Study of asset liability management in Indian banks.

Introduction
Asset Liability Management (ALM) defines management of all assets and liabilities (both off and on balance sheet items) of a bank. It requires assessment of various types of risks and altering the asset liability portfolio to manage risk. Till the early !!"s# the $%I did the real banking business and commercial banks &ere mere e'ecutors of &hat $%I decided. %ut no&# %I( is standardi)ing the practices of banks across the globe and India is part of this process. The success of ALM# $isk Management and %asel Accord introduced by %I( depends on the efficiency of the management of assets and liabilities. *ence these days &ithout proper management of assets and liabilities# the survival is at stake. A bank+s liabilities include deposits# borro&ings and capital. ,n the other side pf the balance sheets are assets &hich are loans of various types &hich banks make to the customer for various purposes. To vie& the t&o sides of banks+ balance sheet as completely integrated units has an intuitive appeal. %ut the nature# profitability and risk of constituents of both sides should be similar. The structure of banks+. balance sheet has direct implications on profitability of banks especially in terms of -et Interest Margin (-IM). (o it is absolute necessary to maintain compatible asset.liability structure to maintain liquidity# improve profitability and manage risk under acceptable limits.

ALM MODELS

Analytical models are very important for ALM analysis and scientific decision making. The basic models are/ . 0A1 Analysis Model 2. 3uration 0A1 Analysis Model 4. (cenario Analysis Model 5. 6alue at $isk (6a$) model 7. (tochastic 1rogramming Model Any of these models is being used by banks through their Asset Liability Management 8ommittee (AL8,). The 9'ecutive 3irector and other vital departments+ heads head AL8, in banks. There are minimum four members and ma'imum eight members. It is responsible for $esponsible for (etting business policies and strategies# 1ricing assets and liabilities# Measuring risk# 1eriodic revie&# 3iscussing ne& products and $eporting.

OBJECTIVES OF THE STUDY

Though %asel 8apital Accord and subsequent $%I guidelines have given a structure for ALM in banks# the Indian %anking system has not enforced the guidelines in total. The banks have formed AL8, as per the guidelines: but they rarely meet to take decisions. 1ublic (ector banks are yet to collect ""; of ALM data because of lack of computeri)ation in all branches. <ith this background# this research aims to find out the status of Asset Liability Management across all commercial banks in India &ith the help of multivariate technique of canonical correlation. The discussion paper has follo&ing ob=ectives to e'plore/ To study the 1ortfolio.Matching behavior of Indian %anks in terms of nature and strengths of relationship bet&een Assets and Liability To find out the component of Assets e'plaining variance in Liability and viceversa To study the impact of o&nership over Asset Liability management in %anks To study impact of ALM on the profitability of different bank.groups

METHODOLOGY
The study covers all scheduled commercial banks e'cept the $$%s ($egional $ural %anks). The period of the study &as from !!2 > 2""5. The banks &ere grouped based on o&nership structure. The groups &ere . -ationali)ed %anks e'cept (%I ? Associates ( ! ) 2. (%I and Associates ( @) 4. 1rivate %anks( 4") 5. Aoreign %anks(4B)

RECLASSIFICATION OF ASSETS & LIABILITIES

The assets and liabilities of a %ank are divided into various sub heads. Aor the purpose of the study# the assets &ere regrouped under si' ma=or heads and the liabilities &ere regrouped under four ma=or heads as sho&n in table belo&. This classification is guided by prior information on the liquidity.return profile of assets and the maturity.cost profile of liabilities. The reclassified assets and liabilities covered in the study e'clude Cother assets+ on the asset side and Cother liabilities+ on the liabilities side. This is necessary to deal &ith the problem of singularity > a situation that produces perfect correlation &ithin sets and makes correlation bet&een sets meaningless. The relevant data has been collected from the $%I &ebsite.

CANONICAL CORRELATION ANALYSIS

Multivariate statistical technique# canonical correlation has been used to access the nature and strength of relationship bet&een the assets and liabilities. To e'plore the relationship bet&een assets and liabilities# &e could merely compute the correlation bet&een each set of assets and each set of liabilities. Dnfortunately# all of these correlations assess the same hypothesis . that assets influence liabilities. *ence# a %onferroni ad=ustment needs to be applied. That is# &e should divide the level of significance by the number of correlations. This %onferroni ad=ustment# of course# reduces the po&er of each correlation and thus can obscure the findings. 8anonical correlation provides a means to e'plore all of the correlations concurrently andthus obviates the need to incorporate a %onferroni ad=ustment. The technique reduces the relationship into a fe& significant relationships.The essence of canonical correlation Measures the strength of relationship bet&een t&o sets of variables (Assets (6) & Liabilities (4) in this case) by establishing linear combination of variables in one set and a linear combinations of variables in other set. It produces an output that sho&s the strength of relationship bet&een t&o variates as &ell as individual variables accounting for variance in other set . A E A F (Liquid Assets) G A2 F ((L$ (ecurities)G A4 F (Investments) G A5 F (Term Loans) G A7 F ((hort Term Loans) G AB F (Ai'ed Assets) % E % F (-et <orth) G %2F (%orro&ings) G %4 F((hort Term 3eposits) G %5 F (Long Term 3eposits) To begin &ith# A and % (called canonicalvariates) are unkno&n. The technique tries to compute the values of Ai and %i such that the covariance bet&een A ? % is ma'imum.

Foreign Banks R square Canonical Loadings Assets LA SLR INV TL STL FA Liabilities NW BOR STD LTD Redundancy Asset Li !i"it# 0.948

Pvt Banks 0.997

Nationalised Banks 0.987

SBI & Associates 0.998

0.243 0.078 0.314 -0.469 0.268 -0.903 -0.664 0.171 0.498 -0.255 0.212 0.196

0.716 0.712 -0.467 -0.464 0.461 -0.945 -0.948 -0.523 0.972 -0.201 0.426 0.539

-0.046 -0.328 -0.662 0.188 0.747 -0.728 -0.885 0.593 0.126 0.007 0.279 0.288

0.237 0.744 0.858 0.568 -0.88 0.644 0.831 -0.83 -0.457 0.964 0.476 0.629

The first ro& (R2) is a measure of the significance of the correlation. In this case all the correlations are significant. The canonical loading is a measure of the strength of the association i.e. it is the percent of variance linearly shared by an original variable &ith one of the canonical variates. A loading greater that 5"; is assumed to be significant. A negative loading indicates an inverse relationship. Aor e'ample# for Aoreign %anks# Ai'ed Assets (AA) under Assets has a loading of .".!"4 and -et <orth (-<) under liabilities has a loading of .".BB5. (ince both are negative this means there is a strong correlation bet&een AA and -<. (imilarly for Aoreign %anks# &e can observe that there is a strong negative correlation bet&eenshort term deposit &ith both Term Loan and Ai'ed Asset.

OBSERVATIONS
As per the summary table above# the canonical co.relation coefficients of different set of banks indicate that different banks have different degree of association among constituents of assets and liabilities. %ank.0roups can be arranged in decreasing order of correlation/ $ (%I ? Associates $ 1rivate %anks $ -ationali)ed %anks $ Aoreign %anks $edundancy factors indicate ho& redundant oneset of variables is# given the other set of variable &hich gives an idea about independent anddependent sets. This also gives an idea aboutthe fact that &hether the bank is assetmanaged or liability managed. Looking at the redundancy factors# the independent and dependent sets for different bank. groups can beidentified/

,ther than foreign bank groups# all other three have asset as their independent set. This means during the study period ( !!2.2""5)# these banks &ere actively managing assets and liability &as dependent upon ho& &ell the assets are managed. This is in perfect consonance &ith the macro indicators. The interest rates &ere coming do&n all these years and banks &ere busy in parking their assets in different avenues &here they could get ma'imum return. Lately# the scenario has changed in terms of interest rates. -o& as there is ample liquidity in the market# banks especially the bigger one is not concerned about the liability. They can al&ays borro& from active money market to manage their liability.

For i!n B"n#$

The canonical function coefficient or the canonical weight of different constituents in case of foreign banks Term Loans and Ai'ed Assets form asset side and -et <orth and (hort Term 3eposit from liability side have significant presence &ith follo&ing interpretation/ 6ery strong co.relation bet&een Ai'ed Assetand -et <orth. (trong negative correlation bet&een short term deposit &ith both Term Loan and Ai'ed Asset. This indicates. 1roper usage of short term deposit. -ot used for long term assets or long term loans.

%ri&"t B"n#$
In case of private banks all constituents of asset side Liquid Assets# (L$ (ecurities# (hort Term Loans# Investments# Term Loans# and Ai'ed Asset are

significantly e'plaining the co.relation &hile on liability side only -et <orth and (hort Term 3eposit are contributing. This sho&s ho& actively these banks manage their asset to generate ma'imum return. This relationship can be interpreted in the follo&ing &ays/ 6ery strong co.relation bet&een AA and -<. (hort Term 3eposits is used for Liquid Assets# (L$ and (hort Term Loans. As defined above LA# (L$ and (TL > all are highly liquid section of assets. (o it is very prudent to employ short term deposit. %orro&ings are used for Investment and Term Loans. As defined# borro&ings are near maturity liability &hile investment and term loans are of long term maturity. (o the private banks are using risky strategy of deploying short term fund in long term investment &hich is clearly against right asset.liability management. Dnder normal circumstances long term investment gives better returns# so this strategy is to generate additional profitability at the cost of liquidity. *o&ever as the money market has become more matured# it is easy to manage liquidity &ithout much of risk.

N"tion"'i( d B"n#$
In case of nationali)ed banks Investment# short term loan# fi'ed asset contribute significantly in e'plaining asset part &hile net &orth and borro&ings constituent of liability is ma=or factor. The ma=or interpretations are/

 6ery strong co.relation bet&een AA and -<. -ationali)ed banks use %orro&ings for (hort Term Loans. There is negative co.relation bet&een %orro&ings and investment. More concerned &ith liquidity than profitability 8onservative strategy ( in comparison to1rivate %anks) 0ood short term maturityHliquidity management -ationali)ed banks use a borro&ing (&hich is near term maturity) for short term a loan &hich is effective &ay of ALM. *o&ever nationali)ed banks deploy long term liability in short term assets. This is distinctly different from private banks strategy. The nationali)ed banks are more concerned about liquidity than profitability.

SBI & A$$oci"t $

Aor (%I group all constituents of Liability namely -et &orth# borro&ings# short term deposits and long term deposits are significant &hile in assets side (L$ investment# Investments# Term loans and fi'ed assets are significant. Aollo&ing can be interpreted/ 6ery strong correlation bet&een AA and -< (trong correlation bet&een %orro&ings and (TL.

 8orrelation bet&een Long term 3eposits and CTerm Loans# Investment and (L$+. (hort Term 3eposits and (hort Term Liabilities are correlated. Most 8onservative strategy ,ver concerned &ith liquidity Dse Long term funds for Long as &ell as medium ? short term loans Among all bank.groups# (%I ? Associates seem to be most prudent asset liability management as short term liability is matched &ith short term asset and long term assets is matched &ith long term liability. %ut at the same time# this group deploy long term fund for medium and short term loans. This can be called over concerned &ith liquidity and that too by paying a price in terms of less profitability by foregoing the opportunity to deploy them in long term assets.

%ROFITABILITY ANALYSIS OF BAN)S

As discussed above# private banks are more aggressive in managing their portfolio for better profit reali)ation. (o let us look into the profitability of these banks and relate that to their ALM. Aor this all banks are divided into t&o groups. 1ublic and 1rivate. -ationali)ed along &ith (%I are clubbed together as public banks &hile foreign and private banks are clubbed together as private banks. The profit figures can be compared in terms of -et 1rofit Margin# $eturn on -et <orth and 9quity Multiplier. Aollo&ing graph depicts the comparison The above comparison sho&s that till 2""2# private banks &ere better in terms of profitability indicators. The aggressive strategy adopted by them in terms of deploying asset for long term is being reflected in the better profitability as compared to public

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