Assets Liability Management

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.

Significance of ALM
Volatility Product Innovations & Complexities Regulatory Environment Management Recognition

Purpose & Objective of ALM

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. It is aimed to stabilize short-term profits, long-term earnings and long-term substance of the bank. The parameters for stabilizing ALM system are: 1. 2. 3. Net Interest Income (NII) Net Interest Margin (NIM) Economic Equity Ratio

RBI DIRECTIVES
Issued draft guidelines on 10th Sept98. Final guidelines issued on 10th implementation of ALM w.e.f. 01.04.99. Feb99 for

To begin with 60% of asset &liabilities will be covered; 100% from 01.04.2000. Initially Gap Analysis to be applied in the first stage of implementation. Disclosure to Balance Sheet on maturity pattern on Deposits, Borrowings, Investment & Advances w.e.f. 31.03.01

Components of a Bank Balance sheet

Liabilities
1. 2. 3. 4. 5. Capital Reserve & Surplus Deposits Borrowings Other Liabilities

Assets
1. 2. 3. 4. 5. 6. Cash & Balances with RBI Bal. With Banks & Money at Call and Short Notices Investments Advances Fixed Assets Other Assets

Contingent Liabilities

Components of 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.

Components of Liabilities
2. Reserves & Surplus
Components under this head includes:
I. II. III. IV. V. Statutory Reserves Capital Reserves Investment Fluctuation Reserve Revenue and Other Reserves Balance in Profit and Loss Account

Components of Liabilities
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 as under: I. Demand Deposits II. Savings Bank Deposits III. Term Deposits

Components of Liabilities
4. Borrowings (Borrowings include Refinance / Borrowings from RBI, Inter-bank & other institutions) I. Borrowings in India i) Reserve Bank of India ii) Other Banks iii) Other Institutions & Agencies II. Borrowings outside India

Components of Liabilities
5. Other Liabilities & Provisions
It is grouped as under: I. II. III. IV. V. Bills Payable Inter Office Adjustments (Net) Interest Accrued Unsecured Redeemable Bonds (Subordinated Debt for Tier-II Capital) Others(including provisions)

Components of Assets
1. Cash & Bank Balances with RBI
I. Cash in hand (including foreign currency notes) II. Balances with Reserve Bank of India In Current Accounts In Other Accounts

Components of Assets
2. BALANCES WITH BANKS AND MONEY AT CALL & SHORT NOTICE
I. In India i) Balances with Banks a) In Current Accounts b) In Other Deposit Accounts ii) Money at Call and Short Notice a) With Banks b) With Other Institutions II. Outside India a) In Current Accounts b) In Other Deposit Accounts c) Money at Call & Short Notice

Components of Assets
3. Investments
A major asset item in the banks balance sheet. Reflected under 6 buckets as under: I. Investments in India in : *
i) Government Securities ii) Other approved Securities iii) Shares iv) Debentures and Bonds v) Subsidiaries and Sponsored Institutions vi) Others (UTI Shares , Commercial Papers, COD & Mutual Fund Units etc.) II. Investments outside India in ** Subsidiaries and/or Associates abroad

Components of Assets
4. Advances
The most important assets for a bank.
A. i) Bills Purchased and Discounted ii) Cash Credits, Overdrafts & Loans repayable on demand iii) Term Loans B. Particulars of Advances : i) Secured by tangible assets (including advances against Book Debts) ii) Covered by Bank/ Government Guarantees iii) Unsecured

Components of Assets
5. Fixed Asset
I. II. Premises Other Fixed Assets (Including furniture and fixtures)

6. Other Assets
I. II. III. IV. V. VI. Interest accrued Tax paid in advance/tax deducted at source (Net of Provisions) Stationery and Stamps Non-banking assets acquired in satisfaction of claims Deferred Tax Asset (Net) Others

Contingent Liability
Banks obligations under LCs, Guarantees, Acceptances on behalf of constituents and Bills accepted by the bank are reflected under this heads.

Banks Profit & Loss Account

A banks profit & Loss Account has the following components: Income: This includes Interest Income and Other Income. Expenses: This includes Interest Expended, Operating Expenses and Provisions & contingencies.

I. II.

Components of Income
1. INTEREST EARNED
I. II. III. IV. Interest/Discount on Advances / Bills Income on Investments Interest on balances with Reserve Bank of India and other inter-bank funds Others

Components of Income
2. OTHER INCOME
I. II. III. IV. V. VI. VII. Commission, Exchange and Brokerage Profit on sale of Investments (Net) Profit/(Loss) on Revaluation of Investments Profit on sale of land, buildings and other assets (Net) Profit on exchange transactions (Net) Income earned by way of dividends etc. from subsidiaries and Associates abroad/in India Miscellaneous Income

Components of Expenses
1. INTEREST EXPENDED
I. II. III. Interest on Deposits Interest on Reserve Bank of India / Inter-Bank borrowings Others

Components of Expenses
2. OPERATING EXPENSES
I. II. III. IV. V. VI. VII. VIII. IX. X. XI. XII. Payments to and Provisions for employees Rent, Taxes and Lighting Printing and Stationery Advertisement and Publicity Depreciation on Bank's property Directors' Fees, Allowances and Expenses Auditors' Fees and Expenses (including Branch Auditors) Law Charges Postages, Telegrams, Telephones etc. Repairs and Maintenance Insurance Other Expenditure

Liquidity Management
Banks liquidity management is the process of generating funds to meet contractual 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.

Adequacy of liquidity position for a bank

a. b. c. d. e. f. g. h. Analysis of following factors throw light on a banks adequacy of liquidity position: Historical Funding requirement Current liquidity position Anticipated future funding needs Sources of funds Options for reducing funding needs Present and anticipated asset quality Present and future earning capacity and Present and planned capital position

Funding Avenues
To satisfy funding needs, a bank must perform one or a combination of the following: Dispose off liquid assets Increase short term borrowings Decrease holding of less liquid assets Increase liability of a term nature Increase Capital funds

a. b. c. d. e.

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

Other categories of liquidity risk

Funding Risk - Need to replace net outflows due to unanticipated withdrawals/non-renewal Time Risk - Need to compensate for non-receipt of expected inflows of funds Call Risk - Crystallization of contingent liability

Statement of Structural Liquidity

All Assets & Liabilities to be reported as per their maturity profile into 8 maturity Buckets:
i. 1 to 14 days ii. 15 to 28 days iii. 29 days and up to 3 months iv. Over 3 months and up to 6 months v. Over 6 months and up to 1 year vi. Over 1 year and up to 3 years vii. Over 3 years and up to 5 years viii. Over 5 years

STATEMENT OF STRUCTURAL LIQUIDITY

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

An Example of Structural Liquidity Statement

1- 1 11 11 Days Days - 1 1 Days- 1Mths - 1Mths - 1 1 Year - 11Years - Over 1 1Month 1Mths 1 Year Years 1Years Years Total

11 11 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 11 1 1 1 1 1 1 1 1 1 11 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 11 1 1 1 1 1 1 1 1 1 11 1 1 1 1 1 11 11 1 1 1 1 1 1 1 11 1 1 1 1 1 1 11 1 1 1 1 1 1 1 11 1 1 1 1 11 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 11 1 1 1 1 1 1 1 1 1 11 1 1 1 1 1 11 11 1 11 11 11 1 1 1 1 1 1 11 11 11 11 11 11 1 1 1 1 1 1 1 1 1 11 11 1 Loans BPLR Linked 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 11 1 1 1 1 1 1 1 1 1 11 Others 1 1 1 1 1 1 1 1 1 11 11 1 1 Total Inflow 1 1 1 1 1 11 1 1 1 1 1 1 11 1 1 1 1 1 1 11 1 1 1 1 11 1 Gap -111 -111 1 -11 11 -111 1 -111 1 1 1 1 Cumulative Gap -111 -111 -111 -111 -111 -111 -111 1 1 -11 .11- .11 11 . .11 11 . 1 -111 1 . 1 . 11 Gap % to Total Outflow 11 1 . 1 -111-11 Capital Liab-fixed Int Liab-floating Int Others Total outflow Investments Loans-fixed Int Loans - floating

ADDRESSING THE MISMATCHES

Mismatches can be positive or negative Positive Mismatch: M.A.>M.L. and Negative Mismatch M.L.>M.A. 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.

STRATEGIES
To meet the mismatch in any maturity bucket, the bank has to look into taking deposit and invest it suitably so as to mature in time bucket with negative mismatch. The bank can raise fresh deposits of Rs 300 crore over 5 years maturities and invest it in securities of 1-29 days of Rs 200 crores and rest matching with other out flows.

Maturity Pattern of Select Assets & Liabilities of A Bank Liability/Assets Rupees (In Cr) 15200 8000 6700 230 270 450 180 00 150 120 8800 3400 3000 400 2000 5800 1300 300 900 3300 In Percentage

I. Deposits a. Up to 1 year b. Over 1 yr to 3 yrs c. Over 3 yrs to 5 yrs d. Over 5 years II. Borrowings a. Up to 1 year b. Over 1 yr to 3 yrs c. Over 3 yrs to 5 yrs d. Over 5 years III. Loans & Advances a. Up to 1 year b. Over 1 yr to 3 yrs c. Over 3 yrs to 5 yrs d. Over 5 years Iv. Investment a. Up to 1 year b. Over 1 yr to 3 yrs c. Over 3 yrs to 5 yrs d. Over 5 years

100 52.63 44.08 1.51 1.78 100 40.00 0.00 33.33 26.67 100 38.64 34.09 4.55 22.72 100 22.41 5.17 15.52 56.90

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.

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