What is the IMF?

Its foundation
July 1944: Representatives of 45 governments meeting in the town of Bretton Woods, New Hampshire, US, agreed on a framework for international economic cooperation. They believed that such a framework was necessary to avoid a repetition of the disastrous economic policies that had contributed to the Great Depression of the 1930s. December 1945: 29 countries signed the Articles of Agreement. The International Monetary Fund (IMF, or the Fund) came into existence. The IMF's founders charged the new institution with overseeing the international monetary system to ensure exchange rate stability.

IMF evolution
1950s-1960s: Bretton Woods system. IMF controls fixed exchange rates and encourages member countries to eliminate exchange restrictions that hinder trade. 1971: The United States suspend the convertibility of the dollar into gold, ending the par value system of fixed exchange rates. mid 1970s: revision of IMF Articles; oil-price shocks. 1980s: the IMF becomes a global firefighter, dealing with international debt problems.IMF evolution 1986-7: IMFs Enhanced Structural Adjustment Facility (ESAF) is established. early 1990s: IMF follows the economic transformation of former Soviet Union countries, then begins its work against global poverty. 1999: the IMF replaces the Enhanced Structural Adjustment Facility with the Poverty Reduction and Growth Facility (PRGF). IMF evolution late 1990s - today: financial crises erupt in Mexico, Southeast Asian countries, Brazil, Argentina, etc. The IMF becomes an instrument in the prevention and management of capital account crises. The IMF also increases its involvement in compliance with standards covering offshore financial centers and anti money laundering and terrorism.

What is ALM ? ALM is a comprehensive and dynamic framework for measuring, monitoring and managing the market risk of a bank. It is the management of structure of balance sheet (liabilities and assets) in such a way that the net earning from interest is maximised within the overall riskpreference (present and future) of the institutions. The ALM functions extend to liquidly risk management, management of market risk, trading risk management, funding and capital planning and profit planning and growth projection.

Benefits of ALM - It is a tool that enables bank managements to take business decisions in a more informed framework with an eye on the risks that bank is exposed to. It is an integrated approach to financial management, requiring simultaneous decisions about the types of amounts of financial assets and liabilities - both mix and volume - with the complexities of the financial markets in which the institution operates
The concept of ALM is of recent origin in India. It has been introduced in Indian Banking industry w.e.f. 1st April, 1999. ALM is concerned with risk management and provides a comprehensive and dynamic framework for measuring, monitoring and managing liquidity, interest rate, foreign exchange and equity and commodity price risks of a bank that needs to be closely integrated with the banks business strategy. Therefore, ALM is considered as an important tool for monitoring, measuring and managing the market risk of a bank. With the deregulation of interest regime in India, the Banking industry has been exposed to the market risks. To manage such risks, ALM is used so that the management is able to assess the risks and cover some of these by taking appropriate decisions. The assets and liabilities of the banks balance sheet are nothing but future cash inflows or outflows. With a view to measure the liquidity and interest rate risk, banks use of maturity ladder and then calculate cumulative surplus or deficit of funds in different time slots on the basis of statutory reserve cycle, which are termed as time buckets.
As a measure of liquidity management, banks are required to monitor their cumulative mismatches across all time buckets in their Statement of Structural Liquidity by establishing internal prudential limits with the approval of the Board / Management Committee.

ALM MISMATCH chapter 5 In finance, an asset-liability mismatch occurs when the financial terms of an institution's assets and liabilities do not correspond. Several types of mismatches are possible. For example, a bank that chose to borrow entirely in U.S. dollars and lend in Russian rubles would have a significant currency mismatch: if the value of the ruble were to fall dramatically, the bank would lose money. In extreme cases, such movements in the value of the assets and liabilities could lead to bankruptcy, liquidity problems and wealth transfer. As another example, a bank could have substantial long-term assets (such as fixed rate mortgages) but short-term liabilities, such as deposits. This is sometimes called a maturity mismatch, which can be measured by the duration gap. Alternatively, a bank could have all of its liabilities as floating interest rate bonds, but assets in fixed rate instruments. Mismatches are handled by asset liability management. Asset-liability mismatches are also important to insurance companies and various pension plans, which may have long-term liabilities (promises to pay the insured or pension plan participants) that must be backed by assets. Choosing assets that are appropriately matched to their financial obligations is therefore an important part of their long-term strategy. Few companies or financial institutions have perfect matches between their assets and liabilities. In particular, the mismatch between the maturities of banks' deposits and loans makes banks susceptible to bank runs. On the other hand, 'controlled' mismatch, such as between short-term deposits and somewhat longer-term, higher-interest loans to customers is central to many financial institutions' business model. Asset-liability mismatches can be controlled, mitigated or hedged.
OR

Lets look at what exactly does this asset-liability mismatch mean. If banks mobilize short term deposits to provide short-term loans or long term deposits to provide long-term loans, it is an ideal situation. But if banks mobilize short-term deposits and lend loans on longer terms, that results in an asset-liability mismatch situation.

Ideally banks should borrow short and lend long, and keep the margin. Usually banks deposits are mobilized (that is they are borrowing) for periods of up to 5 years only. But their loan portfolios (they are lending) specially those relating to auto loans and housing have a far longer duration. This borrow short and lend long means that they have to roll over their liabilities (deposits) faster than their assets (loans). This works fine as long as the there is a reasonable spread between the long-term and short-term rates. But when the spread narrows down, as is the case now (the benchmark 10 year paper in the secondary market is being traded at 7.38% whereas the one year T-Bill is at 6.95% -- a spread of only 43 basis points!) a serious asset-liability mismatch could expose the banks to interest rate risk and could affect their profitability especially if the rolled over funds come at a higher cost than lent funds. According to the latest statistics on banking from RBI, the share of short-term deposits in total time deposits of banks hasincreased from 43.8% at the end of March 2000 to 58.2% at the end of March 2006. On the other hand the tenure of banks advances or loans has been getting longer. As at the end of March 2006, of the total loans and advances of new private sector banks, those with over 5 year tenure had a 17.9% share. In contrast, in their deposits, the share of deposits of 5 years plus maturity was only 1.4%. The situation with foreign banks and old private sector banks is only marginally better. The situation with PSU banks though at present is stated to be even, with banks going for home loan lending aggressively, the asset-liability mismatch is going to be worse. This could pose systemic problems and hence the concern.

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What is asset-liability mismatch? Banks' primary source of funds is deposits, which typically have short- to medium-term maturities. They need to be paid back to the investor in 3-5 years. In contrast banks usually provide loans for a longer pe-riod to borrowers. Home loans, for instance, can have a tenure of up to 20 years. Providing such loans from much shorter maturity funds is called asset-liability mismatch. It creates risks for banks that need to be managed. What are the consequences of asset-liability mismatch? The most serious consequences of asset-liability mismatch are interest rate risk and liquidity risk. Because deposits are of shorter maturity they are repriced faster than loans. Every time a deposit matures and is rebooked, if the interest rates have moved up bank will have to pay a higher rate on them. But the loans cannot be repriced that easily. Because of this faster adjusting of deposits to interest rates asset-liability mismatch affects net interest margin or the spread banks earn.

Chapter 3 RISKS FACED BY BANKS

1. Strategic Risk 2. Regulatory Risk 3. Liquidity Risk 4. Operational Risk 5. Market Risk 6. Foreign Exchange Risk expand on des risks.. ,7. Credit Risk or default Risk

Asset Liability Management: An Overview Asset Liability Management (ALM) can be defined as a mechanism to address the risk faced by a bank due to a mismatch between assets and liabilities either due to liquidity or changes in interest rates. Liquidity is an institutions ability to meet its liabilities either by borrowing or converting assets. Apart from liquidity, a bank may also have a mismatch due to changes in interest rates as banks typically tend to borrow short term (fixed or floating) and lend long term (fixed or floating). A comprehensive ALM policy framework focuses on bank profitability and longterm viability by targeting the net interest margin (NIM) ratio and Net Economic Value (NEV), subject to balance sheet constraints. Significant among these constraints are maintaining credit quality, meeting liquidity needs and obtaining sufficient capital. An insightful view of ALM is that it simply combines portfolio management techniques (that is, asset, liability and spread management) into a coordinated process. Thus, the central theme of ALM is the coordinated and not piecemeal management of a banks entire balance sheet. Although ALM is not a relatively new planning tool, it has evolved from the simple idea of maturity-matching of assets and liabilities across various time horizons into a framework that includes sophisticated concepts such as duration matching, variablerate pricing, and the use of static and dynamic simulation. MeAsuring risk The function of ALM is not just protection from risk. The safety achieved through ALM also opens up opportunities for enhancing net worth. Interest rate risk (IRR) largely poses a problem to a banks net interest income and hence profitability. Changes in interest rates can significantly alter a banks net interest income (NII), depending on the extent of mismatch between the asset and liability interest rate reset times. Changes in interest rates also affect the market value of a banks equity. Methods of managing IRR first require a bank to specify goals for either the book value or the market value of NII. In the former case, the focus will be on the current value of NII and in the latter, the focus will be on the market value of equity. In either case, though, the bank has to measure the risk exposure and formulate strategies to minimise or mitigate risk. The immediate focus of ALM is interest-rate risk and return as measured by a banks net interest margin. ALM is a systematic approach that attempts to provide a degree of protection to the risk arising out of asset/liability mismatch. Asset Liability Management An Overview.indd 2 11/3/2008 12:25:10 PMAsset Liability Management: An Overview Page 3 NIM = (Interest income Interest expense) / Earning assets A banks NIM, in turn, is a function of the interest-rate sensitivity, volume, and mix of its earning assets and liabilities. That is, NIM