Asset Liability Management

in Banks

[Module II]

 Assets

and Liabilities Management (ALM) is a

dynamic process of planning, organizing,
coordinating and controlling the assets and
liabilities their mixes, volumes, maturities,
yields and costs in order to achieve a
specified Net Interest Income (NII).

 The

NII is the difference between interest

income and interest expenses and the basic
source of banks profitability.

Liabilities

Assets

1.
2.
3.
4.
5.

1.

Capital
Reserve & Surplus
Deposits
Borrowings
Other Liabilities

2.

3.
4.
5.
6.

Cash & Balances with

RBI
Bal. With Banks &
Money at Call and
Short Notices
Investments
Advances
Fixed Assets
Other Assets

Contingent Liabilities

1.Capital:
Capital
represents
owners
contribution/stake in the bank.
- It serves as a cushion for depositors and
creditors.
- It is considered to be a long term sources
for the bank.

2. Reserves & Surplus

Components under this head includes:

I.
II.
III.
IV.
V.

Statutory Reserves
Capital Reserves
Investment Fluctuation Reserve
Revenue and Other Reserves
Balance in Profit and Loss Account

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

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

5. Other Liabilities & Provisions

It is grouped as under:
I.
II.
III.
IV.
V.

Bills Payable
Inter Office Adjustments (Net)
Interest Accrued
Unsecured Redeemable Bonds
(Subordinated Debt for Tier-II Capital)
Others(including provisions)

1.

Cash & Bank Balances with RBI

I. Cash in hand
(including foreign currency notes)
II. Balances with Reserve Bank of India
In Current Accounts
In Other Accounts

2. BALANCES WITH BANKS AND MONEY AT

CALL & SHORT NOTICE
I. In India
i) Balances with Banks
a) In Current Accounts
b) In Other Deposit Accounts
ii) Money at Call and Short Notice
a) With Banks
b) With Other Institutions
II. Outside India
a) In Current Accounts
b) In Other Deposit Accounts
c) Money at Call & Short Notice

3. Investments

A major asset item in the banks balance sheet.

Reflected under 6 buckets as under:
I. Investments in India in : *
i) Government Securities
ii) Other approved Securities
iii) Shares
iv) Debentures and Bonds
v) Subsidiaries and Sponsored Institutions
vi) Others (UTI Shares , Commercial Papers, COD &
Mutual Fund Units etc.)
II. Investments outside India in **
Subsidiaries and/or Associates abroad

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

5. Fixed Asset
I.

Premises

II.

Other Fixed Assets (Including furniture and fixtures)

6. Other Assets
I.

II.
III.
IV.
V.
VI.

Interest accrued

Tax paid in advance/tax deducted at source

(Net of Provisions)
Stationery and Stamps
Non-banking assets acquired in satisfaction of claims
Deferred Tax Asset (Net)
Others

Banks obligations under LCs, Guarantees,

Acceptances on behalf of constituents and Bills
accepted by the bank are reflected under this
heads.

I.

II.

A banks profit & Loss Account has the

following components:
Income: This includes Interest Income and
Other Income.
Expenses: This includes Interest Expended,
Operating Expenses and Provisions &
contingencies.

1.

I.
II.
III.

INTEREST EARNED

Interest/Discount on Advances / Bills

Income on Investments
Interest on balances with Reserve Bank
of India and other inter-bank funds
IV. Others

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

1.

I.
II.
III.

INTEREST EXPENDED
Interest on Deposits
Interest on Reserve Bank of India / Inter-Bank
borrowings
Others

2. OPERATING EXPENSES
I.
II.
III.
IV.
V.
VI.
VII.
VIII.
IX.
X.
XI.
XII.

Payments to and Provisions for employees

Rent, Taxes and Lighting
Printing and Stationery
Advertisement and Publicity
Depreciation on Bank's property
Directors' Fees, Allowances and Expenses
Auditors' Fees and Expenses (including Branch Auditors)
Law Charges
Postages, Telegrams, Telephones etc.
Repairs and Maintenance
Insurance
Other Expenditure

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.

 Volatility
Product

Innovations & Complexities

Regulatory Environment
Management Recognition

An effective Asset Liability Management

Technique aims to manage the volume, mix,
maturity, rate sensitivity, quality and liquidity
of assets and liabilities as a whole so as to
attain a predetermined acceptable risk/reward
ration.
It is aimed to stabilize short-term profits, longterm earnings and long-term substance of the
bank. The parameters for stabilizing ALM
system are:
1.

Net Interest Income (NII)

Issued draft guidelines on 10th Sept98.

Final guidelines issued on 10th

implementation of ALM w.e.f. 01.04.99.

To begin with 60% of asset &liabilities will be covered;

100% from 01.04.2000.

Initially Gap Analysis to be applied in the first stage of

implementation.

Disclosure to Balance Sheet on maturity pattern on

Deposits, Borrowings, Investment & Advances w.e.f.
31.03.01

Feb99

for

Banks liquidity management is the process

of generating funds to meet contractual or
relationship obligations at reasonable prices
at all times.
New loan demands, existing commitments,
and deposit withdrawals are the basic
contractual or relationship obligations that a
bank must meet.

Analysis of following factors throw light

on a banks adequacy of liquidity
position:
a. Historical Funding requirement
b. Current liquidity position
c. Anticipated future funding needs
d. Sources of funds
e. Options for reducing funding needs
f.
Present and anticipated asset quality
g. Present and future earning capacity and
h. Present and planned capital position

To satisfy funding needs, a bank must perform

one or a combination of the following:
a.
Dispose off liquid assets
b.
Increase short term borrowings
c.
Decrease holding of less liquid assets
d.
Increase liability of a term nature
e. Increase Capital funds

 Liquidity

Exposure can stem from both internally

and externally.
External liquidity risks can be geographic,
systemic or instrument specific.
Internal
liquidity risk relates largely to
perceptions of an institution in its various
markets:
local,
regional,
national
or
international

 Funding

Risk
- Need to replace net outflows due to
unanticipated withdrawals/non-renewal
Time Risk
- Need to compensate for non-receipt of
expected inflows of funds
Call Risk
- Crystallization

of contingent liability

All Assets & Liabilities to be reported as per

their maturity profile into 8 maturity Buckets:
i.

1 to 14 days

ii. 15 to 28 days
iii. 29 days and up to 3 months
iv. Over 3 months and up to 6 months
v. Over 6 months and up to 1 year

vi. Over 1 year and up to 3 years

vii. Over 3 years and up to 5 years
viii. Over 5 years

 Places

all cash inflows and outflows in the

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

15-28
1-14Days Days

Capital
Liab-fixed Int
Liab-floating Int
Others
Total outflow
Investments
Loans-fixed Int
Loans - floating

300 200
350 400
50 50
700 650
200 150
50 50
200 150
Loans BPLR Linked
100 150
Others
50 50
Total Inflow
600 550
Gap
-100 -100
Cumulative Gap -100 -200
Gap % to Total Outflow
-14.29 -15.38

30 Days- 3 Mths - 6 Mths - 1Year - 3 3 Years - Over 5

3 Month 6 Mths
1Year
Years
5 Years Years

200 600 600 300 200

350 450 500 450 450
0
550 1050 1100 750 650
250 250 300 100 350
0 100 150 50 100
200 150 150 150 50
200 500 350 500 100
0
0
0
0
0
650 1000 950 800 600
100 -50 -150 50 -50
-100 -150 -300 -250 -300
18.18

-4.76

-13.64

6.67

-7.69

200
200
450
200
1050
900
100
50
100
200
1350
300
0
28.57

Total

200
2600
3400
300
6500
2500
600
1100
2000
300
6500
0
0

 Mismatches

can be positive or negative

Positive

Mismatch: M.A.>M.L. and Negative

Mismatch M.L.>M.A.

In

case of +ve mismatch, excess liquidity can be

deployed in money market instruments, creating
new assets & investment swaps etc.
ve mismatch,it can be financed from
market borrowings (Call/Term), Bills
rediscounting, Repos & deployment of foreign
currency converted into rupee.

For

To

meet the mismatch in any maturity

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

Liability/Assets

I. Deposits
a. Up to 1 year
b. Over 1 yr to 3 yrs
c. Over 3 yrs to 5 yrs
d. Over 5 years
II. Borrowings
a. Up to 1 year
b. Over 1 yr to 3 yrs
c. Over 3 yrs to 5 yrs
d. Over 5 years
III. Loans & Advances
a. Up to 1 year
b. Over 1 yr to 3 yrs
c. Over 3 yrs to 5 yrs
d. Over 5 years
Iv. Investment
a. Up to 1 year
b. Over 1 yr to 3 yrs
c. Over 3 yrs to 5 yrs
d. Over 5 years

Rupees
(In Cr)

15200
8000
6700
230
270
450
180
00
150
120
8800
3400
3000
400
2000
5800
1300
300
900
3300

In Percentage

100
52.63
44.08
1.51
1.78
100
40.00
0.00
33.33
26.67
100
38.64
34.09
4.55
22.72
100
22.41
5.17
15.52
56.90

 Generated

by grouping RSA,RSL & OFF-Balance

sheet items in to various (8)time buckets.

RSA:
MONEY AT CALL
ADVANCES ( BPLR LINKED )
INVESTMENT
RSL
DEPOSITS EXCLUDING CD
BORROWINGS

THREE

OPTIONS:
A) RSA>RSL= Positive Gap
B) RSL>RSA= Negative Gap
C) RSL=RSA= Zero Gap

Awareness for ALM in the Bank staff at all

levelssupportive Management & dedicated
Teams.
2. Method of reporting data from Branches/ other
Departments. (Strong MIS).
3. Computerization-Full computerization,
networking.
4. Insight into the banking operations, economic
forecasting,
computerization,
investment,
credit.
5. Linking up ALM to future Risk Management
Strategies.
1.

 Interest

Rate risk is the exposure of a banks

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

 Interest

rate risk refers to volatility in Net

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

 Interest

rate risk mainly arises from:

Gap Risk
Basis Risk
Net Interest Position Risk
Embedded Option Risk
Yield Curve Risk
Price Risk
Reinvestment Risk

 Gap

Analysis- Simple maturity/re-pricing

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

 Duration

Analysis: Duration is a measure of the

percentage change in the economic value of a
position that occur given a small change in level
of interest rate.