ASSET LIABILITY

MANAGEMENT IN
BANKS
By,
Divya Darbha
Ramya Kola
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
Banks profit and loss account
A banks profit & Loss Account has the following
components:

I. Income: This includes Interest Income and

Other Income.
II. Expenses: This includes Interest Expended,
Operating Expenses and Provisions &
contingencies.
Evolution
In the 1940s and the 1950s, there was an abundance of funds in
banks in the form of demand and savings deposits. Hence, the focus
then was mainly on asset management
In the 1980s, volatility of interest rates in USA and Europe caused the
focus to broaden to include the issue of interest rate risk. ALM began
to extend beyond the bank treasury to cover the loan and deposit
functions
Banks started to concentrate more on the management of both sides
of the balance sheet
What is Asset Liability Management??
The process by which an institution manages its balance
sheet in order to allow for alternative interest rate and
liquidity scenarios

Banks and other financial institutions provide services

which expose them to various kinds of risks like credit
risk, interest risk, and liquidity risk

Asset-liability management models enable institutions to

measure and monitor risk, and provide suitable strategies
for their management.
3 tools used by banks for ALM

ALM information systems

ALM Organization

ALM Process
ALM Information Systems
Usage of Real Time information system to gather the
information about the maturity and behavior of loans
and advances made by all other branches of a bank

ABC Approach :
analysing the behaviour of asset and liability products in the
top branches as they account for significant business
then making rational assumptions about the way in which assets and
liabilities would behave in other branches
The data and assumptions can then be refined over time as the bank
management gain experience

The spread of computerisation will also help banks in

accessing data.
ALM Organization
The board should have overall responsibilities and should set the
limit for liquidity, interest rate, foreign exchange and equity price
risk

The Asset - Liability Committee (ALCO)

ALCO, consisting of the bank's senior management (including CEO) should be
responsible for ensuring adherence to the limits set by the Board
Is responsible for balance sheet planning from risk - return perspective including
the strategic management of interest rate and liquidity risks
The role of ALCO includes product pricing for both deposits and advances,
desired maturity profile of the incremental assets and liabilities,
It will have to develop a view on future direction of interest rate movements and
decide on a funding mix between fixed vs floating rate funds, wholesale vs retail
deposits, money market vs capital market funding, domestic vs foreign currency
funding
It should review the results of and progress in implementation of the decisions
made in the previous meetings
ALM Process

Risk Parameters

Risk Identification

Risk Measurement

Risk Management

Risk Policies and Tolerance

Level
 Categories of Risk
Risk is the chance or probability of loss or damage
Credit Risk Market Risk Operational Risk

Transaction Risk Commodity risk Process risk

/default risk
/counterparty risk
Portfolio risk Interest Rate risk Infrastructure risk
/Concentration risk
Settlement risk Forex rate risk Model risk

Equity price risk Human risk

Liquidity risk
But under ALM risks that are typically managed
are.

Liquidity
Currency Risk
Risk

Interest
Rate
Risk

Will now be discussed in detail

Liquidity Risk
Liquidity risk arises from funding of long term assets by short term
liabilities, thus making the liabilities subject to refinancing

Funding Arises due to unanticipated withdrawals of

the deposits from wholesale or retail clients
risk
It arises when an asset turns into a NPA.
Time risk So, the expected cash flows are no longer
available to the bank.

Due to crystallisation of contingent liabilities

Call Risk and unable to undertake profitable
business opportunities when available.
Liquidity Risk Management
Banks liquidity management is the process of generating funds
to meet contractual or relationship obligations at reasonable
prices at all times

Liquidity Management is the ability of bank to ensure that its

liabilities are met as they become due

Liquidity positions of bank should be measured on an ongoing

basis

A standard tool for measuring and managing net funding

requirements, is the use of maturity ladder and calculation of
cumulative surplus or deficit of funds as selected maturity dates
is adopted
Currency Risk
The increased capital flows from different nations following
deregulation have contributed to increase in the volume of
transactions

Dealing in different currencies brings opportunities as well as

risk

To prevent this banks have been setting up overnight limits

and undertaking active day time trading

Value at Risk approach to be used to measure the risk

associated with forward exposures. Value at Risk estimates
probability of portfolio losses based on the statistical analysis
of historical price trends and volatilities.
 Interest Rate Risk
Interest Rate risk is the exposure of a banks financial
conditions to adverse movements of interest rates

Though this is normal part of banking business, excessive

interest rate risk can pose a significant threat to a banks
earnings and capital base

Changes in interest rates also affect the underlying value

of the banks assets, liabilities and off-balance-sheet item

Interest rate risk refers to volatility in Net Interest Income (NII) or

variations in Net Interest Margin(NIM)

NIM = (Interest income Interest expense) / Earning assets