Section: MF - 2

BANKING Assignment - 3

Submitted to: Dr Periasamy P

Name Reg No
Suvhrodeep Mondal 19MBAR0582

Score:

Faculty Signature:
 ANALYSING FINANCIAL STATEMENT OF ICICI BANK

INTRODUCTION
ICICI Bank is India's second-largest bank with total assets of about Rs.1,67,659 crore at March
31, 2005 and profit after tax of Rs. 2,005 crore for the year ended March 31, 2005 (Rs. 1,637
crore in fiscal 2004). ICICI Bank has a network of about 560 branches and extension counters
and over 1,900 ATMs. ICICI Bank offers a wide range of banking products and financial
services to corporate and retail customers through a variety of delivery channels and through
its specialized subsidiaries and affiliates in the areas of investment banking, life and non-life
insurance, venture capital and asset management. ICICI Bank set up its international banking
group in fiscal 2002 to cater to the cross border needs of clients and leverage on its domestic
banking strengths to offer products internationally. ICICI Bank currently has subsidiaries in
the United Kingdom, Canada and Russia, branches in Singapore and Bahrain and
representative offices in the United States, China, United Arab Emirates, Bangladesh and South
Africa.
ICICI Bank's equity shares are listed in India on the Stock Exchange, Mumbai and the National
Stock Exchange of India Limited and its American Depositary Receipts (ADRs) are listed on
the New York Stock Exchange (NYSE).
As required by the stock exchanges, ICICI Bank has formulated a Code of Business Conduct
and Ethics for its directors and employees.
At April 4, 2005, ICICI Bank, with free float market capitalization* of about Rs. 308.00 billion
(US$ 7.00 billion) ranked third amongst all the companies listed on the Indian stock exchanges.
ICICI Bank was originally promoted in 1994 by ICICI Limited, an Indian financial institution,
and was its wholly-owned subsidiary. ICICI's shareholding in ICICI Bank was reduced to 46%
through a public offering of shares in India in fiscal 1998, an equity offering in the form of
ADRs listed on the NYSE in fiscal 2000, ICICI Bank's acquisition of Bank of Madura Limited
in an all-stock amalgamation in fiscal 2001, and secondary market sales by ICICI to
institutional investors in fiscal 2001 and fiscal 2002. ICICI was formed in 1955 at the initiative
of the World Bank, the Government of India and representatives of Indian industry. The
principal objective was to create a development financial institution for providing medium-
term and long-term project financing to Indian businesses. In the 1990s, ICICI transformed its
business from a development financial institution offering only project finance to a diversified
financial services group offering a wide variety of products and services, both directly and
through a number of subsidiaries and affiliates like ICICI Bank. In 1999, ICICI become the
first Indian company and the first bank or financial institution from non-Japan Asia to be listed
on the NYSE.
After consideration of various corporate structuring alternatives in the context of the emerging
competitive scenario in the Indian banking industry, and the move towards universal banking,
the managements of ICICI and ICICI Bank formed the view that the merger of ICICI with
ICICI Bank would be the optimal strategic alternative for both entities, and would create the
optimal legal structure for the ICICI group's universal banking strategy. The merger would
enhance value for ICICI shareholders through the merged entity's access to low-cost deposits,
greater opportunities for earning fee-based income and the ability to participate in the payments
system and provide transaction-banking services. The merger would enhance value for ICICI
Bank shareholders through a large capital base and scale of operations, seamless access to
ICICI's strong corporate relationships built up over five decades, entry into new business
segments, higher market share in various business segments, particularly fee-based services,
and access to the vast talent pool of ICICI and its subsidiaries. In October 2001, the Boards of
Directors of ICICI and ICICI Bank approved the merger of ICICI and two of its wholly-owned
retail finance subsidiaries, ICICI Personal Financial Services Limited and ICICI Capital
Services Limited, with ICICI Bank. The merger was approved by shareholders of ICICI and
ICICI Bank in January 2002, by the High Court of Gujarat at Ahmadabad in March 2002, and
by the High Court of Judicature at Mumbai and the Reserve Bank of India in April 2002.
Consequent to the merger, the ICICI group's financing and banking operations, both wholesale
and retail, have been integrated in a single entity.

HISTORY
ICICI Bank was originally promoted in 1994 by ICICI Limited, an Indian financial institution,
and was its wholly-owned subsidiary. ICICI's shareholding in ICICI Bank was reduced to 46%
through a public offering of shares in India in fiscal 1998, an equity offering in the form of
ADRs listed on the NYSE in fiscal 2000, ICICI Bank's acquisition of Bank of Madura Limited
in an all-stock amalgamation in fiscal 2001, and secondary market sales by ICICI to
institutional investors in fiscal 2001 and fiscal 2002. ICICI was formed in 1955 at the initiative
of the World Bank, the Government of India and representatives of Indian industry. The
principal objective was to create a development financial institution for providing medium-
term and long-term project financing to Indian businesses.
In the 1990s, ICICI transformed its business from a development financial institution offering
only project finance to a diversified financial services group offering a wide variety of products
and services, both directly and through a number of subsidiaries and affiliates like ICICI Bank.
In 1999, ICICI become the first Indian company and the first bank or financial institution from
non-Japan Asia to be listed on the NYSE.

After consideration of various corporate structuring alternatives in the context of the emerging
competitive scenario in the Indian banking industry, and the move towards universal banking,
the managements of ICICI and ICICI Bank formed the view that the merger of ICICI with
ICICI Bank would be the optimal strategic alternative for both entities, and would create the
optimal legal structure for the ICICI group's universal banking strategy. The merger would
enhance value for ICICI shareholders through the merged entity's access to low-cost deposits,
greater opportunities for earning fee-based income and the ability to participate in the payments
system and provide transaction-banking services. The merger would enhance value for ICICI
Bank shareholders through a large capital base and scale of operations, seamless access to
ICICI's strong corporate relationships built up over five decades, entry into new business
segments, higher market share in various business segments, particularly fee-based services,
and access to the vast talent pool of ICICI and its subsidiaries.

In October 2001, the Boards of Directors of ICICI and ICICI Bank approved the merger of
ICICI and two of its wholly-owned retail finance subsidiaries, ICICI Personal Financial
Services Limited and ICICI Capital Services Limited, with ICICI Bank. The merger was
approved by shareholders of ICICI and ICICI Bank in January 2002, by the High Court of
Gujarat at Ahmadabad in March 2002, and by the High Court of Judicature at Mumbai and the
Reserve Bank of India in April 2002. Consequent to the merger, the ICICI group's financing
and banking operations, both wholesale and retail, have been integrated in a single entity.

Financial Statement Analysis

A financial statement analysis consists of the application of analytical tools and techniques to
the data in financial statements in order to derive from them measurements and relationships
that are significant and useful for decision making.
Uses of Financial Statement Analysis:
Financial Statement Analysis can be used as a preliminary screening tool in the selection of
stocks in the secondary market. It can be used as a forecasting tool of future financial conditions
and results. It may be used as process of evaluation and diagnosis of managerial, operating or
other problem areas.

Sources of Financial Information:

The financial data needed in the financial analysis come from many sources. The primary
source is the data provided by the company itself in its annual report and required disclosures.
The annual report comprises of the income statement, the balance sheet, and the statement of
cash flows.

Tools of Financial Analysis:

In the analysis of financial statements, the analyst has a variety of tools available to choose the
best that suits his specific purpose. In this report we will confine ourselves to Ratio Analysis
based on information provided from financial statements such as Balance Sheet and Profit &
Loss Account.
 Profit loss account

Mar ' 11 Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07

Income

Operating income 32,369.69 32,747.36 38,250.39 39,467.92 28,457.13

Expenses

Material consumed - - - - -

Manufacturing expenses - - - - -

Personnel expenses 2,816.93 1,925.79 1,971.70 2,078.90 1,616.75

Selling expenses 305.79 236.28 669.21 1,750.60 1,741.63

Administrative expenses 4,909.00 7,440.42 7,475.63 6,447.32 4,946.69

Expenses capitalized - - - - -

Cost of sales 8,031.72 9,602.49 10,116.54 10,276.82 8,305.07

Operating profit 7,380.82 5,552.30 5,407.91 5,706.85 3,793.56

Other recurring income 7.26 305.36 330.64 65.58 309.17

Adjusted PBDIT 7,388.08 5,857.66 5,738.55 5,772.43 4,102.73

Financial expenses 16,957.15 17,592.57 22,725.93 23,484.24 16,358.50

Depreciation 562.44 619.50 678.60 578.35 544.78

Other write offs - - - - -

Adjusted PBT -10,131.51 -12,354.42 -17,665.98 5,194.08 3,557.95

Tax charges 1,609.33 1,600.78 1,830.51 1,611.73 984.25

Adjusted PAT 5,110.21 3,890.47 3,740.62 4,092.12 2,995.00

Nonrecurring items 41.17 134.52 17.51 65.61 115.22

 Mar ' 11 Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07

Other non cash

adjustments -2.17 - -0.58 - -

Reported net profit 5,149.21 4,024.98 3,757.55 4,157.73 3,110.22

Earnings before
appropriation 8,613.59 6,834.63 6,193.87 5,156.00 3,403.66

Equity dividend 1,612.58 1,337.95 1,224.58 1,227.70 901.17

Preference dividend - - - - -

Dividend tax 202.28 164.04 151.21 149.67 153.10

Retained earnings 6,798.73 5,332.63 4,818.07 3,778.63 2,349.39

Cash Flow

Mar ' 11 Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07

Profit before tax 6,760.70 5,345.32 5,116.97 5,056.10 3,648.04

Net cash flow-operating activity -6,908.92 1,869.21 -14,188.49 -11,631.15 23,061.95

Net cash used in investing

activity -2,108.82 6,150.73 3,857.88 -17,561.11 -18,362.67

Net cash used in fin. Activity 4,283.20 1,382.62 1,625.36 29,964.82 15,414.58

Net inc/dec in cash and

equivalent -4,783.61 8,907.13 -8,074.57 683.55 20,081.10

Cash and equivalent begin of

year 38,873.69 29,966.56 38,041.13 37,357.58 17,040.22

Cash and equivalent end of year 34,090.08 38,873.69 29,966.56 38,041.13 37,121.32
 BALANCE SHEET

Balance Sheet of ICICI Bank ------------------- in Rs. Cr. -------------------

Mar '11 Mar '10 Mar '09 Mar '08 Mar '07

12 mths 12 mths 12 mths 12 mths 12 mths

Capital and Liabilities:

Total Share Capital 1,151.82 1,114.89 1,463.29 1,462.68 1,249.34
Equity Share Capital 1,151.82 1,114.89 1,113.29 1,112.68 899.34
Share Application Money 0.29 0.00 0.00 0.00 0.00
Preference Share Capital 0.00 0.00 350.00 350.00 350.00
Reserves 53,938.82 50,503.48 48,419.73 45,357.53 23,413.92
Revaluation Reserves 0.00 0.00 0.00 0.00 0.00
Net Worth 55,090.93 51,618.37 49,883.02 46,820.21 24,663.26
Deposits 225,602.11 202,016.60 218,347.82 244,431.05 230,510.19
Borrowings 109,554.28 94,263.57 67,323.69 65,648.43 51,256.03
Total Debt 335,156.39 296,280.17 285,671.51 310,079.48 281,766.22
Other Liabilities & Provisions 15,986.35 15,501.18 43,746.43 42,895.39 38,228.64
Total Liabilities 406,233.67 363,399.72 379,300.96 399,795.08 344,658.12
Assets
Cash & Balances with RBI 20,906.97 27,514.29 17,536.33 29,377.53 18,706.88
Balance with Banks, Money
13,183.11 11,359.40 12,430.23 8,663.60 18,414.45
at Call

Advances 216,365.90 181,205.60 218,310.85 225,616.08 195,865.60

Investments 134,685.96 120,892.80 103,058.31 111,454.34 91,257.84
Gross Block 9,107.47 7,114.12 7,443.71 7,036.00 6,298.56
Accumulated Depreciation 4,363.21 3,901.43 3,642.09 2,927.11 2,375.14
Net Block 4,744.26 3,212.69 3,801.62 4,108.89 3,923.42
Capital Work In Progress 0.00 0.00 0.00 0.00 189.66
Other Assets 16,347.47 19,214.93 24,163.62 20,574.63 16,300.26
Total Assets 406,233.67 363,399.71 379,300.96 399,795.07 344,658.11

Contingent Liabilities 883,774.77 694,948.84 803,991.92 371,737.36 177,054.18

Bills for collection 47,864.06 38,597.36 36,678.71 29,377.55 22,717.23

Ratio Analysis

Capital Adequacy Ratio:

A measure of a bank's capital. It is expressed as a percentage of a bank's risk weighted

credit exposures.

Table: 1.1

Mar’ 06 Mar '07 Mar '08 Mar '09 Mar '10

11.12 11.56 10.09 11.93 13.21
 Figures: 1.1

(Source: Calculated from the annual report of ICICI Bank.)

Capital adequacy ratio (CAR) is a ratio of a bank's capital to its risk. National regulators track
a bank's CAR to ensure that it can absorb a reasonable amount of loss and are complying with
their statutory Capital requirements. The formula for Capital Adequacy Ratio is, (Tier 1 Capital
+ Tier 2 Capital)/Risk Weighted Assets. Capital adequacy ratio is the ratio which determines
the capacity of the bank in terms of meeting the time liabilities and other risks such as credit
risk, operational risk, etc. In the simplest formulation, a bank's capital is the "cushion" for
potential losses, which protects the bank's depositors or other lenders. Here, in case of ICICI
Bank we can see that its CAR showed a sudden dip in the year 2008 but after that it has shown
a steady rise for the next 2 years which is a good sign for its depositors and investors.

Debt-Equity Ratio:
A measure of a company's financial leverage calculated by dividing its total
liabilities by stockholders' equity. It indicates what proportion of equity and debt the company
is using to finance its assets.
 Table: 1.2

Mar’ 06 Mar’ 07 Mar’ 08 Mar’ 09 Mar’ 10

69.93 84.22 102.11 186.19 234.24

Figure: 1.2

(Source: Calculated from the annual report of ICICI Bank.)

The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of
shareholders' equity and debt used to finance a company's assets. Here, in case of ICICI Bank
we can see that the Debt-Equity ratio has increased over the years. This is because its equity
capital showed no growth from the year 2006 to 2008 and it decreased by around Rs250 crore
in 2009 and remained the same for the year 2010. But its debt capital has shown a steady
increase over the past 5 years. From this we can infer that since ICICI Bank is a public sector
undertaking it depends much more on debt capital rather than equity capital.

CURRENT RATIO:
Current Ratio may be defined as the relationship between current assets and current
liabilities.
 Table: 1.3

Mar’ 06 Mar’ 07 Mar’ 08 Mar’ 09 Mar’ 10

65.17 79.27 98.16 182.22 238.24

Figure: 1.3
25

20

15
Mar’ 06
15.46
10

(Source: Calculated from the annual report of ICICI Bank.)

A relatively high current ratio is an indication that the firm is liquid and has the ability to pay
its current obligations in time as and when they become due. An increase in the current ratio
represent improvement in the liquidity position of the firm while a decrease in the current ratio
indicates that there has been deterioration in the liquidity position of the firm.

QUICK RATIO:
Quick ratio also known as Acid test or Liquid Ratio is more rigorous test of liquidity than the
current ratio.
 Table: 1.4

Mar’ 06 Mar’ 07 Mar’ 08 Mar’ 09 Mar’ 10

62.16 72.37 96.14 165.46 213.26

Figure: 1.4
25

20

15
Mar’ 06
15.46
10

(Source: Calculated from the annual report of ICICI Bank.)

Usually, a high test ratio is an indication that the firm is liquid and has the ability to meet its
current or liquid liabilities in time and on the other hand a low quick ratio represent that the
firm’s liquidity position is not good.

DEBT TURNOVER RATIO:

Debt turnover ratio indicates the velocity of debt collection of firm. In simple words, it indicates
the number of times average debtors are turnover during the year.
 Table: 1.5

Mar’ 06 Mar '07 Mar '08 Mar '09 Mar '10

15.46 16.45 11.87 17.46 19.25

Figure: 1.5

Chart Title
Series1 Series2

19.25 19.25
17.46
15.46 16.45

11.87

Mar’ 06 Mar '07 Mar '08 Mar '09 Mar '10

(Source: Calculated from the annual report of ICICI Bank.)

Debtors Turnover indicates the number of times the debtors are turned over during a year.
Generally, the higher the value of debtors turnover the more efficient is the management of
debtors and more liquid are the debtors.

Advances to Assets:
A high ratio of Advances to Assets would mean that the chances of Non Performing Assets
formation are also high, which is not a good scenario for a bank.
 Table: 2.1

Mar’ 06 Mar’ 07 Mar’ 08 Mar’ 09 Mar’ 10

0.60 0.63 0.61 0.62 0.60

Figure: 2.1

(Source: Calculated from the annual report of ICICI Bank.)

“Advances to Asset” is also a good indicator of a firm’s Capital Adequacy. A high ratio of
Advances to Assets would mean that the chances of Non Performing Assets formation are also
high, which is not a good scenario for a bank. This would mean the credibility of its assets
would go down. In case of ICICI Bank we can see that it is able to maintain a pretty steady
ratio of its Advances to Assets which means the credibility of its assets is good.

Government Securities to Total Investments:

The ratio of Government Securities to Total investments shows how safe are the company’s
investments.
 Table: 2.2

Mar’ 06 Mar’ 07 Mar’ 08 Mar’ 09 Mar’ 10

0.81 0.83 0.83 0.86 0.86

Figure: 2.2

(Source: Calculated from the annual report of ICICI Bank.)

The ratio of Government Securities to Total investments shows how safe are the company’s
investments. Here, in case of ICICI Bank we can see that its ratio of investments in Government
Securities to Total Investments is very high and it has remained quite steady over the years
with minimal fluctuations. The high ratio tells that ICICI Banks investment policy is
conservative and their investments are safe.
Earning Quality
Percentage Growth in Net Profits

Table: 3.1 (Per cent)

2007 0.61
2008 0.30
2009 0.35
2010 0.81

Figure: 3.1

(Source: Calculated from the annual report of ICICI Bank.)

As per the analysis it can be seen that the net profit of the bank is going continuously from the year
2008 onwards. In the year 2007 -08 the net profit was decreased because of the subprime crises in
USA. And again it was increased in 2008-09 as RBI did not stopped money flow in the market.
Net Profit to total Assets

Table: 3.2 (Per cent)

2006 0.0031
2007 0.0042
2008 0.0049
2009 0.0053
2010 0.0078

Figure: 3.2

(Source: Calculated from the annual report of ICICI Bank.)

Net profit to total assets is continue increasing from 2006 onwards .It means the bank is able to
utilize its assets.
Interest Income to Total Income

Table: 3.3 (Per cent)

2006 7.61
2007 7.86
2008 8.39
2009 8.79
2010 8.06

Figure: 3.3

(Source: Calculated from the annual report of ICICI Bank.)

Non-Interest Income to Total Income

Table: 3.4 (Per cent)

2006 0.30
2007 0.32
2008 0.36
2009 0.35
2010 0.32

Figure: 3.4

(Source: Calculated from the annual report of ICICI Bank.)

Summary of Ratios

Ratios

Mar ' 11 Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07

Per share ratios

Adjusted EPS (Rs) 44.37 34.90 33.60 36.78 33.30

Adjusted cash EPS (Rs) 49.25 40.45 39.70 41.97 39.36

Reported EPS (Rs) 44.73 36.10 33.76 37.37 34.59

Reported cash EPS (Rs) 49.61 41.66 39.85 42.56 40.64

Dividend per share 14.00 12.00 11.00 11.00 10.00

Operating profit per share (Rs) 64.08 49.80 48.58 51.29 42.19

Book value (excl rev res) per share

(Rs) 478.31 463.01 444.94 417.64 270.37

Book value (incl rev res) per share

(Rs.) 478.31 463.01 444.94 417.64 270.37

Net operating income per share (Rs) 281.04 293.74 343.59 354.71 316.45

Free reserves per share (Rs) 358.12 356.94 351.04 346.21 199.52

Profitability ratios

Operating margin (%) 22.80 16.95 14.13 14.45 13.33

Gross profit margin (%) 21.06 15.06 12.36 12.99 11.41

Net profit margin (%) 15.91 12.17 9.74 10.51 10.81

Adjusted cash margin (%) 17.52 13.64 11.45 11.81 12.30

Adjusted return on net worth (%) 9.27 7.53 7.55 8.80 12.31

Reported return on net worth (%) 9.35 7.79 7.58 8.94 12.79
 Mar ' 11 Mar ' 10 Mar ' 09 Mar ' 08 Mar ' 07

Return on long term funds (%) 42.97 44.72 56.72 62.34 82.46

Leverage ratios

Long term debt / Equity - - 0.01 0.01 0.01

Total debt/equity 4.10 3.91 4.42 5.27 9.50

Owners fund as % of total source 19.62 20.35 18.46 15.95 9.52

Fixed assets turnover ratio 3.55 4.60 5.14 5.61 4.52

Liquidity ratios

Current ratio 1.73 1.94 0.78 0.72 0.61

Current ratio (inc. st loans) 0.11 0.13 0.13 0.10 0.08

Quick ratio 15.86 14.70 5.94 6.42 6.04

Inventory turnover ratio - - - - -

Payout ratios

Dividend payout ratio (net profit) 35.23 37.31 36.60 33.12 33.89

Dividend payout ratio (cash profit) 31.76 32.33 31.00 29.08 28.84

Earning retention ratio 64.49 61.40 63.23 66.35 64.80

Cash earnings retention ratio 68.01 66.70 68.87 70.51 70.22

Coverage ratios

Adjusted cash flow time total debt 39.77 44.79 49.41 52.34 65.12

Financial charges coverage ratio 0.43 0.33 0.25 1.25 1.25

Fin. charges cov. ratio (post tax) 1.34 1.26 1.20 1.20 1.22
Component ratios

Material cost component (% earnings) - - - - -

Selling cost Component 0.94 0.72 1.74 4.43 6.12

Exports as percent of total sales - - - - -

Import comp. in raw mat. Consumed - - - - -

Long term assets / total Assets 0.83 0.80 0.75 0.78 0.80

Bonus component in equity capital

(%) - - - - -

Book Value (Rs) 478.31 463.01 444.94 417.64 270.37

 CONCLUSION

The balance-sheet along with the income statement is an important tool for investors and many
other parties who are interested in it to gain insight into a company and its operation. The
balance sheet is a snapshot at a single point of time of the company’s accounts- covering its
assets, liabilities and shareholder’s equity. The purpose of the balance sheet is to give users an
idea of the company’s financial position along with displaying what the company owns and
owes. It is important that all investors know how to use, analyze and read balance-sheet. P &
L account tells the net profit and net loss of a company and its appropriation. In the case of
ICICI Bank, during fiscal 2008, the bank continued to grow and diversify its assets base and
revenue streams. Bank maintained its leadership in all main areas such as retail credit,
wholesale business, international operation, insurance, mutual fund, rural banking etc.
Continuous increase in the number of branches, ATM and electronic channels shows the
growth take place in bank. Trend analysis of profit & loss account and balance sheet shows the
% change in items of p & l a/c and balance sheet i.e. % change in 2006 from 2005 and %change
in 2007 from 2006. It shows that all items are increased mostly but increase in this year is less
than as compared to increase in previous year. In p& l a/c, all items like interest income, non-
interest income, interest expenses, operating expenses, operating profit, profit before tax and
after tax is increased but in mostly cases it is less than from previous year but in some items
like interest income, interest expenses, provision % increase is more. Some items like tax,
depreciation, lease income is decreased. Similarly in balance sheet all items like advances,
cash, liabilities, and deposits are increased except borrowing switch is decreased. % increase
in some item is more than previous year and in some items it is less.
Ratio analysis of financial statement shows that bank’s current ratio is better than the quick
ratio and fixed/worth ratio. It means bank has invested more in current assets than the fixed
assets and liquid assets. The cash flow statement shows that net increase in cash generated from
operating and financing activities is much more than the previous year but cash generated from
investing activities is negative in both years. Therefore analysis of cash flow statement shows
that cash inflow is more than the cash outflow in ICICI Bank. Thus, the ratio analysis and trend
analysis and analysis of cash flow statement show that ICICI Bank’s financial position is good.
Bank’s profitability is increasing but not at high rate. Bank’s liquidity position is fair but not
good because bank invests more in current assets than the liquid assets. As we all know that
ICICI Bank is on the first position among the entire private sector bank of India in all areas but
it should pay attention on its profitability and liquidity. Bank’s position is stable.

ASSET LIABILITY MANAGEMENT

INTRODUCTION
Banks should introduce the proposed ASSET LIABILITY MANAGAENT (ALM) system
positively by April 1st 1999. The introduction of such procedure is necessary to the mismatches
in the assets and liabilities of the banks, which are increasingly seen in the past. Banks are
exposed to several major risks in the course of their business. Sum of them are credit risk,
interest risk, foreign exchange risk, price risk, liquidity risk and operational risk. It is the risk
with respect to interest rate and liquidity that are sought to be hedged and managed by Asset –
Liability Management.
The RBI and ALM propose to divide assets into different time buckets depending on the
maturity and category of the assets. The time buckets are supposed to be used for identifying
cumulative mismatches and establishing internal prudential limits with in the banks the
mismatches that exists after such and exercises should be reported to the RBI periodically.
The rational for accessing risk on a continuing basis is also to ensure that each bank has enough
at all times to cover the risks they incur, including those arising from interest rate risk. Till
now, bank have only focused on maintaining a prudent capital to risk-weighted assets ratio
(CAR), BUT LENDING risk is not only risk. Banks have to ensure that their capital covers all
risks including interest rate and liquidity risks.
Banks being financial intermediaries derive their long term profitability by effectively and
efficiently accepting investment from the public and transforming them to a relatively safe
portfolio of credit by virtue of their better access to market information and expertise in
apprising credit propositions of entrepreneurs. By offering customers the product-Deposits,
Credits, Investments that are in highest demand, the intermediaries earn higher profits. While
earning profits, intermediaries are also known to provide liquidity demanded by the market and
to an extent, also provide certain amount of insulation from credit risk. However, while
providing these services, intermediaries are subjected to interest rate risk since the value of the
short-term liabilities and the long-term assets change differentially in response to interest rate
moves. And being highly leveraged, they are exposed to significant interest rate risk and losses
could at time, be catastrophic if not managed properly.
It is basically a tool for liquidity and interest rate risk management. Bulk of the bank's profit
comes from net interest income and hence the paramount need to measure, control and manage
interest rate exposure. It is no exaggeration to state that many financial institutions failed
miserably by mismanaging the interest rate risk e.g. Housing finance companies of USA. These
institutes used to collect short-term deposits cheaply and lend on long term fixed interest rate
for housing. With deregulation of interest rates, the short-term deposit rates have gone up
leading to poor spread and ultimate collapse. ALM has thus become an absolute necessity.
Directing and controlling the flow, the means, the cost and the yield of the consolidated
funds of the bank with the eye on profit and long-term liability. Management of total
balance sheet liabilities with regards to its size and quality. Managing the net interest
margin with in the overall risk bearing capacity of the bank. It therefore, involves
quantification of risk and conscious decision-making with regard to asset liability structure
so as to maximize interest earning within the framework of perceived risk.

WHAT IS ASSET LIABILITY MANAGAENT?

• ALM is the management of structure of balance in such a way that the net
earning from interest in particular are maximized with overall risk-preference of the
institutions.
• It need to be noted that ALM is an integrated approach to financial
management requiring simultaneous decision about the type of amount of financial
assets and liabilities, both mix and value with the complexities of the financial
markets in which the institution operates.
• Assume that the structure of the existing assets and liabilities is such that at the
aggregate, the maturity of the assets is longer than the maturity of the liabilities.
This would expose to bank to interest rate risk as the interest rate can increase and
decrease. Thus the interest income can suffer in the process .This has to be set right
either by reducing the maturity of assets or increasing the maturity of the liabilities.
 Adjusted bank's liabilities to meet loan demands, liquidity needs and the safety
requirements with a focus on profit and long term operating viability.
 Discretionary funds management where the focal point is to increase or
 decrease interest sensitivity funds at the initiative of the bank.
 Directing and controlling the flow, the means, the cost and the yield of the
consolidated funds of the bank with the eye on profit and long-term liability.
Management of total balance sheet liabilities with regards to its size and quality.
Managing the net interest margin with in the overall risk bearing capacity of the
bank. It therefore, involves quantification of risk and conscious decision-making
with regard to asset liability structure so as to maximize interest earning within the
framework of perceived risk.
ALM helps bankers in successfully matching the assets and liabilities in terms of
rate and maturity with a view to obtain optimum yield to survive in the deregulated
and competitive environment.

WHY ASSET LIABILITY MANAGAENT

In pre-financial reforms era, banks were subjected to control measures by RBI in all activities
undertaken by them which includes:
 Regulated deposit interest rates.
 Minimum lending rates.
 Administered prime lending rates linked to borrow accounts.
 Generally fixed rates transactions, and Numbers of instruments available to the
user were also limited. All the above left the bank with widespread and helped to
maintain their bottom-lines at respectable levels.
The reforms process brought:
 Faced deregulation.
 New player.
 New instruments.
 New products at competitive rates.

Number of risks such as credit risk, interest risk, disintermediation risk,

liquidity risk, foreign exchange risk and market risk.
In the light of the above development and to maintain and improve the bottom-lines, there has
to be some system in place which should help to achieve the organizational objectives.
Asset liability management is one such effective and important tool. Thus, ALM is a risk
management tool through which market risk associated with the business are identified,
measured and monitored to maintain/optimize profits by re-aligning/re -structuring asset and
liabilities.
Important prerequisites successful AI.M is availability of adequate, accurate and expediency
of data. Banking is an activity where bank accept deposits for the purpose of lending. It is also
called intermediation.

 Banks do intermediation with an intention to earn profits.

 While doing so, banks are exposed to certain type of risks.

OBJECTIVES OF ASSET LIABILITY MANAGAENT

Banks being financial intermediaries derive their long term profitability by effectively and
efficiently accepting investment from the public and transforming them to a relatively safe
portfolio of credit by virtue of their better access to market information and expertise in
apprising credit propositions of entrepreneurs. By offering customers the product-Deposits,
Credits, Investments that are in highest demand, the intermediaries earn higher profits. While
earning profits, intermediaries
are also known to provide liquidity demanded by the market and to an extent, also provide
certain amount of insulation from credit risk. However, while providing these services,
intermediaries are subjected to interest rate risk since the value of the short-term liabilities and
the long-term assets change differentially in response to interest rate moves. And being highly
leveraged, they are exposed to significant interest rate risk and losses could at time, be
catastrophic if not managed properly.

Here comes 'Asset Liability Management" as a tool providing a degree of protection to bank
from intermediation risk, thereby making risk acceptable. It helps bank in-Maximization of
income through-

 Spread Management
 Liquidity Management
 Capital Management
 Gap Management

By assessing the impact and choosing optimal combination at

 Various Asset Mixes.

  Various fund combinations.
 Price/Volume relations and
 Interest rate variations.
And managing risk exposure viz.

 Credit Risk.
 Interest Rate Risk.
 Liquidity Risk,
 Market Risk.
 Capital Risk.

ASSET LIABILITY MANAGAENT:

It is basically a tool for liquidity and interest rate risk management. Bulk of the bank's profit
comes from net interest income and hence the paramount need to measure, control and manage
interest rate exposure. It is no exaggeration to state that many financial institutions failed
miserably by mismanaging the interest rate risk e.g. Housing finance companies of USA. These
institutes used to collect short-term deposits cheaply and lend on long term fixed interest rate
for housing. With deregulation of interest rates, the short-term deposit rates have gone up
leading to poor spread and ultimate collapse. ALM has thus become an absolute necessity.

Pre-Requisites for successful ALM

1. Easy access to bank's liabilities for potential investors.
2. Interest rates on bank's assets and liabilities to be competitively determined.
3. Favorable regulatory factor.

HOW TO PRACTISE ASSET LIABILITY MGMT:

Successful implementation of ALM involves -
1. Choosing a suitable length of planning horizon- one, two, three months ahead.
2. Working out estimates of return and risk that might result from pursuing
alternative programmers, and
3. Finally, choosing a model that yields a stable regardless of the level or
movement consistently. The task of generation of desired net interest revenues
regardless of the level or movement of interest rates is achieved primarily
 Estimation of core sources of funds, core deposit, CDs and call
 borrowings.
 Prudential management of funds in respect of size and pattern.
 Minimizing undesirable maturity mismatch; and
 Reducing the gap between rate sensitive assets and rate sensitive
 Liabilities within a risk taking capacity.

WHAT IS RISK?
The risk is nothing but a possible loss or damage going to occur. It has to be managed and
cannot be eliminated to earn maximum profits. There are three types of important risks
involved in the banking activity.
• Credit risk.
• Market risk.
• Operation risk.
and long-term horizons. Based on this, they are to assess their vulnerability to adverse changes,
and. therefore, protect them in advance.
Interestingly, in the international market, the regulator dose not monitors the ALM function of
the banks under its charges. It is internally motivated and not regulated. Managing risk is the
inherent function of a bank, hut banks have ignored house. Although some front line banks
have ALM system in place, there are several banks that do not have sophistication of making
mismatches in assets and liabilities.
The RBI is trying to assist these banks by providing them with an educative guideline of
managing assets and liability. Liquidity risk is the risk of a bank suddenly finding itself
strapped for cash. This arises if the maturity profiles of assets and liabilities do not match. The
objective of ALM is to ensure that the bank is liquid enough to meet all its liabilities.
The RBI is trying to ensure that the short-term liability should not be used to meet long-term
assets. The RBI wanted to discourage banks from borrowing short and investing long. Some
banks were borrowing from the call money market and investing in 90-days commercial
papers.
Obviously, given that the total basket of assets and liabilities is made up of diverse interest-
bearing securities any change in the interest rate scenario impact banks differentially.
According to a study paper prepared by the Basle Committee on bank supervision, although
this risk is a normal part of banking, excessive interest rate risk can pose a significant threat to
a bank's earnings and capital base. Changes in interest rates also affect the underlying value of
the bank's assets, liabilities and off balance sheet instruments because the present value of
future cash flows changes when the interest rate structure changes. Thus, an effective risk
management processes require that bank maintain their interest rate risk with in prudent levels,
said the banks analysts.

HOW THE BANK MANAGES INTEREST RATE RISK THROUGH

ASSET LIABILITY MANAGAENT

Asset Liability Management (ALM) in banks is known as the process of adjusting the liabilities
to meet the desired loan demands, liquidity needs and safety requirements.
A comprehensive ALM policy framework focuses on bank profitability and long-term viability
by targeting a net interest margin (NIM) ratio subject to some balance sheet constrains.
Significant among these constraints are maintaining credit quality, meeting liquidity needs and
obtaining sufficient capital. Minimizing the burden also gets integrated to meet the overall bank
objectives. A successful ALM requires a comprehensive deregulation of interest rates coupled
with a market-driven asset-liability allocation and a favorable regulatory attitude. The latter,
prerequisite has come in, but then coming in to operation of an active and well-developed
secondary market for the bank liabilities and assets is still far from complete.

DIMENSION OF RISK MANAGEMENTS

On the myriad balance-sheet risks that bank face today credit and interest rate risks mostly
accounts for their business risks. These and other risks expose a bank's business to certain
potential losses. These losses are of three types viz., expected, unexpected and stress loss. The
expected loss is always insurable by the myriad hedges and therefore, forms part of banks cost
of operation. There is the unexpected loss under adverse conditions, which cannot be predicted.
It is unexpected loss that is defined as value at risk (VAR). Then there is also a third type of
loss the bank may be prepared to face under extreme conditions which occurs rarely but
possibly. It is called as stress loss.

VALUE AT RISK
Value at risk technically is defined as the "loss amount, accumulated over a certain period that
is not exceeding in more than a certain percentage of all time". VAR (99%, 1 week) is equal to
the loss amount, accumulated over one week, which is not exceeding in more than one week,
and which is not exceeding more than 1% of all lime. For measuring VAR one relics on a
model of random changes in the price of underlying instruments- interest rate changes, changes
in foreign exchange rates etc. and a model for computing sensitivity of derivatives price relative
to the price of underlying instrument. In all these, one has to remember that a VAR measures
is merely a benchmark for relative judgments, such as the risk of one portfolio relates to
another, etc., even if accurate, comparison such as these are specific to a time horizon and the
confidence level with which VAR is chosen.

EARNING AT RISK
Earning at risk (EaR) models capture the period of profit or loss in terms of the realized profit
or loss as per the cost method used currently. It consists of three components viz., funds profit
or loss + redemption profit or loss + sales gain or loss.

EXPANDED VaR
It measures Ear and adjusts it for movement in market valuation as part of the period profit or
loss. It is equal to EaR + change in valuation gain or loss.
CAPITAL AT RISK
Capital at risk (CaR) measures risk as transportation from VaR. it is a surrogate of VaR viewed
from the angle of solvency of the bank. It is equivalent to the unexpected losses since expected
losses are taken care of by way of provisions. So long as the expected plus unexpected losses
stay within the limits of confidence then the bank is said to stay solvent.

INTEREST RATE RISK MANAGEMENT THE CRUX OF ALM

Market risk measures commodity, currency and interest rate risk as well. Commodity risk is
almost non-existent today for many Indian bank's and currency risk is controlled through
regulatory prescription there remains the interest rate risk (IRR) that largely poses a problem
to bank's interest income and hence profitability. It arises because bank's assets and liabilities
generally have their interest rates reset at different times. Changes in interest rates can
significantly alter a bank's net interest incomes (Nil) depending on the extent or mismatch
between the times when asset and liability interest rates are reset.
Changes in interest rates do also affect the market value of bank's equity. A method of
managing IRR first requires a bank to specify goals for either the book value or the market
value of Nil. In the former case, the focus will be on the current value of Nil and in the latter
case; the focus is on the market value of equity. In either case the bank as to measure the risk
exposure and formulate strategies to minimize or migrate the risk. The bank goals and strategies
in doing so normally reflect the management's policy concurrence.
The Gaps of interest rate sensitive may be identifying in the following time buckets:

1. 1-7 days
2. 8-14 days
3. 15-29 days
4. 1 month to 3 months
5. Over 3 months to 6 months
6. Over 6 months to 12 months
7. Over 1 year to 3 years
8. Over 3 years to 5 years
9. Above 5 years
10. Non-sensitive.
Measurement of Liquidity Risk (maturity profile)
All relatively non-sensitivity assets and liability items like intangibles, fixed assets, capital etc.
are taken out and the rest are put in to time buckets according to their remaining maturity as
opposed to original maturity.
Table: Maturity profile (Rs in Crores)
Time bucket Liabilities Assets
3 months 260.00 350.00
6 months 600.00 500.00
9 months 500.00 450.00
1 year 1000.00 1200.00

This information affords comparison of assets and liabilities within each maturity range. The
identified mismatch indicates the future needs for funds and help in planning future
borrowings.

Liquidity always changes with reference to time. Therefore, a statement of potential funds lows
during say the next month and the next month after that can provide the potential change in the
liquidity position of a bank. It helps bank in deciphering which pattern of cash flow is
dangerous, which is not and thus plan remedial action.

Measurement of Interest Rate Risks (GAP Analysis)

The simplest technique for measuring banks interest rate risk exposure begin with a
maturity/re-pricing schedule that distributes interest sensitive asset liability and

VARIOUS TYPE OF RISK INVOLVED IN THE BANKING SECTOR

CREDIT RISK
To address, the credit risk in the bank there is a committee called credit policy committee
(CPC). Which is headed by GM with other top executives as members? They address the issue
pertaining to credit risk. Every year the committee will lay down the norms for lending policy,
which contains several measures like prudential norms, sartorial deployment of funds,
assessment of risk associated with the loan proposal by way of customer credit rating etc. for
entire loan amount with the limit of over Rs 2 laces have been covered under credit audit, which
helps to improve its quality of pre-sanction appraisal and post-sanction monitoring.

MARKET RISK
If the income that is Nil or NIM is affected due to change in the interest rate/price in the market,
such risk are called market risks.
KINDS OF MARKET RISKS
• Interest Rate Risk
• Currency or Forex Risk
• Equity/Commodity Price Risk.

INTEREST RATE RISK

The phased deregulation of interest rate and operational flexibility given to bank in pricing
most of the assets and liabilities has been exposed bank to interest rate risk. Interest rate risk is
the risk where changes in market interest rates might adversely affect a bank's financial
condition. Changes in the interest rates might adversely affect both the current earnings
(earning prospective) and also the net worth of the bank (economic value perspective). The risk
from earning prospective is measured as change in the net interest income (Nil) or net interest
margin (NIM).

CURRENCY OR FOREX RISKS

This risk arises out of liabilities in one currency exceeding the level of assets in the same
currency. Presently, banks re-free to set gap limits with RBI’s approval but are required to
adopt value at risk approach to measure the risk associated with forward exposures. Thus the
open position limits together with gap limits from the risk management approach to forex
operations.

EQUITY PRICE/COMMODITY PRICE RISK

Equity price/commodity price risk arises owing lo changes in the prices of
shares/commodities, where the investors or individual has invested.

EMBEDDED OPTION RISK

• Penalty for premature payment of both deposits.
• Minimum lock in period etc.
• Buying commitment charges on non/underutilization of limits.

KYC and AML Compliance

As per the Prevention of Money Laundering Act, 2002 and the rules mentioned therein, every
banking company, financial institution and intermediary, as the case may be, are required to,
at the time of commencement of an account-based relationship and/or carrying out a financial
transaction as specified under regulations, identify its clients, verify their identity and obtain
information on the purpose and intended nature of the business relationship. Accordingly,
Reserve Bank of India (RBI) has advised banks to follow the (KYC) - ‘Know Your Customer
guidelines', wherein certain personal information of the account-opening prospect or the
customer is obtained. Objective of doing so is to enable the Bank to have positive identification
of its customers. KYC also ensures making reasonable efforts to determine true identity and
beneficial ownership of accounts, source of funds, the nature of customer’s business,
reasonableness of operations in the account in relation to the customer’s business, etc. which
in turn helps the banks to manage their risks prudently. Objective of the KYC guidelines is to
prevent banks being used, intentionally or unintentionally by criminal elements for money
laundering.
KYC guidelines of RBI mandate banks to collect three type of proofs from their customers.
They are:
a) Recent Photograph
b) Proof of identity
c) Proof of address

For whom Bank should obtain complete KYC?

For the purpose of the KYC Policy, a Customer is defined as:
• A person or entity that maintains an account and/or has a business relationship with the Bank;
• One on whose behalf the account is maintained (i.e. the beneficial owner);
• Beneficiaries of transactions conducted by professional intermediaries, such as Stock
Brokers, Chartered Accountants, Solicitors, etc. as permitted under the law;
• Any person or entity connected with a financial transaction, which can pose significant
reputation or other risks to the Bank, say, a wire transfer or issue of a high value demand draft
as a single transaction.

Why does the Bank ask you for proof of your identity and address?
The identification of a customer is very critical process, with a view to protect the customer
interests by preventing from fraudsters who may use the name, address and forge signature to
undertake benami / illegal business activities, encashment of stolen drafts, cheques, dividend
warrants, etc. This also helps to safeguard banks from unwittingly used for the transfer of
deposit of funds derived from criminal activity or for financing terrorism. Identification of
customers will also help to control financial frauds, identify money laundering and suspicious
activities, and for scrutiny / monitoring of large value cash transactions.

Are KYC requirements new?

No, KYC requirements have always been in place and Banks have been taking KYC documents
in accordance with the guidelines issued by RBI from time to time. RBI has revisited the KYC
guidelines in the context of recommendations made by the Financial Action Task Force (FATF)
on Anti Money Laundering standards and on Combating Financing of Terrorism and enhanced
the KYC standards in line with international benchmarks since India is a member of FATF.

Is KYC mandatory? Yes. It is a regulatory and legal requirement.

In terms of the guidelines issued from time to time by the Reserve Bank of India (RBI) on
Know Your Customer [KYC] Standards – Anti Money Laundering [AML] Measures, all banks
are required to put in place a comprehensive policy framework covering KYC Standards and
AML Measures. The Prevention of the Money Laundering Act, 2002 (PMLA) and Rules made
there under also requires Banks, Financial Institutions and Intermediaries to ensure that they
follow certain minimum standards of KYC and AML, as laid down in the Act and the ‘rules’
framed there under.

Anti Money Laundering-What you must know?

Money laundering has become a pertinent problem worldwide threatening the stability of
various regions by actively supporting and strengthening terrorist networks and criminal
organizations. The links between money laundering, organized crime, drug trafficking and
terrorism pose a risk to financial institutions globally.

What is Money Laundering and Financial Terrorism?

Money laundering refers to conversion of money illegally obtained to make it appear as if it
originated from a legitimate source. Money laundering is being employed by launderers
worldwide to conceal criminal activity associated with it such as drugs /arms trafficking,
terrorism and extortion. Financial Terrorism means financial support to, in any form of
terrorism or to those who encourage, plan or engage in terrorism. Money launderers send illicit
funds through legal channels in order to conceal their criminal origin while those who finance
terrorism transfer funds that may be legal or illicit in original in such a way as to conceal their
source and ultimate use, which is to support Financial Terrorism.

Once KYC requirements are complied with while opening the account, whether the bank
can again ask for KYC compliance from me?
Yes. To ensure that the latest details of customer identification are available, banks have been
instructed from time-to-time by RBI to periodically update the customer identification data
based upon the risk category of the customers.
Banks create a customer profile based on details about the customer like social/financial status,
nature of business activity, information about his clients’ business and their location, the
purpose and reason for opening the account, the expected origin of the funds to be used within
the relationship and details of occupation/employment, sources of wealth or income, expected
monthly remittance, expected monthly withdrawals etc. When the transactions in the account
are observed not consistent with the profile, the bank may ask for any additional details /
documents as required.

Periodic updation of KYC documents as per RBI Guidelines

According to the Reserve Bank of India's (RBI's) guidelines on KYC (Know Your Customer)
norms, banks are required to periodically update identification data of their customers,
including the customer's photograph, proof of identity and proof of address. Updating KYC
details regularly also ensures the security of your accounts, to keep your Bank Account
compliant with RBI's KYC guidelines. It is necessary for each customer to update the Bank
about his/her latest communication details.