Professional Documents
Culture Documents
3 - FIG09104 Fin. Mark.& Ins
3 - FIG09104 Fin. Mark.& Ins
1
ASSET – LIABILITY MANAGEMENT (ALM)
TOPIC TO BE COVERED
1. Why ALM?.
2. Concepts of ALM.
3. ALM process and organization.
4. Liquidity risk, position and funding.
5. Liquidity analysis and mitigating methods.
6. Success Conditions of ALM in banks
7. Management of Interest Rate Risk – An Overview.
2
(1) Why ALM?
New Development that Necestated ALM
Globalization of financial markets.
Product innovations & complexities.
Regulatory environment – BIS and Central Banks
regulatory frameworks and guidelines.
Deregulation of financial systems – increased
changes in market rates and risks- have increased
volatility and hence affecting market value,
yields/costs of assets & their spread and market value of
banks.
3
(1) Why ALM?
New Development that Necestated ALM Cont…
Narrowing NII/NIM
Multi-currency balance sheet.
Prevalence of basis risk and embedded option
risk.
Integration of markets – Money market, Forex
international markets + increased contagion risks
and complexity.
Recognition by bank Mgt on strategic coordination of
Assets and Liability management.
4
BUSINESS OF BANKING AND ALM
Banking business entails the identifying,
measuring, accepting, monitoring, controlling or
managing risk.
Thus, the heart or focus of Bank financial
management is Risk Management.
And one of the most important risk
management functions in banking is Asset
Liability Management (ALM) –especially market
risks.
5
ALM is thus, a strategic, integrated approach
to Bank Financial Management involving
simultaneous decisions on the types and
amount of financial assets and liabilities the
bank holds or their mix and volume.
Thus, ALM is basically coordinated
management of the bank balance sheet.
6
(2) CONCEPT OF ALM.
ALM is the process involving decision making
about the composition of assets and liabilities
including off balance sheet (OBS) items of the
bank/ Financial institutions and conducting the
risk assessment – with the aim of minimizing
liquidity and market risks & other risks.
It is a dynamic, integrated process of planning
organizing and controlling of assets and liabilities –
their volume mixes, maturities, yields and costs in
order to maintain liquidity and net interest income
/NIM.
7
(2) CONCEPT OF ALM Cont…
ALM = Strategic, coordinated tool for bank
management. ALM is concerned with strategic
management of the balance sheet by giving due
weighted to market risk viz liquidity risk, interest
rate & currency risk.
ALM function involves planning, directing, controlling
the flows, level, mix, cost and yied of funds of the bank.
ALM builds up assets and liabilities of the bank based
on the concept of the net interest income(NII) OR net
interest margin (NIM).
ASSET LIABILITY MANAGEMENT
Various risks affecting banks/financial
institutions
Liquidity, credit, capital market (interest –rate,
forex and price) and operational risks
Deregulation (Regulatory & Legal) & competitive
risks.
Need to manage risk to protect NIM.
Need for proper risk Management policy.
Liquidity planning, interest rate risk and forex risk
management.
9
OBJECTIVES OF ALM
(1) At macro-level, ALM aims at;
(a)the formulation of critical business policies.
(b)Efficient allocation of funds/capital and
(c)Designing of products with appropriate pricing
strategies.
(2) At micro-level, ALM aims at;
(a) At achieving profitability through price matching
(maintaining health spread and gap between assets
and liabilities (positive gap when interest are
expected to rise and negative gap when … and
10
(b) Ensuring liquidity by means of maturity
matching ( by grouping the assets / liabilities
based on their maturing profiles and then
assessing the liquidity gaps to identify future
financing requirements.
(3) ALM techniques aims to manage the volume,
mix, maturity, rate sensitivity, quality and
liquidity of assets as a whole so as to achieve a
predetermined, acceptable risk/return ratio.
(4) The ultimate objectives of ALM process is to
ensure adequate liquidity and to generate
adequate profitability/stable earnings and to
build the bank’s equity/ capital base, and thus,
to ensure long-term sustainability, while taking
calculate/ reasonable risks.
12
SCOPE OF ALM FUNCTIONS
Liquidity risk management
Management of market risk including interest
rate risk.
Current risk management
Funding and capital planning
Profit planning and growth projections
Trading risk management
13
ALM AS COORDINATED BALANCE SHEET MGT – 1
ALM function as a 2-stage approach to balance
sheet financial mgt:
Stage 1: Balance sheet mgt functions:
Asset side mgt :
Reserve position mgt
Liquidity mgt
Lending/credit/loan mgt
Investment/ security mgt
Fixed asset mgt
14
Stage 1: Balance sheet mgt functions Cont…
Liability side mgt/Liability mgt :
Liquidity & reserve position mgt
Deposit mgt
Long-term Debt mgt (e.g., Bond)
Capital adequacy mgt.
15
Stage 2: Income- Expense functions:
Profit = interest income – interest expenses –
PLL+ Non-interest revenue – Non-interest
Expenses – Taxes.
16
To achieve ALM objectives, banks need to formulate
policies that ensure effective
Spread mgt
Loan and investment portfolio quality
Generating fee income and service charges
Control of Non-interest operating expenses
Tax mgt
Capital Adequacy.
17
ALM ORGANIZATION
BODs have overall responsibility for mgt of risk
and should decide the risk mgt policy of the
bank and set limits for liquidity, interest rate,
foreign exchange and equity price risks.
Asset-Liability coordination (ALCO) consist of the
bank senior mgt, including CEO.
ALCO is responsible for ensuring adherence to
limit set by BODs + deciding business strategy of
the bank on A & L + deciding risk mgt objectives.
18
Composition of ALCO
Depend on the size of the bank, business mix and
organizational structure and complexity.
ALCO include CEO (chairman), Chiefs/Head of
investment, credit, operations, treasury, finance,
international banking, economic research, IT – i.e., Head
of directorate/ operational division/units.
The BODs should have the committee of directors – as
the managerial and supervisory committee consisting of
3 to 4 directors/board members to oversee the
implementation of the system + Funding strategies for
correcting the mismatches in ALM statements.
19
ALM ORGANIZATION- FUNCTIONS OF ALCO.
Implementation of ALM system:
Monitor the risk levels of the bank
Articulate the interest rate position and fix interest rate
on deposits & advances.
Fix differential rate of interest rate on bulk/large deposit.
Deal with dealers authorized limits.
To provide inputs to the treasurer regarding market
reviews and updating the B/sheet movements.
Facilitating and coordinating of putting in place or
improving the ALM system in the bank.
20
(4) LIQUIDITY RISK, POSITION AND FUNDING
What is liquidity risk?
Liquidity risk refers to the risk that the
institution might not be able to generate
sufficient cash flow to meet its contractual or
relationship obligations.
Liquidity exposure can come from internal
(bank specific) factors (how the bank is
perceived in local and international markets) or
external factors (Geographic, market, systemic
or specific instruments/ sources).
21
Effects of liquidity crunch
Liquidity crunch (also known liquidity crisis) – a time
when cash resource are in short supply and demand is
high. During a liquidity crunch, business and consumers
are charged at high interest rate on loans which are
more difficult to obtain
(i) Risks to bank earnings
(ii)Reputational risk
(iii)Contagion effect
(iv)Liquidity crisis can lead to runs on institutions –
Bank/FI failure affect economy.
22
Why Effective Liquidity Management Is An Important
Function For Banks?
(i) Demonstrates to the market that the bank is safe and is
capable to meet its obligations.
(ii)It enables the bank to meet its prio loans commitment.
(iii)It enables the bank to avoid the unplanned &
unprofitable sale of assets at ‘’ the fire sale ‘’ prices
(iv)It lowers the size of the default risk premium the bank
must pay for funds – as the back will be considered
liquidity and safe – and hence minimize cost of
funding. Class member may add other factors
23
Effective Liquidity Management Requires;
(i)Having a strong/effective MIS.
(ii)Centralized liquidity monitoring & control.
(iii)Systematic and rigorous analysis of Net
Funding Requirements (NFRs) under alternative
scenarios.
(iv)Diversification of funding sources.
(v)Effective contingency planning.
24
Liquidity Risks
Broadly there are three types of liquidity risks:
(i)Funding Risk: Due to unanticipated withdrawal/non
renewal of deposits.
(ii)Time Risk: Due to non-receipts of inflows on account
of assets (deterioration in asset quality/non-
performing assets/recovery problems)
(iii)Call Risk: Due to payment of contingent liabilities and
new demand for loans or inability to take up profitable
opportunities due to liquidity inadequacy/
problems/shortage.
25
Liquidity Risks Cont…
Factors Affecting Bank’s Liquidity and risk
Over extension of credit
High level of NPLs
Poor asset quality
Mismanagement
Non recognition of embedded option risk.
Reliance of a few wholesale depositors/deposit
concentrations.
Decline in earnings/ profitability
Expanded business opportunities
26
Liquidity Risks Cont…
Factors Affecting Bank’s Liquidity and risk Cont…
Downgrading by rating agencies
Acquisitions
New tax initiatives/ higher taxes
Lack of appropriate liquidity policy & contingent plan.
27
Measuring and Managing Liquidity Risk
Key steps for managing liquidity risk in banks:
(1)Developing structure ( Effective board and senior Mgt oversight),
policies, strategies, procedures and operating environment for sound
process for measuring, monitoring and controlling liquidity risk.
An integrated risk management policy of the bank should have the following
policies; (a) ALM policy(b) liquidity policy (c) credit/lending policy (d) Derivative
policy (e) Investment policy (f) composite risk policy for foreign exchange and
treasury.
28
Key steps for managing liquidity risk in banks
Cont...
(2)Setting tolerance level and limits for liquidity risk
(e.g., on cumulative cash flow mismatches; LA as
% of ST liabilities; loan to deposits; loan to
capital; % of dependence on different liability
categories. Customers or market segments;
max/min average maturity of different liability
categories and minimum liquidity provision to be
maintained to ensure effective operations)
29
Key steps for managing liquidity risk in banks
Cont..
(3)Measuring and managing liquidity risk.
TWO APPROACHES:
(a)Stock approach (SA)
Stock approach measures the level of assets and
liabilities and OBS exposures on a particular date using
ratios (e.g., core deposits to TA; Net loans to Total
deposits; Time deposits to Total deposits; VL to TA; ST
liabilities to LA; LA to TA; ST liabilities to TA; Cash balance
+ balance with other banks and central banks to TA;
short-term market liabilities to TA etc.)
(b) Follow/ Dynamic approach (DA)
This involve three main dimensions;
(i) Measuring and managing Net Funding
Requirements (NFRs) –gap method – involve
preparation of structural liquidity gap report. The
analysis of NFRs entails the construction of a
maturity ladder ( construction of future cash
inflows vs future cash outflows over a series of
specifies time periods) and calculation of
cumulative net excess or deficit of funds at
selected maturity dates.
31
This involve three main dimensions Cont…
(i) Measuring and managing Net Funding Cont…
A bank’s NFRs are determined by analyzing its
future cash flows (inflows and outflows) based on
the assumptions of the future behavior of assets,
liabilities and OBS items (given alternative
scenario. E.g., general market conditions, bank
specific crisis and general market crisis), and then
calculating the cumulative net excess or shortfall
over the time framework for the liquidity
assesment.
32
(b) Follow/ Dynamic approach (DA)
This involve three main dimensions Cont…
(ii) Managing market access – diversification of
sources of liabilities/ funding, establishing and
maintaining relationships with liability holders
and standby lines of credit, and good name/
reputation of the bank.
(iii) Contingency planning – essential of managing
general market of bank specific liquidity crisis.
Effective contingency plans addresses two (2)
main questions:
33
1)Does the management have an effective strategy
for handling a crisis?
2) Does a management have a proper and adequate
procedure in place for accessing funds (back-up
liquidity) in emergency situation(s)?
34
Methodologies for Measurement
Peer group comparison
Gap between sources and uses
Maturity ladder construction
Determining NFRs under alternative scenarios.
35
Factors to Analyze to Determine the Liquidity
Position Adequacy:
(1)Historical funding requirement
(2)Current liquidity position
(3)Anticipated future funding needs
(4)Source of funds
(5)Option for reducing funding needs
(6)Present and anticipate asset quality
(7)Present and future earning capacity
(8)Present and planned capital position
36
LIQUIDITY FUNDING NEEDS SOURCES
A combination of the following sources:
(1)Disposing of liquidity assets
(2)Increasing short-term liabilities
(3)Increasing long-term liabilities
(4)Mobilizing and diversifying deposits
(5)Increase equity source/capital
(6)Decrease holding of less liquidity assets.
37
GAP/ MISMATCH RISK
It arises on account of holding rate sensitive
assets and liabilities with different principal
amounts, maturity and repricing rates.
Even though maturity dates are same, if there is
mismatch between amount of assets and
liabilities it causes interest rate risk and affects
NII.
38
TOOLS FOR ALM SYSTEM
Gap Analysis
Modified Gap Analysis
Duration Gap Analysis
Value at Risk (VaR)
Simulation
Read for details in each of the tools above
39
GAP METHOD
Three Situations:
(1)RSA > RSL = POSITIVE GAP
(2) RSA < RSL = NEGATIVE GAP
(3) RSA = RSL = ZERO GAP
40
IMPACT ON NII
41
KEY ALM STATEMENTS TO BE PREPARED
(1)Statement of structural liquidity
(2)Statement of interest rate sensitivity
(3)Statement of dynamic liquidity
(4)Statement of maturity and position (MAP)-Forex
(5)Statement of sensitivity to interest rate forex.
42
(1) STATEMENT OF STRUCTURAL LIQUIDITY
Please all cash inflows and outflows in the
maturity ladder as per residual maturity.
Maturity liability (ML): cash flow.
Maturity asset (MA): cash inflow
Cash in to 8 time buckets
Mismatches in the first two buckets not to
exceed 20% of outflows.
Banks can fix higher tolerance level for other
maturity buckets.
43
ADRESSING MISMATCHES
Mismatches can be positive or negative
Positive mismatch: M.A. > M.L.and vice-versa for
negative mismatch
In case of +ve mismatch, excess liquidity can be
deployed in money market instruments, creating
new assets & investment swaps etc.
For a –ve mismatch, it can be financed from
market borrowings(call/term), bills rediscounting,
repos & deployment of foreign currency converted
into Tshs/Local/national currency.
44
DYNAMIC LIQUDITY
Prepared every fortnight for ALCO
Projection is given for the next three months
Tools for assessing the day to day liquidity needs
of the bank.
45
STATEMENT OF INTEREST RATE SENSITIVITY
Generated by grouping RSA, RSL & OFF-BALANCE
SHEET ITEMS in to various (8) time buckets.
Positive gap: Beneficial in case of rising interest
rate.
Negative gap: Beneficial in case of declining
interest rate.
46
SUCCESS OF ALM IN BANKS
Pre-conditions
(1)Awareness for ALM in the bank staff at all levels
supportive management & dedicated and skilled
team/personnel.
(2)Method of reporting data from branches/ other
departments. (Strong MIS)
(3)Computerization – full computerization,
networking.
47
(4)Insight into the banking operations, economic
forecasting, computerization, investment, credit
etc.
(5) Link up ALM to future risk management
strategies.
48
THANK YOU FOR LISTERNING
49