Asset Liability Management
Live Interactive Learning Session- 30-11-2005
Presentation by S P Dhal, Faculty Member, SPBT College
Components of a Bank Balance sheet
1. 2. 3. 4. 5. Capital Reserve & Surplus Deposits Borrowings Other Liabilities
1. Cash & Balances with RBI 2. Bal. With Banks & Money at Call and Short Notices 3. Investments 4. Advances 5. Fixed Assets 6. Other Assets
Components of Liabilities
Capital represents owner’s 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.
Components of Liabilities
2. Reserves & Surplus
Components under this head includes:
I. II. III. IV. V. Statutory Reserves Capital Reserves Investment Fluctuation Reserve Revenue and Other Reserves Balance in Profit and Loss Account
Deposits This is the main source of bank’s funds. Term Deposits
. The deposits are classified as deposits payable on ‘demand’ and ‘time’. Savings Bank Deposits III. They are reflected in balance sheet as under: I.Components of Liabilities
3. Demand Deposits II.
Components of Liabilities
4. Inter-bank & other institutions) I. Borrowings (Borrowings include Refinance / Borrowings from RBI. Borrowings in India i) Reserve Bank of India ii) Other Banks iii) Other Institutions & Agencies II. Borrowings outside India
Bills Payable Inter Office Adjustments (Net) Interest Accrued Unsecured Redeemable Bonds (Subordinated Debt for Tier-II Capital) Others(including provisions)
. II. IV. Other Liabilities & Provisions
It is grouped as under:
I. III. V.Components of Liabilities
Components of Assets
1. 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
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. BALANCES WITH BANKS AND MONEY AT CALL & SHORT NOTICE
I.Components of Assets
2. Outside India a) In Current Accounts b) In Other Deposit Accounts c) Money at Call & Short Notice
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 . Reflected under 6 buckets as under: I.Components of Assets
3. Investments outside India in ** Subsidiaries and/or Associates abroad
. COD & Mutual Fund Units etc. Commercial Papers.) II. Investments
A major asset item in the bank’s balance sheet.
A. Particulars of Advances : i) Secured by tangible assets (including advances against Book Debts) ii) Covered by Bank/ Government Guarantees iii) Unsecured
The most important assets for a bank. Overdrafts & Loans repayable on demand iii) Term Loans B.Components of Assets
4. i) Bills Purchased and Discounted ii) Cash Credits.
Interest accrued Tax paid in advance/tax deducted at source (Net of Provisions) Stationery and Stamps Non-banking assets acquired in satisfaction of claims Deferred Tax Asset (Net) Others
. VI. V.Components of Assets
5. II. III. IV. Other Assets
I. II. Premises Other Fixed Assets (Including furniture and fixtures)
6. Fixed Asset
Guarantees. Acceptances on behalf of constituents and Bills accepted by the bank are reflected under this heads.
Bank’s obligations under LCs.
Banks Profit & Loss Account
A bank’s profit & Loss Account has the following components: Income: This includes Interest Income and Other Income.
I. Expenses: This includes Interest Expended.
. Operating Expenses and Provisions & contingencies.
Interest/Discount on Advances / Bills Income on Investments Interest on balances with Reserve Bank of India and other inter-bank funds Others
IV.Components of Income
1. INTEREST EARNED
. III. II.
Components of Income
2. Exchange and Brokerage Profit on sale of Investments (Net) Profit/(Loss) on Revaluation of Investments Profit on sale of land. OTHER INCOME
I. II. III.
V. VI. from subsidiaries and Associates abroad/in India Miscellaneous Income
. VII. buildings and other assets (Net) Profit on exchange transactions (Net) Income earned by way of dividends etc. IV.
II. INTEREST EXPENDED
I. Interest on Deposits Interest on Reserve Bank of India / Inter-Bank borrowings Others
.Components of Expenses
Telegrams.Components of Expenses
2. X. III. Taxes and Lighting Printing and Stationery Advertisement and Publicity Depreciation on Bank's property Directors' Fees. VI. VIII. IV. II. VII. OPERATING EXPENSES
I. XI. IX. Telephones etc. Allowances and Expenses Auditors' Fees and Expenses (including Branch Auditors) Law Charges Postages. V. Payments to and Provisions for employees Rent. Repairs and Maintenance Insurance Other Expenditure
Organizing & Controlling of Assets & Liabilities. maturities.Assets Liability Management
It is a dynamic process of Planning. mixes.their volumes. yields and costs in order to maintain liquidity and NII.
Significance of ALM
• • • • Volatility Product Innovations & Complexities Regulatory Environment Management Recognition
Net Interest Income (NII) Net Interest Margin (NIM) Economic Equity Ratio
. The parameters for stabilizing ALM system are: 1. It is aimed to stabilize short-term profits. maturity. rate sensitivity. 2.Purpose & Objective of ALM
An effective Asset Liability Management Technique aims to manage the volume. mix. long-term earnings and long-term substance of the bank. quality and liquidity of assets and liabilities as a whole so as to attain a predetermined acceptable risk/reward ration. 3.
• Issued draft guidelines on 10th Sept’98.04. 31.e. • Disclosure to Balance Sheet on maturity pattern on Deposits.
• Final guidelines issued on 10th implementation of ALM w.99. 01.04. • Initially Gap Analysis to be applied in the first stage of implementation. 100% from 01.01
.03. Investment & Advances w.e. Borrowings.f.2000.
• To begin with 60% of asset &liabilities will be covered.f.
Bank’s liquidity management is the process of generating funds to meet contractual or relationship obligations at reasonable prices at all times. existing commitments. and deposit withdrawals are the basic contractual or relationship obligations that a bank must meet. New loan demands.
d.Adequacy of liquidity position for a bank
a. f. e. c. Analysis of following factors throw light on a bank’s 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 Present and planned capital position
. b. g. h.
c. b. d.Funding Avenues
To satisfy funding needs. e.
. 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 Increase Capital funds
systemic or instrument specific. regional. • Internal liquidity risk relates largely to perceptions of an institution in its various markets: local.Types of Liquidity Risk
• Liquidity Exposure can stem from both internally and externally. national or international
. • External liquidity risks can be geographic.
Other categories of liquidity risk
• Funding Risk .Crystallization of contingent liability
.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 .
Over 5 years
.Statement of Structural Liquidity
All Assets & Liabilities to be reported as per their maturity profile into 8 maturity Buckets:
i. 29 days and up to 3 months iv. Over 6 months and up to 1 year
vi. Over 3 months and up to 6 months v. 1 to 14 days ii. Over 3 years and up to 5 years viii. Over 1 year and up to 3 years
vii. 15 to 28 days iii.
.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.
1Year .67 -7.18 -4.69
200 200 450 200 1050 900 100 50 100 200 1350 300 0
28.64 6.6 Mths .29 -15.An Example of Structural Liquidity Statement
15-28 1-14Days Days 30 Days.3 Mths .3 3 Years .76 -13.floating
200 600 600 300 200 350 450 500 450 450 0 550 1050 1100 750 650 250 250 300 100 350 0 100 150 50 100 200 150 150 150 50 200 500 350 500 100 0 0 0 0 0 650 1000 950 800 600 100 -50 -150 50 -50 -100 -150 -300 -250 -300
Capital Liab-fixed Int Liab-floating Int Others Total outflow Investments Loans-fixed Int Loans .57
200 2600 3400 300 6500 2500 600 1100 2000 300 6500 0 0
.Over 5 3 Month 6 Mths 1Year Years 5 Years Years Total
300 200 350 400 50 50 700 650 200 150 50 50 200 150 Loans BPLR Linked 100 150 Others 50 50 Total Inflow 600 550 Gap -100 -100 Cumulative Gap -100 -200 Gap % to Total Outflow -14.
• In case of +ve mismatch. excess liquidity can be deployed in money market instruments. and Negative Mismatch M.A. • For –ve mismatch.L.it can be financed from market borrowings (Call/Term).A. Bills rediscounting.
.>M. creating new assets & investment swaps etc.ADDRESSING THE MISMATCHES
• Mismatches can be positive or negative
• Positive Mismatch: M. Repos & deployment of foreign currency converted into rupee.>M.L.
• To meet the mismatch in any maturity bucket. • 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. the bank has to look into taking deposit and invest it suitably so as to mature in time bucket with negative mismatch.
Loans & Advances a.72 100 22. Investment a. Over 3 yrs to 5 yrs d.Maturity Pattern of Select Assets & Liabilities of A Bank Liability/Assets Rupees (In Cr) In Percentage
I. Up to 1 year b. Over 1 yr to 3 yrs c.00 0.63 44.08 1.51 1. Deposits a. Up to 1 year b.55 22. Over 3 yrs to 5 yrs d.52 56. Over 5 years II. Over 1 yr to 3 yrs c.90
.64 34. Over 1 yr to 3 yrs c. Over 5 years
15200 8000 6700 230 270 450 180 00 150 120 8800 3400 3000 400 2000 5800 1300 300 900 3300
100 52. Borrowings a.33 26.00 33. Up to 1 year b. Up to 1 year b.67 100 38.09 4.41 5. Over 3 yrs to 5 yrs d. Over 5 years Iv. Over 5 years III.17 15. Over 1 yr to 3 yrs c.78 100 40. Over 3 yrs to 5 yrs d.
STATEMENT OF INTEREST RATE SENSITIVITY
• Generated by grouping RSA.RSL & OFFBalance sheet items in to various (8)time buckets.
RSA: • MONEY AT CALL • ADVANCES ( BPLR LINKED ) • INVESTMENT RSL • 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
economic forecasting. Insight into the banking operations. credit. investment. computerization. Method of reporting data from Branches/ other Departments.SUCCESS OF ALM IN BANKS : PRE . Computerization-Full computerization. 5.CONDITIONS
1. networking. Linking up ALM to future Risk Management Strategies. 3. 4. (Strong MIS). 2.
. Awareness for ALM in the Bank staff at all levels–supportive Management & dedicated Teams.
Interest Rate Risk Management
• Interest Rate risk is the exposure of a bank’s financial conditions to adverse movements of interest rates. excessive interest rate risk can pose a significant threat to a bank’s earnings and capital base. liabilities and off-balance-sheet item. • Changes in interest rates also affect the underlying value of the bank’s assets.
. • Though this is normal part of banking business.
Interest Rate Risk
• Interest rate risk refers to volatility in Net Interest Income (NII) or variations in Net Interest Margin(NIM). an effective risk management process that maintains interest rate risk within prudent levels is essential to safety and soundness of the bank. • Therefore.
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
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. an decrease in market interest rates could cause a decline in NII. .conversely. an increase in market interest rates could cause a decline in NII. .If a negative gap occurs (RSA<RSL) in given time band.
. a positive gap (RSA>RSL) in a given time band.Measurement of Interest Rate Risk
• Gap Analysis.
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.