ASSET & LIABILITY MANAGEMENT IN COMMERCIAL BANKS

InstructorBlent enver [email protected]

ALM [email protected]

ALM
Assett

Liability

Asset Management
ALM [email protected]

Liability Management
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ASSET & LIABILITY MANAGEMENT (ALM)

DEFINITION ALM is continuously arranging and rearranging the assets and liabilities of the bank without infringing the liquidity and safety of the bank and with the purpose of maximizing the banks profits.
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LIQUIDITY
The ability of a bank to fulfill its obligations, and after doing so having enough cash left to do its normal daily banking business.

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SAFETY
The ability of a banks Share Holders Equity (SHI) to absorb the future possible losses that may arise and after doing so having enough SHI left to run the bank and to comply with the minimum Capital Requirements.
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Capital protects your bank in rainy days!..

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ALM DEVELPOMENT
1950s
ASSET MNG. LOAN PRODUCTS

1960s
LIABILITY MNG. DEPOSIT PRODUCTS
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1970s
ASSET & LIABILITY MNG. LOAN & DEPOSIT BOTH
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Internet Personal Training Office Automation Computerization Management Reorganization GAAP SC of Accounts Deregulations
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Yesterday

Tomorrow

Arena

Services Organizatio n & Reporting Data

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NEW DEVOPLEPMENTS
1. Deregulation of Interest Rates 2. Deregulation of Foreign Exchange Operations 3. Changes in Laws and Regulations 4. Increase in Deposit Interest Rates
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NEW DEVELOPMENTS
5. Increase in Deposit Interest Rates 6. Change in Deposit Characteristics Increase in Term-Deposits Decrease in Demand-Deposits Increase in Short Terms
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NEW DEVELOPMENTS
7. Increase in Personnel Expenses 8. Increase in Operating Expenses 9. Increase in Technology Investments 10. Frequent Changes in Interest Rates 11. Increase in Share Capital Requirements
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NEW DEVELOPMENTS
12. Change in Asset Structure Increase in Government Bonds Increase in Treasury Bills Increase in Foreign Exch. Loans Increase in Short Term Loans Increase in Non-Performing Loans Increase in Consumer Loans
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NEW DEVELOPMENTS
13. Decrease in S/H Equity Growth 14. Increase in Customer Expectations 15. New Service Points Small Branches ATM and POS Telephone and Internet Banking 16. 24 Hours 365 Days Banking
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1950
SALES FORCE

1970

1980
RELATIONSHIP MANAGEMENT

1990

2000

BRANCH CALL CENTER OUTBOUND DIRECT MAIL CREDIT CARD ATM TELEPHONE BANKING DEB T CARD

IN-STORE BRANCH

SPACE SHARING

FRANCHISE BRANCHES
REMOTE RELATIONSHIP MANAGEMENT

CALL CENTER INBOUND

MAIL

DATABASE MARKETING SMART CARD INTERNET ATM SCREEN PHONES INTERACTIVE 15 TV VIDEO KIOSK

KIOSK

Kaynak: A.T.Kearney

PC INTERNET ALM BANKING BANKING [email protected]

FINANCIAL STATEMENTS
1. BALANCE SHEET 2. STATEMENT OF INCOME 3. STATEMENT OF SHAREHOLDERS EQUITY 4. SOURCES & USES OF FUNDS STATEMENT
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Balance Sheet
Assets
Loans

Income Statement
Interest Income
Deposits

Liabilities

Interest
Earning Assests

Interest
Bearing Treasury Bills Liabiliti es

Interest Expences
Debt

Net Interest Income

NonInterest Earning Assests NonInterest Bearing Liabiliti Share Holders es Equity

Total Assets

Total Liabilities ALM

[email protected]

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Balance Sheet
Assets Loans 100
Interest Earning Assests

Income Statement
Interest Income Deposits
120

Liabilities

36
Interest Expence

Treasury Bills 80

Interest Bearing Liabiliti es

Debt 60

Interest Rate Assets =

%20
Interest Rate Liabiliti es =

9
Net Interest Income

NonInterest Earnin g Assests

Non35
Interest Bearing Liabiliti Share Holders Equity es

30 35

27

%5
18

Total Assets

Total Liabilities

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BALANCE SHEET SHOWS

The Financial Position of a Bank As at a specific date. As of Dec. 31,1998

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BALANCE SHEET EQUATION

ASSETS 100 = Equals = = 100

LIABILITIES + Plus SHAREHOLDERS EQUITY

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ASSET CLASSIFICATION

TOTAL ASSETS
NON INTEREST EARNING ASSETS INTEREST EARNING ASSETS

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LIABILITY CLASSIFICATION
TOTAL LIABILITIES
INTEREST BEARING LIABILITIES NON INTEREST BEARING LIABILITIES

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BALANCE SHEET Assets

Liquid Assets Loans Marketable Securities Investment Securities Fixed Assets Accrued Interest Other Assets Total Assets
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150 400 200 50 100 70 80 1050

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BALANCE SHEET Liabilities

Deposits Bank Borrowings Accrued Expenses Other Liabilities Bonds Issued Shareholders Equity Total Liabilities & S/HE
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400 150 100 80 70 250 1050

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SHAREHOLDERS EQUITY
Share Capital Legal Reserves Retained Earnings Revaluation Surplus Share Premiums Net Income Total S/H Equity
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100 30 50 20 10 40 250
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BALANCE SHEET DOES NOT SHOW

Interest Rates Interest Sensitivity Due Dates Foreign Currency breakdown Collateral

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STATEMENT OF INCOME SHOWS

The results of operations of a bank. For the period between two dates. For the year ended Dec. 31 , 1998

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NET PROFIT
NET PROFIT
TOTAL INCOME TOTAL EXPENSE
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TOTAL INCOME
TOTAL INCOME
NET INTEREST INCOME NET NON-INTEREST INCOME
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NET INTEREST INCOME

NET INTEREST INCOME
INTEREST INTEREST INCOME EXPENSE (+) (-)
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interest income

net interest income net interest income

interest expense

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time

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NET INTEREST INCOME

NET INTEREST INCOME INTEREST INCOME P/L
INTEREST EARNING ASSETS B/S

INTEREST EXPENSE P/L INTEREST BEARING LIABILITIES B/S

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NET NON-INTEREST NONINCOME

NET NON-INTEREST INCOME
NON NON INTEREST INTEREST INCOME EXPENCE (+) (-)
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STATEMENT OF INCOME
Interest Income Interest Expense Net I.Income Non Interest Income Operating Expenses Pre-Tax Profit Tax Provision Net Income
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1000 (700) 300 220 (450) 70 (30) 40

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ANALYSIS OF PROFIT

NET PROFIT
(NP) PROFIT FROM BANKING OPERATIONS (NET OPERATING INCOME) (NOI) PROFIT FROM EXTRAORDINARY TRANSACTIONS (PEXT) PROFIT FROM SECURITY TRANNSACTIONS (PST)

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BANKING RISKS
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BANKING RISKS

C AMEL
A M E L
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CAMEL
Capital
Adequacy

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AMEL

Asset
Quality

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CA

MEL

Management Quality

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CAM

EL

Earnings
Efficiency

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CAME

Liquidity
Risk

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CAMEL RISKS
Capital Adequacy Asset Quality Management Earnings Liquidity
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BANKING RISKS
1.2.3.4.5.CAMEL 6. Credit Risk 7. Interest Rate Risk 8. Interest Rate Sensitivity Risk 9. Foreign Exchange Availability Risk 10. F/X Position Risk
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BANKING RISKS
11. Accounting & Reporting Risk 12. Computer Risk 13. Capital Market Operations Risk 14. Money Market Operations Risk 15. Country (Sovereign) Risk 16. Pricing Risk 17. Market Risk
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BANKING RISKS
18. Theft Risk 19. Fraud & Defalcations Risk 20. Natural Disasters 21. Strategic Risk 22. Fiduciary Risk 23. Transaction Risk 24. Regulatory/Compliance
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BANKING RISKS
25. Reputation Risk 26. Large Loans/Deposits Risk 27. Concentration Risk

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RATIO ANALYSIS
Numerator ______________________ Denominator
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RATIO ANALYSIS

Balance Sheet __________________ Balance Sheet

Income Statement ________________ Balance Sheet

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RATIO ANALYSIS

What is the

What is the

LEVEL ?

TREND ?

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RATIO ANALYSIS
1. Capital Adequacy 2. Asset Quality 3. Management 4. Earnings & Efficiency 5. Liquidity

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RATIO ANALISIS CAPITAL ADEQUACY

The Capital of a Bank protects the Bank against unexpected future losses.

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RATIO ANALYSIS CAPITAL ADEQUACY

1. Shareholders Equity -----------------------------------Total Assets

The ability of the present Capital to support the further growth of Assets
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RATIO ANALYSIS CAPITAL ADEQUACY

2. Shareholders Equity -----------------------------------Risk Weighted Assets

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RATIO ANALYSIS CAPITAL ADEQUACY

3. Shareholders Equity -----------------------------------Risk Weighted Assets + RW Contingent Liabilities
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RATIO ANALYSIS CAPITAL ADEQUACY

4. Total Debt -----------------------------------Shareholders Equity

The ability to raise additional Debt Capital

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RATIO ANALYSIS CAPITAL ADEQUACY

5. Financial Leverage : Total Assets -----------------------------------Shareholders Equity

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RATIO ANALYSIS CAPITAL ADEQUACY

6. Capital Formation Rate : Retained Net Income (RNI) ------------------------------------------------- Average Shareholders Equity RNI = Net Income - Dividends to be paid The internal growth of Equity Capital
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RATIO ANALISIS ASSET QUALITY

1. Loans -------------------------------Total Assets

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RATIO ANALISIS ASSET QUALITY

2. Non Performing Loans = a) Loans past due more than 90 days b) Loans not accruing interest c) Loans with low interest rates d) Loans on which repayment terms have been renegotiated.
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RATIO ANALISIS ASSET QUALITY

3. Non Performing Loans ------------------------------------Total Loans

Indicates how much of the loan portfolio is non performing.

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RATIO ANALISIS ASSET QUALITY

4. Reserves for Non Performing Loans --------------------------------------------- Non Performing Loans Indicates the ability of the loan loss reserve to absorb potential losses from currently non performing loans.
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RATIO ANALISIS ASSET QUALITY

5. Loan Loss Provision ------------------------------------Average Loans

Shows current income reduction in anticipation of loan losses.

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RATIO ANALISIS ASSET QUALITY

6. Net Charge - Offs ------------------------------------Average Loans

Shows current income reduction in anticipation of loan losses.

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RATIO ANALISIS ASSET QUALITY

7. Interest Earning Assets ------------------------------------------------Total Assets

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RATIO ANALISIS ASSET QUALITY

8. Non Interest Earning Assets ------------------------------------------------Total Assets

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RATIO ANALISIS EARNINGS & EFFICIENCY

A Bank with no profit is like a human body with no blood.

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THE PRIMACY OF EARNINGS

A bank can not sustain itself long without a positive cash flow. Earnings are essential to : 1.Absorb loan losses 2.Finance internal growth of capital 3.Attract investors to supply capital
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RATIO ANALISIS EARNINGS & EFFICIENCY

1. Return on Assets ( ROA )

Net Income -------------------------------------------Total Average Assets

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RATIO ANALISIS EARNINGS & EFFICIENCY

2. Return on Equity ( ROE )

Net Income -------------------------------------------Average Shareholders Equity

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RATIO ANALISIS EARNINGS & EFFICIENCY

3. Return on Equity ( ROE ) ROE = ROA * Equity Multiplier

ROE = ( NI / AST ) * ( AST / SHEQ )

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RATIO ANALISIS EARNINGS & EFFICIENCY

4.

Interest Income -------------------------------------------Average Interest Earning Assets

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RATIO ANALISIS EARNINGS & EFFICIENCY

5.

Net Interest Income -------------------------------------------Average Total Assets

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RATIO ANALISIS EARNINGS & EFFICIENCY

6.

Interest Income on Loans -------------------------------------------Average Total Loans

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RATIO ANALISIS EARNINGS & EFFICIENCY

7.

Total Operating Expense ------------------------------------------------ Total Operating Income

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RATIO ANALISIS EARNINGS & EFFICIENCY

8. Efficiency Ratio

Non Interest Expense --------------------------------------------------- Net Interest Income + Fees Commissions

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RATIO ANALISIS EARNINGS & EFFICIENCY

9. Break Even Ratio

Total Expenses - Non Interest Income --------------------------------------------------- Total Average Interest Earning Assets
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RATIO ANALISIS EARNINGS & EFFICIENCY

10. Net Free Funds Ratio Non Paying Liabilities - Non Earning Assets ------------------------------------------------- Interest Earning Assets

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RATIO ANALISIS EARNINGS & EFFICIENCY

11. Interest Rate Sensitivity Gap : Interest Rate Sensitive Assets ( minus ) Interest Rate Sensitive Liabilities Shows the net amount to be effected by the future change of interest rates in the market
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RATIO ANALISIS EARNINGS & EFFICIENCY

12. Interest Rate Sensitivity Gap Ratio : Interest Rate Sensitive Assets ------------------------------------------------Interest Rate Sensitive Liabilities

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RATIO ANALYSIS LIQUIDITY

Inadequate Liquidity of a Bank may cause an accident similar to an airplane crash !

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RATIO ANALISIS LIQUIDITY

1. Loans ------------------------Deposits

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RATIO ANALISIS LIQUIDITY

2. Liquid Assets ------------------------Deposits

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RATIO ANALISIS LIQUIDITY

3. Liquid Assets -------------------------------Deposits + Borrowings

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RATIO ANALISIS LIQUIDITY

4. Assets Due for the Period ----------------------------------------Liabilities Due for the Period

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RATIO ANALISIS LIQUIDITY

5. Net Large Liabilities ---------------------------------------- Net Earning Assets Both numerator & denominator are net of short-term assets. Measures the extent to which net earning assets would be effected by the loss of a banks large liabilities.
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RATIO ANALISIS LIQUIDITY

6. Liquid Assets ----------------------------------------Large Liabilities

Measures the assets readily available to cover a loss of large liabilities.

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RATIO ANALISIS LIQUIDITY

7. Core Deposits ----------------------------------------Earning Assets

Indicates the extend to which earning assets are funded by those deposits considered stable and not subject to interest rate disintermediation.
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RATIO ANALISIS LIQUIDITY

8. Brokered Deposits ----------------------------------------Earning Assets

Measures the extent to which a bank is funding assets with high-priced and volatile brokered deposits.
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MATURITY ANALISIS
Days Cash Loans 0-10 100 200 300 Deposit 400 Borrow 150 550 10-30 200 500 700 300 200 500 30-60 300 200 500 800 200 1000 60-90 50 100 150 20 30 50
90

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MATURITY ANALYSIS
Days Asset Liab 0-10 100 300 10-30 500 200 30-60 1000 1500 -500 +300
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60-90 2000 700

Short - -200 Long +

1300
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OFF - BALANCE SHEET RISK

1. Loan Commitments ----------------------------------------Average Assets

Shows the extent of a banks obligation to make loans.

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OFF - BALANCE SHEET RISK

2.Contingent Liabilities & Commitments --------------------------------------------------- Average Assets Shows the extent of a banks commitments & contingent liabilities.
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I manage

Assets!
% rates, due dates...

RISKS

I manage

Liabilities
% rates, due dates...

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ASSET & LIABILITY MATCH

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A & L Match
Amounts Currency Due Dates Interest Rates Interest Sensitivity Volatility
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Foreign Exchange Position

USA $ Short Position $Liabilities>$Assets

USA $ Long Position $Assets>$Liabilities

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F/X Position Strategy

Increasing F/X Rates Long Position YES Short Position NO
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Decreasing F/X Rates

NO

YES
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Interest Rate Sensitivity

Interest Rate Sensitive Assets/Liabilities IRSA/L are such assets and Liabilities whose interest rates will change before their due dates when there is a change in market interest rates.

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Interest Rate Sensitivity

Interest Rate Sensitive Assets & Liabilities Interest Rate Non-Sensitive Assets & Liabilities

VARIABLE RATES

FIXED RATES

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Interest Rate Sensitivity Gap

Positive Gap IRSA>IRSL IRS GAP = (IRSA IRSL) Negative Gap IRSL>IRSA
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Interest Rate Sensitivity Strategy

Interest Rates Will Increase Positive IRS GAP Negative IRS GAP Interest Rates Will Decrease

YES

NO

NO
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YES
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INTEREST MARGIN
INCREASING THE

INTEREST MARGIN %
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INCREASING INTEREST MARGIN

Interest Income..200 Interest Expense( 50 ) --------- INTEREST MARGIN.. 150 ----------

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$ interest income +

net interest income net interest income interest expense

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time

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INCREASING THE INTEREST MARGIN

BANK STRATEGY TO

INCREASE THE INTEREST MARGIN

INCREASE SIZE

CHANGE INTEREST SPREAD

ALTER ASSET/LIABILITY MIX

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INCREASING THE INTEREST MARGIN

BANK STRATEGY ACTION 1.Expand Assets 2.Reduce Fixed Assets 3.Increase Equity Base

Increase Size

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INCREASE THE INTEREST MARGIN

BANK STRATEGY ACTION 1.Re-Price Asset Portfolio 2.Re-Price Liability Portfolio

Change Interest Spread

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INCREASE THE INTEREST MARGIN

BANK STRATEGY ACTION 1.Plan Taxes 2.Reduce Liquidity 3.Increase Aggressiveness 4.Change Asset Yield Sensitivity 5.Change Liability Cost Sensitivity
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Alter Asset / Liability Mix

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INCREASE THE INTEREST MARGIN

BANK STRATEGY Increase Size ACTION Expand Assets IMPLEMENTATION 1.Offer new Products and Services 2.New Loans/Deposits 2.Open new Branches 3.Expand Promotion Budget 4.Reduce Interest Spread
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EXPAND ASSETS
REPERCUSSION 1.Increase operating Expenses 2.Need for Capital 3.F/A Regulations 4.Decrease Capital Ratio 5.Reduce ROA IMPLEMENTATION 1.Offer new Products and Services 2.New Loans/Deposits 3.Open new Branches 4.Expand Promotion Budget 5.Reduce Interest Spread
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INCREASE THE INTEREST MARGIN

BANK STRATEGY Increase Size ACTION Increase Equity Base IMPLEMENTATION 1.Reduce Dividend pay out 2.Offer Dividend reinvestment 3.Sell Stock 4.Establish Employee Stock Ownership PL
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INCREASE EQUITY BASE

REPERCUSSIONS 1.Hurt shareholders 2.Double taxation S/H 3.Reduce ability to leverage ROA, dilution of earnings 4.Continued Employee Expectations IMPLEMENTATION 1.Reduce Dividend pay out 2.Offer Dividend reinvestment 3.Sell Stock 4.Establish Employee Stock Ownership PL
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INCREASE INTEREST MARGIN

BANK STRATEGY Change Interest Spread ACTION Re-price Portfolio IMPLEMENTATION 1.Increase rates on Loans 2.Compound return more frequently 3.Reduce rates on Deposits 4.Compound cost less frequently
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REPRICE PORTFOLIO
REPERCUSSIONS 1.Lose business Loan quality decrease 2.Increase operations Client dissatisfaction 3.Lose business Liquidity problem 4.Increase operations Client dissatisfaction IMPLEMENTATION 1.Increase rates on Loans 2.Compound return more frequently 3.Reduce rates on Deposits 4.Compound cost less frequently
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INCREASE INTEREST MARGIN

IMPLEMENTATION BANK STRATEGY Alter Asset/Liability Mix 1.Minimize cash 2.Minimize due from 3.Sell Securities & Bonds 4.Increase short term Deposits
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ACTION Reduce Liquidity

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REDUCE LIQUIDITY
REPERCUSSION 1.Liquidity Risk 2.Lose correspondent 3.Incur book losses 4.Increase volatility of deposits IMPLEMENTATION 1.Minimize cash 2.Minimize due from 3.Sell Securities & Bonds 4.Increase short term Deposits
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INCREASE INTEREST MARGIN

BANK STRATEGY Alter Asset/Liability Mix IMPLEMENTATION 1.Increase loan/deposit ratio 2.Increase highest yielding loans 3.Increase highest yielding securities

ACTION Increase Aggressiveness

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INCREASE AGGRESSIVENESS
REPERCUSSION 1.Increase need for capital 2.Increase loan losses 3.Increase security losses IMPLEMENTATION 1.Increase loan/deposit ratio 2.Increase highest yielding loans 3.Increase highest yielding securities

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INCREASE INTEREST MARGIN

BANK STRATEGY Alter Asset/Liability Mix IMPLEMENTATION 1.Increase S/T & variable rate assets if rates will increase 2.Decrease S/T & variable rate assets if rates will decrease

ACTION Change Asset Yield Sensitivity

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CHANGE ASSET YIELD SENSITIVITY

REPERCUSSION 1.Wrong estimate of interest movement, thereby reducing interest spread IMPLEMENTATION 1.Increase S/T & variable rate assets if rates will increase 2.Decrease S/T & variable rate assets if rates will decrease

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INCREASE INTEREST MARGIN

BANK STRATEGY Alter Asset/Liability Mix IMPLEMENTATION 1.Decrease S/T & variable rate liabilities if rates will increase 2.Increase S/T & variable rate liabilities if rates will decrease

ACTION Change Liability Cost Sensitivity

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CHANGE LIABILITY COST SENSITIVITY

REPERCUSSION 1.Wrong estimate of interest movement, thereby reducing interest spread IMPLEMENTATION 1.Decrease S/T & variable rate liabilities if rates will increase 2.Increase S/T & variable rate liabilities if rates will decrease

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