ASSET LIABILITY

MANAGEMENT (ALM)

History of bank failures in US

2012 - 23

2011 - 89

2010 - 157

2009 - 140

Components of a
Bank Balance sheet
Liabilities

Assets

1.
2.
3.
4.
5.

1.

Capital
Reserve & Surplus
Deposits
Borrowings
Other Liabilities

2.
3.
4.
5.
6.

Cash & Balances with

RBI
Bal. With Banks &
Money at Call and
Short Notices
Investments
Advances
Fixed Assets
Other Assets

Contingent Liabilities

Business Risks

Operational Risk
Credit Risk
Market Risk
Liquidity Risk
Interest Rate Risk
Foreign Exchange Risk
Information Risk

What is ALM ?...

Concerned with
management

strategic

Balance

Sheet

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

What is ALM ?...contd..

Periodic monitoring of risk exposures

involving collecting and analysing information

Ability to anticipate, forecast and act so as to

structure banks business to profit

Altering A & L portfolio in a dynamic way to

manage risks
Involves judgement and decision making

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

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

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

Why ALM ?.. Contd..

Increased level of awareness among

top management
- market risks,
interest rate movements

Intense competition for business involving

both assets and liabilities

Why ALM ?.. Contd..

Regulatory initiatives

International initiative Basle Committee

Thus, a call for structured

comprehensive
measures
institutionalising
an
integrated
management system

and
for
risk

Overall Objective..

The central theme of (ALM) is the

management of a banks 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

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

RBI / NABARD Guidelines on ALM

NABARD guidelines on Risk

Systems in Banks April 2005

Management

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 .

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

RBI / NABARD Guidelines on ALM

Once system stabilises, bank gain

experienceswtch
over
to
sophisticated
computerised
techniques Duration Gap analysis,
Simulation & VaR for Interest rate
risk management

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 reportspresent status, progress made & action
plan for future

ALM Process- Three pillars

ALM Information System

ALM Organisation

Management Information System

Information availability, accuracy, adequacy and
expediency

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

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

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

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

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

ALCO-responsibilities

Deciding the business strategy of

the bank, consistent with the
interest rate view, budget and predetermined
risk
management
objectives

Determining the desired maturity

profile and mix of assets and liabilities

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

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

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

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

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 banks
deployment requirements

The cost of liabilities in terms of interest

cost is least and is reduced from time to
time

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

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

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

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

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

Statement of structural liquidity

Time buckets for maturity profile

i.
ii.
iii.
iv.
v.
vi.
vii.
viii.

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

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)

Estimation of short term dynamic liquidity

Interest Rate Risk

Interest rate risk is the risk where changes

in the market interest rates might adversely
affect a banks financial condition

Immediate impact would be on banks

earnings by changing its NII

Long tem impact of changing interest rates

would be on banks Net Worth

Interest rate risk is measured in terms of

change in NII

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

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

Interest rate sensitivity - Reporting format

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

Rate sensitive assets and liabilities

Interest Rate Risk-Gap in time buckets

The gaps may be identified in the following time

buckets

i.

1-28 days

ii.

29 days and upto 3 months

iii.

Over 3 months and upto 6 months

iv.

Over 6 months and upto 1 year

v.

Over 1 year and upto 3 years

vi.

Over 3 years and upto 5 years

vii.

Over 5 years

viii.

Non-sensitive

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

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

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

Thank you