A STUDY ON “ANALYSIS OF NPA AND RECOVERY MANAGEMENT IN

DHANLAXMI BANK LIMITED”, HEAD OFFICE, THRISSUR.

MAJOR PROJECT REPORT

Submitted in partial fulfillment of the requirements

For the award of the degree of

MASTER OF BUSINESS ADMINISTRATION

Of the

UNIVERSITY OF CALICUT

BY

ROOPA K

Reg No: WFAKMBA040

Under the guidance of

Ms. SUMANAM MBA, M PHIL

Assistant Professor

Department of Management Studies

WEST FORT HIGHER EDUCATION TRUST

M.G KAVU P.O, POTTORE

THRISSUR-680581

2010-2012

1
 DECLARATION

I Roopa K 4th Semester MBA student of Department of management studies, West Fort
Higher Education Trust, Thrissur do here by declare that this Minor Project Report
titled “A STUDY ON ANALYSIS OF NPA AND RECOVERY MANAGEMENT
IN DHANLAXMI BANK LTD, HEAD OFFICE, THRISSUR” is a bonafide record
of the work independently done by me under the guidance of Ms Sumanam, Assistant
Professor and is submitted to University of Calicut in partial fulfillment of Degree of
Master of Business Administration. The information and data given in the report is
authentic to the best of my knowledge. I also declare that this project report has not
previously formed partially or fully, the basis for the award of any degree, diploma,
fellowship, associate ship or other similar title of recognition.

Place:

Date: ROOPA K

2
 ACKNOWLEDGEMENT

First and foremost I bow with gratitude before the almighty for all his blessing through
put my life and especially for all the help extended through various known and
unknown hand during the course of my project work entitled “A STUDY ON
ANALYSIS OF NPA AND RECOVERY MANAGEMNT IN DHANLAXMI
BANK LTD, HEAD OFFICE, THRISSUR”

I am indebted to many individuals and institutions for their support in my project

Endeavour. This project would not have been possible without the help and guidance of
many people whom I sincerely thank for extending their unconditional support at all
times.

I am very grateful to Mr. Gilbert Johnson; Head of Recovery Department, Mr. T S

Hariharan, Chief Manager (Recovery), Mr. Shaju Antony (Recovery) and all
members of the Bank Ltd. for their guidance and constant support for completing the
project.

I am also conveying my regards to Dr P P Pillai Dean and Director Westfort Higher

Education Trust Pottore, Thsissur.

I am extremely thankful to DR. Narayanankutti M COM Principal, Westfort

Higher Education Trust Pottore, and Thrissur.

The project has been made possible by the greatest efforts and dedicated support
extended to me by my guide Ms. SUMANAM, Assistant Professor, Department of
Management Studies, West fort Higher Education Trust (WHET) Thrissur

I wish to express my sincere gratitude to all who provided necessary help for preparing
this project.

ROOPA K

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 TABLE OF CONTENTS

CHAPTER TITLE PAGE

NO: NO:
Introduction to the study

1.1 Introduction to project 1

1.2 Executive summary 7

1
1.3 Statement of the problem 8

1.4 Objectives of the study 9

1.5 Scope of the study 10

1.6 Limitations of the study 11

1.7 Theoretical basis 12 - 25

1.8 Definitions of the study 26 - 27

2 Industry profile 28 - 35

3 Company profile 36- 41

4 Review of Literature 42 - 46

4
5 Research Methodology 47 - 48

6 Data Analysis and Interpretation 49 - 58

Findings , Suggestion & Conclusion

7.1 Findings
7 59 - 61
7.2 Suggestion
62 - 64
7.3 Conclusion
65

8 Bibliography 66

9 Annexure 67

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 LIST OF TABLES

TABLE TITLE PAGE

NO: NO:

A) MATURITY PROFILE – LIQUIDITY OF SOUTH INDIAN BANK

6.1 Statement Of Structural Liquidity As On 31-3-2011 49

6.2 Computation Of Mismatch As On 31-3-2011 51

B) INTEREST RATE SENSITIVITY OF SOUTH INDIAN BANK

6.3 Rate Sensitive Gap As On 31-3-2011 53

Net Gap As A Percenatge Of Total Rate Sensitive Assets 56

6.4

6.5 Computation of Rupee Gap and Relative Gap Ratio as on 31-3- 57

2011

6.6 Sensitiveness Of Assets And Liabilities as on 31-3-2011 58

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 LIST OF CHARTS

CHART TITLE PAGE NO:

NO:

1 CHART SHOWING STRUCTURAL LIQUIDITY 50

POSITION AS ON 31/3/2011

2 CHART SHOWING MISMATCH AND PRUDENTIAL 52

LIMT

3 CHART SHOWING RATE SENSITIVE GAP AS ON 54

31-3- 2011

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8
 CHAPTER 1

INTRODUCTION

1.2 INTRODUCTION

The etymology of the word “Risk” can be traced to the Latin word “Rescum” meaning Risk
at Sea or that which cuts. Risk is associated with uncertainty and reflected by way of charge
on the fundamental/ basic i.e. in the case of business it is the Capital, which is the cushion
that protects the liability holders of an institution. These risks are inter-dependent and events
affecting one area of risk can have ramifications and penetrations for a range of other
categories of risks. Foremost thing is to understand the risks run by the bank and to ensure
that the risks are properly confronted, from being a financial intermediary into a risk
intermediary at present. In the process of financial intermediation, the gap of which becomes
thinner and thinner, banks are exposed to severe competition and hence are compelled to
encounter various types of financial and non-financial risks. Risks and uncertainties form an
integral part of banking which by nature entails taking risks. Business grows mainly by
taking risk. Greater the risk, higher the profit and hence the business unit must strike a
tradeoff between the two. The essential functions of risk management are to identify measure
and More importantly monitor the profile of the bank. While Non-Performing Assets are the
legacy of the past in the present, Risk Management system is the pro-active action in the
present for the future. Managing risk is nothing but managing the change before the risk
manages. While new avenues for the bank has opened up they have brought with them new
risks as well, which the banks will have to handle and overcome.

Over the last few years the Indian financial markets have witnessed wide ranging changes at
fast pace. Intense competition for business involving both the assets and liabilities, together
with increasing volatility in the domestic interest rates as well as foreign exchange rates, has
brought pressure on the management of banks to maintain a good balance among spreads,

9
Profitability and long-term viability. These pressures call for structured and comprehensive
measures and not just ad hoc action. The Management of banks has to base their business
decisions on a dynamic and integrated risk management system and process, driven by
corporate strategy. Banks are exposed to several major risks in the course of their business
Credit risk, interest rate risk, foreign exchange risk, equity / commodity price risk, liquidity
risk and operational risks.

ASSET LIABILITY MANAGEMENT:

Asset Liability Management (ALM) is a comprehensive and dynamic framework for

measuring, monitoring and managing the market risk of a bank. It is the management of
structure of balance sheet (liabilities and assets) in such a way that the net earnings from
interest are maximized within the overall risk-preference (present and future) of the
institutions. It 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. In
other words ALM is the act of planning, acquiring, and directing the flow of funds through an
organization.

A comprehensive ALM policy framework focuses on bank profitability and long-term

viability by targeting the net interest margin (NIM) ratio and Net Economic Value (NEV),
subject to balance sheet constraints. Significant among these constraints are maintaining
credit quality, meeting liquidity needs and obtaining sufficient capital. An insightful view of
ALM is that it simply combines portfolio management techniques (that is, asset, liability and
spread management) into a coordinated process. Thus, the central theme of ALM is the
coordinated – and not piecemeal – management of a bank’s entire balance sheet. Although
ALM is not a relatively new planning tool, it has evolved from the simple idea of maturity-
matching of assets and liabilities across various time horizons into a framework that includes
sophisticated concepts such as duration matching, variable rate pricing, and the use of static
and dynamic simulation.

DEFINITION OF ALM

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 ALM is defined as, “the process of decision – making to control risks of existence, stability
and growth of a system through the dynamic balances of its assets and liabilities.”

» The text book definition of ALM is “a risk management technique designed to earn an
adequate return while maintaining a comfortable surplus of assets beyond liabilities. It takes
into consideration interest rates, earning power and degree of willingness to take on debt. It is
also called surplus –management”.

» The goal of asset/liability management (ALM) is to properly manage the risk related to
changes in interest rates, the mix of balance sheet assets and liabilities, the holding of foreign
currencies, and the use of derivatives. These risks should be managed in a manner that
contributes adequately to earnings and limits risk to the financial margin and member equity.

Proper management of asset/liability risk is facilitated through board approved policy, which
sets limits on asset and liability mix, as well as the level of interest rate risk and foreign
currency risk to which the credit union is willing to expose itself. Policy should also set out
guidelines for the pricing, term and maturity of loans and deposits. The use of derivatives, if
any, should also be controlled by policy, which should state among other things that
derivatives must only be used to limit interest rate risk and must never be used for speculative
or investment purposes.

SCOPE OF ALM

» The ALM functions extend to liquidly risk management, management of market risk, trading
risk management, funding and capital planning and profit planning and growth projection.

» Residual maturity:- Residual maturity is the time period which a particular asset or liability
will still take to mature i.e. become due for payment (once at a time, say in case of a term
deposit or in installments, say in case of term loan).

» Maturity buckets:- Maturity buckets are different time intervals (1day, 2-7 days, 15-28,
29days -3 months, 3-6 months, 6 months- 1 year, 1-3 years, 3-5 and above 5 Years), in
which the value of a particular asset or liability is placed depending upon its residual
maturity.

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» Mismatch position: - When in a particular maturity bucket, the amount of maturing liabilities
or assets does not match, such position is called a mismatch position, which creates liquidity
surplus or liquidity crunch position and depending upon the interest rate movement, such
situation may turn out to be risky for the bank.

» The mismatches for cash flows for 1day, 2-7 days, 15-28, 29days -3 months buckets are to
be kept to the minimum (not to exceed 5%, 10%, 15%, 20% each of cash outflows for those
buckets respectively.)

» Role of ALCO: - Asset-Liability Committee is the top most committee to oversee

implementation of ALM system, to be headed by CMD or ED. ALCO would consider
product pricing for both deposits and advances, the desired maturity profile of the

» Incremental assets and liabilities in addition to monitoring the risk levels of the bank. It will
have to articulate current interest rates view of the bank and base its decisions for future
business strategy on this view.

BENEFITS OF ALM
» It is a tool that enables bank managements to take business decisions in a more informed
framework with an eye on the risks that bank is exposed to. It is an integrated approach to
financial management, requiring simultaneous decisions about the types of amounts of
financial assets and liabilities - both mix and volume - with the complexities of the financial
markets in which the institution operates

MEASURING RISK
The function of ALM is not just protection from risk. The safety achieved through ALM also
opens up opportunities for enhancing net worth. Interest rate risk (IRR) largely poses a
problem to a bank’s net interest income and hence profitability. Changes in interest rates can
significantly alter a bank’s net interest income (NII), depending on the extent of mismatch
between the asset and liability interest rate reset times. Changes in interest rates also affect
the market value of a bank’s equity. Methods of managing IRR first require a bank to specify
goals for either the book value or the market value of NII. In the former case, the focus will

12
 be on the current value of NII and in the latter, the focus will be on the market value of
equity. In either case, though, the bank has to measure the risk exposure and formulate
Strategies to minimize or mitigate risk. The immediate focus of ALM is interest-rate risk and
Return as measured by a bank’s net interest margin. ALM is a systematic approach that
attempts to provide a degree of protection to the risk arising out of asset/liability mismatch.
NIM = (Interest income – Interest expense) / Earning assets A bank’s NIM, in turn, is a
function of the interest-rate sensitivity, volume, and mix of its earning assets and liabilities.
That is, NIM = f (Rate, Volume, Mix)

SOURCES OF INTEREST RATE RISK

The primary forms of interest rate risk include repricing risk, yield curve risk, basis
risk and optionality.

EFFECTS OF INTEREST RATE RISK

Changes in interest rates can have adverse effects both on a bank’s earnings and its
economic value.
» The earnings perspective: - From the earnings perspective, the focus of analyses is the impact
of changes in interest rates on accrual or reported earnings. Variation in earnings (NII) is an
important focal point for IRR analysis because reduced interest earnings will threaten the
financial performance of an institution.
» Economic value perspective: - Variation in market interest rates can also affect the economic
value of a bank’s assets, liabilities, and Off Balance Sheet (OBS) positions. Since the
economic value perspective considers the potential impact of interest rate changes on the
present value of all future cash flows, it provides a more comprehensive view of the potential
long-term effects of changes in interest rates than is offered by the earnings perspective.

INTEREST RATE SENSITIVITY AND GAP MANAGEMENT

This model measures the direction and extent of asset-liability mismatch through a funding or
maturity GAP (or, simply, GAP). Assets and liabilities are grouped in this method into time
buckets according to maturity or the time until an insightful view of ALM is that it simply
combines portfolio management techniques into a coordinated process.

13
 AS A TOOL FOR MANAGING IRR, GAP MANAGEMENT SUFFERS FROM
THREE LIMITATIONS:
» Financial institutions in the normal course are incapable of out-predicting the markets, hence
maintain the zero GAP.
» It assumes that banks can flexibly adjust assets and liabilities to attain the desired GAP.
» It focuses only on the current interest sensitivity of the assets and liabilities, and ignores the
effect of interest rate movements on the value of bank assets and liabilities.

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 1.1 EXECUTIVE SUMMARY

Asset liability management is a Risk-management technique, aimed at earning adequate

returns while keeping a comfortable surplus of assets over liabilities. Its objective is to
balance the (1) income earning power of an entity's assets available for pledging as collateral,
(2) current and anticipated interest rates, and (3) entity's debt comfort level. By managing a
company's assets and liabilities, executives are able to influence net earnings, which may
translate into increased stock prices. 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.

Reserve Bank had issued guidelines on ALM system vide Circular dated October 24 2007,
which covered, among others, interest rate risk and liquidity risk measurement / reporting
framework and prudential limits. As a measure of liquidity management, banks are required
to monitor their cumulative mismatches across all time buckets in their Statement of
Structural Liquidity by establishing internal prudential limits with the approval of the Board /
Management Committee. As per the guidelines, the mismatches (negative gap) during the
time buckets of 1day, 2-7 days, 15-28 days, 29days -3 months, in the normal course are not to
exceed 5%,20%, 15% and 20 per cent of the cash outflows in the respective time buckets.

The project examines whether these guidelines are being followed by South Indian Bank Ltd
and how they are managing liquidity and interest rate risk using asset liability management
system.

15
 1.3 STATEMENT OF THE PROBLEM

ALM is a strategic tool used to assess the mismatch between assets and liabilities in banks.
With the volatility in foreign exchange rates as well as in interest rate are confusing trend for
banks to keep proper balance between the assets and liabilities spreads , profitability and long
term viability. Here the South Indian bank wants to know whether these assets and liabilities
are managed efficiently or not.

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 1.4 OBJECTIVES OF THE STUDY

» To determine whether there is any interest rate risk using gap analysis.
» To study the asset liability management implemented at SIB as per RBI guidelines.
» To analyze earnings at risk
» To determine whether there is any liquidity mismatch using maturity ladder.

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 1.5 SCOPE OF THE STUDY

Banks are exposed to several major risks in the course of their business: credit risk, interest
rate risk, foreign exchange risk and equity or commodity price risk, liquidity risk and
operational risk. ALM is concerned with risk management and provides a comprehensive and
dynamic framework for measuring, monitoring and managing liquidity, interest rate, foreign
exchange and equity commodity price risk of banks that need to be closely integrated with
the banks business strategy. It involves assessment of various types of risk and altering the
asset.

ALM is an integral part of the planning process of the commercial banks. It may be
considered as one of the principal component of a planning system. The banks obtain their
funds from a wide variety of sources including current deposits, savings deposits, fixed
deposits, short term borrowings and equity capital. From this pool of funds, the banks should
have a trade off in acquiring the assets that serve the needs for meeting the legal requirement,
earning income and providing liquidity. The south Indian bank has emerged over the years as
the fastest growing traditional bank in Kerala. It has over the years managed its assets and
liabilities exceedingly.

The study is conducting in South Indian Bank as of it is able to understand the

ALM system followed by SIB.

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 1.6 LIMITAIONS OF THE STUDY

» As the concept of ALM is a new one, availability of literature was limited. The data for the
project was mainly the ALM statements of the bank.
» Time available for doing this project was only 21 days which is very small period to analyze
such a vast topic.
» The interpretations made give only brief idea about the asset liability management.

1.7 THEORITICAL BASIS

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Asset-liability management basically refers to the process by which an institution manages its
balance sheet in order to allow for alternative interest rate and liquidity scenarios. Banks and
other financial institutions provide services which expose them to various kinds of risks like
credit risk, interest risk, and liquidity Risk. Asset liability management is an approach that
provides institutions with Protection that makes such risk acceptable. Asset-liability
management models Enable institutions to measure and monitor risk, and provide suitable
strategies for their management. It is therefore appropriate for institutions (banks, finance
companies, leasing companies, Insurance companies and others) to focus on asset-liability
management when they face financial risks of different types. Asset-liability management
includes not only a formalization of this understanding, but also a way to quantify and
manage these risks. Further, even in the absence of a formal asset-liability Management
program, the understanding of these concepts is of value to an Institution as it provides a truer
picture of the risk/reward trade-off in which the Institution is engaged (Fabozzi & Kanishi,
1991), Asset-liability management is a first step in the long-term strategic planning process.
Therefore, it can be considered as a planning function for an intermediate Term. In a sense,
the various aspects of balance sheet management deal with planning As well as direction and
control of the levels, changes and mixes of assets,
Liabilities and capital.

Earlier phase
In the 1940s and the 1950s, there was an abundance of funds in banks in the form of demand
and savings deposits. Because of the low cost of deposits, banks had to develop mechanisms
by which they could make efficient use of these funds. Hence, the focus then was mainly on
asset management. But as the availability of Low cost funds started to decline, liability
Management became the focus of bank Management efforts. Liability management
essentially refers to the practice of buying money through Cumulative deposits, federal funds
and commercial paper in order to fund profitable Loan opportunities. But with an increase in

volatility in interest rates and With A severe recession damaging several economies, banks
started to concentrate more on the management of both sides of the balance sheet.
Categories of risk
Risk in a way can be defined as the chance or the probability of loss or damage. In the case of
banks, these include credit risk, capital risk, market risk, interest Rate risk and liquidity risk.
20
These categories of financial risk require focus, since financial institutions like banks do have
complexities and rapid changes in their Operating environments.
Credit risk: Credit Risk is the potential that a bank borrower/counter party fails to meet the
obligations on agreed terms. There is always scope for the borrower to default from his
commitments for one or the other reason resulting in crystallization of credit risk to the bank.
These losses could take the form outright default or alternatively, losses from changes in
portfolio value arising from actual or perceived deterioration in credit quality that is short of
default. Credit risk is inherent to the business of lending funds to the operations linked
closely to market risk variables. The objective of credit risk management is to minimize the
risk and maximize bank’s risk adjusted rate of return by assuming and maintaining credit
exposure within the acceptable parameters. Credit risk consists of primarily two components,
viz Quantity of risk, which is nothing but the outstanding loan balance as on the date of
default and the quality of risk, viz, the severity of loss defined by both Probability of Default
as reduced by the recoveries that could be made in the event of default. Thus credit risk is a
combined outcome of Default Risk and Exposure Risk. The elements of Credit Risk are
Portfolio risk comprising Concentration Risk as well as Intrinsic Risk and Transaction Risk
comprising migration/down gradation risk as well as Default Risk. At the transaction level,
credit ratings are useful measures of evaluating credit risk that is prevalent across the entire
organization where treasury and credit functions are handled. Portfolio analysis help in
identifying concentration of credit risk, default/migration statistics, recovery data, etc. In
general, Default is not an abrupt process to happen suddenly and past experience dictates that,
more often than not, borrower’s credit worthiness and asset quality declines gradually, which
is otherwise known as migration. Default is an extreme event of credit migration. Off balance
sheet exposures such as foreign exchange forward can tracks, swaps options etc are classified
in to three broad categories such as full Risk, Medium Risk and Low risk and then translated
into risk Neighted assets through a conversion factor and summed up. The management of
credit risk includes a) measurement through credit rating/ scoring, b) quantification through
estimate of expected loan losses, c) Pricing on a scientific basis and d) Controlling through
effective Loan Review Mechanism and Portfolio Management

Capital risk: One of the sound aspects of the banking practice is the maintenance of adequate
capital on a continuous basis. There are attempts to bring in global norms in this field in order
to bring in commonality and standardization in international practices. Capital adequacy also

21
focuses on the weighted average risk of lending and to that extent, banks is in a position to
realign their portfolios between more risky and less risky assets.
Market risk: Market risk is related to the financial condition, which results from adverse
movement in market prices. This will be more pronounced when financial information has to
be provided on a marked-to-market basis since significant fluctuations in asset holdings could
adversely affect the balance sheet of banks. In the Indian context, the problem is accentuated
because many financial institutions acquire bonds and hold it till maturity. When there is a
significant increase in the term structure of interest rates, or violent fluctuations in the rate
structure, one finds substantial erosion of the value of the securities held.

Interest rate risk: Credit Risk is the potential that a bank borrower/counter party fails to meet
the obligations on agreed terms. There is always scope for the borrower to default from his
commitments for one or the other reason resulting in crystallization of credit risk to the bank.
These losses could take the form outright default or alternatively, losses from changes in
portfolio value arising from actual or perceived deterioration in credit quality that is short of
default. Credit risk is inherent to the business of lending funds to the operations linked
closely to market risk variables. The objective of credit risk management is to minimize the
risk and maximize bank’s risk adjusted rate of return by assuming and maintaining credit
exposure within the acceptable parameters. Credit risk consists of primarily two components,
viz Quantity of risk, which is nothing but the outstanding loan balance as on the date of
default and the quality of risk, viz, the severity of loss defined by both Probability of Default
as reduced by the recoveries that could be made in the event of default. Thus credit risk is a
combined outcome of Default Risk and Exposure Risk. The elements of Credit Risk are
Portfolio risk comprising Concentration Risk as well as Intrinsic Risk and Transaction Risk
comprising migration/down gradation risk as well as Default Risk. At the transaction level,
credit ratings are useful measures of evaluating credit risk that is prevalent across the entire
organization where treasury and credit functions are handled. Portfolio analysis help in
identifying concentration of credit risk, default/migration statistics, recovery data, etc. In
general, Default is not an abrupt process to happen suddenly and past experience dictates that,
more often than not, borrower’s credit worthiness and asset quality declines gradually, which
is otherwise known as migration. Default is an extreme event of credit migration. Off balance
sheet exposures such as foreign exchange forward can tracks, swaps options etc are classified
in to three broad categories such as full Risk, Medium Risk and Low risk and then translated
into risk Neighted assets through a conversion factor and summed up. The management of
22
credit risk includes a) measurement through credit rating/ scoring, b) quantification through
estimate of expected loan losses, c) Pricing on a scientific basis and d) Controlling through
effective Loan Review Mechanism and Portfolio Management
Interest Rate Risk
Interest Rate Risk is the potential negative impact on the Net Interest Income and it refers to
the vulnerability of an institution’s financial condition to the movement in interest rates.
Changes in interest rate affect earnings, value of assets, liability off-balance sheet items and
cash flow. Hence, the objective of interest rate risk management is to maintain earnings,
improve the capability, ability to absorb potential loss and to ensue the adequacy of the
compensation received for the risk taken and affect risk return trade-off. Management of
interest rate risk aims at capturing the risks arising from the maturity and re-pricing
mismatches and is measured both from the earnings and economic value perspective.
Earnings perspective involves analyzing the impact of changes in interest rates on accrual or
reported earnings in the near term. This is measured by measuring the changes in the Net
Interest Income (NII) equivalent to the difference between total interest income and total
interest expense. In order to manage interest rate risk, banks should begin evaluating the
vulnerability of their portfolios to the risk of fluctuations in market interest rates. One such
measure is Duration of market value of a bank asset or liabilities to a percentage change in
the market interest rate. The difference between the average duration for bank assets and the
average duration for bank liabilities is known as the duration gap which assess the bank’s
exposure to interest rate risk. The Asset Liability Committee (ALCO) of a bank uses the
information contained in the duration gap analysis to guide and frame strategies. By reducing
the size of the duration gap, banks can minimize the interest rate risk. Economic Value
perspective involves analyzing the expected cash in flows on assets minus expected cash out
flows on liabilities plus the net cash flows on off-balance sheet items. The economic value
perspective identifies risk arising from long-term interest rate gaps. The various types of
interest rate risks are detailed below: Gap/Mismatch risk: It arises from holding assets and
liabilities and off balance sheet items with different principal amounts, maturity dates & re-
pricing dates thereby creating exposure to unexpected changes in the level of market interest
rates. Basis Risk:
It is the risk that the Interest rate of different Assets/liabilities and off balance items may
change in different magnitude. The degree of basis risk is fairly high in respect of banks that
create composite assets out of composite liabilities.

23
Embedded option Risk: Option of pre-payment of loan and Fore- closure of deposits before
their stated maturities constitute embedded option risk
Yield curve risk: Movement in yield curve and the impact of that on portfolio values and
income.
Reprice risk: When assets are sold before maturities.
Reinvestment risk: Uncertainty with regard to interest rate at which the future cash flows
could be reinvested.
Net interest position risk: When banks have more earning assets than paying liabilities, net
interest position risk arises in case market interest rates adjust downwards.
There are different techniques such as a) the traditional Maturity Gap Analysis to measure the
interest rate sensitivity, b) Duration Gap Analysis to measure interest rate sensitivity of
capital, c) simulation and d) Value at Risk for measurement of interest rate risk
. There are certain measures available to measure interest rate risk. These include:
Maturity: Since it takes into account only the timing of the final principal payment, maturity
is considered as an approximate measure of risk and in a sense does not quantify risk. Longer
maturity bonds are generally subject to more interest rate risk than shorter maturity bonds.
Duration: Is the weighted average time of all cash flows, with weights being the present
values of cash flows. Duration can again be used to determine the sensitivity of prices to
changes in interest rates. It represents the percentage change in value in response to changes
in interest rates.

Dollar duration: Represents the actual dollar change in the market value of a holding of the
bond in response to a percentage change in rates.

Convexity: Because of a change in market rates and because of passage of time, duration may
not remain constant. With each successive basis point movement downward, bond prices
increase at an increasing rate. Similarly if rates increase, the rate of decline of bond prices
declines. This property is called convexity. In the Indian context, banks in the past were
primarily concerned about adhering to statutory liquidity ratio norms and to that extent they
were acquiring government securities and holding it till maturity. But in the changed
situation, namely moving away from administered interest rate structure to market
determined rates, it becomes important for banks to equip themselves with some of these
techniques, in order to immunize banks against interest rate risk.

24
 Liquidity risk: Bank Deposits generally have a much shorter contractual maturity than loans
and liquidity management needs to provide a cushion to cover anticipated deposit
withdrawals. Liquidity is the ability to efficiently accommodate deposit as also reduction in
liabilities and to fund the loan growth and possible funding of the off-balance sheet claims.
The cash flows are placed in different time buckets based on future likely behavior of assets,
liabilities and off-balance sheet items. Liquidity risk consists of Funding Risk, Time Risk &
Call Risk.
Funding Risk : It is the need to replace net out flows due to unanticipated
withdrawal/nonrenewal of deposit
Time risk : It is the need to compensate for non receipt of expected inflows of funds, i.e.
performing assets turning into nonperforming assets.
Call risk : It happens on account of crystallization of contingent liabilities and inability to
undertake profitable business opportunities when desired.
The Asset Liability Management (ALM) is a part of the overall risk management system in
the banks. It implies examination of all the assets and liabilities simultaneously on a
continuous basis with a view to ensuring a proper balance between funds mobilization and
their deployment with respect to their a) maturity profiles, b) cost, c) yield, d) risk exposure,
etc. It includes product pricing for deposits as well as advances, and the desired maturity
profile of assets and liabilities. Tolerance levels on mismatches should be fixed for various
maturities depending upon the asset liability profile, deposit mix, nature of cash flow etc.
Bank should track the impact of pre-payment of loans & premature closure of deposits so as
to realistically estimate the cash flow profile.

Risk measurement techniques

There are various techniques for measuring exposure of banks to interest rate risks:
» Gap analysis model: Measures the direction and extent of asset-liability mismatch through
either funding or maturity gap. It is computed for assets and liabilities of differing maturities
and is calculated for a set time horizon. This model looks at the repricing gap that exists
between the interest revenue earned 9n the bank's assets and the interest paid on its liabilities
over a particular period of time (Saunders, 1997). It highlights the net interest income
exposure of the bank, to
Changes in interest rates in different maturity buckets. Repricing gaps are calculated for
assets and liabilities of differing maturities. A positive gap indicates that assets get repriced
before liabilities, whereas, a negative gap indicates that liabilities get repriced before assets.
25
 The bank looks at the rate sensitivity (the time the bank manager will have to wait in order to
change the Posted rates on any asset or liability) of each asset and liability on the balance
sheet. The general formula that is used is as follows: NIIi= R i (GAPi) While NII is the net
Interest income, R refers to the interest rates impacting assets and liabilities in the relevant
maturity bucket and GAP refers to the differences between the book value of the rate
sensitive assets and the rate sensitive Liabilities. Thus when there is a change in the interest
rate, one can easily identify the impact of the change on the net interest income of the bank.
Interest rate changes have a market value effect. The basic weakness with this model is that
this method takes into account only the book value of assets and liabilities and hence ignores
their market value. This method therefore is only a partial measure of the true interest rate
exposure of a bank.

Duration model: Duration is an important measure of the interest rate sensitivity of assets
and liabilities as it takes into account the time of arrival of cash flows and the maturity of
assets and liabilities. It is the weighted average time to maturity of all the preset values of
cash flows. Duration basic -ally refers to the average life of the asset or the liability. DP p =
D ( dR /1+R) The above equation describes the percentage fall in price of the bond for a
given increase in the required interest rates or yields. The larger the value of the duration, the
more sensitive is the price of that asset or liability to changes in interest rates. As per the
above equation, the bank will be immunized from interest rate risk if the duration gap
between assets and the liabilities is zero. The duration model has one important benefit. It
uses the market value of assets and liabilities.
» Value at Risk: Refers to the maximum expected loss that a bank can suffer over a target
horizon, given a certain confidence interval. It enables the calculation of market risk of a
portfolio for which no historical data exists. It enables one to calculate the net worth of the
organization at any particular point of time so that it is possible to focus on long-term risk
implications of decisions that have already been taken or that are going to be taken. It is used
extensively for measuring the market risk of a portfolio of assets and/or liabilities.

» Simulation: Simulation models help to introduce a dynamic element in the analysis of

interest rate risk. Gap analysis and duration analysis as stand-alone tool for asset-liability
management suffer from their inability to move beyond the static analysis of Current interest

26
rate risk exposures. Basically simulation models utilize computer power to provide what if
scenarios, for example: What if the absolute level of interest rates shift. There are nonparallel
yield curve changes. Marketing plans are under-or-over achieved. Margins achieved in the
past are not sustained/improved. Bad debt and prepayment levels change in different interest
rate scenarios. There are changes in the funding mix e.g.: an increasing reliance on short term
funds for balance sheet growth.

ASSET LIABILITY MANAGEMENT

In banking, asset liability management is the practice of managing risk that arises due to
mismatches between the assets and liabilities of the bank. Banks face severe risks such as
liquidity risk, interest rate risk, credit risk and operational risk. Asset liability management
(ALM) is a strategic tool manages interest rate risk and liquidity risk faced by banks, other
financial services companies and corporations. Techniques for assessing asset liability risk
came to include gap analysis and duration analysis. These facilitated technique of gap
management and duration matching of assets and liabilities. Both approaches worked well if
assets and liabilities comprised fixed cash flows. The scope of ALM activities has widened.
Today, ALM departments are addressing foreign exchange risks and other risks. Also ALM
has extended to non financial firms. Corporations have adopted technique of ALM to address
interest rate exposures, liquidity risk and foreign exchange risks. They are using related
technique to address commodities risk.

ALM is the management of structure of balance sheet in such a way that net earnings from
interest are maximized within the overall risk preference of the banks. The ALM functions
extend to liquidity risk management, management of market risk, trading risk management,
funding and capital planning and profit planning and growth projection. It is a tool that
enables bank management to take business decisions in a more informed framework with an
eye on the crisis that the bank is exposed to. It is an integrated approach to financial
management, requiring simultaneous decisions about the types of amounts of financial assets
and liabilities- both mix and volume- with the complexities of financial markets in which the
institution operates. The assets and liabilities of the bank’s balance sheet are nothing but
future cash flows or out flows. With a view to measure liquidity and interest rate risk, bank
use maturity basis of statutory reserve cycle, which are termed as time buckets. As a measure
of liquidity management, banks are required to monitor their cumulative mismatches across

27
 all time buckets in their statement of structural liquidity by establishing internal prudential
limits with the approval of the Board / Management Committee.

The concept of ALM is of recent origin in India. It has been

introduced in the Indian banking industry w.e.f 1ST April 1999. In the regulated banking
environment in India prior to 1990s, the equation of ALM to liquidity management could be
understood. There was no interest rate risk as interest rates were regulated and prescribed by
RBI. Spreads between the deposits and lending rates were very wide; also, these spreads were
more or less uniform among the commercial banks and were changed only by RBI. If a bank
suffered losses in managing its banking assets, the same were absorbed by comfortably wide
spreads. Clearly the bank balance sheet was not being managed by banks themselves; it was
being managed by prescriptions of the regulatory authority and the government. This
situation has now changed. The banks have been given a large amount of freedom to manage
their balance sheets. Increasingly managers of financial firms on asset liability risk. The
problem was not that the value of asset might fall or that the value of liabilities might rise. It
was that capital might be depleted by narrowing of the difference between assets and
liabilities. That the values of assets and liabilities might fail to move in tandem. Asset
liability risk is a leveraged form of risk. The capital of most financial institutions is small
relative to the firm’s assets or liabilities, so small percentage changes in assets or liabilities
can translate into large percentage changes in capital.

ALM has wide applications in financial institution. It is an integral part of the process of
commercial banks. In fact, it may be considered as one of the three principal components of a
planning system. Three components are :-

» ALM which focuses primarily on the day to day or week to week Balance sheet necessary to
achieve short term financial goals.
» Annual profit planning and controls which focus on slightly long term goals and look at a
detail financial plan over the course of a fiscal or calendar year.
» Strategic planning which focuses on the long term financial and non financial aspects of a
bank’s performance.

ALM ORGANISATION

28
 Successful implementation of the risk management process would require strong commitment
on the part of senior management in the bank, to integrate basic operations and strategic
decision making with risk management. The board should have overall responsibility for
management of risks and should decide the risk management policy of the bank and set limits
for liquidity, interest rate and foreign change and equity, price risks.

The Asset Liability Committee (ALCO) consisting of the bank’s

Senior Management including CEO should be responsible for ensuring adherence to the
limits set by the board. It also has to decide the business strategy of the bank (on the Asset
Liability sides) in line with the bank budget and decide risk management objectives.

The ALM support groups consisting of operating

staff should be responsible for analyzing, monitoring and reporting the risk profile of the
ALCO. The staff should also prepare for the forecast, which shows the effect of various
changes market conditions related to the balance sheet. They then recommend the needed
action which is within the bank’s internal limits.

The ALCO is the decision making unit responsible for the balance sheet planning form a risk
return perspective including the strategic management of interest rate and liquidity risks
.Each bank has to set up the role of ALCO; its responsibility has also the decision to be taken
by it.

The business issues that an ALCO would consider include:

» Product pricing for both deposits and advances.

» Decide maturity profile.
» Determine the mix of incremental assets and liabilities.
» Monitor the risk levels.
» Review the results of progress in implementation of decisions taken in meetings.

ALCO OBJECTIVES

» To provide adequate liquidity to the bank for optimum matching of maturing assets and
liabilities without any undue strain on profitability.

29
» To ensure that interest rate risk is properly managed.

Individual banks will have to decide the frequency of holding their ALCO meetings. The
size of ALCO depends on the size of each institution; business mix organizational
complexity. The CEO/CMD/ED should lead the committee so that top management
commitment is involved. The chief of investment, credit, treasury and planning can be
members of the committee. Some banks may even have sub committees and support groups.

ALM Function

The scope of the ALM function can be described as under:

» Liquidity Risk Management

» Management of Market Risk
» Trading Risk Management
» Funding and Capital Planning
» Profit Planning Growth Projection

ALM PRINCIPLES

» ECONOMICVALUE: ALM focuses on Economic Value. A consistent ALM structure can

only be achieved for economic objectives. Economic value is based on future asset and
liability cash flows. ALM uses these future cash flows to determine the risk exposure and
achieve the financial objectives of an entity.

An entity’s financial objectives may include maximizing one or more of these values:
economic value, accounting measures such as earnings and return on equity, or embedded
value. For private pension plans, financial objectives may include the pattern of future
funding requirements. Various accounting measures are affected by rules that change the
emergence of income and the reported book value of the assets and liabilities. These
measures can sometimes distort economic reality and produce results inconsistent with
economic value.
» MUTUALDEPENDENCE : Liabilities and their associated assets are mutually dependent.
Mutual dependence arises in an ALM context because of the necessity to manage the

30
 interdependence between the asset and liability cash flows to achieve economic and financial
objectives. The mutual dependence principle applies to portfolios consisting of both assets
and liabilities. It holds even if the assets and liabilities are affected by different economic
factors, or even if asset and liability cash flows are fixed.The mutual dependence principle
implies that assets and liabilities must be managed concurrently in order to optimize
achievement of economic and financial objectives.
» DIVERSIFICATION :The level of risk associated with a given financial objective can be
reduced through diversification by combining exposures that are less than 100% positively
correlated. Risks are diversifiable through aggregation up to the point where only systematic
risk remains. For example, the return volatility of a portfolio of assets caused by changes to
the level of prevailing interest rates is diversifiable through investing in different asset classes
such as stocks. However, the residual systematic risk cannot be diversified through simple
aggregation. It can, however, be reduced through hedging. In times of significant economic
turmoil asset correlations tend toward 1.0 or – 1.0.
» RISK/REWARDTRADE-OFF: Greater rewards are generally expected from portfolios with
higher levels of risk. Rational investors expect greater rewards for accepting higher levels of
risk. The higher-risk/greater-reward relationship may not hold if the portfolio is sub-optimal
for a given level of risk (i.e., a comparably risky portfolio has a higher return); if an arbitrage
opportunity exists in the markets, or if environmental pressures affect investors’ preferences
and behaviors. As a direct result of the risks accepted, greater Reward commensurate with
higher risk levels may not be actually realized. In an ALM context, the riskiness of a portfolio
is determined by the net position of the combined assets and liabilities.

» CONSTRAINTS: Expected risk/reward trade-off tends to worsen as more constraints are

imposed and as the constraints become more restrictive. An ALM framework contains
internal and external constraints including investment policy requirements, rating agency
expectations, regulatory issues, and required capital goals.
» DYNAMICENVIRONMENT: The risks to which an entity is exposed and the associated
rewards are determined by internal and external factors that change over time. ALM is an
ongoing process. Risks an entity assumes and to which it is exposed are continuously
changing. Internal factors arise from the financial objectives, risk tolerances, and constraints
of the entity. External factors include interest rates, equity returns, competition, and the legal
Environment, regulatory requirements, and tax constraints. Such factors often impact both

31
 assets and liabilities simultaneously, although the impact is not necessarily of the same
magnitude or in the same direction. Furthermore, an entity may have different risk tolerances
under different circumstances and for different time horizons. Accordingly, analyses,
conclusions, and strategies relevant to a specific point in time need to be periodically
reevaluated and updated.

» UNCERTAINTY: Asset and liability cash flows cannot be projected with certainty. The
dynamic environment as well as pure randomness creates uncertainties in the portfolio cash
Flows and, hence, in the true risk exposure. Risk varies as the underlying risk factors (e.g.,
interest rates, equity returns, defaults, policyholder/customer behavior, lapses/withdrawals,
pension shutdowns, etc.) change and as future expected cash flows is replaced by actual cash
flows. This process reflects cash flows reacting to factor changes (e.g., interest-sensitive cash
flows), truing up to actual experience, and results in revisions of future assumptions. The
ultimate risk exposure will be a function of the actual cash flows.
» HEDGING: The overall risk of a portfolio may be reduced through hedging. Hedging plays
an integral role in the ALM process. Once the risks associated with a portfolio or transaction
has been identified, the existing risks can be modified to suit the entity’s risk tolerances and
financial objectives. Undertaking additional risks that partially or fully offset the existing
risks may accomplish this goal. Hedging may be done at either the transaction or portfolio
level. Hedging may be complete or partial, perfect or imperfect (i.e., cross hedging). Hedging
instruments include assets, liabilities, and derivatives. An asset with a matching liability is a
natural hedge.

FUNDAMENTAL STEPS OF AN ALM PROCESS

An effective ALM process begins with the support of the entity’s senior management.
Ongoing communication is essential. The process consists of five fundamental steps:

» ASSESS THE ENTITY’S RISK/REWARD OBJECTIVES : The purpose of ALM is not

necessarily to eliminate or even minimize risk. The level of risk will vary with the return
requirement and entity’s objectives. Financial objectives and risk tolerances are generally
determined by senior management of an entity and are reviewed from time to time.

» IDENTIFY RISKS : All sources of risk are identified for all assets and liabilities. Risks are
broken down into their component pieces and the underlying causes of each component are

32
 assessed. Relationships of various risks to each other and/or to external factors are also
identified.
» QUANTIFY THE LEVEL OF RISK EXPOSURE: Risk exposure can be quantified 1)
relative to changes in the component pieces, 2) as a maximum expected loss for a given
confidence interval in a given set of scenarios, or 3) by the distribution of outcomes for a
given set of simulated scenarios for the component piece over time. Regular measurement
and monitoring of the risk exposure is required.
» FORMULATE AND IMPLEMENT STRATEGIES TO MODIFY EXISTING RISKS
ALM : Strategies comprise both pure risk mitigation and optimization of the risk/reward
tradeoff. Risk mitigation can be accomplished by modifying existing risks through
Techniques such as diversification, hedging, and portfolio rebalancing. For a given risk
tolerance level, a given set of investment opportunities, and a given set of constraints,
optimization ensures that the portfolio has the most desirable risk/reward tradeoff.
Optimization presupposes that the management team has been previously educated on the
risk/reward profile of the business and understands the necessity to take action based on
ALM analysis..

» MONITOR RISK EXPOSURES AND REVISE ALM STRATEGIES AS APPROPRIATE:

ALM is a continual process. All identified risk exposures are monitored and reported to
senior management on a regular basis. If a risk exposure exceeds its approved limit,
corrective actions are taken to reduce the risk exposure. For pension plans, monitoring
current financial status and possible short-term outcomes is very helpful in managing pension
risk. Operating within a dynamic environment, as the entity’s risk tolerances and financial
objectives change, the existing ALM strategies may no longer be appropriate. Hence, these
strategies need to be periodically reviewed and modified. A formal, documented
communication process is particularly important in this step.

1.8 DEFINITION OF TERMS

» Deposit

33
 A deposit is a current account, savings account, or other type of bank account, at a
banking institution that allows money to be deposited and withdrawn by the account
holder. These transactions are recorded on the bank’s books, and the resulting
balances recorded as a liability for the bank, and represent the amount owed by the
bank to the customer. Some banks charge a fee for this service, while others may pay
the customer interest on the funds deposited.

» Term Deposit

A term deposit is a money deposit at a banking institution that cannot be withdrawn

for a certain “term” or period of the time unless a penalty is paid. When the term is
over it can be withdrawn or it can be held for another term. Generally speaking the
longer the term the better the yield on the money. The rate of return is higher than for
savings accounts because the requirements that the deposit be held for an integer
multiple of the term gives the bank the availability to invest it in a higher gain
financial product class.

» Interbank Deposit
Any deposit that is held by one bank for another bank. In most cases, the bank for
which the deposit is being held is referred to as the correspondent bank. The interbank
deposit arrangement requires that both banks hold a “due to account” for the other.

» Term Loan

A loan from a bank for a specific amount that has a specified repayment schedule and
a floating interest rate. Term loans almost always mature between one and 10 years.
For example many banks have term- loan programs that can offer small businesses the
cash they need to operate from month to month. Often a small business will use the
cash from a term loan to purchase fixed assets such as equipment used in its
production process.

34
» Swap

A swap is a derivative in which counterparties exchange cash flows of one party’s

financial instrument for those of the other party’s financial instrument. The benefits in
question depend on the type of financial instruments involved. Swaps can be used to
hedge certain risks such as interest rate risk or to separate on changes in the expected
direction of underlying prices.

» Money At Call

A short term loan that does not have a set repayment schedule. But is payable
immediately and in full upon demand money at call loans gives banks a way to earn
interest while retaining liquidity. Investors might use money at call to cover a margin
account. The interest rate on such loans is called the call-loan rate.

35
 CHAPTER 2

INDUSTRY PROFILE

INDUSTRY PROFILE

FINANCIAL STRUCTURE
The Indian financial system comprises the following institutions:
1. Commercial banks
A. Public sector
B. Private sector
C. Foreign banks
36
 D. Cooperative institutions
(i) Urban cooperative banks
(ii) State cooperative bank
(iii) Central cooperative banks
2. Financial institutions
a. All-India financial institutions (AIFIs)
b. State financial corporations (SFCs)
c. State industrial development corporations (SIDCs)
3. Nonbanking financial companies (NBFCs)
4. Capital market intermediaries

Banking in India

Banking in India originated in the last decades of the 18th century. The first banks were The
General Bank of India, which started in 1786, and Bank of Hindustan, which started in 1790;
both are now defunct. The oldest bank in existence in India is the State Bank of India, which
originated in the Bank of Calcutta in June 1806, which almost immediately became the Bank
of Bengal. This was one of the three presidency banks, the other two being the Bank of
Bombay and the Bank of Madras, all three of which were established under charters from the
British East India Company. For many years the Presidency banks acted as quasi-central

Banks, as did their successors. The three banks merged in 1921 to form the Imperial Bank of
India, which, upon India's independence, became the State Bank of India.

HISTORY

Indian merchants in Calcutta established the Union Bank in 1839, but it failed in 1848 as a
consequence of the economic crisis of 1848-49. The Allahabad Bank, established in 1865 and
still functioning today, is the oldest Joint Stock bank in India.(Joint Stock Bank: A company
that issues stock and requires shareholders to be held liable for the company's debt) It was not
the first though. That honor belongs to the Bank of Upper India, which was established in
1863, and which survived until 1913, when it failed, with some of its assets and liabilities
being transferred to the Alliance Bank of Simla.

37
When the American Civil War stopped the supply of cotton to Lancashire from the
Confederate States, promoters opened banks to finance trading in Indian cotton. With large
exposure to speculative ventures, most of the banks opened in India during that period failed.
The depositors lost money and lost interest in keeping deposits with banks. Subsequently,
banking in India remained the exclusive domain of Europeans for next several decades until
the beginning of the 20th century.

Foreign banks too started to arrive, particularly in Calcutta, in the 1860s. The Comptoire
d'Escompte de Paris opened a branch in Calcutta in 1860, and another in Bombay in 1862;
branches in Madras and Puducherry, then a French colony, followed. HSBC established itself
in Bengal in 1869. Calcutta was the most active trading port in India, mainly due to the trade
of the British Empire, and so became a banking center.

The first entirely Indian joint stock bank was the Oudh Commercial Bank, established in
1881 in Faizabad. It failed in 1958. The next was the Punjab National Bank, established in
Lahore in 1895, which has survived to the present and is now one of the largest banks in
India.

Around the turn of the 20th Century, the Indian economy was passing through a relative
period of stability. Around five decades had elapsed since the Indian Mutiny, and the social,
industrial and other infrastructure had improved. Indians had established small banks, most of
which served particular ethnic and religious communities.

The presidency banks dominated banking in India but there were also some exchange banks
and a number of Indian joint stock banks. All these banks operated in different segments of
the economy. The exchange banks, mostly owned by Europeans, concentrated on financing
foreign trade. Indian joint stock banks were generally undercapitalized and lacked the
experience and maturity to compete with the presidency and exchange banks. This
segmentation let Lord Curzon to observe, "In respect of banking it seems we are behind the
times. We are like some old fashioned sailing ship, divided by solid wooden bulkheads into
separate and cumbersome compartments."

38
The period between 1906 and 1911, saw the establishment of banks inspired by the Swadeshi
movement. The Swadeshi movement inspired local businessmen and political figures to
found banks of and for the Indian community. A number of banks established then have
survived to the present such as Bank of India, Corporation Bank, Indian Bank, Bank of
Baroda, Canara Bank and Central Bank of India.

The fervor of Swadeshi movement lead to establishing of many private banks in Dakshina
Kannada and Udupi district which were unified earlier and known by the name South Canara
( South Kanara ) district. Four nationalized banks started in this district and also a leading
private sector bank. Hence undivided Dakshina Kannada district is known as "Cradle of
Indian Banking".

During the First World War (1914-1918) through the end of the Second World War (1939-
1945), and two years thereafter until the independence of India were challenging for Indian
banking. The years of the First World War were turbulent, and it took its toll with banks
simply collapsing despite the Indian economy gaining indirect boost due to war-
relatedEconomic activities.

NATIONALIZATION

Banks Nationalization in India: Newspaper Clipping, Times of India, July, 20, 1969.Despite
the provisions, control and regulations of Reserve Bank of India, banks in India except the
State Bank of India or SBI, continued to be owned and operated by private persons. By the
1960s, the Indian banking industry had become an important tool to facilitate the
development of the Indian economy. At the same time, it had emerged as a large employer,
and a debate had ensued about the nationalization of the banking industry. Gandhi, then
Prime Minster of India, expressed the intention of the Government of India in the annual
conference of the All India Congress Meeting in a paper entitled "Stray thoughts on Bank
Nationalization." The meeting received the paper with enthusiasm.

Thereafter, her move was swift and sudden. The Government of India issued an ordinance
and nationalized the 14 largest commercial banks with effect from the midnight of July 19,
1969. Jayaprakash Narayan, a national leader of India, described the step as a "masterstroke

39
of political sagacity." Within two weeks of the issue of the ordinance, the Parliament passed
the Banking Companies (Acquisition and Transfer of Undertaking) Bill, and it received the
presidential approval on 9 August 1969.

A second dose of nationalization of 6 more commercial banks followed in 1980. The stated
reason for the nationalization was to give the government more control of credit delivery.
With the second dose of nationalization, the Government of India controlled around 91% of
the banking business of India. Later on, in the year 1993, the government merged New Bank
of India with Punjab National Bank. It was the only merger between nationalized banks and
resulted in the reduction of the number of nationalized banks from 20 to 19. After this, until
The 1990s, the nationalized banks grew at a pace of around 4%, closer to the average growth
rate of the Indian economy.

LIBERALIZATION

In the early 1990s, the then Narasimha Rao government embarked on a policy of
liberalization, licensing a small number of private banks. These came to be known as New
Generation tech-savvy banks, and included Global Trust Bank (the first of such new
generation banks to be set up), which later amalgamated with Oriental Bank of Commerce,
Axis Bank(earlier as UTI Bank), ICICI Bank and HDFC Bank. This move, along with the
rapid growth in the economy of India, revitalized the banking sector in India, which has seen
rapid growth with strong contribution from all the three sectors of banks, namely,
government banks, private banks and foreign banks. The next stage for the Indian banking
has been set up with the proposed relaxation in the norms for Foreign Direct Investment,
Where all Foreign Investors in banks may be given voting rights which could exceed the
present cap of 10%,at present it has gone up to 74% with some restrictions. The new policy
shook the Banking sector in India completely. Bankers, till this time, were used to the 4-6-4
method (Borrow at 4%; Lend at 6%; Go home at 4) of functioning. The new wave ushered in
a modern outlook and tech-savvy methods of working for traditional banks. All this led to the
retail boom in India. People not just demanded more from their banks but also received more.

The Reserve Bank of India is an autonomous body, with minimal pressure from the
government. The stated policy of the Bank on the Indian Rupee is to manage volatility but
without any fixed exchange rate-and this has mostly been true. With the growth in the Indian
economy expected to be strong for quite some time-especially in its Services sector-the

40
demand for banking services, especially retail banking, mortgages and investment services
are expected to be strong. One may also expect M&As, takeovers, and asset sales. In March
2006, the Reserve Bank of India allowed Warburg Pincus to increase its stake in Kotak
Mahindra Bank (a private sector bank) to 10%. This is the first time an investor has been
allowed to hold more than 5% in a private sector bank since the RBI announced norms in
2005 that any stake exceeding 5% in the private sector banks would need to be vetted by
them. In recent years critics have charged that the non-government owned banks are too
aggressive in their loan recovery efforts in connection with housing, vehicle and personal
loans.

ADOPTION OF BANKING TECHNOLOGY

The IT revolution had a great impact in the Indian banking system. The use of computers had
led to introduction of online banking in India. The use of the modern innovation and
computerization of the banking sector of India has increased many folds after the economic
liberalization of 1991 as the country's banking sector has been exposed to the world's market.
The Indian banks were finding it difficult to compete with the international banks in terms of
the customer service without the use of the information technology and computers.

The RBI in 1984 formed Committee on Mechanization in the Banking Industry (1984)[4]
whose chairman was Dr C Rangarajan, Deputy Governor, Reserve Bank of India. The major
recommendation of this committee was introducing MICR. Technology in the all the banks in
the metropolis in India. This provided use of standardized cheque forms and encoders.
In 1988, the RBI set up Committee on Computerization in Banks (1988)[6] headed by Dr.
C.R. Rangarajan which emphasized that settlement operation must be computerized in the
clearing houses of RBI in Bhubaneswar, Guwahati, Jaipur, Patna and Thiruvananthapuram.It
further stated that there should be National Clearing of inter-city cheques at
Kolkata,Mumbai,Delhi,Chennai and MICR should be made Operational. Total numbers of
ATMs installed in India by various banks as on end March 2005 is 17,642.[10] .The New
Private Sector Banks in India is having the largest numbers of ATMs which is followed by
SBI Group, Nationalized banks, Old private banks and Foreign banks[7].The total off site
ATM is highest for the SBI and its subsidiaries and then it is followed by New Private Banks,
Nationalized banks and Foreign banks. While on site is highest for the nationalized bank in
India

41
6000
5000
4000
3000
2000 ON SITE ATM
1000 OFF SITE ATM
0
TOTAL ATM

CLASSIFICATION OF BANKS ACCORDING TO OWNERSHIP

PRIVATE SECTOR PUBLIC SECTOR FOREIGN BANKS IN

BANKS IN INDIA BANKS IN INDIA
INDIA

42
1. Bank of Punjab 1. Allahabad Bank
1. ABN-AMRO Bank
2. Bank of Rajasthan 2. Andhra Bank 2. Abu Dhabi Commercial
Bank
3. Catholic Syrian Bank 3. Bank of Baroda
3. Bank of Ceylon
4. Centurion Bank 4. Bank of India 4. BNP Paribas Bank
5. Citi Bank
5. City Union Bank 5. Bank of Maharashtra
6. China Trust Commercial
6. Dhanalakshmi Bank 6. Canara Bank Bank
7. Deutsche Bank
7. Development Credit Bank 7. Central Bank of India
8. HSBC
8. Federal Bank 8. Corporation Bank 9. JPMorgan Chase Bank
10. Standard Chartered Bank
9. HDFC Bank 9. Dena Bank
11. Scotia Bank
10. ICICI Bank 10. IDBI Bank 12. Taib Bank
11. IndusInd Bank 11. Indian Bank
12. ING Vysya Bank 12. Indian Overseas Bank
13. Jammu & Kashmir Bank 13. Oriental Bank of Commerce
14. Karnataka Bank 14. Punjab & Sind Bank
15. Karur Vysya Bank 15. Punjab National Bank
16. Laxmi Vilas Bank 16. Syndicate Bank
17. South Indian Bank 17. UCO Bank
18. United Western Bank 18. Union Bank of India
19. UTI Bank 19. United Bank of India
20. Vijaya Bank

Banking in Kerala

Banking was one of the more preferred lines of business in Kerala as well as in the princely
states of Travancore and Cochin and the Malabar Province of British India that originally
comprised it in the twentieth century.

43
 A list of some of the banks that operated in that territory during the period id given below.
Due to various reasons most of them were either closed or amalgamated with other banks,
leaving only a handful now.
» Aleppey Bank Ltd-1964 (Amalgamated with Federal Bank Ltd.)
» Bank of Cochin Ltd – 1985 (Amalgamated with State Bank of India)
» Bank of Kerala Ltd -1961 (Amalgamated with Canara Bank)
» Bank of New India Ltd-1961 (Amalgamated with State Bank of Travancore)
» Catholic Bank Ltd-1961 (Amalgamated with Syndicate Bank)
» Chalakudy Public Bank Ltd- 1964(Amalgamated with Fedaral Bank Ltd.)
» CochinNayar Bank Ltd.-1964 (Amalgamated with state Bank of Travancore)
» Cochin Union Bank Ltd- 1964(Amalgamated with Fedaral Bank Ltd)
» Dhanalakshmi Bank Ltd- 1927
» Fedaral Bank Ltd(Originally known as Travancore Fedaral Bank)-1931
» Kottayam Orient Bank Ltd-1961(Amalgamated with State Bank of Travancore)
» Latin Christian Bank Ltd-1964 (Amalgamated with State Bank of Travancore)
» Lord Krishna Bank Ltd-2006(Amalgamated with Centurion bank of Punjab)
» Marthandam Commercial Bank Ltd-1968(Amalgamated with Fedaral Bank Ltd)
» Nedungadi Bank Ltd-1899-2003(Amalgamated with Punjab National Bank)
» Parur Central Bank Ltd-1990 (Amalgamated with Bank of India)
» Quilon Bank Ltd-1937 (Amalgamated to form Travancore National & Quilon Bank Ltd)
» South Indian Bank Ltd-1929
» State Bank of Travancore(originally known as Travancore Bank Ltd)-1945
» St George Union Bank Ltd-1965 (Amalgamated with Fedaral Bank Ltd.)
» Thiya Bank Ltd-1964 (Amalgamated with Lord Krishna Bank Ltd)
» Travancore Forward Bank Ltd.1961 (Amalgamated with State Bank of Travancore)
» Travancore National & Quilon Bank Ltd-1937-38 (Liquidated By Travancore Government)

44
 CHAPTER 3

COMPANY PROFILE

COMPANY PROFILE

The South Indian Bank was established on 29th January 1929. The bank emerged in a period
when swadeshi movement gathered momentum. Till then the money lender and other non
institutionalized financial intermediaries were dominating the banking scenario. Thus the
bank community was under the mercy of non institutionalized agencies that were charging
exorbitant rates of Thrissur joined together and disguised way and means of relieving traders
from the clutches of the money lenders. They contemplated to harness the saving of the
people and to channelize them for productive purpose. The true effort of these people resulted
in the establishment of bank.

With 44 shareholders and paid up capital of Rs.22000 the bank started function as a private
limited company and commenced business on 29th January 1929. On 11th August 1939, it was

45
 converted in to a public limited company. In 1941, the first branch of bank outside Kerala
was opened. The bank received excellent cooperation and support from public at large. Its
growth was slow and steady. This deposit and advances as well as paid up capital and reserve
increased year after year. The number of branches opened every year testified its stability and
popularity. The bank was in the second schedule of the Reserve Bank of India on 7th August
1946.

VISION

To build a strong brand image to make to the South Indian Bank technology driven, customer
oriented and the most preferred bank, where passion for excellence is a way of life,
innovation is a tradition, commitment to values is unshaken and customer loyalty is abiding,
enabling the bank to achieve an impressive all round, (but better than the peer group)
business growth, build a healthy, qualitative and strong asset base and earn commensurate
profits. To emerge as the most preferred bank in the country in terms of brand, values,
principles with core competence in fostering customer aspirations, to build high quality assets
leveraging on the strong and vibrant technology platform in pursuit of excellence and
customer delight and to become a major contributor to the stable economic growth of the
nation.

MISSION

To provide a secure, agile, dynamic and conductive banking environment to customers with
commitment to values and unshaken confidence, deploying the best technology, standard
processes and procedures where customer convenience is of significant importance and to
increase the stakeholders’ value.

MILESTONES IN THE HISTORY

» The FIRST among the private sector banks in Kerala to become a scheduled bank in 1946
under the RBI Act.
» The FIRST bank in the private sector in India to open a currency Chest on behalf of the RBI
in April 1992.
» The FIRST private sector bank to open a NRI branch in November 1992.
» The FIRST bank in the private sector to start an Industrial Finance Branch in March 1993.

46
» The FIRST among the private sector banks in Kerala to open an “Overseas Branch” to cater
exclusively to the export and import business in June 1993.
» The FIRST bank in Kerala to develop an in-house, fully integrated branch automation
software in addition to the in house partial automation solution operational since 1992.
» The FIRST Kerala based bank to implement Core Banking System.
» The THIRD largest branch network among the private Sector banks, in India, with all its
branches under Core banking System.
» The SECOND largest network of branches amongst the old private sector bank – 453
Branches and 51 extension counters spread over 17 states

AWARDS WON

The bank has won the following awards:

» No.1 in Asset Quality – Business Today Ranking of Banks.

» Best Bank in Asset Quality Award- Dun & Bradsheet
» Best NPA Manager – ASSOCHAM- ECO Pulse Survey
» Top Performer in Asset Quality- Analyst in 2008 Survey
» Best Asian Banking Website – Asian Banking & Finance Magazine, Singapore.
» Best Old Private Sector Bank- Financial Express India’s Best Banks 2008-2009
» Best Private sector bank in India in the service quality segment- Outlook money – C fore
Survey
» Award for excellence in Banking Technology from IDRBT(Institute odor Development and
Research in Banking Technology) the technical arm of the RBI(ISO Certification)

OBJECTIVES

» To establish and carry on the business of the banking at registered office of the company and
such branches, agencies or office at cochin, Travancore and other Indian states and in any
other parts of India or elsewhere as may from time to time determined by the directors of the
bank.
» Catering on the business of receiving deposits of money on current asset or otherwise subject
to withdrawal of cheques, drafts and other and carry on the business of the banking in all its
branches and departments.

47
» Borrowing, raising or taking up money either upon or without security, the drawing making,
accepting, discounting, buying, selling collecting and dealing in bill of exchange, handiest,
promissory notes, coupons, drafts, warrants, bill of lading, railway receipts, debentures
certificate script and other instrument and securities , whether transferrable or not, granting
issuing of the letter of credits, travelers cheque, and circular notes, the buying and selling of
foreign exchange including foreign bank note the enquiring, holding, issuing, on
commission, underwriting and dealing in stock funds, shares and debentures, debenture
stocks, bond, obligations, securities and investment of all kinds, the purchasing and selling of
bonds, scripts or valuables on deposits, or for custody or otherwise the collecting and
transmitting of money and securities.
» Acting as agents for government or local authorities or for other person or persons, the
carrying on agency business of any description to other than the business of managing agent
including the power to act attorneys to give discharges and receipts. Contracting for public
and private loans and negotiation and issuing the same. Doing all this as are incidental and
conductive to the promotion or advancement of the business of the company.
» To undertake and carry own all other forms of business as may be permissible for a banking
company to undertake and carry on by any law in force for the time being.

FUNCTIONS

» Accepting deposits
» Making loans and advances
» General utility services
» Agency services

DEPARTMENTS

» Human Resource Development Department

» Planning and Development Department.
» Corporate Finance Department
» Secretarial Department

48
» Credit Control Department
» Inspection Department
» Integrated Risk Management Department
» Accounts Department
» Vigilance Department
» Legal Department
» Computer Department

TIE- UPS

The bank has tie- ups with the following financial institutions:

1. ING life
2. Bajaj Allianz General Insurance Company Ltd.
3. The Export Credit Guarantee Corporation of India.
4. Franklin Templeton
5. ICICI Prudential AMC
6. Sundaram BNP Paribas
7. TATA Mutual Fund
8. Reliance Mutual Fund

49
9. UTI Mutual Funds
10. HDFC Mutual Funds
11. HSBC Investments
12. Principal Mutual Funds
13. Fidelity Fund Management Private Ltd.
14. Birla Sun Life Asset Management Company Ltd
15. Fortis Investments

50
 CORPORATE LOGO

PRODUCTS AND SERVICES

» PERSONAL BANKING
 Loans
 Accounts & Deposits
 Mutual Funds
 Insurance
 Value Added Services
 Money Transfers
» NRI BANKING
 Loans
 Accounts & Deposits
 Mutual Funds
 Insurance
 News
 Value Added Services
 7.Money Transfers

» BUSINESS BANKING
 Business Accounts
 Domestic Finance
 International Finance

51
 Value Added Services
 Money Transfers

52
 CHAPTER 4

REVIEW OF LITERATURE

CHAPTER 5

RESEARCH METHODOLOGY

53
 RESEARCH METHODOLOGY

Research

The word "research" is used to describe a number of similar and often overlapping
activities involving a search for information. For example, each of the following activities
involves such a search; but the differences are significant and worth examining. Research
is a detailed study of a subject, especially in order to discover (new) information or reach a
(new) understanding.

In the Encyclopedia of Social Sciences research is define as “The manipulation of things,

concepts or symbols for the purpose of generalizing to extend, corrector verify knowledge,
whether that knowledge aids in construction of theory or in the practice of art.”

M D.Slesinger and M.Stephenson

Research Methodology

The basic concept of research methodology refers to the way in which companies conduct
their research and how they collect data they need. Whenever a company or organization
needs to investigate a particular area of their business dealings, they need to adapt the
most suitable research methodology for the job. Research methodology is the way in

54
 which researchers specify how they are going to retrieve the all-important data and
information that companies will need to make vital decisions.

Research Type

The research adopted in this project is historical research. As it is a finance project the data
used for analysis will definitely be based on past years but which shapes the present
condition. Historical research is an attempt to describe and learn from past. As such it can
be purely descriptive, recording the sequence of events and presenting the fullest possible
picture of the development of a phenomenon. The intention is to record and describe.

Variables Used for the Study

» Dependent Variable: The dependent variable used for the study is asset and liability.

» Independent Variable: The independent variables used are deposits term deposits
borrowings interbank deposits term loans swaps capital net income.

Methods of Data Collection

The data is collected from secondary source.

Secondary Data
Data is collected through South Indian Bank official websites as well as published
materials like journals, periodicals etc. the statical figures, company figures and company
policies are taken from the annual reports of South Indian Bank Ltd Thrissur

55
TIME INFLOWS OUTFLOWS GAP CUMULATIVE
BUCKETS (In Lakhs) (In Lakhs) (In Lakhs) GAP
(In Lakhs)

CHAPTER 6

DATA ANALYSIS & INTERPRETATION

6.1 TABLE SHOWING STRUCTURAL LIQUIDITY POSITION AS ON 31/3/2011

56
1 Day 56339.39 23992.79 32346.60 32346.60

2-7 Days 110756.44 128790.74 -18034.30 14312.30

8-14 Days 106461.48 110475.77 -4014.29 10298.01

15-28 Days 88848.65 26858.14 61990.51 72288.52

29 Days - 3 470669.26 323023.70 147645.56 219934.07

months

3 Months - 206043.23 196753.27 9289.96 229224.03

6 Months

6 Months - 424899.18 406316.90 18582.29 247806.32

1 year

1 Year- 3 909001.15 668615.56 240385.60 488191.91

Years

3 Years- 5 224980.14 90229.56 134750.58 622942.49

Years

Above 5 670378.85 1292189.26 -621810.42 1132.07

Years
Table 6.1

57
6.2CHART SHOWING STRUCTURAL LIQUIDITY POSITION AS ON 31/3/2011

2000000
1800000
1600000
1400000
1200000
1000000
800000
OUTFLOW
600000
400000 INFLOW
200000
0

Chart 6.1

Interpretation

Inflows are more than the outflows in the bucket category 1 Day, 15-28 Days, 29
Days - 3 months, 3 Months - 6 Months, 6 Months - 1 year, 1 Year- 3 Years, 3 Years-
5 Years. Outflows are more than the inflows in time buckets 2-7 Days, 8-14 Days and
Above 5 Years. When inflows are greater than outflows means bank is managing their
assets and liabilities in a well manner. If outflow is greater than inflow banks are
facing liquidity risks. Even though the time buckets 2-7 Days, 8-14 Days outflows are
more than inflows the cumulative gap is positive and no mismatch is existing it shows
that the bank is not going to face any liquidity risk.

58
 6.3COMPUTATION OF MISMATCH AS ON 31-3-2011

Maturity Inflow Outflow Gap Cumulative Mis Prudent Liquidity

Profile gap match ial Risk
Limit(-)

1 Day 56339.39 23992.79 32346.60 32346.60 134.82 5% Nil

2-7 110756.44 128790.74 -18034.30 14312.30 9.37 10% Nil

Days

8-14 106461.48 110475.77 -4014.29 10298.01 3.91 15% Nil

Days

15-28 88848.65 26858.14 61990.51 72288.52 24.92 20% Nil

Days

29 Days 470669.26 323023.70 147645.56 219934.07 35.87 40%

-3 Nil
months

3 206043.23 196753.27 9289.96 229224.03 28.30 40%

Months Nil
-6
Months

6 424899.18 406316.90 18582.29 247806.32 20.38 40%

Months Nil
- 1 year

1 Year- 909001.15 668615.56 240385.60 488191.91 25.90 40%

3 Years Nil

3 Years- 224980.14 90229.56 134750.58 622942.49 31.54 40%

5 Years Nil

Above 5 670378.85 1292189.26 -621810.42 1132.07 0.03 40%

Years Nil
Table 6.2

» Mismatch indicates the difference between the bank’s capacity to meet its
demand of customers with actual demand of customers when inflow is more
than outflow then it is a favorable situation and vice versa.

59
 6.4CHART SHOWING MISMATCH AND PRUDENTIAL LIMT

160

140

120

100

80

60 Mismatch
40 Prudential Limit
20

-20

-40

-60

Chart 6.2

Interpretation

» All the Time buckets are indicating a positive gap and hence there are no mismatches
at all. That means banks liquidity position is very strong. The prudential limit fixed by
the RBI is far below the bank’s mismatch.

6.5 TABLE SHOWING RATE SENSITIVE GAP AS ON 31-3- 2011

60
 +VE
TIME RSA RSL RSG or Cumulative
BUCKE -VE RSG
T

1 -28 275902.25 182179.28 93722.97 +VE 93722.97

Days

29 428541.02 400088.11 28452.91 +VE 122175.88

Days– 3
Months

3 Months 755627.09 744217.61 11409.47 +VE 133585.36

-6
Months

6 Months 371285.42 712092.96 -340834.54 -VE -207249.19

- 1 year

1 Year- 3 289338.44 595872.44 -306534.00 -VE -513783.19

Years

3 Years- 248114.67 51097.74 197016.93 -VE -316766.26

5 Years

Above 5 564247.31 38785.29 525462.02 +VE 208695.76

Years

Non- 330208.57 526045.73 -195837.15 +VE 12858.60

Sensitive

Total 3263237.76 3250379.16 12858.60 +VE 25717.2

Table 6.3

From the table it is clearly understood that rate sensitive assets is lower than the rate
sensitive liabilities for the time buckets 6 Months - 1 year and 1 Year- 3 Years.
Actually this is a threat situation for the bank. All other time buckets are showing a
positive rate sensitive gap

6.6 CHART SHOWING RATE SENSITIVE GAP AS ON 31-3- 2011

61
 1600000

1400000

1200000

1000000

800000

600000
RSL
400000
RSA
200000
0

Chart 6.3

Interpretation

» The time buckets 6 Months - 1 year, 1 Year- 3 Years and 3 Years- 5 Years indicate a
negative gap.
» The time buckets 1 -28 Days, 29 Days– 3 Months, 3 Months - 6 Months and Above 5
Years shows a positive rate sensitive gap.
» In the time buckets 1 -28 Days, 29 Days– 3 Months, 3 Months - 6 Months and Above
5 years as there is a positive gap bank will get benefit from rising interest rates. Any
falling of interest rate will adversely affect the bank’s profitability. To overcome the
unfavorable situation as said earlier the bank should reduce its exposure to rate
sensitive liabilities and increase its exposure to rate sensitive assets.

62
» In the time buckets 6 Months - 1 year, 1 Year- 3 Years and 3 Years- 5 Years indicate
a negative gap. The cumulative RSG is too is negative hence the bank will get benefit
from falling interest rate. Any rise in interest rate will adversely affect its profitability.
So the bank must be careful while allocating its exposure i.e. it should be more for
rate sensitive liabilities than rate sensitive assets.

6.7 TABLE SHOWING NET GAP AS A PERCENATGE OF TOTAL RATE

SENSITIVE ASSETS

63
 ( In lakhs)

TIME Cumulative Net Gap Cum Gap

BUCKET Total RSA Net Gap Gap To Total Cum RSA To Cum
RSA Assets

1-28 275902.25 93722.97 93722.97 33.97 275902.25 33.96

Days

29 Days- 428541.02 28452.91 122175.88 6.64 704443.27 17.34

3 Months

3-6 755627.09 11409.47 133585.36 1.51 1460070.36 9.15

Months

6Months- 371258.42 -340834.54 -207249.19 -91.81 1831328.78 -11.32

1 Year

1-3 Years 289338.44 -306534.00 -513783.19 -105.94 2120667.22 -24.23

3-5 Years 248114.67 197016.93 -316766.26 79.41 2368781.89 -13.37

Above 5 564247.31 525462.02 208695.76 93.13 2933029.2 7.11

Years
Table 6.4

Interpretation

» Net gap as a percentage to total RSA is negative for the time buckets 6Months-1 Year
and 1-3 Years shows the outflows of the bank.
» Time buckets 1-28 Days, 29 Days-3 Months, 3-6 Months, 3-5 Years and Above 5
Years net gap is positive and considered to be inflows.
» Cum Gap to Cum Assets for the time buckets 1-28 Days, 29 Days-3 Months, 3-6
Months, Above 5 Years is considered to be inflows.
» Cum Gap To Cum Assets for the time buckets 6Months-1 Year and 1-3 Years and 3-5
Years are considered to be outflows for the bank

6.8 TABLE SHOWING RELATIVE GAP RATIO

64
 Time RSA RSL Rupee Gap Total Asset RGR
bucket

1-28 Days
275702.25 182179.28 93722.97 2933056.2 0.031954

29 Days-3 428541.02 400088.11 28452.91 2933056.2

Months
0.009701

3-6 755627.09 744217.61 11409.47 2933056.2

Months 0.00389

6Months-1 371285.42 712092.96 -340834.54 2933056.2

Year -0.1162

1-3 Years 289338.44 595872.44 -306534.00 2933056.2

-0.10451

3-5 Years 248114.67 51097.74 197016.93 2933056.2

0.067171

Above 564247.31 38785.29 525462.02 2933056.2

5Years 0.179152

Total 2933056.2
Table 6.5

Interpretation

» The time buckets 1-3 Years and 6Months-1 Year RGR shows the outflows are more
» The RGR for all other bucket categories are considered to be inflows.

6.9 TABLE SHOWING SENSITVENESS OF ASSETS AND LIABILITIES

Time <0 or >0 RGR <1 or >1 Asset

Bucket Rupee Gap sensitive/Liability

65
 sensitive

1-28 Days 93722.97 >0 0.031954 <1 BOTH

29 Days-3 28452.91 >0 <1 BOTH

Months 0.009701

3-6 11409.47 >0 0.00389 <1 BOTH

Months

6Months- -340834.54 <0 -0.1162 <1 Liability sensitive

1 Year

<0 -0.10451 <1 Liability sensitive

1-3 Years -306534.00

3-5 Years 197016.93 >0 0.067171 <1 BOTH

Above 525462.02 >0 0 .1792 <1 BOTH

5Years
Table 6.6

Interpretation

» The time buckets 6Months-1 Year and 1-3 Years implies the bank is purely liability
sensitive.
» In the time buckets except 6Months-1 Year and 1-3 Years the bank is both asset and
liability sensitive.
» The time bucket which shows purely liability sensitive situation the bank will see an
increase in NII if the interest rates are goes down.

66
 CHAPTER 7

FINDINGS,

SUGGESTION

&

CONCLUSION

FINDINGS

Liquidity risk management

The south Indian Bank has been carrying on Asset Liability Management guidelines as per
the instructions issued by the RBI in the respect. This mainly consists of liquidity risk
management and interest rate risk management. As per the RBI guidelines, the bank has
established an Asset Liability Management system or Asset Liability Management Policy to
continuously monitor measure and manage the market risk, especially liquidity risk and
interest rate risk.

67
 » The objective of liquidity risk management of South Indian Bank is to maintain
adequate liquidity at all times, without keeping any large idle funds. A good liquidity
risk policy will reduce risk and bring in more profit. For this purpose, the bank
prepares statement of structural liquidity
» The most useful tool in measuring liquidity risk is maturity ladder another tool which
is widely used to measure interest rate risk through Gap Analysis.

While analyzing the statement of Structural Liquidity as on 31-3-2011 it is found that:-

» There are no mismatches in the short term time buckets (i.e. 2-7 days and 8-14 days).
These are the critical time buckets as per RBI norms because short term liquidity is
vital for a bank. Here the bank efficiently managing its assets and liabilities and the
prudential limit fixed by the RBI is far below the bank’s mismatch .As there are no
mismatches in the short term, bank is not going to face serious liquidity problem.
» The statement of structural liquidity shows that the bank does not have any negative
mismatch in the medium term time buckets i.e. 3 Months - 6 Months, 6 Months - 1
year, 1 Year- 3 Years, 3 Years- 5 Years.

» In the long term perspective that is in the over 5 years time bucket too no mismatch is
existing. Hence bank will not have to face liquidity risk in the long term perspective
too. So the bank ensures safety in its liquidity position.

Interest rate risk management

Through interest rate risk management, South Indian Bank monitors the effect of various
possible changes in the market conditions. For this purpose, the bank prepares the statement
of the Interest Rate Sensitivity the gap analysis is the widely used technique for measurement
of interest rate risk.

While analyzing the statement of Interest Rate Sensitivity as on 31-3-2011 it is found

that:-

68
 » The time buckets 1 -28 Days, 29 Days– 3 Months, 3 Months - 6 Months and
Above 5 Years shows a positive gap. The cumulative gap is also positive
during this period. So the bank can be benefited from increased interest rates.

» The time buckets 6 Months - 1 year, 1 Year- 3 Years and 3 Years- 5 Years
shows a negative gap. Here also the cumulative gap is negative. So it shows
liability sensitive nature and hence the bank can be benefitted from reducing
interest rates.

OTHER GENERAL FINDINGS

» The bank lies in the segment of risks that can be transferred to other participants &
risks that must be actively managed at the firm level.
» The risk which affects SIB mostly is credit risk and operational risk
» Operational risk, credit risk and legal risk are being absorbed.
» The operational risk is faced due to the reasons such as people, process, systems and
external factors.

» Loss data collection is the measure adopted to check operational risk.

» Basis indicator approach is followed in order to measure the operational risk.

» Process management, service management, people’s management and management
systems and controls are the management systems used in SIB
» Effective internal control system is the key role for effective management of
operational research.
» Operational Risk is controlled by adoption of RCSA (Risk & Control Self
Assessment) which identifies, assesses, control and mitigate the potential risks both
by using internal audit and internal control.
» Performance reviews, information processing, physical control and segregation of
duties- all these techniques are used to model operational risk in SIB.

69
 SUGGESTIONS

Solutions for Managing Liquidity and Interest Rate Risk

Liquidity Risk Management

TIME LIABILITY IS MORE ASSET IS MORE

PERIOD

70
 1. Dispose off excess long dated 1. Follow up to eliminate un
investments reconciled long pending
2. Recover over dues items.
Long 3. Revaluate fixed assets to create
Term additional reserve
4. Go for public issue of equity/
debentures
5. Go for asset reconstruction fund
6. Dispose of outdated assets

1. Recover over dues. 1. Invest in industries and

2. Intensify deposit canvassing efforts companies with high
Medium 3. Limit should be kept on granting loans growth potential
Term and cash credit. 2. Invest in securities
4. Explore avenues of refinance. which will appreciate in
5. Medium term investments yielding capital at the same time
low income should be deposited off. high liquidity.

1. Dispose off short term investment 1. Repay high cost call money
2.Diminish excess cash balance at the and CD’s
Short branches 2. Increase lending exposure
Term 3. Avoid canvassing advances to staff under bill discounting.
4. Reduce excess cash bank balance at all
the branches
5. Explore refinance avenues
6. Reduce outstanding from debtors..

Interest Rate Risk Management

71
TIME PERIOD LIABILITY IS MORE ASSET IS MORE

1. Swap low yield 1. High cost deposit

investment to high should be avoided.
yield investments. 2. High cost refinance
2. Low income facility should be
Long Term investment should be prepaid where such
shared with other facility has been
institutions. availed.
3. Savings bank deposits
and current deposits
should be increased.

72
 1. It can increase the deposit mix 1. Avoid high cost deposit
by increasing savings deposit and certificate of deposit.
Medium Term current deposit. Etc. 2. Proper selection
. procedure has to be
followed while granting
low yielding advances.
3. Repay high cost
refinances already
availed.

1. Increase current account & 1. Invest in short term

saving deposits. securities having high
Short Term 2. Move for short term interest.
borrowing like money at 2. Invest in interbank and
call & short notice. call money deposit
when the interest rate is
at high

73
 CONCLUSION

ALM is an integral part of financial management process of any bank.ALM is concerned

with strategic balance sheet management involving risks caused by changes in the interest
rate exchange rate and liquidity position of the bank.

This project involves a comprehensive study of asset liability management system

implemented in South Indian Bank Ltd. The bank is following asset liability management
framework as per RBI guidelines.

To make ALM system in the banks to be successful the bank must set up Asset Liability
Management Committee (ALCO) and ensure monitoring on a regular basis. The banks can
improve it with a good transfer fund pricing system.

This study shows that bank is not facing any liquidity risk and not only is that it efficiently
managing its assets and liabilities. Overall performance of the bank is very good and the bank
is following the asset liability management framework prescribed by RBI guidelines.

74
 BIBLIOGRAPHY

» G.H Deolakar- The Indian Banking Sector On the Road to Progress

» R. Vaidyanathan - ASCI Journal Of Management Asset-liability management: Issues

and trends in Indian context.

» R.S. Raghavan - Risk Management in Banks.

» Annual Report of South Indian Bank Ltd.

WEBLIOGRAPHY

» www.wikipedia.org
» www.projectparadise.com
» www.southindianbank.com
» www.moneycontrol.com
» www.rbi.org.in
» www.economictimes.com

75