thesis alm(draft) old
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Study on
ASSET AND LIABILITY MANAGEMENT
(ALM)
Prepared by:
S. Tayyab Raza Z.
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ACKNOWLEDGEMENT
I am deeply grateful to Almighty Allah for enabling us to accomplish this onerous task.
Sincere thanks and Special regards to Sir Nawaz without his help and guidance this
robust task could not be completed.
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Table of Contents
Title Page... iAcknowledgement.. ii
Table of Contents. iii
ABSTRACT. ivIntroduction 01
Focus of Study. 02
Literature Survey. 02Problem Statement 09
Theoretical Framework. 09
Hypothesis 11
Methodology 12Population and Sample size.. 12
Data Collection Method 12
Sample Characteristics 13
Variable and Measures. 13Data Analysis Method.. 13
Survey Findings. . 14Measure of Central Tendencies 14
Pearson Correlation.. 15
Qualitative Analysis.. 15Hypothesis Testing 16
Hypothesis One 16
Hypothesis Two 18
Hypothesis Three. 19Hypothesis Four.. 20
Hypothesis Five 22
Hypothesis Six. 23Hypothesis Seven. 24
Discussion Conclusion 25
Conclusion. 25Recommendation. . 27
ANNEXURE-I (Samplecharacteristics).. 29
ANNEXURE-II (Questionnaire) . 31
End notes 34
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ABSTRACT
The focus of the study was to ascertain the overall awareness of Asset and Liability
Management (ALM) in commercial banks. Based on the literature survey, the predictorvariables were identified. These dimensions were:
the importance given to ALM by the management
the techniques employed and their importance
inter-bank market support to asset-liability mismatches
the prime objective of ALM in the opinion of respondents
the extent to which funding and interest risks can be managed through ALM
the supervisory and regulatory role played by State Bank of Pakistan.
Data for testing the hypotheses was collected through a close-ended questionnaire based
on rating scale. The questionnaire administrated for the study was based on 25 items
including 4 items related to personal data. The subject population comprised of 46 local,
foreign commercial banks and DFIs. Of the total population, a sample of 23 elements was
drawn based on judgment sampling.
SURVEY FINDINGS:
All the financial institutions have an Asset Liability Committee (ALCO).
About 74% of ALCOs are headed by their chief executives.
Most of the institutions ALCO has about 5 to 10 members (83%).
About 57% of the incumbents obtained occasional training while 39% received no
training about ALM. No doubt that the members of ALCO are professional but
there should be workshop/seminars on the latest research in the field to
disseminate the knowledge among the senior officials to get the anticipated
results.
The ALCO status is executive in about 78% of the institutions.
Both gap and duration techniques are used in about 78% of the institutions.
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In the opinion of 35% of the respondent institutions there are no specific
guidelines regarding ALM issued by the State Bank of Pakistan except that of
Prudential Regulations.
Seven hypotheses were developed and tested. The summarized results are presented
below:
a) Hypothesis No. 1.0
The hypothesis relating to respondents opinions of no-significant difference on
different ALM techniques was rejected.
b) Hypothesis No. 2.0
The hypothesis relating to respondents opinions of no-significant difference on
the prime objectives of ALM was rejected.
c) Hypothesis N0 3.0
The hypothesis relating to respondents opinions regarding the effectiveness of
State Bank of Pakistans role (guidance, supervisory and regulatory) in ALM
was rejected.
d) Hypothesis No. 4.0
The hypothesis relating to respondents opinions on the effectiveness of inter-bank market support to Assets-Liabilities mismatches was rejected.
e) Hypothesis No. 5.0
The hypothesis relating to respondents opinions that funding risk can be
managed through ALM was accepted.
f) Hypothesis No. 6.0
The hypothesis relating to respondents opinions that interest risk can be managed
through ALM was accepted.
g) Hypothesis No. 7.0
The hypothesis relating to respondents opinions on the degree of importancegiven by the management to ALM was accepted.
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1.0.0 INTRODUCTION
Asset-Liability Management (ALM) is done to cover the risk of interest rate and
liquidity of financial institutions. Therefore, it is an essential part of strategic
management of financial institutions. ALM addresses two types of interest rate
risks. The first is interest rate movements, which affects interest income. The
second risk results from prepayment options of individual borrowers. In this type
of risk the borrowers have option to renegotiate the rates of loans if rates
declines.1
ALM policies deal with two target variables i.e. interest income and Net Present
Value of assets minus liabilities. Exposure is calculated on the basis ofoutstanding balances of all assets and liabilities except equity at book value. The
banks portfolios could be sensitive to the change in the prevailing interest rate. If
the portfolio contains more loans in which the customers have options to
renegotiate its rates, it would be considered as sensitive portfolio. Insensitive
portfolios on the hand would be least affected with the change in prevailing
interest rate.2
Borrowers can exercise prepayment options to renegotiate fixed rates when rates
move down. Depositors also have options to switch over their demand deposits to
higher interest-earning liabilities when rates increase.3
The mismatch or gap is a pivot of ALM. The difference between assets and
liabilities resulting in a deficit or an excess of funds is called liquidity gap. An
interest rate gap is mismatch between the interest accrued on assets and paid on
liabilities.4
Whenever assets are greater than resources, deficits appear, which require funds
from inter-bank market. When resources are greater than assets, the bank has
excess funds for lending or investing. Both deficits and excesses are liquidity
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gaps. A higher portion of liquid assets (surplus) is an indication that the bank is in
stronger position to meet its short term obligations.5
1.1.0 FOCUS OF THE STUDY
The focus of the study was to ascertain the overall awareness of Asset and
Liability Management (ALM) in commercial banks.
1.2.0 LITERATURE SURVEY
Asset-Liability Management is the ongoing process of formulating,
implementing, monitoring and revising strategies related to asset and liabilities in
an attempt to achieve financial objectives for a given set of risk tolerances and
constraints. 6
1.2.1 OBJECTIVE OF ALM:
The basic objective is to ensure that the banks profitability is not fully exposed to
interest and foreign exchange rate risks and management of liquidity. It is worth
mentioning that a huge part of a typical banks profit derives from net interest
income. Hence it is vital to measure, control and manage the interest and foreign
exchange rate exposure. The exposure arises due to different maturity patterns of
the assets and liabilities, which are re-priced from time to time. These changes in
interest rates affect the cost of liabilities and yield on assets, which accordingly
affect the profitability. Many financial institutions have suffered losses due to
mismanaging the interest and foreign exchange rate risk.7
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1.2.2 ASSET AND LIABILITY MANAGEMENT IN COMMERCIAL BANKS:
Asset and Liability Management in Commercial Banks is managing availability of
requisite funds to support assets of the bank or management of liquidity in the
bank. It requires arranging funds to support assets of the bank, which match the
assets in terms of currencies, amounts, tenors and rates. This aim can be achieved
in close coordination with branches where funds are generated and consumed.
ALM is the function of banks Treasury and Finance Planning Units. Following
are the result oriented functions:
Clarity of vision and practicable planning by the Financial Planning unit.
Effective flow of information between branches and the Treasury.
Market knowledge and professional capability of incumbents in treasury.8
1.2.3 RISK INHERENT IN LIABILITY MANAGEMENT:
Banks used to fund their loan portfolios with mismatched customer deposits.
Deposits with varying maturities were bundled together to fund a loan often
having a tenor longer than the longest maturity of a deposit in the bundle. In past
interest rates were stable and fewer investment options were available to savers.
Thus the banks used to extend loans despite maturity mismatches.
Now the scenario has changed due to growing competition from NBFIs,
Government savings schemes and increased volatility of interest rate. Now the
banks depend on inter-bank markets to manage liquidity and asset-liability
mismatches. 9
a) FUNDING RISK:
When a bank is not able to generate the required funds to meets its due
obligation, it is known as funding risk.10
b) INTEREST RATE RISK:
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Extending loans based on mismatched maturities of loans and deposits results
in interest rate risk. In this context there are two possibilities, short-term loans
funded by long term deposits and vice versa. In case short-term loans are
funded by long term deposits and the management is unable to extend these
loans on their maturity on the existing or high rate due to fall in the interest
rate then the management will face loss in spread currently being earned. In
second scenario long-term loans are funded by short-term deposits and the
management is unable to retain these deposits on their maturity on the existing
or low rate due to increase in the interest rate then the management will also
face loss in spread currently being earned. 11
To offset these risks the banks must develop products based on future interest
rate trend, market liquidity and future money supply position due to
intervention of monetary authority.
1.2.4 DEPOSIT-LOAN MISMATCH:
Deposit-loan mismatch falls into two categories. In type one deposits and loans
are equal in quantum but unequal in terms of maturity periods. These mismatches
are common in banks if this continues for a long period then change in interest
rates would adversely affect the exposed portions.
In second type of mismatches, the loan portfolios are based on bundling together
the un-matched deposits. Subsequently the un-funded portions (gap) of such loans
are funded by rollover of existing deposits or by fresh deposits or by inter-bank
borrowings. Thus in case of non-availability of required deposits/funds on time
will cause funding risk. And generating deposits at higher rates will results in
interest rate risk.12
1.2.5 INTEREST RATE RISK MANAGEMENT:
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Banks are usually exposed to interest rate risk in normal course of business
because deposit tenors do not always match the life of loans granted out of these
deposits. A prudent management of the duration mismatches can secure the banks
against drop in interest income and can make additional profit by taking
advantage of the market interest rates. To achieve this goal the term structure of
interest rates needs to be studied, understood and extrapolated to predict future
rate trend and to identify profit opportunities therein so that strategically planned
contracts can be executed.13
1.2.6 GAP ANALYSIS OF INTEREST RATE RISK:
In Gap analysis assets and liabilities (which are sensitive to interest rate changes)
are grouped together according to their maturity dates. In this process two
different types of Gap are expected.14
a) NEGATIVE GAP:
A negative gap will emerge if a bank has a larger amount of interest-sensitive
liabilities than it has interest-sensitive assets and both maturing at the same
time. The difference between these two amounts refers to net exposure. 15
b) POSITIVE GAP:
A positive gap occurs if the amount of interest-sensitive assets exceeds the
amount of interest-sensitive liabilities and both maturing at the same time.16
1.2.7 MANAGING PERIOD AND RATE MISMATCHES:
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Managing period mismatches or duration gapsis an important technique because
the manipulation of this technique is the key to make profit by taking advantage
of the market rates for various time periods. Term structure of rates should be
studied carefully to get benefit from these period mismatches without
compromising the portfolio safety. Asset Liability Management is a tool that
enables bank management to take business decisions in a more informed
framework with an eye on the risks that the bank is exposed to. ALM is thus a
comprehensive and dynamic framework for measuring, monitoring and managing
the liquidity, interest and exchange rate risks.17
1.2.8 BALANCE SHEETS ITEMS ON THE BASIS OF COST AND EARNINGS:
The best combination of items on banks balance sheet on the basis of cost and
earnings will be one in which:
Non-earning assets i.e. Cash etc. are kept to the minimum
No cost liabilities i.e. Current Deposits, Accrued Expenses & Bills Payable
etc. are maximized in order to fund earning assets
Cost bearing liabilities i.e. Saving Deposits, Short-term Deposits, Term
Deposits & Borrowings from other banks are kept to the minimum
Fixed assets are kept to the minimum so that a large part of the capital funds
are available to fund earning assets
However, pursuing such a policy to the extreme is inadvisable from the funding
risk point of view.18
1.2.9 BALANCE SHEETS ITEMS ON THE BASIS OF VOLATILITY:
The best combination of items on banks balance sheet on the basis ofvolatilitywill be one in which:
Volatile liabilities i.e. Current Deposits, Accrued Expenses & Bills Payable
are kept to the minimum
Stable liabilities i.e. Saving Deposits, Short-term Deposits, Term Deposits &
Borrowings from other banks are maximized in order to fund earning assets
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Fixed assets are kept to the minimum so that better part of the capital funds
are available to fund earning assets
But pursuing such a policy to the extreme is also inadvisable from the profitability
point of view. The actual need is a trade off between the volatility and cost of
liability types.19
1.2.10 CONSEQUENCES OF ACCEPTING HOT DEPOSITS:
Occasions may arise when hotdeposits received in banks. They are called so
because these deposits can be withdrawn at any time. These deposits cannot be
advanced to customers for obvious reasons. They can safely be invested only in
money market. This is a difficult liability to handle due to limitation on their
profitable investment. These deposits can result in losses to the bank if they are
accepted on high rates to please some customers. This situation often comes
across when inter-bank market is flushed with funds so it is difficult for Treasury
to invest them at a high enough rate. Further, reserves will be required to maintain
for these deposits, which may be arranged by borrowing at a premium in the form
of securities. In case reserves are maintained through purchased securities then
funds will be stuck with them after the deposit is withdrawn. If there is sufficientsecurities and neednt to buy or borrow securities for related reserve requirements,
then hot deposits may be accepted. But this will partially offset the cost to the
bank and will cause a loss if these deposits have not been invested at a premium
over their cost. However, it can be prove a source of additional risk free revenue
when the overall liquidity position is tightened. 20
1.2.11 STATUTORY RESERVE REQUIREMENTS:
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The most important responsibility among other primary responsibilities of a
Central Bank is ensuring that Depository institutions under its supervision are
sufficiently liquid at all times to meet deposit withdrawals. Banks lend to each
other in the inter-bank market, which create a large chain of payment obligations.
Hence default on these payment obligations by one bank will result in defaults by
other banks, which can be termed as failure of the whole system. To avoid such a
situation a sizeable portion of bank deposits are held by Central Bank as a reserve
to be released as and when a bank faces substantial deposit withdrawals. 21
1.2.12 LIQUIDITY MANAGEMENT STRATEGY:
Liquidity management can be effected by adopting the following strategies:
1. Deposit base should be well diversified both by maturityand depositor profile
2. Liquidity can be raised through discounting, sale, or repurchase deals in
readily marketable securities portfolio
3. Flexibility in raising funds can be ensured in different market conditions
through an optimum mix of investment in both short and long term securities
4. Forex Swaps, Call borrowings and Re-purchases can help to maintain
liquidity5. Preference should be given in lending to those customers who have lines from
other banks which enable them to repay you by drawing on those lines as and
when needed
6. Encourage timely payments by insertion of suchclauses in loan agreements to
minimize loan repayment defaults22
1.2.13 HEDGE EFFICIENCY:
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Hedging is the process through which financial risk can be managed or reduced.
The risk of interest rate movements can be hedged through various instruments
viz. Forward Rate Agreements, Financial Futures, Options and Interest Rate
Swaps. Hedge Efficiency is the degree to which the exposure is covered.23
1.2.14 HEDGING AND EXPOSURE GUIDELINES:
1. Asset-liability mismatch periods and amounts should be restricted to the
prevailing market volatility
2. Allow period mismatches subject to a very calculated view of future market
liquidity
3. Review regularly asset-liability mismatches by taking immediate corrective
steps if the market turns against
4. Exposures may be restricted to un-drawn lines of credit from other banks to
handle unwinding mismatched positions in case of emergency.24
1.3.0 PROBLEM STATEMENT
How much importance is given to ALM by the commercial banks? What
techniques are employed? What is the prime objective of ALM in their opinion?
To what extent funding and interest risks can be managed through ALM. The
supervisory and regulatory role played by State Bank of Pakistan.
1.4.0 THEORETICAL FRAMEWORK
In order to study the commercial banks behavior towards Asset and Liability
Management (ALM) a bracket of variables was worked out, where the dependent
variable overall awareness was the variable of prime interest. The other
variables
importance given to ALM
techniques employed
inter-bank market support
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prime objective of ALM
funding risk management
interest risk management
supervisory and regulatory role played by State Bank of Pakistan
have been used to measure the dependent variable. The above mentioned
variables were predictors variables (independent variables).
Based on the literature survey and information obtained from focus group,
measures and variables were identified. The relationship of the measures and
variables are depicted below:
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1.5.0 HYPOTHESES
Based on the theoretical framework seven different hypotheses were developedand tested which are presented below:
H1O: There is no significant difference of the respondents opinions on the
importance of different ALM techniques.
H2O: There is no significant difference of the respondents opinions on the
prime objectives of ALM.
ImportanceGiven by
Management to ALM
InterestRisk
Management
Fund RiskManagemen
t
Inter-bankMarket
Support
SBPRole
PrimeObjective of
ALM
ALMTechniques
AssetLiability
Management
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H3O: The effectiveness of State Bank of Pakistans role in ALM is at least 4 onthe rating scale of 5 to 1.
H4O: The degree of support of inter-bank market to Asset-Liability mismatches
is at least 4 on the rating scale of 5 to 1.
H5O: The degree to which funding risk can be managed through ALM is at least4 on the rating scale of 5 to 1.
H6O: The degree to which interest risk can be managed through ALM is at least
4 on the rating scale of 5 to 1.
H7O: The importance given by the management to ALM is at least 4 on the
rating scale of 5 to 1.
2.0.0 METHODOLOGY
The methodology adopted for the subject study is briefly discussed below:
2.1.0 POPULATION AND SAMPLE SIZE:
The population for the subject study is the treasury department of commercial
banks in Karachi. There are forty-six local and foreign commercial banks and
DFIs incorporated in Pakistan. The sample size of the study was 23. The sample
was drawn from DFIs, foreign banks and local commercial banks.
2.2.0 DATA COLLECTION METHOD:
The close-ended questionnaires were handed over to the personnel of treasury
department of four DFIs, five foreign and fourteen local commercial banks in
Karachi. The closed-ended questionnaire containing 25 questions out of which
four were related to personal data and the rest were related to subject study. The
questionnaire comprised of nominal and rating scale. Judgement sample technique
was used for collecting the data.
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2.3.0 SAMPLE CHARACTERISTICS:
The characteristics of the subject respondents are presented in Annexure-I.
2.4.0 VARIABLE AND MEASURES
The questionnaire administered for the study was based on 25 items. Four
questions were related to personal information viz. position held, Age, institution
and Gender. The nominal scale was used for measuring the personal information.
The overall awareness level was measured through six dimensions based on the
rating scale. These dimensions were
importance given to ALM
techniques employed
inter-bank market support
prime objective of ALM
funding risk management
interest risk management
supervisory and regulatory role played by State Bank of Pakistan
The above variables were predictor variables (independent variables). The
variable of the primary interest was overall awareness.
2.5.0 DATA ANALYSIS METHOD
The data were mostly measured through the measure of central tendencies
including mean, mode and median etc. The hypotheses developed were tested
through t-test, simple ANOVA and correlation analysis.
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3.0.0 SURVEY FINDINGS:
The survey findings were analyzed linearly, cross section ally in order to have a
better comprehension and understanding of the relationship between dependent
and independent variable, which are discussed below:
3.1.0 MEASURE OF CENTRAL TENDENCIES:
The data pertaining to the prime objective of ALM was based on rating scale,
therefore, the results were analyzed based on mean, mode and standard deviation
etc. The results are summarized below:
TABLE 1
Measure of Central Tendencies
ManagingLiquidity
Risk
CapitalAdequacy
AchievingTargetIncome
Mean 4.87 4.26 3.87
Standard Error 0.07 0.18 0.19
Median 5.00 4.00 4.00
Mode 5.00 5.00 3.00Standard Deviation 0.34 0.86 0.92
Sample Variance 0.12 0.75 0.85
Kurtosis 3.86 0.51 (1.84)
Skewness (2.35) (1.02) 0.28
Range 1.00 3.00 2.00
Minimum 4.00 2.00 3.00
Maximum 5.00 5.00 5.00
Sum 112.00 98.00 89.00
Count 23.00 23.00 23.00
According to the respondents opinion managing liquidity risk with an average of
4.87 is the prime objective of ALM followed by capital adequacy (4.26) and
achieving target net income (3.87). The standard deviation of respondents
opinions on managing liquidity risk was the least i.e. 0.34 as compared to SD on
other variables i.e. 0.86 and 0.92. This indicates that there is less polarization on
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the respondents opinions on managing liquidity risk as the prime objective of
ALM.
3.2.0 PEARSON CORRELATION:
Pearson correlation matrix was drawn in order to determine the correlation
between the dimensions used to measure the prime objective of ALM. The
summarized results are presented below:
TABLE-2
Pearson Correlation Matrix
Managing
Liquidity RiskCapital
AdequacyAchieving
Target Income
ManagingLiquidity Risk
1.00
CapitalAdequacy
0.27 1.00
AchievingTarget Income
0.37 0.45 1.00
The respondents preferring liquidity risk management as the prime objective of
ALM has a comparatively strong correlation with achieving target net income,
and the least with capital adequacy. The respondents that have rated capital
adequacy, as high, the same appears to have a higher correlation with achieving
target net income. The respondents that have rated achieving target net income
high, have higher correlation with capital adequacy.
3.3.0 QUALITATIVE ANALYSIS:
According to the data obtained through questionnaires each financial
institution has a formal set up of Asset Liability Management which is called
Asset Liability Committee (ALCO). It is a critical strategic decision making
body in banks
About 74% of ALCOs are headed by the CEO of the banks.
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83% ALCOs comprise of five to ten members. A moderate number of
members will be helpful for mutual consensus.
In most of the banks there is no supporting staff attached to ALCO except that
of treasury department or PAs to CEOs.
The ALCOs conducts its meeting every month.
About 57% of the incumbents obtained occasional training while 39%
received no training about ALM. No doubt that the members of ALCO are
professional but there should be workshop/seminars on the latest research in
the field to disseminate the knowledge among the senior officials to get the
anticipated results.
The ALCO status is executive in about 78% of the institutions.
Both gap and duration techniques are used in about 78% of the institutions.
In the opinion of 35% of the respondent institutions there are no specific
guidelines regarding ALM issued by the State Bank of Pakistan except that of
Prudential Regulations.
3.4.0 HYPOTHESIS TESTING:
Seven different hypotheses were developed and tested through t-test and simple
ANOVA. The result and interpretation of the seven developed hypotheses are
described below:
3.4.1 HYPOTHESIS ONE
The respondents opinions on the importance of techniques employed to ALM
were measured. The opinions were sought on the techniques such as gap,
duration, and combination of both. The hypothesis developed in this context is
presented below:
H1O: There is no significant difference of the respondents opinions on the
importance of different ALM techniques.
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H1A: There is significant difference of the respondents opinions on the
importance of different ALM techniques.
Statistical representation:
H1O: 1=2=3.
H1A: 123
Where H1o represents the term null hypothesis, H1A represents the term alternate
hypothesis and 1, 2 & 3 are means of gap, duration and combination of both
respectively.
The above hypothesis was tested through simple ANOVA and the summarized
result is represented below:
TABLE-3
` Simple Anova: ALM techniquesSummary
Groups Count Sum Average Variance
Gap 23.00 105.00 4.57 0.44
Duration 23.00 87.00 3.78 1.63
Both 23.00 90.00 3.91 1.63
ANOVA
Source ofVariation
SS df MS F P-value
F crit
BetweenGroups
8.09 2.00 4.04 3.28 0.04 3.14
WithinGroups
81.39 66.00 1.23
Total
89.48 68.00
At 95% confidence level and (2, 66) degree of freedom, the F-critical value is
3.14 and the F-calculated value is 3.28 which falls in the critical region. Hence the
hypothesis relating to respondents opinions of no-significant difference on
different ALM techniques was rejected.
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According to the respondents opinion gap with an average of 4.57 is the
important technique employed to ALM followed by combination of both (4.91)
and duration (3.78).
3.4.2 HYPOTHESIS TWO
The respondents opinions on the prime objective of ALM were measured. The
opinions were sought on the objectives such as managing liquidity risk, capital
adequacy and achieving net income target. The hypothesis developed in this
context is presented below:
H2O: There is no significant difference of the respondents opinions on theprime objective of ALM.
H2A: There is significant difference of the respondents opinions on the primeobjective of ALM.
.
Statistical representation:
H2O: 1=2=3.
H2A: 123
Where H2o represents the term null hypothesis, H2A represents the term alternate
hypothesis and 1, 2 & 3 are means of Managing Liquidity, Capital Adequacy
and Achieving Target Net Income respectively.
The hypothesis was tested through simple ANOVA and the summarized result is
represented below:
TABLE-4
` Simple Anova: Prime objective of ALM.
SummaryGroups Count Sum Average Variance
ManagingLiquidity
23.00 112.00 4.87 0.12
CapitalAdequacy
23.00 98.00 4.26 0.75
AchieveTarget Income
23.00 89.00 3.87 0.85
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Anova
Source ofVariation
SS Df MS FP-
valueF crit
BetweenGroups 11.68 2.00 5.84 10.24 0.00 3.14
WithinGroups
37.65 66.00 0.57
Total 49.33 68.00
At 95% confidence level and (2, 66) degree of freedom, the F-critical value is
3.14 and the F- calculated value is 10.24 which falls in critical region. Hence the
hypothesis relating to respondents opinions of no-significant difference on the
prime objectives of ALM was rejected.
According to the respondents opinion managing liquidity risk with an average of
4.87 is the prime objective of ALM followed by capital adequacy (4.26) and
achieving target net income (3.87).
3.4.3. HYPOTHESIS THREE
The respondents opinions regarding the effectiveness of State Bank of Pakistans
role (guidance, supervisory and regulatory) in ALM were measured. The
hypothesis developed in this context is presented below:
H3O: The effectiveness of State Bank of Pakistans role in ALM is at least 4 onthe rating scale of 5 to 1.
H3A: The effectiveness of State Bank of Pakistans role in ALM is less than 4
on the rating scale of 5 to 1..
Statistical representation:
H3O: 4
H3A: < 4
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Where H3o represents the term null hypothesis, H3A represents the term alternate
hypothesis and is the mean of effectiveness of State Bank of Pakistans role in
ALM.
The hypothesis was tested through t-test and the summarized result is represented
below:
TABLE-5
`
Role of SBP
Mean 3.04
Confidence level 0.95
Degree of Freedom 22
Critical value -1.72
S.D 1.19
t-value to be tested 4.00
t -calculated value (3.87)
At 95% confidence level and 22 degree of freedom, the critical value of t is
-1.72 and the calculated value of t is -3.87, which falls in the critical region.
Hence the hypothesis, relating to respondents opinions on the effectiveness of
State Bank of Pakistans role (guidance, supervisory and regulatory) in ALM ishigh as 4 on the rating scale 5-1, was rejected.
In the opinion of 35% of the respondent institutions there are no specific
guidelines regarding ALM issued by the State Bank of Pakistan except that of
Prudential Regulations.
3.4.4. HYPOTHESIS FOUR
The respondents opinions on the effectiveness of support of inter-bank market to
Assets-Liabilities mismatches were measured. The hypothesis developed in this
context is presented below:
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H4O: The degree of support of inter-bank market to Assets-Liabilities
mismatches is at least 4 on the rating scale of 5 to 1.
.H4A: The degree of support of inter-bank market to Assets-Liabilities
mismatches is less than 4 on the rating scale of 5 to 1.
. Statistical representation:
H4O: 4
H4A: < 4
Where H4o represents the term null hypothesis, H4Arepresents the term alternate
hypothesis and is the mean of degree of support of inter-bank market to Assets-
Liabilities mismatches
The hypothesis was tested through t-test and the summarized result is represented
below:
TABLE-6
`
Support of inter-bank market to Assets-Liabilities mismatches
Mean 3.52
Confidence level 0.95Degree of Freedom 22
Critical value -1.72
S.D 1.33
t-value to be tested 4.00
t-calculated value -1.75
At 95% confidence level and 22 degree of freedom, the critical value of t is
-1.72 and the calculated value of t is 1.75, which falls in the critical region.
Hence the hypothesis, relating to respondents opinions on the effectiveness of
support of inter-bank market to Assets-Liabilities mismatches is high as 4 on the
rating scale of 5-1, was rejected.
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3.4.5. HYPOTHESIS FIVE
The respondents opinions that funding risk can be managed through ALM were
measured. The hypothesis developed in this context is presented below:
H5O: The degree to which funding risk can be managed through ALM is at least
4 on the rating scale of 5 to 1..
H5A: The degree to which funding risk can be managed through ALM is less
than 4 on the rating scale of 5 to 1..
Statistical representation:
H5O: 4H5A: < 4
Where H5o represents the term null hypothesis, H5A represents the term alternate
hypothesis and is the mean of degree to which the funding risk can be managed
through ALM
The hypothesis was tested through t-test and the summarized result is represented
below:
TABLE-7
` Funding Risk Management through ALM
Mean 4.35
Confidence level 0.95
Degree of Freedom 22
Critical value -1.72
S.D 0.83t-value to be tested 4.00
t- calculated value 2.01
At 95% confidence level and 22 degree of freedom, the critical value of t is
-1.72 and the calculated value of t is 2.01, which falls in the non-critical region.
Hence the hypothesis, relating to respondents opinions on the degree to which
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funding risk can be managed through ALM is at least 4 on the rating scale 5-1,
was accepted.
3.4.6. HYPOTHESIS SIX
The respondents opinions that interest risk can be managed through ALM were
measured. The hypothesis developed in this context is presented below:
H6O: The degree to which interest risk can be managed through ALM is at least
4 on the rating scale of 5 to 1.
.H6A: The degree to which interest risk can be managed through ALM is less
than 4 on the rating scale of 5 to 1.
.
Statistical representation:
H6O: 4
H6A: < 4
Where H6o represents the term null hypothesis, H6A represents the term alternate
hypothesis and is the mean of degree to which the interest risk can be managed
through ALM
The hypothesis was tested through t-test and the summarized result is represented
below:
TABLE-8
` Interest Risk Management through ALM
Mean 4.43
Confidence level 0.95Degree of Freedom 22
Critical value -1.72
S.D 0.79
t-value to be tested 4.00
t-calculated value 2.65
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At 95% confidence level and 22 degree of freedom, the critical value of t is
-1.72 and the calculated value of t is 2.65, which falls in the non-critical region.
Hence the hypothesis, relating to respondents opinions on the degree to which
interest risk can be managed through ALM is at least 4 on the rating scale 5-1,
was accepted.
3.4.7. HYPOTHESIS SEVEN
The respondents opinions on the degree of importance given by the management
to ALM were measured. The hypothesis developed in this context is presented
below:
H7O: The importance given by the management to ALM is at least 4 on therating scale of 5 to 1.
.
H7A: The importance given by the management to ALM is less than 4 on therating scale of 5 to 1.
Statistical representation:
H7O: 4
H7A: < 4
Where H7o represents the term null hypothesis, H7A represents the term alternate
hypothesis and is the mean of degree of importance given by the management
to ALM.
The hypothesis was tested through t-test and the summarized result is represented
below:
TABLE-9
` Importance given by the Management to ALM.Mean 4.78
Confidence level 0.95
Degree of Freedom 22
Critical value -1.72
S.D 0.52
t-value to be tested 4.00
t-calculated value 7.24
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At 95% confidence level and 22 degree of freedom, the critical value of t is
-1.72 and the calculated value of t is 7.24, which falls in the non-critical region.
Hence the hypothesis, relating to respondents opinions on the degree of
importance given by the management to ALM is at least 4 on the rating scale 5-1,
was accepted.
According to the data obtained through questionnaires each financial institution
has a formal set up of Asset Liability Management which is called Asset Liability
Committee (ALCO). It is a critical strategic decision making body in banks. The
CEO of the banks heads about 74% of ALCOs, which proves that management
gives importance to ALM.
4.0.0 Discussion Conclusion
The major findings and recommendation are discussed below:
4.1.0 Conclusion:
According to the data obtained through questionnaires each financial institution
has a formal set up of Asset Liability Management which is called Asset Liability
Committee (ALCO). It is a critical strategic decision making body in banks.
About 74% of ALCOs are headed by the CEO of the banks. The ALCO status is
executive in about 78% of the institutions. 83% ALCOs comprise of five to ten
members. A moderate number of members will be helpful for mutual consensus.
In most of the banks there is no supporting staff attached to ALCO except that of
treasury department or PAs to CEOs. The ALCO conducts its meeting every
month.
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According to the respondents opinion gap with an average of 4.57 is the
important technique employed to ALM followed by combination of both (4.91)
and duration (3.78). Both gap and duration techniques are used in about 78% of
the institutions.
In the opinion of 35% of the respondent institutions there are no specific
guidelines regarding ALM issued by the State Bank of Pakistan except that of
Prudential Regulations.
According to the respondents opinion managing liquidity risk with an average of
4.87 is the prime objective of ALM followed by capital adequacy (4.26) and
achieving target net income (3.87).
Seven different hypotheses were developed out of which four were rejected and
three were substantiated, the summarized results are presented below:
1.0: The hypothesis relating to respondents opinions of no-significant
difference on different ALM techniques was rejected. At 95% confidence
level and (2, 66) degree of freedom, the F-critical value is 3.14 and the F-
calculated value is 3.28 which falls in the critical region.
2.0: The hypothesis relating to respondents opinions of no-significant
difference on the prime objectives of ALM was rejected. At 95%
confidence level and (2, 66) degree of freedom, the F-critical value is 3.14
and the F- calculated value is 10.24 which falls in critical region.
3.0: The hypothesis, relating to respondents opinions on the effectiveness of
State Bank of Pakistans role (guidance, supervisory and regulatory) in
ALM is high as 4 on the rating scale 5-1, was rejected. At 95% confidence
level and 22 degree of freedom, the critical value of t is -1.72 and the
calculated value of t is -3.87, which falls in the critical region.
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4.0: The hypothesis, relating to respondents opinions on the effectiveness of
support of inter-bank market to Assets-Liabilities mismatches is high as 4
on the rating scale of 5-1, was rejected. At 95% confidence level and 22
degree of freedom, the critical value of t is -1.72 and the calculated value
of t is1.75, which falls in the critical region.
5.0: The hypothesis, relating to respondents opinions on the degree to which
funding risk can be managed through ALM is at least 4 on the rating scale
5-1, was accepted. At 95% confidence level and 22 degree of freedom, the
critical value of t is -1.72 and the calculated value of t is 2.01, which
falls in the non-critical region.
6.0: The hypothesis, relating to respondents opinions on the degree to which
interest risk can be managed through ALM is at least 4 on the rating scale
5-1, was accepted. At 95% confidence level and 22 degree of freedom, the
critical value of t is -1.72 and the calculated value of t is 2.65, which
falls in the non-critical region.
7.0: The hypothesis, relating to respondents opinions on the degree of
importance given by the management to ALM is at least 4 on the rating
scale 5-1, was accepted. At 95% confidence level and 22 degree of
freedom, the critical value of t is -1.72 and the calculated value of t is
7.24, which falls in the non-critical region.
4.2.0 Recommendation:
About 57% of the incumbents obtained occasional training while 39% received no
training about ALM. No doubt that the members of ALCO are professional but
there should be workshop/seminars on the latest research in the field to
disseminate the knowledge among the senior officials to get the anticipated
results. Banks should make efforts to educate their branch managers and other
relevant staff on the need for ALM and the implications of business decisions on
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the risk profile of the bank. A clear communication of the benefits of risk
management would be the first step towards inculcating an organization-wide risk
culture.
The CEO of the banks heads about 74% of ALCOs. Since the Asset Liability
Committee (ALCO) is a critical strategic decision making body it has to be
headed by the CEO of the bank. The ALCO status is executive in about 78% of
the institutions. Keeping in view the strategic position of ALCO the decisions
emanating from it must be complied with. 83% ALCOs comprise of five to ten
members. A moderate number of members will be helpful for mutual consensus.
In most of the banks there is no supporting staff attached to ALCO except that oftreasury department or PAs to CEOs. There should be a separate supporting unit
to assist the committee exclusively and to ensures timely two-way flow of
information from various departments to the ALM desk, as well as reverse
dissemination of information on the business decisions taken by the ALCO to the
relevant line functions. The ALCO conducts its meeting every month. The
committee should meet at fortnightly basis to have a fair grip of the affairs of
asset liability management.
In the opinion of 35% of the respondent institutions there are no specific
guidelines regarding ALM issued by the State Bank of Pakistan except that of
Prudential Regulations. The State Bank of Pakistan has to ensure that in its drive
for profitability and market share, the banking sector does not expose itself to
high levels of risk. Credit risk traditionally has been and still is the biggest risk
faced by this sector and has to be addressed through various regulations and
guidelines from time to time. The recent bank collapse of Mehran Bank Ltd. and
the losses suffered by Bankers Equity Ltd. demonstrate the importance of assets
and liabilities management. The State Bank should make qualitative judgements
whether ALCOs have satisfied their responsibilities in a prudent manner. A
mechanism needs to be built in so as to enable constant monitoring by the State
Bank of the risk parameters and adherence to regulations. The frequency of
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monitoring the risks would be determined keeping in view the availability of data,
volatility of interest and exchange rates and the pace of change of the risk profile
of the banks balance sheet. It is also the State Banks responsibility to ensure that
the bank puts in place software and management systems and expertise to
regularly monitor and report these risks.
The increasing volatility in interest rates as well as foreign exchange rates
together with competition for business on the asset and liabilities sides is a
challenge for the management of banks and financial institutions to up hold
spreads profitability and long term viability. These challenges need to be
addressed not on transitional basis but on permanent footing.
ANNEXURE-I
(POSITION HELD)
Position Frequency Percentage
Top 10 43.48
Middle 12 52.17
Lower 1 4.35
23 100
(Age Group)
Age Group Frequency Percentage
Below 25 0 0.00
25 - 35 9 39.13
36 - 45 9 39.13
46 - 55 2 8.70
55 Plus 3 13.04
23 100.00
100
101 (RANK OF HEAD)
Rank Of Head Frequency Percentage
CEO 17 73.91
SEVP 5 21.74
EVP 1 4.3523 100.00
100 (COMMITTEE MEMBER )
Committee Member Frequency Percentage
Below 5 2 8.70
Between 5-10 19 82.61
Between 10-15 2 8.70
23 100.00
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100 (TRAINING RECEIVED)
Training Received Frequency Percentage
Never 9 39.13
Occasional 13 56.52
Frequently 1 4.35
23 100.00
(STATUS OF ALM)
Status of ALM Frequency Percentage
Advisory 5 21.74
Executive 18 78.26
23 100.00
100 (IMPORTANCE GIVEN BY MANAGEMENT)
Technique Employed Frequency Percentage
Gap 5 21.74
Duration 0 0.00Both 18 78.26
23 100.00
100 (SPREAD )
Spread % Frequency Percentage
1.0 - 2.0 4 17.39
2.1 - 3.0 9 39.13
3.1 - 4.0 10 43.48
23 100.00
100 (SBP GUIDELINE )
SBP GUIDELINE Frequency PercentageYes 15 65.22
No 8 34.78
23 100.00
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ANNEXTURE-II
Assets / Liabilities Management (ALM)Questionnaire
1. Name of Institute ____________________________________________
2. Position Held
1 Top Management 2 Middle Management 3 Lower Management
3. Age Group
1 Below 25 2 Between 25-35 3 Between 36-45
4 Between 46-55 5 55 Plus
4. Gender
1 Male 2 Female
5. Is there any formal setup of assets/liabilities management at your bank?
1 Yes 2 No
6. What is the rank of the head of ALM setup?
1 CEO 2 SEVP 3 EVP
7. How many members comprise ALM Committee?
1 Below 5 2 Between 5-10 3 Between 10-15
8. How many Supporting personnel are deputed to ALM setup?
1 Below 25 2 Between 25-35 3 Between 36-45
9. How frequently the ALM committee conducts its meetings?
1 Monthly 2 Quarterly 3 Half yearly
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-2-
10. Did you receive training programs regarding ALM?
1 Never 2 Occasional 3 Frequently
11. What is the status of ALM setup in your bank?
1 Advisory 2 Executive
12. Rate the importance given to ALM by the management on rating scale of 5 1, as 5being most and 1 being least.
5 4 3 2 1
13. Which technique is employed to ALM analysis?
14. Rate the importance of technique employed to ALM on rating scale 5 1.
Gap 5 4 3 2 1
Duration 5 4 3 2 1
Both 5 4 3 2 1
15. Rate the support of inter-bank market to asset-liabilities mismatch in your
institution on rating scale 5-1.
5 4 3 2 1
16. Rate the prime objective of ALM on rating scale of 5-1.
Managing liquidity risk 5 4 3 2 1
Capital adequacy 5 4 3 2 1
Achieving target net income 5 4 3 2 1
-3-
1 Gap 2 Duration 3 Both
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17. To what extent funding risk can be managed through ALM, use rating Scale 5 1.
5 4 3 2 1
18. To what extent interest rate risk can be managed through ALM, use rating Scale 51.
5 4 3 2 1
19. What is the percentage gap between market rate of assets and liabilities on your
balance sheet? ___________%
20. Your banks ALM policy is:
1 Proactive 2 Reactive
21. Does your bank adhere to the policies and procedures of ALM?
1 Yes 2 No
22. Has SBP provided any guidelines regarding ALM?
1 Yes 2 No
23. Rate the extent to which SBPs guidelines regarding ALM (if any) satisfy yourrequirements on rating scale 5 1.
5 4 3 2 1
24. Rate the supervisory role played by SBP in assets and liabilities management on
rating scale 51
5 4 3 2 1
25. Rate the regulatory role played by SBP in assets and liabilities management on
rating scale 51.
5 4 3 2 1
ENDNOTES
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1. Joel Bessis, Risk Management Banking, 2nd Edition, John Wiley & Sons, England.
2. Survey on Asset Liability Management Practices of Canadian Insurance Companies,
March 2001, Canadian Institute of Actuaries, Ottawa.
3. A.V. Rajwade, International Banking and Asset Liability Management, The Journalof The Indian Institute of Bankers, India.
4. Dr. Maximillian J. B. Hall, Liability Management in Commercial Banks.
5. Strategic Financial Management by British Professional Publication for ACCA.
6. Dr. Maximillian J. B. Hall, Liability Management in Commercial Banks.
7. Strategic Financial Management by British Professional Publication for ACCA.
8. Dr. Maximillian J. B. Hall, Liability Management in Commercial Banks.