Presentation by S P Dhal, Faculty Member,

SPBT College
Asset Liability Management
in Banks
Live Interactive Learning Session
[Module A]
Components of a
Bank Balance sheet
Liabilities Assets
1. Capital
2. Reserve & Surplus
3. Deposits
4. Borrowings
5. Other Liabilities
1. Cash & Balances with
RBI
2. Bal. With Banks &
Money at Call and
Short Notices
3. Investments
4. Advances
5. Fixed Assets
6. Other Assets
Contingent Liabilities
Components of Liabilities
1.Capital:
Capital represents owners
contribution/stake in the bank.
- It serves as a cushion for depositors and
creditors.
- It is considered to be a long term sources
for the bank.

Components of Liabilities
2. Reserves & Surplus
Components under this head includes:
I. Statutory Reserves
II. Capital Reserves
III. Investment Fluctuation Reserve
IV. Revenue and Other Reserves
V. Balance in Profit and Loss Account

Components of Liabilities
3. Deposits
This is the main source of banks funds. The
deposits are classified as deposits payable on
demand and time. They are reflected in
balance sheet as under:
I. Demand Deposits
II. Savings Bank Deposits
III. Term Deposits


Components of Liabilities
4. Borrowings
(Borrowings include Refinance /
Borrowings from RBI, Inter-bank & other
institutions)
I. Borrowings in India
i) Reserve Bank of India
ii) Other Banks
iii) Other Institutions & Agencies
II. Borrowings outside India
Components of Liabilities
5. Other Liabilities & Provisions
It is grouped as under:

I. Bills Payable
II. Inter Office Adjustments (Net)
III. Interest Accrued
IV. Unsecured Redeemable Bonds
(Subordinated Debt for Tier-II Capital)
V. Others(including provisions)

Components of Assets
1. Cash & Bank Balances with RBI
I. Cash in hand
(including foreign currency notes)
II. Balances with Reserve Bank of India

In Current Accounts
In Other Accounts

Components of Assets
2. BALANCES WITH BANKS AND MONEY AT
CALL & SHORT NOTICE
I. In India
i) Balances with Banks
a) In Current Accounts
b) In Other Deposit Accounts
ii) Money at Call and Short Notice
a) With Banks
b) With Other Institutions
II. Outside India
a) In Current Accounts
b) In Other Deposit Accounts
c) Money at Call & Short Notice

Components of Assets
3. Investments
A major asset item in the banks balance sheet.
Reflected under 6 buckets as under:
I. Investments in India in : *
i) Government Securities
ii) Other approved Securities
iii) Shares
iv) Debentures and Bonds
v) Subsidiaries and Sponsored Institutions
vi) Others (UTI Shares , Commercial Papers, COD &
Mutual Fund Units etc.)
II. Investments outside India in **
Subsidiaries and/or Associates abroad
Components of Assets
4. Advances
The most important assets for a bank.
A. i) Bills Purchased and Discounted
ii) Cash Credits, Overdrafts & Loans
repayable on demand
iii) Term Loans
B. Particulars of Advances :
i) Secured by tangible assets
(including advances against Book Debts)
ii) Covered by Bank/ Government Guarantees
iii) Unsecured

Components of Assets
5. Fixed Asset
I. Premises
II. Other Fixed Assets (Including furniture and fixtures)
6. Other Assets
I. Interest accrued
II. Tax paid in advance/tax deducted at source
(Net of Provisions)
III. Stationery and Stamps
IV. Non-banking assets acquired in satisfaction of claims
V. Deferred Tax Asset (Net)
VI. Others
Contingent Liability
Banks obligations under LCs, Guarantees,
Acceptances on behalf of constituents and
Bills accepted by the bank are reflected
under this heads.
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.
Components of Income
1. INTEREST EARNED

I. Interest/Discount on Advances / Bills
II. Income on Investments
III. Interest on balances with Reserve Bank
of India and other inter-bank funds
IV. Others
Components of Income
2. OTHER INCOME

I. Commission, Exchange and Brokerage
II. Profit on sale of Investments (Net)
III. Profit/(Loss) on Revaluation of Investments
IV. Profit on sale of land, buildings and other
assets (Net)
V. Profit on exchange transactions (Net)
VI. Income earned by way of dividends etc. from
subsidiaries and Associates abroad/in India
VII. Miscellaneous Income
Components of Expenses
1. INTEREST EXPENDED

I. Interest on Deposits
II. Interest on Reserve Bank of India / Inter-Bank
borrowings
III. Others
Components of Expenses
2. OPERATING EXPENSES

I. Payments to and Provisions for employees
II. Rent, Taxes and Lighting
III. Printing and Stationery
IV. Advertisement and Publicity
V. Depreciation on Bank's property
VI. Directors' Fees, Allowances and Expenses
VII. Auditors' Fees and Expenses (including Branch Auditors)
VIII. Law Charges
IX. Postages, Telegrams, Telephones etc.
X. Repairs and Maintenance
XI. Insurance
XII. Other Expenditure
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.
Significance of ALM
Volatility
Product Innovations & Complexities
Regulatory Environment
Management Recognition
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
RBI DIRECTIVES
Issued draft guidelines on 10
th
Sept98.

Final guidelines issued on 10
th
Feb99 for
implementation of ALM w.e.f. 01.04.99.

To begin with 60% of asset &liabilities will be
covered; 100% from 01.04.2000.

Initially Gap Analysis to be applied in the first stage of
implementation.

Disclosure to Balance Sheet on maturity pattern on
Deposits, Borrowings, Investment & Advances w.e.f.
31.03.01
Liquidity Management
Banks liquidity management is the process
of generating funds to meet contractual or
relationship obligations at reasonable prices
at all times.
New loan demands, existing commitments,
and deposit withdrawals are the basic
contractual or relationship obligations that a
bank must meet.
Adequacy of liquidity position for
a bank
Analysis of following factors throw light on a
banks adequacy of liquidity position:
a. Historical Funding requirement
b. Current liquidity position
c. Anticipated future funding needs
d. Sources of funds
e. Options for reducing funding needs
f. Present and anticipated asset quality
g. Present and future earning capacity and
h. Present and planned capital position

Funding Avenues
To satisfy funding needs, a bank must
perform one or a combination of the
following:
a. Dispose off liquid assets
b. Increase short term borrowings
c. Decrease holding of less liquid assets
d. Increase liability of a term nature
e. Increase Capital funds
Types of Liquidity Risk
Liquidity Exposure can stem from both
internally and externally.
External liquidity risks can be geographic,
systemic or instrument specific.
Internal liquidity risk relates largely to
perceptions of an institution in its various
markets: local, regional, national or
international
Other categories of liquidity risk
Funding Risk
- Need to replace net outflows due to
unanticipated withdrawals/non-renewal
Time Risk
- Need to compensate for non-receipt of
expected inflows of funds
Call Risk
- Crystallization of contingent liability
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
STATEMENT OF
STRUCTURAL LIQUIDITY
Places all cash inflows and outflows in the
maturity ladder as per residual maturity
Maturing Liability: cash outflow
Maturing Assets : Cash Inflow
Classified in to 8 time buckets
Mismatches in the first two buckets not to
exceed 20% of outflows
Shows the structure as of a particular date
Banks can fix higher tolerance level for other
maturity buckets.
An Example of Structural Liquidity
Statement
1-14Days
15-28
Days
30 Days-
3 Month
3 Mths -
6 Mths
6 Mths -
1Year
1Year - 3
Years
3 Years -
5 Years
Over 5
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
ADDRESSING THE MISMATCHES
Mismatches can be positive or negative

Positive Mismatch: M.A.>M.L. and Negative
Mismatch M.L.>M.A.

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.
STRATEGIES
To meet the mismatch in any maturity
bucket, the bank has to look into
taking deposit and invest it suitably
so as to mature in time bucket with
negative mismatch.
The bank can raise fresh deposits of
Rs 300 crore over 5 years maturities
and invest it in securities of 1-29 days
of Rs 200 crores and rest matching
with other out flows.

Maturity Pattern of Select Assets & Liabilities of A Bank
Liability/Assets

Rupees
(In Cr)

In Percentage

I. Deposits
a. Up to 1 year
b. Over 1 yr to 3 yrs
c. Over 3 yrs to 5 yrs
d. Over 5 years

15200
8000
6700
230
270

100
52.63
44.08
1.51
1.78

II. Borrowings
a. Up to 1 year
b. Over 1 yr to 3 yrs
c. Over 3 yrs to 5 yrs
d. Over 5 years

450
180
00
150
120

100
40.00
0.00
33.33
26.67

III. Loans & Advances
a. Up to 1 year
b. Over 1 yr to 3 yrs
c. Over 3 yrs to 5 yrs
d. Over 5 years

8800
3400
3000
400
2000

100
38.64
34.09
4.55
22.72

Iv. Investment
a. Up to 1 year
b. Over 1 yr to 3 yrs
c. Over 3 yrs to 5 yrs
d. Over 5 years

5800
1300
300
900
3300

100
22.41
5.17
15.52
56.90

STATEMENT OF
INTEREST RATE SENSITIVITY
Generated by grouping RSA,RSL & OFF-
Balance sheet items in to various (8)time
buckets.
RSA:
MONEY AT CALL
ADVANCES ( BPLR LINKED )
INVESTMENT
RSL
DEPOSITS EXCLUDING CD
BORROWINGS

MATURITY GAP METHOD
(IRS)
THREE OPTIONS:
A) RSA>RSL= Positive Gap
B) RSL>RSA= Negative Gap
C) RSL=RSA= Zero Gap

SUCCESS OF ALM IN BANKS :
PRE - CONDITIONS
1. Awareness for ALM in the Bank staff at all
levelssupportive Management & dedicated
Teams.
2. Method of reporting data from Branches/ other
Departments. (Strong MIS).
3. Computerization-Full computerization,
networking.
4. Insight into the banking operations, economic
forecasting, computerization, investment,
credit.
5. Linking up ALM to future Risk Management
Strategies.
Interest Rate Risk Management
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
Interest rate risk refers to volatility in Net
Interest Income (NII) or variations in Net
Interest Margin(NIM).
Therefore, an effective risk management
process that maintains interest rate risk
within prudent levels is essential to safety
and soundness of the bank.
Sources of Interest Rate Risk
Interest rate risk mainly arises from:
Gap Risk
Basis Risk
Net Interest Position Risk
Embedded Option Risk
Yield Curve Risk
Price Risk
Reinvestment Risk

Measurement of Interest Rate Risk
Gap Analysis- Simple maturity/re-pricing
Schedules can be used to generate simple
indicators of interest rate risk sensitivity of both
earnings and economic value to changing interest
rates.
- If a negative gap occurs (RSA<RSL) in given
time band, an increase in market interest rates
could cause a decline in NII.
- conversely, a positive gap (RSA>RSL) in a
given time band, an decrease in market interest
rates could cause a decline in NII.
Measurement of Interest Rate Risk
Duration Analysis: Duration is a measure
of the percentage change in the economic
value of a position that occur given a small
change in level of interest rate.
THANK YOU