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IN BANKING:
ASSET-LIABILITY
MANAGEMENT (ALM)
BANGLADESH BANK
Asset Liability Management Policy
Banks must have a committee comprising of the senior management of the bank
to make important decisions related to the Balance Sheet of the Bank. The
committee, typically called the Asset Liability Committee (ALCO), should meet
atleast once every month to analysis, review and formulate strategy to manage
the balance sheet.
In every ALCO meeting, the key points of the discussion should be minuted and
the action points should be highlighted to better position the bank’s balance
sheet. In every ALCO meeting, action points taken in the past ALCO meeting
should be reviewed to ensure implementation.
1. To receive and review reports on liquidity risk, market risk and capital
management as covered in this report.
2. To identify balance sheet management issues like balance sheet gaps,
interest rate gap/profiles etc. that are leading to under-performance.
3. To review deposit-pricing strategy for the local market.
4. Review liquidity contingency plan for the bank.
PART A
EXECUTIVE SUMMARY. ....................................................................................................4
PURPOSE/METHODOLOGY/LIMITATIONS/DISCLAIMERS.....................................5
POLICY STATEMENT..........................................................................................................7
ORGANISATIONAL STRUCTURE.....................................................................................8
PROCESS .................................................................................................................................9
4.1 COMMENTARY......................................................................................................10
Changes in market liquidity and or interest rates exposes banks/ business to the
risk of loss, which may, in extreme cases, threaten the survival of institution. As
such, it is important that senior management as well as the Board of Directors
must understand the existence of such risk on the balance sheet and they should
ensure that the structure of the institutions’ business and the level of balance
sheet risk it assumes are effectively managed, that appropriate policies and
procedures are established to control and limit these risks, and that resources are
available for evaluating and controlling interest rate risk. Increasingly Asset
Liability Management has become an integral part of Bank Management.
Banks’ are exposed to Balance Sheet Risk, where it is absolutely necessary for
the management of the bank to understand the existence of such risk and best
manage the exposure to the risk. The Asset Liability Committee (ALCO),
comprising of the senior management of a bank, is primarily responsible for
Balance Sheet Management or more specifically Balance Sheet Risk
Management.
This guide would cover the process of Asset-Liability Management and the role
of ALCO in Balance Sheet management.
Methodology
The guideline is based on the international tools and strategies practiced by the
banks to manage its balance sheet risk. Different reports, researches, databases
etc. published in Asset Liability Management were used as primary input for
this paper.
Limitations
While utmost care has been given to cover every part of Asset Liability
Management, a few complex issues related to Market Risk have not been
Disclaimers
All data used as references and examples are hypothetical assumptions and does
not relate to any bank or organization in any respect.
Board or Management Committee of the Bank should set out the policy
statement in at least for the followings and an annual review should be done
taking into consideration of changes in the balance sheet and market dynamics.
1) Loan Deposit Ratio (LD): The AD ratio should be 80%-85%. However, the
Loan Deposit ratio of the bank should go upto 110%.
The Loan Deposit ratio = Loan/(Deposit+Capital+Funded Reserve)
The ratio will be fixed based on the bank’s capital, Bank’s reputation in the
market and overall depth of the money market.
4) Medium Term Funding Ratio (MTF): The MTF of a bank should not be
less than 30%. The ideal scenario should be 45%. Given, the overall scenario
of current market, it will be suitable to move towards the MTF limit of 45%
as we progress.
The Asset Liability Committee (ALCO) is responsible for balance sheet (asset
liability) risk management. Managing the asset liability is the most important
responsibility of a bank as it runs the risks for not only the bank, but also the
thousands of depositors who put money into it.
CEO / MANAGING
DIRECTOR
Head of Head
Head of
of Head of Head of Head of Head of
Consumer Consumer
Treasury Corporate Finance Credit Operations
Banking Banking Banking
Money Market
Dealers
PART C: PROCESS
&
Analysis & B/S Status &
Treasury Recommendation ALCO Recommended A
Meeting Actions CEO C
T
I
O
Depo-Adv
N
Trend & Outlook Other Balance Sheet Features
P
Feedback & Recommendation O
Other Depts. I
N
T
Feedback & Recommendation S
Consumer Banking
The committee calls for a meeting once every month to set and review strategies
on ALM.
3. Key Agendas
ALCO attends the following issues while managing Balance Sheet Risks:
4. ALCO Paper
4.1 Commentary
A brief summary on the following issues for the last month are provided for
review:
(c) Loan Deposit Ratio: Loan deposit ratio, typically calculated as the ratio
of loans against deposits, is the most common way to see a bank’s
liquidity position. In an ideal scenario, loan deposit ratio should not
exceed 80% (as 20% of DTL is required for statutory requirements).
However, a bank may decide to lend out its capital or raise funds from the
interbank with a view that market interest rates would be low. But
excessive lending (a high Loan Deposit Ratio) may expose a bank in
serious liquidity and interest rate risk as the market liquidity may tighten
any time.
(d) Medium Term Funding Ratio: Banks typically make money by running
mismatches, that is, by borrowing short term and lending long term.
However, short term deposits may go out of the bank upon maturity,
whereas a bank cannot call back long term lendings. Thus a bank has to
find the right combination for longer term mismatch. Medium term
funding ratio is calculated as the ratio of liabilities with a contractual
maturity of more than one year to assets with a contractual maturity of
more than one year. This ratio is intended to highlight the extent to which
we are dependent on being able to roll over short term deposits in order to
fund medium term assets.
The Treasury operation of a bank will review its funding capabilities and
recommend the guidelines to senior management. These guidelines will
be based on the estimated wholesale funding shortfall after calculating the
forecast/contractual cash flow of the entity under normal business
conditions.
The basis of cash flow measurement is to assume that funds are repaid on
their contractual maturity date. For wholesale funds, this is sufficient.
However, it is not realistic to assume that retail business will behave in
this manner. In practice, current accounts and savings deposits are not
withdrawn the next day and overdrafts are not repaid on demand. Retail
business can be expected to follow more or less predictable patterns being
influenced by seasonal factors and other trends. In monitoring liquidity,
an estimate should be made of the expected change in such
assets/liabilities with the resulting need for higher/lower funding from the
wholesale market. Whilst systems constraints will often impede frequent
and timely updating of cash flow data relating to retail business, it is
nevertheless important to include realistic estimates within the MCO data
which Treasury use to manage the bank’s aggregate cash requirements.
The ability to raise cash by selling marketable assets may be factored into
the MCO calculation but only to the extent that these assets are not
already relied upon in order to meet internal or statutory reserve asset
requirements. The MCO guideline is a ‘business as usual’ measure,
which implies that necessary reserve liquidity must be maintained at all
times and so cannot be counted towards meeting the MCO requirement.
Whilst it may not be possible to include specific figures within MCO
controls, banks should also be aware of cash flows from settlement of
foreign exchange transactions and of intra-day exposures arising from the
operation of the daily clearing systems.
To address this risk and to make sure a bank does not expose itself in excessive
mismatch, a bucket-wise (e.g. next day, 2-7 days, 7 days-1 month, 1-3 months,
3-6 months, 6 months-1 year, 1-2 year, 2-3 years, 3-4 years, 4-5 years, over 5
year) maturity profile of the assets and liabilities is prepared to understand
mismatch in every bucket.
However, as most deposits and loans of a bank matures next day (call, savings,
current, overdraft etc.), bucket-wise assets and liabilities based on actual
maturity reflects huge mismatch; although we know that all of the shorter tenor
assets and liabilities will not come in or go out of the bank’s balance sheet. As a
result, banks prepare a forecasted balance sheet where the assets and liabilities
of the nature of current, overdraft etc. are divided into ‘core and non-core’
balances, where core is defined as the portion that is expected to be stable and
will stay with the bank; and non-core to be less stable. The distribution of core
and non-core is determined through historical trend, customer behavior,
statistical forecasts and managerial judgement; the core balance can be put into
over 1 year bucket whereas non-core can be in 2-7 days or 3 months bucket.
2,000
1,500
1,000
500
0
(500)
(1,000)
(1,500)
(2,000)
(2,500)
• Reserve Assets.
• Cash in Tills.
• Specific Government Securities.
• Foreign Currency in open position.
• Specific FDRs.
The ALCO process or the ALCO meeting reviews the ALCO paper along with
the prescribed agendas. The Chairman of the committee, that is the Treasurer or
the CEO, raises issues related to the balance sheet. Treasurer suggests whether
the interest rates need to be repriced, whether the bank needs deposits or
advance growth, whether growth of deposits and advances should be on short or
longer term, what would be the transfer price of funds among the divisions,
what kind of interbank dependency the bank should have etc. In short, all issues
related to liquidity and market risk are covered.
Based on the analysis and views of the Treasurer, the committee takes decisions
to reduce balance sheet risk while maximising profits.
6. Action Points
• Cash flow (long/short) plan based on market interest rates and liquidity.
• Need for change in Fund Transfer Pricing (FTP) &/or customer rates in
line with strategy adapted.
• Address to the limits that are in breach (if any) or are in line of breach
and provide detailed plan to bring all limits under control.
• Address to all regulatory issues that are under threat to non-compliance.
All ALCO members are provided with the minutes (Appendix 2) of the meeting
within the next day. The minute includes:
• The attendees.
• The issues addressed.
• The recommendations provided by the Chairman.
• The action points that were fixed in the meeting.
Apart from the regular monthly meeting, ALCO meeting is also called as and
when any contingent situations arise. A very good example may be, during the
Eid period. At those times, market liquidity dries out and overnight rates shoot
up. Banks who are net borrowers from the market may be exposed to huge
interest expense the high rates in the market. This is an ideal time for a special
ALCO meeting, where the committee may take critical decisions for deposit
mobilisation on an urgent basis for reducing dependency from the market.
Market Risk measures the risk of loss due to adverse movements in market
prices or rates such as interest rates, FX rates. Following are the key
management indicators for managing Market Risk:
VaR = 100 * (8% * 30 days/360 days) – (100 * 10% * 360 days/360 days) =
BDT (0.67 – 10) = BDT 9.33 mio
MAT level = current VaR + latest rolling monthly P/L (21 business days)
Balance sheet risk can be categorised in to two major types of significant risk,
which are liquidity and interest rate risks. Changes in market liquidity and or
interest rates exposes banks/ business to the risk of loss, which may, in extreme
cases, threaten the survival of institution. As such, it is important that senior
management as well as the directors must understand the existence of such risk
on the balance sheet and they should ensure that the structure of the institutions’
business and the level of balance sheet risk it assumes are effectively managed,
that appropriate policies and procedures are established to control and limit
these risks, and that resources are available for evaluating and controlling
interest rate risk.
The risk that bank or business will be unable to meet it’s commitment as they
fall due leading to bankruptcy or rise in funding cost. It is the solvency of
business and which has special reference to the degree of readiness in which
assets can be converted into cash with out loss.
Banks traditionally use the statutory liquidity reserve and their borrowing
capacity in the volatile interbank money market as the source of liquidity. But a
conscious approach to measure and monitor the liquidity is somewhat lacking in
our market. We can learn and draw immense benefit by sharing the best
practices, tools and techniques of liquidity management.
Capital Adequacy
The need to adopt the best international practices, given the globolisation of
economies and businesses. As you are aware of “Basel Committee on Banking
Supervision” and the emphasis on maintaining the Capital Adequacy
commensurate to exposure or risk on balance sheet. The new “Basel Capital
Accord” stipulates that “ Banks must hold capital commensurate with the level
of interest rate risk they undertake”.
As mentioned earlier, Changes in interest rates expose banks to the risk of loss,
which may, in extreme cases, threaten the survival of the institution. In addition
to adequate systems and controls, capital has an important role to play in
mitigating and supporting this risk. As part of sound management, banks
2 ECONOMY/ MARKET 1. No significant change in macro-economic factors, other than inflationary growth.
2. Inflation rose to 4.57% in November 2002, highest since FY1999.
3. Foreign Exchange reserve stands at US$ 1.78 bio in February 2003.
4. Broad Money (M2) recorded an increase of 5.29% during July-Dec 2002 period
compared to same period last year.
5. ADP is expected to cut to BDT 16.5 bio from BDT 19.0 bio for FY 2003
6. Overnight rates in the downtrend after Eid.
7. Treasury Bill yield curve is expected to be stable with no major change in sight.
8. Secondary Market for Treasury Bills is emphasised the BBK.
5 ACTION 1. Introduce new (increased) customer rates to encourage deposit accretion and
emphasize need to focus on account profitability for assets w.e.f. 1st Mar.
2. Finance to determine impact of new rates on avg CB & C&I balance sheet of Jan’03
and advise ALCO.
3. Contingency action plan to manage stressed liquidity discussed & agreed.
KOROTOA BANK
CONTINGENCY ACTION PLAN TO MANAGE STRESSED LIQUIDITY
SCOPE
NB Stressed Liquidity is defined as a condition that arises from a sudden deterioration of the
perceived safety and credibility of the Bank, resulting in substantial withdrawal of funds by
depositors.
TRIGGER POINTS
1. Bangladesh Bank has declined to open the Rediscount/Repo window at our request.
2. Call money market rates have exceeded 25% for more than 7 consecutive days.
3. Call facilities have been declined by the market or a premium over market rates has been
imposed on our borrowing.
Version date: February, 2003 Approved at ALCO Meeting March 03, 2003
1. Phase 1 – Team
- (ALCO Members)
- Chief Executive Officer
- Head of Treasury
- Head of Finance
- Head of Corporate Banking
- Head of Consumer Banking
- Head of Credit
- Head of Operations
2.2 Advise all Divisional Heads of the crisis and cancel leave commitments of Chief Executive
key personnel.
2.3 Review liquid and market assets portfolio by maturity and prepare a Head of Treasury
liquidation strategy. Head of Finance
2.4 Liquidate any long forex positions and reduce forex open position to a Head of Treasury
minimum.
1. Phase 1 – Team
- (ALCO Members)
- Chief Executive Officer
- Head of Treasury
- Head of Finance
- Head of Corporate Banking
- Head of Consumer Banking
- Head of Credit
- Head of Operations
2.1 Communication
2.1.1 Convene Emergency ALCO Meeting to review the crises, agree content Chief Executive
of any external /internal messages and delegate tasks.
2.1.2 Inform Bangladesh Bank of crisis and proposed remedial action, if Chief Executive
deemed necessary. Head of Treasury
2.2.1 Confirm the liquid and market asset portfolio for initial selective Head of Treasury
liquidation.
2.2.2 Assess the level of interbank borrowing capacity and raise funds to Head of Treasury
meet liquidity from the most reliable sources.
2.2.4 Selling Fcy from forex open position limit to generate Lcy liquidity. Head of Treasury
2.2.5 Approach Bangladesh Bank for extended use of the rediscount Head of Treasury
window.
2.2.6 Monitor closely withdrawal patterns, under report to Head of Head of Treasury
Treasury.
2.2.7 Do not approve early redemption of deposits without specific Head of Corporate
approval of the Chief Executive/ Head of Treasury Head of Consumer
2.2.8 Assess overall level of loans/OD and ensure no incremental Head of Corporate
drawdown. No excess to be allowed. Head of Consumer
2.2.9 Assess overall Advances portfolio and activate plan Head of Corporate
contract/recall/seek repayment from customers. Head of Consumer
2. Central Bank
Local Book
Money Market
• Term Deposit
• Call Money
• Repo
Other
• Cash in hand
FCY Book
Money Market
• Term Deposit
• Utilisation of surplus Nostro balances
BDT IN MILLION
Money Market
F Term Deposit 500 12.00%
Central Bank
(Marketable Securities and Reserve
Portfolio)
Other
Signature
Head of Treasury
Head of Finance
Head of Operations
Duration ×
Value at Risk = 2 × Net Present Value ×
(1+ Yieldt −1 ) Volatility
(d y ) × σ2 ( −
Yt Yt −1 ,..........,Yn −1 − Yn )
= × C ×
VAR 2 d
(1 + Yt −1 ) y
(1 + Y −
t 1
)
Duration ×
VAR= 2 × Net Present Value × ( × )
(1+ Yieldt −1 ) Yield t VolatilityR
d
y Yn −1
VAR = 2 ×
C × × Yt × σ2 Yt
(1 + Yt −1 ) y (1 + Yt −1 )
d Yt −1 ,....., Yn
n
VAR P ' folio
= ∑ VAR 2
i
i =1
ALCO PAPERS
Liquidity
`- Corporate Banking Deposits increased by BDT 100 mio; Mainly due to FDR by: (a) 'A' Company (BDT 50 mio) (b) 'Z' Corporation (BDT 50 mio).
`- Corporate Banking Advances decreased by BDT 150 mio; Mainly due to overdraft repayment by: (a) 'A' Company (BDT 50 mio) (b) 'Z' Corporation (BDT 50
mio).
`- Consumer Banking Deposits decreased by BDT 100 mio; Mainly due to maturity of FDR of BDT 50 mio.
`- Consumer Banking Advances decreased by BDT 100 mio; Mainly due to overdraft repayment of BDT 50 mio and maturity of fixed loan of BDT 50 mio.
`- Savings Deposit of corporate banking has decreased by 2%, whereas FDR has increased by 2.5%.
1) TREASURY BILLS
DEPOSIT BANK 'A' BANK 'B' BANK 'C' BANK 'D' KOROTOA BANK
SAVINGS 5.00 7.50 7.50 6.50 8.00
STD 4.00 - - - -
1 MNTH - - - - -
3 MNTH 7.00 9.25 9.00 7.50 9.00
6 MNTH 7.25 9.50 9.50 8.00 9.25
12 MNTH 7.75 11.00 9.75 8.25 9.25
24 MNTH 8.00 11.50 - - 10.00
36 MNTH 8.00 12.00 - - 10.50
LENDING
Agriculture 12.00-16.00 9.00-13.00 11.00-16.00 12.00 14.00
Export Credit 7.00-9.00 7.00 7.00 7.00-9.00 7.00
Small Cottage Ind. 11.50-12.00 11.50-13.00 14.00-16.00 12.00 15.00
Term Loans 9.00-13.00 13.00-15.00 12.50-16.50 15.00 15.00
Working Cap 14.00 12.00-15.00 10.00-15.50 13.25-15.00 15.00
Commentary
1) FDR interest rates varies with amount and tenor for all banks.
Current
ASSETS Current Month Previous Month LIABILITIES Month Previous Month
Reserve Assets 1,000 900 Interbank Deposits (1,000) (625)
Interbank Placings 750 900 Corp. Custy Deposits (1,500) (1,400)
Corp. Custy Assets 2,500 2,350 Cons. Custy Deposits (3,000) (3,100)
Cons. Custy Assets 1,500 1,400 Capital & Reserves (500) (625)
Other Assets 500 600 Other Liabilities (250) (400)
Total Assets 6,250 6,150 Total Liabilities (6,250) (6,150)
Current
CORPORATE ASSETS Current Month Previous Month CORPORATE LIABILITIES Month Previous Month
Overdraft 750 700 Savings Deposits (500) (550)
Fixed Loan 1,000 1,100 Current Deposits (400) (400)
Others 750 550 FDR (300) (350)
Others (300) (100)
Current
CONSUMER ASSETS Current Month Previous Month CONSUMER LIABILITIES Month Previous Month
Overdraft 500 600 Savings Deposits (900) (900)
Fixed Loan 500 450 Current Deposits (600) (650)
Others 500 350 FDR (500) (550)
Others (1,000) (1,000)
28- Feb-
Currency: BDT (Mio) Date 03
Current
Key Management Indicators Month Previous Month Limits Excess?
Wholesale Borrowing Guidelines 1,000 625 2,000 NO
Commitments 1,500 1,800 2,250 NO
Loan Deposit Ratio 89% 83% 100% NO
Medium Term Funding Ratio 60% 54% 50% NO
Swapped Funds Guideline 750 700 1,000 NO
Maximum Cumulative Outflow
(MCO)
1 Day -1,250 -1,300 -1,500 NO
2-7 Day -1,600 -1,500 -2,000 NO
8 Days to 1 Month -1,350 -2,240 -3,000 NO
BDT
Currency: (Mio) Date 28- Feb-03
NET MISMATCH (1,750) (1,250) (350) 250 400 (1,900) 600 500
CUMULATIVE NET MISMATCH (1,250) (1,600) (1,350) (950) (2,850) (2,250) (1,750)
Local Currency Day 1 Day 2 Day 3 Total Stress Day 1 Day 2 Day 3
Net Cumulative Cashflow
Marketable Assets 0 0 0 (Combined) 250 303 328
Reserve Assets 250 250 250
Stress Cash Flow -25 30 45
Surplus/ Shortfall in Reserve/Marketable
Assets 225 280 295
Foreign Currency Day 1 Day 2 Day 3 Other Sources of Liquidity Day 1 Day 2 Day 3
Marketable Assets 0 0 0 NONE
Reserve Assets 10 11 13
Stress Cash Flow 15 12 20
Surplus/ Shortfall in Reserve/Marketable Net Cumulative Cashflow
Assets 25 23 33 (Combined) 250 303 328
(1) Cash Reserve Requirements (CRR) and Statutory Liquidity Ratio (SLR). The bank is required to place the
following percentage of their customer deposits with the central bank, interest free on a monthly basis and Govt. Yes
Securities and Treasury Bills. CRR-4% of average Time and Demand Deposits as at two months prior period SLR
16% of a average Time and Demand deposits as at two months prior period.
(2) Fcy Balance held with Central Bank will not qualify for CRR
(3) Advance to Deposit Ratio
Yes
Bank is not to exceed a total (lcy + fcy) advances to deposit ratio of 120% as per statutory liquidity requirement.
Central Bank does not have a set guideline but they usually come back if the ratio is over 90% for a long time.
(4) Bangladesh Central Bank Position
Yes
Banks operating in Bangladesh are required to maintain credit balance with the Central Bank minimum 4% of time
and Demand Deposits as CRR and the accounts must not be overdrawn
(5) Capital Adequacy Ratio
Yes
Banks operating in Bangladesh are required to maintain a minimum capital at 8% of total risk weighted assets
(6) Large Exposures
Yes
Banks operating in Bangladesh are required to restrict their lending to any large single relationship to 15% of their
capital and with the approval of Central Bank it can be increased to 100% of their capital
Overdraft
Fixed Loan
Others
Savings A/C
Current A/C
FDR
Others