Asset Liability Management inBanks

Presented by, Mayur Bulchandani Roma Makhija

07 28

MEANING COMPONENTS OF
BALANCE SHEET PROFIT AND LOSS RBI RESTRICTIONS CONCENTRATE ON ALM NECESSATITY OF ALM PURPOSE & OBJECTIVE PRE CONDITIONS FOR SUCCESS OF ALM BENEFITS CRAMLES MODEL RISK MANAGEMENT PROCESS TYPES OF RISK IN BANKS CONCLUSION.

Assets Liability Management

It is a dynamic process of Planning, Organizing & Controlling of Assets & Liabilities- their volumes, mixes, maturities, yields and costs in order to maintain liquidity and NII.

In Banking

the practice of managing risks that arise due to mismatches between the assets and liabilities (debts and assets) of the bank. Structural interest rate, forex, equity and liquidity risks are managed and supervised by the Groups Asset and Liability Management function (or ALM ) ALM covers the management of the entire balance sheet of a bank

Components of a Bank Balance sheet

Liabilities
Capital Reserve & Surplus Deposits Borrowings Other Liabilities

Assets
Cash & Balances with RBI Bal. With Banks & Money at Call and Short Notices Investments Advances Fixed Assets 6. Other Assets

Contingent Liabilities

Banks Profit & 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.

Prior To 1970s
Banks

used accrual system of accounting Focus on Asset Management Only Wrong notion among bankers RBI restrictions

Prior To 1970s
A bank

Banks used accrual system of accounting

that borrows 1 Crore (100 Lakhs) at 6 % for a year and lends the same money at 7 % to a highly rated borrower for 5 years. The net transaction appears profitable-the bank is earning a 100 basis point spread - but it entails considerable risk. At the end of a year, the bank will have to find new financing for the loan, which will have 4 more years before it matures. If interest rates have risen, the bank may have to pay a higher rate of interest on the new financing than the fixed 7 % it is earning on its loan.

 Suppose,

at the end of a year, an applicable 4-year interest rate

is 8 %. The bank is in serious trouble. It is going to earn 7 % on its loan but would have to pay 8 % on its financing. Accrual accounting does not recognize this problem. Accrual accounting does not recognize this problem. Based upon accrual accounting, the bank would earn Rs 100,000 in the first year although in the preceding years it is going to incur a loss

vFocus on Asset Management Only coz:

abundance of funds in banks (demand & savings deposits) low cost of deposits

vWrong notion among bankers - that their banks already practice - ALM is a system of matching cash inflows and outflows, and thus of liquidity management.

RBI restrictions

- Spreads between the deposit and lending rates were very wide - Spread were uniform among the commercial banks and were changed only by RBI - balance sheet was not being managed by banks themselves

SO, banks had to develop mechanisms by which they could make efficient use of these funds

After 1970s
With the onset of liberalization, Indian banks are now more exposed to uncertainty and to global competition. This makes it imperative to have proper ALM systems in place.

The Banks started to concentrate on ALM COZ:

Volatile interest rates A severe recession damaging several economies Suffered staggering losses because the firms used

accrual accounting Small percentage changes in assets or liabilities can translate into large percentage changes in capital.

Why asset-liability management is necessary in the Indian bank context:

NIM

- efficient management of net interest margin Maintain exposure to foreign currency fluctuations Increasing proportion of investments by banks Exposure to interest rate volatility

Purpose & Objective of ALM

An effective Asset Liability Management Technique aims to manage the volume, mix, maturity, rate sensitivity, quality and liquidity of assets and liabilities as a whole so as to attain a predetermined acceptable risk/reward ration. It is aimed to stabilize short-term profits, long-term earnings and long-term substance of the bank. The parameters for stabilizing ALM system are: 1. Net Interest Income (NII) 2. Net Interest Margin (NIM) 3. Economic Equity Ratio

SUCCESS OF ALM IN BANKS

1.Awareness for ALM in the Bank staff at all levels supportive Management & dedicated Teams. 2.Method of reporting data from Branches/ other Departments. (Strong MIS). 3.Computerization-Full computerization, networking. 4.Linking up ALM to future Risk Management Strategies

Benefits

Any organization can receive the following benefits from ALM:

1.Improved regulatory compliance 2.Enhanced corporate governance 3.Increased shareholder return 4.Reduced earnings volatility 5.Enhanced cash flow and fair market value forecasting 6.Improved asset and liability alignment

CRAMELS MODEL IN BANKS

C:

CAPITAL PROTECTION R : RISK A: ASSET QUALITY M: MANAGEMENT COMPETENCE E: EARNINGS STRENGTH L: LIQUIDITY RISK S: MARKET RISK

RISK MANAGEMENT: A FOUR STEP PROCESS

RISKS IN A BANK
CREDIT RISK OPERATIONAL RISK MARKET RISK

-LIQUIDITY RISK
-INTEREST RATE RISK -FOREIGN EXCHANGE RISK

Credit Risk

Credit risk may be defined as the potential that a bank borrower or counterparty will fail to meet its obligations on accordance with agreed terms.

Operational Risk

The risk of direct or indirect loss resulting from inadequate of failed internal processes, people and system of from external events is so called operational risk.

Market Risk
Market risk is defined as the losses in on and off balance sheet items arising from movements in market prices
1.LIQUIDITY RISK 2.INTEREST RATE RISK 3.FOREIGN EXCHANGE RISK

ALM PROCESS
1. ALM information systems 2. ALM organization 3. ALM process

CONCLUSION

THANK YOU