demand
• iii) Term Loans
• B. Particulars of Advances
• i) Secured by tangible assets
• (including advances against Book Debts)
• ii) Covered by Bank/ Government Guarantees
• iii) Unsecured

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Components of Assets

• 5. Fixed Asset
• I. Premises
• II. Other Fixed Assets (Including furniture and
  fixtures)
• 6. Other Assets
• I. Interest accrued
•   II. Tax paid in advance/tax deducted at
  source
• (Net of Provisions)
•   III. Stationery and Stamps
•   IV. Non-banking assets acquired in
  satisfaction of claims
•   V. Deferred Tax Asset (Net)
•  VI. Others

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Contingent Liability

• Banks obligations under LCs, Guarantees,
  Acceptances on behalf of constituents and Bills
  accepted by the bank are reflected under this
  heads.

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Banks Profit Loss Account

• A banks profit Loss Account has the following
  components
• Income This includes Interest Income and Other
  Income.
• II. Expenses This includes Interest Expended,
  Operating Expenses and Provisions contingencies.

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Components of Income

• INTEREST EARNED
• I. Interest/Discount on Advances / Bills
•  II. Income on Investments
•  III. Interest on balances with Reserve Bank
• of India and other inter-bank funds
•  IV. Others

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Components of Income

• 2. OTHER INCOME
• I. Commission, Exchange and Brokerage
• II. Profit on sale of Investments (Net)
• III. Profit/(Loss) on Revaluation of Investments
• IV. Profit on sale of land, buildings and other
• assets (Net)
• V. Profit on exchange transactions (Net)
• VI. Income earned by way of dividends etc. from
  subsidiaries and Associates abroad/in India
• VII. Miscellaneous Income

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Components of Expenses

• INTEREST EXPENDED
• I. Interest on Deposits
• II. Interest on Reserve Bank of India /
  Inter-Bank
• borrowings
• III. Others

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Components of Expenses

• 2. OPERATING EXPENSES
• I. Payments to and Provisions for employees
• II. Rent, Taxes and Lighting
•  III. Printing and Stationery
• IV. Advertisement and Publicity
•  V. Depreciation on Bank's property
• VI. Directors' Fees, Allowances and Expenses
•  VII. Auditors' Fees and Expenses (including
  Branch Auditors)
•  VIII. Law Charges
•   IX. Postages, Telegrams, Telephones etc.
•   X. Repairs and Maintenance
•   XI. Insurance
•  XII. Other Expenditure

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Assets Liability Management
ALM
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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Significance of ALM

• Volatility
• Product Innovations Complexities
• Regulatory Environment
• Management Recognition

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Purpose Objective of ALM

• An effective Asset Liability Management
  Technique aims to manage the volume, mix,
  maturity, rate sensitivity, quality and liquidity
  of assets and liabilities as a whole so as to
  attain a predetermined acceptable risk/reward
  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)
• 3. Economic Equity Ratio

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RBI DIRECTIVES

• Issued draft guidelines on 10th Sept98.
• Final guidelines issued on 10th Feb99 for
  implementation of ALM w.e.f. 01.04.99.
• To begin with 60 of asset liabilities will be
  covered 100 from 01.04.2000.
• Initially Gap Analysis to be applied in the first
  stage of implementation.
• Disclosure to Balance Sheet on maturity pattern
  on Deposits, Borrowings, Investment Advances
  w.e.f. 31.03.01

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Liquidity Management

• Banks liquidity management is the process of
  generating funds to meet contractual or
  relationship obligations at reasonable prices at
  all times.
• New loan demands, existing commitments, and
  deposit withdrawals are the basic contractual or
  relationship obligations that a bank must meet.

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Adequacy of liquidity position for a bank

• Analysis of following factors throw light on a
  banks adequacy of liquidity position
• Historical Funding requirement
• Current liquidity position
• Anticipated future funding needs
• Sources of funds
• Options for reducing funding needs
• Present and anticipated asset quality
• Present and future earning capacity and
• h. Present and planned capital position

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Funding Avenues

• To satisfy funding needs, a bank must perform
  one or a combination of the following
• Dispose off liquid assets
• Increase short term borrowings
• Decrease holding of less liquid assets
• Increase liability of a term nature
• e. Increase Capital funds

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Types of Liquidity Risk

• Liquidity Exposure can stem from both internally
  and externally.
• External liquidity risks can be geographic,
  systemic or instrument specific.
• Internal liquidity risk relates largely to
  perceptions of an institution in its various
  markets local, regional, national or
  international

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Other 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
All Assets Liabilities to be reported as per
their maturity profile into 8 maturity Buckets

• 1 to 14 days
• 15 to 28 days
• 29 days and up to 3 months
• Over 3 months and up to 6 months
• Over 6 months and up to 1 year
• Over 1 year and up to 3 years
• Over 3 years and up to 5 years
• Over 5 years

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STATEMENT OF STRUCTURAL LIQUIDITY

• Places all cash inflows and outflows in the
  maturity 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 to exceed
  20 of outflows
• Shows the structure as of a particular date
• Banks can fix higher tolerance level for other
  maturity buckets.

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An Example of Structural Liquidity Statement
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ADDRESSING THE MISMATCHES

• Mismatches can be positive or negative
• Positive Mismatch M.A.gtM.L. and Negative
  Mismatch M.L.gtM.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,
  Repos deployment of foreign currency converted
  into rupee.

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STRATEGIES

• 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.
• The bank can raise fresh deposits of Rs 300 crore
  over 5 years maturities and invest it in
  securities of 1-29 days of Rs 200 crores and rest
  matching with other out flows.

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Maturity Pattern of Select Assets Liabilities
of A Bank
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STATEMENT OF INTEREST RATE SENSITIVITY

• Generated by grouping RSA,RSL OFF-Balance sheet
  items in to various (8)time buckets.
• RSA
• MONEY AT CALL
• ADVANCES ( BPLR LINKED )
• INVESTMENT
• RSL
• DEPOSITS EXCLUDING CD
• BORROWINGS

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MATURITY GAP METHOD(IRS)

• THREE OPTIONS
• A) RSAgtRSL Positive Gap
• B) RSLgtRSA Negative Gap
• C) RSLRSA Zero Gap

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SUCCESS OF ALM IN BANKS PRE - CONDITIONS

• Awareness for ALM in the Bank staff at all
  levelssupportive Management dedicated Teams.
• Method of reporting data from Branches/ other
  Departments. (Strong MIS).
• Computerization-Full computerization, networking.
• Insight into the banking operations, economic
  forecasting, computerization, investment, credit.
• 5. Linking up ALM to future Risk Management
  Strategies.

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Interest Rate Risk Management

• Interest Rate risk is the exposure of a banks
  financial conditions to adverse movements of
  interest rates.
• Though this is normal part of banking business,
  excessive interest rate risk can pose a
  significant threat to a banks earnings and
  capital base.
• Changes in interest rates also affect the
  underlying value of the banks assets,
  liabilities and off-balance-sheet item.

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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 safety and soundness of
  the bank.

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Sources of Interest Rate Risk

• Interest rate risk mainly arises from
• Gap Risk
• Basis Risk
• Net Interest Position Risk
• Embedded Option Risk
• Yield Curve Risk
• Price Risk
• Reinvestment Risk

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Measurement of Interest Rate Risk

• Gap Analysis- Simple maturity/re-pricing
  Schedules can be used to generate simple
  indicators of interest rate risk sensitivity of
  both earnings and economic value to changing
  interest rates.
• - If a negative gap occurs (RSAltRSL) in given
  time band, an increase in market interest rates
  could cause a decline in NII.
• - conversely, a positive gap (RSAgtRSL) in a
  given time band, an decrease in market interest
  rates could cause a decline in NII.

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Measurement of Interest Rate Risk

• Duration Analysis Duration is a measure of the
  percentage change in the economic value of a
  position that occur given a small change in level
  of interest rate.

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THANK YOU