2. Presentation by S P Dhal, Faculty Member, SPBT College Asset Liability Management in Banks Live Interactive Learning Session [Module A]

3. Components of a Bank Balance sheet LiabilitiesAssets 1.Capital 2.Reserve & Surplus 3.Deposits 4.Borrowings 5.Other Liabilities 1.Cash & Balances with RBI 2.Bal. With Banks & Money at Call and Short Notices 3.Investments 4.Advances 5.Fixed Assets 6. Other Assets Contingent Liabilities

4. Components of Liabilities 1.Capital: Capital represents owner’s contribution/stake in the bank. -It serves as a cushion for depositors and creditors. -It is considered to be a long term sources for the bank.

5. Components of Liabilities 2. Reserves & Surplus Components under this head includes: I. Statutory Reserves II. Capital Reserves III. Investment Fluctuation Reserve IV. Revenue and Other Reserves V. Balance in Profit and Loss Account

6. Components of Liabilities 3. Deposits This is the main source of bank’s funds. The deposits are classified as deposits payable on ‘demand’ and ‘time’. They are reflected in balance sheet as under: I. Demand Deposits II. Savings Bank Deposits III. Term Deposits

7. Components of Liabilities 4. Borrowings (Borrowings include Refinance / Borrowings from RBI, Inter-bank & other institutions) I. Borrowings in India i) Reserve Bank of India ii) Other Banks iii) Other Institutions & Agencies II. Borrowings outside India

8. Components of Liabilities 5. Other Liabilities & Provisions It is grouped as under: I. Bills Payable II. Inter Office Adjustments (Net) III. Interest Accrued IV. Unsecured Redeemable Bonds (Subordinated Debt for Tier-II Capital) V. Others(including provisions)

9. Components of Assets 1.Cash & Bank Balances with RBI I. Cash in hand (including foreign currency notes) II. Balances with Reserve Bank of India In Current Accounts In Other Accounts

10. Components of Assets 2. BALANCES WITH BANKS AND MONEY AT CALL & SHORT NOTICE I. In India i) Balances with Banks a) In Current Accounts b) In Other Deposit Accounts ii) Money at Call and Short Notice a) With Banks b) With Other Institutions II. Outside India a) In Current Accounts b) In Other Deposit Accounts c) Money at Call & Short Notice

11. Components of Assets 3. Investments A major asset item in the bank’s balance sheet. Reflected under 6 buckets as under: I. Investments in India in : * i) Government Securities ii) Other approved Securities iii) Shares iv) Debentures and Bonds v) Subsidiaries and Sponsored Institutions vi) Others (UTI Shares, Commercial Papers, COD & Mutual Fund Units etc.) II. Investments outside India in ** Subsidiaries and/or Associates abroad

12. Components of Assets 4. Advances The most important assets for a bank. A. i) Bills Purchased and Discounted ii) Cash Credits, Overdrafts & Loans repayable on demand iii) Term Loans B. Particulars of Advances : i) Secured by tangible assets (including advances against Book Debts) ii) Covered by Bank/ Government Guarantees iii) Unsecured

13. Components of Assets 5. Fixed Asset I. Premises II. Other Fixed Assets (Including furniture and fixtures) 6. Other Assets I. Interest accrued II. Tax paid in advance/tax deducted at source (Net of Provisions) III. Stationery and Stamps IV. Non-banking assets acquired in satisfaction of claims V. Deferred Tax Asset (Net) VI. Others

14. Contingent Liability Bank’s obligations under LCs, Guarantees, Acceptances on behalf of constituents and Bills accepted by the bank are reflected under this heads.

15. Banks Profit & Loss Account A bank’s profit & Loss Account has the following components: I.Income: This includes Interest Income and Other Income. II. Expenses: This includes Interest Expended, Operating Expenses and Provisions & contingencies.

16. Components of Income 1.INTEREST EARNED I. Interest/Discount on Advances / Bills II. Income on Investments III.Interest on balances with Reserve Bank of India and other inter-bank funds IV. Others

17. Components of Income 2. OTHER INCOME I. Commission, Exchange and Brokerage II. Profit on sale of Investments (Net) III.Profit/(Loss) on Revaluation of Investments IV. Profit on sale of land, buildings and other assets (Net) V. Profit on exchange transactions (Net) VI. Income earned by way of dividends etc. from subsidiaries and Associates abroad/in India VII. Miscellaneous Income

18. Components of Expenses 1.INTEREST EXPENDED I. Interest on Deposits II. Interest on Reserve Bank of India / Inter-Bank borrowings III. Others

19. Components of Expenses 2. OPERATING EXPENSES I. Payments to and Provisions for employees II. Rent, Taxes and Lighting III. Printing and Stationery IV. Advertisement and Publicity V. Depreciation on Bank's property VI. Directors' Fees, Allowances and Expenses VII. Auditors' Fees and Expenses (including Branch Auditors) VIII.Law Charges IX. Postages, Telegrams, Telephones etc. X. Repairs and Maintenance XI. Insurance XII. Other Expenditure

20. Assets Liability Management It is a dynamic process of Planning, Organizing & Controlling of Assets & Liabilities- their volumes, mixes, maturities, yields and costs in order to maintain liquidity and NII.

21. Significance of ALM Volatility Product Innovations & Complexities Regulatory Environment Management Recognition

22. Purpose & Objective of ALM An effective Asset Liability Management Technique aims to manage the volume, mix, maturity, rate sensitivity, quality and liquidity of assets and liabilities as a whole so as to attain a predetermined acceptable risk/reward ration. It is aimed to stabilize short-term profits, long-term earnings and long-term substance of the bank. The parameters for stabilizing ALM system are: 1. Net Interest Income (NII) 2. Net Interest Margin (NIM) 3. Economic Equity Ratio

23. RBI DIRECTIVES Issued draft guidelines on 10 th Sept’98. Final guidelines issued on 10 th Feb’99 for implementation of ALM w.e.f. 01.04.99. To begin with 60% of asset &liabilities will be covered; 100% from 01.04.2000. Initially Gap Analysis to be applied in the first stage of implementation. Disclosure to Balance Sheet on maturity pattern on Deposits, Borrowings, Investment & Advances w.e.f. 31.03.01

24. Liquidity Management Bank’s liquidity management is the process of generating funds to meet contractual or relationship obligations at reasonable prices at all times. New loan demands, existing commitments, and deposit withdrawals are the basic contractual or relationship obligations that a bank must meet.

25. Adequacy of liquidity position for a bank Analysis of following factors throw light on a bank’s adequacy of liquidity position: a.Historical Funding requirement b.Current liquidity position c.Anticipated future funding needs d.Sources of funds e.Options for reducing funding needs f.Present and anticipated asset quality g.Present and future earning capacity and h. Present and planned capital position

26. Funding Avenues To satisfy funding needs, a bank must perform one or a combination of the following: a.Dispose off liquid assets b.Increase short term borrowings c.Decrease holding of less liquid assets d.Increase liability of a term nature e. Increase Capital funds

27. Types of Liquidity Risk Liquidity Exposure can stem from both internally and externally. External liquidity risks can be geographic, systemic or instrument specific. Internal liquidity risk relates largely to perceptions of an institution in its various markets: local, regional, national or international

28. Other categories of liquidity risk Funding Risk - Need to replace net outflows due to unanticipated withdrawals/non-renewal Time Risk - Need to compensate for non-receipt of expected inflows of funds Call Risk - Crystallization of contingent liability

29. Statement of Structural Liquidity All Assets & Liabilities to be reported as per their maturity profile into 8 maturity Buckets: i.1 to 14 days ii.15 to 28 days iii.29 days and up to 3 months iv.Over 3 months and up to 6 months v.Over 6 months and up to 1 year vi.Over 1 year and up to 3 years vii. Over 3 years and up to 5 years viii. Over 5 years

30. STATEMENT OF STRUCTURAL LIQUIDITY Places all cash inflows and outflows in the maturity ladder as per residual maturity Maturing Liability: cash outflow Maturing Assets : Cash Inflow Classified in to 8 time buckets Mismatches in the first two buckets not to exceed 20% of outflows Shows the structure as of a particular date Banks can fix higher tolerance level for other maturity buckets.

31. An Example of Structural Liquidity Statement

32. ADDRESSING THE MISMATCHES Mismatches can be positive or negative Positive Mismatch: M.A.>M.L. and Negative Mismatch M.L.>M.A. In case of +ve mismatch, excess liquidity can be deployed in money market instruments, creating new assets & investment swaps etc. For –ve mismatch,it can be financed from market borrowings (Call/Term), Bills rediscounting, Repos & deployment of foreign currency converted into rupee.

33. STRATEGIES… To meet the mismatch in any maturity bucket, the bank has to look into taking deposit and invest it suitably so as to mature in time bucket with negative mismatch. The bank can raise fresh deposits of Rs 300 crore over 5 years maturities and invest it in securities of 1-29 days of Rs 200 crores and rest matching with other out flows.

34. Maturity Pattern of Select Assets & Liabilities of A Bank Liability/AssetsRupees (In Cr) In Percentage I. Deposits a. Up to 1 year b. Over 1 yr to 3 yrs c. Over 3 yrs to 5 yrs d. Over 5 years 15200 8000 6700 230 270 100 52.63 44.08 1.51 1.78 II. Borrowings a. Up to 1 year b. Over 1 yr to 3 yrs c. Over 3 yrs to 5 yrs d. Over 5 years 450 180 00 150 120 100 40.00 0.00 33.33 26.67 III. Loans & Advances a. Up to 1 year b. Over 1 yr to 3 yrs c. Over 3 yrs to 5 yrs d. Over 5 years 8800 3400 3000 400 2000 100 38.64 34.09 4.55 22.72 Iv. Investment a. Up to 1 year b. Over 1 yr to 3 yrs c. Over 3 yrs to 5 yrs d. Over 5 years 5800 1300 300 900 3300 100 22.41 5.17 15.52 56.90

35. STATEMENT OF INTEREST RATE SENSITIVITY Generated by grouping RSA,RSL & OFF- Balance sheet items in to various (8)time buckets. RSA: MONEY AT CALL ADVANCES ( BPLR LINKED ) INVESTMENT RSL DEPOSITS EXCLUDING CD BORROWINGS

36. MATURITY GAP METHOD (IRS) THREE OPTIONS: A) RSA>RSL= Positive Gap B) RSL>RSA= Negative Gap C) RSL=RSA= Zero Gap

37. SUCCESS OF ALM IN BANKS : PRE - CONDITIONS 1.Awareness for ALM in the Bank staff at all levels–supportive Management & dedicated Teams. 2.Method of reporting data from Branches/ other Departments. (Strong MIS). 3.Computerization-Full computerization, networking. 4.Insight into the banking operations, economic forecasting, computerization, investment, credit. 5.Linking up ALM to future Risk Management Strategies.

38. Interest Rate Risk Management Interest Rate risk is the exposure of a bank’s financial conditions to adverse movements of interest rates. Though this is normal part of banking business, excessive interest rate risk can pose a significant threat to a bank’s earnings and capital base. Changes in interest rates also affect the underlying value of the bank’s assets, liabilities and off-balance-sheet item.

39. Interest Rate Risk Interest rate risk refers to volatility in Net Interest Income (NII) or variations in Net Interest Margin(NIM). Therefore, an effective risk management process that maintains interest rate risk within prudent levels is essential to safety and soundness of the bank.

40. Sources of Interest Rate Risk Interest rate risk mainly arises from: –Gap Risk –Basis Risk –Net Interest Position Risk –Embedded Option Risk –Yield Curve Risk –Price Risk –Reinvestment Risk

41. Measurement of Interest Rate Risk Gap Analysis- Simple maturity/re-pricing Schedules can be used to generate simple indicators of interest rate risk sensitivity of both earnings and economic value to changing interest rates. - If a negative gap occurs (RSA<RSL) in given time band, an increase in market interest rates could cause a decline in NII. - conversely, a positive gap (RSA>RSL) in a given time band, an decrease in market interest rates could cause a decline in NII.

42. Measurement of Interest Rate Risk Duration Analysis: Duration is a measure of the percentage change in the economic value of a position that occur given a small change in level of interest rate.

43. THANK YOU