Asset Liability Management

in Banks

Presentation by
Priyank Shah
“If there is any area of banking that has undergone
drastic change, it is the whole subject of
assets/liabilitiessmanagement.”
- Paul S. Nadler
 Assets Liability Management
“ALM is an ongoing process of formulating,
monitoring, revising and framing strategies related to
assets and liabilities in an attempt to achieve the
financial objective of maximizing interest spread or
margins for a given set of risk level”.
 Concept of ALM
• It is not only liquidity management tool but also portfolio
management tool
• System of matching inflow and outflow of cash.
• It is also helpful in managing the credit risk, foreign
exchange risk, operational risk, equity price risk.
• It focus on day to day and week to week B/S management.
• Asset/liability management focuses on the net interest
income if the institutions. Net interest income is the
difference between the amount of interest received from
loans and investments and the amount of interest paid for
deposits and other liabilities.
• Net interest income = interest revenue – interest expense
 Components of a
Bank Balance sheet
Liabilities Assets
1. Capital 1. Cash & Balances with
2. Reserve & Surplus RBI
3. Deposits 2. Bal. With Banks &
4. Borrowings Money at Call and
Short Notices
5. Other Liabilities
3. Investments
4. Advances
5. Fixed Assets
6. Other Assets

Contingent Liabilities
 ALM process rest on three pillars:
ALM information system
• Management information system
• Information availability, accuracy,
adequacy
 ALM organisation
• Structure and responsibilities
•Level of top management
involvement
 ALM process
• Credit risk management
• Management of market risk
(including interest rate risk)
• Liquidity risk management
• Currency risk management
 Credit risk management
• It reflects in
The profitability
Liquidity
Reduced NPAs.
• Ways for credit risk management
 At micro level (focused on clients)
 At macro level (capital adequacy)
 Risk transfer
 INTEREST RATE MANAGEMENT

• MEASURING INTEREST RATE SENSITIVITY

• GAP = RSA – RSL

THREE OPTIONS:
– A) RSA>RSL= Positive Gap
– B) RSL>RSA= Negative Gap
– C) RSL=RSA= Zero Gap
• Relative GAP ratio
• Interest rate sensitivity ratio
Effects of Changes in Interest Rates

Gap Changes in Changes in

Interest Rates Net Interest
Rate
Positive Increase Increase
Positive Decrease Decrease
Negative Increase Decrease
Negative Decrease Increase
Zero Increase Zero
Zero Decrease Zero
 CLASSIFICATION OF ASSETS AND
LIABILITIES
ASSETS CLASSIFI- LAIBILITIES & CLASSIFI-
CATION CAPITAL CATION

Vault cash NRSA Demands deposits NRSL

Short term securities RSA Current accounts NRSL

Long term securities NRSA Money market RSL

deposits
Variable rate loans RSA Short term deposits RSL
Short term loans RSA Long term saving NRSL
Long term loans NRSA Repo transaction RSL
Other assets NRSA Equity NRS
 LIQUIDITY
MANAGEMENT
Statement of Structural Liquidity
All Assets & Liabilities to be reported as per
their maturity profile into 8 maturity Buckets:
i. 1 to 14 days
ii. 15 to 28 days
iii. 29 days and up to 3 months
iv. Over 3 months and up to 6 months
v. Over 6 months and up to 1 year
vi. Over 1 year and up to 3 years
vii. Over 3 years and up to 5 years
viii. Over 5 years
 An Example of Structural LiquidityStatement
15-28 30 Days- 3 Mths - 6 Mths - 1Year - 3 3 Years - Over 5
1-14Days Days 3 Month 6 Mths 1Year Years 5 Years Years Total

Capital 200 200

Liab-fixed Int 300 200 200 600 600 300 200 200 2600
Liab-floating Int 350 400 350 450 500 450 450 450 3400
Others 50 50 0 200 300
Total outflow 700 650 550 1050 1100 750 650 1050 6500
Investments 200 150 250 250 300 100 350 900 2500
Loans-fixed Int 50 50 0 100 150 50 100 100 600
Loans - floating 200 150 200 150 150 150 50 50 1100
Loans BPLR Linked 100 150 200 500 350 500 100 100 2000
Others 50 50 0 0 0 0 0 200 300
Total Inflow 600 550 650 1000 950 800 600 1350 6500
Gap -100 -100 100 -50 -150 50 -50 300 0
Cumulative Gap -100 -200 -100 -150 -300 -250 -300 0 0
Gap % to Total Outflow
-14.29 -15.38 18.18 -4.76 -13.64 6.67 -7.69 28.57
 LIQUIDITY MANAGEMENT IN
FINANCIAL INSTITUTIONS

Various tools used by financial institution:

 Liquid assets
 By setting a limit on maturity mismatches
 A diversified source for liability raising
 By availing funds from the wholesale
market
 Contingency plan
HYPOTHETICAL EXAMPLE OF MISMATCH
BETWEEN ASSETS AND LIABILITIES
A bank that borrows USD 100MM at 3.00%
for a year and lends the same money at
3.20% to a highly-rated borrower for 5
years. The bank is earning a 20 basis point
spread. The bank earned USD 200,000 in
the first year.
Suppose, at the end of 1st year, an
applicable 4-year interest rate is 6.00%.
The bank is in serious trouble. It is going to
be earning 3.20% on its loan and paying
6.00% on its financing.
Market value accounting recognizes the
bank's predicament. The respective market
values of the bank's asset and liability are:
100MM (1.032)5/(1.060)4=92.72MM
100MM(1.030) = 103.0MM
The bank has lost USD 10.28MM
STRATEGIES FOR ASSET / LIABILITY
MANAGEMENT

Aggressive gap management

Defensive gap management
Future,option & swaps
Duration gap management
Problems in Aggressive & Defensive
Gap management

• Time horizon
• Correlation between movement in general
market interest rate and the interest revenue
& cost are constant
• Need to make interest rate forecast
• Narrow focus on net interest income as
opposed to shareholder wealth
 Effect of interest rate changes on
different type of Duration Gap
Duration Gap Net Interest Changes in
Income Market value
of Equity
Positive Increase Decrease
Positive Decrease Increase
Negative Increase Increase
Negative Decrease Decrease
Zero Increase Zero
zero Decrease Decrease
 PROBLEMS IN DURATION GAP
MANAGEMENT
• Only effective when parallel shift in yield
curve
• Assets and liability duration are
significantly different
• Duration drift
Role of Reserve Bank of India

Developing a better understanding ALM

concepts
Introducing an ALM information system
Setting up ALM decision making process

Role of financial Institutions

THANK YOU…