Asset Liability Management in Banks Components of a Bank Balance sheet: liabilities 1. Capital 2. Reserve & Surplus 3. Deposits 4.

Borrowings 5. Other Liabilities A Assets 1. Cash & Balances with RBI 2. Bal. With Banks & Money at Call and Short Notices 3. Investments 4. Advances 5. Fixed Assets 6. 6. Other Assets

Components of Liabilities:-1. Capital: Capital represents owners 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.
2. Reserves & Surplus:
Components under this head includes: I. II. III. IV. V. Statutory Reserves Capital Reserves Investment Fluctuation Reserve Revenue and Other Reserves Balance in Profit and Loss Account

3. Deposits

This is the main source of banks funds. The deposits are classified as deposits payable on demand and time. They are reflected in balance sheet as under: I. II. III. Demand Deposits Savings Bank Deposits Term Deposits

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

5. Other Liabilities & Provisions

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

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

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

3. Investments
A major asset item in the banks 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

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

5. Fixed Asset
I. II. Premises Other Fixed Assets (Including furniture and fixtures)

6. Other Assets
I. II. III. IV. V. Interest accrued Tax paid in advance/tax deducted at source (Net of Provisions) Stationery and Stamps Non-banking assets acquired in satisfaction of claims Deferred Tax Asset (Net)

VI. Others

Contingent Liability:--Banks obligations under LCs, Guarantees, Acceptances on behalf of

constituents and Bills accepted by the bank are reflected under this heads.

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

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

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

Components of Expenses:--1. INTEREST EXPENDED I. II. III. Interest on Deposits Interest on Reserve Bank of India / Inter-Bank borrowings Others 2. OPERATING EXPENSES I. II. III. IV. V. VI. VII. VIII. IX. X. XI. XII. Payments to and Provisions for employees Rent, Taxes and Lighting Printing and Stationery Advertisement and Publicity Depreciation on Bank's property Directors' Fees, Allowances and Expenses Auditors' Fees and Expenses (including Branch Auditors) Law Charges Postages, Telegrams, Telephones etc. Repairs and Maintenance Insurance Other Expenditure

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.

Significance of ALM:- Volatility Product Innovations & Complexities Regulatory Environment Management Recognition

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. 2. 3. Net Interest Income (NII) Net Interest Margin (NIM) Economic Equity Ratio

RBI DIRECTIVES:---- Issued draft guidelines on 10th Sept98. Final guidelines issued on 10th Feb99 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 Liquidity Management
Banks 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.

Adequacy of liquidity position for a bank

Analysis of following factors throw light on a banks 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

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

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

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

Interest Rate Risk Management

Interest Rate risk is the exposure of a banks 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 banks earnings and capital base. Changes in interest rates also affect the underlying value of the banks assets, liabilities and offbalance-sheet item.

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.

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

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.

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.