MANAGING GAP: A CASE STUDY APPROACH TO

ASSET-LIABILITY MANAGEMENT OF BANKS

Madhu Vij

The importance of managing the asset-liability mix in the Indian financial markets has emerged from the
increased volatility in the domestic interest rates as well as foreign exchange rates that has evolved after
liberalization. The deregulated interest rate environment has brought pressure on the management of banks
to maintain a good balance among spreads, profitability and long-term viability. Over the last few years,
theire has been an intense competition and banks have been required to take up strategic planning as an
exercise for asset-liability management in order to survive and grow in the ever increasingly competitive
and risky environment. The paper presents a case study of four banks- Citi bank, ICICI bank, IDBI bank and
SBI and studies how Asset Liability Management can be used as an important tool for managing liquidity
risk and interest rate risk.

INTRODUCTION

ndian banking has undergone a paradigm shift over

the years, and the liberalization of the economy
initiated since 1991 has set in motion dramatic
changes that are fundamentally reshaping the Indian
banking industry. In todays globalized environment,
Indian banks present a picture of a vibrant, internationally
active banking system and they appear far stronger to face
the challenges that are sure to come their way in the future
in the coming years. While the introduction of various
financial sector reforms has resulted in substantial
improvement in the financial performance of the banking
system, it is nevertheless true that there are several areas
of concern that affect the efficiency of the banking system
as a whole. The issue of NPA (non performing assets)
management presents one of the biggest challenges for
the banking sector. The level of NPAs continues to be
high by International Standards, resulting in an adverse
impact on the liquidity, profitability and competitive
functioning of banks. Risk management is another area of
concern as banks are exposed to a number of risks during
the course of their business. In this context, Indian banks
will also have to prepare for the effective implementation
of the Basel 2 norms that become effective by March
2006. As the primary emphasis of the new Accord is on
improving the measurement of risk, banks will need to

prepare for changes in the regulatory framework to

achieve their vision of an efficient and sound banking
system.
The post reform banking scenario has witnessed the
entry of new private and foreign banks, interest rate
deregulation, and a plethora of new products as also
greater use of information technology. Banks are
required to act in a more dynamic environment as they
are also exposed to a whole array of risk, important
among them being liquidity risk and interest rate risk.
An important tool that has assumed significance for
tackling the risks that the Indian banking industry is
facing and which can help banks in ensuring operational
viability and meeting the competitive challenge is
Asset-Liability Management (ALM). ALM is an
integrated approach towards effective balance sheet
management that can be achieved through proper
restructuring of the asset and liability portfolios from
time to time. In todays fast changing market
environment, ALM has become important and at the
same time difficult to practice. Byrne (2000) has argued
that banks still find difficulty in implementing
integrated asset and liability management.
Asset-liability management (ALM) is the art of
ensuring that the maturity profiles of assets match those

50 Vij

of liabilities. It combines the techniques of asset

management, liability management and spread
management into a cohesive process leading to an
integrated management of the total balance sheet. The
primary objective of ALM is to manage the net interest
income in such a way that its level and risk are in tune
with the risk-return objectives of the institution. The
technique does not eliminate risk but tries to manage it
in such a way that the fluctuations in net interest
income are minimized in the short-run and the longterm operating viability of the organization is taken
care of.
Susie Fair (2003) defines ALM as the process of
evaluating balance sheet risk and making prudent
decisions that enable credit unions to remain financially
viable as economic conditions change. A sound ALM
process integrates strategic, profitability and net worth
(capital) planning with risk management. According to
Patrick Totty, (2003) ALM measures balance sheet risk
by predicting how earnings and other key performance
benchmarks react in alternative interest-rate
environments and economic conditions. ALM helps the
bank in the efficient management of their assets and
liabilities with a special focus on profitability, capital
adequacy, liquidity and risk factors in a dynamic and
competitive economic environment. Asset-liability
management views the financial institution as a set of
interrelationships that must be identified, coordinated
and managed as an integrated system (Moynihan,
Purushothaman, Mcleod, and Nichols, 2002).

risk as according to Rajwade (2002) the subject of asset

liability management covers both interest rate risk and
liquidity risk.
The traditional Gap analysis is considered as a
suitable method to measure the Liquidity risk. Liquidity
risk arises from a mismatch in the maturity of assets of
liabilities and can be measured by calculating gaps over
different time intervals as on a given date. Gap can be
calculated as the difference between rate sensitive assets
and rate sensitive liabilities. The Gap for each maturity
bucket is then assessed for the liquidity risk of the bank.
For assessing the interest rate risk, a planning
horizon for forecasting the interest rate fluctuations is
analyzed for different maturity buckets. The rate
sensitive gap for each maturity bucket is used to assess
the impact of interest rate fluctuations on the net interest
income of the banks under study. The forecasting period
analyzed is one year. The impact of both a falling
interest rate and an increasing interest rate on the rate
sensitive assets and rate sensitive liabilities as well as on
the net interest income of the four banks has been
analyzed. The two different scenarios analyzed are:First, interest rates decrease by 50 basis points and
second, interest rates increase by 100 basis points.
The data for calculating the interest rate risk and
liquidity risk was obtained from Reserve Bank of India
publications Report on Trend and Progress of Banking
in India and Statistical Tables relating to banks in India
for various years. The RBI report gives the details of the
maturity profile of the assets and liabilities of the banks
for various years.

In order to manage effectively the various kinds of

risks arising out of assetsliability mismatches, most of
the major commercial banks in India have an AssetsLiability Management Committee (ALCO). The role of
ALCO is primarily directed towards formulating a
balance sheet policy for the bank based on a detailed
assessment of risk-return trade off. ALCOs deliberate
on maintaining liquidity in the short run and are also
involved in evolving appropriate systems and procedure
for the identification and analysis of balance sheet risks
and laying down parameters for efficient management
of these risks.

The paper attempts a case study of four banks

mentioned above and SBI bankand examines how
Asset-Liability Management can be used as an
important tool for managing liquidity risk and
interest rate risk. The paper has been sub-divided
into four sections. Section one discusses the two
important kinds of risk that banks faceliquidity risk
and interest rate risk. Section two presents the GAP
analysis and the net interest income. Section three
analyzes the liquidity risk and interest rate risk position
of the four banks in detail. A comparative analysis of the
four banks has also been presented. Finally, Section four
gives the concluding observations.

RESEARCH DESIGN AND METHODOLOGY

SECTION I

In order to analyze the various aspects of ALM, the

maturity profile of four banks has been considered. The
banks analyzed are Citibank, ICICI bank, IDBI bank
and SBI. The position of the four banks has been
analyzed with respect to liquidity risk and interest rate

LIQUIDITY RISK MANAGEMENT

Liquidity is a matter of cash flows as they pass through
the balance sheet and income statement on a continuous
basis. Liquidity risk is present when, for whatever

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Managing Gap: A Case Study Approach to Asset-Liability Management of Banks 51

reason, this flow is endangered. If there is a demand for

cash, particularly if it comes from outside the
organization, it must be satisfied. The objective of
liquidity risk management is to understand how cash
flows are moving within an organization, to identify the
existence and location of cash flow strains by measuring
emerging liquidity pressures, and to take corrective
actions to prevent these pressures from growing (Taylor,
2001).
Liquidity risk management lies at the heart of
confidence in the banking system as liquidity shortfall in
one institution can have significant repercussions on the
entire banking system. Measuring and managing
liquidity policies are key factors in the business strategy
planning of banks. Liquidity risks are normally
managed by a banks asset and liabilities committee
(ALCO), an approach that requires understanding of
the interrelationships between liquidity risk
management and interest rate management, as well as
the impact that re-pricing and credit risk have on
liquidity or cash flow risk and vice versa. Liquidity is
necessary for banks to compensate for expected and
unexpected balance sheet fluctuations and to provide
funds for growth. A bank has adequate liquidity
potential when it can obtain sufficient funds (either by
increasing liabilities or converting assets) promptly and
at a reasonable cost.
Liquidity needs are usually determined by the
construction of a maturity ladder that comprises
accepted cash inflows over a series of specified time
periods. The difference between the inflows and
outflows in each period (i.e., the excess or deficit of
funds) is a starting point to measure a banks future
liquidity excess or shortfall at any given time. Once
liquidity needs have been determined, a bank must
decide how to fulfill them. Liquidity management is
related to net funding requirement, and, in principle, a
bank may increase its liquidity through asset
management, liability management, but most frequently
a combination of both.
INTEREST RATE RISK
The possibility that changes in market interest rates
might adversely affect a banks financial condition is
known as interest rate risk. Management of interest rate
risk is one of the critical components of market risk
management in banks. Excessive interest rate risk
adversely affects a banks financial condition in the
current year as also in the future. In the current year, the
impact of changes in interest rates is on the net interest

income (NII). Changing interest rates have a long-term

impact on a banks net worth, since the economic value
of a banks assets, liabilities and off-balance sheet
positions are affected by fluctuations in market interest
rates. The interest rate risk, when viewed from these two
perspectives, is known as earnings perspective and
economic value perspective, respectively.
Earnings perspective involves analyzing the impact
of changes in interest rates on accrual or reported
earnings in the near term. This is measured by
measuring the changes in the net interest income or net
interest margin (NIM), i.e., the difference between the
total interest income and the total interest expense.
Economic value perspective involves analyzing the
impact of changes in interest on the expected cash flows
on assets minus the expected cash flows on liabilities
plus the net cash flows on off-balance sheet items. It
focuses on the risk to net worth arising from all repricing mismatches and other interest rate sensitive
positions. According to Randall (2000), economic value
measures the potential earnings contribution of asset and
liability positions by presentvaluing their cash flows at
current discount rates. Properly applied, changes in
economic value over time become the basis for
measuring the funding centers return.
Banks use a number of derivative instruments to
minimize the exposure to interest rate risk, such as:
interest rate swaps, futures, floors, collars and caps. This
risk is considerably enhanced during a period when a
decline in interest rates bottoms out and begins to move
in the opposite] direction. In India, this risk is further
exacerbated since it is the RBI and not the market forces
that still dictate the prevailing level of interest rates.

SECTION 2
GAP MODEL
The most basic interest rate risk exposure measurement
technique that is employed by banks and financial
institutions is GAP analysis. This method requires a
preparation of a re-pricing gap report that distributes rate
sensitive assets, rate sensitive liabilities and off-balance
sheet positions into different time buckets according to
their residual maturity or time remaining to their next repricing, whichever is earlier. The assets and liabilities
that do not have contractual re-pricing intervals or
maturities are assigned to maturity buckets based on
statistical analysis or judgment. Interest rate risk is
measured by calculating gaps over different maturity
buckets. The GAP is defined as the absolute difference

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52 Vij

between Rate Sensitive Assets (RSA) and Rate

Sensitive Liabilities (RSL) for each time bucket.
The sign and magnitude of the GAPS in various
time buckets can be used to assess potential earnings
volatility arising from changes in interest rates. Positive
GAP indicates that RSA are more than RSL and from an
earnings perspective, the position benefits from a rise in
interest rates. A negative GAP on the other hand
indicates that RSL are more than RSA and from an
earning perspective the position would benefit from a
fall in interest rates.
For a given level of gap position, the bank can take
the following positions to improve the net interest
income (NII)

Maintain a positive gap when the interest rates are

rising.
Maintain a negative gap when the interest rates are
declining.
Maintain a zero gap to completely hedge against
any movements in the future interest rates.

Gap can be used as a measure of interest rate sensitivity

by multiplying the gap for a particular time horizon by
an assured change in interest rate to yield an
approximate change in NII that will occur as a result of
such interest rate movements.
Banks do not attempt to maintain a zero gap in all
maturities as provision of liquidity is an important part
of their function and they earn profits by providing that
liquidity. The objective is to determine acceptable levels
of gap. An acceptable gap depends on the banks
investment strategies, the need for replacing assets and
anticipated ability to repay maturing liabilities.
GAP and Net Interest Income
If the bank wants to keep its net interest income immune
from changes in interest rates, it must closely monitor
and manage its GAP carefully. Net interest income is the
difference between interest income and interest
expenses.
NII = Interest Income- Interest Expenses
Changes in interest rates only affect the RSAs and
RSLs over the planning horizon. The fixed rate assets
and fixed rate liabilities are not affected by changes in
interest rate.

Thus:
NII = RSAs x rA- RSL x rl
Where
rA = change in interest rate on RSAs
rl = change in interest rate on RSLs
If rA= rl r i.e. changes in interest rate on RSAs
and RSLs is the same for the time period chosen then the
change in net interest income can be written as
NII = (RSAs - RSLs) x r
Since GAP was earlier expressed as a difference
between RSAs and RSLs, a relationship can be
expressed between a change in interest rates and a
change in the banks net interest income.
NII = GAP x r
It is thus evident that a bank can immunize its net
interest income over a given planning horizon by
eliminating its funding Gap or when its RSAs are equal
to its RSLs.
Active Gap management requires the monitoring of
all markets within which the institution operates plus the
willingness to use interest rate forecasts as the basis for
active asset/liability management. If the bank management
wants to completely insulate the balance sheet from
changes in interest rates, the Gap would be set near to zero
so that changes in asset return would be counterbalanced
by changes in liability costs, irrespective of the direction of
interest rates. If a decline in interest rate was forecasted, the
asset/ liability strategy would try to narrow the Gap, so that
the proportion of rate sensitive assets is reduced. In case a
rise in interest rate is anticipated, the opposite strategy,
increasing the size of the Gap would be attempted. In
addition to the direction of interest rates, Gap
management strategies also depend upon the volatility
of interest rates. In periods of high interest rate volatility,
aggressive positioning with respect to the direction of
interest rates is generally not advisable as the accuracy
of interest rate forecasts are subject to a high degree of
prediction error.

SECTION 3
LIQUIDITY RISK ANALYSIS
Measuring and managing liquidity risk is an important
dimension of ALM. Mismatch in the maturity profile of
assets and liabilities exposes the balance sheet to
liquidity risk. As per the RBI guidelines, while the

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Managing Gap: A Case Study Approach to Asset-Liability Management of Banks 53

mismatches up to one year would be relevant since these

provide early warning signals, the main focus should be
on the short-term mismatches, i.e., 1-14 days and 15 to
28 days. Banks are expected to monitor their cumulative
mismatches across all time buckets by establishing
internal prudential limits with the approval of the Board/
Management Committee.
Table 1 gives the maturity pattern of assets and
liabilities of the four banks for the next 5 years.
According to Table 1, Citi bank is maintaining a
negative cumulative gap for most of the buckets of
maturities. This reflects the banks expectations of
interest rate movements in the future. The strategy that
Citibank is following is a sound one, as it will help the

bank to take advantage of the falling interest rates by

increasing the NII. However, this strategy is not without
risk. Since all the shorter duration gaps are negative, a
sudden firming up of interest rates will sharply reduce
the NII of the bank.
The assets and liabilities profile of ICICI bank
reveal that the bank has a positive cumulative gap in
case of the very short term bucket of 1-14 days and 1528 days and for over 5 years bucket. For all the other
maturity buckets, ICICI is maintaining a negative gap.
The ALM of the bank is quite sound for the current
falling interest rate scenario. However, it shall have to
be very vigilant about a possible interest rate reversal in
the near future and adjust its asset-liability profile

Table 1: Liquidity Risk Assessment of Banks, 2003

Rs. Lakhs
Time Bucket

1-14
days

15-28
Days

29 days3 months

3 Months6 Months

6 Months1 year

1 Year 3 Years

3 Years 5 Years

Over
5 Years

Total

83120

78570

379250

328760

308120

737950

143160

313150

2372080

Rate Sensitive Liabilities 435100

253040

361440

177160

535960

794600

89470

9550

265632

Gap

-351980

-174470

17810

151600

-227840

-56650

53690

303600

-284240

Cumulative Gap

-351980

-526450 -508640

-357040

-584880

-641530

-587840

-284240

501054

243119

562548

377923

908924

2765223

1149263

2393820

Rate Sensitive Liabilities 491136

175457

929205

546822

1658648

3451506

458115

Gap

67662

-366657

-168899

-749724

-686283

691148

9918

77580

-289077

-457976

-1207700 -1893983

49028

28235

108377

55266

45140

159789

38143

Rate Sensitive Liabilities 175255

61717

141503

67496

55227

232729

5980

Gap

-126227

-33482

-33426

-12230

-10087

-72940

32163

232721

Cumulative Gap

-126227

-159709 -193135

-205365

-215452

-288392

-256229

-23508

5285432

1127020 2357926

1615916

1488729

5696274

4375088

9348806

31292191

Rate Sensitive Liabilities 3786523

308022

834014

891609

4129822 16082770 2975480

934937

29943177

Gap

818998

1523912

724307

-2641093 -10386496 1399608

8413869

1349014

1495909 2314907

3838819

4563126

-7064855

1349014

Citi Bank
Rate Sensitive Assets

ICICI Bank
Rate Sensitive Assets

9918

Cumulative Gap

8901874
8247173

2393820

1190985

-1202835

1190985

232721

716699

IDBI Bank
Rate Sensitive Assets

750470
-23508

SBI Bank
Rate Sensitive Assets

Cumulative Gap

1495909

1922033 -8464463

VISIONThe Journal of Business Perspective Vol. 9 No. 1 JanuaryMarch 2005

54 Vij

accordingly. Various instruments to manage IRR can be

employed by ICICI bank to guard against such an
eventuality. These include interest rate swaps, interest
rate futures and options, interest rate caps and collar.
IDBI bank is also maintaining a negative
cumulative gap for most of the maturity buckets. This is
probably an intentional strategy adopted by the bank to
take advantage of the current falling interest rate
scenario.
State Bank of India is having a positive cumulative
gap for all the buckets of maturities except one year to

three years and three years to five years. A positive

cumulative gap for the short term is clearly not a
desirable strategy that SBI is following in the context of
a falling interest rate scenario. The bank will probably
face liquidity risk in the short term if it does not change
its pattern of managing its assets and liabilities.
INTEREST RATE RISK
The objective of any financial institutions is to maintain
interest rate risk at a level as close to zero as possible.
However, many times management takes on interest rate

Table 2: Interest Rate Risk Analysis of Banks, 2003

Rs. Lakhs
Time Bucket

1-14
days

15-28
Days

29 days3 months

3 Months- 6 Months6 Months

1 year

1 Year 3 Years

3 Years 5 Years

Over
5 Years

Total

-1518

1421.2

Change of NII = Gap x ( Change in interest rate)

-50 basis point
Rate Sensitive Assests
Citi

1759.9

872.35

-89.05

-758

1139.2

283.25

-268.45

ICICI

-49.58

-338.3

1833.28

844.48

3748.62

3431.4

-3455.74

IDBI

631.12

167.42

167.12

61.14

50.44

364.7

-160.8

SBI

-7479.54

-4094.98

-7619.56

-3621.52

13205.46

Citi

1759.9

2632.25

2543.2

1785.2

2924.4

3207.65

2939.2

1421.2

ICICI

-49.58

-387.88

1445.4

2289.88

6038.5

9469.9

6014.16

-5954.94

IDBI

631.12

798.54

965.66

1026.8

1077.24

1441.94

1281.14

117.54

SBI

-7479.54

-22815.6

-9610.14

42322.34

35324.3

-6745.04

3036

51932.48 -6998.04

-11969.1 -5954.94
-1163.6

117.54

-42069.3 -6745.04

Cumulative

-11574.52 -19194.08

+100 basis point

Citi

-3519.8

-1744.7

178.1

1516

-2278.4

-566.5

536.9

ICICI

99.18

676.62

-3666.57

-1688.99

-7497.24

-6862.83

6911.48

23938.2 11909.85

IDBI

-1262.27

-334.82

-334.26

-122.3

-100.87

-729.4

321.63

2327.21

SBI

14959.09

8189.98

15239.12

7243.07

-26410.9

-103865

-3519.8

-5264.5

-5086.4

-3570.4

-5848.8

-6415.3

ICICI

99.18

775.8

-2890.77

-4579.76

-12077

IDBI

-1262.27

-1597.09

-1931.35

-2053.65

-2154.52

-2883.92

SBI

14959.09

23149.07 38388.19

45631.26

19220.33

-84644.63 -70648.6 13490.14

VISIONThe Journal of Business Perspective Vol. 9 No. 1 JanuaryMarch 2005

-235.08

13996.08 84138.69 13489.14

Cumulative
Citi

-2842.4

-5878.4

-2842.4

-18939.83 -12028.35 11909.85

-2562.29

-235.08

Managing Gap: A Case Study Approach to Asset-Liability Management of Banks 55

risk if it improves their ability to accomplish long-range

profitability, growth, capitalization and dividend goals.
These managers set policy limits that keep potential
losses due to adverse movements in market rates at
affordable levels. They see interest rate risk in the same
way they see credit riskan opportunity to make money
through effective risk management (Tom Farin, 2001).
Two different interest rate scenarios and their
effects on the net interest income of the banks have been
considered in this section. This type of analysis is
important for the bank in order to adjust its asset-liability
profile to minimize the negative effects of probable
interest scenarios on its NII. Also it can use this
information to hedge its risk using various instruments,
e.g., interest rate swaps, forward rate agreement, caps,
collars etc. Table 2 shows the interest rate risk for the
four banks.
The two different scenarios analyzed are:
Scenario 1: Interest rates decrease by 50 basis
points.
Scenario 2: Interest rates increase by 100 basis
points
The forecasting period analyzed is for the next one
year. The impact of both a falling interest rate and an
increasing interest rate on the RSAs and RSls as well as
on the NII of the four banks has been analyzed.
As Citibank has a negative cumulative gap, the
decrease in interest rates by 50 basis points will have a
positive impact and the NII of the bank is expected to
rise by Rs 29.24 crores for a period less than one year.
However, if the interest rates were to rise in the future,
say by 100 basis points, the NII of the bank would
decrease by Rs 58.48 crores for a period less than one
year. This scenario is clearly not desirable for the bank
especially in the short-term; although in the current
falling interest rate regime it seems unlikely for some
time to come.
ICICI bank is maintaining a positive gap for the
very short term buckets of 1-14 days and 15-28 days but
has a negative gap for a period less than one year. As
shown in table 2, if the interest rates were to decrease by
50 basis points, the NII of the bank would increase by
Rs. 60.38 crores. If the interest rates were to increase by
100 basis points, the NII of the bank would fall by
Rs. 120.77 crores. However, an increasing interest rate
scenario is quite unlikely. For the long-term period, i.e.,
greater than 5 years, ICICI bank is maintaining a

positive gap. Probably, the bank is expecting that the

interest rates will firm up in the longer period. The NII
of the bank would increase by Rs. 119.09 crores for a
period greater than five years if the interest rates were to
increase by 100 basis points.
Since IDBI bank is maintaining a negative gap in all
the maturity buckets, the NII of the bank increases by Rs
10.77 crores for a fall in the interest rates by 50 basis
points (Table 2). But if the interest rates were to increase
by 100 basis points, the NII of the bank would fall by Rs
21.54 crores.
As SBI bank is maintaining a positive gap for a
period less than one year, the NII of the bank falls by
Rs. 96.10 crores when the interest rates decrease by 50
basis points. This is clearly not a very comfortable
scenario for the bank as far as its short-term liquidity is
concerned.
However, if the interest rates were to increase by
100 basis points, the NII of the bank increases by Rs.
192.20 crores. This seems to be an unlikely scenario
keeping in view the current trend of falling interest rates.
Hence, SBI need to monitor its RSAs and RSLs
according to the movement in interest rates. Also,
advanced and meticulous financial planning is required
by banks so as to monitor their net interest income.
Thus, banks should study and watch the interest rate
movements carefully and also have sufficient flexibility
to change its asset-liability portfolio according to
movement in interest rates. Risk is an inalienable
accessory of the financial intermediation business and
banks recognizes the importance of robust risk
management for building up a quality asset portfolio as
well as for ensuring sustained profitability of its
operations over the long-term period. The array and
intensity of risks to which banks are currently exposed
have multiplied in recent years as a result of the
dismantling of the system of administered rates and
pervasive domestic and international competitive
pressures on domestic financial sector participants.
Banks should accordingly adopt an ALM technique that
can withstand various levels of risk exposure and still
remain within the tolerable level of risks set by
management.
In addition to the maturity gap technique, RBI is
making special efforts for introducing modern
techniques like Duration analysis, Simulation and Value
at Risk for managing IRR. But for this, the IT services
need to be strengthened in banks.

VISIONThe Journal of Business Perspective Vol. 9 No. 1 JanuaryMarch 2005

56 Vij
Table 3: Comparative Analysis among Banks, 2003
Rs. Lakhs
Time Bucket

1-14
days

15-28
Days

Change of NII = Gap x ( Change in interest rate)

Liquidity Risk Assessment Gap (% of total asset)
Citi
-13.94%
-6.91%
ICICI
0.09%
0.63%
IDBI
-15.92%
-4.22%
SBI
3.98%
2.18%
Cumulative Gap (% of total asset)
Citi
-13.94%
-20.85%
ICICI
0.09%
0.72%
IDBI
-15.92%
-20.14%
SBI
3.98%
6.16%
Foreign Currency Gap ( % of total asset)
Citi
-3.91%
-1.25%
ICICI
0.08
0.02
IDBI
0.14%
0.15%
SBI
1.91%
0.21%
Cumulative Foreign Currency Gap ( % of total asset)
Citi
-3.91%
-5.16%
ICICI
0.08
0.1
IDBI
0.14%
0.29%
SBI
1.91%
2.12%
Change of NII = Gap x ( Change in interest rate)
-50 basis point
% of total asset
Citi
0.07%
0.03%
ICICI
0.00%
0.00%
IDBI
0.08%
0.02%
SBI
-0.02%
-0.01%
Cumulative
Citi
0.07%
0.10%
ICICI
0.00%
0.00%
IDBI
0.08%
0.10%
SBI
-0.02%
-0.03%
+100 basis point
% of total asset
Citi
-0.14%
-0.07%
ICICI
0
0.01%
IDBI
-0.16%
-0.04%
SBI
0.04%
0.02%
Cumulative
Citi
-0.14%
-0.21%
ICICI
0.00%
0.01%
IDBI
-0.16%
-0.20%
SBI
0.04%
0.06%

29 days3 months

3 Months6 Months

6 Months1 year

1 Year 3 Years

3 Years 5 Years

Over
5 Years

0.70%
-3.43%
-4.21%
4.05%

6.00%
-1.58%
-1.54%
1.92%

-9.03%
-7.01%
-1.27%
-7.03%

-2.24%
-6.42%
-9.19%
-27.63%

2.12%
6.47%
4.05%
3.72%

12.02%
22.41%
29.35%
22.38%

-20.15%
-2.71%
-24.35%
10.21%

-14.15%
-4.29%
-25.89%
12.13%

-23.18%
-11.30%
-27.16%
5.10%

-25.42%
-17.72%
-36.35%
-22.53%

-23.30%
-11.25%
-32.30%
-18.81%

-11.28%
11.16%
-2.95%
3.57%

-1.17%
-0.6
0.35%
0.82%

0.67%
-0.76
0.90%
0.98%

-3.43%
-0.64
0.29%
0.00%

3.38%
0.06
-0.96%
-1.02%

0.28%
-0.14
0.05%
0.29%

0.00%
0.94
-0.92%
0.11%

-6.33%
-0.5
0.64%
2.94%

-5.66%
-1.26
1.54%
3.92%

-9.09%
-1.9
1.83%
3.92%

-5.71%
-1.84
0.87%
2.90%

-5.43%
-1.98
0.92%
3.19%

-5.43%
-1.04
0.00%
3.30%

0.00%
0.02%
0.02%
-0.02%

-0.03%
0.01%
0.01%
-0.01%

0.04%
0.04%
-0.01%
0.04%

0.01%
0.03%
0.04%
0.14%

-0.01%
-0.03%
-0.02%
-0.02%

-0.06%
-0.12%
-0.15%
-0.11%

0.10%
0.02%
0.12%
-0.05%

0.07%
0.03%
0.13%
-0.06%

0.11%
0.07%
0.12%
-0.02%

0.12%
0.10%
0.16%
0.12%

0.11%
0.07%
0.14%
0.10%

0.05%
-0.05%
-0.01%
-0.01%

0
-0.03%
-0.04%
0.04%

0.06%
-0.01%
-0.02%
0.02%

-0.09%
-0.07%
-0.01%
-0.07%

-0.02%
-0.06%
-0.09%
-0.27%

0.02%
0.06%
0.04%
0.03%

0.12%
0.22%
0.29%
0.22%

-0.21%
-0.03%
-0.24%
0.10%

-0.15%
-0.04%
-0.26%
0.12%

-0.24%
-0.11%
-0.27%
0.05%

-0.26%
-0.17%
-0.36%
-0.22%

-0.24%
-0.11%
-0.32%
-0.19%

-0.12%
0.11%
-0.03%
0.03%

VISIONThe Journal of Business Perspective Vol. 9 No. 1 JanuaryMarch 2005

Managing Gap: A Case Study Approach to Asset-Liability Management of Banks 57

COMPARATIVE ANALYSIS

CONCLUSIONS

Gap Analysis and Interest Rate Risk

According to Balino and Ubide (2000), the banking

sector is entering a new world in which national and
institutional boundaries are becoming less important.
Inevitably, supervisory and regulatory systems will
have to adapt their work methods in order to remain
effective. Technology has also revolutionized the
banking industry in a big way, and today banks cannot
afford to ignore the importance of ALM. This is the
function that will help banks and financial institutions to
keep their profit margins intact, and is, perhaps, the only
way for banks to survive in the changing environment
where the composition, duration and risk profile of their
assets and liabilities have an important bearing on their
growth and profitability.

When we consider cumulative gaps of all banks, we find

that IDBI was in the best position among the four
banks under study. As indicated in Table 3, it had a gap
of 2.95 per cent of total assets. This means that in the
long run IDBI would be in the best position among the
four banks to deal with the interest rate volatility. At the
same time, Citibank had the highest gap among banks in
the long run, that is 11.28 per cent of total assets. The
other two banksICICI and SBIhad cumulative gaps
of 11.16 per cent and 3.57 per cent respectively.
These facts are consistent with the interest shock
simulation, in the long run. IDBI would be relatively
least affected by interest shocks, while Citibank would
be hit hardest if the shock occurs. Also, IDBI would be
least exposed to the interest rate risk in the long term.
In the short run i.e., less than twelve months, SBI had
the narrowest gap among the four banks. It had a
cumulative gap of 5.10 per cent of total assets, whereas
IDBI had the widest gap, 27.16 per cent of total assets,
for the same period. The other two banks had relatively
high negative gaps, more than 10 per cent, for the bucket
that is shorter than one year. This implies that all the
banks, except SBI, preferred to take advantage of the
declining interest rate movement in India. For the last few
years, RBI had a policy of soft interest rate, constantly
cutting down the rate. Citi bank and IDBI bank were the
two banks that had gained most from the policy.
Foreign Currency Risk
In the long run, IDBI seems to be in the best position
among the banks. It had a zero balance of foreign
currency asset/liability. This would keep them secure
from any foreign exchange volatility.
Citi Bank funded its foreign currency assets through
long-term liability in foreign currency. Most of their
foreign liability will mature after five years. This might
imply that Citibank takes advantage of cheap offshore
funds and Indias relatively high interest rate.
ICICI bank had a low foreign currency gap, 1.04 per
cent while SBI had a positive foreign currency gap (3.30
per cent). In the short run only ICICI had the narrowest
negative gap of 1.9 per cent among the four banks. Citi
bank had the highest gap of -9.09 per cent of total assets.
The other two banks, IDBI and SBI had positive foreign
currency gaps, i.e., 1.83 per cent and 3.92 per cent
respectively. This implies that in the present trend of
falling interest rate scenario, their NII would decrease.

Technology has also helped banks to improve their

product delivery and profitability. Switching to other
distribution channels like ATMs, Tele-banking, etc.,
have helped banks not only to improve their customer
service but to also reduce transaction costs. ATMs have
been gaining popularity and Tele-banking and Internet
banking are also becoming popular, as the convenience
factor creates a very favorable impression on the minds
of bank customers.
Of late, RBI has started stressing on the importance
of setting up a good MIS system by banks. For the
traditional gap analysis to be effective and successful,
banks have realized that the presence of an effective
MIS system is imperative. It will facilitate managers to
forecast income and portfolio values based on different
interest rate assumptions by using various sophisticated
models and advanced techniques of forecasting.
In most of the developed countries, banks are using
advanced software for ALM. In order to favorably
compare with International standards, Indian banks
need to adopt the latest market driven strategies so as to
favorably compete and be compared with banks in other
developed countries. Also, in the context of the differing
environment and the diverse nature of activities
undertaken by different banks, the process of ALM will
differ from bank to bank and the success of the
technique will depend upon how effectively the banks
are able to forecast and manage the risk they carry and
are exposed to. Rajwade (2002) has argued that the
prompt availability of assets and liabilities data, in
particular residual maturities, as also off-balance sheet
transactions like interest rate swaps, is the key to an
effective ALM strategy. This would present a major
challenge to banks in India, which may not be optimally
computerized.

VISIONThe Journal of Business Perspective Vol. 9 No. 1 JanuaryMarch 2005

58 Vij

REFERENCES
Balino, Tomas, J. and Ubide, Angel (2000), The New World of
Banking, Finance and Development, June.
Byrne, Jim (2000), Bringing Banking Risk Up To Date,
Balance Sheet, Bradford: 2000. Vol. 8, No. 6
Farin, Tom (2001), Developing a Dynamic Interest Rate Risk
Management Program, Journal of Finance, May-June.
Moynihan, G.Purushothaman, P. McLeod, M. and Nichols, G.
(2002), DSSALM: A Decision Support System for Asset
and Liability Management.

Rajwade, A.V. (2002), Issues in Asset Liability Management,

Economic and Political Weekly, February.
Randall, Payant, W. (2000), Making Asset Liability
Management Performance Count, Bank Accounting and
Finance, (Euromoney Publications) Fall , Vol. 14, No. 1.
Susie Fair (2003), The Yellow Brick Road to ALM Success,
Credit Union Magazine, August.
Taylor, Jeremy F. (2001), The Rational Management of
Liquidity Risk, Bank Accounting and Finance, Euromoney
Publications, Fall, Vol. 15 Issue 1.

Patrick Totty (2003), Demystifying ALM, Credit Union

Magazine, August.

Madhu Vij, Ph.D. (dramadhuvij@hotmail.com) is an Associate Professor at the Faculty of Management Studies, (FMS),
University of Delhi where she teaches International and Corporate Finance. Her specialization includes: International
Financial Management, Management of Financial Services, Management of Financial Institutions, Financial and
Management Accounting. She has recently completed a project sanctioned by the UGC on Asset Liability Management in
Banks and Financial Institutions.Currently, she is working on a project sanctioned by ICSSR on Capital Flows in a
Globally Competitive Environment: Implications of Changing Country Risk Rating. Dr Vij is the author of four books and
has contributed several articles in management journals in the field of banking and finance. She has also presented a number
of papers in national and international conferences. She is actively involved with a number of training programme
conducted by FMS and is currently the Management Science Association and Placement advisor at FMS.

VISIONThe Journal of Business Perspective Vol. 9 No. 1 JanuaryMarch 2005