05 ALM Guidelines Short

ASSET LIABILITY ASSET LIABILITY MANAGEMENT (ALM)MANAGEMENT (ALM)

History of bank failures in USHistory of bank failures in US

2012 - 23

2011 - 89

2010 - 157

2009 - 140

Components of a Bank Balance sheet

Liabilities Assets

1. Capital

2. Reserve & Surplus

3. Deposits

4. Borrowings

5. Other Liabilities

1. Cash & Balances with RBI

2. Bal. With Banks & Money at Call and Short Notices

3. Investments

4. Advances

5. Fixed Assets

6. Other AssetsContingent Liabilities

Business Risks

• Operational Risk

• Credit Risk

• Market Risk

• Liquidity Risk

• Interest Rate Risk

• Foreign Exchange Risk

• Information Risk

What is ALM ?...What is ALM ?... Concerned with strategic Balance Sheet Concerned with strategic Balance Sheet

managementmanagement

Match between assets and liabilities in BSMatch between assets and liabilities in BS

Risks stem from mismatch between A&L – Risks stem from mismatch between A&L – credit, liquidity, interest, currencycredit, liquidity, interest, currency

ALM is not to avoid risk but to manage risk, ALM is not to avoid risk but to manage risk, sustaining profitabilitysustaining profitability

What is ALM ?...contd..What is ALM ?...contd..• Periodic monitoring of risk exposures Periodic monitoring of risk exposures

involving collecting and analysing informationinvolving collecting and analysing information

• Ability to anticipate, forecast and act so as to Ability to anticipate, forecast and act so as to structure bank’s business to profitstructure bank’s business to profit

• Altering A & L portfolio in a dynamic way to Altering A & L portfolio in a dynamic way to manage risksmanage risks

• Involves judgement and decision makingInvolves judgement and decision making

Defining ALMDefining ALM ALM involves Planning, directing and ALM involves Planning, directing and

Controlling the flow , mix, cost and yield of Controlling the flow , mix, cost and yield of the consolidated funds of bankthe consolidated funds of bank

Assesses various asset mixes, funding Assesses various asset mixes, funding combinations, price volume relations and their combinations, price volume relations and their implications on Liquidity, Income and Capital implications on Liquidity, Income and Capital ratioratio

Planning procedure which accounts for all Planning procedure which accounts for all assets and liabilities of a bank by rate, assets and liabilities of a bank by rate, amount and maturity amount and maturity

Why ALM ?Why ALM ?• Banks exposed to credit and market risks Banks exposed to credit and market risks

in view of asset-liability transformation in view of asset-liability transformation

• Risks increased with liberalisation and Risks increased with liberalisation and growing integration of domestic markets growing integration of domestic markets with external markets with external markets

• Banks now operate in deregulated Banks now operate in deregulated environment and are required to determine environment and are required to determine interest rates on various productsinterest rates on various products

Why ALM ?.. Why ALM ?.. Contd..Contd..

• Need to maintain balance among Need to maintain balance among spread, profitability and long-term spread, profitability and long-term viabilityviability

• Increasing volatility in domestic Increasing volatility in domestic interest rates as well as foreign interest rates as well as foreign exchange rates exchange rates

• New financial product innovationNew financial product innovation


• Increased level of awareness among Increased level of awareness among top management - market risks, top management - market risks, interest rate movementsinterest rate movements

• Intense competition for business involving Intense competition for business involving both assets and liabilities both assets and liabilities


• Regulatory initiativesRegulatory initiatives

• International initiative – Basle CommitteeInternational initiative – Basle Committee

• Thus, a call for structured and Thus, a call for structured and comprehensive measures for comprehensive measures for institutionalising an integrated risk institutionalising an integrated risk management system management system

Overall Objective..Overall Objective.. • The central theme of (ALM) is the The central theme of (ALM) is the

management of a bank’s management of a bank’s entireentire balance balance sheet on sheet on continuouscontinuous basis with a view to basis with a view to ensure a proper ensure a proper balancebalance between funds between funds mobilisation and their deployment with mobilisation and their deployment with respect to their maturity profiles, cost and respect to their maturity profiles, cost and yield as well as risk exposure so as to yield as well as risk exposure so as to improve improve profitabilityprofitability, ensure adequate , ensure adequate liquidityliquidity, manage , manage risksrisks and ensure long and ensure long term term viabilityviability

RBI / NABARD Guidelines on ALMRBI / NABARD Guidelines on ALM• Draft guidelines issued on 10 Sept 1998Draft guidelines issued on 10 Sept 1998

• Final guidelines issued on 10 Feb 1999 for Final guidelines issued on 10 Feb 1999 for implementation from 1 April 1999implementation from 1 April 1999

• At least 60% of assets and liabilities to be At least 60% of assets and liabilities to be covered initiallycovered initially

• 100% coverage from 1 April 2000100% coverage from 1 April 2000

RBI / NABARD Guidelines on ALMRBI / NABARD Guidelines on ALM

• NABARD guidelines on Risk Management NABARD guidelines on Risk Management Systems in Banks – April 2005Systems in Banks – April 2005

• Guidelines were issued to 5 select State Guidelines were issued to 5 select State Cooperative Banks viz. Andhra Pradesh, Cooperative Banks viz. Andhra Pradesh, Tamil Nadu. Maharashtra. Punjab and Tamil Nadu. Maharashtra. Punjab and West Bengal SCBs and 12 selected RRBs West Bengal SCBs and 12 selected RRBs for for implementation of Asset - Liability implementation of Asset - Liability Management (ALM) System wef Management (ALM) System wef 1.4.2007- so far satisfactory .1.4.2007- so far satisfactory .


BOS Meeting 27.3.2008 decided BOS Meeting 27.3.2008 decided introduction of ALM in all the SCBs & introduction of ALM in all the SCBs & RRBs wef 1.7.2008RRBs wef 1.7.2008

ALM to be introduced in phased ALM to be introduced in phased manner in DCCBs.manner in DCCBs.

Initially selected 31 DCCBs for ALM Initially selected 31 DCCBs for ALM wef 1.9.2008wef 1.9.2008

Interim target to cover 100% Interim target to cover 100% business by 1.4.2009business by 1.4.2009


Once system stabilises, bank gain Once system stabilises, bank gain experience- swtch over to experience- swtch over to sophisticated computerised sophisticated computerised techniques –Duration Gap analysis, techniques –Duration Gap analysis, Simulation & VaR for Interest rate Simulation & VaR for Interest rate risk managementrisk management


Review of computerisation in bankReview of computerisation in bank Suitability of manpower –implementationSuitability of manpower –implementation ALM policy approved by BODALM policy approved by BOD Constitute ALCO to review ALM Constitute ALCO to review ALM

implementation in bankimplementation in bank Start generating reports as requiredStart generating reports as required Capacity building (KM) of nodal officerCapacity building (KM) of nodal officer Upgrade MIS for preparation of reportsUpgrade MIS for preparation of reports Send detailed monthly progress reports- Send detailed monthly progress reports-

present status, progress made & action present status, progress made & action plan for futureplan for future

ALM Process- Three pillarsALM Process- Three pillars • ALM Information SystemALM Information System

• Management Information SystemManagement Information System• Information availability, accuracy, adequacy and Information availability, accuracy, adequacy and

expediencyexpediency

• ALM OrganisationALM Organisation• Structure and responsibilitiesStructure and responsibilities• Level of top management involvementLevel of top management involvement

• ALM ProcessALM Process• Risk parameters, risk identification, risk Risk parameters, risk identification, risk

measurement, risk management, risk policies and measurement, risk management, risk policies and procedures, prudential limits & auditing, reporting procedures, prudential limits & auditing, reporting & review& review

ALM Information SystemsALM Information Systems• Information is the key to the ALM processInformation is the key to the ALM process

• Varied business profiles – no uniform ALM system Varied business profiles – no uniform ALM system for all banksfor all banks

• Methods range from simple Gap statement to Methods range from simple Gap statement to extremely sophisticated simulation methods.extremely sophisticated simulation methods.

• Availability of Availability of adequate, timely and accurate adequate, timely and accurate informationinformation, the central element for ALM exercise, the central element for ALM exercise

ALM Information Systems-ChallengesALM Information Systems-Challenges• Large network of branches and lack of an Large network of branches and lack of an

adequate support system to collect information adequate support system to collect information

• Problem to be addressed through ABC approach Problem to be addressed through ABC approach – atleast 60-70% of total business-analysing – atleast 60-70% of total business-analysing behaviour of assets and liabilities in sample behaviour of assets and liabilities in sample branchesbranches

• Investment portfolio – easy since centralisedInvestment portfolio – easy since centralised

• Spread of computerisation helpsSpread of computerisation helps

ALM OrganisationALM Organisation

• Board to have overall responsibility and frame risk Board to have overall responsibility and frame risk management policymanagement policy

• Board to set limits for liquidity, interest rate and Board to set limits for liquidity, interest rate and exchange rate risksexchange rate risks

• ALCO (Asset Liability Committee) consisting of senior ALCO (Asset Liability Committee) consisting of senior management including CEO decides strategy and adheres management including CEO decides strategy and adheres to objectiveto objective

• ALM Support Groups, responsible for analysing, ALM Support Groups, responsible for analysing, monitoring and reporting the risk profiles to ALCOmonitoring and reporting the risk profiles to ALCO

• Staff also prepare the forecasts (simulations) showing Staff also prepare the forecasts (simulations) showing effects and recommend actioneffects and recommend action

ALCO-responsibilitiesALCO-responsibilities

• ALCO decision making unit- Responsible for ALCO decision making unit- Responsible for balance sheet planning from risk return balance sheet planning from risk return perspectiveperspective

• Monitoring the market risk levels by ensuring Monitoring the market risk levels by ensuring adherence to the various risk limits set by the adherence to the various risk limits set by the bankbank

• Articulating the current interest rate view and a Articulating the current interest rate view and a view on future direction of interest rate view on future direction of interest rate movementsmovements

ALCO-responsibilitiesALCO-responsibilities

• Deciding the business strategy of Deciding the business strategy of the bank, consistent with the the bank, consistent with the interest rate view, budget and pre-interest rate view, budget and pre-determined risk management determined risk management objectives objectives

• Determining the desired maturity Determining the desired maturity profile and mix of assets and liabilitiesprofile and mix of assets and liabilities

ALCO-responsibilities..ALCO-responsibilities..contd..contd..

• Product pricing for both assets and Product pricing for both assets and liabilities sideliabilities side

• Deciding the funding strategy i.e. source Deciding the funding strategy i.e. source and mix of liabilities or sale of assetsand mix of liabilities or sale of assets

• Reviewing implementation of decisions Reviewing implementation of decisions made in the previous meeting made in the previous meeting

Composition of ALCOComposition of ALCO

• The size of ALCO depends on size of The size of ALCO depends on size of institution, business mix and organisational institution, business mix and organisational complexitycomplexity

• CEO to head the CommitteeCEO to head the Committee

• Chiefs of Investment, Credit, Resource Chiefs of Investment, Credit, Resource Management, Funds Management/ Management, Funds Management/ Treasury, Banking and Economic Research Treasury, Banking and Economic Research to be members of the Committeeto be members of the Committee

Composition of ALCO….Composition of ALCO….

• Head of Technology Division be an inviteeHead of Technology Division be an invitee

• Some banks may have sub-committees Some banks may have sub-committees and support groupsand support groups

• Management committee to oversee and Management committee to oversee and reviewreview

ALM ProcessALM Process

Scope of ALM function can be defined as:Scope of ALM function can be defined as:

Liquidity Risk ManagementLiquidity Risk Management Interest rate risks managementInterest rate risks management Trading risk managementTrading risk management Funding and capital planningFunding and capital planning Profit planning and growth projectionProfit planning and growth projection RBI guidelines mainly cover Liquidity and RBI guidelines mainly cover Liquidity and

Interest rate risksInterest rate risks

Policy for creation of liabilitiesPolicy for creation of liabilitiesAn appropriate policy for creation of An appropriate policy for creation of

liabilities has to take care that:liabilities has to take care that:

• Adequate financial resources (i.e.funds) Adequate financial resources (i.e.funds) are mobilised keeping in view the bank’s are mobilised keeping in view the bank’s deployment requirements deployment requirements

• The cost of liabilities in terms of interest The cost of liabilities in terms of interest cost is least and is reduced from time to cost is least and is reduced from time to timetime

Policy for creation of liabilitiesPolicy for creation of liabilities

• The servicing / operational cost of the The servicing / operational cost of the liabilities is kept low with emphasis on liabilities is kept low with emphasis on volumesvolumes

• The liabilities should come from fairly The liabilities should come from fairly diversified sources so that set backs in diversified sources so that set backs in one area do not affect the overall financial one area do not affect the overall financial resource positionresource position

Policy for creation of assetsPolicy for creation of assets

An appropriate policy for creation of An appropriate policy for creation of assets has to aim at:assets has to aim at:

• Making provisions for meeting statutory Making provisions for meeting statutory requirements like reserves-CRR, SLRrequirements like reserves-CRR, SLR

• Maximising of the yield or return on Maximising of the yield or return on various components of assetsvarious components of assets

• Maintenance of adequate liquidity Maintenance of adequate liquidity through appropriate mix of assetsthrough appropriate mix of assets

Policy for creation of assets…Policy for creation of assets…

• Diversification of assets so as to Diversification of assets so as to minimise lossesminimise losses

• Lending advances with prudence based Lending advances with prudence based on risk perception with the sole on risk perception with the sole objective that it should not turn out to objective that it should not turn out to be non-performingbe non-performing

Liquidity Risk ManagementLiquidity Risk Management

• Assured ability to meet its liabilities as they Assured ability to meet its liabilities as they become due reduces the probability of an become due reduces the probability of an adverse situation developingadverse situation developing

• Liquidity shortfall in one institution can Liquidity shortfall in one institution can have repercussions on the entire systemhave repercussions on the entire system

Liquidity Risk Management….Liquidity Risk Management….

• Assets commonly considered as liquid like Assets commonly considered as liquid like Government securities and other money Government securities and other money market instruments could also become market instruments could also become illiquid when the market and players are illiquid when the market and players are unidirectional unidirectional

• Liquidity has to be tracked through Liquidity has to be tracked through maturity or cash flow mismatchesmaturity or cash flow mismatches

• Use of maturity ladder – standard toolUse of maturity ladder – standard tool

Statement of structural liquidityStatement of structural liquidity

Time buckets for maturity profileTime buckets for maturity profilei.i. 1-14 days1-14 days

ii.ii. 15-28 days15-28 days

iii.iii. 29 days and upto 3 months29 days and upto 3 months

iv.iv. Over 3 months and upto 6 monthsOver 3 months and upto 6 months

v.v. Over 6 months and upto 1 yearOver 6 months and upto 1 year

vi.vi. Over 1 year and upto 3 yearsOver 1 year and upto 3 years

vii.vii. Over 3 years and upto 5 yearsOver 3 years and upto 5 years

viii.viii. Over 5 yearsOver 5 years

Liquidity mismatches… Liquidity mismatches… contd..contd..

• The mismatches during 1-14 & 15-28 days not to The mismatches during 1-14 & 15-28 days not to exceed 20% of cash outflows exceed 20% of cash outflows

• Maturing liability is a cash outflow and maturing Maturing liability is a cash outflow and maturing asset is a cash inflowasset is a cash inflow

• Tolerance level in mismatches to be determined Tolerance level in mismatches to be determined based on asset-liability base, nature of business, based on asset-liability base, nature of business, future strategy etc.future strategy etc.

• Banks to monitor their short term liquidity on a Banks to monitor their short term liquidity on a dynamic basis over a time horizon spanning dynamic basis over a time horizon spanning from 1-90 days (short term dynamic liquidity from 1-90 days (short term dynamic liquidity statement)statement)

Estimation of short term dynamic liquidityEstimation of short term dynamic liquidity

Interest Rate RiskInterest Rate Risk• Interest rate risk is the risk where changes Interest rate risk is the risk where changes

in the market interest rates might adversely in the market interest rates might adversely affect a bank’s financial conditionaffect a bank’s financial condition

• Immediate impact would be on bank’s Immediate impact would be on bank’s earnings by changing its NII earnings by changing its NII

• Long tem impact of changing interest rates Long tem impact of changing interest rates would be on bank’s Net Worth would be on bank’s Net Worth

• Interest rate risk is measured in terms of Interest rate risk is measured in terms of change in NII change in NII

Interest Rate Risk…Interest Rate Risk…

• Traditional Gap analysis method is to be used Traditional Gap analysis method is to be used nownow

• Move over to modern techniques of Interest Move over to modern techniques of Interest Rate Risk measurement like Duration Gap Rate Risk measurement like Duration Gap analysis, simulation, VAR graduallyanalysis, simulation, VAR gradually

• Gap or Mismatch analysis measures gaps Gap or Mismatch analysis measures gaps between rate sensitive assets and rate sensitive between rate sensitive assets and rate sensitive liabilitiesliabilities

Interest Rate Risk-measurementInterest Rate Risk-measurement• An asset or liability is considered rate An asset or liability is considered rate

sensitive if: sensitive if:

• Within the time interval under consideration Within the time interval under consideration there is a cash flowthere is a cash flow

• the interest rate resets/reprises the interest rate resets/reprises contractually during the periodcontractually during the period

• RBI changes the interest ratesRBI changes the interest rates

• It is contractually pre-payable or It is contractually pre-payable or withdrawable before the stated maturitywithdrawable before the stated maturity

Interest rate sensitivity - Reporting formatInterest rate sensitivity - Reporting format

Interest Rate Risk-measurementInterest Rate Risk-measurement• Gap report is generated by grouping the RSA, Gap report is generated by grouping the RSA,

RSL into time buckets according to residual RSL into time buckets according to residual maturity or next reprising period, whichever is maturity or next reprising period, whichever is earlier.earlier.

• All investments, advances, deposits, borrowings, All investments, advances, deposits, borrowings, purchased funds etc that mature/reprise within a purchased funds etc that mature/reprise within a specified timeframe are interest rate sensitivespecified timeframe are interest rate sensitive

Rate sensitive assets and liabilitiesRate sensitive assets and liabilities

Interest Rate Risk-Gap in time bucketsInterest Rate Risk-Gap in time buckets The gaps may be identified in the following time The gaps may be identified in the following time

bucketsbuckets

i.i. 1-28 days1-28 days

ii.ii. 29 days and upto 3 months29 days and upto 3 months

iii.iii. Over 3 months and upto 6 monthsOver 3 months and upto 6 months

iv.iv. Over 6 months and upto 1 yearOver 6 months and upto 1 year

v.v. Over 1 year and upto 3 yearsOver 1 year and upto 3 years

vi.vi. Over 3 years and upto 5 yearsOver 3 years and upto 5 years

vii.vii. Over 5 yearsOver 5 years

viii.viii. Non-sensitiveNon-sensitive

Interest Rate Risk – Gap reportInterest Rate Risk – Gap report• The gap is the difference between RSA and RSL The gap is the difference between RSA and RSL

for each time bucketfor each time bucket

• RSA>RSL - positive gapRSA>RSL - positive gap

• RSA<RSL - negative gapRSA<RSL - negative gap

• Positive – beneficial with rising ratesPositive – beneficial with rising rates

• Negative – beneficial with declining rates Negative – beneficial with declining rates

• Each bank should set prudential limits on Each bank should set prudential limits on individual gaps with the approval of the individual gaps with the approval of the Board/Management CommitteeBoard/Management Committee

General….General….

• Classification of various components Classification of various components of assets and liabilities into different of assets and liabilities into different time buckets made is benchmarktime buckets made is benchmark

• Better equipped banks may Better equipped banks may reclassify based on data/studies reclassify based on data/studies subject to approval of ALCO/Boardsubject to approval of ALCO/Board

• Note approved by ALCO/Board to be Note approved by ALCO/Board to be sent to RBIsent to RBI

Summary….Summary….

• Coordinated financial management Coordinated financial management of BSof BS

• Risk by choice and not by chanceRisk by choice and not by chance• A pulse on approach to market risk A pulse on approach to market risk

managementmanagement• Increased awareness of market risksIncreased awareness of market risks• Both science and an artBoth science and an art

Thank youThank you

05 ALM Guidelines Short

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