Asset and Liability Management in Indian Banks

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Asset and Liability Management in Indian Banks.

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  • Agenda Asset-Liability basic idea Risk & Risk management NPA RBI Guidelines Narasimham Committee Basel Accord ALM ALCO ALM Info ALM Process ALM implementation Problem Suggestion
  • Components of a Bank Balance Sheet Liabilities 1. Paid in Capital 2. Reserve & Surplus 3. Deposits 4. Borrowings 5. Other Liabilities Asset 1. Cash & Balances with RBI 2. Money at Call and Short Notices 3. Investments 4. Advances 5. Other Assets
  • Example of Mismatch Bank A It takes loan from Giver Ltd. and lends to Receiver Ltd. It borrows Rs 100 million for 1 yr @ 6.00% p.a. from Giver Ltd. and lends to Receiver Ltd. for 5 years @ 6.20% p.a. Apparently the gain is: 20 bps But A have to borrow again at the end of 1 year to finance the loan which still has 4 more years to mature. Interest rate for 4 yrs maturity at the end of 1 yr: 7.00% p.a. Here Earning is 6.20% p.a. & Payment is 7.00% p.a. Market Value method of accounting Asset = 100*(1.06) ^4 = 126.247 million Liability = 100*(1.07)^4 = Rs 131.079 million Loss = Rs 4.832 million So the root cause of problem Mismatch between Assets & Liabilities.
  • NPA(Non Performing Assets) A Loan which is an asset for a bank turns into a Non Performing Asset when the EMI, principal or interest component for the loan is not paid within 90 days from the due date. The assets or loans are classified as:- Standard Assets Sub-standard Assets Doubtful Assets Loss Assets
  • Asset Classification
  • NPA- Continues.. A Loss Asset is considered uncollectible and of such little value for the bank in retaining the account on its book and ideally, such loans should be written off. Thus, Loss assets should be written off. If loss assets are permitted to remain in the books for any reason, 100% of the outstanding should be provided for. Apart from above, there are Guidelines by RBI for provisions under special circumstances. Unsecured exposure is defined as an exposure where the realizable value of the security, as assessed by the bank/approved values/RBIs inspecting officers, is not more than 10%, ab-initio, of the outstanding exposure. Exposure includes all funded and non-funded exposures. Security are tangible security properly discharged to the bank and do not include intangible securities like guarantees, etc.
  • Provisioning Coverage Ratio (PCR) Provisioning Coverage Ratio (PCR): The ratio of provisioning to gross non-performing assets. Indicates the extent of funds a bank has kept aside to cover loan losses.
  • NPA(RBI Guidelines) As per RBI guidelines, NPA is defined as under: Non -performing asset (NPA) is a loan or an advance where; interest and/ or instalment of principal remain overdue for a period of more than 90 days in respect of a term loan, the account remains out of order in respect of an Overdraft/Cash Credit (OD/CC), the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted, the instalment of principal or interest there on remains overdue for two crop seasons for short duration crops, the instalment of principal or interest there on remains overdue for one crop season for long duration crops, the amount of liquidity facility remains outstanding for more than 90 days, in respect of a securitisation transaction undertaken in terms of guidelines on securitization dated February 1, 2006. in respect of derivative transactions, the overdue receivables representing positive mark-to-market value of a derivative contract, if these remain unpaid for a period of 90 days from the specified due date for payment.
  • Net NPA Net NPA = Gross NPA (Balance in Interest Suspense account + DICGC/ECGC claims received and held pending adjustment + Part payment received and kept in suspense account + Total provisions held).
  • Net NPA of Indian Banks
  • BASEL 2 ACCORD Elements of Basel 2 rules Basel II is split into three approaches or pillars :- Pillar 1 The Minimum Capital Requirements (1) Credit risk The capital requirements are stated under two approaches - The standardised approach. The internal ratings-based (IRB) approach. Within IRB there is a foundation approach and an advanced approach, the latter of which gives banks more scope to set elements of the capital charges themselves.
  • Operational Risk An element of Basel II is the capital charge to cover banks operational risk. There are three different approaches for calculating the operational risk capital charge. These are: The basic indicator approach, under which 20% of total capital would be allocated. An internal estimation by a bank of the expected losses due to operational risk for each business line. Operational risk here would be risk of loss as a result of IT Failures and legal risk and so on. Total Minimum Capital The sum of the capital calculation for credit risk exposure, operational risk and the bank's trading book will be the total minimum capital requirement. This capital requirement will be expressed as an 8% risk-asset ratio, identical to the rules under Basel 1 .
  • PILLAR 2 Supervisory Approach In Basel II there is a requirement for a supervision approach to capital allocation. First, banks must have a procedure for calculating their capital requirements in accordance with their individual risk profile. PILLAR 3 DISCLOSURE Basel II sets out rules on core disclosure that banks are required to meet, and which supervisors must enforce. The disclosures include : Capital The elements that make up the bank's capital, such as the types of instruments that make up the Tier 1 and Tier 2 capital. Risk exposure - The overall risk exposure of a bank, as measured by credit risk, market risk, operational risk and so on. Hence, this would include a profile of the ALM book, including maturity profile of the loan book, interest-rate risk.
  • Narasimham Committee From the 1991 India economic crisis to its status of third largest economy in the world by 2011, India has grown significantly in terms of economic development. So has its banking sector. Two such expert Committees were set up under the chairmanship of M Narasimham they submitted their recommendations in the 1990s in reports widely known as the M Narasimham Committee-I (1991) report and the Narasimham Committee- 2 (1998) Report. Background During the decades of the 60s and the 70s, India nationalised most of its banks. This culminated with the balance of payments crisis of the Indian economy where India had to airlift gold to International Monetary Fund (IMF) to loan money to meet its financial obligations.
  • Given that rigidities and weaknesses had made serious inroads into the Indian banking system by the late 1980s, the Government of India (GOI), post-crisis, took several steps to remodel the country's financial system. In the light of these requirements, two expert Committees were set up in 1990s under the chairmanship of M Narasimham an ex-RBI (Reserve Bank of India) governor which are widely credited for spearheading the financial sector reform in India. The first Narasimham Committee (Committee on the Financial SystemCFS) was appointed by Manmohan Singh as India's Finance Minister on 14 August 1991,and the second one (Committee on Banking Sector Reforms) was appointed by P Chidambaram as Finance Minister in December 1998. The purpose of the Narasimham-I Committee was to study all aspects relating to the structure, organisation, functions and procedures of the financial systems and to recommend improvements in their efficiency and productivity. The Committee submitted its report to the Finance Minister in November 1991 which was tabled in Parliament on 17 December 1991.
  • Stronger banking system The Committee recommended for merger of large Indian banks to make them strong enough for supporting international trade. It recommended a three tier banking structure in India through establishment of three large banks with international presence, eight to ten national banks and a large number of regional and local banks. It cautioned that large banks should merge only with banks of equivalent size and not with weaker banks. Implementation of Recommendations Based on the other recommendations of the committee, the concept of a universal bank was discussed by the RBI and finally ICICI bank became the first universal bank of India. The RBI published an "Actions Taken on the Recommendations" report on 31 October 2001 on its own website.
  • The Narasimham-II Committee was tasked with the progress review of the implementation of the banking reforms since 1992 with the aim of further strengthening the financial institutions of India. It focussed on issues like size of banks and capital adequacy ratio am