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CONCEPT OF ASSET LIABILITY MANAGEMENT Is an integrated and dynamic approach that aims at managing the mismatches of assets and liabilities in terms of maturity , cost and yields. Has to be integrated with the bank’s strategy.


OBJECTIVES OF ALM To manage the market risk in a manner that minimizes the impact of net interest income fluctuations (short term obj.) and protect the net economic value of the bank (long term obj.) To maintain a healthy and sustainable balance between profitability and liquidity To control the volatility in all accounts To manage liquidity risk


FUNCTIONS OF ALM To provide information and guidelines to the management of the bank about the current risk profile of the bank and also to ascertain the impact of current decisions on the future risk profile. To match the assets and liabilities of the bank Maximize the net interest income and minimize the market risk To provide all kinds of information relevant for decision making on key aspects of the bank


SCOPE OF ALM Review of interest rate scenario Fixation of interest (product Pricing) on both , assets and liabilities Assessment of existing loan portfolio Assessment of existing investment portfolio Measurement of financial risks Review of actual performance as against the projection w.r.t . net profit, interest rate spread and balance sheet ratios Strategic planning and budgeting Examining the profitability of new products


ALM PROCESS The ALM process rests on three pillars: ALM information systems Management Information System Information availability, accuracy, adequacy and expediency ALM organisation Structure and responsibilities Level of top management involvement ALM process Risk parameters Risk identification Risk measurement Risk management Risk policies and tolerance levels.

ALM information systems :

ALM information systems Information availability and collection is the key to the ALM information systems Proper and timely flow of relevant information from the branch levels to the head office goes a long way in generation of reports that help the management in decision making process. This collected information needs to be presented in a manner most useful to the management.

ALM organisation :

ALM organisation The ALM should be organized to function at the following three levels: The Board should have overall responsibility for management of risks and should decide the risk management policy of the bank and set limits for liquidity, interest rate, foreign exchange and equity price risks. 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. The ALM desk consisting of operating staff should be responsible for analysing , monitoring and reporting the risk profiles to the ALCO.

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Each bank’s ALCO will be set up in view of the size of each institution, business mix and organizational complexity. It should be responsible for taking decisions on the business and risk management strategies Periodical reviews have to be conducted in order to ensure that the plans are in line with the market trends, growth of the banks, financing needs of the bank, interest rate movements, etc. Responsible or product pricing Follow up – comparison of actuals with projected.

ALM process :

ALM process RISK PARAMETERS The first step is to define the risk parameters such that they are capable of capturing the risk on the immediate profitability as well as on the long term performance. Choice of the parameters is dependent on : Degree of volatility in the operating environment ( external business risk) Expertise available with the bank Future prospects of the market Two most commonly used parameters are : Risk to Net Interest Income – immediate risk arising due to mismatches in cash flows Risk to Market Value of Portfolio Equity – Measures long term impact.

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RISK IDENTIFICATION Involves the identification of the 5 types of financial risks Credit Risk Interest Rate Risk – earning sensitivity and price sensitivity of instruments Liquidity Risk – mismatches in maturity pattern of assets and liabilities Capital Risk Market risk – from adverse price movements in the market ( Portfolio value) Other types of risks could be Policy risk, environmental risk , brand risk,etc.

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RISK MEASUREMENT There are various ways in which the risk can be measured : INTEREST RATE RISK GAP ANALYSIS DURATION METHOD SIMULATION VALUE AT RISK ( VaR ) LIQUIDITY RISK Statement of Structural Liquidity CURRENCY RISK Gap limits Value at risk


GAP ANALYSIS The Gap or Mismatch risk can be measured by calculating Gaps over different time intervals as at a given date. Gap analysis measures mismatches between rate sensitive liabilities and rate sensitive assets (including off-balance sheet positions). An asset or liability is Normally classified as rate sensitive if: within the time interval under consideration, there is a cash flow; the interest rate resets/ reprices contractually during the interval; RBI changes the interest rates in cases where interest rates are administered ; and it is contractually pre-payable or withdraw able before the stated maturities.

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The Gap Report should be generated by grouping rate sensitive liabilities, assets and off balance sheet positions into time buckets according to residual maturity or next Repricing period, whichever is earlier The Gaps may be identified in the following time buckets: i ) upto 1 month ii) Over one month and upto 3 months iii) Over 3 months and upto 6 months iv) Over 6 months and upto 12 months v) Over 1 year and upto 3 years vi) Over 3 years and upto 5 years vii) Over 5 years viii) Non-sensitive

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The Gap is the difference between Rate Sensitive Assets (RSA) and Rate Sensitive Liabilities (RSL) for each time bucket. A positive Gap indicates that it has more RSAs than RSLs whereas the negative Gap indicates that it has more RSLs. The Gap reports indicate whether the institution is in a position to benefit from rising interest rates by having a positive Gap (RSA > RSL) or whether it is in a position to benefit from declining interest rates by a negative Gap (RSL > RSA). The Gap can, therefore, be used as a measure of interest rate sensitivity.

Interest Rate Sensitivity :

Interest Rate Sensitivity Liabilities Capital, Reserves and Surplus - Non-sensitive. Current Deposits - Non-sensitive. Savings Bank Deposits - Sensitive to the extent of interest paying (core)portion. This may be included in the 3-6 months bucket. The non-interest paying portion may be shown in non-sensitive bucket. Term Deposits and Certificates of Deposit -Sensitive and reprices on maturity. The amounts should be distributed to different buckets on the basis of remaining maturity. However, in case of floating term deposits, the amounts may be shown under the time bucket when deposits contractually become due for repricing . Borrowings - Fixed - Sensitive and reprices on maturity. The amounts should be distributed to different buckets on the basis of remaining maturity. Borrowings – Floating- Sensitive and reprices when interest rate is reset. The amounts should be distributed to the appropriate bucket which refers to the repricing date.

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Borrowings - Zero Coupon -Sensitive and reprices on maturity. The amounts should be distributed to the respective maturity buckets. Borrowings from RBI Upto 1 month bucket. Refinances from other agencies. (a) Fixed rate : As per respective maturity (b) Floating rate : Reprices when interest rate is Reset Other Liabilities and Provisions Bills Payable - Non-sensitive. Inter-office Adjustment -Non-sensitive. Provisions- Non-sensitive. Others -Non-sensitive. Repos/Bills Re-discounted (DUPN), Swaps (Buy / Sell) etc. Reprices only on maturity and should be distributed to the respective maturity buckets.

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Assets Cash Non – sensitive. Balances with RBI Interest earning portion may be shown in 3 – 6 months bucket. The balance amount is nonsensitive . Balances with other Banks ( i ) Current Account - Non-sensitive. (ii) Money at Call and Short Notice, Term Deposits and other placements. - Sensitive on maturity. The amounts should be distributed to the respective maturity buckets. Investments (Performing) ( i ) Fixed Rate / Zero Coupon - Sensitive on maturity. (ii) Floating Rate - Sensitive at the next repricing date Advances (Performing) ( i ) Bills Purchased and Discounted (including bills under DUPN) - Sensitive on maturity (ii) Cash Credits / Overdrafts (including TODs) / Loans repayable on demand and Term Loans - Sensitive only when PLR/risk premium is changed. Of late, frequent changes in PLR have been noticed. Thus, each bank should foresee the direction of interest rate movements and capture the amounts in the respective maturity buckets by which time PLR would be revised.

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Shares / Units of Mutual Funds -Non-sensitive. NPAs (Advances and Investments) ( i ) Sub-Standard - 2-5 years bucket. (ii) Doubtful and Loss - Over 5 years bucket. Fixed Assets -Non-sensitive. Other Assets. ( i ) Inter-office Adjustment - Non-sensitive. (ii) Others - Non-sensitive. Reverse Repos, Swaps (Sell/Buy) and Bills Rediscounted (DUPN) - Sensitive on maturity. Other products (Interest Rate) ( i ) Swaps - Sensitive and should be distributed under different buckets with reference to maturity. (ii) Other Derivatives - Should be suitably classified as and when introduced.

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