Asset Liability Management

- Barkha Jadwani

Asset Liability Management (ALM)

Asset Liability Management is concerned with strategic balance sheet management involving risks caused by changes in interest rates, exchange rate, credit risk and the liquidity position of bank.(icel) (vmm r sql)Aim of ALM is to manage the volume, mix, maturity, rate, sensitivity, quality and liquidity of assets and liabilities as a whole to attain a predetermined acceptable risk/reward ratio. It also aims to generate adequate/stable earnings and to steadily build an organisations equity over time, while taking reasonable and measured risks. One of the most important risk management function

 IT is a integrated strategic mangerial approach of managing total balance sheet dynamics having regard to its size and quality in such a way that the net earning is maximised with having overall risk prefernce of the bank. It is concerned with managing NIM to ensure that its level and riskiness are compatible . It is essential for surviva l of bank in deregulated environment .

Why ALM
Globalisation of financial markets. Deregulation of Interest Rates. Multi-currency Balance Sheet. Product Innovation Regulatory environment To minimize the Liquidity Risk and Market Risk Narrowing NII / NIM

D GN MRTP

Liquidity Risk Management

Tracked through maturity or cash flow mismatches in various maturity buckets viz 1 to 14 days, 15 to 28 days, 29 days to 3 months.. The difference between sources of funds (inflows) and uses of funds (outflows) in specific time bands is known as liquidity gap Liquidity gap may be positive or negative As per current RBI guidelines, the prudential liquidity gap limits for negative gaps in time bucket next day, 2-7 days, 8-14 days and 15 - 28 days have been fixed at 5, 10, 15 and 20 per cent of the cash outflows in the respective time-buckets. For cumulative negative gaps across all time-buckets, banks are expected to fix their own prudential limits, with the approval of the Board / ALCO.

Liquidity Risk Management

Statement of Structural Liquidity and Short Term Dynamic liquidity Banks are required to provide in their liquidity management policy, contingency measures to meet shortfall in liquidity. Contingency measures may include stand-by credit lines from other banks, liquid investments and maintenance of adequate securities (in excess of minimum requirement) to facilitate borrowing under LAF/under CBLO Bank management should measure not only the liquidity positions of banks on an on-going basis but also examine how liquidity requirements are likely to evolve under crisis scenarios

MATURITY PROFILE-LIQUIDITY
Outflows Capital, Reserves & Surplus Deposits Borrowings and bonds Other liabilities Contingent liabilities Inflows Cash Balance with RBI Balance with other banks Investments Advances Fixed Assets

Interest Rate Risk (IRR)

Changes in interest rates impact a banks earnings (i.e. reported profits) through changes in its Net Interest Income (NII). Changes in interest rates also impact a banks Market Value of Equity (MVE) or Net Worth through changes in the economic value of its rate sensitive assets, liabilities and off-balance sheet positions.

Earnings Perspective Traditional Gap Analysis

The focus of the TGA is to measure the level of a banks exposure to interest rate risk in terms of sensitivity of its NII to interest rate movements It involves bucketing of all RSA and RSL and off balance sheet items as per residual maturity/ re-pricing date in various time bands and computing Earnings at Risk (EaR) i.e. loss of income under different interest rate scenarios over a time horizon of one year.

Interest Rate Risk (IRR) Traditional Gap Analysis

An asset or liability is normally classified as rate sensitive if: i. within the time interval under consideration, there is a cash flow; ii. the interest rate resets/reprices contractually during the interval; iii. RBI changes the interest rates in cases where interest rates are administered; iv. it is contractually pre-payable or withdrawable before the stated maturities. The Gap is the difference between Rate Sensitive Assets (RSA) and Rate Sensitive Liabilities (RSL) for each time bucket. The positive Gap indicates that it has more RSAs than RSLs whereas the negative Gap indicates that it has more RSLs. Even if maturity dates are same, there is interest rate risk which can affects NII For the interest rate gaps in various time buckets, the prudential limits will have to be fixed by the Board / ALCO

IMPACT ON NII

Interest Rate Risk (IRR) Economic Value Perspective DGA

The focus of the DGA is to measure the level of a banks exposure to interest rate risk in terms of sensitivity of Market Value of its Equity (MVE) to interest rate movements. The DGA involves bucketing of all RSA and RSL as per residual maturity/ re-pricing dates in various time bands and computing the Modified Duration Gap (MDG). The RSA and RSL include the rate sensitive off balance sheet asset and liabilities. MDG can be used to evaluate the impact on the MVE of the bank under different interest rate scenarios. MDG = [MDA-(MDL*RSL/RSA)]

Role of Treasury in ALM

o Market risk is identified and monitored through Treasury o As the asset liability mismatches cannot be ironed out physically, treasury uses derivatives to bridge the liquidity and rate sensitivity gaps o Derivatives can be used to hedge individual transactions or aggregate risks as reflected in the asset-liability mismatches o As the markets develop credit products are being substituted by treasury products o Credit derivatives help diversify the credit and use the capital more efficiently

Transfer Pricing

o Treasury notionally buys and sells the deposits and loans of the bank and the price at which the treasury buys and sells forms the basis for assessing profitability of banking activity o Once transfer pricing is implemented, treasury takes care of the liquidity and interest rate risks of the entire bank, and profits of department reflect only the credit risk

ALM process
The ALM process rests on three pillars: ALM information systems => Management Information System => Information availability, accuracy, adequacy and expediency ALM organisation => Structure and responsibilities => Level of top management involvement ALM process => Risk parameters => Risk identification => Risk measurement => Risk management => Risk policies and tolerance levels.

ALCO
The Asset - Liability Committee (ALCO) consisting of the bank's senior management including CEO is responsible for ensuring adherence to the limits set by the Board as well as for deciding the business strategy of the bank (on the assets and liabilities sides) in line with the bank's budget and decided risk management objectives. The ALCO is a decision making unit responsible for balance sheet planning from risk - return perspective including the strategic management of interest rate and liquidity risks. It will have to develop a view on future direction of interest rate movements and decide on a funding mix between fixed vs floating rate funds, wholesale vs retail deposits, money market vs capital market funding, domestic vs foreign currency funding, etc. Individual banks will have to decide the frequency for holding their ALCO meetings.