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ALM and its relevance now:

For any type of industry, it is the level of raw material that is in stores which makes the
concern to run or stop. More so, for a bank where cash acts as a raw material to meet the
operational needs. Bank plays on the spread from its operation [charging more on the
assets i.e., mainly from borrowers and paying less on liabilities mainly to depositors].

Now a days, in any major manufacturing or services industry, the level of cash holding
determines the management’s efficiency level i.e., the liquidity needed for its day-to-day
operations. For, a finance industry, particularly this raw material – CASH acts as a double
edged sword i.e., if applied / used there is no guarantee that the funds which has gone out
of the system would come back as per the agreed terms & conditions, if held as it is, there
will not be any gain. On the other hand, the value of the funds would depreciate because
of the inflationary pressure. Here comes the utility of Asset Liability Management.
Generally, ALCO [Asset Liability Committee consisting of senior management of the bank]
is vested with the responsibility of overseeing the liquidity needs of the bank – how, it
should be ensured, managed, monitored etc. The operational features are left to the
various functional divisions [like: Resource Mobilisation Division for Deposit, Credit
Department for Advances, Treasury Department for funds management] of the bank of
course, after giving proper directions.

Practical uses of ALM:

1. The first and foremost use is that of determining the level of cash required for
repaying the liability obligations [after taking into considerations of inflow &
outflow of funds]. For a bank, the satisfying the level of demand is of utmost
importance – to avoid any run-on banks – the liquidity level needed for the day to
day operations – that too in the present context of 24 X 7 it is very essential.

2. If there is any surplus [inflow is more than outflow of funds], whether it could be
utilized / applied so as to generate additional income.

3. If there is deficit [outflow is more than inflow of funds], different avenues for
generating resources [not only mobilizing deposits] could be looked into for meeting
the requirement of repayment obligations in next 1 day, 15 days, 1 month, 2 months
and so on for various time buckets.
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4. Top management would know about the actions to be taken for plugging the liquidity
needs, of course, after vying the cost-benefit with respect to different avenues
for generating the funds needed i.e., to maintain the required liquidity level.

5. To facilitate better financial management, which should not be taken for granted
for, it is a ongoing process to keep a tab on the activity of the organization.

6. Gives practical orientation to Balance Sheet Management.

7. Improves quality of loan dispersed.

8. Enables to focus on fee based incomes [Non Interest Income]

9. Used in a better spread management [between asset & liability pricing]

10.Enables to control and limits exposure to different entities

11. Used to maintain required CAR [Capital Adequacy Ratio]

12. Ensures continues cash flow

13. Overall, ALM ensures required liquidity level.

14.Gives direction to management – to determine how the operations was running

previously, how it is at the present and how / where the business is leading.

Finally, it should be understood that ALM package is an instrument to limit the extent of
loss [-at the most, to the extent of the balance sheet size] and extent of profit goes to
the extent of the capability of the management to understand and interpret the outcome
of ALM analysis and its reports.

Generally, for any business – more so, in a highly cash generating one and in
financial entities, any adverse impact is immediate one and the resonance would be
felt at a later stage – conclusion of the Balance sheet for the quarter / half-year /
year end and official publication for the public consumption. Here comes the
capability of the management for cooking-up the accounts. The reason is not far
to seek, for, there is a scope for drawing Balancing Sheets – based on the purpose
for which it is needed. The categorization might be:
1. Balance sheet for Income Tax purpose
2. Balance sheet for Company Registry purpose
3. Balance sheet for Banks and Stock Exchanges
4. Real Balance sheet for internal review of the top management.
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Many a time, there is every possibility of basing on the audited balance sheet
statistics alone, even though, there might be variance to the ground realities. It is
the same case with the financial organizations and dependence would be more if it
is audited and certified with the seal of so called auditing firm with international
repute.

When economy is growing and when business of corporate is also widening, there is
no dearth of liquidity i.e., there is no problem for liquidity – there will be a
continuous inflow of funds. There is more significance to this need of liquidity
because the modern businesses have grown not only vertically but also in wide
areas. Many a business establishments have diversified – other than their core
area. If that particular non-core area is growing fast, there is no problem for the
parent company, which has established it. But, if that particular non-core area
business is under-growing strain, if the parent organisation is having surplus
liquidity, the non-core area business can be managed to the extent of financial
capability of the parent organisation. If the liquidity dries up, it not only affects
the parent organisation and also subsidiaries. More, the diversified operations,
more the problem and its impact on the business. If the organisation is operating
in financial sector, there will be more demand for the liquidity and there is no time
frame within which it can recoup the required liquidity. [A person might have
deposited the funds for 5 years but, if the funds are required, he may ask for
pre-closer of the deposit. If it is a bank, bank has to satisfy his demand otherwise
there will be run-on bank. But, if it is a private business establishment, it may
dither itself from paying to the customer. Anyhow, the liquidity risk ensues. The
message is conveyed to the market at a rapid pace in case of a financial institution
and slowly in case of others]. Same case with Satyam, where it had made diversion
of its funds to Maytas, which was in realty sector. Realty sector was not
performing and the business of Satyam was also receding because of widespread
economy downtrend globally and US in particular – from where 62 % of its business
is coming from.

Satyam and its management might be under the delusion that there business might
be ever growing and there will be continuous inflow of funds. In business cycle, the
experience is that businesses of non-essential goods are affected most rather
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than essential commodities i.e., why food industry is not affected immediately
unlike car industry.

Anyone with the knowledge of business cycle knows that neither downtrend in the
business nor growth is continuous but the impact of both, are different in the
sense that uptrend is gradual and downtrend is swift. In the downtrend of
business, first, liquidity dries up and to satisfy the liquidity needs, there might be
distress sales. In such an eventuality, the experience is that purchaser might
postpone his decision expecting further fall in prices. And this may be a
continuous one till settling of his expected price. But, the plight of the distress
seller knows no bounds. Owing to such consequences, business establishments may
resort for one or other unethical attempts in sailing over the testing times. If the
firm has not managed the business in a professional way, tiding over the immediate
liquidity needs might lead to unethical means. They would be sucked-in to the
sludge at the earliest opportunity or little longer, if their luck holds good. It is for
the system and prevailing laws, regulations and loopholes, if any, which may book
the culprits or look the other way.

In any economy, financial sector is the nerve centre for the sustenance of good
business environment. Banking plays an important role in development of economy.
Because of the global downtrend, and after the failure of big financial entities like
Lehman Brothers, etc., G 20 countries agreed that banks should not be allowed to
fail, for, Banking is a vital link in the financial chain for creation and continuance
of liquidity. If this link broken, there would be havoc in the economy because of
the rippling effect.

Coming to the Corporate Governance, one may think that it is the look of Balance
Sheet. For many, it is the glossy Balance Sheet and flashy office which conveys to
the outside world about the existence of the company – “ appearances are quite
deceptive”. Often, road side vendor is of the opinion the person wearing good
clothes is his impending purchaser! And vice versa is also true to a larger extent.
Often it is the gullible public who is carried away by such gimmicks.

Satyam – a classic case?

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Satyam had won Golden Peacock Award for best practice in Corporate Governance
in 2008 and many such awards and accolades since its inception. Over the years,
hours of TV analysis & reams of paper have been spent on the performance of the
company informing the laymen in detail about its performance and consequent
wealth creation and benefits to the society at large.

Initially, when the inflow was increasing, the company diverted the funds to other
activities in subsidiary / sister companies – often in un related areas – like: real
estate concern – Maytas. Earlier, real estate sector was booming and so also the
parent company – Satyam, which is in software sector. So long as the going was
good, both enjoyed and floated along the tide. For any outflow needs, the company
relied on the constant inflows, which it took as granted. This happens in any
company which plays its main inflow channel to plug the outflow needs. But, the
problem of liquidity ensues if it has not parked its earlier inflows properly and
ensured its return to the system at the required time. The problem multiplied in
case of Satyam for its inflow through software either stopped or got erratic.
More than 60 % of its business was from US and the economy was sliding day by
day. Further, because of downtrend in the domestic realty sector as well, the
diverted funds to Maytas got evaporated very fast. Consequently, the parent
company suffered heavily and faced dire necessity of liquidity. At the same time,
it wanted to give a good picture to the outside world to sustain the big picture.
Hence, all sorts of manipulation started. When the situation was no longer tenable,
both hands were raised resulting in the chaos.

Some questions arises in the minds of public. First whether “Duty of Care“ was
exercised? The answer is unambiguous negative response. The public / share
holders / strategic investors / regulators – all dithered in the discharge of the
respective responsibility. Even though the regulator and mandatory bodies stand
apart from general public but, as inherent part of the society owing to their
accessibility to the classified information they have got unassailable responsibility
to protect the well being of the society’s interests. Secondly, whether independent
directors owed their “Duty of Loyalty” to whom? - To protect the interest of the
company or society? The answer is once again a big negative. Those, who have
observed the corporate practices will vouchsafe that often, chairman prefers to
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fill the board with “yes men / henchmen” with a tacit understanding. Law permits
the lifting of “corporate veil” in the event of any suspicion of wrong doings by the
company. It is a moot point whether anytime it was exercised and to what extent
and consequences?

From the earlier days of corporate establishments and practices, the failed
entities were vouchsafed by auditing firms and guaranteed by promoters. If the
auditing firm is of an international brand, the credibility may be even stronger!
See, What M/S Price Waterhouse Coopers have done to Satyam [Arthur Anderson
to Enron] giving a jolt to the confidence reposed by the public. The list is
exhaustive and fast growing by day. When the goings are strong, they reaped the
benefits and in many cases they virtually lynched the institutions afterwards.
Finally, when it is no longer feasible for them either they have filed for bankruptcy
or run away from the scene. It is same with Mardoff, Satyam or some one else.
The players, acts, screenplays, tactics differs from time to time, business to
business and country to country.

It is the liquidity concern that gives the first indication that the firm is having a
problem in meeting its obligations. This happens in all going concerns and the
impact is very perceptible in case of a financial institution. If the liquidity risk is
not taken care within the stipulated time might lead to interest rate risk, credit
risk and so on. There is no compartmentalization of any risk. One type of risk
might lead to another risk and this varies from organization to organization and
from sector to sector. Once again, there is no water tight treatment. It is like an
escaped endemic bacteria and the effect is often disastrous resulting in
widespread devastation. i.e., why liquidity risk is given the prime importance by
firms and is plugged immediately as soon as any signal has surfaced.

In this, the society’s role is also important. Now, there is selective leak of
information about how the promoters of Satyam earlier deceived APSFC as far as
back in early 1986 - 90 and then demat scam ensued in 2002. This type of
deceiving the system is almost prevalent in all the areas [the criminalization of
politics etc.,]. If such people come together they will seek help from their
brethren and scratch their backs mutually hoodwinking the public at large. This
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will continue till their lady luck smiles. Hence, it is for the public to be vigil and
apex / statutory bodies like SEBI etc to take actions against the errant companies.

Warning signals emanating regarding liquidity should be taken in all seriousness and
corrected at the earliest opportunity, otherwise it is just like escaping of a vicious gas on
which no-one has control and spill-over effect would be disastrous for the business
environment. Law pertaining to “Floatation Principle” can be remembered here. Only 1/9th
portion of floating iceberg is visible. Likewise, Liquidity problem is perceptible to the
outside world bit by bit and finally it assumes gigantic proportions leading to
uncontrollable consequences. The liquidity crises might lead to more complications if the
organization is unethical in its practices. Hence, it is very essential to perceive the
liquidity concerns and take corrective timely actions.

By sureshan

sureshan_nag@rediff.com