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Asset & Liability Management
Introduction
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What is ALM about ? Liquidity
Interest rate risk (in the main portfolio, not in trading books) Balance sheet management
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Balance Sheet Management
Capital Funding Bond issues Deposit pricing Portfolio Composition Securitisation Credit concentrations and their solution
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ALM, business units, and relevant issues
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Why do we need ALM ? Maturity Transformation (banks borrow short and lend long) Bank portfolios generate interest rate risk Capital needs to be allocated and managed Portfolio imbalances (eg. All retail deposits from one country)
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Organising ALMAC The Asset and Liability Management Committee
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The Balance Sheet, The Regulator and Bank Capital
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Capital Adequacy Requirements
Capital Must Exceed 8% of Risk-Weighted Assets Risk Weighted Assets calculated by applying factors (Risk Weights) to on & off-balance sheet items
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Risk Weights
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Examples of Capital Adequacy Calculation
Asset = $100M GECC Bond Risk Weight = 100% Capital Required = 8% x 100% x $100M = $8M Example 2 Asset = $100M Deutsche Bank Bond Risk Weight = 20% Capital Required = 8% x 20% x $100M = $1.6M
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Other Developments BIS 1996 BIS 2000+ Capital required for market risk
Three New Approaches to Credit Risk Capital needed for liquidity risk, operational risk etc.
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Three Approaches Approaches Internal Standardised Credit - Risk
Ratings - based Approach Modelling Approaches
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Tiers of Capital Tier 1 Tier 2 Shareholders funds
Can be used to support trading and banking Tier 2 Perpetual, medium, long-term subordinated debt, general provisions, fixed asset revaluation reserves
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Tiers of Capital (Continued)
Short-term Subordinated Debt Can be used to support trading activities Aggregate Rule Tier 2 + Tier 3 can only be used up to the level of Tier 1
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Regulatory vs Economic
Economic capital is not the same as regulatory capital Regulatory calculation basically flawed Economic capital should be used for return on capital calculations
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ALM Decisions and Capital Concerns
Portfolio Composition Interest Rate (and other market risks) Long-term funding
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Liquidity Risk Measurement and Management
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Liquidity Risk Measurement
Construct a maturity ladder, and net funding requirement. Assumptions on maturity are needed Maturities can be contractual or expected or worst-case.
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Assumptions for an Expected Mismatch
Likely maturity of retail deposits Drawdowns of committed facilities Seasonality Discount to be applied to marketable securities
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A Maturity Ladder Expected Maturity
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Net Funding Requirement Expected Maturity
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A Liquidity Ladder Contractual Maturity
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Liquidity Management Tools of Liquidity Management
Standby Facilities Marketable Securities Can be used as collateral for loans through repos etc. In the last resort …… Central Bank facilities
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Funding Requirement Contractual Maturity
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Types of Interest Rate Risk
Repricing Risk Exposure to changes in the absolute level of interest rates Yield Curve Risk Basis Risk Optionality
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Interest Rate Risk Classification and Measurement
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Parallel Shift
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Steepening
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Effects of Interest Rate Risk
Net Interest Income may fall Net Asset Value (Portfolio) Value may fall
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Measurement Techniques
Bucket and Gap analysis Duration Price Value of a Basis Point Large Exposure Reporting
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Measurement Techniques
More Advanced Techniques VaR and Related Techniques Monte Carlo Simulation Historical Simulation Dynamic Simulation including strategy and business changes
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Interest Rate Derivatives
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Interest Rate Derivatives
Interest rate swaps FRAs Eurodollar futures Overnight Index Swaps Caps & Floors IROs
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Interest Rate Swap Bank Swap Provider LIBOR Fixed Rate
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Credit Exposure Profiles for Interest Rate and Currency Swaps
Time Exposure Currency swap Interest rate
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Balance Sheet Management
Long-Term Funding
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Long Term Funding - The Key Issues
Currency, Amount, Maturity Investor concerns: Market Access Hedging: Hidden costs of credit and capital MIS
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A Typical Long-Term Funding Process
Appoint Lead Manager: Advises on Timing, Swaps, Documentation Set target, maturity, required currency Assess Proposals Appoint Paying Agent, Get tax advice, listing Sale to Investors Syndication
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Standard Market Interest Rate Swap
Issuer Swap Provider LIBOR 4.90%
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Interest Rate Swap for a New Issue
5 Year Issue 4.75% Coupon Issue Price Fees 0.1% LIBOR BP Issuer Swap Provider 4.75% Fees
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Currency Swaps Start Interest Exchange Maturity Sterling Principal
Issuer Swap Provider Sterling Principal Euro Principal Sterling Interest Euro Interest Start Interest Exchange Maturity
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Balance Sheet Management
Securitisation
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Securitisation : Key Issues
Vehicle must be bankruptcy remote Must be off balance sheet Credit Enhancement
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Securitisation Examples
Mortgage pass-throughs & CMOs Credit Card Receivables Collateralised Loan Obligations
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Credit Enhancement Overcollateralisation Tranching Reserves
Credit Insurance
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Mortgage Pass-through
Mortgages Originator SPV Cash Cash Securities Investor
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Cashflow Details Credit Support Mortgagor SPV Servicer Note Holder
Principal Plus Interest Mortgage payments less servicing fee Note Holder Servicer Mortgage Payments Collects payments
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Tranching Principal Cashflows Time Fast Pay Medium Pay Slow Pay
Tranche A Tranche B Tranche C
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Credit Derivatives Basic Instruments and Issues
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Types of Credit Derivative
Credit Default Swaps & Options Total Rate of Return Swaps Credit-Linked Notes Various Spread Products
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Credit Default Options
Fee (BP) Bank A Bank B Zero No credit event Credit event CEP
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Total Return Swaps Bank B Bank A Bond C (Reference credit)
Total positive returns on Bond C Bank B Bank A LIBOR + Spread + Losses on Bond C Bond C (Reference credit)
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Credit-Linked Note Non-Principal Protected
Coupon Issuer (Bank B) Principal Investor (Bank A) No credit event Credit event Principal Less CEP Bond C (Reference credit)
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Credit Derivatives and ALM
Can reduce credit risk concentrations Can provide funding opportunities Can be used in securitisation transactions Under some circumstances, can reduce regulatory capital usage
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A Typical CLO $100M in loans 50 senior secured bank loans
Average rating B1 Diversified by industry & obligor LIBOR + 275 5 Year Average Life Class A $85M 12 year maturity LIBOR + 50 Aa3 Class B $7M 12 year maturity LIBOR + 120 Baa3 Equity $8M 12 Year maturity subordinated
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