PGP 2007-09 : Term III Commercial Banking :PGP 2007-09 : Term III Commercial Banking Asset Liability Management April 2008


Pre-Financial Sector Reforms (1991) :Com Bkg 2008 ALM 2008 2 Pre-Financial Sector Reforms (1991) Geographical spread of Bank branches Directed Investments / Credit Programs Administered Rates of Interest Accrual based accounting Problems of Recovery of Loans Deterioration in Quality of Assets /Loans Erosion of Profits No Computerisation Trade Union Issues


Banking Reforms 1993 onwards :Com Bkg 2008 ALM 2008 3 Banking Reforms 1993 onwards L-P-G Policy of GOI since 1991 Technological Changes – ATMs / Internet New Products and Services : Competition Narasimham Committee - I / II on Financial / Banking Sector Reforms (1991 & 1997) Capital Adequacy Ratio : IRAC Norms : NPAs Priority Sector Loans: Reduce from 40 to 10%? Reduce SLR (40%) and CRR (15%) Benchmark Prime Lending Rates Enactment / Amendments to various laws


Banking Sector Reforms ……. :Com Bkg 2008 ALM 2008 4 Banking Sector Reforms ……. Market determined Rates of Interest No directed lending or investments Organisational Changes : Transparency 4 way classification of Loan Accounts / Assets Provisioning for Losses o/a NPAs & Std Assets ALM (1999) and Risk Management, KYC in Banks Non Performing Assets definition revised from 4 quarters (1993) dues in Principal & Interest to 3 (1994) to 2 (1995) quarters and now from April 01, 2004 – just 90 days / 1 quarter ! Basel II norms for Bank Supervision from 2008!


ALM - Introduction :Com Bkg 2008 ALM 2008 5 ALM - Introduction


Slide 6:Com Bkg 2008 ALM 2008 6


Slide 7:Com Bkg 2008 ALM 2008 7


Slide 8:Com Bkg 2008 ALM 2008 8


Risks :Com Bkg 2008 ALM 2008 9 Risks Various Risks Interest Rate Risk Foreign Exchange Risk Liquidity Risk Credit Risk Contingency Risk


Liquidity Risk Profile of a Bank(Rs in crores) :Com Bkg 2008 ALM 2008 10 Liquidity Risk Profile of a Bank(Rs in crores)


International Initiatives in Managing Risks :Com Bkg 2008 ALM 2008 11 International Initiatives in Managing Risks Till the 1980s, a professional risk manager was unheard of Late 1980s, US Financial Firms started using VaR Basel I ;1988 Risk Metrics, 1995 Bank for International Settlement (BIS) - a series of risk management guidelines for Banks worldwide Market Risk Guidelines of Basel, 1996 Basel II process ( November 2005 Document)


Risk Management :Com Bkg 2008 ALM 2008 12 Risk Management How to bring it (Risks) down to manageable levels? The 5-step process Identification of risks Quantification Policy formulation Strategy formulation Monitoring


WHAT IS ALM? :Com Bkg 2008 ALM 2008 13 WHAT IS ALM? An attempt to match: Assets and Liabilities In terms of: Maturities and Interest Rates Sensitivities To minimize: Interest Rate Risk and Liquidity Risk


Slide 14:Com Bkg 2008 ALM 2008 14 Asset Liability Management How Liquid are the assets of the Bank How easily can the Bank generate loans from market


Asset Liability Management :Com Bkg 2008 ALM 2008 15 Asset Liability Management ALM is an integral part of the financial management process of any bank. ALM is concerned with strategic balance sheet management involving risks caused by changes in the interest rates, exchange rates and the liquidity position of the bank. While managing these three risks forms the crux of ALM, credit risk and contingency risk also form a part of the ALM


Asset Liability Management :Com Bkg 2008 ALM 2008 16 Asset Liability Management ALM can be termed as a risk management technique designed to earn an adequate return while maintaining a comfortable surplus of assets beyond liabilities. It takes into consideration interest rates, earning power, and degree of willingness to take on debt and hence is also known as Surplus Management


ALM and NIM :Com Bkg 2008 ALM 2008 17 ALM and NIM ALM is all about efficient management of balance sheet dynamics with regard to its size, constituents and quality. It is the process of managing the Net Interest Margin (NIM) within the overall risk bearing ability of a bank ALM process depends on the understanding of the balance sheet; the availability, accuracy, adequacy and expediency of the data and the MIS system


GAP Analysis :Com Bkg 2008 ALM 2008 18 GAP Analysis One way to measure the direction and extent of asset-liability mismatch is by using gap analysis. The analysis derives its name from the “gap” which is the difference between the amounts of Rate Sensitive Asset (RSA) and Rate Sensitive Liabilities (RSL).


HISTORY OF ALM :Com Bkg 2008 ALM 2008 19 HISTORY OF ALM Mid 1970s in the U.S.A. Interest Rate Risk Deregulation of Interest Rates Liquidity Risk Credit Risk


Definition of ALM :Com Bkg 2008 ALM 2008 20 Definition of ALM ALM is defined as, “the process of decision – making to control risks of existence, stability and growth of a system through the dynamic balances of its assets and liabilities.” The text book definition of ALM is “a risk management technique designed to earn an adequate return while maintaining a comfortable surplus of assets beyond liabilities. It takes into consideration interest rates, earning power and degree of willingness to take on debt. It is also called surplus- management”.


Slide 21:Com Bkg 2008 ALM 2008 21 SUCCESS OF ALM PROCESS The ALM process rests on Three Pillars: ALM Information Systems ALM Organisation ALM Process


1. ALM INFORMATION SYSTEM :Com Bkg 2008 ALM 2008 22 1. ALM INFORMATION SYSTEM Decision Support and Reporting Tool Comparison between different Branches Product Analysis Duration Gap Analysis Risk Planning and Management Flexible Design Strategic Planning of the Asset-Liability Mix Simulation Analysis Transfer- Pricing Mechanism


2. ALM ORGANISATION :Com Bkg 2008 ALM 2008 23 2. ALM ORGANISATION Strong Commitment of Senior Management ALCO should comprise the Senior Management ( including the CEO) A Support Group of Operational Staff


Slide 24:Com Bkg 2008 ALM 2008 24


Slide 25:Com Bkg 2008 ALM 2008 25


Slide 26:Com Bkg 2008 ALM 2008 26


3. ALM PROCESS :Com Bkg 2008 ALM 2008 27 3. ALM PROCESS The scope of ALM function can be described as follows: Liquidity Risk Management Management of Market Risks Trading Risk Management Funding and Capital Planning Profit Planning and Growth Projection


Slide 28:Com Bkg 2008 ALM 2008 28 Price Matching (Rs. cr.) * Average cost/return on liabilities/assets.


Slide 29:Com Bkg 2008 ALM 2008 29 Maturity Matching (Rs. cr.) (period in months)


Risks in ALM :Com Bkg 2008 ALM 2008 30 Risks in ALM Interest Rate Risk: It is the risk of having a negative impact on a bank’s future earnings and on the market value of its equity due to changes in interest rates. Liquidity Risk: It is the risk of having insufficient liquid assets to meet the liabilities at a given time. 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.


MANAGEMENT OF LIQUIDITY RISK :Com Bkg 2008 ALM 2008 31 MANAGEMENT OF LIQUIDITY RISK Availability of funds as & when liabilities are due Liquidity through maturity & cash flow matching Maturity ladder & calculation of cumulative surplus/deficits at selected dates


MANAGEMENT OF LIQUIDITY RISK :Com Bkg 2008 ALM 2008 32 MANAGEMENT OF LIQUIDITY RISK 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


MANAGEMENT OF LIQUIDITY RISK :Com Bkg 2008 ALM 2008 33 MANAGEMENT OF LIQUIDITY RISK Main focus on Short Term mismatches Mismatches during 1-30 days < 20 % of cash outflows in the same bucket For higher limits, special sanction from the Board Statement of Structural Liquidity (maturity ladder)


MANAGEMENT OF Interest Rate Risk :Com Bkg 2008 ALM 2008 34 MANAGEMENT OF Interest Rate Risk Impact on Net Interest Income (NII) Long term impact on market value/ net worth Techniques: Gap Analysis Duration Gap Analysis Simulation Value at Risk


1. GAP ANALYSIS :Com Bkg 2008 ALM 2008 35 1. GAP ANALYSIS 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


Slide 36:Com Bkg 2008 ALM 2008 36


Regulatory Environment – Risk Management Guidelines in India :Com Bkg 2008 ALM 2008 37 Regulatory Environment – Risk Management Guidelines in India ALM Guidelines - February,1999 Operating Guidelines on Risk Management, October 7, 1999 covering broad contours for management of credit, liquidity, interest rate, foreign exchange and operational risks. December 2000 : Capital Adequacy Guidelines for Primary Dealers covering Credit and Market Risk On September 20, 2001, two Working Groups were constituted in Reserve Bank of India drawing experts from select banks and FIs for preparing detailed Guidance Notes on Credit Risk and Market Risk Management by banks.


Risk Regulation in India :Com Bkg 2008 ALM 2008 38 Risk Regulation in India Identified further steps to be taken by banks for improving their existing risk management framework, suiting to Indian conditions 2005 – Detailed Capital Adequacy guidelines for Banks to move towards Basel II, 2007- final guidelines 2006 – April 17, the ALM framework of 1999 updated. 2007- Pillar II guidelines being issued


RBI revised guidelines 2007-08 :Com Bkg 2008 ALM 2008 39 RBI revised guidelines 2007-08 Issued on Sept 05, 2007 Feb 10, 1999 guidelines covered Interest Rate and Liquidity Risk Management Cumulative mis-matches in first bucket to be reported in Statement of Structural Liquidity -ve Gap in 1-14 and 15-28 days buckets not to exceed 20 % of the cash flows Need for revising this position – Hence revised the first bucket to 1, 2-7 & 8-14 days


RBI Revised ALM :Com Bkg 2008 ALM 2008 40 RBI Revised ALM Cumulative negative mismatches / Gap in new buckets – Next day, 2-7, 8-14 and 15-28 days not to exceed 5, 10, 15 and 20 % respectively of cash flow Format of Statement of Structural Liquidity has been revised accordingly Guidance instructions have been furnished Banks given time to fine-tune MIS by 1 Jan’08 Reporting frequency to continue as monthly Supervision will be fortnightly – April 01,2008 Financing of gaps above norms to be indicated