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ASSET LIABILITY

MANAGEMENT

CONTENTS
Serial Topic Page No
I. Guidance-cum-completion certificate 7
II. Acknowledgement 8

III. Executive Summary 9


IV. Corporate Profile 11
V. Purpose and scope of study 14
VI. Methodology 14
VII. Project Details 15
1. Introduction 16
1.1. Definition of risk 16
1.2. Relation between risk and return 16
2. Risk in context of banking sector 17
2.1. Types of Risks 17
3. Risk Management 21
3.1. Key Factors in the evolution of financial institution 21
risk management practice
3.2. Steps involved in risk management 21
3.3. Techniques of risk management 22
4. Asset Liability Management 23
4.1. Definition 23
4.2. Importance of ALM 23
4.3. Significance of ALM 24
4.4. Parameters for stabilizing ALM 24
5. ALM Organizational Structure 25
5.1. Composition of ALCO 25
5.2. The Mid Office 25
5.3. The Dealing Room 26
5.4. The Back Office 26
5.5. Functions of ALM: Roles & Responsibilities 27
6. ALM Process 28
7. Management of Liquidity Risk 35
7.1. Adequacy of liquidity position of a bank 37
7.2. Sources of liquidity risk 37

ASSET LIABILITY
MANAGEMENT 2009
7.3. Types of liquidity risk 37
7.4. Measuring and managing market risk 38
7.5. Case study on dynamic liquidity 41
7.6. Structural liquidity statement 43
8. Management of Interest Rate Risk 44
8.1. Types of Interest rate risk 47
8.2. Effects of Interest rate risk 51
8.3. Interest rate risk management techniques 51
8.4. Sound interest rate risk management principles 52
9 Management of Exchange Rate Risk 53
9.1. Types of exchange risk 54
9.2. Tools and techniques of managing foreign exchange 55
risk
9.3. Steps in forex risk management 56
9.4. Strategies for foreign exchange management 58
10. Fund Transfer Pricing 59
11. Value at Risk (VaR) & Duration based ALM 61
11.1. The idea behind VaR 61
11.2. Methods of calculating VaR 61
11.3. Uses of VaR 62
12. Importance of IT and software in ALM 63
12.1. A Typical ALM System 64
13. Collection and Analysis of Data 68
13.1. ALM: A Banks Case Study 69
13.2. Data Analysis 69
14. Findings and recommendations 71
14.1. Liquidity under crisis scenario 71
14.2. Estimation of liquidity under market crisis scenario 72
15. Conclusion 73
16. Constraints and limitations 74
17. Scope of further study 74
18. Annexure I 75
19. Annexure II 80
20. Bibliography 83

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ASSET LIABILITY MANAGEMENT

LIST OF TABLES

Serial Topic Page no.


1 Organizational structure (UCO Bank) 13
2 Some probable risk scenario 20
3 ALM History 23
4 Composition of Liquid Fund 36
5 Dynamic liquidity structure of ABC Bank 42
6 Expected balance sheet of hypothetical bank 45
7 1% increase in short term rates: Expected balance sheet of 46
hypothetical bank

8 1% decrease in short term rates: Expected balance sheet of 46


hypothetical bank

9 Proportionate doubling in size: Expected balance sheet of 46


hypothetical bank

10 Increase in RSAs and decrease in RSLs: Expected balance 47


sheet of hypothetical bank

11 Statement showing impact of changing interest rates on 48


repricing assets and liabilities

12 Relation between interest rate changes and their impact on 49


NII

13 Interest sensitive gap position of 1-30 days bucket of XYZ 49


bank and Net impact on NII under changed scenario

14 Table showing yield curve risk involved as the spread 50


between two maturities of Treasury Bills is narrowed

15 Fund Management Profit Centre: The liability, credit and 60


mismatch spreads of a bank

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ASSET LIABILITY MANAGEMENT

LIST OF FIGURES

Serial Topic Page no.

1 Graph showing risk return trade-off 16

2 Flow of information towards decision making in ALM 29

3 Impact of hedging on expected cash flows of the firm 54

4 Conceptual comparison on differences among Operating, 55


Transaction and Translation foreign exchange exposure
5 Framework of Foreign Exchange Risk Management 57