Sai project

INTRODUCTION OF BANKING

The name bank derives from the Italian word banco, desk, used during the
Renaissance by Florentines bankers, who used to make their transactions
above a desk covered by a green tablecloth.

Banking" means the accepting, for the purpose of lending or investment, of
deposits of money from the public, repayable on demand or otherwise, and
withdrawable by cheque, draft, and order.

"Banking Company" means any company which transacts the business of
banking in India and includes the State Bank, but does not include the Industrial
Investment Corporation Limited. Explanation.--Any company which is engaged in
the manufacture of goods or carries on any trade and which accepts deposits of
money from the public merely for the purpose of financing its business as such
manufacturer or trader shall not be deemed to transact the business of banking.

Banking India

Banking in India has its origin as early as the Vedic period and form the economy
point of view, the major task of banks is to act as intermediaries channeling
saving to investment requirement of savers are reconciled with the credit need of
investors and consumers .

A bank is a business which provides financial services for profit. Traditional
banking services include receiving of money, lending money and processing
transactions.Some banks (called Banks of issue) issue as legal tender. Many
banks offer ancillary financial services to make additional profit; for example:
selling Insurance Product ,Investment product & stock broking.

The Indian Banking Industry can be categorized into non-scheduled banks and
scheduled banks. Scheduled banks constitute of commercial banks and co-
operative banks. There are about 67,000 branches of Scheduled banks spread
across India. During the first phase of financial reforms, there was a
nationalization of 14 major banks in 1969. This crucial step led to a shift from
Class banking to Mass banking. Since then the growth of the banking industry in
India has been a continuous process.

As far as the present scenario is concerned the banking industry in India is in a
transition phase. The Public Sector Banks (PSBs), which are the foundation of
the Indian Banking system account for more than 78 per cent of total banking
industry assets. Unfortunately they are burdened with excessive Non Performing
assets (NPAs), massive manpower and lack of modern technology. On the other
hand the Private Sector Banks are witnessing immense progress. They are
leaders in Internet banking, mobile banking, phone banking, ATMs. On the other
hand the Public Sector Banks are still facing the problem of unhappy employees.
There has been a decrease of 20 percent in the employee strength of the private
sector in the wake of the Voluntary Retirement Schemes (VRS). As far as foreign
banks are concerned they are likely to succeed. Indusland Bank was the first
private bank to be set up in India. IDBI, ING Vyasa Bank, SBI Commercial and
International Bank Ltd, Dhanalakshmi Bank Ltd, Karur Vysya Bank Ltd, Bank of
Rajasthan Ltd etc are some Private Sector Banks. Banks from the Public Sector
include Punjab National bank, Vijaya Bank, UCO Bank, Oriental Bank, Allahabad
Bank, Andhra Bank etc.

Currently in most jurisdictions the business of banking is regulated and banks
require permission to trade. Authorization to trade is granted by Bank regulatry
authorities and provide rights to conduct the most fundamental banking services
such as accepting deposist and making loans.

History of Banking in India

Without a sound and effective banking system in India it cannot have a healthy
economy. The banking system of India should not only be hassle free but it
should be able to meet new challenges posed by the technology and any other
external and internal factors.

For the past three decades India's banking system has several outstanding
achievements to its credit. The most striking is its extensive reach. It is no longer
confined to only metropolitans or cosmopolitans in India. In fact, Indian banking
system has reached even to the remote corners of the country. This is one of the
main reasons of India's growth process.

The first bank in India, though conservative, was established in 1786. From 1786
till today, the journey of Indian Banking System can be segregated into three
distinct phases. They are as mentioned below:

Early phase from 1786 to 1969 of Indian Banks
Nationalization of Indian Banks and up to 1991 prior to Indian banking
sector Reforms.
New phase of Indian Banking System with the advent of Indian Financial &
Banking Sector Reforms after 1991. To make this write-up more
explanatory, I prefix the scenario as Phase I, Phase II and Phase III.

Phase I

The General Bank of India was set up in the year 1786. Next came Bank of
Hindustan and Bengal Bank. The East India Company established Bank of
Bengal (1809), Bank of Bombay (1840) and Bank of Madras (1843) as
independent units and called it Presidency Banks. These three banks were

amalgamated in 1920 and Imperial Bank of India was established which started
as private shareholders banks, mostly Europeans shareholders.

During the first phase the growth was very slow and banks also experienced
periodic failures between 1913 and 1948. There were approximately 1100 banks,
mostly small. To streamline the functioning and activities of commercial banks,
the Government of India came up with The Banking Companies Act, 1949 which
was later changed to Banking Regulation Act 1949 as per amending Act of 1965
(Act No. 23 of 1965). Reserve Bank of India was vested with extensive powers
for the supervision of banking in India as the Central Banking Authority.
During those day‟s public has lesser confidence in the banks. As an aftermath
deposit mobilization was slow. Abreast of it the savings bank facility provided by
the Postal department was comparatively safer. Moreover, funds were largely
given to traders.

Phase II

Government took major steps in this Indian Banking Sector Reform after
independence. In 1955, it nationalized Imperial Bank of India with extensive
banking facilities on a large scale especially in rural and semi-urban areas. It
formed State Bank of India to act as the principal agent of RBI and to handle
banking transactions of the Union and State Governments all over the country.
Seven banks forming subsidiary of State Bank of India was nationalized in 1960
on 19th July, 1969, major process of nationalization was carried out. It was the
effort of the then Prime Minister of India, Mrs. Indira Gandhi. 14 major
commercial banks in the country were nationalized.

Second phase of nationalization Indian Banking Sector Reform was carried out in
1980 with seven more banks. This step brought 80% of the banking segment in
India. The following are the steps taken by the Government of India to Regulate
Banking Institutions in the Country:

1949: Enactment of Banking Regulation Act.
1955: Nationalization of State Bank of India.
1959: Nationalization of SBI subsidiaries.
1961: Insurance cover extended to deposits.
1969: Nationalization of 14 major banks.
1971: Creation of credit guarantee corporation.
1975: Creation of regional rural banks.
1980: Nationalization of seven banks with deposits over 200 crore. After
the nationalization of banks, the branches of the public sector bank India
raised to approximately 800% in deposits and advances took a huge jump
by 11,000%.Banking in the sunshine of Government ownership gave the
public implicit faith and immense confidence about the sustainability of
these institutions.

Phase III

This phase has introduced many more products and facilities in the banking
sector in its reforms measure. In 1991, under the chairmanship of M
Narasimham, a committee was set up by his name which worked for the
liberalization of banking practices.

The country is flooded with foreign banks and their ATM stations. Efforts are
being put to give a satisfactory service to customers. Phone banking and net
banking is introduced. The entire system became more convenient and swift.
Time is given more importance than money.

The financial system of India has shown a great deal of resilience. It is sheltered
from any crisis triggered by any external macroeconomics shock as other East
Asian Countries suffered. This is all due to a flexible exchange rate regime, the
foreign reserves are high, the capital account is not yet fully convertible, and
banks and their customers have limited foreign exchange exposure.

INDIAN BANKING STRUCTURE

SBI
Group Nationalized Regional
Banks Rural Bank

Foreign
Commercial
Banks in
India
Public
Indian Sector Scheduled
Commercial Commercial Banks
Banks Banks
Private
Sector
Non-
Scheduled
Banks

R
Co-operative State Central Primary
B Banks Co-operative Co-operative Credit
I Banks Banks Banks

IFCI, IRBI
SFC, NSIC
Industrial ICICI, IDBI
SIDC/SIIC
DICGC

Development Insurance
Banks and
Credit
Agricultural NABARD Guarantee
AFC
Investment LIC, GIC
UIT
Housing NHB
Export EXIM Banks
Import ECGC

Services typically offered by banks
Although the type of services offered by a bank depends upon the type of bank
and the country, services provided usually include:

 Taking deposits from their customers and issuing Checking and Saving
accounts to individuals and businesses.
 Extending Loans to individuals and businesses.
 Cashing Cheques
 Facilitating money transactions such as Wire Transfer and cashier
checks.
 Issuing Credit cards, ATM crads & debit crads
 Storing valuables, particularly in a Safe Deposits Box.
 Cashing and distributing Bank rolls.

 Financial Transactions can be performed through many different
Channels
o Branch
o ATM
o Mail
o Telephone Banking
o Online Banking
 INNOVATIONS IN BANKING IN INDIA

o Internet Banking
o Mobile Banking
o Payment Systems
o Benefits of Technology in Banking
 BANKING BEYOND BANKING
o Personal Banking
o Retail Banking
o NRI Services
o Any Branch Banking

Types of banks

Banks' activities can be characterized as retail banking dealing directly with
individuals and small businesses, and investment banking, relating to activities
on the financial markets. Most banks are profit-making, private enterprises.
However, some are owned by government, or are non-profit making.

Indian Banking system can be roughly classified into three broab categories viz.

 Commercial Banks
 Development Banks
 Co-operative Banks

 Commercial Banks

the term used for a normal bank to distinguish it from an investment bank. After
the great depression, the U.S. Congress required that banks only engage in
banking activities, whereas investment banks were limited to capital markets
activities. Since the two no longer have to be under separate ownership, some
use the term "commercial bank" to refer to a bank or a division of a bank that
mostly deals with deposits and loans from corporations or large businesses.
Today commercial banking system in india may be distinguished
1. Public Sectors Banks
2. Private Sector Banks.

 Development Banks

This type of bank provide long term finance to Industries and Trade.Development
banking sectors are as above-

1. Industrial Finance Corporation Of India
2. Industrial development bank of india
3. Industrial Credit And Investment Bank Of India
4. Small Industrial Development Banks Of India
5. National Bank for Agriculture And Rural Development
6. Exprot Import And Of India

 Co-operative Banks

The Co operative banks in India started functioning almost 100 years ago. The
Cooperative bank is an important constituent of the Indian Financial System,
judging by the role assigned to co operative, the expectations the co operative is
supposed to fulfill, their number, and the number of offices the cooperative bank
operate. Though the co operative movement originated in the West, but the
importance of such banks have assumed in India is rarely paralleled anywhere
else in the world. The cooperative banks in India play an important role even
today in rural financing. The businesses of cooperative bank in the urban areas
also have increased phenomenally in recent years due to the sharp increase in
the number of primary co-operative banks. Co operative Banks in India are
registered under the Co-operative Societies Act. The cooperative bank is also
regulated by the RBI. They are governed by the Banking Regulations Act 1949
and Banking Laws (Co-operative Societies) Act, 1965.

 Co-operative Sectors
1. State Co-operative Bank
2. Central Co-operative Bank
3. Primary Agriculture Credit Societies
4. Urban Co-operative Bank
5. Primary Land Development Bank
6. State Land Development Bank

Values & Principles of Co-Operative Bank

Co-operatives are based on the values of self-responsibility, democracy, equality
and Solidarity. In the tradition of their founders, co-operative members believe in
the ethical values of honesty, openness, social responsibly and caring others.

Principles

1. Voluntary and open membership – Co-operative are voluntary
organizations, open to all persons able to use their services and willing to
accept the responsibility of membership without gender, social, racial,
political discrimination.
2. Democratic member control – Co-operative are democratic organization
control by their members, who actively participate in setting their polices
and making decision, men and women serving as elected representative
are accountable to the membership. In co-operatives, members have
equal voting rights and co-operative at other levels are also organized I a
democratic manner.
3. Member‟s economic participation – Members contributes equitably to
and democratically controls the capital of their co-operative. At least part
of capital is usually the common property of the co-operative.
4. Autonomy and independence – Co-operatives are autonomous, self
help organization control by their members.
5. Education training and information – Co-operative provides education
and training for their members, elected representatives, mangers and
employees so that they can contribute effectively to the development of
their co-operative.
6. Concern for community – Co-operative work for their substantial
development of their communities through policies approved by their
members.

Some facts about Cooperative banks in India

1. Some cooperative banks in India are more forward than many of the state
and private sector banks.
2. According to NAFCUB the total deposits & landings of Cooperative Banks
in India is much more than Old Private Sector Banks & also the New
Private Sector Banks.
3. This exponential growth of Co operative Banks in India is attributed mainly
to their much better local reach, personal interaction with customers, and
their ability to catch the nerve of the local clientele.

Cooperative banks in India finance rural areas under:

1. Farming
2. Cattle
3. Milk
4. Hatchery
5. Personal finance

Cooperative banks in India finance urban areas under

1. Self-employment
2. Industries
3. Small scale units
4. Home finance
5. Consumer finance
6. Personal finance

Developments in Co-operative Banking

Co-operative banking has passed through many phases since the enactment of
the Agricultural Credit Co-operative Societies Act in 1904. Co-operative banks,
developed largely as an offshoot of official policy, expanded rapidly in the post-
independence era and played an important role in implementation of various
Government schemes. Their business is now binger-engineered to strengthen
their role in contributing to financial inclusion and deepening banking penetration
in an increasingly competitive financial landscape.

The co-operative Banking system, with two broad systems of Urban and Rural
co-operative, forms and integral part of India finical system with a wide network
and extensive coverage, these institutions have played an important role in
enlarging the ambit of institutional credit by way of including banking habits
among the poor and those in remote areas. In recent time, co-operative banks
have tried to improve credit deliveries through some financial innovation.

 Urban Co-operative Banks

The term Urban Co-operative Banks (UCBs), though not formally defined, refers
to primary cooperative banks located in urban and semi-urban areas. These
banks, till 1996, were allowed to lend money only for non-agricultural purposes.
This distinction does not hold today. These banks were traditionally centered on
communities, localities work place groups. They essentially lent to small
borrowers and businesses. Today, their scope of operations has widened
considerably.

The origins of the urban cooperative banking movement in India can be traced to
the close of nineteenth century when, inspired by the success of the experiments
related to the cooperative movement in Britain and the cooperative credit
movement in Germany such societies were set up in India. Cooperative societies
are based on the principles of cooperation, - mutual help, democratic decision

making and open membership. Cooperatives represented a new and alternative
approach to organization as against proprietary firms, partnership firms and joint
stock companies which represent the dominant form of commercial organization.

The Beginnings (UCBs)

The first known mutual aid society in India was probably the „Anyonya Sahakari
Mandali‟ organized in the erstwhile princely State of Baroda in 1889 under the
guidance of Vithal Laxman also known as Bhausaheb Kavthekar. Urban co-
operative credit societies, in their formative phase came to be organized on a
community basis to meet the consumption oriented credit needs of their
members. Salary earners‟ societies inculcating habits of thrift and self help
played a significant role in popularizing the movement, especially amongst the
middle class as well as organized labour. From its origins then to today, the
thrust of UCBs, historically, has been to mobilize savings from the middle and
low income urban groups and purvey credit to their members - many of which
belonged to weaker sections.

The Cooperative Credit Societies Act, 1904 was amended in 1912, with a view to
broad basing it to enable organization of non-credit societies. The Maclagan
Committee of 1915 was appointed to review their performance and suggest
measures for strengthening them. The committee observed that such institutions
were eminently suited to cater to the needs of the lower and middle income strata
of society and would inculcate the principles of banking amongst the middle
classes. The committee also felt that the urban cooperative credit movement was
more viable than agricultural credit societies. The recommendations of the
Committee went a long way in establishing the urban cooperative credit
movement in its own right.

In the present day context, it is of interest to recall that during the banking crisis
of 1913-14, when no fewer than 57 joint stock banks collapsed, there was a there
was a flight of deposits from joint stock banks to cooperative urban banks.
Maclagan Committee chronicled this event thus:

“As a matter of fact, the crisis had a contrary effect, and in most provinces, there
was a movement to withdraw deposits from non-cooperatives and place them in
cooperative institutions, the distinction between two classes of security being well
appreciated and a preference being given to the latter owing partly to the local
character and publicity of cooperative institutions but mainly, we think, to the
connection of Government with Cooperative movement”.

UCBs are unique in terms of their clientele mix and channels of credit delivery.
UCBs reorganized with the objective of promoting thrift and self-help among the
middle class/lower middleclass population and providing credit facilities to the
people with small means in the urban/semi urban centers. On account of their
local feel and familiarity, UCBs are important for achieving greater financial
inclusion. In recent times, however, UCBs have shown several weaknesses,
particularly related to their financial health.Recognising their important role in the
financial system, it has been the endeavor of the Reserve Bank to promote their
healthy growth. However, the heterogeneous nature of the sector has called For
a differentiated regime of regulation. In recent years, therefore, the Reserve Bank
has provided regulatory support to small and weak UCBs, while the same time
strengthening their supervision.

 Recent Developments(UCBs)

Over the years, primary (urban) cooperative banks have registered a significant
growth in number, size and volume of business handled. As on 31st March, 2003
there were 2,104 UCBs of which 56 were scheduled banks. About 79 percent of
these are located in five states, - Andhra Pradesh, Gujarat, Karnataka,
Maharashtra and Tamil Nadu. Recently the problems faced by a few large UCBs
have highlighted some of the difficulties these banks face and policy endeavors
are geared to consolidating and strengthening this sector and improving
governance.

STRUCTURE OF CO-OPERATIVE BANK

Co-Operative Credit Structure

Agricultural Credit Non-Agricultural Credit

State Co-operative
Short-term & Long Term Banks
Medium Term

Central Co-operative
State State ARDBs Banks
Co-operative
Banks
Primary ARDBS Primary Credit Societies
Central
Co-operative
Banks
Employee
Urban Co- Other
Primary Credit Co- operative Societies
Societies operative Societies
Banks

1. PACS 5. Service Co-
2. FSS 6. M-p Soc.
3. L-SCS 7. Grain Banks
4. LAMPS

Features of Cooperative Banks
Co-operative Banks are organized and managed on the principal of co-operation,
self-help, and mutual help. They function with the rule of "one member, one
vote". Function on "no profit, no loss" basis. Co-operative banks, as a principle,
do not pursue the goal of profit maximization.

Co-operative bank performs all the main banking functions of deposit
mobilization, supply of credit and provision of remittance facilities. Co-operative
Banks provide limited banking products and are functionally specialists in
agriculture related products. However, co-operative banks now provide housing
loans also.

UCBs provide working capital loans and term loan as well. The State Co-
operative Banks (SCBs), Central Co-operative Banks (CCBs) and Urban Co-
operative Banks (UCBs) can normally extend housing loans up to Rs 1 lakh to an
individual. The scheduled UCBs, however, can lend up to Rs 3 lakh for housing
purposes. The UCBs can provide advances against shares and debentures also.
Co-operative bank do banking business mainly in the agriculture and rural sector.
However, UCBs, SCBs, and CCBs operate in semi urban, urban, and
metropolitan areas also. The urban and non-agricultural business of these banks
has grown over the years. The co-operative banks demonstrate a shift from rural
to urban, while the commercial banks, from urban to rural.

Co-operative banks are perhaps the first government sponsored, government-
supported, and government-subsidized financial agency in India. They get
financial and other help from the Reserve Bank of India NABARD, central
government and state governments. They constitute the "most favored" banking
sector with risk of nationalization. For commercial banks, the Reserve Bank of
India is lender of last resort, but co-operative banks it is the lender of first resort

which provides financial resources in the form of contribution to the initial capital
(through state government), working capital, refinance.

Co-operative Banks belong to the money market as well as to the capital market.
Primary agricultural credit societies provide short term and medium term loans.
Land Development Banks (LDBs) provide long-term loans. SCBs and CCBs also
provide both short term and term loans.

Co-operative banks are financial intermediaries only partially. The sources of
their funds (resources) are (a) central and state government, (b) the Reserve
Bank of India and NABARD, (c) other co-operative institutions, (d) ownership
funds and, (e) deposits or debenture issues. It is interesting to note that intra-
sectoral flows of funds are much greater in co-operative banking than in
commercial banking. Inter-bank deposits, borrowings, and credit from a
significant part of assets and liabilities of co-operative banks. This means that
intra-sectoral competition is absent and intra-sectoral integration is high for co-
operative bank.
Some co-operative bank is scheduled banks, while others are non-scheduled
banks. For instance, SCBs and some UCBs are scheduled banks but other co-
operative bank is non-scheduled banks. At present, 28 SCBs and 11 UCBs with
Demand and Time Liabilities over Rs 50 crore each included in the Second
Schedule of the Reserve Bank of India Act. Co-operative Banks are subject to
CRR and liquidity requirements as other scheduled and non-scheduled banks
are. However, their requirements are less than commercial banks. Since 1966
the lending and deposit rate of commercial banks have been directly regulated by
the Reserve Bank of India. Although the Reserve Bank of India had power to
regulate the rate co-operative bank but this have been exercised only after 1979
in respect of non-agricultural advances they were free to charge any rates at their
discretion. Although the main aim of the co-operative bank is to provide cheaper
credit to their members and not to maximize profits, they may access the money
market to improve their income so as to remain viable.

PRUDENTIAL NORMS AND ASSETS-LIABILITY
MANAGEMENT GUILDLINES FOR UCBS.

The reserve bank continued with its efforts to enhance the financial health of
UCBs. In pursuance, certain policy changes were made in regard to prudential
norms on capital adequacy, income recognition, Assets classification and
provisioning in respect of UCBs.Capital adequacy requirement for UCBs are at
present lower then those prescribed for commercial banks. By March 31 st, 2005
UCBs. Would have to fall in line with the discipline applicable to commercial
banks. Accordingly, they are required to adhere to capital adequacy standards in
a phased manner over a period of three years.

CRAR ratio For UCBs.

AS ON 31ST CRAR FOR CR A R FOR CRAR FOR
MARCH SCHEDULED NON - COMMERCIAL
UCBS SCHEDULED BANKS
UCBS
2002 8 6 9
2003 9 7 9
2004 As applicable to 9 9
commercial bank
2005 As applicable to As applicable to
commercial bank commercial bank
2006 As applicable to As applicable to
commercial bank commercial bank

EXTENTION OF 90 DAYS NPA NORMS

RBI has been tightening prudential norms in line with the best international
practices in recent years. Accordingly, to ensure greater transparency, the time
period for reckoning as advance as non performing would be reduced from the
existing 180 days to 90 days with effect from March 31st, 2004. In this connection
banks were instructed to move over to charging of interest at monthly rates, with
effect from April 1, 2002.However, “gold” loans and “small” loans up to Rs.
100000 will continue to be covered by the 180 days norms for recognitions of
loan impairment.
LICENSING OF NEW BANKS

The number of UCBs has been rising rapidly recent years. The RBI has
constituted a screening committee of eminent external exports to examine not
only the background and credentials of promoters but also to consider but also
considering the environment / business projections submitted by the promoters
and other factors influencing the viability of the proposed bank. During the year
under review, the committee considered 90 proposals for the organization of the
new banks, and granted “in principle” approval in two cased. In addition, 22
proposals were closed, as the promoters of the proposed banks failed to comply
with the stipulated eligibility requirements. During the period under review, 131
licenses were issued for opening new branches.

WEAK BANKS

Based on new classification, the number of UCBs classifies under the class II / III
/ IV category as on March 31st, 2003 stood at 944. During the period under
review 142 weak banks could not comply with the stipulated minimum capital
requirements.

CHALLENGES FACED BY UCBs.

After a relatively fast growth during the priod,1993 to 1999 the sector saw a
substantial number of new urban co-operative banks coming up and growth rate
of the banks being consistently higher than the all India average for all banks,
the period of the year 2000-2001 till now has been that of sluggish growth and
difficulties for the sector. The share of urban banks in terms of resources grew
from around 4% in 1993-1994 to over (% in 2001-2002. The size of a large of
2000 strong urban banks also grew at a fast pace during this period. However,
involvement of one of the largest urban co-operative banks in Gujarat in the stock
market scam of 2001 sent stock waves in the entire urban co-operative banking
sector and affected the sector‟s public image very badly. Since a very large
number of smaller urban banks in Gujarat were having deposits with
Madhaupura Mercantile Co-operative bank (MMCB), which got involved in the
scam, the public confidence, which had come down very badly, has not been
restored till date. Similarly during these times there were some problems in a few
banks in Maharashtra on account of bad management. The responses of the
regulators have been by way of imposition of further stringent norms and rules in
order for them to be on par with those applied to commercial bank.
In the back drop of the developments that have taken place in the urban co-
operative banking sector during the last 4-5 years, the following could be
identified as main challenges to the sector in the coming years.

 STRENTENING THE PUBLIC IMAGE

Among all the section of banking industry urban co-operative banks constitute
the largest section in terms of number of institutions. They also constitute the
most unevenly distributed group among all section of the banking industry. Out of
over 2000 urban co-operative banks in the country, over 70% are concentrated in
three states of Maharashtra, Gujarat and Karnataka. Their compositions in terms

of size also vary vastly. While there are banks with over Rs.2000 Corore
deposits, a sizable number of banks are most advanced and technologically
being members of RTGS etc., a large number of them are in the initial stages of
computerization. Even the management styles, levels of professionalisation and
competence levels of staff also vary form bank to bank.

Urban co-operative banks in any town are typically promoted by prominent
members of the society there. They are usually businessman, traders,
landowners, teachers, lawyers, social workers etc., and while in small places, the
reputation of the bank generally is in keeping with the standing of the promoters
and the board members. And the society in that area, in larger cities the
members and the clients look at the banks and assess them largely on their
public image by focusing on two factors.

o Ensuring that the board members are persons of integrity and of good
standing in the society who have fair understanding of banking systems.
o Following principals of take adventurous decision to grow at a faster pace
than others.

While these are internal factors that are within the competence of the bank, there
are certain aspects on which it would not have much control but they would
nevertheless have important bearing on the public image of the bank. If there are
a number of urban co-operative banks in town, it has been observed that any
problem with one bank has a contagion effect on other banks also,
notwithstanding the fact that these other banks, Bering a few are not large
enough to have a brand name and an identity by which general public could
distinguish one from the other while taking decision on whether to keep moneys
in a particular bank or not .Today, the publics perception is that deposits with
only public sector banks are safe and that there is always an element of risk
involved when the deposits are with either smaller private sector banks or with
the co-operative banks, while it is not easy to change this perception, much can

be done by the urban co-operative banks by adhering strictly to the prudential
norms and following the disclosure requirements so that the depositors have
access to the true state of health of the bank. Following the disclosure norms
become easy if the banks has no weakness to hide. A very striking difference
between a co-operative bank and a commercial bank is the involvement of the
co-operative bank in social activities of the area of its operation. There are a
large number of well managed and sound co-operative banks who are involved in
many socially relevant activities in the field of health, education and at the time of
emergencies like natural calamities. These activities improve the image and
esteem of the bank in the eyes of the local citizens.

 MANGING THE GROWTH

It is possible to mange a small size bank with common sense and sincerity.
However, it requires professional approach and specialized financial knowledge
to mange a financial institution that is growing a very fast clip. It has been
observed that many of the urban co-operative banks which were in the range of
25-50 crores deposits have within a span of five years grown to banks with 300-
500 crores deposits. This phenomenal growth brings in its wake enormous
challenges. The board of directors, however well meaning they might be find it
very difficult to run the bank unless they are supported by professionals. The
challenge before the board would be to put a professional management team in
place and also to be able to work with that team, so that the synergies of the
board members in the form of the local feel and knowledge about the area in
which the bank operating is complimented with professional and technical
knowledge of the management team to get the best result for the bank. This
scenario would necessitate the board to drastically change its style of
functioning, introduce formal systems of accountability and also familiarize with
the management information systems. To bring about this change, there should
be complete willingness on the part of the board members to work hard towards
it.

Managing growth also involves constant efforts to look out for changes in
business profiles to maximize the return out of the growth and at the same time
to keep the risk management aspect in mind.

As the urban co-operative banks like any other institution in the co-operative
sector are democratic organizations, there is always involvement of local leaders
who invariably owe allegiance to one political party or the other. The challenge
before the urban co-operative banks is to utilize the strength of political
connections or allegiance of its members/promoters/directors to the benefit of the
institution rather than its detriment as it has often been observed in the history of
co-operative banks. These co-operative leaders must firmly put the interest of the
banks above any political consideration so that health of co-operative banks is in
way compromised. To elaborate, people in public life generally tend to oblige
others, and if this tendency is carried to the board room of the bank, the
institution could be put into difficulties on account of unprofessional decision.

 REGULAATION OF COMMUNITY BASED FINACIAL
INSTITUTION

This subject perhaps constitutes the most formidable challenge to the regulators,
the stockholders and the government. In setting out to meet the challenge of
regulating community based institutions like urban, co-operative banks, one must
first Cleary perceive institutions to be different from the commercial banks for the
simple reasons that the client base of co-operative banks is different from the
commercial banks. Commercial banks have the reach, the middle class and the
small section of the lower middle class as their depositors, large and medium
industries, SSIs, exporters and traders as their borrows, while the co-operative
banks have only the middle and lower middle class and weaker section as their
depositors and their borrowers. While commercial banks are speared over entire
geographical region with branches in large metros, town as well as villages, A
very large number of co-operative banks have their branches confine to a single

town, which may be a small urban area or Sámi rural place. The commercial
banks collect deposits from various centers to deploy them at other centers. The
urban co-operative banks usually deploy funds collected form one place for the
benefit of borrowers in that place only. While the commercial banks on account of
their resources and technology are in the position to offer a wide range of
services to their clients, the urban co-operative banks on the other hand by and
large, can offer only limited service to their customers.

In view of this significant difference in the working of co-operative banks ands
that of commercial banks, a uniform prescription of norms, particularly the
application of prudential norms will not yield the desire results. In the last 3 years
no worth while attempt has been made to define the role of urban co-operative
banks as a sections of community based banking systems, to ascertains in
details the impact of these banks in states where they are well establishes, the
need or otherwise for promoting such institutions in other states, and above all to
develop a system of regulation and supervision that will bring the best out of the
urban co-operative banks. This is a real challenge before the regulators. They
must recognize this challenge and work upon it. If the regulators continue to what
they have been ding during the last few years, and only concentrate on
imposition of norms that are not attainable by almost half of the total number of
urban co-operative banks, they would only be succeeding only in presiding over
closure of large number of them every year.

SURAT PEOPLE‟S CO-OPERATIVE BANK LTD

With the advent of 20th century, co-operative movement gathering momentum in
our country. In the early years of the century, there were only a few banks ran by
solely profit conscious foreign managements, absolutely unmindful of their social
obligation. Further there was also widespread economics exploitation of the
common man in general and of socially and economically weaker sections of the
society in particular by the money lenders who were lending money to them at
exorbitant rates of interest with stringent conditions subjected them to crushing
indebtedness. In such a socio-economic at the time, co-operative banks were
looked upon to play a vital role.

Inspired by the exhortation of late autorothfield, the then register of co-
operatives, Bombay province, that a large number of co-operative banks should
be established to cater to the banking needs of the common man, late
REVSAHEB VRUNDAVANDAS JADAV, A VISIONARY dreamt of establishing
a co-operative bank. this, dream of his turned into reality when he, ably aided by
late CHUNILAL SAPAIYA, a seasoned banker founded a co-operative bank in
the name and style of “ The Surat People's Co-operative Bank Ltd‟‟.in the year
1922 at SURAT . To be precise, it was registered on 10th march, 1922 and
started functioning with effect from 22nd April, 1922. It enjoys the distinction of

being the “first urban co-operative bank of India‟‟. The Surat People's Co-
operative Bank Ltd was popularly known as JADAVSAHEB‟S BANK, reason
being that one or the other of the four member of Jadav family were associated
with it in some way or other during a span of six decades. Late REVSAHEB
VRUNDAVANDAS JADAV, apart from being the founder of the bank, was also its
managing director since its inception till the year 1955. Late TAKOREBHAI
brother of REVSAHEB JADAV was honorary secretary and manager of the bank
since its inception till the year 1950.Whereas late SUDHIRBHAI JADAV, son of
late REVSAHEB JADAV , was the Managing Director of the bank form the year
1961 to 1985. After his retirement form the bank‟s service, he was on BOARD
OF DIRECTORS of the bank for one year.

Progressively marching ahead THE SURAT PEOPLE‟S CO-OPERATIVE BANK
acquired the status of 'Scheduled Bank' on 1st September, 1988. The bank has
been catering to the needs of small entrepreneurs, artisans, professionals, and
weaker section of the society to become a co-operative bank in letter and spirit.

Over the year, the SPCBL has set its eyes on strategic planning for the future in
order to arm itself to face competition in wake of sea change that the banking
industry has been witnessing on account of policy of liberalization of economy.

ORGANISATION STRUCTURE

President

Vice Director

Director

General Manager

Deputy General Manager

Asst. General Manager

Manager

Officers

Clerks

There are two AGMs in the bank. Under each AGM there is one Executive.
Under executive there are three managers, similarly under managers there are
two officers and there are three clerks.

OBJECT OF THE BANKS:

The objects of the bank are as under:

 To encourage thrift and mutual co-operative among its members.
 To create funds to be lent at moderate rate of interest to the members of
the banks in accordance with procedure specified in bye laws.
 To give possible help and necessary guidance to traders who are
members of the banks, in the conduct of their business.
 To do HUNDI business

 To lend money on security to member.
 With previous permission of the registrar, to purchase any property for the
business of or for the use of bank to construct it or to make suitable
alterations as may be necessary and to maintain the same.
 To perform any function as may be deemed lawful for the bank and that as
the central Government or State Government may direct.

 To do every kind of trust and agency business and particularly do the work
of investment of funds, sale of properties and of recovery or acceptance of
money.
 To undertake the management of trusts and for that purpose to accept any
office of trustees executors or any office to perform duties of such a
confidential nature either independently or jointly with some other person
as the Bord deems its.
 To undertake every kind of banking and sharafi business and also to
undertake of giving guarantee and letter credit on behalf of members.

STRENGTHS

 The bank was the first “ First Registered Urban Co-operative Bank” of
India
 Among the first 13 Co-operative Bank to get the “Scheduled Bank”
Status.
 The bank introduced "Total Branch Automation" in the 1992-93.
 Presently, all the branches are computerized.
 Bank has started its own “Training Centre” to provide training to the
employees of other co-operative banks since 1995-96.
 The first Bank to provide the "Depository Participant Services" in South
Gujarat.
 The Bank with "A" Rank.
 The Bank has implemented “Tele Banking Facility” and “view Account
Terminal” [VAT] facility at all branches for providing better customer
service.

PAST PERFORMANCE

Financial Position As on 31-3-2006

Detail Amount In Rs.
Authorized Share
25,00,00,000.00
Capital
Paid up Share
16,44,64,100.00
Capital
Reserve Fund 54,17,29,574.75
Other Reserves and
179,44,28,238.25
Funds
Deposits 720,16,49,931.56
Advances 359,13,32,357.81
Investments 449,74,69,866.70
Working Capital 1009,66,95,577.50
Net Profited 9,75,12,937.42
Net Non Performing
0.00
Assets
Audit Class "A"

NUMBERS OF MEMBERS

No. Of Members 70000
60000
50000
40000
30000 53,687 55,979 57,470 58,158 59,369
50,523
20000
10000
0 2001 2002 2003 2004 2005 2006
1 2 3 4 5 6

Year

Total Numbers have increased by 20% since 2001

PAID UP SHARE CAPITAL

18000000
Paid Up Share Capital

16000000
14000000
12000000
10000000
80000000
60000000
40000000
20000000
0
1 2 3 4 5 6 7
Year

Paid up Share capital has increased by nearly 60% since 2001

RESERVE FUND

60000000
Reserved Fund 50000000
40000000
30000000
20000000
10000000
0
1 2 3 4 5 6 7
Year

Reserved Fund has increased by nearly 42% since 2001

DEPOSITS

8E+09
7E+09
6E+09
Deposits

5E+09
4E+09
3E+09
2E+09
1E+09
0
1 2 3 4 5 6
Year

Deposits have increased by approximately 25% over 4 years since
2001

ADVANCES

4E+09
3.5E+09
Advances 3E+09
2.5E+09
2E+09
1.5E+09
1E+09
50000000
0
1 2 3 4 5 6
Year

Advances have increased by nearly 22% since 2001

The above charts and analysis shows the overall positive growth of the Surat
People‟s Co-operative Bank.

AWARDS

 As per @1st Annual Report (1996-97) of NAFCUB - New Delhi. The Bank
was awarded rank as under for :
Net Profit : 6th
Deposits : 8th
Advances : 9th

 Bank achieved the coveted "Award of Excellence" from NAFCUB,
New Delhi at their 8th all India conference of Urban Co-operative
Banks & Credits Societies.

 Surat Jilla Sahakari Sangh declared our bank as the best "Urban Co-
operative Bank” for the year 1999-2000 in Surat district.

 The bank with "A" Rank.

SERVICES

 Safe Deposit Lockers:

We are offering you safe deposit lockers for safety of your valuable
things like gold, silver, hard cash, diamonds, important documents.
We offer our customer safe deposit vault or locker at a large no of
branches. There is a nominal annual charge which depends on the size of
lockers. Basically use of lockers is to make your most valuable thing secure.

Your family is going out of station, or there 2 to 3 family member at your home
so at that there is fear of thief , and even for make your self tension free you
should go for safe deposit lockers. and this all things when ever you want back
you can take back instantly from bank and again if your purpose will be solve
again you can give it back.

 VAT (View Account Terminal) Services

You can easily have information about your account. You
can come to know account status like balance, latest transaction,
using just touch screen. VAT machine is available at our all branches.

Letter of Credit Service:

Document, consisting of specific instructions by a
buyer of goods, that is issued by a bank to the
seller who is authorized to draw a specified sum
of money under certain conditions, i.e., the receipt by the bank of certain
documents within a given time. An irrevocable L/C provides guarantee by the
issuing bank in the event that all terms and conditions are met by the buyer (or
drawee). A revocable L/C can be canceled or altered by the drawee after it has
been issued by drawee's bank.

 SMS banking Services :

We are providing tele banking service at our
all the branches. Using SMS banking you can have current information about
your status of account. Like balance of your account in English and gujrati
language both. Even you can come to know status about all kinds of account.
Like (Current account, Savings account, Loan Account, Overdraft). Even, we are
giving facility of tale fax also. So you can have your account statement on your
fax.

 Fund Transfer

In this facility, Bank gives facility of fund transfer of fund transfer between two
different branches. Bank provides this service at free charges. In this facility
customer has account in one branch of the bank, and he wants that money in
other branch of the bank then customer can get his/her money form other branch
without any risk or charges. It is not necessary customer has also account in
other branch but that branch where he deposited money; he has account in that
branch.

 ATM

In these facilities, Bank provides a service to customer of fastest transaction
in account. It is 24 hour services. Whenever customer require to withdraw
money form his account in off time of bank, customer can easily withdraw
money form their account, Even customer can easily get information about his
account like, account balace,statement of last 5 to 6 transaction. In SPCBL,
among 19 branches this service is providing in 9 branches.

 Pay Order Service:

Pay order is most secure way to make payment to your party. Pay order can be
make of your party's name. And it is best proof that you made a payment of this
amount and on this date. So, instead of giving cheque you can make pay order
from bank and bank will make a payment from your account. There is no charge
of pay order. It is absolutely free service.

 Demand Draft

Demand Draft is a less expensive way for remitters to transfer money to your
party's account.

A demand draft is more secure than a normal cheque as it can only be credited
to a specific payee's account, and a customer can only be reimbursed under
indemnity if the cheque is lost or stolen. It is secure and safe. It offers a
convenient way to settle your trade business when documentation is required.
People's bank draft is a law-cost, convenient method of making non-urgent
payments.
Bank will charge you only Rs. 20/- to make Demand draft of any amount

VISION 2010

 Home banking,
 Any Window concept
 Inter branches connectivity [Branchless banking]
 Global banking facility through interest banking
 Bank‟s presence in metros
 No.1 UBRAN Co-Operative BANK for business and profit per employee
 Patronage for development of Surat city.
 Introduction of full fledged specialized branch viz. foreign exchange,
agriculture advances & industries advances.
 Functioning as merchant banker.
 Technically qualified staff to meet challenges of high tech banking.

PRODUCTS

 DEPOSITS:

1. Current Account
2. Savings Account
3. Recurring Deposits
4. Fixed Deposits
5. Cash Certificate
6. Vashudhara Pension Plan
7. Monthly Income Plan
8. Vashudhara Deposit

 LOANS:

1. Vashudhara Awas Yojna (Home Loan)
2. Personal Loan
3. Loan for Self Employed and Professionals
4. Business or Industrial Loan
5. Consumer Loan
6. Vehicle Loan
- For Personal Vehicle (two Wheeler/Car Loan)
- For Commercial Loan – Vehicle using for commercial purpose.
7. Education Loan
8. Loan against N.S.C./K.V.P./ Gov. Security/ L.I.C. Policy
9. Mortgage Loan
10. Technology Up gradation Fund

Social Contribution

In this global jubilee years-

 The SPCP Memorable Trust with a fund of Rs 10 lakh was farmed in its
golden jubilee year.
 Fund stands at Rs.2.60 crror on 31st march 2001
 Trust donates from its interest incomes to various instantiations engaged
in –Social education & Medical services.

DONATIONS

Bank, too, donates. Form its charity funds to various institutions.

 Bank‟s civic contribution Swami Vivekananda Traffic, Island at makkai
pool, Nanpura, Surat.
 Surat People‟s bank senate Hall at VNSGU, Surat.
 Surat people‟s bank English Medium College Of Commerce Surat.
 Surat P.B.Mahavir C.T.Scan Centers Surat.

Benefits for share holders

 Insurance cover of Rs. 1 lakh 2 share holder in case death by accidents.
 Awards to children of shareholders on achievements of examinations.

Purpose of Study

We know that the basic function of bank is to accepting deposits for purpose
deposits for the purpose of lending and to make investments. It involves the
pricing mechanism to sustain in the market and to enhance the value creation for
shareholders and deposit holders of bank. In fact there is keen competition in
banking after the introduction of economic reforms lending to liberalization of
financial and banking sector. The changes that had taken place in the operational
side of banking in the form of diversification of products/services, free to choose
products/market segments, emphasis on customer service adoption of
sophisticated technology etc.

So we have to accept that now a day‟s scenario of banking is changed and
bankers are forced to come the edge of their seats rather than sit easily and do
the business. They have to keeping keen eye on each and every movement of
market, industry, economy and politics. Main thing for bankers to manage the
bank‟s assets and liabilities in order to maintain both liquidity and profitability.
ALM is the main and most important tools for banks management. An effective
ALM implementation makes the banker more alert in managing the assets and
liabilities by considering their respective maturity profiles to take necessary
initiatives. We all know that now a day‟s co-operative banking sector is passing
through crucial stage and for that main responsible factor is mis-management of
their Assets-liability. So as a member of co-operative banking family I have tried
my best to Focus on the most important subject and that is Assets and Liability
Management.

OVERVIEW ON ALM

Banking is the business which deals mainly with other people‟s money by way of
mobilizing deposits and deployment of funds through lending and investment.
Increasing the “spread” is an important object and out of which the bank has to
cover the Cost of Management (COM) and Risk Cost (RC) to earn net profit. It
increases the loan and investment portfolio, the liquidity will be affected and as
against this, if the high degree of liquidity is maintained the profitability may be
deteriorate. Therefore the position of a banker is between the “Devil and Deep
Sea” and it becomes crucial task of managing funds effectively. The bank must
give weight to the principals of safety, liquidity and profitability while managing its
affairs of business, therefore fund management is crucial task for banking
industry and ALM is main tool of fund management.
The deregulation and globalization of economy has changed the canvas
significantly. These changes led to major transformation in both the
administrative and operational side of the banking. These developments have
resulted in tough competition and more risk. The banks are moving towards
designing new innovative financial products/services to attract more and more
customers and moving in new direction along with their conventional banking. In
this backdrop, the status of co-operative banks is crucial and it is a big struggle
for them to retain their existence in the industry. They have to be
professionalized in their functions and operations especially in field of fund
management by adopting some standard tools and techniques like ALM. ALM is
a technique available for the bankers to manage the bank‟s assets liability order
to maintain both liquidity and spread on the basis of their respective maturity
period.
Considering the fact that the deregulated environment has brought the bank on
the subtle line of leeway where any error may prove to be very fatal and the fact
that it very to err. Assets and Liabilities management has to be foreseen as a
most vital component of banking industry and management.

DEFINATION AND MEAMING OF ALM

Assets

Items having realizable value owned by the business are known as assets.
Assets owned by the business are known as business assets. Cash, land,
building, machinery, stock, furniture, goodwill, patent, copyright, trademark,
etc.are included in assets.
Assets are classified into three types
 Fixed assets,
 Current assets,
 Fictitious assets

Liability

Any amount payable by the business to any outsiders is known as liability. By
credit purchase of goods, the amount becomes payable or liability is created.
Sometimes, liability is also created by borrowing funds.
There are two types of liabilities
 Current liability
 Long-term liability

Assets and liabilities, for not only facing the challenges ahead but also for
improving its bottom lines and thereby to improve the net worth of the bank. The
technique of mangeing assts and liabilities together know as Assets Liability
management (ALM) Through ALM banks not only equip themselves to price their
assets and liabilities at appropriate levels by also manage the related risks too.
Eventually role of the banks form mere deposit takers and distribute through
asset liability management in the coming years

Assets Liability Management

Asset-Liability Management has been defined as a continuous process planning,
organizing, and controlling Asset and Liability volumes, maturities, rates and
yields. In the present Environment it is defined as process of adjusting bank
liabilities to meet loan demands, liquidity needs and safety requirements. To put
it simply, assets-liability management is the management of total balance-sheet
dynamics with regard to its size and quality. It involves
 Quantification of risk and
 Conscious decision making with regard to assets-liability structure in order
to maximize interest earning within framework of perceived risk.

In other words ALM can be defined as the process of managing the net interest
margin (NIM) within the overall risk bearing capacity of a bank. Thus it calls for
an integrated approach towards financial management conditioned to
simultaneous decision making with regard to types and size of financial assets
and liabilities, their mix and volumes so as to insulate the spread from adverse
direction. Thus, the secret of successful banking under deregulated and
competitive environment hinges on matching of assets and liabilities in terms of
rate and maturity with a view to obtaining optimum yield.

In other way we said Assets liability management has been organizing and
controlling asset and liability volumes, maturities, rates and yields. Simply put,
assets liability management (ALM) is a tool that enables bank management, to
take business decision in a more informed framework. The ALM function informs
the manager what the current market risk profile of the bank is and the impact
that various alternative business decision would have on the future risk profile.
The manger can then choose the best course of action depending on his bord‟s
risk appetite. Consider for example, a situation where the chief of bank‟s retail
deposit mobilization function wants to know the kind of deposits that the

branches should be told to encourage. To answer this question correctly he
would need to know inter alia the exiting cash flow profile of the bank. Let us
assume that the structure of the existing assets and liabilities of the bank are
such that at the aggregate the maturity of assets is longer than maturity of
liabilities. This would expose the bank interest rates risk [if interest rates were to
increase it would adversely affect the banks net interest income] In order to
reduce the risk the bank would have to either reduce the average maturity of its
assets perhaps by decreasing its holding of Government securities or decrease
the average maturity of its assets, perhaps by reducing its dependence on call
money market funds. Thus, give the above information on the exiting risk profile
of the bank, the retail deposits chief knows that the bank can reduce its future
risk by marketing its long-term deposits products more aggressively. If necessary
he may offer increased rates on long-term deposits and or decreasing rates on
the shorter term deposits.

The above example illustrates how correct business decision making can be
added by the interest rate risk related information. The real world of banking is of
course more complicated. The risk related information is just one of many pieces
of information required by a manger to take decision. In the above example itself
the retail deposits chief would also have considered a host of other factors like
competitive pressures, demand and supply factors, impact of the decision on the
banks retail lending products, ECT before taking a final decision. The important
thing; however is that ALM is a tool that encourages business decision making in
a more disciplined framework with an eye on the risk that the bank is exposed to
ALM is thus a comprehensive and dynamic framework for measuring, monitoring
and managing the market risk, i.e., Liquidity interest and exchange rate risk of a
bank. It has to be closely integrated with the bank‟s business strategy as this
affects the future risk profile of the bank. This framework needs to be built around
a foundation of sound methodology and human and technology infrastructure. It
has to be supported by the bord‟s risk philosophy, which clearly specifies the risk
policies and tolerance limits.

OBJECTIVES OF ALM IN THE BANK

Main objectives of the ALM are:
1. To Protect / enhance the market value of the net worth
2. To increase the net interest income
3. To maintain / protect spreads or Net Interest Margin

The primary objective of the asset-liability management is not to eliminate risk,
but to manage it in such a way that the volatility of net interest income is
minimized in the short-term horizon. Broadly the objectives would include
controlling the volatility of net income, net interest margin, capital adequacy, and
liquidity risk and finally ensuring an acceptable balance between profitability,
growth and risk. In other words, the ultimate objective of ALM is profitability and
long term operating viability of the organization in risky environment.

Scope of ALM

A sound ALM should focus on
1. Review of interest rate outlook.
2. Fixation of interest / product pricing on both assets and liabilities.
3. Examining loan portfolio.
4. Examining investment portfolio.
5. Measuring foreign exchange risk.
6. Managing liquidity risk.
7. Review of actual performance vis-à-vis projections in respect of net profit,
interest spread and other balance sheet ratios.
8. Budgeting and strategic planning.
9. Examining the profitability of new products.
10. Review of transfer pricing

RBI GUIDELINES ON ASSETS LIABILITY MANAGEMENT

RBI had issued guidelines in February 1999 for putting in place Assets Liability
Management System in banks. These guidelines where issued for managing
liquidity risk, interest rate risk and currency risk. Banks were asked to set up an
internal assets liability committee (ALCO) headed by chief executive office / CMD
or the executive director. The managing committee of the board was also to
oversee the implementation of the system and also to review periodically.

Keeping in view the level of computerization and MIS system in banks adoption
of uniform Assets Liability Management System for all banks was considered not
to be feasible. To begin with, banks were directed to endeavor to cover at least
60% of the asset and liabilities for analysis and were required to set target for
coverage of 100% data by April 2000.

As banks are aware, interest rate risk is the risk where changes in market
interest rates might adversely affect a bank‟s financial condition. The immediate
impact of changes in interest rates is on bank‟s earnings (i.e. reported profits)
through changes in its Net Interest Income (NII). A long-term impact of changes
in interest rates is on bank‟s Market Value of Equity (MVE) or Net Worth through
changes in the economic value of its assets, liabilities and off-balance sheet
positions. The interest rate risk, when viewed from these two perspectives, is
known as „earnings perspective‟ and „economic value‟ perspective,
respectively.

The present guidelines to banks approach interest rate risk measurement from
the „earnings perspective‟ using the traditional Gap Analysis (TGA). To
begin with, the TGA was considered as a suitable method to measure Interest
Rate Risk. Reserve Bank had also indicated then its intention to move over to
modern techniques of Interest Rate Risk measurement like Duration Gap

Analysis (DGA), Simulation and Value at Risk over time, when banks acquire
sufficient expertise and sophistication in acquiring and handling MIS.

Reserve Bank had advised banks on June 24, 2004 to assign explicit capital
charge for interest rate risk in the trading book applying the standardized duration
gap approach advocated by the Basel Committee on Banking Supervision. Since
banks have gained considerable experience in implementation of the TGA and
also become familiar with the application of the DGA to their trading books, it is
felt that this would be an opportune time for banks to graduate to the Duration
Gap Analysis for management of Interest Rate Risk in its entirety. With this
move, banks would fully migrate to application of the „economic value
perspective‟ to interest rate risk management.

The salient features of the draft guidelines furnished in the

 . Banks shall adopt the DGA for interest rate risk management in addition to the
TGA followed presently.
 The proposed framework, both DGA and TGA, will be applied to all
assets, liabilities and off balance sheet items of the bank.
 Keeping in view the level of computerization and the current MIS in banks,
adoption of a uniform ALM System for all banks may not be feasible. The
proposed guidelines have been formulated to serve as a benchmark for
banks. Banks which have already adopted more sophisticated systems
may continue their existing systems but they should fine-tune their current
information and reporting system so as to be in line with the ALM System
suggested in the Guidelines.
 Banks should adopt the modified duration gap approach while applying
the DGA to measure interest rate risk in their balance sheet from the
economic value perspective. In view of the evolving state of
computerization and MIS in banks, a simplified framework has been
suggested, which allows banks to

o group assets and liabilities under the broad heads indicated in
Appendix I under various time buckets; and
o compute bucket-wise Modified Duration of these groups of assets/
liabilities using the suggested common maturity, coupon and yield
parameters;
 Reserve Bank is aware that measurement of interest rate risk with the
above approximations does not reflect the true level of risk and hence
would expect banks to migrate over time to application of the modified
duration approach to each item of asset/ liability/ off-balance sheet item
instead of applying it at the „group‟ level. However, banks with the
necessary IT support, MIS and skill capabilities may straightaway
implement the more granular DGA by computing the Modified Duration of
each item of asset, liability and off-balance sheet item.
 Each bank should set appropriate internal limits for interest rate risk based
on its risk bearing and risk management capacity, with the prior approval
of its Board / Risk Management Committee of the Board.
 Banks should compute the volatility of earnings (in terms of impact on Net
Interest Income) and volatility of equity (in terms of impact on it –book
value of net worth) under various interest rate scenarios.
 Banks should adopt a more granular approach to measurement of liquidity
risk by splitting the first time bucket (1-14 days as at present) in the
Statement of Structural Liquidity by dividing into two buckets viz. 1-7 days
and 8-14 days. In addition to the existing prudential limits operating for the
1-14 days bucket and the 15-28 days bucket, the negative mismatch
during the 1-7 days bucket should not exceed 20% of the cash outflows in
that bucket. The frequency of supervisory reporting of the Structural
Liquidity position shall be fortnightly instead of monthly, as at present.

While determining the likely cash inflow / outflows, banks have to make a
number of assumptions according to their assets liability profile. Indian banks
with large branch network can (on the stability of their deposit base as most

deposits are rolled over) afford to have large tolerance level in mismatch in
the long term if their term deposits base is quite high. While determining
tolerance level the banks may take into account all relevant factors based on
their assets liability base, nature of business, future strategy, etc.

NEED FOR IMPLEMENTING ALM SYSTEM IN
CO.OPERATIVE BANKS.

Banking industry in India has undergone many changes, By the introduction of
banking sector reforms, deregulation of interest rates, and competition in the
industry focus on customer relationship ect. The co-operative banks woke up and
started evolving strategies and practices to make sure of their presence. The
changes and development that took place in the industry‟s business practice
specially the field of fund management. Some initiatives were necessary to
improve further. Co-operative banks should not be exempted form such
developments and in fact it is essential for them to proceed on the professional
way with the objective of widening the interest spread. The co-operative banks
began to modify their resource pool particularly the deposit mix by accepting
more short term deposits to reduce the cost of funds and finally the short term
liabilities are the higher side then long term liabilities. This situation has caused
for the mis-matches in two ways:

 Maturity mis match between assets and liabilities, and
 Interest rate mis match between interest rate sensitive assets and interest
sensitive liabilities. The second factor gets direct impact on profitability.

The co-operative having local footing with strong membership base and at the
same time they have provided the required level of service to their members.
Therefore to gain the member confidence, as they are the investors, it is the duty
of co-operative banks to maintain sufficient liquidity by honoring their demands in
time. As a business proposition the co-operative banks also has to earn some
profit to meet other cost such as establishment cost and risk cost. With the
improved lines of business and diversified landing and investment portfolio in big
way, the co-operative banks are going to bear the impact of risk to greater extent
in the forth-coming days. Therefore the co-operative banks must evolve a

suitable ALM system as suggested by RBL (Based committee on banking
supervision) to their funds management practices. Implementing a suitable ALM
mechanism in co-operative banks provide the scope for exercising selective
control on assets and liabilities and also offer the following benefits.

 Striking a right balance between liquidly and profitability.
 Analyzing both the time and rate sensitivity of assets and liabilities.
 Supplying adequate data input to the budgeting and decision making
process of bank especially in the re-alignment of Assets Liability
composition.
 Leveling of funds in the long-run perspective by identifying the
surplus/deficit at regular intervals.
 Reducing interest rate risk (IRR) and liquidity risk (LR).

The very nature of the banking business is incurring risk to earn profit. The risk
factor is inherent in the banking business. The risks encountered by the banks
are as under:-
 Liquidity Risk
 Interest Rate Risk
 Credit Risk
 Market Risk
 Capital Risk
 Commercial Risk
 Price Risk
 Operational Risk
 Solvency Risk
 Exchange Rate Risk
 Political Risk
 Human Risk
 Technology Risk
 Legal Risk

ALM SYSTEM

The frame work of Assets Liability management in bank generally includes their
main divisions Viz. Information system process and committee which is illustrated
in the Figure – 1. The information system is the basic requirement for the ALM
technique, as the continuous supply of adequate data and information is always
needed.

The ALM process is an analytical framework, which enables to study the
dimensions of assets and liabilities and also to find liquidity and sensitivity
gaps. The ALM process gives weight to the following five elements.

o Risk Parameters.
o Risk Identification.
o Risk Measurement.
o Risk management.
o Risk Policies and Tolerance Level.

Third segment of ALM is the ALM committee (ALCO), which is responsible for
the successful implementation of system. The structure of the committee and the
level of Top management involvement should be well defined to excise proper
control over the whole system.

HOW TO WORK ALM

----------------------------------------------------------------------------------------------------------

SELECTED
BRANCH
D A 1
A
T L 2
Ho A ISM LGM IRRM
C 3
B
A 4
MONEY N O
MARKET K

ALM MIS ALM PROCESS ALCO

---------------------------------- ------------------------------------------ ----------------------

o ISM Interest Spread Management.
o LGM Liquidity Gap Management
o IRRM Interest Rate Risk Management

1. Developing implementation and managing annual budget.
2. Review of reports and monitoring the performance.
3. Risk management program.
4. Management reporting.

ALM INFORMATION SYSYEM (ALMMIS)

The implementation of ALM system necessitates the banks to conceive a
suitable management information system. The ALMMIS must ensure the
availability, accuracy, adequacy and expediency of information. The head office
should collect required data in a structural format and other information at a
regular interval from benches and it should be centralized into a databank. The
data must be accessible to make it easily available to suit the requirements of
ALM committee (ALCO)

The nature of data required is normally in the form of maturity wise pattern of
various assets and liabilities, into various time bands, needs some bases and this
process can be done through the past experience of bank. In these regard the
bank may collect information relating to the behaviors and maturity pattern of
deposits and advances form selected branches who contribute mainly to the
volume of business. This data collection serves the bank to make some rational
assumption for GAP analysis and report preparation. Reliable and authentic
information should also be collected from the money market. Therefore the MIS
must ensure the supply of timely adequate and accurate data and information
through reports collected from various terminals in order to make the ALM more
effective.

The problem of ALM needs to be addressed by following on ABC approach i.e.
analyzing the behavior of assets and liability products in the top branches
accounting for significant business and then making rational assumption about
the way in which assets and liabilities would behave in other branches. In respect
of foreign exchange investment functions it would be much easier to collect
reliable information. The data and assumptions can be refined over time as the
bank management gain experience of conduction business within an ALM
framework. The spread of computerization will also help banks in accessing data.

ALM ORGANIZATION (ALM COMMITTEE)

Successful implementation of the risk management process would require strong
commitment on the part of their boards and senior management. The board
should have overall responsibility for management of risks and should decide the
risk management policy and procedures, set prudential limits, auditing, reporting
and review mechanism in respect of liquidity rate and forex risks.

The Asset-Liability Committee (ALCO) consisting of bank‟s senior management
including CEO should be responsible for deciding the business strategy [on the
assets and liabilities sides] in line with the bank‟s business and risk management
objectives.

The ALM desk consisting of operating staff should be responsibilities for
analyzing, monitoring and reporting the risk profiles to the risk profile to the
ALCO. The staff should also prefer forecasts [simulation] showing the effects of
various possible changes in market conditions related to the balance sheet and
recommend the action to adhere to bank‟s internal limits.

The ALCO is decision making unit responsible for balance sheet planning from
risk-return perspective including the strategic management of liquidity, interest
rate and forex risks. The business and risk management strategy of the bank
should ensure that the bank operates within the limits/parameters set by the
board. The business issues that an ALCO considers, inter alia, includes pricing of
both deposits and advances, desired maturity profile and mix of incremental
assets and liabilities etc. in addition to monitoring the risk levels of the bank, the
ALCO should review the result of and progress in implementation of the decision
made in the previous meeting. The ALCO‟s future business strategy decision
should be based on the banks view on current interest rates. In respect of the
funding policy, for instance, its responsibility would be to decide on source and

mix of liabilities or sale of assets, Towards this end, it will have to develop a view
on future direction of interest rate movements and decide on funding mixes
between fixed vs. floting rate funds, wholesale vs. retail deposits, short term vs.
long term deposits etc,

Individual bank will have to decide the frequency for holding their ALCO meeting.
This committee meets regularly, at least once a month, through ideally it should
be once a fortnight , to review the liquidity potential vis-à-vis market conditions
and determines the strategies to maintain adequate liquidity, decides on raising
resources having regard to the cost in tune with the market condition, and
deployment of resources in profitable avenues.

RESPONSIBILITIES OF ALCO

Assessment of future interest rate scenario.
Assessment of the liquidity profile of the bank.
Assessment various risks, if any, in the balance sheet and drawing
strategies.
Monitoring spreads based on the changing scenario.
Drawing strategies to hedge risks perceived.
Guidance to the policies / strategies implemented and to alter/ change if
situation needs.
Review of actual performance vis-à-vis corporate projections.
Budgeting and planning.
Drawing short term as well as long term strategies depending on the
situation.

GUIDANCE

MONITORING
REVIEW

ASSESSMENT
ALCO STRATEGIES

PROJECTION PERCEIVED

BUDGTING

COMPOSITION OF ALCO

The size [number of members] of ALCO would depend on the size of each
institution, level of business and organization structure. The responsibility of
Asset Liability Management is on the treasury Department of the bank. To ensure
commitment of Top management and timely response to market dynamics, the
CEO or the Secretary should head the committee. The Chief of
investment/Treasury including forex, credit, planning etc, can be members of the
committee. In addition, the head of the Information Technology Division if a
separate division exists should also be invitee for building up of Management
Information System [MIS and related IT network. Some banks, large banks, may
even have sub-committees and supported Groups. The ALCO agenda consist of
comprehensive data on market conditions particularly with focus on liquidity in
Market ongoing interest rates fir sources and deployment avenues, the reserve
position, the yield pattern, spread, fee based income and overall profitability, the
avenues for raising resources and deployment, the classified data on maturity
pattern on assets and liabilities in different buckets [block/periods] as well as
classified data on interest rate sensitive assets and liabilities. The ALCO
considers maturity mismatches and ascertains gaps of creating liquidity in those
time buckets. While doing so Alco considers interest rate sensitive of respective
liabilities, if the resources are to be raised or respective assets, if surplus is to be
deployed. Major concern of ALCO in a sense, will be managing interest rate risk
and in the process, liquidity risk.

ALCO FUNCTION

ALCO meets periodically to assess the information of each department in detail.
Generally ALCO fixes the time horizon for planning. ALCO meets frequently
when market is volatile, sensitive, ect, so that prompt policy decision and
strategies can be planned.

During its meeting ALCO review;

a) Minutes of the previous meeting.
b) Review of fund gap reports and other reports.
c) Current commercial and market rates, to ensure that loans are priced
appropriately.
d) Current liability and deposit pricing matrixes so as to ensure that funds are
priced in accordance with overall funding policy.
e) Prospective assessment of accessibility of funds at a price that will give a
reasonable and consistent return on investment.
f) Results of the implementation of funding strategies which are designed to
ensure that the bank has adequate funds for credit, investment and
deposit repayment.

ALM committee at Surat People‟s bank include

 General Manger
 Deputy General Manger
 Assistant General Manger
 Investment Department Executive
 EDP executive

ALM PROCESS

In comparison with the commercial bank the scope of business and line of
banking operation of co-operative banks are limited. BY considering the ways
and means of resources mobilization and also based on the degree of exposure
to new risk related lending and investment portfolio of co-operative banks
exclusively focus on the following three major areas.

A. Identification of Risk

B. Measurement of Risk

C. Management of Risk

The identification stage intensifies different types of risk encountered by bank
due to interest rate fluctuations.

In the next stage bank tries to measure those risk using different models
suggested by RBI.

And finally bank takes various steps for the management of risk.

Now let us see each step in detail.

STAGE 1- IDENTIFICATION OF RISK

There are different types of risk faced by the bank. In this first stage bank tries to
identify those risk, which causes gap in Assets and Liabilities.

The uncertainty of interest rate movements gave rise to interest rate risk thereby
causing banks to look for processes to manage their risk. In the wake of interest
rate risk came with liquidity risk as inherent components of risk for banks. The
recognition of these risks brought Assets Liability Management to the centre-
stage of financial intermediation.

Now let us see about both the risk which causes mismatch in ALM.

1. Interest Rate Risk

CATGORIES OF INTEREST RATE RISK AND THEIR IMPACT
MISMATCH RISK

Banks, as apart of their business of intermediation between the savers and the
investors in the economy, assume liabilities and create assets, which are of
different maturities and sizes. The liabilities and assets are priced differently and
the difference between the interest received on assets and interest paid on
liabilities is bank‟s net interest income. Essentially, assets and liabilities mature
or fall due for reprising at different time intervals. Obliviously, there is a reprising
mismatch between assets and liabilities. The deposits have to be reprised, may
be at higher interest rates, at the end of one year while assets will continue to
provide fix return. If interest rates rise by the time the deposit is due to mature,
bank will be able to raise new deposit only at higher interest rates prevailing in
the market. This will result in interest spread between deposits and investment
getting reduced and adversely affecting Net Interest Income (NII) of the bank.

Also, mere maturity matching between assets and liabilities need not necessarily
protect bank from mismatch risk, the reprising may be at shorter interval and can
create mismatch in reprising and resultant interest rate risk.

 BASIS RISK

The risk of interest rates attached to different group of banks assets and liabilities
changing by different degrees are called basis risk. Further, changes in deposit
interest typically lag behind loan rates. The complex linkages between interest
rates in different segment of the market (Call, Repos, CDs. Inter bank Term
Money, etc.) contribute to the basis risk. Typically, in a falling interest rate
scenario, it is possible that interest rate on assets may be lowered generally
while the deposit may continue at the contracted higher interest rates The
following illustration will make the concept of basis risk clear.

(Interest sensitivity Gap Position 1-30 days Bucket)
LIABILITIES ASSETS
Call Money 50 Treasury Bills 30
Repo 50 Advances 120
Deposits 100
Total 200 Total 150
Negative Gap 50

If the interest rate rises by 1% bank will lose 0.5 crore per year assuming that the
rise in interest will be uniformly applicable to all the time items of assets and
liabilities. But in real world interest rates on assets and liabilities do not change in
same proportions. For instance, Call may go up 1%, Repo by 0.5%, Deposits by
0.25%, T-Bills by 1% and advances by 0.75%. The following table shows that if
interest rate the impact on net interest income will be gain of 0.2% crore instead
of loss of 0.5% crore as in the above case when on basis risk was taken into
account.

INCREASE IN (LOSS) / GAIN
INTEREST RATE DUE TO
INTEREST
RATE RISE
Call Money 50 0.01 (0.5)
Repo 50 0.005 (0.25)
Deposits 100 0.0025 (0.25)
Total (1)
Treasury Bills 30 0.01 0.3
Advances 120 0.0075 0.9
Total 1.2
Net Impact On NII 0.2(1.2-1)

 YIELD CURVE RISK

On account of volatility in interest rates, the yields curve unpredictability and
often substantially, change in shape. If the interest rates on assets and liabilities
are pegged to the bench mark rates (like T-bills cut off rates), there is the risk
that the interest spread may decreases as term spread narrows down. Assume
that the bank has raised a floating rate deposit, which will be reprised 1% above
the 91 day T-Bills cutoff and invested the amount in a floating rate loan of same
reprising interval but a spread of involved, as the spread between the two
maturities of T-Bills narrowed.

Period 91Days Tb 364 Days Term Interest
Tb spread Spread
Between
Deposit
And Loan.
April 2005 6.26 6.82 0.56% 1.56%
June 2005 6.34 6.98 0.64% 1.64%
August 2005 6.56 7.12 0.56% 1.56%
March 2007 6.89 7.34 0.45% 1.45%

 EMBEDDED OPTION RISK

Traditionally, Banks provide an option to depositors to prematurely close the
deposits and to borrowers to prepay the advances. Banks customers would be
exercising the option at the time most unfavorable to the bank in other words,
depositors may prematurely close the deposits when interest rates increase and
redeposit at higher rates and when interest rate decline borrowers may option to
prepay the loans and renew the same at the lower rate. In both cases banks NII
is adversely affected.

 REINVESTMENT RISK

The expected yield on investment, generally indicated by yield to maturity, is
based on the important assumption that the bond will be held till maturity during
the life of the bond, the periodic coupons received will be reinvested at an
interest rate equal to YTM. These assumption can go wrong in which case
income from investments by way of coupons get reinvested at lower rates incase
the interest rate decline.

 NON-PAYING LIABILITIES

The NII of the bank would be buoyant if it has more non-paying liabilities like
current deposits, float funds, etc, the volume of such deposits become volatile
and may even decline if the corporate undertake final cash management. With
the prospect of improvement in the payment and settlement infrastructure, such
idle balances left in the account by clients are likely to decline. The bank would
therefore be required to replace such liabilities with interest paying liabilities and
these would enhance the interest rate and sensitivity in the banks balance sheet.
Thus the volatility in the levels of non-paying liabilities would cause the risk to the
NII of the bank.

 PRICE RISK

The values of investments change inversely to interest rates. Thus if interest rate
in the market increase, investment suffers depreciation and if interest rate
declines investment in bank portfolio gain in value. The price changes in
investments are on account of present values of each cash flow being altered
when discounted by the new interest rate. However, we can generalize the
concept and extend the same to all items of assets and liabilities of bank balance
sheet, which conceptually constitute series of expected cash flows and as such,
have present values (market values) which vary with market interest rates. It
follows thus, that all items of assets and liabilities for a bank are exposed to price
risk. Price risk will impact the values for assets and liabilities and in turn, market
value of net worth which the difference between markets value of assets and
liabilities.

Sound Interest Rate Risk Management

 Sound interest rate risk management involves the application of four basic
elements in the management of assets and liabilities and off-balance sheet
instruments.
o Appropriate board and senior management oversight.
o Adequate risk management policies and procedures.
o Appropriate risk measurements, monitoring and control Function,
o Comprehensive internal controls and independent audits.

 The specific manner in which a bank applies these elements in managing
its interest rate will depend upon the complexity and nature of its holding and
activities as well as on level of interest rate risk exposure. What constitutes
adequate interest rate risk management practices can therefore very
considerably For Example, Less complex banks, whose senior managers are
active involved in details of day to day operations may be able to rely on
relatively base interest rate risk management process. However, other
organization that has more complex and wide-ranging activities are likely to
require more elaborate and formal interest rate risk management processes. To
address their broad range of financial activities and to provide senior
management with the information they need to monitor and direct day to day
activities. Moreover the complex interest rate risk management process
employed at such banks require adequate internal controls that include audits or
other appropriate oversight mechanisms to ensure the integrity of the
information used by senior officials in overseeing compliance with political and
limit. The duties of the individual involved in the risk measurement, monitoring
and control functions must be sufficiently separate and independent from the
business marks and positions takers to ensure the avoidance of conflict of
interest

 As other risk factor categories, the committee believes that interest rate
risk should be monitored on a consolidated, comprehensive basis to
include interest rate exposures in subsidiaries. At the same time however,
institutions should fully recognize any legal distinctions and possible
obstacles to cash flow movements among affiliates and adjust their risk
management process accordingly. While consolidation may provide a
comprehensive measure in respect of interest rate risk, it may also
underestimate risk when positions in one affiliate are used to offset
position in another affiliate. This is because a conventional accounting
consolidation may allow theoretical offsets between such position form
which a bank may not in practice be able to benefit because of legal or
operational constraints. Management should recognize the potential for
measures to undertake risks under such circumstances.
.

INTEREST RATE RISK: REGULATIORY ASPECTS

 RBI Guidelines:-

The phased deregulation of interest rates and the operational flexibility given to
banks in pricing most of the assets and liabilities have exposed the banking
system to Interest Rate Risk. Interest rate risk is the risk where changes in
market interest rates might adversely affect a bank's financial condition. Changes
in interest rates affect both the current earnings (earnings perspective) as also
the net worth of the bank (economic value perspective). The risk from the
earnings' perspective can be measured as changes in the Net Interest Income
(Nil) or Net Interest Margin (NIM). In the context of poor MIS, slow pace of
computerization in banks and the absence of total deregulation, the traditional
Gap analysis is considered as a suitable method to measure the Interest Rate
Risk. It is the intention of RBI to move over to modern techniques of Interest Rate
Risk measurement like Duration Gap Analysis, Simulation and Value at Risk at a
later date when banks acquire sufficient expertise and sophistication in MIS. 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/reprises contractually during the interval;
 RBI changes the interest rates (i.e. interest rates on Savings Bank Deposits,
advances upto Rs.2 lakh, DRI advances, Export credit, Refinance, CRR
balance, etc.) in cases where interest rates are administered ; and
 it is contractually pre-payable or withdrawable before the stated maturities

2. LIQUIDITY RISK

 CONCEPT OF LIQUDITY

Liquidity is the ease with which an individual, business firm or financial institution
can obtain cash by selling non-cash assets. Access to cash is important in
financial management of all business enterprises as it helps in ensuing smooth
function of the enterprises.

Providing liquidity to the customers is one of the intermediation functions of
banks. It is therefore important that bank‟s own liquidity is at a comfortable level.
Bank Liquidity may be defined as ability to raise a certain amount of funds at
certain within a certain amount of time. If a bank is in a position to raise addition
funds at a cheaper rate in a short period compared to another bank, then the
liquidity position of that bank is considered better than the other bank.

Liquidity needs of an individual bank are to be related to the demands made or
likely to made by both depositors and borrowers for funds over a period of time.
Looking to the varied customer profile of banks needs to assess its liquidity
needs based on the nature and composition of its Assets and liabilities.

A bank is liquid if it can meet all the demands made for cash against it at
precisely those items when cash is demanded. Moreover whatever sources
funds bank may choose to upon must be available at a reasonable cost and time.

The liquidity of an individual bank is different form the liquidity in the financial
system. While the overall liquidity in the financial system is dependent on various
macroeconomic variables and policy stance by Reserve Bank of India (RBI),
which is the Central bank liquidity of an individual bank can be managed through
careful planning and anticipation of deposits and loan changes.

Liquidity is different form liquidation of an enterprise refers to its ability to meet its
obligation as a going concern while liquidation is the process of disposal of
assets meeting its liabilities and essentially involves winding up of business
enterprise. Liquidity refers to the realizable value of units‟ assets and whether it
will be sufficient to meet liabilities.

 LIQQUIDITY RISK

Liquidity Risk is the possibility the possibility that an institution may be unable to
meet its maturing commitments or may do so only by borrowing funds at
prohibitive costs or by disposing assets at rock bottom prices.

It originates form the mismatches in the maturity pattern of assets and liabilities.
Analysis of liquidity risk involves the measurement of not only the liquidity
position of the bank on on-going basis but also examination of how funds
requirements are likely to be affected, under crisis scenarios.

The liquidity risk in banks manifests itself in different dimensions.

 Funding Risk - need to replace net outflows due to unanticipated
Withdrawal / non-renewal of deposits (wholesal and retail)

 Time Risk - need to compensate for non-receipt of expected inflows of
Funds, i.e. performing Assets turning into non-per morning
Assets.

 Call Risk - due to crystallization of contingent liabilities and unable to
Undertake profitable business opportunities when desirable.

NEED FOR LIQUIDITY BY BANKS

Liquidity has two separate and mutually exclusive purposes. One need for
liquidity is to provide funds to meet net decline in deposits. Other is to provide
and to meet increase in loans and investments that are rising faster than
deposits.

 Demand form depositors :

On the liability side of the balance sheet, deposit withdrawals represent an
important factor requiring banks to be liquid. Banks are able to attract deposits
from public not only by promising some return on their money but also by
committing themselves to repayment on demand. Banks must therefore build
adequate amount of liquidity in their assets portfolio so that they may in case of
necessity meet any claims upon them in cash on demand. If the depositors‟
cheque is not honored, the bank will lose confidence of the public, which may
result in mass run on the banks counters. The very arrival of bank is thus
endangered.

 Demand form Borrowers :

On the asset side of the balance sheet, demands for loans form customers have
to be accommodated as these accounts have a substantial impact upon the
banks profit. High value borrowers enjoy large borrowing limit form banks which
are not always fully drawn banks require to maintain sufficient liquidity to
accommodate requests for fresh loans as also provision for full utilization of
credit limits already sanctioned.

 Statutory Requirements :

Under section 24 of banking regulation Act, 1949 all scheduled Commercial
banks are required to maintain on a daily basis a proportion of net demand and
time liabilities in the form of securities approved by RBI. At present, commercial
banks are required to maintain Cash Reserve Ratio (CRR) to the extent of 6% of
net demand and time abilities in the form of deposits in the account maintained
with RBI. Banks have also to maintain Statutory Liquidity Ratio (SLR) to the
extent of 25% of net demand and time abilities in the form of approved securities.
Thus a scheduled commercial bank must maintain CRR and SLR as these are
considered as most liquid assets. However in practice these assets can be used
only for a brief period to take care of temporary liquidity, as have to be replaced
immediately to maintain prescribed levels.

LIQUIDITY MANAGEMNT: REGULATIORY ASPECTS

 RBI Guidelines:-

RBI had issued guidelines in February 1999 for putting in place Asset Liability
Management System in Banks. These guidelines were issued for managing
Liquidity Risk, Interest Rate Risk and Currency Risk. Banks were asked to set up
an internal Assets Liability Committee (ALCO) headed by Chief Executive Officer
/ CMD or the Executive Director. The Managing Committee or any specific
committee of the Board was also to oversee the implementation of the system
and review functioning periodically.

Measuring and managing liquidity needs are vital activities of commercial banks.
By assuring a bank's ability to meet its liabilities as they become due, liquidity
management can reduce the probability of an adverse situation developing. The
importance of liquidity transcends individual institutions, as liquidity shortfall in
one institution can have repercussions on the entire system. Bank management
should measure not only the liquidity positions of banks on an ongoing basis but
also examine how liquidity requirements are likely to evolve under crisis
scenarios. Experience shows that assets commonly considered as liquid like
Government securities and other money market instruments could also become
illiquid when the market and players are unidirectional. Therefore liquidity has to
be tracked through maturity or cash flow mismatches. For measuring and
managing net funding requirements, the use of a maturity ladder and calculation
of cumulative surplus or deficit of funds at selected maturity dates is adopted as
a standard tool.

The Maturity Profile as given in Appendix I could be used for measuring the
future cash flows of banks in different time buckets. The time buckets given the
Statutory Reserve cycle of 14 days may be distributed as under:

1) 1 to 14 days
2) 15 to 28 days
3) 29 days and upto 3 months
4) Over 3 months and upto 6 months
5) Over 6 months and upto 12 months
6) Over 1 year and upto 2 years
7) Over 2 years and upto 5 years
8) Over 5 years

Within each time bucket there could be mismatches depending on cash inflows and
outflows. While the mismatches upto one year would be relevant since these
provide early warning signals of impending liquidity problems, the main focus should
be on the short-term mismatches viz., 1-14 days and 15-28 days. Banks, however,
are expected to monitor their cumulative mismatches (running total) across all time
buckets by establishing internal prudential limits with the approval of the Board /
Management Committee. The mismatch during 1-14 days and 15-28 days should
not in any case exceed 20% of the cash outflows in each time bucket. If a bank in
view of its asset -liability profile needs higher tolerance level, it could operate with
higher limit sanctioned by its Board / Management Committee giving reasons on the
need for such higher limit. A copy of the note approved by Board / Management
Committee may be forwarded to the Department of Banking Supervision, RBI. The
discretion to allow a higher tolerance level is intended for a temporary period, till the
system stabilizes and the bank are able to restructure its asset -liability pattern.

The Statement of Structural Liquidity may be prepared by placing all cash inflows
and outflows in the maturity ladder according to the expected timing of cash flows. A
maturing liability will be a cash outflow while a maturing asset will be a cash inflow.
It would be necessary to take into account the rupee inflows and outflows on
account of forex operations including the readily available forex resources ( FCNR
(B) funds, etc) which can be deployed for augmenting rupee resources.

While determining the likely cash inflows / outflows, banks have to make a number
of assumptions according to their asset - liability profiles. For instance, Indian banks
with large branch network can (on the stability of their deposit base as most
deposits are renewed) afford to have larger tolerance levels in mismatches if their
term deposit base is quite high. While determining the tolerance levels the banks
may take into account all relevant factors based on their asset-liability base, nature
of business, future strategy etc. The RBI is interested in ensuring that the tolerance
levels are determined keeping all necessary factors in view and further refined with
experience gained in Liquidity Management.

In order to enable the banks to monitor their short-term liquidity on a dynamic basis
over a time horizon spanning from 1-90 days, banks may estimate their short-term
liquidity profiles on the basis of business projections and other commitments. An
indicative format for estimating Short-term Dynamic Liquidity is enclosed.

 Basel Committee for Banking Supervision (BCBS) Principles
for the assessment of liquidity management in banks:

The Basel Committee for Banking Supervision has focused on developing greater
understanding by Commercial banks to manage their liquidity on a global
consolidated basis. The recent technological and financial innovations have
provided banks with risk control tools for managing their liquidity. The declining
ability of banks in developed markets to rely on core deposits and their increased
reliance on wholesale funds has put pressure on liquidity.

According to Basel Committee, the process used to manage liquidity depends on
the size and sophistication of the bank as well as nature and complexity of its
activities.

SOURCES OF LIQUIDITY

The primary sources of liquidity can be classified in to two categories. The first
category consists of assets in which funds are temporarily invested with the
assurance that they will either mature or will be paid when liquidity is readily
saleable, without material loss before maturity. The second category includes the
various methods by which banks can borrow or otherwise obtain funds.

Assets that can be classified as liquid assets and serve as primary source of
liquidity be of high credit quality. They should be either of short maturity or easily
marketable with little chance of loss. The amount of liquid assets may be limited
by the willingness of bank to hold such Assets generally earn less than loans or
less liquid Assets. The sources of bank liquidity are mostly available through
money market and bank really on it for meeting liquidity needs in the are normal
course of business.

The potential sources of bank liquidity are as under –

 Money at call and short notice
 Short Term Central Government Securities
 Other Marketable Short Term Securities
 Securities purchased under agreement to resell
 Refinance form RBI
 Bills Rediscounting.

SOURCES OF LIQUIDITY RISK

Liquidity Risk in banks may be attributed to following factors

 Mismatch in Tenor profile of Assets and Liabilities:
Advances and investments form a major chunk on the assets side of a bank‟s
balance sheet. Banks in an effort to diversify their credit portfolio have started
lending and investing in various projects with long repayment periods. Banks due
to yield considerations have also been investing in government securities with
maturity as long as 30 years. However deposits of the bank are repayable on
demand or generally are for a maturity of 1-5 years. Thus banks have their long-
term assets financed out of liabilities, which are predominantly of short term. This
mismatch in tenor profile of assets and liabilities is likely to create liquidity risk in
a situation when roll over of deposits is rendered difficult.

 Embedded Options:
Banks provide option to term depositors for prepayment of deposits on recovery
of certain penalty. Similarly borrowers are allowed by some banks to prepay
loans. Both borrowers and depositors may use this option in a changing interest
rate scenario to take advantage of these changes. These embedded options
available both to depositors and borrowers make liquidity management a difficult
task for the bank.

 Non-Performing Assets:
Banks are faced with the problem of non-performing assets. Loan that default in
payment of interest and principal amount with a delay exceeding two quarters are
classified as Non-Performing Assets by banks. Such assets deprive banks of
cash inflows originally envisaged at the time of sanction. Banks that have got
substantial funds blocked in non-performing Assets are likely to face liquidity
problems.

 Undrawn credit limits:
Banks provide cash credit / Overdraft facilities to borrowers for meeting working
capital requirements. These facilities are in the form of running account and
borrowers depending on need withdraw funds. Banks have to maintain sufficient
liquidity to take care of utilization of undrawn credit facilities by the borrows.

OBJECTIVE AND POLICIES

Objectives:

The objective if Liquidity Management is to maintain statutory prescriptions, meet
contractual and maturing cash outflows and to profitable deploy surplus cash.
Sound liquidity management involves prudently managing cash flows as also
concentration of assets and liabilities (both on and off balance sheet) with a view
to satisfy that cash inflows have an appropriate relationship to approaching cash
outflows.
Holding excess liquidity has a bearing on profitability because liquid assets in the
form of cash and short-term securities generate lower yields. A trade off between
liquidity needs and profitability necessitates determination of optimum level of
liquidity. This will have to be supported by liquidity planning that assesses
potential future liquidity needs taking into account changes in economic, political,
regulatory and other operating conditions.

The primary objectives of liquidity management are to ensure

 An optimum liquidity position.
 Avoid concentration of funding that May leave the bank vulnerable to
potential liquidity problems.

Policies:

Banks are required to formulate Assets Liability Management Policy for
management of market risk including risk. Liquidity Management is part of the
banks Asset Liability Management Policy and Investment Policy for liquidity
management should provide broad framework for identification, measurement
and assessment of liquidity needs.

The policy may broadly include following aspects:

 It should provide for the establishment of Asset Liability Committee
(ALCO), the committee‟s membership and role as also periodicity of the
meetings to be held by the committee.

 The Policy may define reporting mechanism of the decisions taken by
ALCO to the Bank‟s Board / senior management and feed back to be
received form the Bank‟s Board.

 The policy needs to specify authority structure for making liquidity and
funds management decisions.

 The policy may provide for periodic review of the bank‟s deposit structure.
The review to include the colume and trend of the various types of
deposits offered, maturity distribution of time deposits, interest rates being
paid on each type of deposits and caps on large deposits.

 The policy to address funding concentration or excessive reliance on any
single source or type of funding.

 The policy in conjunction with the bank‟s Investment policy should
determine which type of investment is permitted, the desired mix and the
maturity distribution.
 Conveys the Board‟s risk tolerance and establishes target liquidity ratios
such as loan to deposit ratio, long-term assets funded by less stable
funding sources, individual and aggregated limits on borrowed funds by
type and source.
 The policy to specify the mechanism for periodic review of compliance
with policy guidelines such as established limits and legal reserves
requirements by senior management
 The policy to include contingency plan that addresses alternative source
of funds if initial projections of funding source and uses undergo any
change or if a liquidity crisis arises.
 The policy to formulate a process for measuring and monitoring liquidity
through cash flow projections or using models.
 The policy to provide authority and procedures for access to wholesale
funding sources and to establish a process for measuring and monitoring
unused borrowing capacity.
 The policy to focuses on satisfying the liquidity requirements that are
prescribed by RBI as part of regulatory mechanism.
 The policy to consider putting in place certain limits on duration of
liabilities and investment portfolio.
 Commitment ratios – Track the total commitment given to corporate /
banks and other financial institutions and to limit the off balance sheet
exposure.
 Limit on maximum cumulative outflow across all time bands.

LIQUIDITY MANGEEMNT: PLAN

All banks should have board approved written policies and procedures for the
day-today management of liquidity. The liquidity strategy and policies should be
communicated throughout the bank. The board of directors should be informed
regularly on the liquidity situation of the bank and the board should ensure that
senior management monitors and controls liquidity risk.

Bank management should have in place appropriate policies and procedures that
set and provide for the regular review of the limits on the sizes of liquidity
positions over particular time horizon. Management information adequate to
measure, monitor, control and report liquidity risk should be in place.

As part of the process for the on-going measurement of funding requirements,
banks should analyze liquidity under various scenarios and the underlying
assumptions for such scenarios should be reviewed periodically.

Relationship with lenders, other liability holders and market participants should
be diversified and reviewed periodically to ensure a capacity to access funding
either through new borrowings or the sale of assets.

Contingency plans should be in force and should include strategies for handling
liquidity crisis and procedures for addressing cash flow shortfalls in emergency
situations.

The bank should maintain an adequate system of internal control that involves
regular independent reviews and evaluations of the effectiveness of the liquidity
management system and ensuring that appropriate remedial steps are taken.

Other Risk

A. Credit Risk

It arises due to failure of borrowers to discharge their repayment obligation as per
contracted terms. This is the oldest & most important risk for the bankers. It
originates out of commercial choice of customer and is closely related to the
business police of the people implementing the policy. Credit risk is very critical
to banks since the defaulter of a small number of large borrowers could get into
strophic losses. Similar highly volatile interest rate environment may lead to
deterioration in the quality of credit portfolio. Traditional credit risk is a primary
challenge for financial institution and such risk are related to lay down credit
policy of the bank. The misjudgment of these risks may lead to eventual failure of
the banks, through the respective credit policies is highly interrelated with the
market risk.
The credit risk is caused by market risk variables. Management of such risks is
also a vital responsibility of the bank. In a highly volatile interest rate environment
loan defaults may increase the risk by deteriorating the credit policy.

B. Market Risk

It is a risk to bank‟s financial condition that would result form adverse movement
in the market places. It is the risk of adverse deviations of the market to market
value of the trading portfolio during the period required to liquidate the tractions
or revaluing the portfolio for balance sheet purposes. Primarily the impact on the
market risk is observed in the movement of portfolio value. Any decline in value
therefore will result in a market loss. This gets further aggravated adequacy
norms by the regulatory authorities. Accidentally the market risk could prove to
be dangerous for the banks.

C. Foreign Exchange Rate Risk & Currency Risk

It is the risk to the bank due to the fluctuation in the exchange rate of foreign
currency viz a viz –Indian currency. The impact of the movement of the rate of
exchange shall reflect directly on the fore portfolio of the bank resulting in the
change in the value of foreign exchange assets. Generally co-operative banks
are not in this type on business so this risk is not that much affected to them.

Floating exchange rate arrangement has brought in its wake pronounced
volatility adding a new dimension to the risk profile of banks' balance sheets. The
increased capital flows across free economies following deregulation have
contributed to increase in the volume of transactions. Large cross border flows
together with the volatility has rendered the banks' balance sheets vulnerable to
exchange rate movements.

Dealing in different currencies brings opportunities as also risks. If the liabilities in
one currency exceed the level of assets in the same currency, then the currency
mismatch can add value or erode value depending upon the currency
movements. The simplest way to avoid currency risk is to ensure that
mismatches, if any, are reduced to zero or near zero. Banks undertake
operations in foreign exchange like accepting deposits, making loans and
advances and quoting prices for foreign exchange transactions. Irrespective of
the strategies adopted, it may not be possible to eliminate currency mismatches
altogether. Besides, some of the institutions may take proprietary trading
positions as a conscious business strategy.

DRIVERS OF UNEXPECTED OUT– COMES

Uncertainty Lack of Information
Un expected out comes.
Mis match in ALM
Risk Lack of Knowledge

Equivocal Lack of Judgment

Error Lack of care

GOLDEN RULES ABOUT RISK

 No risk is separated in watertight compartments.

 The final effect is through interplay of these risks.

 Risk is associated with product or position.

 Risk can reduce by increased knowledge.

 Avoiding risk means avoiding encashment of the opportunities.

PROBLEM IDENTIFICATION

 Management Dilemma

Management dilemma is usually the symptom of an actual problem. Asset –
Liability Mismatch is often the biggest problem in a bank, hence its Management
is a bigger concern. For this study Management dilemma found was:

“Mismatch of Assets and Liabilities at Surat People‟s Co-operative Bank”

 Management Question

Management question restates the dilemma in question form. Here the
management question was:

“How the Assets and Liabilities mismatch can be managed.”

 Problem Statement

The management question generated led to the formulation of the following
problem statement.

“Asset – Liability Management at Surat People‟s Co-operative Bank”

RESEARCH OBJECTIVES

1. I have to Measurement and Management of Risk which affect the banks
Asset – Liability position.

2. To study how the interest rate and liquidity risks affect assets and
Liabilities of the Bank.

SCOPE OF THE STUDY

1. The scope of the study includes: In depth study of Asset – Liability
statement as 22 / 12 / 2006 of Surat People‟s Co-operative Bank for the
measurement of interest rate risk.

2. Study of Asset – Liability statement as on 26 / 12 / 2003 and as on 22 / 12
/ 2006 for the purpose of measurement of liquidity risk.

3. The scope also includes study of cash flow statement of 2003 to 2006 for
calculation of ratios.

BENEFITS OF THE STUDY

1. Bank could also know about the causes of mismatch in Assets and
Liabilities.

2. Bank could also know different types of risks as well as how to measure
and mange them which cause the mismatch.

RESEARCH DESIGN

“Research design is the plan, structure and strategy of investigation conceived so
as to obtain answers to research questions and to control variance.”

This study can classify as exploratory study. Exploration was needed at three
different stages.

 Initially exploration was needed just to learn something about
management dilemma.

 In the next step exploration was needed to find out how different risk
affects Assets and Liability position of the bank.

 Finally exploration was needed to find out the measures to manage the
mismatch.

SAMPLE DESIGN

ALCO committee is consulted by one General Manager, one Deputy General
Manager, two Asst. General Manager and one Executive. In this study five
members from ALCO committee, 35 members from Loan Department and 4
members from Investment Department. All the members of ALCO committee,
members of loan department and members of investment department were
selected as the samples of this study.

Further in this study, type of the sample selected was non-probabilistic
systematic sampling method. Since the study was about Measurement and
Management of Risk at Surat People‟s Co-operative bank, the information about
various risks was available from employees of Investment Department as well as
Loan Department.

Primary Data collection

The primary data is seeking information from the persons experienced in the
area of the study. We interviewed bank employees and agents for more detailed
information. Interviewing them bought us to light many aspects, which were
important across the range of the subject. Through experience survey we got
data, which we couldn‟t get through secondary data analysis.

DATA COLLECTION

The objectives of the exploration may be accomplished with different exploratory
techniques used in this study were:

SOURCE OF INFORMATION

INTERNAL SOURCE EXTERNAL SOURCE

BUOCHURE WWW.RBI.COM
MANUALS RBI MANUALS
ANNUAL REPORTS ALM SYSTEM IN BANKS
WWW.SPCB.COM GUDILINES- RBI BOOK
ASSET – LIABILITY ALM IN BANKS – DILIP
STATEMENT KUMAR SARMA
FINANCIAL STATEMENTS (ECONOMIST) SBH

When I just started with the project I first went on for Bank‟s internal data
sources. I visited bank‟s website www.spcb.com.Then I also reffed to manual‟s
broachers, product prostrations, etc. This gave me general information about
bank and the banking industry. Then for further details I went on for external
sources. I went on for external sources. We referred to books of economist –
Dilip Kumar Sarma, RBI manuals for guidelines, website of RBI.

ANALYTICAL TOOL

In this project Microsoft Excel as well as different types of the charts are used as
the analytical tool.

1. Excel Sheet - Excel sheet is used to make various calculations while
measuring the interest rate risk by using the formula bar.

2. Column Charts – Column charts compare the values across the
categories. They are used to show the past performance of the bank.

3. Percentage – percentage is used to calculated liquidity ratio.

LIMITATIONS OF THE STUDY

1. The weights of the standardized gap are based on the forecast which is in
turn based on the individual perception.

2. In addition to interest rate risk and liquidity risk there are some other risks
such as credit risk which fall within the ALM framework but they are not
considered in the study because they have negligible impact on mismatch
of Assets and Liabilities.

3. Value at Risk Method is new method for quantification of risks. Through
this method, the current economic value of assets and liabilities are
arrived at by depreciation and appreciation of the original period value of
the product with the corresponding movements of the interest rates. – This
type of method does not take bank in their measurement of risk.

STAGE 2 – MEASUREMENT OF RISK

INTEREST RATE RISK

Interest rate risk can be measured by 3 methods:

1. Traditional Gap Method
2. Standardized Gap Method
3. Duration Gap Method

 Traditional Gap Method

John Clifford in 1975 originally formulated the concept of IRRM in an article
entitled “A perspective on Assets Liability Management” Both assets and
liabilities were divided into three pools of funds – variable, fixed and non-rate
funds.

Traditional gap analysis involves an analysis in management of banks position in
interest sensitive assets, liabilities and off-balance sheet items with reference to
the existing interest sensitivity exposure of the bank as on a particular day. The

gap analysis usually covers the performance period adopted by the bank for its
performance planning. While ideally such repricing gaps may be worked out on a
daily basis factoring the projected business over a given period of time, a simpler
method is adopted in practice where by assets and liabilities as on the reference
date are grouped as per the repricing maturities under predefined time buckets.
The choice of the length and number of time buckets depend upon the nature of
activity of the financial institutions.

Rate Sensitive Gaps

ASSETS LIABILITY

Variable Variable
Rate Rate

--------------------------- Rate
--------------------------- Sensitive Gap
Fixed
Rate
Fixed
Rate ----------------------------
Rate
--------------------------- Non Sensitive Gap
Non
Rate
Sensitive
Rate

Rate sensitive gap =Controllable + Non-Controllable gap

The Gap is the difference between Rate Sensitive Assets (RSA) and Rate
Sensitive Liabilities (RSL) for each time bucket. The Positive Gap indicates that it
has more RSAs then 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.

If management feels that in any bucket the repricing gap is high and signifies a
higher interest rate risk exposure, it will try to reduce such gaps. Thus, bank can
hedge itself against interest rate changes no matter which way the rates the rates
move, by making sure for each time bucket that the volume of repriceable
liabilities.

The Gap analysis address the problem of impact on Net Interest Income (NII) as
such is carried out for the planning horizon and confines itself to the possible
changes in the interest rate occurring during such time horizon. The starting point
for the gap analysis is therefore to decide on the time buckets and the
identification of the interest rate sensitive assets and liabilities. An item of assets
/ liabilities is the interest rate sensitive if it matures or contractually falls due for
repricing during the time bucket. Thus the proceeds for the maturing loan can be
reinvested in the another assets at yield related to the yield currently available on
similar assets and liabilities like cash on hand, premises, current account
balances are obviously kept out as they are not subject to repricing. If the amount
of repriceable assets is not equal to the amount of repriceable liabilities the gap
is said to be exist.

If the interest rate rises, the banks NII will increase, because more of bank‟s
assets will reprice at a higher rate than liabilities and therefore, revenue will

increase more than the cost of borrowed funds. On the other hand, if the interest
rate falls when the bank is asset sensitive the banks NII will decline as interest
revenues form the reprised assets drop by more then interest rate expenses
associated with the repriced liabilities. Similarly, if the interest sensitive liabilities
exceed the interest sensitive assets due for repricing in a particular time bucket,
the bank is said to be liability sensitive or negatively gapped during that time
bucket. The impact on NII resulting form the changes in the interest rate will be
exactly opposite to those discussed for the positive gap. The important
assumption is that the extent of rise in interest rate both on asset and liability side
will be same and concurrent across the time.
When Gap =1, RSA is perfectly matched with RSL. An increase in the interest
rates will have equal impact on assets and liabilities and thus net interest margin
will be maintained, assuming spread of returns on assets over liability costs was
positive at the beginning of the period.

When Gap >1, there are more RSA than RSL. When the interest rate rises, the
margin will also increase and opposite is true when the interest rate declines.

On the other hand, if Gap <1, and interest rate rises, the cost of funding will
increase and reduce the interest margin a declining interest rate scenario, the
funding cost will fall faster, thus raising the margin.

The relationship between interest rate changes and their impact on net interest
income are shown in below table:

GAP INTEREST RATE IMPACT ON NII

CHANGE
Positive Increase Positive
Positive Decrease Negative
Negative Increase Negative
Negative Decrease Positive

The adverse impact on NII is calculated by multiplying the gaps with the
expected change in the interest rates.

Assumptions

1. The repricing item is spread over, within the buckets, uniformly and as such
the mid point of bucket can be taken as an approx. Point at which the
repricing takes place.

2. The assets or a liability repriced continues to remain in the balance sheet
yielding income / incurring cost at the repriced rate during the remaining
period of the performance horizon.

3. Further, the change in rate is assumed be equal for all items of assets and
liabilities.

 Shortcoming of Gap method

1. Basically a balance sheet concept and captures only principal assets and
liabilities revenue flows are ignored
2. Static analysis: business growth is not taken in to account
3. Assumes parallel shift in the yield curve

4. Dose not take into account time value of money
5. Emphasis on short term and NII
6. Forecasting of interest rates difficult through essential
7. The simple Traditional Gap Analysis does not reckon Basis Risk
8. Simplifying assumptions are made about the time of repricing of assets
and liabilities within the bucket.
9. The Bucketing is rather arbitrary and there could be mismatch within the
time buckets.

Gap position of Surat people‟s Co-operative Bank as on 22 / 12 / 2006 (In
Crores)
Up to Over 3 Over 6 Over 1 Over3
3 Months Months Year Year Over 5 Non –
Month And And And And Years Sensitiv Total
Up to 6 Up to 1 Up to Up to 5 e
Month Year 3 Years Assets
Years

Total 65.15 66.30 73.19 223.48 48.02 7.71 568.56 1052.41
Liabilities

Total
Assets 52.07 95.16 62.01 221.51 192.49 376.89 63.89 1064.02

Interest
Rate
Sensitive _
Gap 13.08 28.86 -11.18 -1.97 144.47 369.18 -504.67 11.61
(Repricable
Asset-
Repricable
Liabilities)
_
Cumulative 13.08 15.78 4.60 2.63 147.10 516.28 11.61
Gap
If Interest

Rate _ -
Increases 13.08 0.2886 0.1118 0.0197 1.4447 3.6918 -5.0467
By 1 %
If Interest
Rate 0.131 -0.289 -0.112 0.0197 -1.4447 -3.6918 5.0467
Decreases
By 1 %

If the first Gap -13.08 is left unattended would entail a deduction in NII by
-13.08 * 0.01 * (12 / !2) = -13.08 crore if interest rate increases similar
calculation are made in respect of other relevant gaps also as shown in the
above table.

Approximate Overall Size of the x Overall change in
Change in Banks NII = Cumulative gap the interest rates
= 11.61 x 0.01
= 0.1161 crores.

 STANDISED GAP METHOD

Traditional gap analysis would lead to conclusion that if banks gap is zero its NII
is protected form interest rate risk. However, in really zero gap does not eliminate
all interest rate risk because the interest rate attached to banks assets and
liabilities do not change in unison and to the same degree. Thus, to a particular
course in the market leading to change in the interest rate, different segments
(loans, call money, CDs, ect) respond to the changes in the macro indicators like
bank rate. But changes in the interest rates on loans and deposits follow with
lags and in-different magnitudes.

In order to obviate the above problem of basis risk, the traditional gap analysis
can be modified by weighting the classes of liabilities / assets with the elasticity

of interest rate unique to the that class with reference to the bench market
interest rate.

 Shortcoming of Standardized Gap method

1. Basically a balance sheet concept and captures only principal assets and
liabilities revenue flows are ignored
2. Static analysis: business growth is not taken in to account
3. Assumes parallel shift in the yield curve
4. Dose not take into account time value of money
5. The Bucketing is rather arbitrary and there could be mismatch within the
time buckets.
Weighted Rate sensitive items of ALM statement as on December 2006

Rate Sensitive Change In Balance sheet
Liabilities/ Assets Nominal Interest rate Refigured to
Maturing/ Repricing Value Reflect Rate
(Weights)
During the Time Sensitive
(1) (2)
Bucket Upto 3 Months (1 * 2)

Rate Sensitive
Liabilities
Total Borrowings 0.00 0.50 0
Term Deposits 65.15 0.50 32.575
Saving Deposits 0.00 0.25 0
Total (B) 32.58

Rate Sensitive
Assets

Balance With RBI 0.00 1.0 0
Balance With Other
Bank
Call Money 15.00 1.50 22.5
Term Deposit 8.50 0.50 4.25
Investment in
Government Securities 18.24 1.50 27.36
Advances 7.36 1.50 11.04
Total (A) 65.15
Total Interest 32.57
Sensitive Gap(A-B)

(Weights)
(1) (2)
Bucket 3-6 Month (1 * 2)

Rate Sensitive
Liabilities
Term Deposits 42.55 0.50 21.28
Saving Deposits 23.75 0.25 5.94
Total (B) 27.22

Rate Sensitive
Assets
Balance With RBI 6.28 1.0 6.28
Balance With Other
Bank

Call Money 0.00 1.50 0
Term Deposit 53.00 0.50 26.5
Investment in
Advances 14.2 1.50 21.3
Total (A) 78.8
Sensitive Gap(A-B)

(Weights)
(1) (2)
Bucket Upto 6 Month (1 * 2)
to 1 year

Rate Sensitive
Liabilities
Total (B) 36.60

Rate Sensitive
Assets
Balance With Other

Bank
Term Deposit 26.33 0.50 13.17
Investment in
Advances 32.86 1.50 49.29
Total (A) 66.69
Sensitive Gap(A-B)

(Weights)
(1) (2)
Bucket Upto 1 Year to (1 * 2)
3 years

Rate Sensitive
Liabilities
Term Deposits 223.48 0.50 111.74
Total (B) 111.74

Rate Sensitive
Assets
Balance With Other

Bank
Investment in
Advances 142.75 1.50 214.13
Total (A) 322.43
Sensitive Gap(A-B)

(Weights)
(1) (2)
Bucket Upto 3 Year to (1 * 2)
5 years

Rate Sensitive
Liabilities
Total (B) 24.01

Rate Sensitive
Assets
Balance With Other

Bank
Term Deposit 15.42 0.50 7.71
Investment in
Advances 126.35 1.50 189.53
Total (A) 273.32
Sensitive Gap(A-B)

(Weights)
(1) (2)
Bucket Over 5 Years (1 * 2)

Rate Sensitive
Liabilities
Total (B) 3.86

Rate Sensitive
Assets
Balance With Other
Bank

Investment in
Advances 72.97 1.50 109.46
Total (A) 562.78
Sensitive Gap(A-B)

Summary of Standardized Gap Method

3 Months Months Year Year Over 5
Month And And And And Years
Up to 6 Up to 1 Up to 3 Up to 5
Month Year Years Years

Interest Rate
Sensitive
Gap
(Repricable
Asset- 32.57 51.58 30.09 210.69 249.31 558.92
Repricable
Liabilities)

Cumulative 32.57 84.15 114.24 324.93 574.24 1133.16
Gap
If Interest Rate
Increases By 1 0.3257 0.5158 0.3009 2.1069 2.4931 5.5892
%
If Interest Rate
Decreases -0.3257 -0.5158 -0.3009 -2.1069 -2.4931 -5.5892
By 1 %

If the first (-) 0.3257 is left unattended would entail a reduction in NII
by 32.57 * 0.01 * (12/12) = (-) 0.3257 crore if interest rate deceases
by 1%. Similar calculations are made in respect of other relevant
gaps also as shown in the above table.

Approximate Overall Size of the x Overall change in
Change in Banks NII = Cumulative gap the interest rates
= 1133.16 x 0.01
= 11.3316 crores.

Traditional Method Vs Standardized Method

3 Month Month Year Year Over 5
Month s s And And Years
And And Up to Up to
Up to 6 Up to 1 3 5
Month Year Years Years

Interest
Rate
Traditional Sensitive _
GAP Gap 13.08 28.86 -11.18 -1.97 144.4 369.1
(Repricabl 7 8
Method e
Asset-
Repricable
Liabilities)
If Interest
Rate _ -
Increases 13.08 0.2886 0.1118 0.019 1.444 3.691
By 1 % 7 7 8
Interest
Rate
Standardize Sensitive
Gap

d (Repricabl 32.57 51.58 30.09 210.6 249.3 558.9
e 9 1 2
GAP
Asset-
Method Repricable
Liabilities)
If Interest
Rate 0.325 0.5158 0.3009 2.106 2.493 5.589
Increases 7 9 1 2
By 1 %

As may be seen From above that as per the Tradition Gap Method, if there is one
percent increase in bank rate impact on NII in Up to 3 months” time bucket is
Negative but in Standardized Gap Method the Impact on NII is Positive. The
reason for this difference is that Standardized Gap Method takes care of Basic
Risk also. In order to take care of basis risk, it is necessary that bank should be
in a position to forecast not only the direction of interest rate movements but
also the changes in different assets segments.

 Duration Gap Method

Duration method measures the impact of the changes of interest rates on the
market value of assets and liabilities. The origin of such a method goes back to
the practice existed for calculating current value of bonds. The existing method
for such calculation was based on cash flows and average maturity. But
calculation of average maturity implicitly assumes no time value for money,
whereas in practice early receipts are of more value than latter receipts. Duration
method takes care of this by weighting all cash flows by the time at which they
occur.

So if the duration of a financial instrument is known, the change in the price of
that instrument in response to a given change in interest rate can be calculated.
Another feature of this method is that it is additive.

Duration is measure of the percentage change in the economic value of a
position that will occur given a small change in level of interest rates. It reflects
the timing and size of cash flows that occur before maturity, the higher the
Duration (in absolute value). Higher duration implies that a given change in the
level of interest rates will have a larger impact on economic value.

Duration – based weight can be used in combination with a maturity / repricing
schedule to provide a rough approximation of the change in a bank‟s economic
value that would occur given a particular change in the level of market interest
rates.

Alternatively, an institution could estimate the effect of changing market rates by
calculating the pricies duration of each assets, liability, and then deriving the net
position for the bank based on these more accurate measures, rather than by
applying an estimated average duration weight to all positions in a given time
band. This would eliminate potential errors occurring when aggregating cash
flows.

As Duration is the direct outcome of interest rate and maturity, it may also be
defined as the measure of price sensitivity to its change in interest rates.

 PROPERTIES OF DURATION

1. Duration is less than its maturity. This is because of the
intermediary cash flows which reduce its effective maturity.

2. Duration is directly related to maturity. Longer the maturity larger
will be the duration.

3. Duration is inversely related to the market interest rates or Yield.

4. Duration of portfolio is equal to the weighted average duration of all
the items in the portfolio.

5. Higher frequency of intermediary cash flow reduces duration.

Duration Gap

 Steps in Computation Of Duration

1. Ascertain timing a calculate magnitude of cash flows
2. Find present value of each cash flow (Using discount factors)
3. Find time- weighted PV of each cash flow
4. Find total of all TWPVs
5. Divide total in step 5 by total in step 3

When the market interest rates are expected to change it will cause the change
in value of assets portfolio as well as liability portfolio. This will in turn have the
impact on the net worth of the bank.

Net Worth = Assets – Liabilities.

Change in Net Worth = Change in value - Change in value of
Of assets Liabilities

% Change in Value = Duration x Change in Yield.

To protect the negative impact on net worth due to interest rate changes bank
can follow the following steps of duration Gap analysis.

STEPS IN DURATION GAP ANALYSIS

 Management develops in interest rate forecast.

 Management estimates the weighted duration of Assets (DA) and
weighted duration of liabilities(DL)

 Management calculates DGAP

DGAP = DA – DL

The positive DGAP indicates that duration of assets is greater than
duration of liabilities.
The negative DGAP indicates that duration of assets is less than
duration of liabilities.

The zero DGAP indicates that duration of assets and duration liabilities
are equal.

The impact of changing market interest rates on the bank‟s net worth is indicated
given below:

Nature Of DGAP Direction of interest Impact on bank‟s net
rates movement worth
Positive Rise Decrease
Fall Increases
Negative Rise Increases
Fall Decrease
Zero Rise No change
Fall No Change

Duration Gap at Surat People‟s Bank

Duration of Assets (DA) = Sum of Product of Asset‟s Duration
= 4.6463 Years

Duration of Liabilities (DL) = Sum of product of Liability‟s Duration
= 4.2438Years

Assets Liabilities
A Portfolio of Assets with 1064.02 A Portfolio of Liabilities 794.85
a Duration of 4.64 years with a Duration of
4.24years

Equity + Reserves 269.17
1064.02 1064.02

Duration Gap = DA – Liabilities / Assets * DL
= 4.64 – (794.85 / 1064.02) * 4.24
= 4.64 -3.18
= 1.46
Here the duration Gap is positive. Hence impact of change in interest rates on
Net Worth of the Bank will be as follows

Nature Of DGAP Direction of interest Impact on bank‟s net
rates movement worth
Positive Rise Decrease
Fall Increases
Now we see how the value of net worth is affected through change in value of
assets and liabilities if interest rate moves in either direction.

Interest rate rises by 1%

% Change in value of Assets = -DA X Change in Yield
= -4.64 x 0.01
= 0.0464 or 4.64%
Therefore, Change in value of Assets = 1064.02 - 4.64%
= 1064.02 - 49.37
= 1014.65
% Change in value of Liabilities = -DL x Change in Yield
= - 4.24 x 0.01
= - 0.0424 or 4.24%
Therefore, Change in value of Liabilities =794.85 - 4.24%

= 794.85 – 33.70
= 761.15

Change in Net Worth = Change in value - Change in value
Of Assets of liabilities

= 49.37 – 33.70
= 15.67 crores
Assets Liabilities
4.24years
269.17 – 15.67
1014.65 1014.65
Thus, the net worth will decrease by 15.67 crores
Interest rate decreases by 1%

% Change in value of Assets = -DA X Change in Yield
= -4.64 x 0.01
= 0.0464 or 4.64%
Therefore, Change in value of Assets = 1064.02 + 4.64%
= 1064.02 + 49.37
= 1113.39

% Change in value of Liabilities = -DL x Change in Yield
= - 4.24 x 0.01
= - 0.0424 or 4.24%
Therefore, Change in value of Liabilities =794.85 + 4.24%
= 794.85 + 33.70
= 828.55

Change in Net Worth = Change in value - Change in value
Of Assets of liabilities

= 49.37 – 33.70
= 15.67 crores

Assets Liabilities
4.24years
269.17+15.67
1113.39 1113.39

Thus, the net worth will increase by 15.67 crores

LIQUIDITY RISK

Liquidity Risk can be calculated through various Liquidity Ratios such as:-

1. Liquid Assets to Total Assets
2. Loans to Deposit
3. Loans to Assets
4. Loans to Investment
5. Commitments to Total Assets
6. Net Cash Flow to Total Assets
7. Net Cash Flow to Total Liabilities
8. Net Cash Flow to Core Deposits
9. Net Cash Flow to Volatile Deposits

LIQUIDTY RATIO AT SURAT PEOPLE‟S CO-OPERATIVE BANK

Liquidity ratios provide the primary means of judging a bank‟s liquidity position.
For business firms, as we are aware “Current Ratio” (current assets divided by
current liabilities) forms the primary ratio to measure liquidity. However for banks
there are no universally recognized liquidity ratios. One reason for this is that
liabilities of non-financial firms are highly predictable because they have fixed
maturities while a large proportion of bank‟s liabilities are repayable on demand.
Following liquidity ratios are generally analyzed by bank.

 Liquid Assets To Total Assets

LIQUID ASSETS 2003 2004 2005 2006
Cash 8.47 6.41 7.68 6.89
Balance With RBI 31.80 31.90 34.55 41.02
Balance With Other Banks 135 90.83 95.04 137.04
Investment available for 285.02 375.80 357.47 289.97
sales
Money market instrument 0 6.75 6.00 6.00
TOTAL 460.29 511.70 500.74 480.92

Total Assets 899.37 865.78 942.07 1064.02

Liquid Assets to Total 51.18% 59.10% 53.15% 45.20%

Assets

Liquid Assets as a percent of total assets show the percentage of liquid assets in
the asset structure of the bank. So we can say that higher the proportion of
Liquid Assets in the Total assets, higher the liquidity of the bank.

For the Surat People‟s Co-operative Bank, Liquid Assets to Total Assets as on
December 2003 was 51.18% While as on Dec 2004 it is 59.10% These assets
are presumed to be immediately convertible in to cash in case of any liquidity
requirements and the amounts provide a measure of liquidity position of the
bank. Thus on Dec 2005 was 53.15% while as on Dec 2006 was 45.20%.These
Assets are presumed to be as compared with last two years not to increases but
as compare it decrease it not good for bank but compare with other co-operative
bank its position of the bank is improving which shows the strong liquidity
position of the bank.
 Loan to Deposits

2003 2004 2005 2006
Loans 323.02 339.86 337.63 396.49
Total Deposits 681.11 623.04 682.06 783.83
Loans to Total Deposits 47.42% 54.55% 49.50% 50.58%

Loans to deposits ratio indicates the degree to which the bank has already used
up its available resources to accommodate the credit needs of the customers.
The presumption is that the higher the ratio of loans to deposits, the less able the
bank will be to make addition loans. This ratio is normally 60% which indicate is
the good position. A high loan deposits ratio indicates that a bank has a large
proportion of its interest earning assets in loans and small percent in securities.

As loans are not easily saleable like securities, a high loan deposits ratio
indicates that a bank will have comparatively low liquidity.

However this ratio indicates nothing about the liquidity of the remaining assets or
the nature of bank are other liabilities, which could be a source of great liquidity.
In spite of this shortcoming, the loan to deposits ratio is useful as one in group of
liquidity ratios. The loan deposit ratio undoubtedly has a psychological impact on
bank management. As the ratio increases, lending policies may become more
cautious and selective. Obviously the total of loanable funds, roughly measured
as percentage of deposits, sets an upper limit to a bank‟s ability to make
additional loans without recourse to more or less continuous borrowings.

Since loans to total deposits ratio has increased in 2006 as compared to previous
year, bank as comparatively low liquidity. But still difference is very less and bank
is till in good liquidity position.

 Loan to Assets

2003 2004 2005 2006
Loans 323.02 339.86 337.63 396.49
Assets 899.37 865.78 942.07 1064.02
Loan to Assets 35.92% 39.25% 35.84% 37.26%

The loans, being liquid assets for a bank, this ratio indicate the percentage of
liquid assets to total assets. Arise in this ratio would indicate lower liquidity and

the need to evaluate other liquidity ratios. Loans to total assets for both-2005 &
2006 the year is nearly equal, thus bank has maintain its liquid position.

 Loan to Investment

2003 2004 2005 2006
Loans 323.02 339.86 337.63 396.49
Investment 376.56 371.40 444.79 458.54
Loan to Investment 85.78% 91.50% 75.91% 86.47%

Bank has got two main channels for deployment of resources viz, loans and
investments. While loans are expected to provide higher returns compared to
investments, these suffer form higher credit risk and more illiquid then
investments. Thus a proper mix of loans and investments keeping in view
liquidity and yield considerations needs to be fixed.

Here ratio has increased from 85.78% in 2003 to 91.51% in 2004. Then it
decreases from 75.91% in 2005 & then it anginas increased 86.47%. Thus bank
is improving its position by maintain a good mix of loans and investment in the
portfolio.

 Commitments to Total Assets

2003 2004 2005 2006
Commitments 217.28 467.82 432.52 296.72
Assets 899.37 865.78 942.07 1064.02
Commitments to total 24.16% 54.03% 45.91% 27.89%

Assets

Commitments are total limits sanctioned for letters of credit, bank guarantees and
committed lines of credit. If a bank has a high level off of balance sheet exposure
compared to its total assets, it can create liquidity risk. Higher the ratio creates
the problem for bank in future.

Here ratio increased from 24.16% in 2003 to 54.03% in 2004. Thus it increased
more than double so it gives signal for liquidity problem in next year or in future
but bank can decreased their ratio from 45.91 in 2005 to from 27.89% in 2006 its
good for future.

Cash flow associated liquidity ratios.

The net cash flow or mismatch in cash inflow and outflows over a particular time
period serve as the basic parameter to assess the liquidity position of the bank.
Following ratio could be estimated for liquidity measurement.
 Net Cash flow to total Assets

2003 2004 2005 2006
Net Cash Flow 26.66 32.59 7.01 23.32
Assets 899.37 865.78 942.07 1064.02
Net Cash flow to total 2.96% 3.76% 0.74% 2.19%
Assets

Net cash flow to total assets will help in judging the impact of cash flow mismatch
on liquidity. A ratio of 10% – 15% may be considered a tolerable level. Since

here these percentages are only 2.96%, 3.76%, 0.74% and 2.19% for 2003,
2004, 2005 and 2006 respectively bank in not in a good position.

 Net Cash flow to total Liabilities

2003 2004 2005 2006
Net Cash Flow 26.66 32.59 7.01 23.32
Liabilities 881.78 849.26 929.08 1052.41
Liabilities

Similarly, net cash flow to total liabilities will measure liquidity under conditions
when fluctuations in liabilities are major concern for meeting liquidity. A ratio of
10% - 15% may be considered a tolerable level. Since here these percentage are
3.02%, 3.84%, 0.75% and 2.22% respectively bank in not in good position.

 Net Cash flow to Core Deposits

2003 2004 2005 2006
Net Cash Flow 26.66 32.59 7.01 23.32
Core Deposits 597.18 654.42 547.74 626.18
Core Deposits

The bank has to maintain sufficient liquidity to meet payment obligations on
withdrawal of these Deposits. This Ratio indicates the extent to which cash flows
are able to meet the demand from Depositors. A bank should not require a high
level of positive mismatch (Net cash flow) because core deposits are those which
remain with bank for considerable period of time. Here the ratios are nearly 4% -
5% for three years, which are sufficient to meet liabilities.

 Net Cash flow to Volatile Deposits

2003 2004 2005 2006
Net Cash Flow 26.66 32.59 7.01 23.32
Volatile Deposits 26.73 28.19 22.66 23.97
Net Cash flow to total 99.73% 115% 30.94% 97.29%
Volatile Deposits

The bank has to maintain sufficient liquidity to meet payment obligations on
withdrawal of these Deposits. This ratio indicates the extent to which cash flows
are able to meet the demand form Depositors.
A bank should require a high level of positive mismatch (Net cash flow) because
volatile deposits are those, which are not remains with bank for considerable
period of time. Here the ratios are 99.73% for the year 2003 that is adequate, but
for the year 2004 it is 115%, which is not needed. Bank reduced the ratio in 2005
it is 30.94% then it increases for the year 2006 it is 97.29% its good for the bank.
The ratio must maintain the level up to 100%.

STAGE 3 – MANAGEMENT OF RISK

 TRADITIONAL GAP METHOD

The bank should mange the gaps as close to zero as possible thus performing
Defensive Interest Sensitive Gap management.

However, a profit maximization approach, by taking positions in gaps based on a
view on interest rates would be considered Aggressive Management of Gaps.
Under this approach, the bank should try to reduce or increase the size of the

gaps according to their view on interest rate movements. But this involves
considerable risk for the banks in the event of the interest rate view turning to be
incorrect. Thus bank can mange gap by adopting following strategy.

1. If Interest rates are expected to increase in near future then Bank
should try to maintain Positive Gap (i.e. rate Sensitive assets are
more than the Rate Sensitive Liabilities) So that there will positive
impact on NII.

2. If interest rates are expected to Decrease in near future then Bank
should try to Maintain Negative Gap (i.e. Rate Sensitive Liabilities
are more than the Rates Assets) so that there will be a positive
impact on NII.

 STANDARDIZED GAP METHOD

Gap model suggest that a bank which chooses not to speculate on future interest
rates can reduce interest rate risk by obtaining a Zero Gap. Then bank is fully
hedged because its interest rate risk is negligible. Alternatively, a bank may
choose to speculate on future interest rates and actively mange the Gap.

The bank should mange the gaps as close to zero as possible performing
Defensive Interest Sensitive Gap Management.

However, a profit maximization approach, by taking positions in gaps based on a
view on interest rates would be considered Aggressive Management of Gaps.
Under this approach, the bank should try to reduce or increase the size of the
gaps according to their view on interest rate movements. But this involves
considerable risk for the banks in the event of the interest rate view turning to be
incorrect. Thus bank can mange gap by adopting following strategy.

1. If Interest rates are expected to increase in near future then Bank should
try to maintain Positive Gap (i.e. rate Sensitive assets are more than the
Rate Sensitive Liabilities) So that there will positive impact on NII.

2. .If interest rates are expected to Decrease in near future then Bank should
try to Maintain Negative Gap (i.e. Rate Sensitive Liabilities are more than
the Rates Assets) so that there will be a positive impact on NII.

 DURATION GAP METHOD

POSSIBLE
NATURE OF INTEREST RATE MANAGEMENT OUTCOME IF
BANK VIEW ACTION VIEW TURNS
RIGHT
Risk Averse Rates will rise or Move Gap to Zero Net worth remains
fall unchanged
Risk Taker Rates will rise Move to Negative Net Worth
Duration Gap increase

Risk Taker Rates will fall Move to positive Net Worth
Duration Gap Increase

 LIQUIDITY RISK

It can be known form the calculation of above liquidity Ratios that except few
ratios all the ratios are showing positive sign for liquidity position of the bank. The
ratios like liquid assets to total assets, loans to deposits, loan to total assets,
loans to investment and net cash flows to volatile deposits are showing good sign
for bank liquidity. So the bank should maintain such liquidity position. On the
other side bank has to focus on ratio, which is not favorable for liquidity position
of the bank.

CONCLUSION

After having training at Surat People‟s Co-operative Bank I have found that
although today in the banking sector, Co-operative banks have failed in winning
the trust of the people, Surat People‟s Co-operative Bank is successful in doing
so. It is having strong capital base which is the main strength of the bank.
Moreover, Bank has qualified, customer oriented and co-operative staff who can
take right action at right time which the basic requirement in today‟s competitive
world.

After doing analysis about Assets-liability management. It was found that:

 Bank has good liquidity position. Hence mismatch in Assets – Liability will
not match affected by the liquidity risk if bank maintain the same position
in future.

 Although much wide Gap in assets and liabilities still the Interest rates
fluctuation, being beyond the control of the bank may pose problem for the
Assets – Liability Management of the bank.

RECOMMENDATION

 To manage Interest rate risk bank should be allowed to deal in derivatives
for hedging purpose.

 Bank can use various models and ratios suggested in this report for
interest rate risk and liquidity risk measurement.

 Bank can follow risk management Techniques suggested for Assets –
liability Management.

 Value at Risk Method is new method for quantification of risks. Through
this method, the current economic value of assets and liabilities are
arrived at by depreciation and appreciation of the original period value of
the product with the corresponding movements of the interest rates. – This
type of method does not take bank in their measurement of risk.

BIBLIOGRAPHY

 References:

1. Business Research Methods
-Cooper and Shindler

2. Annual Reports of the Bank.

3. Risk Management – CAIIB

4. RBI – Report of ALM
- B. Raghavendran

5. State Bank of Hyderabad for ALM
– Report of Dilip Sarma (Economist)

 Websites:

1. www.spcbl.com.
2. www.rbi.com.

Sai project

More Related Content

What's hot (18)

Similar to Sai project (20)

Recently uploaded (20)

Sai project