CAIIB-RISK

MANAGEMENTASSET LIABILITY
MANAGEMENT
MODULE A
G.R.RAO, Faculty, IIBF

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BANKING BUSINESS ON
26.09.2008
figures in crores
DEMAND DEPOSITS 4,96,673
TERM DEPOSITS
29,45,465

34,42,138

LOANS, CC,OD
BILL FINANCE

25,42,467

24,36,890
1,05,577

CASH : DEPOSIT RATIO = 9.91

CREDT: DEPOSIT RATIO =73.86
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BANKING BUSINESS Contd...

CRR : 9
S L R : 25
TOTAL 34
HOW BANKS MANAGE
CREDIT & CASH TOTALLING 83.77 %
OF DEPOSITS
BORROWING TO DEPOSITS: 11.74 %
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PRESENT DAY PRORITIES

NET PROFIT WHICH IS OPERATING

PROFIT - PROV. & APPROPRIATIONS

OPERATING PROFIT
(OP) =INT. INC. + OTH. INC.
NET.INT. INC.(NII) ALSO CALLED
SPREAD = INT. (EARNED SPENT)
O.P. = (INT. EARNED INT.SPENT)
- OTHER (EXPNS. INC.)
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NII AND NIM

BANKS WILL BE INTERESTED IN NIM

AND WOULD LIKE TO SEE IT GROW

NIM MANAGEMENT IS MAINLY ASSET
AND LIABILITY MANAGEMENT
IT MANAGES ASSETS AND
LIABILITIES TO IMPROVE NIM UNDER
A GIVEN RISK FRAME WORK

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ASSET LIABILITY MANAGEMENT

ENSURE ACCEPTABLE NII / NIM AND

LONG TERM IMPROVEMENT IN NET

WORTH FOR A GIVEN RISK LEVEL
INCLUDES PLANNING, ACQUIRING AND
DEPLOYING FUNDS FOR ABOVE
PURPOSE
IT IS ONGOING PROCESS OF
FORMULATING, MONITORING, REVISING
AND FRAMING STRATEGIES RELATED
TO ASSETS AND LIABILITIES
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ALM Contd
ENCOMPASSES MANAGEMENT OF

LIQUIDITY AND INTEREST RISKS

AVOIDS VOLATILITY, HELPS PRODUCT
INNOVATION AND COMPLIANCE OF
REGULATIONS
IN REGULATED ENVIRONMENT IT IS
DAY TO DAY FUND MANAGEMENT
FUNCTION ONLY
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ALM Contd..
FROM BALANCE SHEET ANGLE

RESERVE MAINTENANCE
LIABILITY MANAGEMENT
ASSET MANAGEMENT
INVESTMENT MANAGEMENT
CAPITAL MANAGEMENT
LIQUIDITY MANAGEMENT

FROM P&L

ANGLE
SPREAD MANAGEMENT

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ALM- FUNDS MANAGEMENT

INCOME ON FUNDS LENT SHOULD

BE MAXIMUM
EXPENSES ON FUNDS BORROWED
SHOULD BE REASONABLE
ENNSURING FUND AVAILABILITY IS
LIQUIDTY MANAGEMENT
AT REASONABLE COST IS INT. MGMT

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LIQUIDITY MANAGEMENT
TO ENSURE SUPPLY OF NEEDED

FUNDS FOR

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EXISTING BUSINESS AND NEW

BUSINESS
TAKE CARE OF MIS-MATACHES IN
MATURITIES OF ASSETS & LIABILITIES
PROJECTS FINANCIAL STRENGTH TO
SOCIETY AND BANKING SYSTEM WHICH
IN TURN ENABLES EASY AVAILABILITY
OF FUNDS AT REASONABLE COST
10

HOW LIQUIDITY GETS AFFECTED

DUE TO REGULATORY CHANGES
DUE MARKET CHANGES BOTH

EXISTING AND POTENTIAL

DUE TO CUSTOMERS ACTIONS
DUE TO CRYSTALLISATION OF
CONTINGENT LIABILITIES
DUE TO NPAs
BIG FRAUDS
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LIQUIDITY MANAGEMENT
ESTIMATION OF SIZE AND TIME OF

FUND REQUIREMENTS CORRECTLY

PLANNING APPROPRIATELY IN
ADVANCE CONSIDERING COSTS AT
DIFFERENT TIMES
ACQUIRE FUNDS AT OPTIMUM
COSTS

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LIQUIDITY MANAGEMENT
WHY CASH FLOW ESTIMATES CAN

GO WRONG

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DECREASE IN ANTICIPATED
REALISATIONS BOTH PRINCIPAL & INT.
INCREASE IN NPA LEVELS BEYOND
ESTIMATES
SUDDEN SPURT IN ASSET BEYOND
BANKS CONTROL

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LIUQUIDITY MANAGEMENT
TYPES OF RISKS IN LIQUIDITY MGMT
FUNDING RISK
NEED TO PROVIDE FUNDS FOR
UNEXPECTED OUTGOINGS
TIME RISK
NEED FOR COMPENSATING NON REALISED
SOURCES
CALL RISK
CRYSTALLISATION OF CONTINGENCIES

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FOREIGN CURRENCY LIQUIDITY

MANAGEMENT- PROCESS
FINALISE STRATEGY (QUALITY&
QUANTITY) FOR EACH CURRENCY OF
EXPOSURE
STIPULATE LIMITS FOR TOLERANCES REG.

MISMATCHES IN DIFFERENT TIME BANDS

LOAN TO DEPOSIT AND LOAN TO CAPITAL
LIQUID ASSETS TO ST LIAB.

MEASURE, MONITOR AND MANAGE

LIQUIDITY

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LIQUIDITY MANAGEMENT
IDENTIFICATION OF PRIMARY AND

SECONDARY RESOURCES
DIVERSIFICATIONOF RESOURCES
CRISIS SCENARIO STUDIES
CONTINGENCY PLANNING

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DIFFERENT APPROACHES TO
LIQUIDITY MANAGEMENT
STOCK APPROACH & FLOW A PPROACH
IN FLOW APPROACH INFLOWS AND

OUTFLOWS ARE MEASURED FOR

DIFFERENT TIME BUCKETS AND UNDER
DIFFERENT SCENARIOS LIKE
NORMAL TIMES, BANK SPECIFIC CRISIS
AND SYSTEMIC CRISIS AND FUNDING
AVENUES IDENTIFIED
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RBI GUIDELINES
GROUP LIKELY INFLOWS AND

OUTFLOWS INTO DIFFERENT TIME

BUCKETS AND PRESCRIBING MAX
MISMATCH IN NEAR TERM BUCKETS
1 DAY
5%
2-7 DAYS
10%
8-14 DAYS
15%
5-28 DAYS
20%
PERCENTAGES ARE MAX. FOR
RESPECTIVE TIME BUCKET

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INTEREST RISK MANAGEMENT

RISK OF INT. INC. GETTING AFFECTED

DUE TO EXTERNAL FACTORS ONLY

MARKET INTEREST RATES AND
REGULATORY INTEREST RATES
IMPACT WILL BE ON BOTH ADVANCES
AND INVESTMENTS
LIQUIDTY AND INTEREST RISK ARE NOT
EXCLUSIVE
NOT ALL ASSETS OR LIAB. WILL BE
IMPACTED
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INTEREST RISK MANAGEMENT

GAP OR MISMATCH RISK

IT IS RISK DUE TO FUNDING OF

ASSETS WHICH WILL REPRICE IN
DIFFERENT PERIOD FROM THAT OF
LIABILITIES

BASIS RISK

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DUE TO DIFFERENT IMPACT ON

ASSETS AND LIABILITIES IN THE SAME
TIME BUCKET
20

INTEREST RISK Contd

EMBEDDED OPTION RISK

INHERENT RIGHT WITH AN ASSET OR

LIABILITY FOR REPRICING

YIELD CURVE RISK OR RATE LEVEL

RISK

DUE TO CHANGES INITIATED BY

REGULATOR/ MARKET FORCES

VOLATILITY RISK

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SUDDEN VOLATILITIES IN MARKT.

MORE IN CASE OF BORROWED FUNDS
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MEASUREMENT OF INTEREST RISK

GAP METHOD AND ANALYSIS

GROUP RATE SENSITIVE ASSETS AND

LIABILITIES INTO DIFFERENT BUCKETS
STUDY THE IMPACT OF INTEREST CHANGES
BOTH POSITIVE AND NEGATIVE ON THE NIM

DURATION METHOD
MODIFIED DURATION METHOD
SIMULATION APPROACH

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STATIC AND DYNAMIC SIMULATION

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GAP ANALYSIS
GAP IS + VE IF ASSETS > LIABILITIES

NII = GAP * r ( CHANGE IN INT. RATE)

NIM = NII / EARNING ASSETS(EA)
GAP * r = NIM * EA = NIM* EA * C
C IS ACCEPTABLE CHANGE IN NIM
WORKING BACKWARDS YOU CAN
ARRIVE AT THE ACCEPTABLE GAP FOR
AN ACCEPTABLE C
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LIMITATIONS IN GAP METHOD

GAP MAY NOT BE AMENABLE TO

CHANGE TO SUIT DESIRED C

PRESUMES THAT BOTH ASSETS AND
LIAB. WILL BE UNIFORMLY IMPACTED
DOESNOT TAKE INTO ACCOUNT TIME
VALUE OF CASH FLOWS
WHEN THERE IS SIGNIFICANT CHANGE
EVEN THOSE WHICH ARE NOT TO BE
REPRICED WILL BE REPRICED
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ADJUSTED DURATION
IN THIS METHOD ASSETS AND

LIABILITIES ARE GROUPED

DEPENDING UPON THEIR EXTENT OF
LIKELY IMPACT AND NOT INTO TIME
BUCKETS BY ASSIGNING DIFFERENT
WEIGHTS
RATE ADJ. GAP = WAI* AI WLI*LI

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MODIFIED DURATION
MODIFIED DURATION (MD) IS USED TO

STUDY THE CHANGE IN PRICE OF AN

ASSET DUE TO A CHANGE IN INTEREST
RATE
MD = D/ (1+ r) AND
PC = - MD* r / 100
PC IS CHANGE IN PRICE AND r IS
CHANGE IN INTEREST RATE IN BASIS
POINTS AND THIS IS USEFUL ONLY IN
CASE OF SMALL CHNGES IN INTEREST
RATES
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MANAGEMENT OF FOREX RISK

TRANSACTION EXPOSURE

CURRENCY RISK IN SPECIFIC FOREX

TRANSACTION BETWEEN EXECUTION
AND SETTLEMENT

TRANSLATION EXPOSURE

CURRECNY RISK INVOLVED AT THE

TIME OF REPORTING TRANSACTIONS
AT THE END OF ACCOUNTING YEAR TO
H.O.

OPERATING EXPOSURE
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FOREX RISK MGMT. TOOLS

FORWARDS
FUTURES-CURRENCY
OPTIONS
SWAPS
MONEY MARKET INSTRUMENTS

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MONEYMARKETINSTRUMENTS CAN BE
USED LIKE A FORWARD CONTRACT
INMGMT. OF FOREX RISK
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RISK MGMT. IN DEALING ROOM

OPEN POSITION
OVERNIGHT AND DAY LIGHT LIMITS
STOP LOSS LIMITS
CAP ON SIZE OF TRANSACTION

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TWO PRACTICAL PROBLEMS

ON DURATION ANALYSIS
1. ASSETS AND LIABILITIES OF FMG FINANCES
ALONGWITH THEIR DURATION AND INTEREST
RATRES ARE AS PER GIVEN TABLE. IDENTIFY RISK
SENSITIVEGAP AND NIM. DURING AFORECASTING
PERIOD OF 1YEAR IF INTEREST RATES FALL BY 2 %
WHAT WOULD BE IMPLICATION ON NIM
2. ABC BANK HAS EARNING ASSETS AMNOUNTING TO
Rs 1980 CRORES AND THEIR NIM IS 4%.
MANAGEMENTS POLICY SAYS THAT A 2.5%
DEVIATION FROM NIM IS ACCEPTABLE. BANK
FORECASTS THAT INTEREST RATES WOULD
INCREASE BY 0.75% DURING NEXT12 MONTHS.
WHAT SHOULD BE THE GAP OF THE BANK IF THEY
HAVE TO BE WITHIN THE GIVEN RANGE OF NIM
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OBJECTIVE QUESTIONS
1. THE NEED TO REPLACE NET OUTFLOWS
DUE TO UNANTICIPATED WITHDRAWAL OF
DEPOSITS IS KNOWN AS ---------RISK.
2. THE NEED TO COMPENSATE FOR NONRECEIPT OF EXPECTED INFLOWS OF
FUNDS IS CLASSIFIED AS -----RISK.
3. CALL RISK ARISES DUE TO
CRYSTALLISATION OF ------.
4. MATURITY LADDERS ENABLES THE BANK
TO ESTIMATE THE DIFFERENCE
BETWEEN-----AND------IN PREDETERMINED
PERIODS.
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OBJECTIVE QUESTIONS
Q. THE INSTITUTION IS IN A POSITION TO BENEFIT
FROM RISING INTEREST RATES WHEN ASSETS
ARE THAN LIABILITIES.
A. LESSER.
B. GREATER
C. EQUAL
D. HALF.

Q. THE LIQUIDITY RISK ARISING OUT OF

UNANTICIPATED WITHDRAWAL OR NON
RENEWAL OF DEPOSITS IS CALLED AS
A. FUNDING RISK.
B. TIME RISK.
C. MARKET RISK
D. OPERATIONAL RISK.
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OBJECTIVE QUESTIONS
Q.LIQUIDITY RISK ARISING OUT OF CRYSTALLIZATION OF
LIABILITIES AND CONVERSION OF NON FUND BASED
LIMITS TO FUND BASED LIMITS IS KNOWN AS
A. CALL RISK.
B. TIME RISK.
C. OPERATIONAL RISK.
D. MARKET RISK.
Q. STOCK APPROACH OF MEASURING AND MANAGING
LIQUIDITY RISK AND FUNDING REQUIREMENTS IS
BASED ON
A. LEVEL OF ASSETS AND LIABILITIES AND BALANCE
SHEET EXPOSURE ON A PARTICULAR DATE.
B. BASED ON STOCKS PLEDGED TO BANK IN CASH
CREDIT ACCOUNT
C. STOCK OF INVESTMENTS OF BANK.
D. NONE OF ABOVE.
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OBJECTIVE QUESTIONS
Q. UNDER GAP METHOD THE NET FUNDING

REQUIREMENT IS CALCULATED BASED ON

A. RESIDUAL MATURITIES OF ASSETS AND LIABILITIES.
B. ACTUAL MATURITIES OF ASSETS AND LIABILITIES
C. BOTH THE ABOVE.
D. NONE OF ABOVE.

Q. CASH INFLOWS ARISE FROM MAINLY:

A. MATURING ASSETS.
B. MATURING LIABILITIES.
C. MATURING OFF BALANCE SHEET EXPOSURE.
D. MATURING TIME DEPOSITS.
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OBJECTIVES
Q. IF THERE IS SIGNIFICANT DEFICIT OBSERVED SAY AFTER 30
DAYS PERIOD OPTION AVAILABLE FOR BANK IS TO
A. ACQUIRE AN ASSET MATURING ON THAT DAY.
B. RENEW OR ROLL OVER A 30 DAY LIABILITY.
C. ACQUIRE A LIABILITY MATURING AFTER 30 DAYS.
D. NONE OF ABOVE.
Q. PRESENTLY NUMBER OF SUB DIVISIONS IN 1-14 DAYS
TIME BUCKET FOR STRUCTURAL LIQUIDITY ARE
A. FOUR.
B. THREE
C. FIVE .
D. NONE OF ABOVE.

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OBJECTIVES
Q. CAPITAL , RESERVES AND SURPLUS ARE SLOTTED
IN WHICH TIME BUCKET IN STRUCTURAL LIQUIDITY
STATEMENT:
A. OVER 5 YEARS.
B. OVER 3 YEARS.
C. OVER 1 YEAR.
D. OVER 6 MONTHS.

Q. SAVING AND CURRENT DEPOSIT MAY BE TREATED

AS VOLATILE PORTION UPTO
A. 10% AND 15 % RESPECTIVELY.
B.20% AND 30% RESPECTIVELY.
C. 30% AND 40% RESPECTIVELY.
D. NONE OF ABOVE

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OBJECTIVES
Q.

WHAT IS BASIS RISK:

A. RISK THAT INTEREST RATE OF DIFFERENT ASSETS AND

LIABILITIES MAY CHANGE IN DIFFERENT MAGNITUDES IS
CALLED BASIS RISK.
B. RISK RELATING TO BASIS ON WHICH LOAN IS SANCTIONED.
C. RISK RELATED TO YIELD CURVE.
D. NONE OF ABOVE.
Q. ONE OF THE STRATEGIES FOR REDUCING THE ASSET OR
LIABILITY SENSITIVITY COULD BE :
A. INCREASE FLOATING RATE INSTRUMENTS.
B. INCREASE FIXED RATE INSTRUMENTS.
C. NONE OF ABOVE.
D. ALL THE ABOVE.

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OBJECTIVES
Q. HIGHER THE DURATION IMPLIES THAT A GIVEN CHANGE
IN THE LEVEL OF INTEREST RATES WILL HAVE
A. LARGER IMPACT ON ECONOMIC VALUE.
B. SMALLER IMPACT ON ECONOMIC VALUE.
C. NO IMPACT.
D. NONE OF ABOVE.

Q. DURATION WILL BE HIGHER IF

A. LONGER THE MATURITY DATE OR SMALLER THE
PAYMENTS THAT OCCUR BEFORE MATURITY ( COUPON
PAYMENTS)
B. SHORTER THE MATURITY AND HIGHER THE PAYMENTS
THAT OCCUR BEFORE MATURITY ( COUPON PAYMENTS)
C. NONE OF ABOVE.
D. ALL THE ABOVE.

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OBJECTIVES
Q. SHORT TERM DYNAMIC LIQUIDITY STATEMENT RELATE
TO
A. MONITORING LIQUIDITY ON DYNAMIC BASIS OVER A TIME
HORIZON OF 1-90 DAYS.
B. MONITORING LIQUIDITY ON DYNAMIC BASIS OVER A TIME
HORIZON OF 7-90 DAYS.
C. MONITORING LIQUIDITY ON DYNAMIC BASIS OVER A TIME
HORIZON OF 28-90 DAYS.
D. NONE OF ABOVE.
Q. IN STATEMENT OF INTEREST RATE SENSITIVITY :
A. ONLY RUPEE ASSETS AND LIABILITIES AND OFF BALANCE
SHEET POSITIONS SHOULD BE REPORTED.
B. ALL ASSETS AND LIABILITIES SHOULD BE REFLECTED.
C. ONLY FOREIGN CURRENCY ASSETS AND LIABILITIES
SHOULD BE REFLECTED.
D. NONE OF ABOVE.
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THANQ

WISH U ALL SUCCESS IN EXAM

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