Asset Liability

Management
in Banks
 Components of a
Bank Balance sheet
Liabilities Assets
1. Capital 1. Cash & Balances
2. Reserve & Surplus with 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
Contingent
 Components of Liabilities

1. Capital:
Capital represents owner’s
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 bank’s 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 bank’s 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

Bank’s 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 bank’s 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
 Asset Liability Management
❑ Asset Liability Management (ALM) is a strategic management tool to
manage interest rate risk and liquidity risk faced by banks.
❑ It can be known as a risk management technique designed to earn
an adequate return while maintaining a comfortable surplus of
assets beyond liabilities.
❑ It takes into consideration interest rates, earning power, and degree of
willingness to take on debt and hence is also known as Surplus
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 Net Interest Income.
 Asset Liability
Committee (ALCO)
 Composition of ALCO
❑ Chairperson or Head of ALCO: This individual, often a senior executive or board
member, leads the committee’s activities, ensures alignment with the bank’s
overall strategy, and communicates ALCO’s decisions to senior management
and the board of directors.
❑ Chief Financial Officer (CFO): The CFO is a key member of ALCO and is
responsible for providing financial data and insights. They play a pivotal role in
assessing the financial implications of ALCO’s decisions.
❑ Chief Risk Officer (CRO): The CRO brings risk expertise to the committee and
helps evaluate the risk-return trade-offs associated with ALM decisions. They
ensure that ALCO’s actions align with risk appetite and regulatory
❑ Treasury Head: The head of the treasury department manages the bank’s liquidity,
investments, and funding. They provide critical input on the bank’s liquidity position
and funding needs.
❑ Head of Asset Management: This individual oversees the bank’s loan portfolio and
its credit quality. They help assess credit risk and the impact of lending decisions on
the bank’s ALM.
❑ Market Risk Manager: The market risk manager focuses on evaluating interest rate
risk and market-related factors. They assist ALCO in understanding how changes in
market conditions can affect the bank’s balance sheet.
❑ Economist: An economist provides insights into economic trends and forecasts that
may influence ALM decisions. They assess the macroeconomic factors that can
impact the bank’s financial position.
 Functions of ALCO
❖ Liquidity Management
Ensures the institution has sufficient liquid assets to meet its short-
term obligations.
Monitors the liquidity position and adjusts the funding mix to maintain
an optimal balance.
Formulates contingency funding plans to address unexpected liquidity
crises.
 Functions of ALCO
❖ Interest Rate Risk Management
Identifies, measures, and mitigates risks associated with changes in
interest rates.
Monitors interest rate sensitivity gaps and establishes limits to reduce
exposure.
Implements hedging strategies (e.g., swaps, futures) to manage
interest rate risks.
 Functions of ALCO
❖ Balance Sheet Management
Aligns the composition of assets and liabilities to achieve financial
stability and maximize returns.
Ensures the duration and maturity of assets and liabilities are well-
matched to minimize risks.
Evaluates the impact of macroeconomic factors on the balance sheet.
 Functions of ALCO
❖ Profitability Optimization
Sets pricing strategies for loans, deposits, and other financial products
to enhance net interest margin (NIM).
Balances the risk-return trade-off to achieve sustainable profitability.
Evaluates the cost of funds and ensures efficient allocation of
resources.
 Functions of ALCO
❖ Capital Adequacy Management
Ensures compliance with regulatory capital requirements (e.g., Basel III
norms).
Monitors capital adequacy ratios and adjusts strategies to maintain a
strong capital base.
Plans for capital infusion or retention of earnings as needed.
 Functions of ALCO
❖ Scenario Analysis and Stress Testing
Conducts stress tests and scenario analyses to assess the impact of
adverse conditions on liquidity and solvency.
This helps identify potential vulnerabilities and develops contingency plans
to address potential crises.

❖ Regulatory Compliance
Ensures compliance with central bank guidelines and other regulatory
frameworks.
Submits periodic reports on liquidity, interest rate gaps, and risk exposures
to regulators.
Aligns policies and practices with evolving regulatory standards.
 Functions of ALCO
❖ Communication and reporting
Effective communication is essential in ALM.
The framework ensures that relevant information is communicated to
senior management, the board of directors, and regulatory authorities.
Regular reporting and transparency are key components.

❖ Strategic planning
ALM contributes to the bank’s strategic planning by aligning ALM
strategies with the institution’s overall goals and risk appetite.
It helps guide decisions related to business expansion, product
offerings, and risk management.
Timeline of ALM
Pre 1908s

o Before the 1980s, financial institutions in many countries,

including India, typically had simple balance sheets and did not
manage the maturity mismatches between assets and liabilities
in a structured way.
o ALM was not a formalized process during this period.
 1980s – Emergence of ALM
o During the 1980s, as interest rate volatility increased, financial institutions started
realizing the need for a structured approach to managing risks related to interest
rates and liquidity.
o The rise of financial deregulation and the global integration of financial markets,
especially after the Bretton Woods system collapsed in the 1970s, made it
increasingly important for institutions to manage these risks proactively.
 1990s – Formalization of ALM
o The 1990s saw the formal introduction of ALM as a critical tool in financial
institutions, particularly in India after economic liberalization in 1991. The
financial sector reforms included a focus on risk management practices, capital
adequacy, and market discipline.
o The Reserve Bank of India (RBI) issued guidelines for asset-liability
management in Indian banks, urging them to set up ALCOs (Asset-Liability
Committees) and implement policies for managing interest rate and liquidity
risks.
 2000s – Expansion and Refinement

o In the 2000s, the global financial markets became more complex, with greater
financial innovation, leading to further refinement in ALM practices.
o The Basel II framework (adopted globally by the early 2000s) emphasized the
need for banks to hold capital in proportion to the risks they were exposed to,
thus increasing the importance of ALM in managing risks.
 2010s and Beyond – ALM in the
Context of Global Regulation

o With the introduction of Basel III regulations in the aftermath of the 2008 global
financial crisis, ALM practices were further enhanced to ensure stronger liquidity
buffers and capital adequacy.

o Financial institutions in India and globally have increasingly integrated stress

testing and scenario analysis into their ALM frameworks to better understand the
potential impact of economic shocks and market volatility.