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Asset liability management in banks


Sr. No.


Page No.





Earlier Phase


Asset/Liability Management Strategy




Terms of ALM Policy


ALM Models


ALM Organisation


ALM Process


Scope of ALM


Implementation Issues


Guidelines of ALM in Banks


Emerging Issues in Indian Context


Challenges faced by ALM



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Asset liability management in banks






In banking, asset and liability management (often abbreviated ALM) is the practice of
Managing risks that arise due to mismatches between the assets and liabilities
(debts and assets) of the bank. This can also be seen in insurance.
Banks face several risks such as the liquidity risk, interest rate risk, credit risk and
Operational risk. Asset liability management (ALM) is a strategic management tool to
manage interest rate risk and liquidity risk faced by banks, other financial services
companies and corporations.
Banks manage the risks of asset liability mismatch by matching the assets and
liabilities according to the maturity pattern or the matching of the duration, by
hedging and by securitization. Much of the techniques for hedging stem from the
delta hedging concepts introduced in the Black–Scholes model and in the work of
Robert C. Merton and Robert A. Jarrow. The early origins of asset and liability
management date to the high interest rate periods of 1975-6 and the late 1970s and
early 1980s in the United States. Van Deventer, Imai and Mesler (2004), chapter 2,
outline this history in detail.
Modern risk management now takes place from an integrated approach to enterprise
risk management that reflects the fact that interest rate risk, credit risk, market risk,
and liquidity risk are all interrelated. The Jarrow-Turnbull model is an example of a
risk management methodology that integrates default and random interest rates. The
earliest work in this regard was done by Robert C. Merton. Increasing integrated risk
management is done on a full mark to market basis rather than the accounting basis
that was at the heart of the first interest rate sensivity gap and duration calculations.
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Asset liability management in banks


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
1990s, the RBI did the realbanking business and commercial banks were mere
executors of what RBI decided. But now, BIS is standardizing the practices of banks
across the globe and India is part of this process. The success of ALM, Risk
Management and Basel Accord introduced by BIS depends on the efficiency of the
management of assets and liabilities. Hence these days without proper management
of assets and liabilities, the survival is at stake. A bank’s liabilities include deposits,
borrowings and capital. On the other side of the balance sheets are assets which are
loans of various types which banks make to the customer for various purposes. To
view the two sides of banks’ balance sheet as completely integrated units has an
intuitive appeal. But 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 Net Interest Margin (NIM). So it is
absolute necessary to maintain compatible asset-liability structure to maintain
liquidity, improve profitability and manage risk under acceptable limits.

Liquidity management is a provoking idea for the management of the financial
institutions to ponder about and act. But how to act and when to act are the
questions which lead to Assets and Liability Management (ALM), a management tool
to monitor and manage various aspects of risks associated with the balance sheet
management, including the management and balance sheet exposure of the
institutions. In other words, “ALM is an ongoing process of formulating, monitoring,
revising and framing strategies related to assets and liabilities in an attempt to
achieve the financial objective of maximizing interest spread or margins for a
given set of risk level.” It is not only a liquidity management tool, but also a portfolio
Management tool to alter the composition of assets and liability portfolio to manage
the risk by using various risk mitigating measures. Assets/liability management is an
integral part of the planning process of commercial banks. In fact, asset/liability
management may be considered as one of the three principal components of a
planning system. The three components are:
• Asset/liability management which focuses primarily on the day-to-day or week-toweek balance sheet management necessary to achieve short term financial goals.
• Annual profit planning and controls which focus on slightly longer term goals and
look at a detailed financial plan over the course of a fiscal or calendar year.
• Strategic planning which focuses on the long run financial and non financial
aspects of a bank’s performance.

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Asset liability management in banks


In the 1940s and the 1950s, there was an abundance of funds in banks in the form of
demand and savings deposits. Because of the low cost of deposits, banks had to
develop mechanisms by which they could make efficient use of these funds. Hence,
the focus then was mainly on asset management. But as the availability of low cost
funds started to decline, liability management became the focus of bank
management efforts.
The ALM, historically, has evolved from the early practice of managing liquidity on
the bank’s asset side, to a later shift to the liability side and termed liability
management, to a still later realization of using both the assets as well as the
liabilities side of the balance sheet to achieve optimum resources management, i.e.,
an integrated approach. Prior to deregulation, bank funds were
obtained from relatively stable demand deposits and from small time deposits.
Interest rate ceiling limited the extent to which banks could compete for funds.
Opening more branches in order to attract fresh deposits. As a result, most sources
of funds were core deposits which were quite impervious to interest rate movements
in this environment bank fund management concentrate on the control of assets.
he bank’s ability to grow will be hampered if they do not have access to the funds
required to create assets. They have freedom to obtain funds by borrowing from both
the domestic and international markets. As they tap different source of funds, there is
an increased need for liability management and it becomes an important part of their
financial management. With liability management, banks now have two sources of
funds – core deposits and purchased funds – with quite different characteristics. For
core deposits, the volume of funds is relatively insensitive to changes in interest rate
levels.. However core deposits have the disadvantage of not being overly responsive

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Asset liability management in banks


to management needs for expansion. If a bank experiences sizeable increase in loan
demand, it cannot expect the core deposits to increase proportionately. For
purchased funds, however, the bank can obtain all the funds
that it wants if it is willing to pay the market determined price. Unlike core deposits
where the bank determines the price, the interest rates on purchased funds are set
in the national money market. The bank can be thought of as a price taker in the
purchased funds market whereas in the core deposit market it can be viewed as a
price setter. The purchased funds give complete flexibility in terms of the volumes
and timing of the availability of funds. management, the core deposits offer the
advantage of stability.
However core deposits have the disadvantage of not being overly responsive to
management needs for expansion. If a bank experiences sizeable increase in loan
demand, it cannot expect the core deposits to increase proportionately. For
purchased funds, however, the bank can obtain all the funds that it wants if it is
willing to pay the market determined price. Unlike core deposits where the bank
determines the price, the interest rates on purchased funds are set in the national
money market.

The recent volatility of interest rates broadened to include the issue of credit risk and
market risk and to ensure that their risk management capabilities are commensurate
with the risk of their business. The induction of credit risk into the issue of
determining adequacy of bank capital further enlarged the scope of ALM.
.According to policy approach of Basel II in India, to conform to best international
standards and in the process emphasis is on harmonization with the international
best practices. If this were so, the scope and the role of ALM become all the more
enlarged. Incidentally, commercial banks in India will start implementing Basel II with
effect from March 31, 2008 though, as indicated by the governor of the RBI, a
marginal stretching beyond this date can not be ruled out in view of latest indications
of the state of preparedness. In current spell, earning a proper return for the
promoter of equity and maximization of its market value means management of the
balance sheet of the institution.
In other words, this also implies that managements are now expected to target
required profit levels and ensure minimization of risks to acceptable levels, to retain
the interest of the investing community. In today’s competitive environment, if the
organization has to remain in the business, costing and product pricing policies have
to be suitably structured. Thus, with the changing requirement, there is a need for
not only managing the net interest margin of the organization but at the same time
ensuring that liquidity is managed, how much liquid the organization has to be
definitely, worked out on the basis of scenario analysis, but the knowledge to
management, adopt the new system and organizational changes that are called for it
to manage, have to be defined. Thus, the concept of ALM is much wider and is of
greater significance

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Asset liability management in banks 6 COMPONENTS OF BANK’S BALANCE SHEET This assets and liabilities of a Bank are divided into various sub heads. This classification is guided by prior information on the liquidity-return profile of assets and the maturity-cost profile of liabilities. For the purpose of the study. as a percentage of total assets. Contingent Liabilities Bank’s Assets: o o o o o o Cash and Balance with RBI Balance with other banks Investment Advances Fixed assets Other assets BALANCE SHEET MIX ALM policy should establish portfolio limits on the mix of balance sheet liabilities such as deposits and other types of funding. the assets were regrouped under six major heads and the liabilities were regrouped under four major heads as shown in table below. The reclassified assets and liabilities covered in the study exclude ‘other assets’ on the asset side and ‘other liabilities’ on the liabilities side. This is necessary to deal with the problem of singularity – a situation that produces perfect correlation within sets and makes correlation between sets meaningless. K C College . Bank’s Liabilities: o Capital o Reserve and Surplus o o o o Deposits Borrowings Other Liabilities & Pro.

the stakeholders in each line of business are able to appreciate the cost of capital required for respective lines of business and how it is impacting the bottom-line ultimately. Similarly. financial instruments. The management strategy in such banks was thus more biased towards asset management. For such banks the major concern was how to expand the assets securely and profitably. investments) return should be guided by annual planning targets.g. etc. his recommended practice may not be practical for smaller. ALM policy should promote the maximization of earning assets which reward the credit union for its operating risks. lending license constraints and regulatory restrictions on investments.) should be set by policy considering differential levels of risk and return. less complex credit unions which have a limited membership base. The assets of a credit union can be classified into two broad categories: earning assets and non-earning assets. ASSET MANAGEMENT STRATEGY Some banks had the traditional deposit base and were also capable of achieving substantial growth rates in deposits by active deposit mobilization drive using their extensive branch network. prudent portfolio limits on the mix of balance sheet assets (e. loans by credit category. ALM policy should state that an appropriate mix of deposits and other liabilities will be maintained to reflect member expectations and to correlate (by term and pricing) to the mix of assets held. thereby rendering a consistent picture of forecasts across the institution. this Section provides direction on setting policy constraints on the size and types of loans and investments so as to make the best use of available funds maximize financial margin while maintaining an appropriate level of safety. K C College .Asset liability management in banks 7 considering the differential costs and volatility of these types of funds. savings and personal loans) or which do not have sufficient financial resources to effectively promote diversification. The mix of assets (loans. a simple balance sheet without much product diversification (e. Credit was thus the major key decision area and the investment activity was based on maintaining a statutory liquidity ratio or as a function of liquidity management. The integration of planning solutions with the risk and performance management framework is a major milestone in this direction.g. If this is the case. Oracle Financial Services Balance Sheet Planning solution helps fulfill the need for extending ALM income forecasts and Balance Sheet projections into enterprise planning activities. The management in the bank would like to ensure that beyond the capital planning and ALM teams. Earning assets are those assets which generate direct revenues for the credit union.

Liability management also provides a bank with an alternative to asset management K C College . and the bank chooses between these alternatives based on the relative costs and risks involved. a bank will use a variety of liability management instruments to obtain the liquidity needed for daily cash management.e. by buying the funds it needs. Depending on cost and availability. Basically. OBJECTIVES: When a bank needs funds to cover deposit withdrawals or ton expand its loans to acquire other assets. for loan expansion. a bank in need of liquidity may chose to borrow government funds or issue CD’s rather than sell T bills or other liquid assets. it can obtain the needed funds in two ways. But these banks possessed superior asset management skills and hence could fund assets by relying on the wholesale markets using Call money. Liability management provides a bank with an alternative to asset liquidation to obtain needed funds. One way of acquiring funds is to liquidate some of the short term assets that the bank holds in units liquidity account for this purpose. banks primarily sought to achieve maturities and volumes of funds by flexibly changing their bid rates for funds. liability management seeks to control the sources of funds that a bank can obtain quickly and in large amounts. A bank can also obtain funds by acquiring additional liabilities i. CD’s Bill Rediscounting etc. Deregulation of interest rates coupled with reforms in the money market introduced by the reserve bank provided these banks with the opportunity to compete with funds from the wholesale market using the pricing strategy to achieve the desired volume. which cannot be increased to any great degree over a short time period. unlike demand and savings deposits. mix and cost.Asset liability management in banks 8 LIABILITY MANAGEMENT STRATEGY Some banks on the other hand were unable to achieve retail deposit growth rates since they did not have a wide branch network. and for other earnings opportunities. So under the Liability management approach. For example: depending on a bank’s size and on market conditions.

With liability management. Liability management also provides a bank with the means of funding long term growth. If the bank’s only source liquidity is its assets. this is possible because the bank’s liquidity account doesn’t have to bear the full burden of the bank’s liquidity needs. K C College . but the added options that liability management provides also require greater complexity in planning and executing funds management strategies. depending on which option provides the best combination of earnings and safety. It does so by enabling a bank to expand its loans ad other assets by managing its liabilities so that a certain volume of its liabilities remains outstanding at all times so that it can build up on its deposit levels and thereby expand the level of its loans. This approach of funding is normally followed within a context of a long term upswing in the economy in which the borrowers seek more loans for business expansion and depositors place their funds in negotiable time certificates to earn competitive rates. Another benefit of liability management is that it allows banks to invest greater percentage of its available funds in its securities that provide less liquidity but offer higher earnings. whether or not market conditions are favorable. In such cases. the bank may be able to raise the needed funds by incurring liabilities. bank management must have a clear idea of the level of outstanding liabilities that it can count on holding through tight money periods by offering competitive rates. BENEFITS OF LIABILITY MANAGEMENT: he key benefit of using Liability Management as a funding strategy is that it provides a bank with an alternative to asset management for short term adjustments of funds. For example: Assume that the bank experiences a sudden and unexpected marked decline in the level of its demand deposits. This is so since banks can obtain money market deposits and liabilities only by paying market rates and the behaviour of financial markets cannot be predicted with complete accuracy. A bank that has the option of obtaining liquidity through its liabilities has an opportunity to increase profitability because it can reduce the amount of short term assets it holds for liquidity purposes and place those funds into longer term securities that offer less liquidity but offer higher earnings. RISKS INVOLVED IN LIABILITY MANAGEMENT: Although the use of liability management along with asset management allows a bank the least costly method of obtaining liquidity from a wider range of funding options. it must sell some of its securities to obtain the funds needed to cover the run off of its deposits.Asset liability management in banks 9 in obtaining the greatest value from inflows of funds. thereby postponing the sale of its assets until conditions are more favourable. therefore a bank which follows both assets and liability management strategies has the option of using cash inflows to obtain more short term liquid assets or to repay outstanding liabilities.

nonaccrual loans/investments and capital (e.e. i.Asset liability management in banks 10 Another risk involved is that of issuing long term fixed rate CD’s at the peak of the business cycle. Under Regulation 76/95. The basic benefits of liability management lie in the options it provides a bank in obtaining a least costly method of funding given the bank’s particular needs and the existing conditions of the financial markets. operational procedures should set maximum limits that can still accommodate members' needs. ADVANTAGES ALM can help protect a financial institution or corporation against a variety of financial and nonfinancial risks. This liquidity need not be held in cash. surplus cash is often left on the premises of a credit union rather than being placed into interest bearing accounts. Despite the legal flexibility. Non-earning assets should therefore be minimized. investment in cash. excessive funds in transit (e.g. In fact if short term assets are funded by long term liabilities and rates subsequently decline. balances that are not cleared daily for deposit with the league). Operational procedures should limit the maximum amount of cash left on premises. High teller floats or ATM balances. smaller banks may find it impossible to compete for funds when prices are high. Another risk that relates to the changing market conditions is the stability of the bank’s sources of borrowed or purchased funds. he mere process of identifying risks enables businesses to be better prepared to deal with these risks in the most cost-effective way. or idle cash in non-interest current accounts will increase the amount of non-earning assets and lower financial spread. Such banks face the very real possibility that their sources of funds may disappear just when they are most needed. While large money center banks are usually able to obtain funds under tight money conditions if they are willing to pay market rates. K C College . The risk that a funding house may prove unreliable is also a real problem for smaller banks that move outside their trading areas or that undertake funding by means of liability instruments with which they are not completely familiar. This results in more costly CD’s in the future with a fall in the interest rates.g. fixed) assets. a bank may find that it is paying more for funds than it can earn on those funds. but can be in the form of callable deposits of a league or a Canadian chartered bank/trust company (see section 16 of Regulation 76/95). The risk involved in liability management basically results from too much reliance on the use of purchased funds without recognizing the impact that changing market conditions or other unanticipated changes can have on the bank’s ability to secure funds when the money is scarce. In the case of teller floats or ATM balances. there is a requirement for credit unions to maintain a certain amount of its assets in liquid form.

The philosophy should set out the broad goals and objectives of the credit union’s asset/liability portfolio. who represent the membership at large.Asset liability management in banks 11 ALM ensures that a company’s capital and assets are used in the most efficient way. ALM can prove costly in terms of both the time required of employees and the investment required in management tools such as IT and techniques such as hedging. K C College . as established by the board of directors. This philosophy governs all ALM policy constraints and helps address new situations where policy does not yet exist. DISADVANTAGES ALM is only as good as the people on the ALM committee and the operational procedures that they follow. It can be used as a strategic and business tool to improve earnings. While goals and objectives will differ depending upon the circumstances and environment of the credit union. Financial derivatives instruments must only be used to limit interest rate risk and must never be used for speculative or investment purposes. ASSET/LIABILITY MANAGEMENT PHILOSOPHY Adopting an asset/liability management philosophy is an important first step in drafting ALM policy.  Product terms. pricing and balance sheet mix must balance members’ product demands with the need to protect the equity of the credit union. the ALM philosophy should always address the following principles: he credit union will manage its asset cash flows in relation to its liability cash flows in a manner that contributes adequately to earnings and limits the risk to the financial margin.

In order to ensure that deposit and lending rates are sufficiently responsive. For larger gap mismatches. the following factors should be considered: Cost of funds and the spread required for financing the loan. In order to protect financial margin.  Market rates offered by the competition. the price for these loans could be made more attractive than terms whose funding sources are scarce. Where funding from deposits is high for a particular term of loan. Liquidity requirements of the competitor institution may differ vastly from the credit union's needs. In order to establish fair interest rates for both the borrower and the credit union. caution should be exercised when setting rates. therefore. Loan pricing can also be used to balance minor gap mismatches. Pricing strategies of competitor institutions will reflect the need for funds in these organizations. The interest rates offered on loans should reflect an adequate margin above the rates on deposits being used to fund loans. policy may delegate to management the authority to set interest rates without board approval but in accordance with pre-established criteria as described below: Deposit Pricing Policy: Rates offered on deposits should be tied to external benchmarks in the local market and should generally approximate the average of these market indicators (for example. if sufficient earnings and reserves are available. a net contribution to earnings is provided. Policy should allow management flexibility to negotiate more favorable rates within a prescribed range to maintain key deposit accounts. Loan pricing is crucial for establishing a successful lending program. credit unions should avoid engaging in price wars with competitor financial institutions including other credit unions. the bank rate or the prime rate). Loan Pricing Policy: It is recommended that loans be priced at market rates and subject to interest rate rebates only at the end of the year. in order to cover all operating expenses and capital requirements.Asset liability management in banks 12 PRICING ALM policy specifies that the pricing of all loans and deposits offered should be established so that overall. however. a derivative instrument may be a more practical option. K C College .

 Maturity and repayment terms of the loan. the longer the period. so long as these do not exceed the maximum term limits approved by the board. Share Pricing Policy: When issuing capital shares.  Credit risk of the loan (e. When stock dividends are offered as an alternative to cash dividends. and require that any products with terms greater than five years require special board approval. size and security).g. here are no regulatory requirements for the maximum term on any assets or liabilities which a credit union can assume. Operational procedures can describe the availability of alternative term deposits and correlate differential pricing for these products within this limit. These limits should be broad enough so that management can set varying terms for individual products in operational procedures based on product purpose. before stock dividends are declared. he board may want to set a general five year maximum term on deposits in policy. discretionary dividend rates should be subject to ALM policy criteria approved by the board.Asset liability management in banks 13  Excess liquidity position of the credit union. other classes of shares and borrowings. loan purpose.  Length of loan amortization period (generally. the future costs of increased fixed dividends should be analyzed for ongoing affordability. Term Loans: K C College . Term Deposits: It is recommended that the board establish maximum term limits on term deposits. the higher the rate). Dividend rates should be set with due regards to the average cost of alternative funds such as deposits. TERMS OF ALM POLICY ALM policy should set reasonable limits on the terms of loans and deposits.

term loans be offered with five year maximum maturities.g. investments. selective prepayment penalties should be established by operational policy.liability strategy emerged. Operational Procedures: he criteria for offering term loans of varying length can be specified in operational procedures.Asset liability management in banks 14 It is recommended that the board establish maximum term limits on term loans. he volume. ALM STRATEGY As interest rated in both the liability and the asset side were deregulated. and require that any products with terms greater than five years require special board approval. and foreign exchange. mix and cost/return of both liabilities and assets need to be planned and monitored in order to achieve the bank’s short and long term goals. For mortgages with terms exceeding one year. he board may want to set a general five year maximum term on loans in policy. Consequently the need to adopt a comprehensive Asset. K C College . loan maturities in excess of five years may occasionally be sanctioned up to a prescribed policy limit or approved by the board on an exception basis. It should be coordinated and internally consistent so that the spread between the bank’s earnings from assets and the costs of issuing liabilities can be maximized. Operational procedures can require that loan terms be set to similar lengths as the life of the security (e. it is recommended that generally. term loans should be substantially matched by contractual maturity dates against non-callable term deposits. and the usually limited consumer demand for term deposits in excess of five years. CD’s and the retail deposit rates turned outdo be variable over a period of time due to competition and the need to keep the bank interest rates in alignment with market rates. the key objectives of which were as under. Management control would comprehensively embrace all the business segments like deposits. Operational procedures can describe the availability of alternative term loans and correlate differential pricing for these products within this limit. borrowing. Credit unions should consult with their league for appropriate strategies prior to offering extended term mortgages. credit. large loans secured by higher valued assets would normally have longer terms to maturity).For increased competitiveness. interest rates in various market segments such as call money. however. Due to the higher repayment and security risks of longer term loans. Mortgage terms of seven to ten years have become more commonplace in the market but generally should only be offered by credit unions if arrangements are in place to manage the gap between five year funding deposits and those longer term mortgages.

Hence bank would also look at the impact of such a loan on its liquidity along with the credit risk and not in isolation. The basic models are: 1. By identifying the acceptable risk limits. other banks that do not employ such a system in totality might find it useful to adopt the integrated ALM approach which has been presented as a conceptual argument ALM MODELS Analytical models are very important for ALM analysis and scientific decisionmaking. While a similar system might already be in use in several competitive banks in one form or the other. payments. Stochastic K C College . the bank achieves greater stability thus ensuring higher returns for the shareholders.Asset liability management in banks 15 Suitable pricing mechanism covering all products like credit. Value at Risk (VaR) model 5. This model helps us to identify those loans that contribute to the ROA and Roe of the bank. This puts the bank on the road to SHAREHOLDER VALUE CREATION. The bank would now have flexibility in accepting and rejecting the loan only after having considered all parameters. If the liquidity profile of the portfolio is improved the loan can be priced favorably for the borrower. Scenario Analysis Model 4. STRATEGIC APPROACHES TO ALM Spread Management : his focuses on maintaining an adequate spread between a bank’s interest expense on liabilities and its interest income on assets. Duration GAP Analysis Model 3. Gap Management: his focuses on identifying and matching rate sensitive assets and liabilities to achieve maximum profits over the course of interest rate cycles A bank will price the loan even taking the liquidity risk. GAP Analysis Model 2. and custodial financial advisory services should be put in place to cover all costs and risks. Incorporating the default probabilities helps the bank to price the loan appropriately in line with its risk profile. that liquidity profile of the bank is improved. It will provide the necessary direction to the bank in structuring the loan in such a way.

The Executive Director and other vital departments’ heads head ALCO in banks. These pertain to accuracy of data and reliability of the assumptions made. This model looks at the reprising gap that exists between the interest revenue earned 9n the bank's assets and the interest paid on its liabilities over a particular period of time (Saunders. Measuring risk. R refers to the interest rates impacting assets and liabilities in the relevant maturity bucket and GAP refers to the differences between the book value of the rate sensitive assets and the rate sensitive liabilities. Discussing new products and Reporting. It highlights the net interest income exposure of the bank. Thus when there is a change in the interest rate. This could be difficult and sometimes contentious. under various interest rate scenarios. Pricing assets and liabilities. There are minimum four members and maximum eight members.. 1997). etc. The basic weakness with this model is that this method takes into account only the book value of assets and liabilities and hence ignores their market value. one should be in a position to look at alternatives pertaining to prices. FUTURE GAPS: It is possible that the simulation model due to the nature of massive paper outputs may prevent us from seeing wood for the tree. K C College . it is extremely important to combine technical expertise with an understanding of issues in the organization. a negative sensitivity (the time the bank manager will have to wait in order to change the posted rates on any asset or liability) of each asset and liability on the balance sheet. Hence. Interest rate changes have a market value effect. Gap analysis model: Measures the direction and extent of asset-liability mismatch through either funding or maturity gap. Periodic review. whereas. growth rates. In such a situation. It is responsible for Responsible for Setting business policies and strategies. one can easily identify the impact of the change on the net interest income of the bank. It is computed for assets and liabilities of differing maturities and is calculated for a set time horizon. The general formula that is used is as follows: NIIi= R i (GAPi) While NII is the net interest income. There are certain requirements for a simulation model to succeed. Reprising gaps are calculated for assets and liabilities of differing maturities. to changes in interest rates in different maturity buckets. This method therefore is only a partial measure of the true interest rate exposure of a bank. It is also to be noted that managers may not want to document their assumptions and data is not easily available for differential impacts of interest rates on several variables. reinvestments. In other words.Asset liability management in banks 16 Programming Model : Any of these models is being used by banks through their Asset Liability Management Committee (ALCO). A positive gap indicates that assets get reprised before liabilities.

The duration model has one important benefit. the bank will be immunized from interest rate risk if the duration gap between assets and the liabilities is zero. Last but not the least. Simulation: Simulation models help to introduce a dynamic element in the analysis of interest rate risk. more importantly the time involved in simulation modelling. It is the weighted average time to maturity of all the preset values of cash flows. As per the above equation. If we cannot afford the cost or. Duration model: Duration is an important measure of the interest rate sensitivity of assets and liabilities as it takes into account the time of arrival of cash flows and the maturity of assets and liabilities.Asset liability management in banks 17 simulation models need to be used with caution particularly in the Indian situation. It is used extensively for measuring the market risk of a portfolio of assets and/or liabilities. the use of simulation models calls for commitment of substantial amount of time and resources. Value at Risk: Refers to the maximum expected loss that a bank can suffer over a target horizon. Absolute level of interest rates shift. There are nonparallel yield curve changes Marketing plans are under-or-over achieved K C College . Basically simulation models Utilize computer power to provide what if scenarios. It uses the market value of assets and liabilities. for example: What if: the. DP p = D ( dR /1+R) he above equation describes the percentage fall in price of the bond for a given increase in the required interest rates or yields. Duration basic -ally refers to the average life of the asset or the liability. The larger the value of the duration. given a certain confidence interval. It enables the calculation of market risk of a portfolio for which no historical data exists. the more sensitive is the price of that asset or liability to changes in interest rates. it makes sense to stick to simpler types of analysis. Gap analysis and duration analysis as stand-alone too15 for asset-liability management suffer from their inability to move beyond the static analysis of current interest rate risk exposures. It enables one to calculate the net worth of the organization at any particular point of time so that it is possible to focus on long-term risk implications of decisions that have already been taken or that are going to be taken.

: an increasing reliance on short term funds for balance sheet growth. it also takes action and initiates changes in response to the market dynamics. Needless to say ALCO has to be supported by an efficient analytics providing detailed analysis. and liquidity. scenario analysis and recommendation for action. for e. forecasts. ALM Organization T he Board of Directors would have the overall responsibility for the ALM & risk management and should lay down the tolerance limits for liquidity and interest rate risk in line with the organization’s philosophy.g. including the Chief Executive. Typically. Changes in multiple target variables such as net interest income. ALCO not only makes business decisions. Further. ALCO Support Group will provide the data analysis. In addition to K C College . capital adequacy. the Asset Liability Committee (ALCO) is responsible for deciding on the business strategies consistent with the laid down policies and for operating them. but also monitors their implementation and their impact. This dynamic capability adds value to the traditional methods and improves the information available to management in terms of: Accurate evaluation of current exposures of asset and liability portfolios to interest rate risk. ALCO consists of the senior management. forecasts and scenario analysis for ALCO. However.Asset liability management in banks 18 Margins achieved in the past are not sustained /improved Bad debt and prepayment levels change in different interest rate scenarios There are changes in the funding mix.

Individual banks will have to decide the frequency for holding their ALCO meetings. business mix and organizational complexity or ensure commitment of the Management. Credit. capital market funding. wholesale vs. its responsibility would be to decide on source and mix of liabilities or sale of assets. Some banks may even have subcommittees. for instance. domestic vs.Asset liability management in banks 19 monitoring the risk levels of the bank. the CEO/CMD or ED should head the Committee. Funds Management / Treasury (forex and domestic). Towards this end. The Chiefs of Investment. In addition the Head of the Information Technology Division should also be an invitee for building up of MIS and related computerization. foreign currency funding. International Banking and Economic Research can be members of the Committee. the ALCO should review the results of and progress in implementation of the decisions made in the previous meetings. The content of d asset liability management includes: Background & Overview of Asset and Liability Committee (ALCO) Role & Objectives Sample Statements on Role / Function of ALCO K C College . retail deposits. money market vs. it will have to develop a view on future direction of interest rate movements and decide on a funding mix between fixed vs. floating rate funds. In respect of the funding policy. etc. COMPOSITION OF ALCO he size (number of members) of ALCO would depend on the size of each institution. COMMITTEE OF DIRECTORS Banks should also constitute a professional Managerial and Supervisory Committee consisting of three to four directors which will oversee the implementation of the system and review its functioning periodically. The ALCO would also articulate the current interest rate view of the bank and base its decisions for future business strategy on this view.

MCI)  Money Market.Asset liability management in banks Capital of a financial institution Funding and Liquidity Structural Market Risk of on and Off Balance Sheet items Asset / Liability Composition  What comprises Assets? What comprises Liability? Detail discussion on characteristics of the major assets and liabilities Sample Balance Sheet of some local commercial banks Off Balance-Sheet items Role of ALCO in Capital Management Minimum Capital Standards and Compliance Capital Structure of a Banking Institution  Regulatory Capital. Compliance & Maintenance Illustration : Sub-Prime crisis impact on Bank’s Capital What would ALCO look at Capital Adequacy  Growth of Assets-Liabilities and adequacy of Capital Role of ALCO in Funding and Liquidity Management  Liquidity Structure and Regulatory Framework Liquidity Concept and Objectives (MCO. Liquidity and their significance to Banking Institutions  Regulatory Framework and Compliance Regulatory Limits. Ratios. Utilization Liquidity Profile and Associated Risks : K C College 20 .

Investments and operational risk are also major considerations. ALM PROCESS The ALM process rests on three pillars:  ALM information systems => Management Information System => Information availability. adequacy and expediency  ALM organization => Structure and responsibilities K C College . accuracy. From a regulatory perspective. such as limits and ratios. Actions GOAL OF COMMITTEE Management of assets and liability incorporates interest rate risk and liquidity considerations into a bank's operating model. ALCO responsibilities include managing market risk tolerances. A sound practice is to conduct ALCO meetings at least quarterly to review the bank's level of exposure to changing interest rates and to determine management's degree of compliance with internal policies and quantitative parameters. and reviewing immediate funding needs and sourcespossibly engaging an independent third party to validate the assumptions and data contained in internally or externally prepared management reports. approving a contingency funding plan. establishing appropriate MIS. one of the ALCO's goals is to ensure adequate liquidity while managing the bank's spread between the interest income and interest expense. Objectives.Asset liability management in banks 21  Growth in Asset-Liability Types and implication on Liquidity  Assessment of Change in Liquidity Profile  ALCO’s Role. reviewing and approving the liquidity and funds management policy at least annually.

rate risk and stay solvent. earn net income and second. Earnings allow a credit union’s capital to increase. consolidation. therefore. and report these findings to the board. RISK MEASUREMENT AND BOARD REPORTING It is recommended that the credit union measure the performance and risk level of the credit union’s asset/liability management activities. Risk Measurement: The following are minimum risk and performance measures of ALM. however. which is necessary for growth. remain solvent. and member demands for better. required by sound business and financial practices: K C College . A credit union must manage its cash flowing into and out of its assets and liabilities and the interest rates related to its financial products.Asset liability management in banks 22 => Level of top management involvement  ALM process => Risk parameters => Risk identification => Risk measurement => Risk management => Risk policies and tolerance levels ASSET-LIABILITY MANAGEMENT AND FINANCIAL GOALS Credit unions have many financial goals. more convenient products can reduce earnings and. intense competition. more efficient. Credit union managers must focus on asset-liability management because fluctuating interest rates. Understanding the characteristics of cash flow is necessary to adequately measure interest. two are basic to their survival: first. capital. or able to meet demands for cash (such as payment of operating expenses).

The credit union must also meet ALM measurement requirements set out in the Act and Regulations. Management should also provide the board with a summary on compliance with ALM policy and relevant regulatory requirements. Board Reports The above measurements should be reported to the board of directors. Every proposal either takes the bank away from the target Gap or brings it closer to the same. liability and capital growth or decline. Every bank would have certain target Gaps. so that management can determine whether the credit union is meeting its goals.  Periodic measurement or projection of the impact of interest movements. The liquidity score reflects the impact of the proposal on the liquidity profile of the bank. Material variances from plan.  Periodic measurement of financial margin. as well as management's plan to correct the variance should also be included in the report.  Periodic measurement of operational cash flows. so that the board can also monitor ALM activities and ensure adherence to regulatory requirements and to the annual business plan. Management can also assess whether there are material variances from the plan which need to be addressed.  Periodic assessment of the appropriateness of financial derivatives held.  Periodic measurement of asset. Credit score of risk in asset liability management The credit score is the result of the credit appraisal process.Asset liability management in banks 23 Periodic measurement of overall balance sheet mix. Risk Management Techniques Sections 7401 to 7405 provide techniques for measuring and monitoring the adequacy of the credit union's ALM activities. The score also is a reflection of the cost of funding the liquidity mismatch that it might create. these measurements should be compared to financial targets in the annual business plan and the budget. and their causes. The interest rate score reflects the spread earned by the corporate bank over and above the transfer price. The credit union may track any other measures of the loan portfolio as it sees fit. This score reflects the impact of the proposal on the Gap profile of the bank. It is at this stage that the credit risk is quantified in terms of default probabilities. This looks at the K C College .  Periodic measurement of the level of unhedged foreign currency funds.

Weights should be assigned to the different performance scores based on the bank’s future strategies and the current balance sheet status. then any loan with a score below 2 should be rejected. Management of market risks(including Interest Rate Risk) III Funding and capital planning K C College . SCOPE OF ALM The scope of ALM function can be described as follows: I. The weighted average of these scores will give us the COMPOSITE SCORE of the loan.Asset liability management in banks 24 possibility of a credit default.g. the weights being assigned on the basis of the relative strategic importance of each of these three parameters specific to the bank. demands. Asset Evaluation: Once the three performance scores are available. Higher the composite score better is the chance of the loan being accepted The calculation of the composite score has certain underlying requirements: Every bank should have a minimum composite score based on its risk appetite.. A bank might have a minimum composite score of two. the entire evaluation of the asset can be condensed to a one-page report. Here the performance measures are graded on a scale of 1-5. E. This kind of arrangement.. diligent monitoring of the asset to keep the bank updated with its liquidity profile. if we fix a minimum composite score of 2. Liquidity risk management II. no questions asked. a bank with heavy focus on the control of already high NPAs should give higher weights to credit performance score. but care should be taken to see to it that most of the loans in the portfolio do not fall very close to the minimum composite score as this would worsen its risk profile. E g. however.

Bank management should measure not only the liquidity positions of banks on an ongoing basis but also examine how liquidity requirements are likely to evolve under crisis scenarios.. over 1 month & up to 2 months. However. Guidelines also provide a format for estimating short-term dynamic liquidity in a time horizon spanning one day to six months. Detailed guidance also is given for the classification of the assets & liabilities in each time bucket. the difference between rate sensitive assets and rate sensitive liabilities is to be used as a measure of interest rate sensitivity. Liquidity Risk Management: Measuring and managing liquidity needs are vital activities of commercial banks. such estimates provide a rational framework for pricing of assets and liabilities. liquidity management can reduce the probability of an adverse situation developing. The guidelines also provide benchmarks about the classification of various components of assets and liabilities into different time buckets for preparation of GAP reports.e. I. By assuring a bank's ability to meet its liabilities as they become due. banks need to estimate the future behaviour of assets and liabilities and off--balance sheet items in response to changes in market variables and also the probabilities of options on internal transfer pricing model for assigning values for funds sourced and funds used for operating their ALM system. For instance. The importance of liquidity transcends individual institutions. time buckets on the basis of defeasance periods. The formats of statement of structural liquidity are given by the Reserve Bank of India. Trading risk management The guidelines given in this note mainly address Liquidity and Interest Rate risks. The gap i. The guidelines specify the use of a maturity ladder up to 8 time buckets and calculation of cumulative surplus or deficit of funds at selected maturity dates is adopted as a standard tool. Profit planning and growth projection V. In fact. etc.Asset liability management in banks 25 IV.. K C College . This tool is to be used for estimating short-term liquidity profiles on the basis of business projections and other commitments. the trading book securities are to be shown less than one day to 30 days. as liquidity shortfall in one institution can have repercussions on the entire system.

While determining the K C College . he Maturity Profile as given could be used for measuring the future cash flows of banks in different time buckets. The mismatch during 1-14 days and 15-28 days should not in any case exceed 20% of the cash outflows in each time bucket. he Statement of Structural Liquidity may be prepared by placing all cash inflows and outflows in the maturity ladder according to the expected timing of cash flows. Banks. If a bank in view of its asset -liability profile needs higher tolerance level. It would be necessary to take into account the rupee inflows and outflows on account of forex operations including the readily available forex resources ( FCNR (B) funds. are expected to monitor their cumulative mismatches (running total) across all time buckets by establishing internal prudential limits with the approval of the Board / Management Committee. The time buckets given the Statutory Reserve cycle of 14 days may be distributed as under:  1 to 14 days 15 to 28 days  29 days and up to 3 months  Over 3 months and up to 6 months  Over 6 months and up to 12 months  Over 1 year and up to 2 years Over 2 years and up to 5 years  Over 5 years Within each time bucket there could be mismatches depending on cash inflows and outflows. While the mismatches up to one year would be relevant since these provide early warning signals of impending liquidity problems. till the system stabilizes and the bank is able to restructure its asset -liability pattern.. 1-14 days and 15-28 days. RBI. it could operate with higher limit sanctioned by its Board / Management Committee giving reasons on the need for such higher limit. the main focus should be on the short-term mismatches viz. etc) which can be deployed for augmenting rupee resources.Asset liability management in banks 26 Experience shows that assets commonly considered as liquid like Government securities and other money market instruments could also become illiquid when the market and players are unidirectional. A copy of the note approved by Board / Management Committee may be forwarded to the Department of Banking Supervision. For measuring and managing net funding requirements. A maturing liability will be a cash outflow while a maturing asset will be a cash inflow. the use of a maturity ladder and calculation of cumulative surplus or deficit of funds at selected maturity dates is adopted as a standard tool. The discretion to allow a higher tolerance level is intended for a temporary period. Therefore liquidity has to be tracked through maturity or cash flow mismatches. however.

While determining the tolerance levels the banks may take into account all relevant factors based on their asset-liability base. generally through ALCO. and their appetite for risk. as a matter of routine. An indicative format for estimating Short-term Dynamic Liquidity is enclosed.  Strategic Direction Bank management. create scenarios on top of native cash flows. Scenario Analysis: Liquidity analysis scenarios are generated. The RBI is interested in ensuring that the tolerance levels are determined keeping all necessary factors in view and further refined with experience gained in Liquidity Management. For instance. future strategy etc. All analysis referred to above provide measures enabled by these scenarios. Indian banks with large branch network can (on the stability of their deposit base as most deposits are renewed) afford to have larger tolerance levels in mismatches if their term deposit base is quite high. then liquidity K C College . For instance. In order to enable the banks to monitor their short-term liquidity on a dynamic basis over a time horizon spanning from 1-90 days. Recent volatility in the wholesale funding markets has served to highlight the importance of sound liquidity risk management practices and reinforce the lesson that those banks with well. banks have to make a number of assumptions according to their asset .liability profiles. best case and likely.Asset liability management in banks 27 likely cash inflows / outflows. nature of business. the composition of their funding. if the bank has major positions in global capital markets. (This may be used to commit money in money markets). Many banks. They alter nature of native cash flows based on their prior knowledge. Because banks vary widely in their funding needs. This strategy should address the inherent liquidity risks. These scenarios are scrutinized and their impact approved by ALCO as a matter of routine. A typical measure would involve worst case (MCO analysis). there is no one set of universally applicable methods for managing liquidity risk. which are generated by the institution’s core businesses. the competitive environment in which they operate. The banking industry has developed many innovative solutions in response to these challenges. Derived cash flows are indeed scenarios that have been predefined. banks may estimate their short-term liquidity profiles On the basis of business projections and other commitments. some of which are presented here.developed risk management functions are better positioned to respond to new funding challenges. must articulate the overall strategic direction of the bank’s funding strategy by determining what mix of assets and liabilities will be utilized to maintain liquidity.

In the past.  Measurement Systems Most banking experts agree that maintaining an appropriate system of metrics is the linchpin upon which the liquidity risk management framework rests. then liquidity should be managed to reduce the impact of a decline in asset quality or a runoff of core deposits. The varied funding K C College . This resulted in situations where asset and liability profiles structured for maximum profitability had to be reconfigured (often at a loss) to meet sudden liquidity demands. asset/liability management’s goal was primarily to maximize revenue while liquidity management was managed separately. the best ALCO groups have realized that liquidity management must be integral to avoid the steep costs associated with having to rapidly reconfigure the asset/liability profile from maximum profitability to increased liquidity.  Integration Liquidity management must be an integral part of asset/liability management. Some of the greatest changes in risk management have occurred in the integration area. and provide the basis for projecting possible funding scenarios rapidly and accurately. Instead of liquidity management being the responsibility of a small group of staff.Asset liability management in banks 28 should be managed to lessen the impact of sudden changes in global markets. While the struggle between maximizing profitability and providing adequate liquidity continues to this day. This strategy must be documented through a comprehensive set of policies and procedures and communicated throughout the bank. management needs a set of metrics with position limits and benchmarks to quickly ascertain the bank’s true liquidity position. ascertain trends as they develop. The bank’s asset and liability management policy should clearly define the role of liquid assets along with setting clear targets and “liquidity-generating business lines “an internal earnings credit while charging “liquidity-using business lines cost centers for funding. This is frequently done through the use of loan growth and balance sheet targets that are “pushed down” to business line managers. In addition. If they are to successfully manage their liquidity position. Another innovative method is to require business lines to structure deals as if they had to fund them on a stand-alone basis. Or if the bank funds commercial loans with core deposits. Some banks achieve this goal through the use of a transfer pricing system . the bank should establish appropriate benchmarks and limits for each liquidity measure. it is now integrated into the day-to-day decision-making process of core business line managers.

benchmarks. Currency Risk: Floating exchange rate arrangement has brought in its wake pronounced volatility adding a new dimension to the risk profile of banks' balance sheets. In addition. Following the introduction of "Guidelines for Internal Control over Foreign Exchange Business" in 1981. maturity mismatches K C College . some of the institutions may take proprietary trading positions as a conscious business strategy. Stock measures look at the dollar levels of either assets or liabilities on the balance sheet to determine whether or not these levels are adequate to meet projected needs. then the currency mismatch can add value or erode value depending upon the currency movements. Models are built utilizing hypothetical scenarios to develop measures. Balance-sheet-based measures are generally best suited to smaller institutions which fund their business lines. Banks undertake operations in foreign exchange like accepting deposits. As a result. While this combination works well for smaller banks. Ever since the RBI (Exchange Control Department) introduced the concept of end of the day near square position in 1978. Dealing in different currencies brings opportunities as also risks. these banks have either developed or have purchased model-based measurement systems to assist them in liquidity measurement. most of these banks utilize flow measures to determine their net cash position. As a result. and limits. These banks generally develop their measurement system and their corresponding benchmarks and limits based on either selected peer group analysis or on studies of historical liquidity needs over time.Liability Management. The increased capital flows across free economies following deregulation have contributed to increase in the volume of transactions. with core deposits. The simplest way to avoid currency risk is to ensure that mismatches. making loans and advances and quoting prices for foreign exchange transactions. are reduced to zero or near zero. Besides. Large cross border flows together with the volatility has rendered the banks' balance sheets vulnerable to exchange rate movements. if any. If the liabilities in one currency exceed the level of assets in the same currency. Flow measures use cash inflows and outflows to determine a net cash position and any resultant surplus or deficit levels of funding. banks have been setting up overnight limits and selectively undertaking active day time trading. Irrespective of the strategies adopted. Mismatched currency position besides exposing the balance sheet to movements in exchange rate also exposes it to country risk and settlement risk. generally loans. it may not be possible to eliminate currency mismatches altogether.Asset liability management in banks 29 needs of institutions preclude the use of one universal set of metrics. banks frequently use a combination of stock and flow liquidity measures or have gone to exclusive reliance on models. Managing Currency Risk is one more dimension of Asset. regional and global institutions that have significant trading operations and are heavily reliant on purchased funding find that stock and flow measures are no longer adequate to meet their needs.

II. banks have a trading book and a banking book.Asset liability management in banks 30 (gaps) are also subject to control. The application of techniques like modified or dollar duration gap and convexity gap analysis to such a profile will enable risk measurement of interest rate sensitivity. The Basel Committee on Bank Supervision stipulates the benchmark in this regard as the 200 basis points parallel shift in yield curve. traditionally. However. Financial institutions make money as they take market risk. preserving market risk. Both traded and non-traded assets and liabilities carry market risk and any technique should address this. For monitoring such risks banks should follow the instructions contained in Circular A. spread over time is a measurement of market risk. For example. The Basel Committee also uses this differentiation. For purposes of determining interest rate sensitivity. Series) No. Management of market risks(including Interest Rate Risk) Interest rate risk is measured using traditional techniques for measurement of market risk. All products carry market risk and this need to be addressed as well. 1997 issued by the Exchange Control Department. Following the recommendations of Expert Group on Foreign Exchange Markets in India (Sodhani Committee) the calculation of exchange position has been redefined and banks have been given the discretion to set up overnight limits linked to maintenance of additional Tier I capital to the extent of 5 per cent of open position limit. A. Presently.52 dated December 27.D (M. They are not replacements for flesh and blood managers. The essential distinction between a banking book and a trading book is in the method used for the recognition of the risks and valuation. K C College . central banks of individual countries have the freedom to vary this norm. then it is has to locate 10 year assets to minimize market risk for that loan. Market risk exists due to volatility of interest rates. This measure is a basic measurement technique. Gap between interest rate sensitive assets and liabilities. if a bank provides a 10 year housing loan. Thus the open position limits together with the gap limits form the risk management approach to forex operations. Combined book represents a reasonable estimate of bank’s interest rate risk profile. Statistical techniques help make judgments. Sensitivity of Net Interest Income (NII) to interest rate change is another way of measuring the interest rate risk. There is no guarantee that history will repeat itself and new paths and patterns may emerge. both books may be mapped to zero coupon bonds. the banks are also free to set gap limits with RBI's approval but are required to adopt Value at Risk (VaR) approach to measure the risk associated with forward exposures. It must be understood that all statistical techniques are forecasting algorithms based on history in some form or the other.

 Dollar duration: Represents the actual dollar change in the market value of a holding of the bond in response to a percentage change in rates. with weights being the present values of cash flows. they have to adopt innovative and sophisticated techniques to meet some of these challenges. With each successive basis point movement downward. This poses extra challenges to the banking sector and to that extent. Duration can again be used to determine the sensitivity of prices to changes in interest rates.  Duration: Is the weighted average time of all cash flows.Asset liability management in banks 31 Interest rate Gap Interest rate gap of a bucket is calculated in a manner similar to liquidity gap. duration may not remain constant. Tolerance of gap in terms of percentage. bond prices increase at an increasing rate. Longer maturity bonds are generally subject to more interest rate risk than shorter maturity bonds. Tolerance provides control point as well. maturity is considered as an approximate measure of risk and in a sense does not quantify risk. These include:  Maturity: Since it takes into account only the timing of the final principal payment.In the Indian K C College . Making buckets too small leaves a large number of buckets. Making them too large may hide some sensitivity issues Gaps may be identified in the following time buckets: I) up to 1 month ii) Over one month and up to 3 months iii) Over 3 months and up to 6 months iv) Over 6 months and up to 12 months v) Over 1 year and up to 3 years vi) Over 3 years and up to 5 years vii) Over 5 years viii) Non-sensitive Therefore. which is due to circumstances outside its control. the rate of decline of bond prices declines. absolute values is a risk control measure. Buckets may be determined carefully. There are certain measures available to measure interest rate risk. Similarly if rates increase. the banking industry in India has substantially more issues associated with interest rate risk. This property is called convexity. It represents the percentage change in value in response to changes in interest rates.  Convexity: Because of a change in market rates and because of passage of time.

unutilized portion of cash credit. First of all.honored view of the credit market needs re-examining. these tools seem inefficient and the time. the ALM involves holistic perspective for decision-making and factors in the market dynamics. collateral and by making provisions against possible defaults. Credit risk differs from market risk in that the default risk of an individual company is tied to its own performance and not to the performance of other companies. ALM takes into account the time value of money whereas balance sheet accounting ignores time element.g. When one talks of lending.Asset liability management in banks 32 context. future contracts or by matching within the existing book. banks in the past were primarily concerned about adhering to statutory liquidity ratio norms and to that extent they were acquiring government securities and holding it till maturity. However. The only way actually today off default risk is by means of some instrument that is directly related to the specific comp INADEQUACY OF BALANCE SHEET ANALYSIS FOR ALM ALM techniques are used over and above balance sheet techniques. default risk cannot be hedged by means of a market index. Current banking practices view the management of credit risk outside the scope of the ALM framework. Mapping Non-term products K C College . it becomes important for banks to equip themselves with some of these techniques. in order to immunize banks against interest rate risk. Further. in a banking system where 40% of the loan able funds are locked in the priority sector and competitive pressures often driving the banks to compromise on the self-devised stringent lending norms. But in the changed situation. Exposure to credit risk has long been hedged or reduced through portfolio diversification. the fact that banks carry substantial credit risk on their balance sheets cannot be ignored.. namely moving away from administered interest rate structure to market determined rates. Credit risk. there is a low correlation between the default risk of an individual counterparty and any aggregate index of corporate performance such as the market index. This essentially involves borrowing and lending of funds and assuming the risk of lending in the process. Credit Derivatives: The role of a bank in any economic system is financial intermediation. In today’s global market. Credit risk management is not a new concept. The regulators are happy with stringent reporting norms with reference to provisions for non-performing assets. as most bankers claim. Secondly. So. In fact. ALM requires factoring the off-balance sheet items to estimate their potential impact on the banks e. the first issue that should come up is the borrower’s credibility. is taken care of by having stringent lending preconditions and diligent monitoring of the loan portfolio.

A business unit or a branch located in a residential area is by definition a deposittaking branch. STRATEGIZING ALM FRAMEWORK ALM policy is drafted and updated by bank’s ALCO. Thus. options. They are generally split into two or more parts based on their behavior. Basel II norms specify different treatments for the derivatives. futures and derivatives may be used to take positions. These parts are volatile and core. for example. market risk. ALM policy requires that board of directors. there is conceptual difficulty in mapping them into zero coupon bonds as the timing of the occurrence of such cash flows is not known. weighted average interest rates of deposit collection by time buckets compared to a standard yield curve. Banking keeps changing and in times will change even further. complex and sophisticated models are required to map derivative type of instruments into the cash flow model. as given out by simple balance sheet is distorted.. In India. Thus.e. Thus. Thus. Volatile portion is typically assigned to the first bucket. Once bank K C College . Thus. ALM policies need to change with the changes in the market on a continuous basis. its profitability should be measured by efficiency of deposit collection i. it was liability creation that was the prime driver. regardless of US Dollar rate changes. Asset Liability committee follow a formal procedure. bank is fully protected. Therefore. Options. Probability is deliberate in derivative class of instruments. liquidity risk etc. offering customer protection as well. though business itself does not change. Transfer Pricing for Measuring Profitability Profitability by business units. ALM Policy covers bank’s position on all risks – credit risk. Core is expected to be with the bank and will mature in later time buckets. Futures and derivatives Bank uses these instruments to hedge positions. apart from hedging.Asset liability management in banks 33 Certain products like savings bank have no contracted maturity terms. bank has to hedge by taking a corresponding short position. Probabilistic cash flow products Savings bank and current account are examples form the banking book of probabilistic cash flow behavior. This ensures that practices are current. To offer a customer a long position in US Dollar at a certain rate. concept of funds transfer pricing has emerged strongly in the past few years. Thus. for a large number of years.

Competition may introduce new products based on their ALM positions. as long as gap remains within tolerance. Practical bankers use an absolute amount. then it is deemed zero. Regulators specify use of percentage of tolerance for gaps. assets represent all inflows and liabilities represent all outflows. Thus. Since all products are mapped. thus making it easier to analyze. policies must be laid out for measurement and implementation of liquidity controls in any financial institution. the banks would look at multiple asset creation avenues. Hence. ALCO needs to understand impact of probabilistic cash flows before approving such products. is an example. 1 month to 2 months etc. Complexities are introduced by options – both explicit and embedded. Before being offered. of late. This organization is termed a maturity bucket scheme. policy should address parameters that should never be crossed. it is the asset creation that drives the liability growth. Thus gaps in each time bucket are analyzed. us. For example. Structural Liquidity: Structural liquidity is critical for an institution. 1-14 days. these are even more vital for a financial organization. All cash flows are mapped to corresponding buckets. 15-days to 1 month. Thus. Product: Both assets and liabilities are considered products and operational parameters defined for both. Thus. Gap Measurement: time buckets are defined as bands. entire portfolio of cash flows is now reduced to a bucket representation.Asset liability management in banks 34 gathered enough funds. Therefore. Even plain vanilla deposits need to be priced and priced by timeframe. Savings bank and cash credit is a classic case of embedded options. the statement in K C College . product creation needs to go through a proper introduction and approval mechanisms through Risk Management and ALCO. Individuals practice structural liquidity measurement and control for personal portfolios. deposits may have various characteristics and structures for interest rates. Thus. The policy defines products that the bank may deal in – both on assets and liabilities. However.

a credit union which is funding short-term loans with long-term deposits will experience shrinking revenues and financial margin as its loan interest income falls while deposit interest expense remains fixed.Asset liability management in banks 35 the beginning that zero gap is impractical and not desired either. fixed rate assets. Inform staff of their priority to increase certain product volumes through cross selling efforts. Bank’s funding or lending gaps may be very deliberate. In an environment of falling interest rates.  Where pricing policy will not stem demand for longer term. in-branch posters and contest prizes. except that the opposite tactics should be employed. Consumer or commercial loans earn a higher yield and can be matched against variable rate deposits. the correction of an unfavorable mismatch and the option to earn a return for continuing service.  Consider selling a portion of the fixed rate mortgage portfolio to other industry players. Procedures for Reducing Exposure to Falling Rates (Closing a Positive Gap): He same procedures as those described above may be used to reduce exposure to falling rates (close a positive gap).  Market/promote products which will close the gap position.  Change portfolio mix in favor of variable rate loans. encourage the conversion of maturities in the existing portfolio. the following approaches are recommended to reduce exposure to falling interest rate (close a positive gap): K C College .  Where new business is not available to correct the gap position. Unfavorable rates should be used to discourage loan/deposit terms that will enlarge the negative gap. Recommended methods of promoting products include advertisements. Promote variable rate consumer loans over fixed rate mortgages. Procedures for Reducing Exposure to Rising Rates (Closing a Negative Gap): During a period of climbing interest rates. or convert closed fixed rate loans to open loans to encourage prepayment. In order reduce this exposure. In brief. a credit union which is funding its long term loans with short term deposits (negative gap) will experience rising financing costs as its deposits float at increasingly high rates. the following procedures may be applied to shorten the term of assets and lengthen the term of liabilities:  Price products so that favorable rates encourage shorter maturities for loans and longer maturities for deposits. restrict the availability of fixed rate loans. Such an arrangement allows ongoing member contact. Allow members to negotiate in midterm an extended maturity for fixed rate deposits.

the other way is to simply calculate cost to close gap for each bucket based on interest rate and assuming that all cash flows occur at the gap median. Policies should address all issues concerning the bank. Proper revisions to this document. IMPLEMENTATION ISSUES Policy: Lack of a coherent.  where pricing does not stem demand. documented and practical policy is a big hindrance to ALM implementation.  Market and promote products which close the gap. Most often. Cost to close of the last bucket is them taken as an outflow in the previous bucket and that closed and so on all the way till the first bucket is closed. apart from ALCO and these must be documented.  Allow members to extend mortgage terms at current fixed rates. The last bucket is closed first using market interest rate for that bucket. ALCO membership itself may not be aware of implications of risks being measured and impact. Some implementations divide all buckets to months internally and calculate cost to close at month level. Cost to close gap: This is another measurement for structural liquidity.  Invest excess liquidity of the investment portfolio into longer term vehicles. K C College .  Change portfolio mix in favour of fixed rate mortgages.  Create incentives for members to cash term deposits early. all policies should be clearly explained to all members of board. restrict funds available for variable rate loans.Asset liability management in banks 36  Price products to dampen demand for variable rate loans and fixed rate term deposits. tolerance to limits of cost to close is defined as a measure of structural liquidity risk and this is used for control. That gives the total cost to close gap.

The argument is that for all other purposes. it is required to follow policy implicitly in both letter and spirit. There was a case of a manual branch of a bank that was closed for 6 months in a year due to inclement weather and was largely inaccessible. Sensible options need to be chosen and manual branch without computer was an example. K C College . Most dramatic failures in the last decade have not been because of market risk or credit risk but bad risk management organizations. Openness and transparency are essential to a proper risk organization. it is mapping of models to zero coupon bonds that are an issue. will be helpful as it would help in decision –making. Most organizations react badly to some positions going wrong by taking more risks and enter vicious cycle of risks. assumptions are being made. Measurement of risk is a fairly simple phenomenon and does go on regardless. It must be remembered that many data items are assumptions and gaps must be measured in perspective. Understanding of complexities: Many people in a bank need to understand risk measurements and risk mitigation procedures. ‘Risk Taking’ and ‘Risk management’ are generally two distinct parts of any organization and both must report to a board completely independently. However. as they are people who come closest to understanding complex financial instruments.Asset liability management in banks 37 a quarterly review needs to be organized as well as parameters may be changing due to change in situations. appropriate assumptions have to be made in any event. As data may not be obtained from this branch for 6 months. Risk organization in banks generally land up reporting to treasury. Organization and culture: ALM function needs to be separated clearly from operations as it involves control and strategy functions. in modern banking. arguments are that this should exist within the bank. Formalization of understanding. in charge of ‘risk taking’ is overlooked. The fact that they are a business unit. This must be a big pointer to boards and ALCOs on avoidance of such issues Data and models: Data may not be available at all times in requisite format. Thus. especially at a top level. Once again.

Asset liability management in banks 38 Unrealistic goals: An ALCO secretary was seen desperately trying to tweak with parameters to ‘show’ less gaps in liquidity reports. In any event. as evidenced by failures in the last decade. ALCO’s job is to correctly determine positions and put in place appropriate remedial measures using appropriate risks. and lending segments. INFORMATION TECHNOLOGY AND ASSET-LIABILITY MANAGEMENT Many of the new private sector banks and some of the non-banking financial companies have gone in for complete computerization of their branch network and have also integrated their treasury. Returns are expected for taking risks. which is accurate and reliable. market risks and credit risks are not the only causes for failure. forex. The electronic fund transfer system as well as demat holding of securities also significantly alters mechanisms of implementing asset-liability K C College . A zero gap is not practical. The information technology initiatives of these institutions provide significant advantage to them in asset-liability management since it facilitates faster flow of information. It is not to show things as good when they are not. Banks assume market and credit risk and hence they make returns.

Asset liability management in banks 39 management because trading. certificates of deposits. in view of the centralized nature of the functions.e. the boundaries of asset-liability management architecture itself is changing because of substantial changes brought about by information technology. These pressures call for structured and comprehensive measures and not just ad hoc K C College . it would be much easier to collect reliable information ASSET . which is evolving in the financial system. and call borrowings. keeping in mind the capital adequacy norms laid down by the regulatory authorities. storage. Intense competition for business involving both the assets and liabilities. In respect of foreign exchange. Simulation models are relatively easier to consider in the context of networking and also computing powers. and to that extent the operations managers are provided with multiple possibilities which were not earlier available in the context of large numbers of branch networks and associated problems of information collection. Information is the key to the ALM process. In other words. facilitates cross-bank initiatives in asset-liability management to reduce aggregate unit cost. borrowing. asset-liability management refers to the management of deposits. In the Indian context. analyzing the behaviour of asset and liability products in the top branches accounting for significant business and then making rational assumptions about the way in which assets and liabilities would behave in other branches. The open architecture. has brought pressure on the management of banks to maintain a good balance among spreads. given a certain level of risk. profitability and long-term viability.  Reducing the gap between rate sensitive assets and rate sensitive liabilities. and retrieval. transaction. forex reserves and capital. The problem of ALM needs to be addressed by following an ABC approach i. together with increasing volatility in the domestic interest rates as well as foreign exchange rates. his would prove as a reliable risk reduction mechanism. investment portfolio and money market operations.LIABILITY MANAGEMENT SYSTEM IN BANKS – GUIDELINES Over the last few years the Indian financial markets have witnessed wide ranging changes at fast pace. Considering the large network of branches and the lack of an adequate system to collect information required for ALM which analyses information on the basis of residual maturity and behavioral pattern it will take time for banks in the present state to get the requisite information. Information technology can facilitate decisions on the following issues:  Estimating the main sources of funds like core deposits. investments. credit. and holding costs get reduced.

Asset liability management in banks 40 action. The Management of banks has to base their business decisions on a dynamic and integrated risk management system and process. managing business after assessing the risks involved. foreign exchange risk. this note lays down broad guidelines in respect of interest rate and liquidity risks management systems in banks which form part of the Asset-Liability Management (ALM) function. The initial focus of the ALM function would be to enforce the risk management discipline viz. a new study from the EDHEC Risk and Asset Management Research K C College . liquidity risk and operational risks. interest rate risk. ASSET-LIABILITY MANAGEMENT DECISIONS IN PRIVATE BANKING Working from the observation that the contribution of asset-liability management techniques developed for institutional investors is not yet familiar within private banking. driven by corporate strategy. Banks are exposed to several major risks in the course of their business -credit risk. The objective of good risk management programmes should be that these programmes will evolve into a strategic tool for bank management. equity / commodity price risk.

amount and certainty of future cash flows that will be received and invested. whether it involves real estate or inflation) must be taken into account in managing their assets. nature. which private bankers rarely do when they put together their clients’ overall strategic asset allocation. It generates the SLP / IRS / MAP / SIR reports and supports risk management K C College . Noël Amenc. but the probability or the expectation of the individual’s long-term financial objectives not being achieved. but its capacity to match the client’s liabilities. personal wealth managers tend to confine their clients to mandates that are only differentiated through their level of volatility. their projects. According to the authors of the study. credit reserve ratio (CRR) and other ratios as per Reserve Bank of India (RBI) guidelines. it is not so much the short-term risk represented by the volatility of the assets that is the determining element in taking an individual’s risk aversion into account. The clients’ liability constraints (horizon. which could have varying exposures to risk factors. In the end. Taking these elements into account leads to asset allocations that are very different from the allocation provided by an optimization carried out in a static mean-variance or mean-VaR framework. ASSET LIABILITY MANAGEMENT SYSTEM ALM is a risk management tool that helps a bank's management take investment / disinvestment decisions. as performed by the vast majority of private wealth managers. In that sense. Within the framework of private financial management offerings. asset-liability management represents a genuine means of adding value to private banking that has not been sufficiently explored to date.Asset liability management in banks 41 Centre. It is not so much the risk-adjusted performance of a fund or even of a given asset class that is the determining factor in including it in the client’s personal wealth. Lionel Martellini and Volker Ziemann. without the client’s personal wealth constraints and objectives being genuinely taken into account in order to determine the overall strategic asset allocation. private wealth management is not sufficiently different from the management of a diversified or profiled mutual fund. maintain the required statutory liquidity ratio (SLR). entitled “Asset-Liability Management Decisions in Private Banking” shows the expected benefits of a transposition of that kind.

data analysis and interest rate simulation. it is necessary to register the branch. the Asset Liability Management System consists of seven modules: Administration: the administration module lets the administrator conduct various user activities as well as some distinct functions. modify or delete account heads with the help of this function.  Bucket codes maintenance: The user can set various buckets for various reports. Before extracting data from any branch. Rule guide: the rule guide is one of the most important modules in the system. In case the buckets defined by the RBI for SLP. IRS. 50 per cent in the second bucket and 20 per cent in the third bucket). This module sets up user-level permissions to access different options from the ALM system. Registration: this module handles registration of the bank and its branches into the ALM system. MAP or SIR change. 30 per cent in the first bucket. Percentage settings: Percentages can be defined to identify the 'bucket' for all those account heads that are of a percentage type (for example. modify or delete an existing user or lock / unlock a user. this function can be used. Only the administrator has privileges to access this module for setting the various parameters of the ALM system. Data processing can be carried out only after all the required parameters have been set. he various functions performed by the module are: Enable / disable account heads: The user can enable or disable asset or liability account heads in the system. Basically. For example. The bank / branch ID and address are also updated in the database during registration. The administrator can add a new user. Account head maintenance: The user can add. bucket codes defined by RBI for SLP are: o 1 to 14 days o 15 to 28 days o 29 days and up to 3 months o Over 3 months and up to 6 months o Over 6 months and up to 12 months o Over 1 year and up to 2 years K C College . Various categories linked with a group of users can be set.Asset liability management in banks 42 modules like graphical analysis. depending on the category of the user.

Asset liability management in banks 43 o Over 2 years and up to 5 years o Over 5 years Settings of account heads to appear in a report: The user can select the account heads which should appear in a report. pre-consolidation and consolidation.  Consolidation: This has two sub-modules. this function can be used. For example. IRS. The pre-consolidation sub-module consolidates the balances of all the account heads branch-wise and puts them into appropriate time buckets. bucket codes defined by RBI for SLP are: o 1 to 14 days K C College . RBI code mapping: This function lets the user map ALM account codes with the RBI account codes. Data process: This module allows the user to upload the data into the system manually or through a flat file for: O Trial balance o Residual accounts o Parameterized accounts o Bucket-wise accounts the user can set the 'as on date' and copy the data for one particular branch from the previous 'as on date' to the next 'as on date' with the help of this module. whereas the consolidation sub-module consolidates the data from all the branches and computes the figures at bank level into various time buckets Reports: Generates various reports: o Structural liquidity profile (SLP) o Interest rate sensitivity (IRS) o Maturity and position (MAP) Bucket codes maintenance: The user can set various buckets for various reports. Client code mapping: This function lets the user map ALM account codes with the client account codes. MAP or SIR change. with the help of this function. In case the buckets defined by the RBI for SLP.

an asset–liability mismatch occurs when the financial terms of an institution's assets and liabilities do not correspond. The projected balances could be of any account head or any time bucket of an account head for the structural liquidity profile report.Asset liability management in banks 44 o 15 to 28 days o 29 days and up to 3 months o Over 3 months and up to 6 months o Over 6 months and up to 12 months o Over 1 year and up to 2 years o Over 2 years and up to 5 years o Over 5 years Data analysis: Data analysis projects the balance of any account head for any future date by three different methods — linear. three or more previous 'as on dates' is available with the system. ASSET-LIABILITY MISMATCH In finance. Several types of mismatches are possible. polynomial and exponential — provided the historical data for two. such K C College . a bank that chose to borrow entirely in US dollars and lend in Russian rubles would have a significant currency mismatch: if the value of the ruble were to fall dramatically. This is also known as forecasting. For example. In extreme cases. the bank would lose money.

This makes it imperative to have proper asset-liability management system in place. which may have long-term liabilities (promises to pay the insured or pension plan participants) that must be backed by assets. EMERGING ISSUES IN THE INDIAN CONTEXT With the onset of liberalization. On the other hand. Mismatches are handled by asset liability management. As another example.Asset liability management in banks 45 movements in the value of the assets and liabilities could lead to bankruptcy. Few companies or financial institutions have perfect matches between their assets and liabilities. but assets in fixed rate instruments. Choosing assets that are appropriately matched to their financial obligations is therefore an important part of their long-term strategy. such as deposits. liquidity problems and wealth transfer. This is sometimes called a maturity mismatch. The following points bring out the reasons as to why asset-liability management is necessary in the Indian context. Asset–liability mismatches are important to insurance companies and various pension plans. Indian banks are now more exposed to uncertainty and to global competition. a bank could have substantial long-term assets (such as fixed-rate mortgages) but short-term liabilities. Alternatively. which can be measured by the duration gap. such as between short-term deposits and somewhat longer-term. mitigated or hedged. In particular. higher-interest loans to customers is central to many financial institutions' business model. 'controlled' mismatch. Asset–liability mismatches can be controlled. a bank could have all of its liabilities as floating interest rate bonds. the mismatch between the maturities of banks' deposits and loans makes banks susceptible to bank runs. K C College .

K C College . An increasing proportions of investments by banks is being recorded on a marketto-market basis and as such large portion of the investment portfolio s exposed to market risks. Countering the adverse impact of these changes is possible only through efficient asset-liability management techniques. WHERE THE ASSET-LIABILITY MANAGEMENT IS GOING Changes in the availability of computers and the vast increase in their calculation power have led to ongoing refinements in the way risk is measured and managed. The following are three key topics where the results can significantly affect the risk measure ad where quantification is still difficult. Net Interest Margin=Net interest income/Average earning assets Net interest margin can be viewed as the spread on earning assets. asset-liability management refers to the process of managing the net interest margin within a given level of risk. will require efficient asset-liability management practices. there is an increasing possibility that the risk arising out of exposure to interest rate volatility will be built into the capital adequacy norms specified by the regulatory authorities. The biggest open issues on the risk measurement side are about the modeling of behavior-either the clients’ or the banks’. in turn. 2. 3. As the focus on the net interest margin has increased over the years. This. Several banks have inadequate and inefficient management system that have to be altered so as to ensure that the banks are sufficiently liquid. Efficient management of net interest margin becomes essential as the basic objective of banks is to maximize income while reducing their exposure to risk. 4. In the context of a bank.Asset liability management in banks 46 1.

All of these issues are about refinements to the basic approaches of asset-liability management. customer. a lot of work has been done to try to describe the balance behavior of savings and checking accounts. but they are still implemented by a minority of institutions. On the risk management side. While there are several distinct methodologies. but the framework is not going to change without a big push from somewhere else. market. The ideas are out there. and quantifying the impact of "unexpected" movements in one or more factors. all the strength and shortcoming and all demonstrating room for improvement. he next step in performance measurement will be to attempt to quantify returns in terms of the amount of risk taken. and competitor data. here is a wide range of methodologies in use. CHALLENGES FACED BY ASSET LIABILITY MANAGEMENT The Asset Liability Management function's main challenge lies in measuring the sensitivity of risk exposures to any change in one or more factors. understanding and quantifying performance remains an open issue. Funds transfer pricing systems allow some quantification of return from the interest rate but are not designed to describe how good that performance was. (b) Average life of non-maturity deposits: Again. in various approaches to risk-adjusted performance measurement systems. There is no definitive answer as to the average life of a deposit.Asset liability management in banks 47 (a) Prepayment: Much work has been done to describe the prepayment of mortgages. K C College . They do not represent radical departures from the basic frameworks of risk-measurement and risk-management. The process of asset-liability management will continue to refine itself. (c) Pricing strategies: The rates that banks pay on retail products still move at the discretion of the banks and in response to the factors other than moves in market rates. Other key challenges include:  Collating and cleaning product. no clear favorite emerges.

Asset Liability Management is a broad field with various specialties. Designing and implementing stochastic and deterministic modelling for earnings. customer behavior. process. Our services range from setting up the entire Asset Liability Management process to providing support in specific areas such as: Defining. system and controls for foreign exchange. credit integration. Conducting comprehensive front to back review and implementation of all supporting measurement.  Modelling the financial characteristics and event probabilities of non-maturity assets and liabilities such as customer deposits. or measure the impact of new regulations.Asset liability management in banks 48  Capturing the quality. CONCLUSION It is important to note that the conglomerate approach to financial institutions. capital management. This implies that the distinction between commercial banks and the K C College . risk and return. sourcing and maintaining Asset Liability Management data definition requirements. valuation. competitors and other external factors. governance. liquidity and overall integrated risk management. and liquidity risk implications on earnings. Value at Risk. could be replicated in Indian situations.  Modelling the potential growth and evolution of the balance sheet in response to business development strategies. Defining and developing Asset Liability Management models to calculate the risk and return impact of new products or new markets. credit cards.  Building an integrated modelling process that captures credit. interest rate risk. investment rollovers. cost to close. deposits or overall business areas – this includes supporting statistical studies and analysis. Reviewing and building behavioural models and implementation for cards. value and the overall balance sheet condition. valuation and risk-based performance of the balance sheet. option adjusted spread. which is increasingly becoming popular in the developed markets. Defining appropriate Asset Liability Management governance and providing guidance to the Asset Liability Management committee on directing the balance sheet. market.

org. The success of ALM. A bank’s liabilities include deposits. But it also provides opportunities of diversification across activities that could facilitate risk management on an enhanced footing. On the other side of the balance sheets are assets which are loans of various types which banks make tithe customer for various purposes.Asset liability management in banks 49 term lending institutions could become blurred. the strategy for the asset-liability management becomes more challenging because one has to adopt a modular approach in terms of meeting asset-liability management requirements of different decision and product lines. the survival is at stake. Balance sheet has direct implications on profitability of banks especially in terms of Net Interest Margin (NIM).in/Lists/Knowledge%20Bank/Attachments/106/Assel__liability K C College .in/rdocs/PressRelease/PDFs/3204. profitability and risk of constituents of both sides should be similar. improve profitability and manage risk under acceptable limits. The structure of banks’. insurance and pension borrowings and capital. But the nature.rbi. Risk Management and Basel Accord introduced by BIS depends on the efficiency of the management of assets and liabilities. BIBLIOGRAPHY  To view the two sides of banks’ balance sheet as completely integrated units has an intuitive appeal. So it is absolute necessary to maintain compatible assetliability structure to maintain liquidity. Hence these days without proper management of assets and liabilities. In such a situation. It is also possible that the same institution involves itself in short term and long term lending borrowing activities like mutual funds.pdf http://www.

html   sa=t&rct=j&q=asset+liability+management&source=web&cd http://www.htm INDEX K C College 50 .riskglossary.Asset liability management in banks .com/link/asset_liability_management.