Final Project Report 11111

8/8/2019 Final Project Report 11111

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Assets Liabilities Management

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ACKNOWLEDGEMENTWe hereby express our sincere thanks to Ms. Karishma Chawla, BCIDS

(SPJIMR), for her support, suggestions and encouragement throughout our

work.

We also thank her for her constant supervision and guidance throughout the

project work. We are also grateful to all faculty members at BCIDS for theirsupport.

PRASHANT AGRAWAL

SHOBHIT SONKAR

NIDHI CHANDRA

HITESH WAGHELA


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DECLARATIONWe, Prashant Agrawal, Shobhit Sonkar, Nidhi Chandra, Hitesh Waghela

students of APPFSM of BCIDS, hereby declare that this project report entitled

ASSETS AND LIABILITY MANAGEMENT is prepared by us during the

academic year 2009-2010 under the guidance and supervision of Ms. Karishma

Chawala, Faculty member, BCIDS, Mumbai.

DATE:

PLACE: Mumbai

PRASHANT AGRAWAL

SHOBHIT SONKAR

NIDHI CHANDRA

HITESH WAGHELA


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LIST OF CONTENT

S.No. PARTICULARS PAGE

NO.1 Balance sheet of YES Bank 5

2 Introduction 6

3 Component of Bank Balance Sheet 7

4 ALM in Bank 16

History of ALM18

Objective of ALM 19

Purpose of ALM 20

5 ALM Process 21

6 ALM Organisation 25

7 Liquidity Management 29

8 Risk in ALM 32

y Interest Rate Risk 32

y Foreign Exchange Risk 32

y Liquidity Risk 32

y Credit Risk 34

9 Measuring and Managing Liquidity Risk 35


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Stock Approach 36

Flow Approach 36

10 Statement of Structural Liquidity 37

11 Gap Analysis 39

12 Duration Analysis 41

13 Success of ALM in Bank 42

14 Reference 43


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

Mar '07 Mar '08 Mar '09

Capital and Liabilities:12 mths 12 mths 12 mths

Total Share Capital 280.00 295.79 296.98

Equity Share Capital 280.00 295.79 296.98

Share Application Money 0.00 0.00 0.00

Preference Share Capital 0.00 0.00 0.00

Reserves 507.06 1,023.13 1,327.24

Revaluation Reserves 0.00 0.00 0.00

Net Worth 787.06 1,318.92 1,624.22

Deposits 8,220.39 13,273.16 16,169.42

Borrowings 867.32 986.21 2,189.06

Total Debt 9,087.71 14,259.37 18,358.48

Other Liabilities & Provisions 1,228.68 1,404.13 2,918.10

Total Liabilities 11,103.45 16,982.42 22,900.80

Mar '07 Mar '08 Mar '09

Assets: 12 mths 12 mths 12 mths

Cash & Balances with RBI 389.76 959.24 1,277.72

Balance with Banks, Money at Call 903.08 668.33 644.99

Advances 6,289.73 9,430.27 12,403.09

Investments 3,073.12 5,093.71 7,117.02

Gross Block 86.66 133.01 194.88

Accumulated Depreciation 17.38 35.73 64.15

Net Block 69.28 97.28 130.73

Capital Work In Progress 1.59 3.89 0.39

Other Assets 376.88 729.70 1,326.86

Total Assets 11,103.44 16,982.42 22,900.80

Contingent Liabilities 51,724.67 65,990.12 39,632.14

Bills for collection 336.91 2,884.42 3,849.80

Book Value (Rs) 28.11 44.59 54.69


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Introduction

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 real banking business and commercial banks

were mere executors of what RBI decided. But now, BIS is standardiz ing 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 banks

liabilities include deposits, borrowings and capital. On the other side o f 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.


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COMPONENTS OF A BANK BALANCE SHEET

Liabilities AssetsCapital

Reserve & Surplus

Deposits

Borrowings

Other Liabilities

Cash & Balances with RBI

Bal. With Banks & Money at Call and Short

Notices

Investments

Advances

Fixed Assets

Other Assets

Contingent Liabilities

1. Capital:

Capital represents owners contribution/stake in the bank.It serves as a

cushion for depositors and creditors.It is considered to be a long term sources

for the bank.

2. Reserves & Surplus

Components under this head include:

I. Statutory Reserves

It is the amount of money any bank has to maintain with the

Reserve bank for every customer. Say you deposit Rs. 100 in ABC

Bank, the bank cannot lend all the 100 bucks. They have to pledge

a small amount say Rs. 10 with RBI and can lend only theremaining 90 and make an income out of that 90.This 10 bucks is

the statutory reserve. The RBI modifies this reserve periodically.

II. Capital Reserves

The expression capital reserves shall not include an amount

regarded as free for distribution through the profit & loss account.


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Surplus on revaluation or sale of fixed assets should be treated ascapital reserves

III. Investment Fluctuation ReserveThe net profits and losses of an investment company from the

purchase and sale of securities shall be respectively credited and

debited by the company to a reserve account to be kept by it and to

be called the "investment fluctuation reserve

IV. Revenue and Other Reserves

The expression Revenue Reserves shall mean any reserve other

than capital reserve. This item will include all reserves, other than

those separately classified.

V. Balance in Profit and Loss Account

Includes balance of profit after appropriations. In the case of loss

balance may be shown as a deduction.

3. Deposits

This is the main source of banks funds. The deposits are classified as

deposits payable on demand and time. They are reflected in balance sheet asunder:

I. Demand Deposits

Includes all banks deposits repayable on demand. Others Includesall demand deposits of the non-bank sectors. Credit balances inoverdrafts, cash credit accounts deposits payable at call, overdue

deposits, inoperative current accounts, matured time deposits andcash certificates, etc. are to be included under this category .

II. Savings Bank Deposits

Includes all savings bank deposits (including inoperative

savings bank accounts).Includes all types of banksdeposits repayable after a specified term.Includes alltypes of deposits of the non-bank sector repayable after

specified term. Fixed deposits, cumulative andrecurring deposits, cash certificates, annuity deposits,


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deposits mobilised under various schemes, ordinary staff

deposits, foreign currency non-resident deposits.

4. Borrowings

(Borrowings include Refinance / Borrowings from RBI, Inter-

bank & other institutions)

Includes borrowings/refinance and rediscount obtained from Reserve Bank of

India.Includes borrowings/refinance and rediscount obtained from commercial banks (including co-operative banks) Includes borrowings/refinance and

rediscount from Industrial Development Bank of India, Export-Import Bank ofIndia, National Bank for Agricultural and Rural Development and other

institutions, agencies (including liability against participation certificates, ifany)

Includes borrowings and rediscounts of Indian branches abroad

as well as borrowings of foreign branches.This item will be shown separately: Includes secured borrowings/refinance in

India and outside India .

5. Other Liabilities & Provisions

It is grouped as under:

Bills Payable

Inter Office Adjustments (Net)

Interest Accrued

Unsecured Redeemable Bonds

(Subordinated Debt for Tier-II Capital)

Others(including provisions


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Components of Assets

1.Cash & Bank Balances with RBI

Includes cash in hand including foreign currency notes foreign and also

foreign branches in the case of banks having such branches. Includes thebalance maintained with the Reserve Bank of India in Current Account.

2.Balances with banks and money at call & short notice

Includes balances held with the Reserve Bank of India other than in currentaccounts, if any. Includes all balances with banks in India (including co-operative banks). Balances in current accounts and deposit accounts should beshown separately. Includes deposits repayable within 15 days or less than 15

days notice lent in the inter-bank call money short other banks market notice inIndia Includes balances held by foreign branches and balances held by Indian

branches of the banks outside India.Balances held with foreign branches by other branches of the bank should

not be shown under this head but should be included in inter branch accounts.

The amounts held in current accounts and deposit accou nts should be shown

separately. Includes deposits usually classified in foreign countries as money atcall and short notice.

3.Investments

A major asset item in the banks balance sheet. Reflected under 6

buckets as under:

I. Investments in India in :y Government Securities

y Other approved Securities

y Shares

y Debentures and Bonds

y Subsidiaries and Sponsored Institutions

y Others (UTI Shares , Commercial Papers, COD &


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Mutual Fund Units etc.)

II. Investments outside India in

Subsidiaries and/or Associates abroad

4. Advances

In classification under Section A, all outstandings in India as well as outside

less provisions made, will be , classified under three heads as indicated and

both secured and unsecured advances will be included under these heads.

All advances or part of advances which are secured by tangible assets may be

shown here. The item will include advances in India and outside India.

Advances in India and outside India to the extent they are covered by

guarantees of Indian and foreign governments and Indian and foreign banks are

to be included. All advances not classified under (i) and (ii) will be included

here.

Advances should be broadly classified into Advances in India and Advances

outside India. Advances in India will be further classified on the sectoral basis

as indicated advances to sectors which for the time being are classified as

priority sectors according to the instructions of the Reserve Bank are to be

classified under the head Priority sectors. Advances to Central and State

Governments and other Government undertakings including Government

companies and corporations which are, according to the statutes, to be

treated as public sector. All advances to the banking sector including co -

operative banks will come under the head Banks. All the remaining advances

will be included under this head Others and typically this category will include

non-priority advances to the private, joint and co-operative sectors.


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5. Fixed Asset

I. Premises

Premises wholly or partly owned by the banking company for the purpose of

business including residential premises should be shown against Premises. In

the case of premises and other fixed assets, the previous balance, additions

thereto and deductions there from during the year as also the total depreciation

written off should be shown. Where sums have been written off on reduction of

capital or revaluation of assets, every balance sheet after the first balance sheet

subsequent to the reduction or revaluation should show the revised figures with

the date and amount of revision made .

II. Other Fixed Assets (Including furniture and fixtures)

Motor vehicles and all other fixed assets other than furniture premises but

including furniture and fixtures should be shown under this head.

6. Other Assets

I. Interest accrued

Interest accrued but not due on investments and advances and interest due but

not collected on investments will be the main components of this item. As banks

normally debit the borrowers account with interest due on the balance sheetdate, usually there may not be any amount of interest due on advances. Only

such interest as can be realised in the ordinary course should be shown under

this head.


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II. Tax paid in advance/tax deducted at source

(Net of Provisions)

The amount of tax deducted at source on securities, .advance tax paid, etc. to the

extent that these items are not set off against relative tax provisions should be

shown against this item.

III. Stationery and Stamps

Only exceptional items of expenditure on stationery like bulk purchase of

security paper, loose leaf or other ledgers, etc. which are shown as quasi -asset tobe written off over a period of time should be shown here. The value should be

on a realistic basis and cost escalation should not be taken into account, as these

items are for internal use.

IV. Others

This will include non-banking assets and items like claims which have not beenmet, for instance, clearing items, debit items representing addition to assets or

reduction in liabilities which have not been adjusted for technical reasons, want

of particulars, etc. advances given to staff by a bank as employer and not as a

banker, etc. Items, which are in the nature of expenses, which are pending

adjustments, should be provided for and the provision netted against this item so

that only realisable value is shown under this head. Accrued income other than

interest may also be included here.


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Contingent Liability

Banks obligations under LCs, Guarantees, Acceptances on behalf of

constituents and Bills accepted by the bank are reflected under this heads .

RECLASSIFICATION OF ASSETS &

LIABILITIES

The assets and liabilities of a Bank are divided into various sub heads. For the

purpose of the study, the assets were regrouped under six major heads and theliabilities were regrouped under four major heads as shown in table below. This

classification is guided by prior information on the liquidity -return profile of assets

and the maturity-cost profile of liabilities. 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.

Reclassification of Liabilities

Net Worth Capital, Reserves and Surpluses

Borrowing Borrowing from RBI, banks, other FlIs both

from India and Abroad

Short term Deposits Demand Deposits and Savings BankDeposits

Loan Term Deposit All deposit not included in short term


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Table Reclassification of Assets

Liquid Assets Cash in hand,Balance with RBI,Bal withBank,Money at Call and short notice

SLR Securities Govt Securities and other approved

Securities

Investment Other than SLR such as shares,Debentures

bonds,subsidiaries and others

Term Loans Term loan

Short term Loans Advances not in TL Bill Purchased and

discounted cash credit ,overdraft and loans

Fixed Assets Fixed Assets


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Asset liability management in banks


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INTRODUCTION:

Definition

It is a dynamic process of Planning, Organizing & Controlling of Assets &

Liabilities- their volumes, mixes, maturities, yields and costs in order to

maintain liquidity and NII.

y An attempt to match:

Assets and Liabilities

To explore the relationship between assets and liabilities, we could merely compute

the correlation between each set of assets and each set of liabilities.

Unfortunately, all of these correlations assess the same hypothesis - that assets

influence liabilities. Hence, a Bonferroni adjustment needs to be applied. That is,

we should divide the level of significance by the number of correlations. This

Bonferroni adjustment, of course, reduces the power of each correlation and thus

can obscure the findings. Canonical correlation provides a means to explore all

of the correlations concurrently andthus obviates the need to incorporate a

Bonferroni adjustment. The technique reduces the relationship into a few

significant relationships.The essence of canonical correlation Measures the

strength of relationship between two sets of variables (Assets (6) & Liabilities (4)

in this case) by establishing linear combination of variables in one set and a

linear combinations of variables in other set. It produces an output that shows the

strength of relationship between two variates as well as individual variables

accounting for variance in other set

.A = A1 * (Liquid Assets) + A2 * (SLR Securities)+ A3 * (Investments) + A4 *

(Term Loans) + A5 *

(Short Term Loans) + A6 * (Fixed Assets)


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B = B1 * (Net Worth) + B2* (Borrowings) + B3 *(Short Term Deposits) + B4 *

(Long Term Deposits)

To begin with, A and B (called canonicalvariates) are unknown. The technique

tries to compute the values of Ai and Bi such that the covariance between A & B

is maximum.

Asset Liability Management

Asset Management Liability Management

How Liquid are the assets of

the Bank

How easy can the bank

generate loans from market


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HISTORY OF ALM

Historically, ALM has evolved from the early practice of managing liquidity on

the bank's asset side, to a later shift to the liability side, termed liabilitymanagement, to a still later realization of using both the assets as well as

liabilities sides of the balance sheet to achieve optimum resources management.

But that was till the 1970s. In the 1980s, volatility of interest rates in USA and

Europe caused the focus to broaden to include the issue of interest rate risk.

ALM began to extend beyond the ban k treasury to cover the loan and deposit

functions. The induction of credit risk into the issue of determining adequacy of

bank capital further enlarged the scope of ALM in later 1980s .

s

In the current decade, earning a proper return of bank equity and hence

maximization of its market value has meant that ALM covers the management

of the entire balance sheet of a bank. This implies that the bank managements

are now expected to target required profit levels and ensure minimization of

risks to acceptable levels to retain the interest of investors in their banks. This

also implies that costing and pricing policies have become of paramount

importance in banks.

Deregulation of interest rates

Interest Rate Risk

Liquidity Risk Credit Risk


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OBJECTIVE OF ALM

y An effective Asset Liability Management Technique aims to manage the

volume, mix, maturity, rate sensitivity, quality and liquidity of assets and

liabilities as a whole so as to attain a predetermined acceptable

risk/reward ration

y Aim is to stabilize the short-term profits, long-term earnings and long-

term substance of the bank. The parameters that are selected for the

purpose of stabilizing asset liability management of banks are:

-Net Interest Income (NII)

Interest Income-Interest Expenses

-Net Interest Margin (NIM)

Net Interest Income/Average Total Assets

-Economic Equity Ratio

The ratio of the shareholders funds to the total assets measures the shifts

in the ratio of owned funds to total funds. The fact assesses the sustenance

capacity of the bank.

PURPOSE OF ALM

y Review the interest rate structure and compare the same to the

interest/product pricing of both assets and liabilities y Examine the loan and investment portfolios in the light of the

foreign exchange risk and liquidity risk that might arise.


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y Examine the credit risk and contingency risk that may originate

either due to rate fluctuations or otherwise and assess the quality

of assets.

y Review,the actual performance against the projections made and

analyse the reasons for any effect on spreads

ALM PROCESS

The scope of ALM function can be described as follows:

y Liquidity Risk Management

It is the risk of having insufficient liquid assets to meet the liabilities

at a given time.

y Management of Market Risks

Market risk is the risk that the value of a portfolio, either an investment

portfolio or a trading portfolio, will decrease due to the change in value of the

market risk factors.

Market Risks are:

Equity risk, the risk that stock prices and/or the implied volatility will

change.

Interest rate risk, the risk that interest rates and/or the implied volatility will

change.


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Currency risk, the risk that foreign exchange rates and/or the implied

volatility will change.

Commodity risk, the risk that commodity prices (e.g. corn, copper, crude oil)

and/or implied volatility will change.

y Trading Risk Management

Proper risk management is a key to success in forex trading. Learning how to

manage your risk can make or break your trading career. Trading Risk

Management includes:

Introduction to Risk Management Managing Risk on a Demo Account Choosing a Lot Size Extreme Leverage Risk Reward Ratio Surviving a wild forex market Risk Management Ideas

Money Management Basics Position Sizing Limiting Losses Creating a Trading Plan

y Funding and Capital Planning

Capital budgeting (or Capital planning) is the planning process used to

determine the budget for major capital, or investment, expenditures.

Many formal methods are used in capital budgeting, including the techn iques

such as


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Accounting rate of return

Net present value

Profitability index

Internal rate of return

Modified internal rate of return Equivalent annuity

When a corporation determines its capital budget, it must acquire said funds.

Three methods are generally available to publicly traded corporations: corporate

bonds, preferred stock, andcommon stock. The ideal mix of those fundingsources is determined by the financial managers of the firm and is related to the

amount of financial risk that corporation is willing to undertake. Corporate

bonds entail the highest financial risk and therefore gene rally have the lowest

interest rate. Preferred stock have no financial risk but dividends, including all

in arrears, must be paid to the preferred stockholders before any cash

disbursements can be made to common stockholders; they generally have

interest rates higher than those of corporate bonds. Finally, common stocks

entail no financial risk but are the most expensive way to finance capital

projects.

y Profit Planning and Growth Projection

Profit is an essential cost of business activity and must be planned and managed

just like other costs. Successful business performance requires balancing costs

and revenues as illustrated by the following model.

Costs of the future (profit) + current costs (expenses) = Average revenue perunit sold x sales volume (net revenue).


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The effective manager must make trade -offs among these variables to keep this

equation in balance and this requires effective profit planning.

Advantages of Profit Planning

Performance evaluation

Awareness of responsibilities.

Cost consciousness

Disciplined approach to problem-solving

Thinking about the future

Financial planning

Confidence of lenders and investors

Why ALM?

One-line answer to manage NIM

How NIM is linked to ALM?

Planning process of a Commercial Bank

1.Day-to-day week-to-week Balance Sheet management to achieve

short-term fin goals

2.Annual Profit Planning

3.Strategic planning- long term fin and non-fin aspects


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Ass

tsLi

biliti

s Management

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AL ORGANISATION

a) The B shoul have overall responsi ilit for management of risks and

should decide the risk management policy ofthe bank and setlimits for

li uidity, interest rate, foreign exchange and equity price risks.


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b) The Asset - Liability Committee (ALCO) consisting of the bank's senior

management including CEO should be responsible for ensuring adherence to

the limits set by the Board as well as for deciding the business strategy of the

bank (on the assets and liabilities sides) in line with the bank's budget and

decided risk management objectives.

c) The ALM desk consisting of operating staff should be responsible for

analysing,monitoring and reporting the risk profiles to the ALCO. The staff

should also prepare forecasts (simulations) showing the effects of various

possible changes in market conditions related to the

balance sheet and recommend the action needed to adhere to bank's internal

limits.

The ALCO is a decision making unit responsible for balance sheet planning

from risk -return perspective including the strategic management of interest rate

and liquidity risks. Each bank will have to decide on the role of its ALCO ,its

responsibility as also the decisions to be taken by i t.

The size (number of members) of ALCO would depend on the size of each

institution, business mix and organisational complexity. To ensure commitment

of the Top Management, the CEO/CMD or ED should head the Committee. The

Chiefs of Investment, Credit, Funds Management / Treasury (forex and

domestic), International Banking and Economic Research can be members of

the Committee. In addition the Head of the Information Technology Division

should also be an invitee for building up of MIS and related computerisation.

Some banks may even have sub-committees .

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.


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AssetsLiabilities Management

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LIQUIDITY MANAGEMENT(Project focus on Liquidity Management)


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LIQUIDITY MANAGEMENT

Banks liquidity management is the process of generating funds to meetcontractual or relationship obligations at reasonable prices at all times.

New loan demands, existing commitments, and deposit withdrawals are

the basic contractual or relationship obligations that a bank must meet.

Banks need liquidity to meet deposit withdrawal and to fund loan

demands. The variability of loan demands and variability of deposits

determine banks liquidity needs. It represents the ability to accommodate

decreases in liability and to fund increases in assets. It demonstrates the

market place that the bank is safe and therefore capable of repaying its

borrowings. It enables bank to meet its prior loan commitments, whether

formal or informal. It enables bank to avoid the unprofitable sale of

assets. It lowers the size of the default risk premium the bank must pay

for funds.

ADEQUACY OF LIQUIDITY POSITION FOR A BANK

Analysis of following factors throw light on a banks adequacy of liquidity

position:

y Historical Funding requirement

y Current liquidity position

y Anticipated future funding needs

y Sources of funds

y Options for reducing funding needs

y Present and anticipated asset quality

y Present and future earning capacity and

y Present and planned capital position


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FUNDING AVENUESTo satisfy funding needs, a bank must perform one or a combination of the

following:

y Dispose off liquid assets

y Increase short term borrowingsy Decrease holding of less liquid assets

y Increase liability of a term nature

y Increase Capital fund


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RISKS IN ALM

Interest Rate Risk

Foreign Exchange Risk Liquidity Risk

Credit Risk

Contingency Risk

Interest Rate Risk: It is the risk of having a negative impact

on a banks future earnings and on the market value of its equity

due to changes in interest rates.

Forex Risk: It is the risk of having losses in foreign exchange

assets and liabilities due to exchanges in exchange rates among

multi-currencies under consideration.

Liquidity Risk: It is the risk of having insufficient liquid

assets to meet the liabilities at a given time.

TYPES OF LIQUIDITY RISK:

Liquidity Exposure can stem from both internally and

externally.

External liquidity risks can be geographic, systemic or

instrument specific. Internal liquidity risk relates largely to perceptions of an

institution in its various markets: local, regional, national or

international.


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OTHER CATEGORIES OF LIQUIDITY RISK:

Funding Risk

Time Risk

Call Risk.

Funding Risk:

Need to replace net outflows due to unanticipated withdrawal/non-

renewal of deposits arises due to :

-Fraud causing substantial loss

-Systemic Risk

-Loss of confidence-Liabilities in foreign currencies

Time Risk:

Need to compensate for non-receipt of expected inflow of funds,

arises due to,

-Severe deterioration in the asset quality

-Standard assets turning into non-performing

assets

-Temporary problems in recovery

-Time involved in managing liquidity

Call Risk:

Crystallisation of contingent liabilities and inability to undertake

profitable business oppurtunities when desirable,arises due to,

-Conversion of non-fund based limit into fund based. -Swaps

and options.


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How do a bank manages its liquidity risk?

Measuring and managing liquidity needs are vital activities of

commercial banks. By assuring a bank's ability to meet its liabilitiesas they become due, liquidity management can reduce the probability

of an adverse situation developing. The importance of liquidity

transcends individual institutions, as liquidity shortfall in one

institution can have repercussions on the entire system. 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.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. Therefore liquidity has to be

tracked through maturity or cash flow mismatches.

For measuring and managing net funding requirements, 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.


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STEPS IN MEASURING AND MANAGING LIQUIDITY

RISK

Developing a structure for managing liquidity risk.

Setting tolerance level and limit for liquidity risk.

Measuring and managing liquidity risk

Setting tolerance level for a bank:

y To manage the mismatch levels so as to avert wide

liquidity gaps-The residual maturity profile of assets and

liabilities will be such that mismatch level for time bucket

of 1-14 days and 15-28 days remain around 20% of cash

outflows in each time bucket.

y To manage liquidity and remain solvent by maintaining

short-term cumulative gap up to one year(short term

liabilities-short term assets at 15% of total outflow of

funds.

Measuring and Managing Liquidity Risk

y Stock Approach

y Flow Approach


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Stock Approach :

It is based on the level of assets and liabilities as well as off balance

sheet exposures on a particular date.The following ratios are

calculated to assess the liquidity position of the bank:

- Ratio of core deposits to total assets

- Net loans to total deposits ratio

-Ratio of time deposits to total deposits

- Ratio of volatile liabilities to total assets

- Ratio of short term liabilities to liquid assets

- Ratio of liquid assets to total assets

- Ratio of short term liabilities to total assets

- Ratio of prime assets to total assets

- Ratio of market liabilities to total assets.

Flow Approach:

-Measuring and managing net funding requirements.

-Managing Market Access

-Contingency Planning

Measuring and Managing net funding requirements:

y Flow method is the basic approach followed by Indian

Banks.It is called as gap method of measuring and

managing liquidity.It requires the preparation of structuralliquidity gap report.In this method net funding requirement

is calculated on the basis of residual maturities of assets &

liabilities.These residual maturities represent net cash

flows ie.difference between cash outflow & cash inflow in

future time buckets


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y These calculations are based on the past behaviour pattern

of assets and liabilities as well as off balance

sheetexposures.Cumulative gap is calculated at various

time buckets.In case gap is negative bank has to manage

the shortfall.

y The analysis of net funding requirements involves the

construction of a maturity ladder and the calculation of a

cumulative net excess or deficit of funds at selected

maturity dates.

Maturity ladder & calculation of cumulative

surplus/deficits at selected dates

Construction of time buckets:

1 to 30/31 days

Over 1 month and upto 2 months

Over 2 months and upto 3 months

Over 3 months and upto 6 months

Over 6 months and upto 1 year

Over 1 year and upto 3 years

Over 3 years and upto 5 years

Over 5 years


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STATEMENT OF STRUCTURAL LIQUIDITY

Places all cash inflows and outflows in the maturity ladder as per

residual maturityMaturing Liability: cash outflow

Maturing Assets : Cash Inflow

Classified in to 8 time buckets

Mismatches in the first two buckets not to exceed 20% of outflows

Shows the structure as of a particular date

Banks can fix higher tolerance level for other maturity buckets.

ADDRESSING TO 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 ve mismatch,it can be financed from market

borrowings(call/Term),Bills rediscounting,repos & deployment

of foreign currency converted into rupee.

INTEREST RATE RISK

y Interest rate risk refers to volatility in Net Interest Income (NII)

or variations in Net Interest Margin(NIM).


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y Therefore, an effective risk management process that maintains

interest rate risk within prudent levels is essential to safety and

soundness of the bank

Sources of Interest Rate Risk

Interest rate risk mainly arises from:

Gap Risk

Basis Risk

Net Interest Position Risk

Embedded Option Risk

Yield Curve Risk

Price Risk

Reinvestment Risk

Measurement of Interest Rate Risk

There are various techniques to measure this risk:

1.Gap Analysis

2.Duration Gap Analysis

3.Simulation

4.Value at Risk


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GAP ANALYSIS

The gap is the difference between the amount of assets andliabilities on which the interest rates are reset during a given

period

It arises on account of holding rate sensitive assets and liabilities

with different principal amounts, maturity/repricing rates

Even though maturity dates are same, if there is a mismatch

between amount of assets and liabilities it causes interest raterisk and affects NII

Calculating Gap over different time intervals at a given date

Mismatches between RSL and RSA

(GAP = RSA(( i) - RSL(( i) = NII(( i) for each time bucket

Positive GAP ( RSA > RSL )

Increasing Interest Rates would be beneficial for a Bank

Negative GAP ( RSL > RSA )

Falling Interest Rates would be beneficial for a Bank


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IMPACT ON NII

Gap Interest rate Change Impact on NII

Positive Increases Positive

Positive Decreases Negative

Negative Increases Negative

Negative Decreases Positive

Duration Analysis:

Duration is a measure of the percentage change in the economic value

of a position that occur given a small change in level of interest rate.

Interest Rate Risk Management

Interest Rate risk is the exposure of a banks financial conditions

to adverse movements of interest rates.

Though this is normal part of banking business, excessive interest

rate risk can pose a significant threat to a banks earnings and

capital base.

Changes in interest rates also affect the underlying value of the

banks assets, liabilities and off-balance-sheet item.


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SUCCESS OF ALM IN BANKS :

PRE CONDITIONS

1.Awareness for ALM in the Bank staff at all levelssupportive

Management & dedicated Teams.

2.Method of reporting data from Branches/ other Departments.

(Strong MIS).

3.Computerization-Full computerization, networking.

4.Insight into the banking operations, economic forecasting,

computerization, investment, credit.

5. Linking up ALM to future Risk Management Strategies.

s


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REFERENCES:

y www.rbi.org.in

y www.wikipedia.org

y www.google.com

y www.almprofessional.com

Final Project Report 11111

Documents

Transcript of Final Project Report 11111