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Asset Liability Management in Banks

Components of a Bank Balance sheet:

Components of a Bank Balance sheet Liabilities Assets Capital Reserve & Surplus Deposits Borrowings Other Liabilities Cash & Balances with RBI Bal. With Banks & Money at Call and Short Notices Investments Advances Fixed Assets 6. Other Assets Contingent Liabilities

Components of Liabilities :

Components of Liabilities Capital: Capital represents owner’s 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:

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

Components of Liabilities:

Components of Liabilities 3. Deposits This is the main source of bank’s 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:

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:

Components of Liabilities 5. Other Liabilities & Provisions It is grouped as under: I. Bills Payable II. Inter Office Adjustments (Net) III. Interest Accrued

Components of Assets:

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

Components of Assets:

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

Components of Assets:

Components of Assets 3. Investments A major asset item in the bank’s balance sheet. Reflected under 6 buckets as under: I. Investments i) Government Securities ii) Other approved Securities iii) Shares iv) Debentures and Bonds v) Others (UTI Shares , Commercial Papers, COD & Mutual Fund Units etc.)

Components of Assets:

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 ii) Covered by Bank/ Government Guarantees iii) Unsecured

Components of Assets:

Components of Assets 5. Fixed Asset I. Premises II. Other Fixed Assets (Including furniture and fixtures) 6. Other Assets I. Interest accrued II. Tax paid in advance/tax deducted at source III. Stationery and Stamps

Contingent Liability:

Contingent Liability Bank’s obligations under LCs, Guarantees, Bills accepted by the bank are reflected under this heads.

Banks Profit & Loss Account:

Banks Profit & Loss Account A bank’s profit & Loss Account has the following components: Income: This includes Interest Income and non interest & Other Income. II. Expenses: This includes Interest Expended, Operating Expenses and Provisions & contingencies.

Components of Income:

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

Components of Income:

Components of Income 2. NON INTEREST AND OTHER INCOME I. Commission, Exchange and Brokerage II. Profit on sale of Investments (Net) III. Profit/(Loss) on Revaluation of Investments IV. Profit on sale of land, buildings and other assets (Net) V. Profit on exchange transactions (Net)

Components of Expenses:

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

Components of Expenses:

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

Assets Liability Management :

Assets Liability Management ALM 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.

Purpose & Objective of ALM:

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. Net Interest Income (NII) 2. Net Interest Margin (NIM)

Liquidity Management:

Liquidity Management Bank’s 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:

Adequacy of liquidity position for a bank Analysis of following factors throw light on a bank’s 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 h. Present and planned capital position

Statement of Structural Liquidity:

Statement of Structural Liquidity All Assets & Liabilities to be reported as per their maturity profile into 8 maturity Buckets: 1 to 14 days 15 to 28 days 29 days and up to 3 months Over 3 months and up to 6 months Over 6 months and up to 1 year Over 1 year and up to 3 years Over 3 years and up to 5 years 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 :

An Example of Structural Liquidity Statement


ADDRESSING THE MISMATCHES Mismatches can be positive or negative Positive Mismatch: A>L and Negative Mismatch L>A In case of +ve mismatch, excess liquidity can be deployed in money market instruments, creating new assets & investments etc. For –ve mismatch,it can be financed from market borrowings (Call/Term), Bills rediscounting, Repos etc.


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.


SUCCESS OF ALM IN BANKS : PRE - CONDITIONS Awareness for ALM in the Bank staff at all levels–supportive Management & dedicated Teams. Method of reporting data from Branches/ other Departments. (Strong MIS). Computerization-Full computerization, networking. Insight into the banking operations, economic forecasting, computerization, investment, credit. 5. Linking up ALM to future Risk Management Strategies.

Interest Rate Risk Management:

Interest Rate Risk Management Interest Rate risk is the exposure of a bank’s 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 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 item.

Interest Rate Risk:

Interest Rate Risk Interest rate risk refers to volatility in Net Interest Income (NII) or variations in Net Interest Margin(NIM). Therefore, an effective risk management process that maintains interest rate risk within prudent levels is essential to safety and soundness of the bank. Interest rate risk can be measured by gap and duration analysis.


Assignment Risk management in banks: Basel accord II CAMEL methodology

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