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ASSET LIABILITY MANAGEMENT (ALM)

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  1. ASSET LIABILITY MANAGEMENT (ALM)

  2. History of bank failures in US • 2012 - 23 • 2011 - 89 • 2010 - 157 • 2009 - 140

  3. Components of a Bank Balance sheet Contingent Liabilities

  4. Business Risks • Operational Risk • Credit Risk • Market Risk • Liquidity Risk • Interest Rate Risk • Foreign Exchange Risk • Information Risk

  5. What is ALM ?... • Concerned with strategic Balance Sheet management • Match between assets and liabilities in BS • Risks stem from mismatch between A&L – credit, liquidity, interest, currency • ALM is not to avoid risk but to manage risk, sustaining profitability

  6. What is ALM ?...contd.. • Periodic monitoring of risk exposures involving collecting and analysing information • Ability to anticipate, forecast and act so as to structure bank’s business to profit • Altering A & L portfolio in a dynamic way to manage risks • Involves judgement and decision making

  7. Defining ALM • ALM involves Planning, directing and Controlling the flow , mix, cost and yield of the consolidated funds of bank • Assesses various asset mixes, funding combinations, price volume relations and their implications on Liquidity, Income and Capital ratio • Planning procedure which accounts for all assets and liabilities of a bank by rate, amount and maturity

  8. Why ALM ? • Banks exposed to credit and market risks in view of asset-liability transformation • Risks increased with liberalisation and growing integration of domestic markets with external markets • Banks now operate in deregulated environment and are required to determine interest rates on various products

  9. Why ALM ?.. Contd.. • Need to maintain balance among spread, profitability and long-term viability • Increasing volatility in domestic interest rates as well as foreign exchange rates • New financial product innovation

  10. Why ALM ?.. Contd.. • Increased level of awareness among top management - market risks, interest rate movements • Intense competition for business involving both assets and liabilities

  11. Why ALM ?.. Contd.. • Regulatory initiatives • International initiative – Basle Committee • Thus, a call for structured and comprehensive measures for institutionalising an integrated risk management system

  12. Overall Objective.. • The central theme of (ALM) is the management of a bank’s entire balance sheet on continuous basis with a view to ensure a proper balance between funds mobilisation and their deployment with respect to their maturity profiles, cost and yield as well as risk exposure so as to improve profitability, ensure adequate liquidity, manage risks and ensure long term viability

  13. RBI / NABARD Guidelines on ALM • Draft guidelines issued on 10 Sept 1998 • Final guidelines issued on 10 Feb 1999 for implementation from 1 April 1999 • At least 60% of assets and liabilities to be covered initially • 100% coverage from 1 April 2000

  14. RBI / NABARD Guidelines on ALM • NABARD guidelines on Risk Management Systems in Banks – April 2005 • Guidelines were issued to 5 select State Cooperative Banks viz. Andhra Pradesh, Tamil Nadu. Maharashtra. Punjab and West Bengal SCBs and 12 selected RRBs for implementation of Asset - Liability Management (ALM) System wef 1.4.2007- so far satisfactory .

  15. RBI / NABARD Guidelines on ALM • BOS Meeting 27.3.2008 decided introduction of ALM in all the SCBs & RRBs wef 1.7.2008 • ALM to be introduced in phased manner in DCCBs. • Initially selected 31 DCCBs for ALM wef 1.9.2008 • Interim target to cover 100% business by 1.4.2009

  16. RBI / NABARD Guidelines on ALM • Once system stabilises, bank gain experience- swtch over to sophisticated computerised techniques –Duration Gap analysis, Simulation & VaR for Interest rate risk management

  17. RBI / NABARD Guidelines on ALM • Review of computerisation in bank • Suitability of manpower –implementation • ALM policy approved by BOD • Constitute ALCO to review ALM implementation in bank • Start generating reports as required • Capacity building (KM) of nodal officer • Upgrade MIS for preparation of reports • Send detailed monthly progress reports- present status, progress made & action plan for future

  18. ALM Process- Three pillars • ALM Information System • Management Information System • Information availability, accuracy, adequacy and expediency • ALM Organisation • Structure and responsibilities • Level of top management involvement • ALM Process • Risk parameters, risk identification, risk measurement, risk management, risk policies and procedures, prudential limits & auditing, reporting & review

  19. ALM Information Systems • Information is the key to the ALM process • Varied business profiles – no uniform ALM system for all banks • Methods range from simple Gap statement to extremely sophisticated simulation methods. • Availability of adequate, timely and accurate information, the central element for ALM exercise

  20. ALM Information Systems-Challenges • Large network of branches and lack of an adequate support system to collect information • Problem to be addressed through ABC approach – atleast 60-70% of total business-analysing behaviour of assets and liabilities in sample branches • Investment portfolio – easy since centralised • Spread of computerisation helps

  21. ALM Organisation • Board to have overall responsibility and frame risk management policy • Board to set limits for liquidity, interest rate and exchange rate risks • ALCO (Asset Liability Committee) consisting of senior management including CEO decides strategy and adheres to objective • ALM Support Groups, responsible for analysing, monitoring and reporting the risk profiles to ALCO • Staff also prepare the forecasts (simulations) showing effects and recommend action

  22. ALCO-responsibilities • ALCO decision making unit- Responsible for balance sheet planning from risk return perspective • Monitoring the market risk levels by ensuring adherence to the various risk limits set by the bank • Articulating the current interest rate view and a view on future direction of interest rate movements

  23. ALCO-responsibilities • Deciding the business strategy of the bank, consistent with the interest rate view, budget and pre-determined risk management objectives • Determining the desired maturity profile and mix of assets and liabilities

  24. ALCO-responsibilities..contd.. • Product pricing for both assets and liabilities side • Deciding the funding strategy i.e. source and mix of liabilities or sale of assets • Reviewing implementation of decisions made in the previous meeting

  25. Composition of ALCO • The size of ALCO depends on size of institution, business mix and organisational complexity • CEO to head the Committee • Chiefs of Investment, Credit, Resource Management, Funds Management/ Treasury, Banking and Economic Research to be members of the Committee

  26. Composition of ALCO…. • Head of Technology Division be an invitee • Some banks may have sub-committees and support groups • Management committee to oversee and review

  27. ALM Process Scope of ALM function can be defined as: • Liquidity Risk Management • Interest rate risks management • Trading risk management • Funding and capital planning • Profit planning and growth projection • RBI guidelines mainly cover Liquidity and Interest rate risks

  28. Policy for creation of liabilities An appropriate policy for creation of liabilities has to take care that: • Adequate financial resources (i.e.funds) are mobilised keeping in view the bank’s deployment requirements • The cost of liabilities in terms of interest cost is least and is reduced from time to time

  29. Policy for creation of liabilities • The servicing / operational cost of the liabilities is kept low with emphasis on volumes • The liabilities should come from fairly diversified sources so that set backs in one area do not affect the overall financial resource position

  30. Policy for creation of assets An appropriate policy for creation of assets has to aim at: • Making provisions for meeting statutory requirements like reserves-CRR, SLR • Maximising of the yield or return on various components of assets • Maintenance of adequate liquidity through appropriate mix of assets

  31. Policy for creation of assets… • Diversification of assets so as to minimise losses • Lending advances with prudence based on risk perception with the sole objective that it should not turn out to be non-performing

  32. Liquidity Risk Management • Assured ability to meet its liabilities as they become due reduces the probability of an adverse situation developing • Liquidity shortfall in one institution can have repercussions on the entire system

  33. Liquidity Risk Management…. • Assets commonly considered as liquid like Government securities and other money market instruments could also become illiquid when the market and players are unidirectional • Liquidity has to be tracked through maturity or cash flow mismatches • Use of maturity ladder – standard tool

  34. Statement of structural liquidity

  35. Time buckets for maturity profile • 1-14 days • 15-28 days • 29 days and upto 3 months • Over 3 months and upto 6 months • Over 6 months and upto 1 year • Over 1 year and upto 3 years • Over 3 years and upto 5 years • Over 5 years

  36. Liquidity mismatches… contd.. • The mismatches during 1-14 & 15-28 days not to exceed 20% of cash outflows • Maturing liability is a cash outflow and maturing asset is a cash inflow • Tolerance level in mismatches to be determined based on asset-liability base, nature of business, future strategy etc. • Banks to monitor their short term liquidity on a dynamic basis over a time horizon spanning from 1-90 days (short term dynamic liquidity statement)

  37. Estimation of short term dynamic liquidity

  38. Interest Rate Risk • Interest rate risk is the risk where changes in the market interest rates might adversely affect a bank’s financial condition • Immediate impact would be on bank’s earnings by changing its NII • Long tem impact of changing interest rates would be on bank’s Net Worth • Interest rate risk is measured in terms of change in NII

  39. Interest Rate Risk… • Traditional Gap analysis method is to be used now • Move over to modern techniques of Interest Rate Risk measurement like Duration Gap analysis, simulation, VAR gradually • Gap or Mismatch analysis measures gaps between rate sensitive assets and rate sensitive liabilities

  40. Interest Rate Risk-measurement • An asset or liability is considered rate sensitive if: • Within the time interval under consideration there is a cash flow • the interest rate resets/reprises contractually during the period • RBI changes the interest rates • It is contractually pre-payable or withdrawable before the stated maturity

  41. Interest rate sensitivity - Reporting format

  42. Interest Rate Risk-measurement • Gap report is generated by grouping the RSA, RSL into time buckets according to residual maturity or next reprising period, whichever is earlier. • All investments, advances, deposits, borrowings, purchased funds etc that mature/reprise within a specified timeframe are interest rate sensitive

  43. Rate sensitive assets and liabilities

  44. Interest Rate Risk-Gap in time buckets • The gaps may be identified in the following time buckets • 1-28 days • 29 days and upto 3 months • Over 3 months and upto 6 months • Over 6 months and upto 1 year • Over 1 year and upto 3 years • Over 3 years and upto 5 years • Over 5 years • Non-sensitive

  45. Interest Rate Risk – Gap report • The gap is the difference between RSA and RSL for each time bucket • RSA>RSL - positive gap • RSA<RSL - negative gap • Positive – beneficial with rising rates • Negative – beneficial with declining rates • Each bank should set prudential limits on individual gaps with the approval of the Board/Management Committee

  46. General…. • Classification of various components of assets and liabilities into different time buckets made is benchmark • Better equipped banks may reclassify based on data/studies subject to approval of ALCO/Board • Note approved by ALCO/Board to be sent to RBI

  47. Summary…. • Coordinated financial management of BS • Risk by choice and not by chance • A pulse on approach to market risk management • Increased awareness of market risks • Both science and an art

  48. Thank you