Asset Liability Management

ASSET-LIABILITY MANAGEMENT SYSTEM Presented by c.s.balakrishnan ALM

WHY ALM? Globalisation of financial markets. Deregulation of Interest Rates. Multi-currency Balance Sheet. Prevalance of Basis Risk and Embedded Option Risk. Integration of Markets – Money Market, Forex Market, Government Securities Market. Narrowing NII / NIM.

ALM ALM is the process involving decision making about the composition of assets and liabilities including off balance sheet items of the bank / FI and conducting the risk assessment.

ASSET LIABILITY MANAGEMENT Various risks affecting banks / FIs Credit, Market, Operational Deregulation & competition Need to manage risk to protect NIM Need for proper risk mgt policy Liquidity planning, interest rate risk management ALM guidelines issued for banks in Feb 1999 and for FIs in Dec 1999

ALM is concerned with strategic management of Balance Sheet by giving due weightage to market risks viz. Liquidity Risk, Interest Rate Risk & Currency Risk. ALM function involves planning, directing, controlling the flow, level, mix, cost and yield of funds of the bank ALM builds up Assets and Liabilities of the bank based on the concept of Net Interest Income (NII) or Net Interest Margin (NIM). Concept of ALM

WHAT IS ALM ALM is concerned with strategic Balance Sheet management involving all market risks It involves in managing both sides of balance sheet to minimise market risk

ALM Objectives Liquidity Risk Management. Interest Rate Risk Management. Currency Risks Management. Profit Planning and Growth Projection.

LIQUIDITY RISK What is liquidity risk? Liquidity risk refers to the risk that the institution might not be able to generate sufficient cash flow to meet its financial obligations EFFECTS OF LIQUIDITY CRUNCH Risk to bank’s earnings Reputational risk Contagion effect Liquidity crisis can lead to runs on institutions Bank / FI failures affect economy

LIQUIDITY RISK Factors affecting liquidity risk Over extension of credit High level of NPAs Poor asset quality Mismanagement Non recognition of embedded option risk Reliance on a few wholesale depositors Large undrawn loan commitments Lack of appropriate liquidity policy & contingent plan

LIQUIDITY RISK Tackling the liquidity problem A sound liquidity policy Funding strategies Contingency funding strategies Liquidity planning under alternate scenarios Measurement of mismatches through gap statements

LIQUIDITY RISK METHODOLOGIES FOR MEASUREMENT Liquidity index Peer group comparison Gap between sources and uses Maturity ladder construction

LIQUIDITY RISK RBI GUIDELINES Structural liquidity statement Dynamic liquidity statement Board / ALCO ALM Information System ALM organisation ALM process (Risk Mgt process) Mismatch limits in the gap statement Assumptions / Behavioural study

ALM SYSTEM Liquidity Gap report – fortnightly 1-14 d & 15 – 28 d – tolerance limit Fix cumulative gap limits IRS statements – monthly Fix prudential limits To compile currency wise liquidity and IRS reports

MATURITY PROFILE-LIQUIDITY Outflows Capital, Reserves & Surplus Deposits Borrowings and bonds Other liabilities

MATURITY PROFILE-LIQUIDITY Inflows Cash Balance with RBI Balance with other banks Investments Advances

IRR - Relevance in India Deregulation of interest rates brought: Volatility in rates - call, PLR, Govt. securities Yield Curve Competition - free pricing of assets and liabilities Pressure on NII / NIM, MVE

RSA, RSL RSA (Rate Sensitive Assets) – Assets whose value is dependent on current interest rate RSL (Rate Sensitive Liabilities) – Liabilities whose value is dependent on current interest rate

Gap/Mismatch Risk It arises on account of holding rate sensitive assets and liabilities with different principal amounts, maturity/repricing rates Even though maturity dates are same, if there is a mismatch between amount of assets and liabilities it causes interest rate risk and affects NII

IMPACT ON NII Gap Interest rate Change Impact on NII Positive Increases Positive Positive Decreases Negative Negative Increases Negative Negative Decreases Positive

Three-tier organizational set-up for ALM Implementation : Management Committee of the Board (MC) Oversees the ALM implementation by ALCO Reviews the ALM implementation periodically Funding strategies for correcting the mismatches in ALM Statements. ALM ORGANISATION

ASSET-LIABILITY MANAGEMENT COMMITTEE (ALCO) - ALCO headed by E.D. - GM (T) – (Nodal Officer). - GMs : Central Accounts, P&D, Credit, Risk Management International Division are the members. - GM (IT) & AGM (Economist) are the invitees for ALCO meetings.

FUNCTIONS OF ALCO Implementation of ALM System Monitor the risk levels of the Bank. Articulate the Interest Rate Position & fix interest rate on Deposits & Advances. Fix differential rate of interest rate on Bulk Deposits. Facilitating and coordinating to put in place the ALM System in the Bank.

ALM STATEMENTS TO BE SUBMITTED TO RBI Statement of Structural Liquidity (Annexure - I) [DSB Statement No.8] - Rupee Statement of Interest Rate Sensitivity (Annexure - II) [DSB Statement No. 9] - Rupee Statement of Dynamic Liquidity (Annexure - III) Statement of Maturity and Position (MAP) (Annexure - IV) [DSB Statement No.10 ] - Forex Statement of Sensitivity to Interest Rate (SIR)(Annexure - V)[DSB Statement No.11] - Forex

Gap Analysis Modified Gap Analysis Duration Gap Analysis Value at Risk (VaR) Simulation Tools for ALM System

LIQUIDITY RISKS Broadly of three types: Funding Risk: Due to withdrawal/non-renewal of deposits Time Risk: Non-receipt of inflows on account of assets(loan installments) Call Risk: contingent liabilities & new demand for loans Dynamic liquidity is done to measure the liquidity risks

STATEMENT OF STRUCTURAL LIQUIDITY Placed 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 Banks can fix higher tolerance level for other maturity buckets.

ADDRESSING TO MISMATCHES Mismatches can be positive or negative Positive Mismatch: M.A.>M.L. and vice-versa for Negative Mismatch 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.

DYNAMIC LIQUIDITY Prepared every fortnight for ALCO Projection is given for the next three months Tools for assessing the day to day liquidity needs of the bank

STATEMENT OF INTEREST RATE SENSITIVITY Generated by grouping RSA,RSL & OFF-Balance sheet items in to various (8)time buckets. Positive gap : Beneficial in case of rising interest rate Negative gap: Beneficial in case of declining interest rate

CALCULATION OF NII/NIM NII: INT.EARNED-INT. EXPENDED INT. EARNED: ADV+INVEST+BALANCE WITH RBI INT. EXPENDED:DEPOSITS+INT. ON RBI BORROWINGS NIM= (NII/TOT.EARNING ASSET)X100

ALM & BALANACE SHEET LIABILITY (OUTFLOWS) ASSET (INFLOWS) 1 Capital 1 Cash & Balances with RBI 2 Reserves & Surplus 2 Balances with Banks & Money at call/Short-notice lendings. 3 Deposits 3 Investments. 4 Borrowings 4 Advances 5 Other Liabilities & Provisions 5 Fixed Assets. 6 Contingent Liabilities 6 Other Assets.

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.

Asset Liability Management

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Asset Liability Management

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