What is Asset Liability Management in Bank?

ALM is continuous process of

a. Planning
b. Organizing and
c. Controlling the asset liability volumes, maturities, rates, yield

Objectives of ALM: To protect/enhance >the solvency position of the bank

a. The net interest income (NII)

b. The net interest margin (NIM) or spread
c. Market value of net worth of the bank.

Strategy:

1. Spread Management: Maximum the spread by reducing the exposure to cyclical rates and
stabilize the earning.
2. Gap Management: Balancing the gap between interest sensitive assets and interest sensitive
liabilities by distributing the assets and liabilities into various time bands(buckets) according to
their maturity period. {Interest sensitive assests-liabilities are re priced means those are impact
by change in interest rate
3. Interest sensitivity analysis: understanding the impact of change of interest rates on bank’s
spread/net interest margin.

Risk Managed through ALM;

1. Interest rate risk

a. Gap or mismatch risk
b. Basis risk
c. Embedded option risk
d. Yield curve risk
e. Reinvestment risk
2. Liqudity Risk

Interest rate risk-Gap or mismatch risks

 Market risk take place in different forms and one of these is gap or mismatch or re-pricing risk.
 The assets and liabilities of the banks can have different maturities.
 Gap or mismatch indicates the gap between re-pricing assets and liabilities, also called rate
sensitive assets and liabilities.
 To calculate the Gap in rate sensitive assets or liabilities, the assets and liabilities are required to
be placed in different time buckets.
Rate sensitive Assets & liabilities
Rate sensitive assets and liabilities mean where the re-pricing will take place at the end of a particular
period.
 For example, in a one year time bucket, RSA/RSL will include
1. Assets or liability maturing within one year.
2. Any full or partial principal payment will be re-priced within one year.
3. In case of floating rate of interest, the bench mark will change within one year.
4. This re-pricing on the basis of different time buckets impacts the net interest income and
net interest margin, if there is gap in amount of maturing assets and liabilities.

Assets and liabilities

Type of Asset or Assets ROI Liabilities ROI

liability
Rate sensitive 500 8.00% 600 4%
Fixed rate 350 11.00% 220 6%
Non earning 150 0% 100 0%
Equity - - 80 -
Total 1000 1000
Assumed as maturing at end of one year

NII={(0.08 * 500) + (0.11 *350)} –{(0.04 * 600) + (0.06 *220)}

NII= 78.50 -37.20=41.30

NIIM= 41.30/850 =4.86%

Gap = 500-600= -100

Assets and liabilities(1% increase in ROI)

Type of Asset or Assets ROI Liabilities ROI

liability
Rate sensitive 500 9.00% 600 5%
Fixed rate 350 11.00% 220 6%
Non earning 150 0% 100 0%
Equity - - 80 -
Total 1000 1000
Assumed as maturing at end of one year

NII={(0.09 * 500) + (0.11 *350)} –{(0.05 * 600) + (0.06 *220)}

NII= 83.50 -43.20=40.30

NIIM= 40.30/850 =4.74%

Gap = 500-600= -100

Interest Rate Risk-Basis risk

 Interest rate risk as part of market risk, take place in different forms and one of these is basis
risk.
 If the assets and liabilities have same maturity, still there can be a interest rate risk in the form
of basis risk.
 The basis risk arises due to assets and liabilities priced on different basis.
 For example a 5 year, Rs 2crore floating rate term loan is funded by a 2 year, floating rate FDR
 Bench mark for TL is 5 year govt bond and for FDR the bench mark is 364 days treasury bill.

NII and NIIM before re- pricing

Type of asset or liability Before re-pricing ROI

Term Loan 200 11%
Fixed Deposit 200 0.8%
Spread 3%
NII 6 lac
NIIM 3%

NII and NIIM after re- pricing

Type of asset or liability Before re-pricing ROI

Term Loan 200 10.5%
Fixed Deposit 200 7.75%
Spread 2.75%
NII 5.5 lac
NIIM 2.75 %