ASSET-LIABILITY MANAGEMENT

Presented by
K.Eswar
K.Eswar

Banks are exposed to credit and market risks in view of asset-liability transformation in the back drop of liberalization of Indian financial markets. Banking is not about avoiding risk but managing it. Strategic management in a deregulated environment covering spreads, profitability and long term viability. Risks should be identified, measured and managed. Inter-relationship between various risks should be understood. Need for sharper assessment and efficacy of liquidity management. Need for comprehensive K.Eswar ALM.

ALM & BANKS

ALM Objectives
Liquidity Risk Management. Interest Rate Risk Management. Currency Risks Management. Profit Planning and Growth Projection.

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RBI DIRECTIVES
Issued draft guidelines on 10th Sept98. Final guidelines issued on 10th Feb99 for implementation of ALM w.e.f. 01.04.99. To begin with 60% of asset &liabilities will be covered gradually covering 100%. Initially Gap Analysis to be applied in the first stage of implementation. Disclosure to the B/S on the maturity pattern of deposits / borrowings / advances and investments. In Oct 2007 amendments to ALM function issued K.Eswar . Splitting the first time bucket.

ALM STATEMENTS TO BE SUBMITTED To RBI

1.
2. 3. 4.

5.

Statement of Structural Liquidity (Annexure I) [DSB Statement No.8] - Rupee Statement of Interest Rate Sensitivity (Annexure II) [DSB Statement No. 9] - Rupee Statement of Dynamic Liquidity (Annexure - III) Statement of Maturity and Position (MAP) (Annexure IV) [DSB Statement No.10 ] - Forex Statement of Sensitivity to Interest Rate (SIR)(Annexure - V)[DSB Statement No.11] - Forex

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LIQUIDITY RISKS
Broadly of three types: Funding Risk: Due to withdrawal/non-renewal of deposits Time Risk: Non-receipt of inflows on account of assets(loan installment) Call Risk: Contingent liabilities & new demand for loans
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Managing Liquidity Risk.

Setting tolerance limits: Cumulative cash flow mismatches. Take care of draw down of commitments. marketability of liquid assets, discount to price volatility and drop in price in the event of forced sale. Core liability to core assets. (Core liability: core portion of SB,CD,TD, Share capital , reserves and subordinated debts.) (Core assets: Statutory balances of CRR and SLR, Long term loans and fixed assets.)

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Managing Liquidity Risk.

Purchased Fund to liquid assets: Ratio of bulk deposit to liquid assets: (Purchased funds consist of call borrowings , refinance availed, bulk deposit, inter bank term borrowing.) (short term liquid assets : cash, call/CBLO lending, HFT and AFS Investments, dues from Banks in current account.

Loan to capital ratio.

CD to total liabilities.

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Measuring and Managing Liquidity

Stock approach. Flow approach. Stock approach: Ratio of core deposit to total assets. Net loans to total deposits. Ratio of time deposit to total deposits.

Ratio of market liabilities to total assets.

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Flow approach.
Measuring and managing net funding requirements: Construction of maturity ladder, Liquidity gap based on residual maturities of assets and liabilities to arrive at deficit or surplus, cumulative gap, behavioral pattern, off balance sheet items.

Evaluate on alternate scenarios.

Managing Market access. Contingency planning.

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Flow approach
IF there is a significant funding requirement in a period say 30 days hence: Alternative options ? Acquire an asset or roll over the liability. Objective to close gap before it gets too close. Managing market access and contingency planning is key to efficacy of the ALM function. K.Eswar

Interest Rate Sensitivity.

Head of Account Liability Capital Reserve CD SB Rate sensitivity and time bucket NRS NRS Sensitive to the extent of interest paying(core) portion.Include in 3-6 month.Non interest paying portionin non rate sensitive bucket.

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Head of Account Liability Term Deposit and CD

Rate sensitivity and time bucket

Sensitive and reprices on maturity.Amount should be distributed to different buckets on the basis of remaining term to maturity.How ever in case of floating rate deposits, place under time bucket when deposits become contractually K.Eswar become due for reprising.

Head of Account Borrowing Fixed

Borrowings floating

Rate sensitivity and time bucket Sensitive and reprices on maturity.Amount to be distributed to different buckets on the basis of remaining maturity. Sensitive and repcies when interest rate is reset.Distribute to the bucket when refers to K.Eswar repricing date.

Head of Account Borrowing Zero coupon

Rate sensitivity and time bucket Sensitive and reprises on maturity. Amount should be appropriated to the respective maturity bucket. Upto 1 month bucket. Fixed Rate :As per respective maturity Floating : Reprices when K.Eswar interest rate is reset.

Borrowing from RBI Refinance from other agencies.

Head of Account Other Liabilities and Provisions. Bills payable Inter office adjustment Provisions.

Rate sensitivity and time bucket

Non sensitive. Non sensitive. Non Sensitive. Reprices on maturity and should be distributed in K.Eswar the respective buckets.

Repo/Bills rediscounting/Swaps

Head of Account

Rate sensitivity and time bucket Non Sensitive. Non sensitive.

ASSETS Cash Balance with RBI Balance with other Banks Current Money at call/notice/Term

Non Sensitive. Sensitive on maturity . Place in respective K.Eswar maturity bucket.

Head of Account

Rate sensitivity and time bucket Sensitive on maturity. Sensitive at next repricing date. Non sensitive.

Investments: Fixed Rate/Zero coupon Floating Rate

Shares /Units of MF

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Head of Account

Rate sensitivity and time bucket

Advances BP and Bills discounted Sensitive on maturity. CC/OD/Loans repayable Sensitive only when on demand and Term Loan PLR/risk premium is changed.

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Head of Account NPA: SSA Doubtful Asset Fixed Asset.

Rate sensitivity and time bucket 3-5 year bucket. Over 5 years. NRS

Inter office adjustment a/c NRS Leased asset Sensitive on cash flow. Distribute to respective maturity buckets of cash flow. K.Eswar

Head of Account

Reverse Repo,swaps,Rediscountin g. Swaps Sensitive and to be shown with reference to maturity. Note : Amount to be shown net of provisions ,interest suspense, claims received from ECGC. K.Eswar

Rate sensitivity and time bucket Sensitive on maturity.

GUIDANCE FOR SLOTTING THE FUTURE CASH FLOWS OF BANKS IN THE REVISED TIME BUCKETS
Heads of Accounts Classification into time buckets

A. Outflows
1. 2. Capital, Reserves and Surplus Demand Deposits (Current and Savings Bank Deposits) Over 5 years bucket Savings Bank and Current Deposits may be classified into volatile and core portions. Savings Bank (10%) and Current (15%) Deposits are generally withdrawable on demand. This portion maybe treated as volatile. While volatile portion can be placed in the Day 1, 2-7 days and 8-14 days time buckets, depending upon the experience and estimates of banks and the core portion may be placed in over 1-3 years bucket.

The above classification of Savings Bank and Current Deposits is only a benchmark. Banks which are better equipped to estimate the behavioural pattern, roll-in and roll-out, embedded options etc. on the basis of past data/empirical studies could classify them in the appropriate buckets, i.e. behavioural maturity instead of contractual maturity, subject to the approval of the Board/ALCO.
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Heads of Accounts 3. Term Deposits

Classification into time buckets Respective maturity buckets. Banks which are better equipped to estimate the behavioural pattern, roll-in and roll-out, embedded options, etc. on the basis of past data/empirical studies could classify the retail deposits in the appropriate buckets on the basis of behavioural maturity rather than residual maturity. However, the wholesale deposits should be shown under respective maturity buckets (wholesale deposits for the purpose of this statement may be Rs.15 lacs or any such higher threshold approved by the Banks Board).

4. Certificates of Deposit, Respective maturity buckets. Where call/put options are built Borrowings and Bonds into the issue structure of any instrument/s, the call/put date/s (including Subordinated Debt) should be reckoned as the maturity date/s and the amount should be shown in the respective time buckets. 5. Other Liabilities and Provisions: (i) Bills Payable (1) The core component which could reasonably be estimated on the basis of past data and behavioural pattern may be shown under Over 1-3 years time bucket. The balance amount may be placed in Day 1, 2-7 days and 8-14 days buckets, as per behavioural pattern.
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Heads of Accounts (ii) Provisions other than for loan loss and depreciation in investments.

Classification into time buckets

(ii)

Respective buckets depending on the purpose.

(iii)

(iii) Other liabilities

Respective maturity buckets. Items not representing cash payables (i.e. income received in advance etc.) may be placed in over 5 years bucket.

6.

Export Availed.

Refinance Respective maturity buckets of underlying assets.

B.

INFLOWS
Day 1 bucket While the excess balance over the required CRR/SLR may be shown under Day 1 bucket, the Statutory Balance may be distributed amongst various time buckets corresponding to the maturity profile of DTL with a time-lag of 14 days.

1. Cash 2. Balance with RBI

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Heads of Accounts

Classification into time buckets

3.
(i)

Balances with other Banks: Current Account

(i)

(ii) (ii) Money at Call and Short Notice, Term Deposits and other placements. 4. (i) Investments (Net of provisions)* Approved Securities

Non-withdrawable portion on account of stipulations of minimum balances may be shown under Over 1-3years bucket and the remaining balances may be shown under Day 1 bucket. Respective maturity buckets.

(i) Respective maturity buckets, excluding the amount required to be reinvested to maintain SLR corresponding to the DTL profile in various time buckets.

(ii) Corporate debentures and (ii) Respective maturity buckets. Investments classified as NPIs Bonds, PSU Bonds, CDs and should be shown under over 3-5 years bucket (Sub-standard) or CPs, Redeemable Preference over 5 years bucket (Doubtful). shares, Units of Mutual Funds (close ended etc.)
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Heads of Accounts (iii) Shares

Classification into time buckets (iii) Listed shares (except strategic investments) in 2-7 days bucket with a haircut of 50%. Other Shares in Over 5 years bucket.

(iv)

Units of Mutual Funds (Open ended)

Investments Subsidiaries/ Ventures. Securities in the Trading Book.

(iv) Day 1 bucket.

(v)

in (v) Over 5 years bucket. Joint

(vi)

(vi) Day 1, 2-7 days, 8-14 days, 15-28 days and 29-90 days according to defeasance periods.

* Provisions may be netted from the gross investments provided provisions are held securitywise. Otherwise provisions should be shown in over 5 years bucket.

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Heads of Accounts 5. Advances (Performing)

Classification into time buckets

(i)

Bills Purchased and (i) Discounted (including bills under DUPN)

Cash Credit/Overdraft (including TOD) and Demand Loan (ii) component of Working Capital.

Respective maturity buckets.

(ii)

Banks should undertake a study of behavioural and seasonal pattern of availments based on outstandings and the core and volatile portion should be identified. While the volatile portion could be shown in the near term maturity buckets, the core portion may be shown under Over 1-3 years bucket.
Interim cash flows may be shown under respective maturity buckets.

(iii) Term Loans

(iii)

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Heads of Accounts 6. NPAs (Net of provisions, interest suspense and claims received from ECGC/DICGC)

Classification into time buckets

(i) Sub-standard (ii) Doubtful and Loss 7. Fixed Assets/ Assets on lease.

(i) Over 3-5 years bucket. (ii) Over 5 years bucket. Over 5 years bucket/ Interim cash flows may be shown under respective maturity buckets.

8. Other Assets Intangible Assets

Intangible assets and assets not representing cash receivables may be shown in Over 5 years bucket.
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Heads of Accounts C. 1. (i) Off Balance Sheet Items Lines of Credit committed/available.

Classification into time buckets

(ii)

(iii) 2.

Lines of Credit (i) committed to/from Institutions. Unavailed portion of (ii) Cash Credit/ Overdraft/Demand loan component of Working Capital limits (outflow). (iii) Export Refinance Unavailed (inflow) Contingent Liabilities Letters of Credit/ Guarantees (outflow)

Day 1 bucket.

Banks should undertake a study of the behavioural and seasonable pattern of potentital availments in the accounts and the amounts so arrived at may be shown under relevant maturity buckets upto 12 months. Day 1 bucket.

Devolvement of Letters of Credit/Guarantees, initially entails cash outflows. Thus, historical trend analysis ought to be conducted on the devolvements and the amounts so arrived at in respect of outstanding Letters of Credit/Guarantees (net of margins) should be distributed amongst various time buckets. The assets created out of devolvements may be shown under respective maturity buckets on the basis of probable recovery dates.
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Heads of Accounts 3.

Classification into time buckets

Other Inflows/Outflows (i) Repo / Bills Rediscounted (i) Respective maturity buckets. (DUPN)/CBLO/Swaps INR/USD, maturing forex forward contracts etc. (outflow/inflow). (ii) Interest payable/ receivable (outflow/inflow) Accrued interest which are appearing in the books on the reporting day. (ii) Respective maturity buckets.

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Note:
(i) Liability on account of event cash flows i.e. short fall in CRR balance on reporting Fridays, wage settlement, capital expenditure etc. which are known to the Banks and any other contingency may be shown under respective maturity buckets. The event cash outflows, including incremental SLR requirement should be reported against Outflows Others. All overdue liabilities may be placed in the Day 1, 2-7 days and 8-14 days buckets based on behavioural estimates. Interest and instalments from advances and investments which are overdue for less than one month may be placed in Day 1, 2-7 days and 8-14 days buckets, based on behavioural estimates. Further, interest and instalments due (before classification as NPAs) may be placed in 29 days to 3 months bucket if the earlier receivables remain uncollected.

(ii)

(iii)

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STATEMENT OF STRUCTURAL LIQUIDITY

Place all cash inflows and outflows in the maturity ladder as per residual maturity Maturing Liability: cash outflow Maturing Assets : Cash Inflow Classified in to 10 time buckets Mismatches in the first four buckets not to exceed 5%.10%,15% and 20% of comulative outflows Banks can fix higher tolerance level for other maturity buckets.
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ADDRESSING MISMATCHES
Mismatches can be positive or negative Positive Mismatch: M.A.>M.L. and vice-versa for Negative Mismatch In case of +ve mismatch, excess liquidity can be deployed in money market instruments, creating new assets & investment swaps etc. For ve mismatch,it can be financed from market borrowings(call/Term),Bills rediscounting,repos & deployment of foreign currency converted into rupee.
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DYNAMIC LIQUIDITY
Prepared every fortnight for ALCO Projection is given for the next three months Tools for assessing the day to day liquidity needs of the bank

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STATEMENT OF INTEREST RATE SENSITIVITY

Generated by grouping RSA,RSL & OFFBalance sheet items in to various (8)time buckets. Positive gap : Beneficial in case of rising interest rate Negative gap: Beneficial in case of declining interest rate
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POSITIVE GAP: CASE STUDY

RSA: 2800 RSL: 1800 GAP: (+) 1000 CHANGE IN NII= GAPx CHANGE IN INT.RATE MORE REPRICABLE ASSETS THAN LIABILITIES
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CALCULATION OF NII/NIM
NII: INT.EARNED-INT. EXPENDED INT. EARNED: ADV+INVESTMENT INT. EXPENDED:DEPOSITS+INT. ON RBI BORROWINGS NIM= (NII/TOT.EARNING ASSET)X100

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Q. Net Interest Margin NIM is defined as a. Net interest income divided by total earning assets. b. Interest income interest expenses. c. total interest income divided by total assets. d. None of above.

Q..Ratio of share holders funds to total assets is called as a. Debt equity ratio. b. TOL/TNW ratio. c. Economic equity ratio. d. No ne of above.

Q The institution is in a position to benefit from rising interest rates when assets are than liabilities. Lower. Greater Equal Half. Q. The liquidity risk arising out of unanticipated withdrawal or non renewal of deposits is called as a. Funding Risk. b. Time risk. c. Market Risk d. Operational risk.

Q. Stock approach of measuring and managing liquidity risk and funding requirements is based on a. level of assets and liabilities and balance sheet exposure on a particular date. b. based on stocks pledged to Bank in Cash Credit Account c. Stock of Investments of bank. d. None of above.

Q. Flow approach to measuring and managing liquidity consist of a. Measuring and managing net funding requirements. b. Managing market access. c. Contingency planning. d. All the above.

Q. Under gap method the net funding requirement is calculated based on a. residual maturities of assets and liabilities. b. Actual maturities of assets and liabilities c. Both the above. d. None of above. Q. Cash inflows arise from mainly: a. Maturing assets. b. Maturing liabilities. c. Maturing off balance sheet exposure. d. Maturing time deposits.

q. Cash outflows arise out of mainly. a. Maturing liabilities. b. Maturing assets. c. Maturing T Bills. d. Maturing CPs. Q. Different between the cash in flow and cash out flow will result into.. if the cash inflows are lower than the cash outflows: a. deficit. c. Surplus d. None of above. e. No impact.

Q. If there is significant deficit observed say after 30 days period the option available for bank is to a. acquire an asset maturing on that day. b. renew or roll over a 30 day liability. c. Acquire a liability maturing after 30 days. d. None of above. Q. In the year 2007 RBI has for the purpose of measurement of liquidity risk split the first time bucket of 1-14 days in its structural liquidity in a. Four time buckets. b. Three time buckets c. Five time buckets. d. None of above.

 Q the net cumulative negative mismatch during the next day, 2-7 days, 8-14 days and 15-28 days buckets should not exceed a.5%,10%, 15% and 20% of cumulative cash inflows in respective time bucket. b. 20%,15%,10% and 5% of cumulative cash inflows. c.10%,5%,25% and 30% of cumulative cash inflows. Q. Frequency of structural liquidity position is a. fortnightly b. Weekly. c. Monthly d. Quarterly.

Capital , Reserves and Surplus are slotted in which time bucket in Structural Liquidity Statement: Over 5 years. Over 3 Years. Over 1 Year. Over 6 months. Q. Saving and Current deposit may be treated as volatile portion up to a. 10% and 15 % respectively. b.20% and 30% respectively. c. 30% and 40% respectively. d. None of above

Q. Placement of volatile portion and core portion of Saving and current deposit may be done as under: a. volatile portion in day 1 time bucket and core portion in 1-3 year bucket. b. Volatile portion in 7 day time bucket and core portion in 5 year bucket. c. Volatile portion in 2-7 days time bucket and core portion in 1 year time bucket. d. none of above. Q. Cash should be shown under which time bucket for inflow: a. 1 day. b. 2-7 days. c. 8-14 days. d. One year.

Q. Investment in shares and mutual fund (open ended) should be shown in a. Over 5 year bucket b. Over 1 year bucket. c. Over 2 year Bucket. D. None of above. Q. Investment in subsidiaries and joint ventures to be shown a. In over 5 year bucket. b. In over 3 year bucket. c. In over 1 year bucket. d. None of above.

Q. Core portion of Cash credit advances may be shown under a. 1-3 year time bucket. b. over 3 year time bucket. c. Over 5 years time bucket. d. None of above. Q. Term Loans to be shown under: a. Interest and principal of the loan under residual maturity bucket. b. Principal under residual maturity bucket. c. all in 5 year and above bucket. d. None of above.

Q. Sub Standard loans to be shown under a. Over one year bucket. b. Over 2 year bucket. c. Over 3 years bucket. d. Over 3-5 year bucket.

Q. Fixed Assets: a. Over 5 year bucket. b. Over 2 year bucket. c. Over 1 year bucket. d. none of above.

 Q. The net cumulative negative mismatches during the day 1, 2-7, 8-14 and 15-28 days buckets if exceed the prudential limits may be financed from market by a. Market borrowings ( call /term) b. Bills discounting c. Repo d. All above.

Q. Market Value of an asset is conceptually equal to a. Present value of current and future cash flows from that asset and liability. b. future value of current and future cash flows from that asset and liability. c. None of above. d. all the above. Q. There fore rising interest rates increase the discount rates on those cash flows and thus a. Decrease the market value of asset or liability. b. Increase the market value of asset or liability. c. No impact is caused. d. None of above.

Q. Falling interest rate decrease the discount rates on these cash flows and thus a. Increase the market value of an asset or liability. c. Decrease the market value of an asset or liability. d. No Impact. e. None of above. Q. What is basis risk: a. risk that interest rate of different assets and liabilities may change in different magnitudes is called basis risk. b. Risk relating to basis on which loan is sanctioned. c. Risk related to yield curve. d. None of above.

 Q. Yield Curve Risk is known as: a. Risk owing to altering of yields across maturities and its impact on NII b. Risk owing to wrong drawing of yield curve by Bank staff. c. risk of lower current yield . d. None of above. Q. Gap method is basically used for a. measuring banks interest rate risk exposure. b. measure maturity mismatch c. Measure potential losses from off balance sheet exposure. d. None of above.

Q. In a given time band a negative or liability sensitive gap occurs when a. Rate sensitive liabilities exceed rate sensitive assets. b. Rate sensitive assets exceed rate sensitive liabilities. c. None of above. d. All the above. Q. with a negative gap , an increase in market interest rates could cause a a. decline in net interest income. b. Increase in net interest income. c. None of above. d. All above.

Q. Higher the duration implies that a given change in the level of interest rates will have a. larger impact on economic value. b. smaller impact on economic value. c. No Impact. d. None of above. Q. Duration will be higher if a. longer the maturity date or smaller the payments that occur before maturity ( coupon payments) b. shorter the maturity and higher the payments that occur before maturity ( coupon payments) c. None of above. d. all the above.

Q. One of the strategies for reducing the asset or liability sensitivity could be : a. Increase floating rate instruments. b. Increase fixed rate instruments. c. None of above. d. all the above. Q. The Duration of Zero coupon bond would be a. Greater than its maturity. b. Shorter than its maturity. c. Equal to its maturity. d. None of above.

None of above. Q. Under Put option the buyer has a. Right to sell but not obligation to sell b. Right to buy but not obligation to buy c. Right to receive interest payments. d. None of above. Q. Under Call option the buyer has a. Right to buy but not obligation to buy b. right to sell but not obligation to buy c. None of above.

Q. Short term dynamic liquidity statement relate to a. monitoring liquidity on dynamic basis over a time horizon of 1-90 days. b. monitoring liquidity on dynamic basis over a time horizon of 7-90 days. c. monitoring liquidity on dynamic basis over a time horizon of 28-90 days. d. None of above. Q. In statement of interest rate sensitivity : a. Only rupee assets and liabilities and off balance sheet positions should be reported. b. All assets and liabilities should be reflected. c. Only foreign currency assets and liabilities should be reflected. d. None of above.

Q. Gap is the difference between a. Rate Sensitive Assets and Rate Sensitive Liabilities for each time bucket. b. Rate Sensitive Liabilities and Rate Sensitive Assets for each time bucket. c. None of above. d. all above.

Q If positive gap of RSA > RSL, Bank will A.Benefit from rising interest rate. B.Lose from rising interest rate. C.None of above. D.All of above.

Q. If negative gap of RSL > RSA will benefit from a. declining interest rate. b. Rising interest rate. c. None of above. d. No impact.

Q. Capital , Reserves and Surplus are a. Non interest rate sensitive. b. Interest Rate Sensitive. c. None of above.

Q. Provisions and inter office adjustments are a. Rate sensitive. b. Rate non sensitive. c. None of above. d. all of above.

Q. Current account balance is a. Rate sensitive. b. Rate non sensitive. c. None of above. d. All of above.

Thank You

5/9/2013

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