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ASSET LIABILITY MANAGEMENT (ALM)

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Title: ASSET LIABILITY MANAGEMENT Author: D Last modified by: Don Created Date: 7/8/2003 6:18:12 AM Document presentation format: On-screen Show (4:3) – PowerPoint PPT presentation

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Title: ASSET LIABILITY MANAGEMENT (ALM)


1
ASSET LIABILITY MANAGEMENT (ALM)

2
History of bank failures in US
  • 2012 - 23
  • 2011 - 89
  • 2010 - 157
  • 2009 - 140

3
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
4
Business Risks
  • Operational Risk
  • Credit Risk
  • Market Risk
  • Liquidity Risk
  • Interest Rate Risk
  • Foreign Exchange Risk
  • Information Risk

5
What is ALM ?...
  • Concerned with strategic Balance Sheet management
  • Match between assets and liabilities in BS
  • Risks stem from mismatch between AL credit,
    liquidity, interest, currency
  • ALM is not to avoid risk but to manage risk,
    sustaining profitability

6
What is ALM ?...contd..
  • Periodic monitoring of risk exposures involving
    collecting and analysing information
  • Ability to anticipate, forecast and act so as to
    structure banks business to profit
  • Altering A L portfolio in a dynamic way to
    manage risks
  • Involves judgement and decision making

7
Defining ALM
  • ALM involves Planning, directing and Controlling
    the flow , mix, cost and yield of the
    consolidated funds of bank
  • Assesses various asset mixes, funding
    combinations, price volume relations and their
    implications on Liquidity, Income and Capital
    ratio
  • Planning procedure which accounts for all assets
    and liabilities of a bank by rate, amount and
    maturity

8
Why ALM ?
  • Banks exposed to credit and market risks in view
    of asset-liability transformation
  • Risks increased with liberalisation and growing
    integration of domestic markets with external
    markets
  • Banks now operate in deregulated environment and
    are required to determine interest rates on
    various products

9
Why ALM ?.. Contd..
  • Need to maintain balance among spread,
    profitability and long-term viability
  • Increasing volatility in domestic interest rates
    as well as foreign exchange rates
  • New financial product innovation

10
Why ALM ?.. Contd..
  • Increased level of awareness among top management
    - market risks, interest rate movements
  • Intense competition for business involving both
    assets and liabilities

11
Why ALM ?.. Contd..
  • Regulatory initiatives
  • International initiative Basle Committee
  • Thus, a call for structured and comprehensive
    measures for institutionalising an integrated
    risk management system

12
Overall Objective..
  • The central theme of (ALM) is the management of
    a banks entire balance sheet on continuous basis
    with a view to ensure a proper balance between
    funds mobilisation and their deployment with
    respect to their maturity profiles, cost and
    yield as well as risk exposure so as to improve
    profitability, ensure adequate liquidity, manage
    risks and ensure long term viability

13
RBI / NABARD Guidelines on ALM
  • Draft guidelines issued on 10 Sept 1998
  • Final guidelines issued on 10 Feb 1999 for
    implementation from 1 April 1999
  • At least 60 of assets and liabilities to be
    covered initially
  • 100 coverage from 1 April 2000

14
RBI / NABARD Guidelines on ALM
  • NABARD guidelines on Risk Management Systems in
    Banks April 2005
  • Guidelines were issued to 5 select State
    Cooperative Banks viz. Andhra Pradesh, Tamil
    Nadu. Maharashtra. Punjab and West Bengal SCBs
    and 12 selected RRBs for implementation of Asset
    - Liability Management (ALM) System wef 1.4.2007-
    so far satisfactory .

15
RBI / NABARD Guidelines on ALM
  • BOS Meeting 27.3.2008 decided introduction of ALM
    in all the SCBs RRBs wef 1.7.2008
  • ALM to be introduced in phased manner in DCCBs.
  • Initially selected 31 DCCBs for ALM wef 1.9.2008
  • Interim target to cover 100 business by 1.4.2009

16
RBI / NABARD Guidelines on ALM
  • Once system stabilises, bank gain experience-
    swtch over to sophisticated computerised
    techniques Duration Gap analysis, Simulation
    VaR for Interest rate risk management

17
RBI / NABARD Guidelines on ALM
  • Review of computerisation in bank
  • Suitability of manpower implementation
  • ALM policy approved by BOD
  • Constitute ALCO to review ALM implementation in
    bank
  • Start generating reports as required
  • Capacity building (KM) of nodal officer
  • Upgrade MIS for preparation of reports
  • Send detailed monthly progress reports- present
    status, progress made action plan for future

18
ALM Process- Three pillars
  • ALM Information System
  • 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
    procedures, prudential limits auditing,
    reporting review

19
ALM Information Systems
  • Information is the key to the ALM process
  • Varied business profiles no uniform ALM system
    for all banks
  • Methods range from simple Gap statement to
    extremely sophisticated simulation methods.
  • Availability of adequate, timely and accurate
    information, the central element for ALM exercise

20
ALM Information Systems-Challenges
  • Large network of branches and lack of an adequate
    support system to collect information
  • Problem to be addressed through ABC approach
    atleast 60-70 of total business-analysing
    behaviour of assets and liabilities in sample
    branches
  • Investment portfolio easy since centralised
  • Spread of computerisation helps

21
ALM Organisation
  • Board to have overall responsibility and frame
    risk management policy
  • Board to set limits for liquidity, interest rate
    and exchange rate risks
  • ALCO (Asset Liability Committee) consisting of
    senior management including CEO decides strategy
    and adheres to objective
  • ALM Support Groups, responsible for analysing,
    monitoring and reporting the risk profiles to
    ALCO
  • Staff also prepare the forecasts (simulations)
    showing effects and recommend action

22
ALCO-responsibilities
  • ALCO decision making unit- Responsible for
    balance sheet planning from risk return
    perspective
  • Monitoring the market risk levels by ensuring
    adherence to the various risk limits set by the
    bank
  • Articulating the current interest rate view and a
    view on future direction of interest rate
    movements

23
ALCO-responsibilities
  • Deciding the business strategy of the bank,
    consistent with the interest rate view, budget
    and pre-determined risk management objectives
  • Determining the desired maturity profile and mix
    of assets and liabilities

24
ALCO-responsibilities..contd..
  • Product pricing for both assets and liabilities
    side
  • Deciding the funding strategy i.e. source and mix
    of liabilities or sale of assets
  • Reviewing implementation of decisions made in the
    previous meeting

25
Composition of ALCO
  • The size of ALCO depends on size of institution,
    business mix and organisational complexity
  • CEO to head the Committee
  • Chiefs of Investment, Credit, Resource
    Management, Funds Management/ Treasury, Banking
    and Economic Research to be members of the
    Committee

26
Composition of ALCO.
  • Head of Technology Division be an invitee
  • Some banks may have sub-committees and support
    groups
  • Management committee to oversee and review

27
ALM Process
  • Scope of ALM function can be defined as
  • Liquidity Risk Management
  • Interest rate risks management
  • Trading risk management
  • Funding and capital planning
  • Profit planning and growth projection
  • RBI guidelines mainly cover Liquidity and
    Interest rate risks

28
Policy for creation of liabilities
  • An appropriate policy for creation of liabilities
    has to take care that
  • Adequate financial resources (i.e.funds) are
    mobilised keeping in view the banks deployment
    requirements
  • The cost of liabilities in terms of interest cost
    is least and is reduced from time to time

29
Policy for creation of liabilities
  • The servicing / operational cost of the
    liabilities is kept low with emphasis on volumes
  • The liabilities should come from fairly
    diversified sources so that set backs in one area
    do not affect the overall financial resource
    position

30
Policy for creation of assets
  • An appropriate policy for creation of assets has
    to aim at
  • Making provisions for meeting statutory
    requirements like reserves-CRR, SLR
  • Maximising of the yield or return on various
    components of assets
  • Maintenance of adequate liquidity through
    appropriate mix of assets

31
Policy for creation of assets
  • Diversification of assets so as to minimise
    losses
  • Lending advances with prudence based on risk
    perception with the sole objective that it should
    not turn out to be non-performing

32
Liquidity Risk Management
  • Assured ability to meet its liabilities as they
    become due reduces the probability of an adverse
    situation developing
  • Liquidity shortfall in one institution can have
    repercussions on the entire system

33
Liquidity Risk Management.
  • Assets commonly considered as liquid like
    Government securities and other money market
    instruments could also become illiquid when the
    market and players are unidirectional
  • Liquidity has to be tracked through maturity or
    cash flow mismatches
  • Use of maturity ladder standard tool

34
Statement of structural liquidity
35
Time buckets for maturity profile
  1. 1-14 days
  2. 15-28 days
  3. 29 days and upto 3 months
  4. Over 3 months and upto 6 months
  5. Over 6 months and upto 1 year
  6. Over 1 year and upto 3 years
  7. Over 3 years and upto 5 years
  8. Over 5 years

36
Liquidity mismatches contd..
  • The mismatches during 1-14 15-28 days not to
    exceed 20 of cash outflows
  • Maturing liability is a cash outflow and maturing
    asset is a cash inflow
  • Tolerance level in mismatches to be determined
    based on asset-liability base, nature of
    business, future strategy etc.
  • Banks to monitor their short term liquidity on a
    dynamic basis over a time horizon spanning from
    1-90 days (short term dynamic liquidity
    statement)

37
Estimation of short term dynamic liquidity
38
Interest Rate Risk
  • Interest rate risk is the risk where changes in
    the market interest rates might adversely affect
    a banks financial condition
  • Immediate impact would be on banks earnings by
    changing its NII
  • Long tem impact of changing interest rates would
    be on banks Net Worth
  • Interest rate risk is measured in terms of change
    in NII

39
Interest Rate Risk
  • Traditional Gap analysis method is to be used now
  • Move over to modern techniques of Interest Rate
    Risk measurement like Duration Gap analysis,
    simulation, VAR gradually
  • Gap or Mismatch analysis measures gaps between
    rate sensitive assets and rate sensitive
    liabilities

40
Interest Rate Risk-measurement
  • An asset or liability is considered rate
    sensitive if
  • Within the time interval under consideration
    there is a cash flow
  • the interest rate resets/reprises contractually
    during the period
  • RBI changes the interest rates
  • It is contractually pre-payable or withdrawable
    before the stated maturity

41
Interest rate sensitivity - Reporting format
42
Interest Rate Risk-measurement
  • Gap report is generated by grouping the RSA, RSL
    into time buckets according to residual maturity
    or next reprising period, whichever is earlier.
  • All investments, advances, deposits, borrowings,
    purchased funds etc that mature/reprise within a
    specified timeframe are interest rate sensitive

43
Rate sensitive assets and liabilities
44
Interest Rate Risk-Gap in time buckets
  • The gaps may be identified in the following time
    buckets
  • 1-28 days
  • 29 days 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
  • Non-sensitive

45
Interest Rate Risk Gap report
  • The gap is the difference between RSA and RSL for
    each time bucket
  • RSAgtRSL - positive gap
  • RSAltRSL - negative gap
  • Positive beneficial with rising rates
  • Negative beneficial with declining rates
  • Each bank should set prudential limits on
    individual gaps with the approval of the
    Board/Management Committee

46
General.
  • Classification of various components of assets
    and liabilities into different time buckets made
    is benchmark
  • Better equipped banks may reclassify based on
    data/studies subject to approval of ALCO/Board
  • Note approved by ALCO/Board to be sent to RBI

47
Summary.
  • Coordinated financial management of BS
  • Risk by choice and not by chance
  • A pulse on approach to market risk management
  • Increased awareness of market risks
  • Both science and an art

48
  • Thank you
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