Asset Liability

Management
PRESENTATION ON ALM

A K CHATTERJEE
FACULTY, IIBF,MUMBAI
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.
 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
 Scope of ALM Function

The scope of ALM function can be described as :

• Liquidity Risk Management
• Management of Market Risks
• Trading Risk Management
• Funding and Capital Planning
• Profit planning and growth projection
ALM ORGANISATION

BOARD OF
DIRECTORS

RISK
MANAGEMENT
COMMITTEE OF
THE BOARD

CREDIT POLICY OPERATIONAL ASSET LIABILITY

COMMITTEE RISK COMMITTEE COMMITTEE
(CPC) (ORCO) (ALCO)
 ALCO Members
Chairman & Managing Director - Chairman
• MEMBERS
• Executive Directors
• Chief General Manager - Treasury
• Chief General Manager - Credit
• General Manager - Risk Management
• General Manager - P&D
• General Manager – Operations
• General Manager – Priority Sector
• General Manager – Retail Banking
Fundamental issues addressed by
ALCO

 What constitutes liquidity

 How much liquidity is enough
 How much capital is adequate
 What are the various forms of interest rate risk that
can affect the Bank
 How to measure the interest rate risk and
 How much interest rate risk can the Bank tolerate.
 Business issues addressed by ALCO
 Implementation of ALM on an on-going basis.
 Monitor the risk level of the Bank.
 Monitor the structure of the Balance Sheet in the light of the
capital adequacy norms.
 Articulate the current interest rate view of the Bank and devise
future business strategies such as product pricing for deposits and
advances.
 Develop a view of future direction of interest rate movement and
decide on the funding mix between wholesale vs. retail deposits,
money market vs. Capital market etc.
 Develop new products and services.
 The list of reports presented to ALCO
No. STATEMEN Objective Description Frequency
T
1 Statement of Monitor liquidity position of Classification of assets, liabilities and off- Fortnightly
Structural the bank balance sheet instruments in various
Liquidity maturity buckets
2 Statement of Monitor interest rate risk Re-pricing of assets, liabilities and off- Monthly
Interest Rate position of the Bank balance sheet instruments in various
Sensitivity maturity buckets
3 Performance Track specific performance NII and NIM Incremental and average cost Monthly
analysis parameters of funds, Cost of deposits and Yield on
advances etc.

4 Statement of Project business figures forLiquidity projection based on the estimated Monthly
Dynamic coming quarter, review inflows and outflows over a period of 90
Liquidity variances against budgets days comprising of net increase in
and reset targets Advances, Investments and off B. S. sheet
items and net increase in deposits & off B.
S. items etc.
5 Review of Measure bank’s performance Deposits, advances and investment of the Monthly
key business in terms of key business bank compared with those of all scheduled
figures figures and comparison with commercial banks
industry performance
Contingent Liabilities
 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.
 Liquidity Risk

Liquidity risk is the risk that a bank will not be

able to meet short-term financial obligations due
to the inability to convert assets into cash without
incurring a loss. This most often occurs when
assets (such as securities) cannot be sold for a
reasonable price due to a lack of buyers, large
price movements, or widening bid-ask spreads.
 Types of Liquidity Risk

Banks face the following types of liquidity risk:

Funding Liquidity Risk – the risk that a bank will not be able to
meet efficiently the expected and unexpected current and future
cash flows and collateral needs without affecting either its daily
operations or its financial condition.

Market Liquidity Risk – the risk that a bank cannot easily offset or
eliminate a position at the prevailing market price because of
inadequate market depth or market disruption.

Call Risk:- Crystallization of contingent liability

 Liquidity Management

Bank’s 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 bank’s

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
 Contingency Funding Plan:

 A bank should formulate a contingency funding plan

(CFP) for responding to severe disruptions which might
affect the bank’s ability to fund some or all of its
activities in a timely manner and at a reasonable cost
 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
Statement of Structural Liquidity
All Assets & Liabilities to be reported as per their
maturity profile into 11 maturity Buckets:
i. 1 day
ii. 2 to 7 days
iii. 8 to 14 days
iv. 15 to 30 days
v. 31 days and up to 2 months
vi. Over 2 months and up to 3 months
vii. Over 3 months and up to 6 months
viii.Over 6 months and up to 1 year
ix. Over 1 year and up to 3 years
x. Over 3 years and up to 5 years
xi. Over 5 years
 Ratios in respect of Liquidity Risk Management
Sl. No. Ratio Significance Industry
Average
(in %)
1. (Volatile liabilities – Measures the extent to which volatile money supports bank’s
40
Temporary Assets) basic earning assets. Since the numerator represents short-
/(Earning Assets – term, interest sensitive funds, a high and positive number
Temporary Assets) implies some risk of illiquidity.

2. Core deposits/Total Measures the extent to which assets are funded through stable
50
Assets deposit base.
3. (Loans + mandatory SLR Loans including mandatory cash reserves and statutory liquidity
80
+ mandatory CRR + Fixed investments are least liquid and hence a high ratio signifies the
Assets)/Total Assets degree of ‘illiquidity’ embedded in the balance sheet.

4. (Loans + mandatory SLR Measure the extent to which illiquid assets are financed out of
150
+ mandatory CRR + Fixed core deposits.
Assets) / Core Deposits

5. Temporary Assets/Total Measures the extent of available liquid assets. A higher ratio
40
Assets could impinge on the asset utilisation of banking system in
terms of opportunity cost of holding liquidity.

6. Temporary Assets/ Measures the cover of liquid investments relative to volatile

60
Volatile Liabilities liabilities. A ratio of less than 1 indicates the possibility of a
liquidity problem.

7. Volatile Liabilities/Total Measures the extent to which volatile liabilities fund the
60
Assets balance sheet.
 Interest Rate Risk Management

 Interest Rate risk is the exposure of a bank’s 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 bank’s
earnings and capital base.
 Changes in interest rates also affect the underlying value of
the bank’s 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.
 STATEMENT OF
INTEREST RATE SENSITIVITY

 Generated by grouping RSA,RSL & OFF-Balance sheet items in

to various (10)time buckets.

RSA:
 MONEY AT CALL
 ADVANCES ( Floating Rate)
 INVESTMENT

RSL
 DEPOSITS
 BORROWINGS
 MATURITY GAP METHOD
(IRS)

THREE OPTIONS:
A) RSA>RSL= Positive Gap
B) RSL>RSA= Negative Gap
C) RSL=RSA= Zero Gap
 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.
 Liquidity Coverage Ratio
Liquidity coverage ratio – States that at minimum and on an
ongoing basis, the bank must maintain an adequate level of
unencumbered High Quality Liquid Assets that can be
converted into cash to meet its liquidity needs for 30 calendar
day time horizon under severe liquidity stress scenario.

The LCR was introduced as part of the Basel III reforms

following the 2008 global financial crisis and was finalized by
the Basel Committee on Banking Supervision in January 2013.
LCR Implementation Timelines in India

As on Minimum LCR to be
Maintained
1 January 2015 60%
1 January 2016 70%
1 January 2017 80%
1 January 2018 90%
1 January 2019 100%
 Components of LCR
 HQLA: Liquid assets comprise of high quality assets that
can be readily sold or used as collateral to obtain funds in a
range of stress scenarios.

1. Level 1 Assets: Stocks of liquid assets

2. Level 2 a Assets: Stocks of liquid assets with minimum 15%
haircut
3. Level 2b. Assets: Minimum 50% haircut, within 15% of
total HQLA

Such as Cash including cash reserves in excess of required

CRR, Government securities in excess of the minimum SLR
requirement. Within the mandatory SLR requirement,
Government securities to the extent allowed by RBI1 , under
Marginal Standing Facility (MSF)
 Components of LCR Cont…

 Cash Inflows:
1. Maturity of secured lending transaction
2. Inflows from Counterparties
3. Inflows form derivative transactions, Other
contractual payments
 Components of LCR Cont…

 Cash Outflows:
1. Retail Demand Deposits
2. Unsecured wholesale funding
3. Term Deposit
4. Deposits with Clearing Corporation
5. Derivatives Revaluation
6. Collateral Depreciation
 Other Component of LCR

 Contractual Maturity Mismatch

 Concentration of Funding
 Available Unencumbered Assets
 LCR by Significant Currency
 Market-related Monitoring Tools
 Basel III Liquidity Returns

S. Name of the Basel III Liquidity Frequency of Time period by

No. Return (BLR) submission which required
to be reported
1 Statement on Liquidity Coverage Monthly within 15 days
Ratio (LCR)- BLR-1
2 Statement of Funding Monthly within 15 days
Concentration – BLR-2
3 . Statement of Available Quarterly within a month
Unencumbered Assets - BLR-3
4 LCR by Significant Currency - Monthly within a month
BLR-4
5 Statement on Other Information Monthly within 15 days
on Liquidity - BLR-5
 NSFR
 The LCR promotes short-term resilience of banks to potential
liquidity disruptions by ensuring that they have sufficient high
quality liquid assets (HQLAs) to survive an acute stress scenario
lasting for 30 days. The NSFR promotes resilience over a longer-
term time horizon by requiring banks to fund their activities with
more stable sources of funding on an ongoing basis.

 Definition of NSFR:
The NSFR is defined as the amount of available stable funding
relative to the amount of required stable funding. “Available stable
funding” is defined as the portion of capital and liabilities expected to
be reliable over the time horizon considered by the NSFR, which
extends to one year.
 Net Stable Funding Ratio

 Net stable funding ratio - requires a minimum

amount of funding that is expected to be stable over
a one year time horizon based on liquidity risk
factors assigned to assets and off-balance sheet
liquidity exposures.

NSFR guidelines will come into effect from April 1, 2021.

 POLICY RATES,RESERVE RATIOS,MARKET TRENDS

 POLICY RATES:
 Police Repo rate: 6.50%
 Standing deposit facility rate: 6.25%
 Marginal standing facility rate: 6.75%
 Bank rate: 6.75%
 Fixed reverse repo rate: 3.35%
Reserve ratios:
 CRR: 4.50%
 SLR: 18.00%
MARKET TRENDS
 CALL RATES :5.10% to 6.50%
 91 day T bill: 6.5116%
 182 day T bill: 6.6404%
 364 day T bill: 6.5991%
 LARGE CAP, MID CAP, SMALL CAP

 SEBI has, vide its circular no. SEBI/HO/IMD/DF3/CIR/P/2017/114 dated 6th

October 2017, defined large cap, mid cap and small cap companies in order to
ensure uniformity in respect of the investment universe for equity mutual
fund schemes. Further, SEBI has also stipulated that AMFI shall prepare the
list of stocks in this regard, in accordance with the points specified under
para 8 of the circular.

 LARGE CAP: 1st-100thcompany in terms of full market capitalization (₹67017

CRORE BASED ON JULY-DEC DATA)
 MID CAP: 101st-250thcompany in terms of full market capitalization.(₹21994
CRORE)
 SMALL CAP: 251stcompany onwards in terms of full market capitalization
 The free-float methodology can be contrasted with the full-market
capitalization method, which takes into calculation both active and inactive
shares when determining market capitalization.
 The free-float method excludes locked-in shares, such as those held by
insiders, promoters, and governments.
 Digital Lending:
 A remote and automated lending process,
 largely by use of seamless digital technologies
 for customer acquisition,
 credit assessment,
 loan approval, disbursement, recovery, and associated customer service.
Digital Lending Apps/Platforms (DLAs):
 Mobile and web-based applications with user interface that facilitate
digital lending services.
 DLAs will include apps of the Regulated Entities (REs)
 as well as those operated by Lending Service Providers (LSPs) engaged by
REs
 for extending any credit facilitation services in conformity with extant
outsourcing guidelines issued by the Reserve Bank.
 Lending Service Provider (LSP):
 An agent of a Regulated Entity who carries out one or more of lender’s
functions or part thereof in customer acquisition,
 underwriting support, pricing support, servicing, monitoring,
 recovery of specific loan or loan portfolio
 on behalf of REs in conformity with extant outsourcing guidelines issued
by the Reserve Bank.
 “Climate-related financial risks” means the potential risks that may arise
from climate change or from efforts to mitigate climate change, their
related impacts and economic and financial consequences.
 “Climate resilience” means the capacity of an RE to adjust to climate-related
changes, developments or uncertainties. It involves the capacity to manage
climate-related risks and benefits from climate-related opportunities,
including the ability to respond and adapt to climate-related physical and
transition risks. It includes both strategic and operational resilience of RE to
climate-related changes, developments or uncertainties.
 “Greenhouse gases (GHGs)” are those gaseous constituents of the
atmosphere, both natural and anthropogenic, that absorb and emit radiation
at specific wavelengths within the spectrum of thermal infrared radiation
emitted by the earth’s surface, by the atmosphere itself, and by clouds. This
property causes the greenhouse effect. Carbon dioxide (CO2), methane
(CH4), and nitrous oxide (N2O) are the primary greenhouse gases in the
earth’s atmosphere.
 Scope 1 greenhouse gas emissions” are direct greenhouse gas
emissions that occur from sources that are owned or controlled by the
RE.
 Scope 2 greenhouse gas emissions” are indirect greenhouse gas
emissions from the generation of purchased or acquired electricity,
steam, heating or cooling consumed by the RE. Purchased and
acquired electricity is electricity that is purchased or otherwise brought
into the RE’s boundary. These emissions physically occur at the facility
where electricity is generated.
 Scope 3 greenhouse gas emissions” are indirect greenhouse gas
emissions (not included in Scope 2 greenhouse gas emissions) that
occur in the value chain of an entity, including both upstream and
downstream emissions.
 Transition risk” means the risks related to the process of adjustment
towards a low-carbon economy, viz. (i) Changes in climate-related
policies and regulations, (ii) Emergence of newer technologies (iii) Shift
in customers’ preferences and behavior.
Thank you