ASSET LIABILITY MANAGEMENT SYSTEM

Presented By SARAS Group

S Shrikant Popat 35A Amit Pandey 31R Rohan Sawant 38A Ashwin Surve 43S Sahil Wason 49

Assets Liability Management It is a dynamic process of Planning, Organizing & Controlling of Assets & Liabilities- their volumes, mixes, maturities, yields and costs in order to maintain liquidity and NII.

Significance of ALM

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

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

RBI DIRECTIVES• Issued draft guidelines on 10th Sept’98.

• Final guidelines issued on 10th Feb’99 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 of Deposits, Borrowings, Investment & Advances w.e.f. 31.03.01

Liquidity ManagementBank’s 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.

Adequacy of liquidity position for a bank

Analysis of following factors throw light on a bank’s adequacy of liquidity position:

a. Historical Funding requirementb. Current liquidity positionc. Anticipated future funding needsd. Sources of fundse. Options for reducing funding needsf. Present and anticipated asset qualityg. Present and future earning capacity andh. Present and planned capital position

Funding Avenues

To satisfy funding needs, a bank must perform one or a combination of the following:

a. Dispose off liquid assetsb. Increase short term borrowingsc. Decrease holding of liquid assetsd. Increase liability of a term naturee. Increase Capital funds

Types of Liquidity Risk

• Liquidity Exposure can stem 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

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

Statement of Structural LiquidityAll Assets & Liabilities to be reported as per their maturity profile into 10 maturity Buckets:

i. Next day

ii. 2 to 7 days

iii. 8 to 14 days

iv. 15 to 28 days

v. 29 days and up to 3 months

vi. Over 3 months and up to 6 months

vii. Over 6 months and up to 1 year

viii. Over 1 year and up to 3 years

ix. Over 3 years and up to 5 years

x. Over 5 years

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 10 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.

An Example of Structural Liquidity Statement 1-14Days

15-28 Days

30 Days-3 Month

3 Mths - 6 Mths

6 Mths - 1Year

1Year - 3 Years

3 Years - 5 Years

Over 5 Years Total

Capital 200 200Liab-fixed Int 300 200 200 600 600 300 200 200 2600Liab-floating Int 350 400 350 450 500 450 450 450 3400Others 50 50 0 200 300Total outflow 700 650 550 1050 1100 750 650 1050 6500Investments 200 150 250 250 300 100 350 900 2500Loans-fixed Int 50 50 0 100 150 50 100 100 600Loans - floating 200 150 200 150 150 150 50 50 1100Loans BPLR Linked 100 150 200 500 350 500 100 100 2000Others 50 50 0 0 0 0 0 200 300Total Inflow 600 550 650 1000 950 800 600 1350 6500Gap -100 -100 100 -50 -150 50 -50 300 0Cumulative Gap -100 -200 -100 -150 -300 -250 -300 0 0Gap % to Total Outflow-14.29 -15.38 18.18 -4.76 -13.64 6.67 -7.69 28.57

ADDRESSING THE MISMATCHES• 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, Repos & deployment of foreign currency converted into rupee.

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.

Maturity Pattern of Select Assets & Liabilities of A BankLiability/Assets Rupees

(In Cr)In Percentage

I. Depositsa. Up to 1 yearb. Over 1 yr to 3 yrsc. Over 3 yrs to 5 yrsd. Over 5 years

1520080006700230270

10052.6344.08 1.51 1.78

II. Borrowingsa. Up to 1 yearb. Over 1 yr to 3 yrsc. Over 3 yrs to 5 yrsd. Over 5 years

450180 00150120

10040.00 0.0033.3326.67

III. Loans & Advancesa. Up to 1 yearb. Over 1 yr to 3 yrsc. Over 3 yrs to 5 yrsd. Over 5 years

880034003000 4002000

10038.6434.09 4.5522.72

Iv. Investmenta. Up to 1 yearb. Over 1 yr to 3 yrsc. Over 3 yrs to 5 yrsd. Over 5 years

58001300 300 9003300

10022.41 5.1715.5256.90

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 )• INVESTMENTRSL• DEPOSITS EXCLUDING CD• BORROWINGS

MATURITY GAP METHOD(IRS)

• THREE OPTIONS:• A) RSA>RSL= Positive Gap• B) RSL>RSA= Negative Gap• C) RSL=RSA= Zero Gap

SUCCESS OF ALM IN BANKS :PRE - CONDITIONS

1. Awareness for ALM in the Bank staff at all levels–supportive Management & dedicated Teams.

2. Method of reporting data from Branches/ other Departments. (Strong MIS).

3. Computerization-Full computerization, networking.4. Insight into the banking operations, economic

forecasting, computerization, investment, credit.5. Linking up ALM to future Risk Management

Strategies.

Interest Rate Risk Management• Interest Rate risk is the exposure of a bank’s

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 bank’s earnings and capital base.

• Changes in interest rates also affect the underlying value of the bank’s assets, liabilities and off-balance-sheet item.

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.

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

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 (RSA<RSL) in given time band, an increase in market interest rates could cause a decline in NII.- conversely, a positive gap (RSA>RSL) in a given time band, an decrease in market interest rates could cause a decline in NII.

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.

ALM StrategiesThere are three ALM techniquesa) Asset Management Strategy (AMS) – this is a strategy

concerns with control of incoming funds through the determination of loans/credits allocation and their interest rates.

b) Liability Management Strategy (LMS)– deals with controlling of sources of funds and monitoring of the mix and cost of deposit and nondeposit liabilities – by controlling price, interest rate.

c) Fund Management Strategy (FMS) – this a a more balanced approach of ALM that incorporates both AMS and LMS. The basic objectives of FMS are:

ALM Strategies

• The control of volume, mix, and return or cost of both assets and liabilities for the purpose of achieving a bank’s goals.

• The coordination of asset and liability management as a means of achieving internal consistence and maximizing the spread between revenue and costs, and minimization of risk exposure.

• Maximization of returns and minimization of costs from supplying services.

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