caiib super notes: bank financial management: module d: balance sheet management: components of...

CAIIB – Super-Notes © M S Ahluwalia Sirf Business

Components of Assets and Liabilities in Bank’s Balance Sheet and their Management

Module D: Balance Sheet Management

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CAIIB – SUPER NOTES

Bank Financial Management: Components of Assets and Liabilities in

Bank’s Balance Sheet and their Management





Contents

Coverage:

1. Components of a Bank’s Balance Sheet

2. What is Asset Liability Management?

3. Significance of Asset Liability

Management

4. Purpose and Objectives of Asset

Liability Management

5. ALM as co-ordinated Balance Sheet

Management





COMPONENTS OF A BANK’S BALANCE SHEET

1.





Components of Balance Sheet

Sources of Funds/Liabilities Sources of Funds/Liabilities

• Capital

• Reserves and Surplus

• Deposits

• Borrowings

• Other liabilities and Provisions

Application of Funds/Assets Application of Funds/Assets

• Cash in Hand and Balance with RBI

• Balances with Banks and Money at Call and Short Notice

• Investments

• Advance

• Fixed Assets

• Other Assets





Capital

• Represents owner’s stake

• Cushion for depositors and creditors in case of losses

• Long Term source of funds

• Prescribed by RBI

Authorised Capital

Authorised Capital

Issued Capital Issued Capital

Subscribed Capital

Subscribed Capital

Paid-up Capital Paid-up Capital





Reserves and Surplus

• Statutory Reserves

• Capital Reserve

• Revenue Reserve

• Issue of Shares at Premium

• Other Reserves

Reserves Reserves

• The credit balance in profit and loss account

Surplus Surplus





Deposits

• Main source of funds for the banks

Deposits Deposits

Deposits Payable on

Demand

Deposits Payable on

Demand

Current Deposits Current Deposits

Overdue Deposits Overdue Deposits

Call Deposits Call Deposits

Savings Bank Deposits

Savings Bank Deposits

Term Deposits

Term Deposits

Fixed Deposits

Fixed Deposits

Short Deposits

Short Deposits

Recurring Deposits Recurring Deposits





Borrowings

• Refinance obtained from:

– RBI

– Other Commercial Banks

– Other Institutions and Agencies like IDBI, EXIM Bank of India, NABARD

etc.





Other Liabilities and Provisions

Bills Payable Bills Payable

• Includes drafts, telegraphic transfers, travellers cheques, mail transfers payable, payslips, banker’s cheques and other miscellaneous items

Inter-Office Adjustments Inter-Office

Adjustments

• Credit balance of the net inter-office adjustments

Interest Accrued Interest Accrued

• Interest accrued but not due on deposits and borrowings

Others Others

• Income Tax

• TDS

• Interest Tax

• Provisions etc.





Cash and Balances with RBI

• Includes

• Foreign Currency Notes

• Cash Balances in the overseas branches

Cash in Hand Cash in Hand

• In order to meet statutory cash reserve requirements (CRR)

Balances with RBI Balances with RBI

• Balance in Current Accounts and Term Deposits with other banks

• All loans made in the interbank call money market repayable within 15 days notice.

Balances with Banks and money at Call and Short Notice Balances with Banks and money at Call and Short Notice





Investments

• Investments in

– Govt. Securities

– Approved Securities

– Shares

– Debentures and Bonds

– Subsidiaries and/or Joint Ventures

– Other investments





Advances

• Form major part of assets for all the banks

Advances Repayable on Demand

Advances Repayable on Demand

Cash Credits

Overdrafts

Loans repayable on Demand

Advances with Specific Due Date

Advances with Specific Due Date

Term Loans

Bills Purchased/Discounted

Bills Purchased/Discounted

Clean or Documentary

Domestic or Foreign

Secured/Unsecured Advances

Secured/Unsecured Advances

Secured by Tangible Assets

Covered by Bank/Government

Guarantees

Unsecured Advances





Fixed Assets

• Immovable properties

• Premises

• Furniture and Fixtures

• Hardware

• Motor Vehicles etc





Other/Miscellaneous Assets

Inter-Office Adjustments Inter-Office

Adjustments Interest Accrued Interest Accrued

Tax Paid in Advance/Tax Deducted at

Source

Tax Paid in Advance/Tax Deducted at

Source

Stationery and Stamps

Stationery and Stamps

Non Banking Assets acquired in

Satisfaction of claims

Non Banking Assets acquired in

Satisfaction of claims

Others Others

Other items primarily include claims in the form of clearing items, unadjusted debit balances

representing additions to assets and deductions from liabilities and advances provided to the

employees of the bank.





Contingent Liabilities

• Banks obligations under issuance of Letters of Credit, Guarantees and

acceptances on behalf of constituents and bills accepted by the bank on

behalf of its customers

• Claims against the bank not acknowledged as debts

• Liability for partly paid-up investments

• Liability on account of outstanding ForEx contracts

• Other items like Arrears of Cumulative dividends, bills rediscounted,

underwriting commitments, estimated amount of contracts remaining to

be executed on capital account and not provided for etc.





Bank’s P&L Statement

Profit and Loss Statement

Profit and Loss Statement

Income Income

Interest Income Interest Income

Other Income Other Income

Expenses Expenses

Interest Expended Interest

Expended

Operating Expenses Operating Expenses

Provisions and Contingencies Provisions and Contingencies





Income

Interest Income Interest Income

Interest/Discount on Advances/Bills

Income on Investments

Interest on balances with RBI and Other Interbank Funds

Others

Other Income Other

Income

Commission, Exchange and brokerage

Profit on Sale or Investments

Profit on Revaluation of Investment

Profit on Sale of Land, Building and Other Assets

Profit on Exchange Transactions

Income earned by way of dividends etc

Miscellaneous Income





Expenses Interest Expended Interest Expended

Interest on Deposits

Interest on RBI/Interbank Borrowings

Others

Operating Expenses Operating Expenses

Payments to and Provisions for Employees

Rent. Taxes and Lighting

Printing and Stationery

Advertisement and Publicity

Depreciation on Bank’s Property

Director’s fees, Allowances and Expenses

Auditor’s Fees and Expenses

Law Charges

Postage

Repairs and Maintenance

Insurance

Other Expenditure

Provisions and Contingencies Provisions and Contingencies





WHAT IS ASSET LIABILITY MANAGEMENT?

2.





Asset Liability Management

• Concerned with Strategic Balance Sheet Management involving risks

caused by changes in Rates of Interest, exchange rate, credit risk, and

liquidity position of bank

• Integrated Balance Sheet Management: All components of balance sheet

and its different maturity mix would be looked at from the profit angle of

the bank

• ALM is the act of Planning, Acquiring and directing the flow of funds

through an organisation to generate adequate and stable earnings to

steadily build an organisation’s equity over time while taking reasonable

and measured business risks





Asset Liability Management

• The management of the Net Interest Margin (NIM) to ensure its level and

riskiness are compatible with risk/return objectives of the bank

• Co-ordinated management of a bank’s balance sheet to allow for

alternative interest rate, liquidity and prepayment summaries

• Views the financial institutions as a set of inter relationships that must be

identified, coordinated and managed as an integral system

• To match the assets and liabilities and minimise liquidity as well as market

risk.

• Per liability basis: Matching a specific asset to support each liability





Balance Sheet Restructuring

• The strategy of actively managing the composition and mix of

assets and liabilities portfolios

• Efforts are made to adjust and readjust the portfolios in

response to corporate objectives, economic conditions and

future interest rate scenario to prevent undesirable imbalance

between asset and liability maturities





SIGNIFICANCE OF ASSET LIABILITY MANAGEMENT

3.





Significance of Asset Liability Management

Volatility Volatility

• Rate fluctuations affect the market value, yields, costs of assets and liabilities

Product Innovation

Product Innovation

• New financial products have an impact on the risk profile of the bank

Regulatory Environment Regulatory

Environment

• Central Banks issue framework and guidelines to deal with ALM policies

Management Recognition

Management Recognition

• Increasing awareness of the change in risk scenario and need for ALM





PURPOSE AND OBJECTIVES OF ASSET LIABILITY MANAGEMENT

4.





Purpose

• Purpose is to:

– Enhance the asset quality

– Quantify risks associated with assets and liabilities

– Manage the risks identified above

• Aims to stabilise:

– Short Term profits

– Long Term Earnings

– Long Term Substance of the Bank





Process

Review the interest rate structure and compare the same to the interest/product pricing of both assets and liabilities

Review the interest rate structure and compare the same to the interest/product pricing of both assets and liabilities

Examine the loan and investment portfolios in the light of the foreign exchange risk and the liquidity that might arise

Examine the loan and investment portfolios in the light of the foreign exchange risk and the liquidity that might arise

Examine the credit risk and contingency risk that may originate either due to rate fluctuations or otherwise and assess the quality of assets

Examine the credit risk and contingency risk that may originate either due to rate fluctuations or otherwise and assess the quality of assets

Review the actual performance against the projections made and analyse the reasons for any effect on the spreads

Review the actual performance against the projections made and analyse the reasons for any effect on the spreads





Parameters for purpose of stabilising ALM

• NII = Interest Income – Interest Expenses

• Measures impact of volatility on Short Term Profit

• NII fluctuation needs to be minimised to stabilise Short Term Profits

Net Interest Income (NII) Net Interest Income (NII)

• NIM= NII/Average Total Assets

• ‘Spread’ on the earning assets

Net Interest Margin (NIM) Net Interest Margin (NIM)

• Shareholder’s Funds/Total Assets

• Measures the shift between owned and total funds

• Assesses the sustenance capacity

Economic Equity Ratio Economic Equity Ratio





Objectives

Macro Level

Macro Level

Formulation of critical business

policies

Efficient allocation of

Capital

Designing of Products with

efficient pricing strategies

Micro Level Micro Level

Profitability through Price

Matching

Liquidity by Maturity Matching





Micro Level Objectives

• Aims to maintain spreads by ensuring deployment of liabilities at rate higher than costs

• Indicates whether institution can benefit from:

• Rising interest rates by positive gap (Assets > Liabilities)

• Declining interest rates by negative gap (Liabilities>Assets)

Price Matching Price Matching

• Grouping Assets and Liabilities based on their maturity profiles

• Gap assessed to identify future financing requirements

Liquidity Matching Liquidity Matching





Objectives… another perspective

• Spread Management

• Loan Quality

• Generating Fee Income and Service Charges

• Control of Non-Interest Operating Expenses

• Tax Management

• Capital Adequacy





ALM AS CO-ORDINATED BALANCE SHEET MANAGEMENT

5.





Two Stage Approach B

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Stage 1: Specific Balance Sheet Management

Functions

Stage 1: Specific Balance Sheet Management

Functions

Asset Side Management Asset Side Management

Reserve Position Management Reserve Position Management

Liquidity Management Liquidity Management

Investment/Security Management

Investment/Security Management

Loan Management Loan Management

Fixed Assets Management Fixed Assets Management

Liability Side Management Liability Side Management

Liability Management Liability Management

Reserve Position Management Reserve Position Management

Long-Term Management (Notes and Debentures) Long-Term Management (Notes and Debentures)

Capital Management Capital Management Stage 2: Income-Expense Function

Stage 2: Income-Expense Function

Profit = Interest Income – Interest Expense – Provision for

Loan Loss + Non-Interest Revenue – Non-Interest Expense

- Taxes

Profit = Interest Income – Interest Expense – Provision for

Loan Loss + Non-Interest Revenue – Non-Interest Expense

- Taxes





Do you have any questions or queries or some feedback to give?

Just mark an email to [email protected]




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CAIIB – Super-Notes © M S Ahluwalia Sirf Business For more Super-Notes: Click Here

M S Ahluwalia, amongst other things, is a visual artist, blogger,

blog designer and of course an MBA and Banker from New

Delhi, India.

To know more about him you may visit his blog-site: Estudiante De La Vida

















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