Presentation by S P Dhal, Faculty Member, SPBT College

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Asset Liability Management in Banks
Module A
Live Interactive Learning Session- 30-11-2005

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

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Components of a Bank Balance sheet
Liabilities Assets
Capital Reserve Surplus Deposits Borrowings Other Liabilities Cash Balances with RBI Bal. With Banks Money at Call and Short Notices Investments Advances Fixed Assets 6. Other Assets
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. 1 to 14 days
2. 15 to 28 days
3. 29 days and up to 3 months
4. Over 3 months and up to 6 months
5. Over 6 months and up to 1 year
6. Over 1 year and up to 3 years
7. Over 3 years and up to 5 years
8. 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