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2 One of the most important risk-managemnet
functions in bank is Asset Liability
Management.
2 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.
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At the governance level, boards need to recognise liquidity risk as the ultimate killer. This means
a board needs to clearly articulate the risk tolerance of the organization and subject the balance
sheet to regular scrutiny. Guiding principles need to be included as part of this process. The
following 5 principles are valuable:

1. Diversify sources and term of funding ± concentration and contagion were the killers in the
recent crisis.
Ô. Identify, measure, monitor and control ± it is still surprising that many banks do not fully
understand the composition of their balance sheet to a sufficient level of detail to allow for
management of the risks.
3. Understand the interaction between liquidity and other risks ± e.g. basis risk ± the flow on
impact of an event in one area can be devastating to others.
4. Establish both tactical and strategic liquidity management platforms ± keep a focus on both
the forest and the trees.
5. Establish detailed contingency plans and stress test under multiple scenarios regularly.
 ºurpose and objectives of ALM
A Review the interest rate structure and compare the
same to the interest/product pricing of both assets
and liabilities.
A Examine the loan and investment portfolios in the
light of the foreign exchange risk and liquidity
risk that might arise.
A Examine the credit risk and contingency risk that
may originate either due to rate fluctuations or
otherwise and assess the quality of assets.
A Review,the actual performance against the
projections made and analyse the reasons for
any effect on spreads.
A Aim is to stabilise the short-term profits,long-
term earnings and long-term substance of the
bank.The parameters that are selected for the
purpose of stabilising asset liability
management of banks are:
-Net Interest Income(NII)
-Net Interest Margin(NIM)
-Economic Equity Ratio
2 Net Interest Income-
Interest Income-Interest Expenses.

2 Net Interest Margin-

Net InterestIncome/Average Total Assets

2 Economic Equity Ratio-

The ratio of the shareholders funds to the total
assets measures the shifts in the ratio of owned
funds to total funds.The fact assesses the
sustenance capacity of the bank.
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 Regulatory Environment ±
Risk Management Guidelines in India
2 ALM Guidelines - February,1999
2 Operating Guidelines on Risk Management, October
7, 1999 covering broad contours for management of
credit, liquidity, interest rate, foreign exchange and
operational risks.
2 December Ô : Capital Adequacy Guidelines for
ºrimary Dealers covering Credit and Market Risk
2 On September Ô , Ô 1, two Working Groups were
constituted in Reserve Bank of India drawing experts
from select banks and FIs for preparing detailed
Guidance Notes on Credit Risk and Market Risk
Management by banks.
 Risk Regulation in India
2 Identified further steps to be taken by banks for
improving their existing risk management framework,
suiting to Indian conditions

2 Ô 5 ± Detailed Capital Adequacy guidelines for Banks to

move towards Basel II, Ô 7- final guidelines

2 Ô
± April 17, the ALM framework of 1999 updated.

2 Ô 7- ºillar II guidelines being issued

 RBI revised guidelines Ô 7- 
2 Issued on Sept 5, Ô 7
2 Feb 1 , 1999 guidelines covered Interest Rate and
Liquidity Risk Management
2 Cumulative mis-matches in first bucket to be reported
in Statement of Structural Liquidity
2 -ve Gap in 1-14 and 15-Ô days buckets not to exceed
Ô % of the cash flows
2 Need for revising this position ± Hence revised the
first bucket to 1, Ô-7 & -14 days
 RBI Revised ALM
2 Cumulative negative mismatches / Gap in new
buckets ± Next day, Ô-7, -14 and 15-Ô days
not to exceed 5, 1 , 15 and Ô % respectively
of cash flow
2 Format of Statement of Structural Liquidity
has been revised accordingly
2 Guidance instructions have been furnished
2 Banks given time to fine-tune MIS by 1 Jan¶ 
2 Reporting frequency to continue as monthly
2 Supervision will be fortnightly ± April 1,Ô 
2 Financing of gaps above norms to be indicated
 RBI Guidelines on Liquidity Risk
2 Methodology prescribed in ALM System-
Structural Liquidity Statement & Dynamic
Liquidity Ladder are simple
2 Need to make assumptions and trend analysis-
Behavioural maturity analysis
2 Variance Analysis at least once in six months and
assumptions fine-tuned
2 Track the impact of exercise of options &
potential liquidity needs
2 Cap on inter-bank borrowings & Call money
 Statement of Structural Liquidity
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2 ºlaces all cash inflows and outflows in the
maturity ladder as per residual maturity
2 Maturing Liability: cash outflow
2 Maturing Assets : Cash Inflow
2 Classified in to  time buckets
2 Mismatches in the first two buckets not to exceed
Ô % of outflows
2 Shows the structure as of a particular date
2 Banks can fix higher tolerance level for other
maturity buckets.
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2 Mismatches can be positive or negative
2 ºositive Mismatch: M.A.>M.L. and Negative
Mismatch M.L.>M.A.
2 In case of +ve mismatch, excess liquidity can be
deployed in money market instruments, creating
new assets & investment swaps etc.
2 For ±ve mismatch,it can be financed from market
borrowings (Call/Term), Bills rediscounting,
Repos & deployment of foreign currency
converted into rupee.