A

PROJECT REPORT

ON

“ASSEST & LIABILITIES AND MANAGEMENT

OF

HDFC BANK

Project submitted in partial fulfillment for the award of degree of

MASTERS OF BUSINESS ADMINISTRATION

OF

JNTU

SUBMITTED BY

K V RAMANAIAH

H.T. NO: 10H51E0023

CMR ENGINEERING COLLEGE

(Affiliated to JNTUH)

Medchal Secunderabad-500014

(2010-2012)

1

DECLARATION

I, the undersigned, hereby declare that the project report entitled

“(Assest&liabilities and management)” carried out at (HDFC Bank). Is my

original work written and submitted by me in partial fulfillment of Master`s

Degree in Business Administration of (JNTUHYDERABAD University). I also

declare that this project has not been submitted earlier in any other university or

institution.

Date: (K V Ramanaiah)

2

ACKNOWLEDGEMENT

I take this opportunity to extend my profound thanks and deep sense of

gratitude to the authorities of (HDFC Bank). For giving me the opportunity to

undertake this project works in their esteemed organization. I profusely thank Mr.

Company Guide Name (Designation)

My sincere thanks to Honorable secretary Sri K Suresh, (College Name)

principal Mr.------------, HOD Mr. Koteshwear Rao, and my project guide Mr.

Koteshwar Rao. For the kind encouragement and constant support extended in

completion of this project work. From the bottom of my heart

I am also thankful to all those who have incidentally helped me, through

their valued guidance, co-operation and unstinted support during the course of my

project.

K V Ramanaiah

3

ABSTRACT

Asset-Liability Management (ALM) can be termed as 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 and hence is also known as Surplus Management.

But in the last decade the meaning of ALM has evolved. It is now used in many different

ways under different contexts. ALM, which was actually pioneered by financial institutions and

banks, are now widely being used in industries too. The Society of Actuaries Task Force on

ALM Principles, Canada, offers the following definition for ALM: "Asset Liability Management

is the on-going process of formulating, implementing, monitoring, and revising strategies related

to assets and liabilities in an attempt to achieve financial objectives for a given set of risk

tolerances and constraints."

The need of the study is to concentrates on the growth and performance of The Housing

Development Finance Corporation Limited (HDFC) and to calculate the growth and

performance by using asset and liability management. And to know the management of

nonperforming assets.

To know financial position of The Housing Development Finance Corporation Limited

(HDFC)

The burden of the Risk and its Costs are both manageable and transferable. Financial

service firms, in the addition to managing their own risk, also sell financial risk management to

others. They sell their services by bearing customers financial risks through the products they

provide. A financial firm can offer a fixed-rate loan to a borrower with the risk of interest rate

movements transferred from the borrower to the . Financial innovations have been concerned

with risk reduction then any other subject. With the possibility of managing risk near zero, the

challenge becomes not how much risk can be removed.

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INDEX

S.No: CONTENTS PAGE NO.

CHAPTER-1 1-13

INTRODUCTION

Scope of the Study

Objectives of the Study

Needs and importants

Methodology of the Study

Limitations of the Study

CHAPTER-2 14-23

REVIEW OF LITERATURE

CHAPTER-3 24-34

COMPANY PROFILE

INDUSTRIAL PROFILE

CHAPTER-4 35-59

CONCEPTUAL FRAMWORK

CHAPTER-5 60-85

DATA ANALYSIS AND INTERPRITION

CHAPTER-6 86-90

FINDINGS CONCLUSION SUGGESTIONS BIBILIOGRAPHY

5

CHAPTER-IINTRODUCTION

6

INTRODUCTION

Asset Liability Management (ALM) is a strategic approach of managing the balance sheet

dynamics in such a way that the net earnings are maximized. This approach is concerned with

management of net interest margin to ensure that its level and riskiness are compatible with the

risk return objectives.

If one has to define Asset and Liability management without going into detail about its

need and utility, it can be defined as simply “management of money” which carries value and

can change its shape very quickly and has an ability to come back to its original shape with or

without an additional growth. The art of proper management of healthy money is ASSET AND

LIABILITY MANAGEMENT (ALM

The Liberalization measures initiated in the country resulted in revolutionary changes in the

sector. There was a shift in the policy approach from the traditionally administered market

regime to a free market driven regime. This has put pressure on the earning capacity of co-

operative, which forced them to foray into new operational areas thereby exposing themselves to

new risks. As major part of funds at the disposal from outside sources, the management is

concerned about RISK arising out of shrinkage in the value of asset, and managing such risks

became critically important to them. Although co-operatives are able to mobilize deposits, major

portions of it are high cost fixed deposits. Maturities of these fixed deposits were not properly

matched with the maturities of assets created out of them. The tool called ASSET AND

LIABILITY MANAGEMENT provides a better solution for this.

ASSET LIABILITY MANAGEMENT (ALM) is a portfolio management of assets and

liability of an organization. This is a method of matching various assets with liabilities on the

basis of expected rates of return and expected maturity pattern

In the context of ALM is defined as “a process of adjusting s liability to meet loan

demands, liquidity needs and safety requirements”. This will result in optimum value of the

same time reducing the risks faced by them and managing the different types of risks by keeping

it within acceptable levels.

7

RBI revises asset liability management guidelines

February 6/2012In the era of changing interest rates, Reserve Bank of India (RBI) has now

revised its Asset Liability Management guidelines. Banks have now been asked to calculate

modified duration of assets (loans) and liabilities (deposits) and duration of equity.

This was stated by the executive director of RBI, V K Sharma, and here today. He said that

this concept gives banks a single number indicating the impact of a 1 per cent change of interest

rate on its capital, captures the interest rate risk, and can thus help them move forward towards

assessment of risk based capital. This approach will be a graduation from the earlier approach,

which led to a mismatch between the assets and liabilities.

The ED said that RBI has been laying emphasis that banks should maintain a more realistic

balance sheet by giving a true picture of their non performing assets (NPAs), and they should not

be deleted to show huge profits. Though the banking system in India has strong risk management

architecture, initiatives have to be taken at the bank specific level as well as broader systematic

level. He also emphasized on the need for sophisticated credit-scoring models for measuring the

credit risks of commercial and industrial portfolios.

Emphasizing on a need for an effective control system to manage risks, he said that the

implementation of BASEL II norms by commercial banks should not be delayed. He said that the

banks should have a robust stress testing process for assessment of capital adequacy in wake of

economic downturns, industrial downturns, market risk events and sudden shifts in liquidity

conditions. Stress tests should enable the banks to assess risks more accurately and facilitate

planning for appropriate capital requirements.

Sharma spoke at length about the need to extend the framework of integrated risk

management to group-wide level, especially among financial conglomerates. He said that RBI

has already put in place a framework for oversight of financial conglomerates, along with SEBI

and IRDA. He also said that at the systematic level efforts are being made to create an enabling

environment for all market participants in terms of regulation, infrastructure and instruments.

8

NEED AND IMPORTANTS OF THE STUDY:

The need of the study is to concentrates on the growth and performance of HDFC and to

calculate the growth and performance by using asset and liability management and to know the

management of nonperforming assets.

To know financial position of HDFC

To analyze existing situation of HDFC

To improve the performance of HDFC

To analyze competition between HDFC with other cooperatives.

IMPORTANTS OF THE STUDY:

Fees and Charges:-

Fees payable on the Credit Card by the Card member:-

The fees may vary for each Card member, and from offer to offer. The same is

communicated to the Card member at the time of applying for the credit card. The above fees as

applicable are billed to the card account and are stated in the card statement of the month in

which it is card charged.

Annual Fees �

Renewal Fees

Cash Advance Fees:-

The Card member can use the Card to access cash in an emergency from ATMs in India or

abroad.

9

SCOPE OF THE STUDY:

In this study the analysis based on ratios to know asset and liabilities management under

HDFC and to analyze the growth and performance of HDFC by using the calculations under

asset and liability management based on ratio.

Ratio analysis

Comparative statement

Common size balance sheet.

GEOGRAPHICAL SCOPE:-

The same problem was with the all other branches of HDFC Bank even out of the pune city. The management is conducting the same research on a big ground while my contribution is tiny. Though my sample size and geographical area was defined and confine to a particular territory but the application of output from the research are going to

be wide.PRODUCT SCOPE:-

Studying the increasing business scope of the bank. Market segmentation to find the potential customers for the bank. To study how the various products are positioned in the market. Corporate marketing of products. Customers’ perception on the various products of the bank

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OBJECTIVES OF THE STUDY

To study the concept of ASSET & LIABLITY MANAGEMENT in HDFC

To study process of CASH INFLOWS and OUTFLOWS in HDFC

To study RISK MANAGEMENT under HDFC

To study RESERVES CYCLE of ALM under HDFC

To study FUNCTIONS AND OBJECTIVES of ALM committee.

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METHODOLOGY OF THE STUDY

The study of ALM Management is based on two factors.

1. Primary data collection.

2. Secondary data collection

PRIMARY DATA COLLECTION:

The sources of primary data were

The chief manager – ALM cell

Department Sr. manager financing & Accounting

System manager- ALM cell

Gathering the information from other managers and other officials of the organization.

SECONDARY DATA COLLECTION:

Collected from books regarding journal, and management containing relevant information

about ALM and Other main sources were

Annual report of the HDFC

Published report of the HDFC

RBI guidelines for ALM.

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LIMITATION OF THE STUDY:

This subject is based on past data of HDFC

The analysis is based on structural liquidity statement and gap analysis.

The study is mainly based on secondary data.

Approximate results: The results are approximated, as no accurate data is Available.

Study takes into consideration only LTP and issue prices and their difference for

Concluding whether an issue is overpriced or under priced leaving other.

The study is based on the issues that are listed on NSE only.

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CHAPTER-II

REVIEW OF LITERATURE

14

Paper Title:-Sovereign Risk and Asset and Liability

Management Conceptual Issues(SRALM)

Authour:- G. Papaioannou, and Author Iva Petrova(2000)

Findings:-

Country practices towards managing financial risks on a sovereign balance

sheet continue to evolve. Each crisis period, and its legacy on sovereign

balance sheets, reaffirms the need for strengthening financial risk

management. This paper discusses some salient features embedded in in the

current generation of sovereign asset and liability management (SALM)

approaches, including objectives, definitions of relevant assets and liabilities,

and methodologies used in obtaining optimal SALM outcomes. These

elements are used in developing an analytical SALM framework which could

become an operational instrument in formulating asset management and

debtor liability management strategies at the sovereign level. From a

portfolio perspective, the SALM approach could help detect direct and

derived sovereign risk exposures. It allows analyzing the financial

characteristics of the balance sheet, identifying sources of costs and risks,

and quantifying the correlations among these sources of risk. The paper also

outlines institutional requirements in implementing an SALM framework and

seeks to lay the ground for further policy and analytical work on this topic.JEL

Paper Title :- Integrating Asset-Liability Risk Management with

Portfolio Optimization for Individual Investors II (IALRM)

Author :- Travis L. Jones, Ph.D.(2002)

Findings :-

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A majority of private client practitioners rely on mean-variance optimization (MVO),rules of

thumb, or model portfolios for making asset allocation recommendations. Considerations for

income levels and other constraints figure into the typical approach. However, not enough

attention is given to the nature of an investor’s multiple time horizons and implications for cash

flows. These are the future demands placed upon the portfolio. The risks that these demands will

not be met need to be clearly understood in order to validate any asset allocation decision. This

study presents an approach of incorporating MVO within a multi-horizon, asset-liability

Management risk model. This approach allows for cash-flow matching of a portion of an

investor’s portfolio within the optimization framework. This allows an individual’s portfolio to

provide short-term cash flow, as needed, while also considering the longer-term demands on the

portfolio.

Part Title :- Asset & liability management (ALM) modelling with

risk control by stochastic dominance.

Author name :- Xi Yang, Jacek Gondzi & Andreas Grothey(2001)

Findings:-

An Asset Liability Management model with a novel strategy for controlling the risk of

underfunding is presented in this article. The basic model involves multi-period decisions

(portfolio rebalancing) and deals with the usual uncertainty of investment returns and future

liabilities. Therefore, it is well suited to a stochastic programming approach. A stochastic

dominance concept is applied to control the risk of underfunding through modelling a chance

constraint. A small numerical example and an out-of-sample back test are provided to

demonstrate the advantages of this new model, which includes stochastic dominance constraints,

over the basic model and a passive investment strategy. Adding stochastic dominance constraints

comes with a price. This complicates the structure of the underlying stochastic program. Indeed,

the new constraints create a link between variables associated with different scenarios of the

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same time stage. This destroys the usual tree structure of the constraint matrix in the stochastic

program and prevents the application of standard stochastic programming approaches, such as

(nested) Benders decomposition and progressive hedging. Instead, we apply a structure-

exploiting interior point method to this problem. The specialized interior point solver, object-

oriented parallel solver, can deal efficiently with such problems and outperforms the industrial

strength commercial solver CPLEX on our test problem set. Computational results on medium-

scale problems with sizes reaching about one million variables demonstrate the efficiency of the

specialized solution technique. The solution time for these non-trivial asset liability models

appears to grow sub linearly with the key parameters of the model, such as the number of assets

and the number of realizations of the benchmark portfolio, which makes the method applicable

to truly large-scale problems.

Paper Title:- An investigation of asset liability management

practices in Kenya Commercial Banks(IALM)

Author:- Macharia, & Irungu Peter(2003)

Findings :-

Risk management practices in commercial banks are commonly known as asset liability

management and it remains critical in ensuring safety of depositors' funds as well as investors'

stake. Asset liability management is a requirement by the Central Banks of any country in order

to ensure full compliance to the set risk management guidelines. This study was designed to

establish the asset/liability management practices by Commercial Banks in Kenya and to find out

the extent of asset-liability management by these banks. The study will be important to

commercial banks, scholars and it will contribute more knowledge to the existing information on

asset liability management. The population under study comprised of all Heads of Treasury

Operations of the 43 Commercial Banks in Kenya. Census study was used because the

population was relatively small for sampling and gave a better representation of the various risk

management practices employed by various commercial banks as well as their asset liability

management practices. Each respondent filled and submitted a self administered questionnaire

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that was dropped and picked later. The questionnaire responses were summarized and the results

analyzed using Statistical data analysis programme (SPSS) to describe the relationship between

the dependent and the independent variables. Findings were presented by way of charts, graphs

and tables. Several deductions were drawn from the findings. These included: responding banks

employed both conventional and bank-specific asset liability management practices. Most banks

considered credit/default risk to be the most critical of all financial risk exposures though some

empirical evidence shows that foreign exchange risk is the most critical risk for most firms.

Majority of the banks did not find the Kenyan currency market to be information efficient:

speculation and forecasting techniques were extensively used by most of them. Regular and

systematic appraisal of asset/liability management policies was a common practice amongst most

banks. Most banks also indicated that their asset/liability management systems were governed by

guidelines set by the management board which is a cross functional outfit covering all the major

functions in the bank this showed that ALM is a highly strategic issue in the banks Most banks,

regardless of their size, extensively utilized most of the conventional hedging instruments. Micro

hedge approach, accounting and economic exposure measurement strategies, natural hedging and

diversification were some of the most utilized strategies. Some hedging practices were

considered by most banks to be more important than others. These included use of forward

contracts and foreign currency options as hedging instruments, and use of matching/natural

hedging strategy.

Pper Title:- Industry - with Asset Liability Management in Indian

Bankingspecial reference to Interest RateRisk Management in

ICICI Bank

Author:- Dr. B. Charumathi

Findings:-

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. The

easing of controls on interest rates has led to higher interest rate volatility in India. Hence, there

18

is a need to measure and monitor the interest rate exposure of Indian banks. This paper entitled

“A Study on the Assets and Liabilities Management (ALM) Practices with special reference to

Interest Rate Risk Management at ICICI Bank” is aimed at measuring the Interest Rate Risk in

ICICI Bank by using Gap Analysis Technique. Using publicly available information, this paper

attempts to assess the interest rate risk carried by the ICICI bank in March 2005, 2006, & 2007.

The findings revealed that the bank is exposed to interest rate risk .Index Terms—Interest

volatility, risk, Indian banks

Paper Title:- ASSET-LIABILITY MANAGEMENT UNDER

BENCHMARK AND MEAN-VARIANCECRITERIA IN A JUMP

DIFFUSION MARKET

Author :- Yan ZENG(1), Zhongfei LI(2)

Findings:-

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. The

easing of controls on interest rates has led to higher interest rate volatility in India. Hence, there

is a need to measure and monitor the interest rate exposure of Indian banks. This paper entitled

“A Study on the Assets and Liabilities Management (ALM) Practices with special reference to

Interest Rate Risk Management at ICICI Bank” is aimed at measuring the Interest Rate Risk in

ICICI Bank by using Gap Analysis Technique. Using publicly available information, this paper

attempts to assess the interest rate risk carried by the ICICI bank in March 2005, 2006, & 2007.

The findings revealed that the bank is exposed to interest rate risk. Index Terms—Interest

volatility, risk, Indian banks

19

Pepar Title :- Optimal Asset Allocation in Asset Liability

Management

Author:- Jules H. van Binsbergen, Michael W. Brandt

Findings :-

We study the impact of regulations on the investment decisions of a defined benefits pension

plan. We assess the influence of ex ante (preventive) and ex post (punitive) risk constraints on

the gains to dynamic, as opposed to myopic, decision making. We find that preventive measures,

such as Value-at-Risk constraints, tend to decrease the gains to dynamic investment. In contrast,

punitive constraints, such as mandatory additional contributions from the sponsor when the plan

becomes underfunded, lead to very large utility gains from solving the dynamic program. We

also show that financial reporting rules have real effects on investment behavior. For example,

the current requirement to discount liabilities at a rolling average of yields, as opposed to at

current yields, induces grossly suboptimal investment decisions.

Paper Title: IMPORTANCE OF ASSET AND LIABILITY

MANAGEMENT IN THE NIGERIA BANKING INDUSTRY (A

CASE STUDY OF EQUITY BANK NIGERIA LIMITED)

Authors:- faloye and andrew

Findings :-

This study examines the extent to which Asset and Liability management is crucial to the

existence and survival of a bank. Banking is confidence driven and the extent to which this

confidence is secured and retained depends on the efficiency with which Bank asset and

liabilities are managed to the satisfaction of the various constituencies that the bank serves viz:

Depositors, Borrowers, Shareholders, Regulatory Authorities and the Community. The scope of

this survey is an in-depth study of the Assets and Liabilities Management in EquityBank of

Nigeria Limited in the years before re-structure (1993 to 1995) and after the re-structure (1996 to

1998). The survey will be limited to select Heads of Department and above. The survey would

20

also cover both the surviving members of the Meridien Equity Bank, the restructuring

management from Nigerian Intercontinental Merchant Bank Limited and new members of staff

after the restructure. It was found out that the crisis of confidence in the financial system and its

illiquidity is traced to the macro-economic and political problems of the country. Government's

unsuccessful attempt to arrest the above through various measures as well as the massive looting

of the treasury led to high loan defaults and exacerbated the financial crisis and the resulting

mass liquidation of financial Institutions and commercial banks did not properly address the

problem of effective Asset and liability management and this triggered off the bank failures

already witnessed. It can therefore be concluded that effective asset and liability management is

critical factor in a commercial bank. It is of utmost necessity that good asset and liability

management policies should be in place in a capitalist society to mobilize available resources

(liabilities) and divert them to profitable instruments (assets) to achieve bank viability and

growth: Inefficient Asset and Liability Management could result in bank failure.

Paper title :-A Financial assets and liabilities management support

system

Author:- Yung-Hsin Wang, Ta-Hua Kuo

Findings :-

This paper describes the design and implementation of a decision support system (DSS) based on

the fund dispatching decision viewpoint from the financial division of a business group. An

integrated data warehouse is established and the technique of online analytical processing

(OLAP) is applied to analyze daily transaction data of an enterprise resource planning system

with determined management goal. We adopt the Business Dimensional Lifecycle approach to

accomplish the system design and development. The DSS system developed is to provide latest

and timely information of financial asset and liability positions in each company within the case

business group so that decision makers can have a clear decision support in fund dispatching.

While most related researches on fund dispatching focused especially on efficient banking

capital management and few studies were done for general financial department of traditional

enterprise let alone for the business group, this study has made a progress in this issue and the

21

resultant system is applicable to the similar business group .the interest rate changing adversely,

this in turn protects the owner's equity of the bank. We use seven-day's reacquired interest rate

data to estimate the frequency distribution of the fluctuation of the future market rate and solved

the problem to describe the fluctuation of the interest rate with multi-factors.

CHAPTER-III

COMPANY PROFILE

Industrial profile

22

Company profile& industrial profile:-

A bank is a financial institution that accepts deposits and channels those deposits into

lending activities. Banks primarily provide financial services to customers while enriching

investors. Government restrictions on financial activities by banks vary over time and location.

Banks are important players in financial markets and offer services such as investment funds and

loans. In some countries such as Germany, banks have historically owned major stakes in

industrial corporations while in other countries such as the United States banks are prohibited

from owning non-financial companies. In Japan, banks are usually the nexus of a cross-share

holding entity known as the keiretsu. In France, bancassurance is prevalent, as most banks offer

insurance services (and now real estate services) to their clients.

The level of government regulation of the banking industry varies widely, with countries

such as Iceland, having relatively light regulation of the banking sector, and countries such as

China having a wide variety of regulations but no systematic process that can be followed typical

of a communist system.

The oldest bank still in existence is Monte dei Paschi di Siena, headquartered in Siena,

Italy, which has been operating continuously since 1472.

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History

Origin of the word:-

The name bank derives from the Italian word banco "desk/bench", used during the

Renaissance by Jewish Florentine bankers, who used to make their transactions above a desk

covered by a green tablecloth. However, there are traces of banking activity even in ancient

times, which indicates that the word 'bank' might not necessarily come from the word 'banco'.

In fact, the word traces its origins back to the Ancient Roman Empire, where moneylenders

would set up their stalls in the middle of enclosed courtyards called macella on a long bench

called a bancu, from which the words banco and bank are derived. As a moneychanger, the

merchant at the bancu did not so much invest money as merely convert the foreign currency into

the only legal tender in Rome—that of the Imperial Mint.

The earliest evidence of money-changing activity is depicted on a silver drachm coin from

ancient Hellenic colony Trapezus on the Black Sea, modern Trabzon, c. 350–325 BC, presented

in the British Museum in London. The coin shows a banker's table (trapeza) laden with coins, a

pun on the name of the city.

In fact, even today in Modern Greek the word Trapeza (Τράπεζα) means both a table and a

bank.

Traditional banking activities:-

Banks act as payment agents by conducting checking or current accounts for customers,

paying cheques drawn by customers on the bank, and collecting cheques deposited to customers'

24

current accounts. Banks also enable customer payments via other payment methods such as

telegraphic transfer, EFTPOS, and ATM.

Banks borrow money by accepting funds deposited on current accounts, by accepting term

deposits, and by issuing debt securities such as banknotes and bonds. Banks lend money by

making advances to customers on current accounts, by making installment loans, and by

investing in marketable debt securities and other forms of money lending.

Banks provide almost all payment services, and a bank account is considered indispensable

by most businesses, individuals and governments. Non-banks that provide payment services such

as remittance companies are not normally considered an adequate substitute for having a bank

account.

Banks borrow most funds from households and non-financial businesses, and lend most

funds to households and non-financial businesses, but non-bank lenders provide a significant and

in many cases adequate substitute for bank loans, and money market funds, cash management

trusts and other non-bank financial institutions in many cases provide an adequate substitute to

banks for lending savings to.

Entry regulation:-

Currently in most jurisdictions commercial banks are regulated by government entities and

require a special bank licence to operate.

Usually the definition of the business of banking for the purposes of regulation is extended

to include acceptance of deposits, even if they are not repayable to the customer's order—

although money lending, by itself, is generally not included in the definition.

Unlike most other regulated industries, the regulator is typically also a participant in the

market, i.e. a government-owned (central) bank. Central banks also typically have a monopoly

on the business of issuing banknotes. However, in some countries this is not the case. In the UK,

for example, the Financial Services Authority licences banks, and some commercial banks (such

25

as the Bank of Scotland) issue their own banknotes in addition to those issued by the Bank of

England, the UK government's central bank.

Definition:-

The definition of a bank varies from country to country.

Under English common law, a banker is defined as a person who carries on the business of

banking, which is specified as:

conducting current accounts for his customers

paying cheques drawn on him, and

collecting cheques for his customers.

In most English common law jurisdictions there is a Bills of Exchange Act that codifies the

law in relation to negotiable instruments, including cheques, and this Act contains a statutory

definition of the term banker: banker includes a body of persons, whether incorporated or not,

who carry on the business of banking' (Section 2, Interpretation). Although this definition seems

circular, it is actually functional, because it ensures that the legal basis for bank transactions such

as cheques do not depend on how the bank is organised or regulated.

The business of banking is in many English common law countries not defined by statute but

by common law, the definition above. In other English common law jurisdictions there are

statutory definitions of the business of banking or banking business. When looking at these

definitions it is important to keep in minds that they are defining the business of banking for the

purposes of the legislation, and not necessarily in general. In particular, most of the definitions

are from legislation that has the purposes of entry regulating and supervising banks rather than

regulating the actual business of banking. However, in many cases the statutory definition

closely mirrors the common law one. Examples of statutory definitions:

26

"banking business" means the business of receiving money on current or deposit account,

paying and collecting cheques drawn by or paid in by customers, the making of advances to

customers, and includes such other business as the Authority may prescribe for the purposes of

this Act; (Banking Act (Singapore), Section 2, Interpretation).

"Banking business" means the business of either or both of the following:-

receiving from the general public money on current, deposit, savings or other similar

account repayable on demand or within less than [3 months] ... or with a period of call or

notice of less than that period;

paying or collecting cheques drawn by or paid in by customers[6]

Since the advent of EFTPOS (Electronic Funds Transfer at Point Of Sale), direct credit,

direct debit and internet banking, the cheque has lost its primacy in most banking systems as a

payment instrument. This has led legal theorists to suggest that the cheque based definition

should be broadened to include financial institutions that conduct current accounts for customers

and enable customers to pay and be paid by third parties, even if they do not pay and collect

cheques.

Accounting for bank accounts:-

Bank statements are accounting records produced by banks under the various accounting

standards of the world. Under GAAP and IFRS there are two kinds of accounts: debit and credit.

Credit accounts are Revenue, Equity and Liabilities. Debit Accounts are Assets and Expenses.

This means you credit a credit account to increase its balance, and you debit a debit account to

decrease its balance.

This also means you debit your savings account every time you deposit money into it (and

the account is normally in deficit), while you credit your credit card account every time you

spend money from it (and the account is normally in credit).

27

However, if you read your bank statement, it will say the opposite—that you credit your

account when you deposit money and you debit it when you withdraw funds. If you have cash in

your account, you have a positive (or credit) balance; if you are overdrawn, you have a negative

(or deficit) balance.

The reason for this is that the bank, and not you, has produced the bank statement. Your

savings might be your assets, but the bank's liability, so they are credit accounts (which should

have a positive balance). Conversely, your loans are your liabilities but the bank's assets, so they

are debit accounts (which should also have a positive balance).

Where bank transactions, balances, credits and debits are discussed below, they are done so

from the viewpoint of the account holder—which is traditionally what most people are used to

seeing.

Economic functions:-

Issue of money, in the form of banknotes and current accounts subject to cheque or payment

at the customer's order. These claims on banks can act as money because they are negotiable

and/or repayable on demand, and hence valued at par. They are effectively transferable by

mere delivery, in the case of banknotes, or by drawing a cheque that the payee may bank or

cash.

netting and settlement of payments – banks act as both collection and paying agents for

customers, participating in interbank clearing and settlement systems to collect, present, be

presented with, and pay payment instruments. This enables banks to economise on reserves

held for settlement of payments, since inward and outward payments offset each other. It also

enables the offsetting of payment flows between geographical areas, reducing the cost of

settlement between them.

credit intermediation – banks borrow and lend back-to-back on their own account as middle

men.

credit quality improvement – banks lend money to ordinary commercial and personal

borrowers (ordinary credit quality), but are high quality borrowers. The improvement comes

from diversification of the bank's assets and capital which provides a buffer to absorb losses

28

without defaulting on its obligations. However, banknotes and deposits are generally

unsecured; if the bank gets into difficulty and pledges assets as security, to rise the funding it

needs to continue to operate, this puts the note holders and depositors in an economically

subordinated position.

maturity transformation – banks borrow more on demand debt and short term debt, but

provide more long term loans. In other words, they borrow short and lend long. With a

stronger credit quality than most other borrowers, banks can do this by aggregating issues

(e.g. accepting deposits and issuing banknotes) and redemptions (e.g. withdrawals and

redemptions of banknotes), maintaining reserves of cash, investing in marketable securities

that can be readily converted to cash if needed, and raising replacement funding as needed

from various sources (e.g. wholesale cash markets and securities markets).

Law of banking

Banking law is based on a contractual analysis of the relationship between the bank (defined

above) and the customer—defined as any entity for which the bank agrees to conduct an account.

The law implies rights and obligations into this relationship as follows:

The bank account balance is the financial position between the bank and the customer:

when the account is in credit, the bank owes the balance to the customer; when the

account is overdrawn, the customer owes the balance to the bank.

The bank agrees to pay the customer's cheques up to the amount standing to the credit of

the customer's account, plus any agreed overdraft limit.

The bank may not pay from the customer's account without a mandate from the customer,

e.g. a cheque drawn by the customer.

The bank agrees to promptly collect the cheques deposited to the customer's account as

the customer's agent, and to credit the proceeds to the customer's account.

The bank has a right to combine the customer's accounts, since each account is just an

aspect of the same credit relationship.

The bank has a lien on cheques deposited to the customer's account, to the extent that the

customer is indebted to the bank.

29

The bank must not disclose details of transactions through the customer's account—

unless the customer consents, there is a public duty to disclose, the bank's interests

require it, or the law demands it.

The bank must not close a customer's account without reasonable notice, since cheques

are outstanding in the ordinary course of business for several days.

These implied contractual terms may be modified by express agreement between the customer

and the bank. The statutes and regulations in force within a particular jurisdiction may also

modify the above terms and/or create new rights, obligations or limitations relevant to the bank-

customer relationship.

Some types of financial institution, such as building societies and credit unions, may be

partly or wholly exempt from bank licence requirements, and therefore regulated under separate

rules.

The requirements for the issue of a bank licence vary between jurisdictions but typically include:

Minimum capital

Minimum capital ratio

'Fit and Proper' requirements for the bank's controllers, owners, directors, and/or senior

officers

Approval of the bank's business plan as being sufficiently prudent and plausible.

Types of banks:-

Banks' activities can be divided into retail banking, dealing directly with individuals and

small businesses; business banking, providing services to mid-market business; corporate

banking, directed at large business entities; private banking, providing wealth management

services to high net worth individuals and families; and investment banking, relating to activities

on the financial markets. Most banks are profit-making, private enterprises. However, some are

owned by government, or are non-profit organizations.

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Central banks are normally government-owned and charged with quasi-regulatory

responsibilities, such as supervising commercial banks, or controlling the cash interest rate. They

generally provide liquidity to the banking system and act as the lender of last resort in event of a

crisis.

Types of retail banks:-

Commercial bank: the term used for a normal bank to distinguish it from an investment

bank. After the Great Depression, the U.S. Congress required that banks only engage in

banking activities, whereas investment banks were limited to capital market activities.

Since the two no longer have to be under separate ownership, some use the term

"commercial bank" to refer to a bank or a division of a bank that mostly deals with

deposits and loans from corporations or large businesses.

Community Banks: locally operated financial institutions that empower employees to

make local decisions to serve their customers and the partners.

Community development banks: regulated banks that provide financial services and

credit to under-served markets or populations.

Postal savings banks: savings banks associated with national postal systems.

Private banks: banks that manage the assets of high net worth individuals.

Offshore banks: banks located in jurisdictions with low taxation and regulation. Many

offshore banks are essentially private banks.

Savings bank: in Europe, savings banks take their roots in the 19th or sometimes even

18th century. Their original objective was to provide easily accessible savings products to

all strata of the population. In some countries, savings banks were created on public

initiative; in others, socially committed individuals created foundations to put in place the

necessary infrastructure. Nowadays, European savings banks have kept their focus on

retail banking: payments, savings products, credits and insurances for individuals or

small and medium-sized enterprises. Apart from this retail focus, they also differ from

commercial banks by their broadly decentralised distribution network, providing local

31

and regional outreach—and by their socially responsible approach to business and

society.

Building societies and Landesbanks: institutions that conduct retail banking.

Ethical banks: banks that prioritize the transparency of all operations and make only what

they consider to be socially-responsible investments.

Islamic banks: Banks that transact according to Islamic principles.

Types of investment banks:-

Investment banks "underwrite" (guarantee the sale of) stock and bond issues, trade for

their own accounts, make markets, and advise corporations on capital market activities

such as mergers and acquisitions.

Merchant banks were traditionally banks which engaged in trade finance. The modern

definition, however, refers to banks which provide capital to firms in the form of shares

rather than loans. Unlike venture capital firms, they tend not to invest in new companies.

Both combined:-

Universal banks, more commonly known as financial services companies, engage in several

of these activities. These big banks are very diversified groups that, among other services, also

distribute insurance— hence the term bancassurance, a portmanteau word combining "banque or

bank" and "assurance", signifying that both banking and insurance are provided by the same

corporate entity.

Other types of banks

Islamic banks adhere to the concepts of Islamic law. This form of banking revolves around

several well-established principles based on Islamic canons. All banking activities must avoid

interest, a concept that is forbidden in Islam. Instead, the bank earns profit (markup) and fees on

the financing facilities that it extends to customers.

32

Industrial profile

The Housing Development Finance Corporation Limited (HDFC):-

The Housing Development Finance Corporation Limited (HDFC) was amongst the first to

receive an 'in principle' approval from the Reserve Bank of India (RBI) to set up a bank in the

private sector, as part of the RBI's liberalization of the Indian Banking Industry in 1994. The

bank was incorporated in August 1994 in the name of 'HDFC Bank Limited', with its registered

office in Mumbai, India. HDFC Bank commenced operations as a Scheduled Commercial Bank

in January 1995.

OVERVIEW OF THE INDUSTRY

HDFC is India's premier housing finance company and enjoys an impeccable track record

in India as well as in international markets. Since its inception in 1977, the Corporation has

maintained a consistent and healthy growth in its operations to remain the market leader in

mortgages. Its outstanding loan portfolio covers well over a million dwelling units. HDFC has

developed significant expertise in retail mortgage loans to different market segments and also

has a large corporate client base for its housing related credit facilities. With its experience in the

financial markets, a strong market reputation, large shareholder base and unique consumer

franchise, HDFC was ideally positioned to promote a bank in the Indian environment.

As on 31st December, 2009 the authorized share capital of the Bank is Rs. 550 crore. The

paid-up capital as on said date is Rs. 455,23,65,640/- (45,52,36,564 equity shares of Rs. 10/-

each). The HDFC Group holds 23.87 % of the Bank's equity and about 16.94 % of the equity is

held by the ADS Depository (in respect of the bank's American Depository Shares (ADS) Issue).

27.46 % of the equity is held by Foreign Institutional Investors (FIIs) and the Bank has about

4,58,683 shareholders.

The shares are listed on the Bombay Stock Exchange Limited and The National Stock

Exchange of India Limited. The Bank's American Depository Shares (ADS) are listed on the

33

New York Stock Exchange (NYSE) under the symbol 'HDB' and the Bank's Global Depository

Receipts (GDRs) are listed on Luxembourg Stock Exchange under ISIN No US40415F2002.

Mr. Jagdish Capoor took over as the bank's Chairman in July 2001. Prior to this, Mr.

Capoor was Deputy Governor of the RBI

MANAGEMENT

The Managing Director, Mr. Aditya Puri, has been a professional banker for over 25 years,

and before joining HDFC Bank in 1994 was heading Citibank's operations in Malaysia.The

Bank's Board of Directors is composed of eminent individuals with a wealth of experience in

public policy, administration, industry and commercial banking. Senior executives representing

HDFC are also on the Board. Senior banking professionals with substantial experience in India

and abroad head various businesses and functions and report to the Managing Director. Given

the professional expertise of the management team and the overall focus on recruiting and

retaining the best talent in the industry, the bank believes that its people are a significant

competitive strength.

BOARD OF DIRECTORS

Mr. Jagdish Capoor, Chairman

Mr. Keki Mistry

Mrs. Renu Karnad

Mr. Arvind Pande

Mr. Ashim Samanta

Mr. Chander Mohan Vasudev

Mr. Gautam Divan

Dr. Pandit Palande

34

Mr. Aditya Puri, Managing Director

Mr. Harish Engineer, Executive Director

Mr. Paresh Sukthankar, Executive Director

Mr. Vineet Jain (upto 27.12.2008)

REGISTERED OFFICE:-

HDFC Bank House,

Senapati Bapat Marg,

Lower Parel,

Website: www.hdfcbank.com

HDFC Bank offers a wide range of commercial and transactional banking services and

treasury products to wholesale and retail customers. The bank has three key business segments

Wholesale Banking Services:-

The Bank's target market ranges from large, blue-chip manufacturing companies in the

Indian corporate to small & mid-sized corporates and agri-based businesses. For these customers,

the Bank provides a wide range of commercial and transactional banking services, including

working capital finance, trade services, transactional services, cash management, etc. The bank is

also a leading provider of structured solutions, which combine cash management services with

vendor and distributor finance for facilitating superior supply chain management for its corporate

customers. Based on its superior product delivery / service levels and strong customer

orientation, the Bank has made significant inroads into the banking consortia of a number of

leading Indian corporates including multinationals, companies from the domestic business

houses and prime public sector companies. It is recognised as a leading provider of cash

management and transactional banking solutions to corporate customers, mutual funds, stock

exchange members and banks.

35

Retail Banking Services:-

The objective of the Retail Bank is to provide its target market customers a full range of

financial products and banking services, giving the customer a one-stop window for all his/her

banking requirements. The products are backed by world-class service and delivered to

customers through the growing branch network, as well as through alternative delivery channels

like ATMs, Phone Banking, NetBanking and Mobile Banking.

The HDFC Bank Preferred program for high net worth individuals, the HDFC Bank Plus

and the Investment Advisory Services programs have been designed keeping in mind needs of

customers who seek distinct financial solutions, information and advice on various investment

avenues. The Bank also has a wide array of retail loan products including Auto Loans, Loans

against marketable securities, Personal Loans and Loans for Two-wheelers. It is also a leading

provider of Depository Participant (DP) services for retail customers, providing customers the

facility to hold their investments in electronic form.

HDFC Bank was the first bank in India to launch an International Debit Card in association

with VISA (VISA Electron) and issues the Mastercard Maestro debit card as well. The Bank

launched its credit card business in late 2001. By March 2009, the bank had a total card base

(debit and credit cards) of over 13 million. The Bank is also one of the leading players in the

“merchant acquiring” business with over 70,000 Point-of-sale (POS) terminals for debit / credit

cards acceptance at merchant establishments. The Bank is well positioned as a leader in various

net based B2C opportunities including a wide range of internet banking services for Fixed

Deposits, Loans, Bill Payments, etc.

Treasury:-

Within this business, the bank has three main product areas - Foreign Exchange and

Derivatives, Local Currency Money Market & Debt Securities, and Equities. With the

liberalisation of the financial markets in India, corporates need more sophisticated risk

36

management information, advice and product structures. These and fine pricing on various

treasury products are provided through the bank's Treasury team. To comply with statutory

reserve requirements, the bank is required to hold 25% of its deposits in government securities.

Awards and Achievements - Banking Services:-

2011

Outlook Money Best Bank Award 2011

- Best Bank - Runner Up

Best Commercial Vehicle Financier

- Driving Positive Change

Businessworld Best Bank award

- Best Bank

BCI Continuity & Resilience Award

- Most Effective Recovery of the Year

Financial Express Best Bank Survey 2010-11

- Best in Strength and Soundness - 2nd Best in the Private Sector

CNBC TV18's Best Bank & Financial Institution Awards

- Best Bank- Mr. Aditya Puri, Outstanding Finance Professional

Dun & Bradstreet Banking Awards 2011

Best Private Sector Bank - SME Financing

ISACA 2011 award for IT Governance

Best practices in IT Governance and IT Security

IBA Productivity Excellence Awards 2011

New Channel Adopter (Private Sector)

DSCI (Data Security Council of India) Excellence Awards 2011

Security in Bank

Euromoney Awards for Excellence 2011

Best Bank in India

37

FINANCE ASIA Country Awards 2011: India

- BEST BANK- BEST CASH MANAGEMENT BANK- BEST TRADE FINANCE BANK

Asian Banker Strongest Bank in Asia Pacific

BloombergUTV's Financial Leadership Awards 2011

Best Bank

IBA Banking Technology Awards 2010

Winner -1) Technology Bank of the Year2) Best Online Bank3) Best Customer Initiative4) Best Use of Business Intelligence5) Best Risk Management SystemRunners Up - Best Financial Inclusion

IDC FIIA Awards 2011

Excellence in Customer Experience

2010

Global Finance Award

Best Trade Finance Provider in India for 2010

2 Banking Technology Awards 2009

1) Best Risk Management Initiative and 2) Best Use of Business Intelligence.

SPJIMR Marketing Impact Awards (SMIA) 2010

2nd Prize

Business Today Best Employer Survey

Listed in top 10 Best Employers in the country

38

Corporate Governance:-

The bank was among the first four companies, which subjected itself to a Corporate

Governance and Value Creation (GVC) rating by the rating agency, The Credit Rating

Information Services of India Limited (CRISIL). The rating provides an independent assessment

of an entity's current performance and an expectation on its "balanced value creation and

corporate governance practices" in future. The bank has been assigned a 'CRISIL GVC Level 1'

rating, which indicates that the bank's capability with respect to wealth creation for all its

stakeholders while adopting sound corporate governance practices is the highest.We are aware

that all these awards are mere milestones in the continuing, never-ending journey of providing

excellent service to our customers. We are confident, however, that with your feedback and

support, we will be able to maintain and improve our services.

Technology:-

HDFC Bank operates in a highly automated environment in terms of information

technology and communication systems. All the bank's branches have online connectivity, which

enables the bank to offer speedy funds transfer facilities to its customers. Multi-branch access is

also provided to retail customers through the branch network and Automated Teller Machines

(ATMs).

The Bank has made substantial efforts and investments in acquiring the best technology

available internationally, to build the infrastructure for a world class bank. The Bank's business

is supported by scalable and robust systems which ensure that our clients always get the finest

services we offer. The Bank has prioritised its engagement in technology and the internet as one

of its key goals and has already made significant progress in web-enabling its core businesses. In

each of its businesses, the Bank has succeeded in leveraging its market position, expertise and

technology to create a competitive advantage and build market share.

39

Mission and Business Strategy:-

Our mission is to be "a World Class Indian Bank", benchmarking ourselves against

international standards and best practices in terms of product offerings, technology, service

levels, risk management and audit & compliance. The objective is to build sound customer

franchises across distinct businesses so as to be a preferred provider of banking services for

target retail and wholesale customer segments, and to achieve a healthy growth in profitability,

consistent with the Bank's risk appetite. We are committed to do this while ensuring the highest

levels of ethical standards, professional integrity, corporate governance and regulatory

compliance.

Our business strategy emphasizes the following :

Increase our market share in India’s expanding banking and financial services industry by

following a disciplined growth strategy focusing on quality and not on quantity and delivering

high quality customer service.

Leverage our technology platform and open scaleable systems to deliver more products to

more customers and to control operating costs.

Maintain our current high standards for asset quality through disciplined credit risk

management.

Develop innovative products and services that attract our targeted customers and address

inefficiencies in the Indian financial sector.

Continue to develop products and services that reduce our cost of funds.

Focus on high earnings growth with low volatility.

HDFC Bank is headquartered in Mumbai. The Bank at present has an enviable network of

1,725 branches spread in 771 cities across India. All branches are linked on an online real-time

basis. Customers in over 500 locations are also serviced through Telephone Banking. The Bank's

40

expansion plans take into account the need to have a presence in all major industrial and

commercial centres where its corporate customers are located as well as the need to build a

strong retail customer base for both deposits and loan products. Being a clearing/settlement bank

to various leading stock exchanges, the Bank has branches in the centres where the NSE/BSE

have a strong and active member base.

The Bank also has 3,898 networked ATMs across these cities. Moreover, HDFC Bank's

ATM network can be accessed by all domestic and international Visa/MasterCard, Visa

Electron/Maestro, Plus/Cirrus and American Express Credit/Charge cardholders.

AIMS:

Continuous effort to improving the services.

Evaluating individual skill trough training and motivations.

Total involvement through participant’s management activities.

Creating healthy and safe environment.

Social development.

41

CHAPTER-IV

CONCEPTUAL FRAMWORK

42

ASSET LIABILITY MANAGEMENT (ALM) SYSTEM:-

Asset-Liability Management (ALM) can be termed as 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 and hence is also known as Surplus Management.

  But in the last decade the meaning of ALM has evolved. It is now used in many different

ways under different contexts. ALM, which was actually pioneered by financial institutions and

banks, are now widely being used in industries too. The Society of Actuaries Task Force on

ALM Principles, Canada, offers the following definition for ALM: "Asset Liability Management

is the on-going process of formulating, implementing, monitoring, and revising strategies related

to assets and liabilities in an attempt to achieve financial objectives for a given set of risk

tolerances and constraints."

 

Basis of Asset-Liability Management

Traditionally, banks and insurance companies used accrual system of accounting for all

their assets and liabilities. They would take on liabilities - such as deposits, life insurance

43

policies or annuities. They would then invest the proceeds from these liabilities in assets such as

loans, bonds or real estate. All these assets and liabilities were held at book value. Doing so

disguised possible risks arising from how the assets and liabilities were structured. 

Consider a bank that borrows 1 Crore (100 Lakhs) at 6 % for a year and lends the same

money at 7 % to a highly rated borrower for 5 years. The net transaction appears profitable-the

bank is earning a 100 basis point spread - but it entails considerable risk. At the end of a year, the

bank will have to find new financing for the loan, which will have 4 more years before it

matures. If interest rates have risen, the bank may have to pay a higher rate of interest on the new

financing than the fixed 7 % it is earning on its loan.

 Suppose, at the end of a year, an applicable 4-year interest rate is 8 %. The bank is in

serious trouble. It is going to earn 7 % on its loan but would have to pay 8 % on its financing.

Accrual accounting does not recognize this problem. Based upon accrual accounting, the bank

would earn Rs 100,000 in the first year although in the preceding years it is going to incur a loss.

  The problem in this example was caused by a mismatch between assets and liabilities. Prior

to the 1970's, such mismatches tended not to be a significant problem. Interest rates in developed

countries experienced only modest fluctuations, so losses due to asset-liability mismatches were

small or trivial. Many firms intentionally mismatched their balance sheets and as yield curves

were generally upward sloping, banks could earn a spread by borrowing short and lending long.

  Things started to change in the 1970s, which ushered in a period of volatile interest rates

that continued till the early 1980s. US regulations which had capped the interest rates so that

banks could pay depositors, was abandoned which led to a migration of dollar deposit overseas.

Managers of many firms, who were accustomed to thinking in terms of accrual accounting, were

slow to recognize this emerging risk. Some firms suffered staggering losses. Because the firms

used accrual accounting, it resulted in more of crippled balance sheets than bankruptcies. Firms

had no options but to accrue the losses over a subsequent period of 5 to 10 years.

  One example, which drew attention, was that of US mutual life insurance company "The

Equitable." During the early 1980s, as the USD yield curve was inverted with short-term interest

44

rates sky rocketing, the company sold a number of long-term Guaranteed Interest Contracts

(GICs) guaranteeing rates of around 16% for periods up to 10 years. Equitable then invested the

assets short-term to earn the high interest rates guaranteed on the contracts. But short-term

interest rates soon came down. When the Equitable had to reinvest, it couldn't get even close to

the interest rates it was paying on the GICs. The firm was crippled. Eventually, it had to

demutualize and was acquired by the Axa Group.

 Increasingly banks and asset management companies started to focus on Asset-Liability

Risk. The problem was not that the value of assets 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 and that the values of assets and liabilities might fail to move in tandem. Asset-liability

risk is predominantly a leveraged form of risk.

  The capital of most financial institutions is small relative to the firm's assets or liabilities,

and so small percentage changes in assets or liabilities can translate into large percentage

changes in capital. Accrual accounting could disguise the problem by deferring losses into the

future, but it could not solve the problem. Firms responded by forming asset-liability

management (ALM) departments to assess these asset-liability risk.

Techniques for assessing Asset-Liability Risk:-

Techniques for assessing asset-liability risk came to include Gap Analysis and Duration

Analysis. These facilitated techniques of managing gaps and matching duration of assets and

liabilities. Both approaches worked well if assets and liabilities comprised fixed cash flows. But

cases of callable debts, home loans and mortgages which included options of prepayment and

floating rates, posed problems that gap analysis could not address. Duration analysis could

address these in theory, but implementing sufficiently sophisticated duration measures was

problematic. Accordingly, banks and insurance companies started using Scenario Analysis.

 Under this technique assumptions were made on various conditions, for example: -

45

Several interest rate scenarios were specified for the next 5 or 10 years. These specified

conditions like declining rates, rising rates, a gradual decrease in rates followed by a

sudden rise, etc. Ten or twenty scenarios could be specified in all.

Assumptions were made about the performance of assets and liabilities under each

scenario. They included prepayment rates on mortgages or surrender rates on insurance

products.

Assumptions were also made about the firm's performance-the rates at which new

business would be acquired for various products, demand for the product etc.

Market conditions and economic factors like inflation rates and industrial cycles were

also included.

  Based upon these assumptions, the performance of the firm's balance sheet could be

projected under each scenario. If projected performance was poor under specific scenarios, the

ALM committee would adjust assets or liabilities to address the indicated exposure. Let us

consider the procedure for sanctioning a commercial loan. The borrower, who approaches the

bank, has to appraise the banks credit department on various parameters like industry prospects,

operational efficiency, financial efficiency, management qualities and other things, which would

influence the working of the company. On the basis of this appraisal, the banks would then

prepare a credit-grading sheet after covering all the aspects of the company and the business in

which the company is in.

  Then the borrower would then be charged a certain rate of interest, which would cover the

risk of lending.

But the main shortcoming of scenario analysis was that, it was highly dependent on the

choice of scenarios. It also required that many assumptions were to be made about how specific

assets or liabilities will perform under specific scenarios. Gradually the firms recognized a

potential for different type of risks, which was overlooked in ALM analyses. Also the

deregulation of the interest rates in US in mid 70 s compelled the banks to undertake active

planning for the structure of the balance sheet. The uncertainty of interest rate movements gave

rise to Interest Rate Risk thereby causing banks to look for processes to manage this risk.

46

  In the wake of interest rate risk came Liquidity Risk and Credit Risk, which became

inherent components of risk for banks. The recognition of these risks brought Asset Liability

Management to the centre-stage of financial intermediation. Today even Equity Risk, which until

a few years ago was given only honorary mention in all but a few company ALM reports, is now

an indispensable part of ALM for most companies. Some companies have gone even further to

include Counterparty Credit Risk, Sovereign Risk, as well as Product Design and Pricing Risk as

part of their overall ALM.

  Now a day's a company has different reasons for doing ALM. While some companies view

ALM as a compliance and risk mitigation exercise, others have started using ALM as strategic

framework to achieve the company's financial objectives. Some of the business reasons

companies now state for implementing an effective ALM framework include gaining

competitive advantage and increasing the value of the organization.

Asset-Liability Management Approach:-

ALM in its most apparent sense is based on funds management. Funds management

represents the core of sound bank planning and financial management. Although funding

practices, techniques, and norms have been revised substantially in recent years, it is not a new

concept. Funds management is the process of managing the spread between interest earned and

interest paid while ensuring adequate liquidity. Therefore, funds management has following

three components, which have been discussed briefly.

Liquidity Management:-

Liquidity represents the ability to accommodate decreases in liabilities and to fund increases

in assets. An organization has adequate liquidity when it can obtain sufficient funds, either by

increasing liabilities or by converting assets, promptly and at a reasonable cost. Liquidity is

essential in all organizations to compensate for expected and unexpected balance sheet

fluctuations and to provide funds for growth. The price of liquidity is a function of market

conditions and market perception of the risks, both interest rate and credit risks, reflected in the

47

balance sheet and off-balance sheet activities in the case of a bank. If liquidity needs are not met

through liquid asset holdings, a bank may be forced to restructure or acquire additional liabilities

under adverse market conditions. Liquidity exposure can stem from both internally (institution-

specific) and externally generated factors. Sound liquidity risk management should address both

types of exposure. External liquidity risks can be geographic, systemic or instrument-specific.

Internal liquidity risk relates largely to the perception of an institution in its various markets:

local, regional, national or international. Determination of the adequacy of a bank's liquidity

position depends upon an analysis of its: -

Historical funding requirements

Current liquidity position

Anticipated future funding needs

Sources of funds

Present and anticipated asset quality

Present and future earnings capacity

Present and planned capital position

  As all banks are affected by changes in the economic climate, the monitoring of economic

and money market trends is key to liquidity planning. Sound financial management can minimize

the negative effects of these trends while accentuating the positive ones. Management must also

have an effective contingency plan that identifies minimum and maximum liquidity needs and

weighs alternative courses of action designed to meet those needs. The cost of maintaining

liquidity is another important prerogative. An institution that maintains a strong liquidity position

may do so at the opportunity cost of generating higher earnings. The amount of liquid assets a

bank should hold depends on the stability of its deposit structure and the potential for rapid

expansion of its loan portfolio. If deposit accounts are composed primarily of small stable

accounts, a relatively low allowance for liquidity is necessary.

  Additionally, management must consider the current ratings by regulatory and rating

agencies when planning liquidity needs. Once liquidity needs have been determined,

48

management must decide how to meet them through asset management, liability management, or

a combination of both.

 Asset Management:-

Many banks (primarily the smaller ones) tend to have little influence over the size of their

total assets. Liquid assets enable a bank to provide funds to satisfy increased demand for loans.

But banks, which rely solely on asset management, concentrate on adjusting the price and

availability of credit and the level of liquid assets. However, assets that are often assumed to be

liquid are sometimes difficult to liquidate. For example, investment securities may be pledged

against public deposits or repurchase agreements, or may be heavily depreciated because of

interest rate changes. Furthermore, the holding of liquid assets for liquidity purposes is less

attractive because of thin profit spreads.

 Asset liquidity, or how "salable" the bank's assets are in terms of both time and cost, is of

primary importance in asset management. To maximize profitability, management must carefully

weigh the full return on liquid assets (yield plus liquidity value) against the higher return

associated with less liquid assets. Income derived from higher yielding assets may be offset if a

forced sale, at less than book value, is necessary because of adverse balance sheet fluctuations.

  Seasonal, cyclical, or other factors may cause aggregate outstanding loans and deposits to

move in opposite directions and result in loan demand, which exceeds available deposit funds. A

bank relying strictly on asset management would restrict loan growth to that which could be

supported by available deposits. The decision whether or not to use liability sources should be

based on a complete analysis of seasonal, cyclical, and other factors, and the costs involved. In

addition to supplementing asset liquidity, liability sources of liquidity may serve as an alternative

even when asset sources are available.

Liability Management:-

Liquidity needs can be met through the discretionary acquisition of funds on the basis of

interest rate competition. This does not preclude the option of selling assets to meet funding

49

needs, and conceptually, the availability of asset and liability options should result in a lower

liquidity maintenance cost. The alternative costs of available discretionary liabilities can be

compared to the opportunity cost of selling various assets. The major difference between

liquidity in larger banks and in smaller banks is that larger banks are better able to control the

level and composition of their liabilities and assets. When funds are required, larger banks have a

wider variety of options from which to select the least costly method of generating funds. The

ability to obtain additional liabilities represents liquidity potential. The marginal cost of liquidity

and the cost of incremental funds acquired are of paramount importance in evaluating liability

sources of liquidity. Consideration must be given to such factors as the frequency with which the

banks must regularly refinance maturing purchased liabilities, as well as an evaluation of the

bank's ongoing ability to obtain funds under normal market conditions.

  The obvious difficulty in estimating the latter is that, until the bank goes to the market to

borrow, it cannot determine with complete certainty that funds will be available and/or at a price,

which will maintain a positive yield spread. Changes in money market conditions may cause a

rapid deterioration in a bank's capacity to borrow at a favorable rate. In this context, liquidity

represents the ability to attract funds in the market when needed, at a reasonable cost vis-e-vis

asset yield. The access to discretionary funding sources for a bank is always a function of its

position and reputation in the money markets.

  Although the acquisition of funds at a competitive cost has enabled many banks to meet

expanding customer loan demand, misuse or improper implementation of liability management

can have severe consequences. Further, liability management is not riskless. This is because

concentrations in funding sources increase liquidity risk. For example, a bank relying heavily on

foreign interbank deposits will experience funding problems if overseas markets perceive

instability in U.S. banks or the economy. Replacing foreign source funds might be difficult and

costly because the domestic market may view the bank's sudden need for funds negatively.

Again over-reliance on liability management may cause a tendency to minimize holdings of

short-term securities, relax asset liquidity standards, and result in a large concentration of short-

term liabilities supporting assets of longer maturity. During times of tight money, this could

cause an earnings squeeze and an illiquid condition.

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  Also if rate competition develops in the money market, a bank may incur a high cost of

funds and may elect to lower credit standards to book higher yielding loans and securities. If a

bank is purchasing liabilities to support assets, which are already on its books, the higher cost of

purchased funds may result in a negative yield spread.

Preoccupation with obtaining funds at the lowest possible cost, without considering

maturity distribution, greatly intensifies a bank's exposure to the risk of interest rate fluctuations.

That is why banks who particularly rely on wholesale funding sources, management must

constantly be aware of the composition, characteristics, and diversification of its funding

sources.

Procedure for Examination of Asset Liability Management:-

In order to determine the efficacy of Asset Liability Management one has to follow a

comprehensive procedure of reviewing different aspects of internal control, funds management

and financial ratio analysis. Below a step-by-step approach of ALM examination in case of a

bank has been outlined.

 Step 1

The bank/ financial statements and internal management reports should be reviewed to assess the

asset/liability mix with particular emphasis on: -

Total liquidity position (Ratio of highly liquid assets to total assets).

Current liquidity position (Minimum ratio of highly liquid assets to demand

liabilities/deposits).

Ratio of Non Performing Assets to Total Assets.

Ratio of loans to deposits.

Ratio of short-term demand deposits to total deposits.

Ratio of long-term loans to short term demand deposits.

Ratio of contingent liabilities for loans to total loans.

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Ratio of pledged securities to total securities.

 Step 2

It is to be determined that whether bank management adequately assesses and plans its

liquidity needs and whether the bank has short-term sources of funds. This should include: -

Review of internal management reports on liquidity needs and sources of satisfying these

needs.

Assessing the bank's ability to meet liquidity needs:-

Step 3

The banks future development and expansion plans, with focus on funding and liquidity

management aspects has to be looked into. This entails: -

Determining whether bank management has effectively addressed the issue of need for

liquid assets to funding sources on a long-term basis.

Reviewing the bank's budget projections for a certain period of time in the future.

Determining whether the bank really needs to expand its activities. What are the sources

of funding for such expansion and whether there are projections of changes in the bank's

asset and liability structure?

Assessing the bank's development plans and determining whether the bank will be able to

attract planned funds and achieve the projected asset growth.

Determining whether the bank has included sensitivity to interest rate risk in the

development of its long term funding strategy.

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 Step 4

Examining the bank's internal audit report in regards to quality and effectiveness in terms of

liquidity management

 Step 5

Reviewing the bank's plan of satisfying unanticipated liquidity needs by: -

Determining whether the bank's management assessed the potential expenses that the

bank will have as a result of unanticipated financial or operational problems.

Determining the alternative sources of funding liquidity and/or assets subject to necessity.

Determining the impact of the bank's liquidity management on net earnings position.

 Step 6

Preparing an Asset/Liability Management Internal Control Questionnaire which should

include the following: -

Whether the board of directors has been consistent with its duties and responsibilities and

included: -

A line of authority for liquidity management decisions.

A mechanism to coordinate asset and liability management decisions.

A method to identify liquidity needs and the means to meet those needs.

Guidelines for the level of liquid assets and other sources of funds in relationship to

needs.

Does the planning and budgeting function consider liquidity requirements?

Are the internal management reports for liquidity management adequate in terms of

effective decision making and monitoring of decisions.

Are internal management reports concerning liquidity needs prepared regularly and

reviewed as appropriate by senior management and the board of directors.

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Whether the bank's policy of asset and liability management prohibits or defines certain

restrictions for attracting borrowed means from bank related persons (organizations) in

order to satisfy liquidity needs.

Does the bank's policy of asset and liability management provide for an adequate control

over the position of contingent liabilities of the bank?

Is the foregoing information considered an adequate basis for evaluating internal control

in that there are no significant deficiencies in areas not covered in this questionnaire that

impair any controls?

 Asset Liability Management in Indian Context:-

The post-reform banking scenario in India was marked by interest rate deregulation, entry

of new private banks, and gamut of new products along with greater use of information

technology. To cope with these pressures banks were required to evolve strategies rather than ad

hoc solutions. Recognising the need of Asset Liability management to develop a strong and

sound banking system, the RBI has come out with ALM guidelines for banks and FIs in April

1999.The Indian ALM framework rests on three pillars: -

ALM Organisation (ALCO):-

The ALCO or the Asset Liability Management Committee consisting of the banks senior

management including the CEO should be responsible for adhering to the limits set by the board

as well as for deciding the business strategy of the bank in line with the banks budget and

decided risk management objectives. ALCO is a decision-making unit responsible for balance

sheet planning from a risk return perspective including strategic management of interest and

liquidity risk. The banks may also authorise their Asset-Liability Management Committee

(ALCO) to fix interest rates on Deposits and Advances, subject to their reporting to the Board

immediately thereafter. The banks should also fix maximum spread over the PLR with the

approval of the ALCO/Board for all advances other than consumer credit.

 

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ALM Information System:-

The ALM Information System is required for the collection of information accurately,

adequately and expeditiously. Information is the key to the ALM process. A good information

system gives the bank management a complete picture of the bank's balance sheet.

 ALM Process:-

The basic ALM processes involving identification, measurement and management of risk

parameter .The RBI in its guidelines has asked Indian banks to use traditional techniques like

Gap Analysis for monitoring interest rate and liquidity risk. However RBI is expecting Indian

banks to move towards sophisticated techniques like Duration, Simulation, VaR in the future.

For the accrued portfolio, most Indian Private Sector banks use Gap analysis, but are gradually

moving towards duration analysis. Most of the foreign banks use duration analysis and are

expected to move towards advanced methods like Value at Risk for the entire balance sheet.

Some foreign banks are already using VaR for the entire balance sheet.

ALM has evolved since the early 1980's. Today, financial firms are increasingly using

market value accounting for certain business lines. This is true of universal banks that have

trading operations. Techniques of ALM have also evolved. The growth of OTC derivatives

markets has facilitated a variety of hedging strategies. A significant development has been

securitization, which allows firms to directly address asset-liability risk by removing assets or

liabilities from their balance sheets. This not only eliminates asset-liability risk; it also frees up

the balance sheet for new business.

  Thus, the scope of ALM activities has widened. Today, ALM departments are addressing

(non-trading) foreign exchange risks as well as other risks. Also, ALM has extended to non-

financial firms. Corporations have adopted techniques of ALM to address interest-rate

exposures, liquidity risk and foreign exchange risk. They are using related techniques to address

commodities risks. For example, airlines' hedging of fuel prices or manufacturers' hedging of

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steel prices are often presented as ALM. Thus it can be safely said that Asset Liability

Management will continue to grow in future and an efficient ALM technique will go a long way

in managing volume, mix, maturity, rate sensitivity, quality and liquidity of the assets and

liabilities so as to earn a sufficient and acceptable return on the portfolio.

  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 earning from interest is maximised within the overall risk-

preference (present and future) of the institutions.  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. 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

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

industry w.e.f. 1st April, 1999.  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 and commodity price risks of a bank that needs to be

closely integrated with the banks’ business strategy.

Therefore, ALM is considered as an important tool for monitoring, measuring  and

managing the market risk of a bank.   With the deregulation of interest regime in India, the

Banking industry has been exposed to the market risks.   To manage such risks, ALM is used so

that the management is able to assess the risks and cover some of these by taking appropriate

decisions.

  The assets and liabilities of the bank’s balance sheet are nothing but future cash inflows or

outflows. With a view to measure the liquidity and interest rate risk, banks use of maturity ladder

and then calculate cumulative surplus or deficit of funds in different time slots on the basis of

statutory reserve cycle, which  are termed as time buckets.  

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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.

 The ALM process rests on three pillars:

i. ALM Information Systems

Management Information Systems

Information availability, accuracy, adequacy and expediency

ii. ALM Organization

Structure and responsibilities

Level of top management involvement

iii. ALM Process

Risk parameters

Risk identification

Risk measurement

Risk management

Risk policies and tolerance levels.

As per RBI guidelines, commercial banks are  to distribute the outflows/inflows in

different residual maturity period known as time buckets.  The Assets and Liabilities were

earlier  divided  into 8 maturity buckets (1-14 days; 15-28 days; 29-90 days; 91-180 days; 181-

365 days, 1-3 years and 3-5 years and above 5 years), based on the remaining period to their

maturity (also called residual maturity).  All the liability figures are outflows while the asset

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figures are inflows.   In September, 2007, having regard to the international practices, the level of

sophistication of banks in India, the need for a sharper assessment of the efficacy of liquidity

management and with a view to providing a stimulus for development of the term-money

market, RBI revised these guidelines and it was provided that

the banks may adopt a more granular approach to measurement of liquidity risk by

splitting the first time bucket (1-14 days at present) in the Statement of Structural

Liquidity into three time buckets viz., next day , 2-7 days and 8-14 days.   Thus, now we

have 10 time buckets.

After such an exercise, each bucket of assets is matched with the corresponding bucket of

the liabililty.   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 turnout to be risky for the bank.    Banks are required to monitor such

mismatches and take appropriate steps so that bank is not exposed to risks due to the

interest rate movements during that period.

The net cumulative negative mismatches during the Next day, 2-7 days, 8-14 days and

15-28 days buckets should not exceed 5 % ,10%, 15 % and 20 % of the cumulative cash

outflows in the respective time buckets in order to recognise the cumulative impact on

liquidity.

The Board’s of the Banks have been entrusted with the overall responsibility for the

management of risks and is required to decide the risk management policy and set limits

for liquidity, interest rate, foreign exchange and equity price risks.

Asset-Liability Committee (ALCO) is the top most committee to oversee the

implementation of ALM system and it is to be headed by CMD or ED.  ALCO considers

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. 

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Rate Sensitive Assets & Liabilities : -

An asset or liability is termed as rate sensitive when

Within the time interval under consideration, there is a cash flow,

The interest rate resets/reprices contractually during the interval,

BI changes interest rates where rates are administered and,

It is contractually pre-payable or withdrawal before the stated maturities.

Assets and liabilities which receive / pay interest that vary with a benchmark rate are re-

priced at pre-determined intervals and are rate sensitive at the time of re-pricing.

INTEREST RISK:

The phased deregulation of interest rates and the operational flexibility given to banks in

pricing most of the assets and liabilities imply the need for the banking system to hedge the

Interest-Rate Risk. Interest Rate Risk is the risk where changes in market interest rates might

adversely affect the Bank’s Net Interest Income. The gap report should be generated by grouping

interest rate sensitive liabilities, assets and off balance sheet positions into time buckets

according to residual maturity or next reprising period, whichever is earlier. Interest rates on

term deposits are fixed during their currency while the advance interest rates are floating rates.

The gaps on the assets and liabilities are to be identified on different time buckets from 1–28

days, 29 days upto 3 months and so on. The interest changes should be studied vis-a-vis the

impact on profitability on different time buckets to assess the interest rate risk.

GAP ANALYSIS:-

The various items of rate sensitive assets and liabilities and off-balance sheet items are classified

into time buckets such as 1-28 days, 29 days and upto 3 months etc. and items non-sensitive to

interest based on the probable date for change in interest.The gap is the difference between Rate

Sensitive Assets (RSA) and Rate Sensitive Liabilities (RSL) in various time buckets. The

positive gap indicates that it has more RSAS  than RSLS whereas the negative gap indicates that

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it has more RSLS. The gap reports indicate whether the institution is in a position to benefit from

rising interest rates by having a Positive Gap (RSA > RSL) or whether it is a position to benefit

from declining interest rate by a negative Gap (RSL > RSA).

TOTAL FINANCIAL SERVICES FIRMS RISK:-

Total Risk

(Responsibility of CEO)

Business Risk Financial Risk

Product Market Risk Capital Market Risk

(Responsibility of the (Responsibility of the

Chief Operating Officer) Chief Financial Officer)

Credit Interest rate

Strategic Liquidity

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Regulatory currency

Operating Settlement

Human resources Basis

Legal

PRODUCT MARKET RISK:-

This risk decision relate to the operating revenues and expenses of the form that impact the

operating position of the profit and loss statements which include crisis, marketing, operating

systems, labor cost, technology, channels of distributions at strategic focus. Product Risks relate

to variations in the operating cash flows of the firm, which effect Capital Market, required Rates

Of Return :

CREDIT RISK

STRATEGIC RISK

COMMODITY RISK

OPERATIVE RISK

HUMAN RESOURCES RISK

LEGAL RISK

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Risk in Product Market relate to the operational and strategic aspects of managing operating

revenues and expenses. The above types of Product Risks are explained as follows :

CREDIT RISK:-

The most basic of all Product Market Risk or other financial intermediary is the erosion of

value due to simple default or non-payment by the borrower. Credit risk has been around for

centuries and is thought by many to be the dominant financial services today’s intermediate the

risk appetite of lenders and essential risk ness of borrowers. manage this risk by ;

making intelligent lending decisions so that expected risk of borrowers is both accurately

assessed and priced;

Diversifying across borrowers so that credit losses are not concentrated in time;

purchasing third party guarantees so that default risk is entirely or partially shifted away from

lenders.

STRATEGIC RISK:-

This is the risk that entire lines of business may succumb to competition or obsolescence. In

the language of strategic planner, commercial paper is a substitute product for large corporate

loans. Strategic risk occurs when a is not ready or able to compete in a newly developing line of

business. Early entrants enjoyed a unique advantage over newer entrants. The seemingly

conservative act of waiting for the market to develop posed a risk in itself. Business risk accrues

from jumping into lines of business but also from staying out too long.

COMMODITY RISK:-

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Commodity prices affects and other lenders in complex and often unpredictable ways. The

macro effect of energy price increases on inflation also contributed to a rise in interest rates,

which adversely affected the value of many fixed rate financial assets. The subsequent crash in

oil prices sent the process in reverse with nearly equally devastating effe.

OPERATING RISK:-

Machine-based system offer essential competitive advantage in reducing costs and

improving quality while expanding service and speed. No element of management process has

more potential for surprise than systems malfunctions. Complex, machine-based systems

produce what is known as the “black box effect”. The inner working of system can become

opaque to their users. Because developers do not use the system and users often have not

constitutes a significant Product Market Risk. No financial service firm can small management

challenge in the modern financial services company.

HUMAN RESOURCES RISK:

Few risks are more complex and difficult to measure than those of personnel policy; they are

Recruitment, Training, Motivation and Retention. Risk to the value of the Non-Financial Assets

as represented by the work force represents a much more subtle of risk. Concurrent with the loss

of key personal is the risk of inadequate or misplaced motivation among management personal.

This human redundancy is conceptually equivalent to safety redundancy in operating systems. It

is not inexpensive, but it may well be cheaper than the risk of loss. The risk and rewards of

increased attention to the human resources dimension of management are immense.

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LEGAL RISK:-

This is the risk that the legal system will expropriate value from the shareholders of financial

services firms. The legal landscape today is full of risks that were simply unimaginable even a

few years ago. More over these risks are very hard to anticipate because they are often unrelated

to prior events which are difficult and impossible to designate but the management of a financial

services firm today must have these risks at least in view. They can cost millions.

CAPITAL MARKET RISK:-

In the Capital Market Risk decision relate to the financing and financial support of Product

Market activities. The result of product market decisions must be compared to the required rate

of return that results from capital market decision to determine if management is creating value.

Capital market decisions affect the risk tolerance of product market decisions related to

variations in value associated with different financial instruments and required rate of return in

the economy.

LIQUIDITY RISK

INTEREST RATE RISK

CURRENCY RISK

SETTLEMENT RISK

BASIS RISK

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LIQUIDITY RISK:-

For experienced financial services professionals, the foremost capital market risk is that of

inadequate liquidity to meet financial obligations. The obvious form is an inability to pay desired

withdrawals. Depositors react desperately to the mere prospect of this situation.

They can drive a financial intermediary to collapse by withdrawing funds at a rate that

exceeds its capacity to pay. For most of this century, individual depositors who lost faith in

ability to repay them caused failures from liquidity. Funds are deposited primarily as a financial

of rate. Such funds are called “purchased money” or “headset funds” as they are frequently

bought by employees who work on the money desk quoting rates to institutions that shop for the

highest return. To check liquidity risk, firms must keep the maturity profile of the liabilities

compatible with that of the assets. This balance must be close enough that a reasonable shift in

interest rates across the yield curve does not threaten the safety and soundness of the entire firm.

INTEREST RATE RISK:-

In extreme conditions, Interest Rate fluctuations can create a liquidity crisis. The fluctuation

in the prices of financial assets due to changes in interest rates can be large enough to make

default risk a major threat to a financial services firm’s viability. There’s a function of both the

magnitude of change in the rate and the maturity of the asset. This inadequacy of assessment and

consequent mispricing of assets, combined with an accounting system that did not record

unrecognized gains and losses in asset values, created a financial crisis. Risk based capital rules

pertaining to have done little to mitigate the interest rate risk management problem. The decision

to pass it of, however is not without large cost, so the cost benefit tradeoff becomes complex.

CURRENCY RISK:-

The risk of exchange rate volatility can be described as a form of basis risk among

currencies instead of basis risk among interest rates on different securities. Balance sheets

comprised of numerous separate currencies contain large camouflaged risks through financial

reporting systems that do not require assets to be marked to market. Exchange rate risk affects

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both the Product Markets and The Capital Markets. Ways to contain currency risk have

developed in today’s derivative market through the use of swaps and forward contracts. Thus,

this risk is manageable only after the most sophisticated and modern risk management technique

is employed

SETTLEMENT RISK:-

Settlement Risk is a particular form of default risk, which involves the competitors.

Amounts settle obligations having to do with money transfer, check clearing, loan disbursement

and repayment, and all other inter- transfers within the worldwide monetary system. A single

payment is made at the end of the day instead of multiple payments for individual transactions.

BASIS RISK :-

Basis risk is a variation on the interest rate risk theme, yet it creates risks that are less easy to

observe and understand. To guard against interest rate risk, somewhat non comparable securities

may be used as a hedge. However, the success of this hedging depends on a steady and

predictable relationship between the two no identical securities. Basis can negate the hedge

partially or entirely, which vastly increases the Capital Market Risk exposure of the firm.

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CHAPTER-V

DATA ANALYSIS

&

INTERPRETATION

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RISK MANAGEMENT SYSTEM

Assuming and managing risk is the essence of business decision-making. Investing in a new

technology, hiring a new employee, or launching a marketing campaign is all decisions with

uncertain outcomes. As a result all the major management decisions of how much risk to take

and how to manage the risk.

The implementation of risk management varies from business to business, from one

management style to another and from one time to another. Risk management in the financial

services industry is different from others. Circumstances, Institutions and Managements are

different. On the other hand, an investment decision is no recent history of legal and political

stability, insights into the potential hazards and opportunities.

Many risks are managed quantitatively. Risk exposure is measured by some numerical

index. Risk cost tradeoff many tools are described by numerical valuation formulas.

Risk management can be integrated into a risk management system. Such a system can

be utilized to manage the trading position of a small-specialized division or an entire financial

institution. The modules of the system can be implemented with different degrees of accuracy

and sophistication.

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RISK MANAGEMENT SYSTEM

Dynamics of risk factors

Cash flows Arbitrage

Generator Pricing Model

Price and Risk

Profile Of Contingent Claims

Dynamic Risk Target

Trading Rules Optimizer Risk Profile

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RISK MANAGEMENT SYSTE:-

Arbitrage pricing models range from simple equations to large scale numerically

sophisticated algorithms. Cash flow generators also vary from a single formula to a

simulator that accounts for the dependence of cash flows on the history of the risk factors.

Financial engineers are continuously incorporating advances in econometric

techniques, asset pricing models, simulation techniques and optimization algorithms to

produce better risk management systems.

The important ingredient of the risk management approach is the treatment of risk

factors and securities as an integrated portfolio. Analyzing the correlation among the real,

financial and strategic assets of an organization leads to clear understanding of risk

exposure. Special attention is paid to risk factors, which translate to correlation among

the values of securities. Identifying the correlation among the basic risk factors leads to

more effective risk management.

CONCLUSION:-

The burden of the Risk and its Costs are both manageable and transferable. Financial

service firms, in the addition to managing their own risk, also sell financial risk management to

others. They sell their services by bearing customers financial risks through the products they

provide. A financial firm can offer a fixed-rate loan to a borrower with the risk of interest rate

movements transferred from the borrower to the. Financial innovations have been concerned

with risk reduction than any other subject. With the possibility of managing risk near zero, the

challenge becomes not how much risk can be removed.

Financial services involve the process of intermediation between those who have financial

resources and those who need them, either as a principal or as an agent. Thus, value breaks into

several distinct functions, and it includes the intermediation of the following:

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Maturity Preference mismatch, Default, Currency Preference mis-match, Size of

transaction and Market access and information.

RISK MANAGEMENT IN HDFC:-

Narasimham committee II , advised to address market risk in a structured manner by

adopting Asset and Liability Management practices with effect from April 1st 1989.

Asset and liability management (ALM) is “the Art and Science of choosing the best mix

of assets for the firm’s asset portfolio and the best mix of liabilities for the firm’s liability

portfolio”. It is particularly critical for Financial Institutions.

For a long time it was taken for granted that the liability portfolio of financial firms was

beyond the control of the firm and so management concentrated its efforts on choosing the asset

mix. Institutions treasury department used the funds provided by deposits to structure an asset

portfolio that was appropriate for the given liability portfolio.

With the advent of Certificate of Deposits (CDs), a tool by which to manipulate the mix of

liabilities that supported their Asset portfolios, which has been one of the active management of

assets and liabilities.

Asset and liability management program evolve into a strategic tool for management, the

main elements of the ALM system are:

ALM INFORMATION.

ALM ORGANISATION.

ALM FUNCTION.

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ALM INFORMATION:-

ALM is a risk management tool through which Market risk associated with business are

identified, measured and monitored to maintain profits by restructuring Assets and Liabilities.

The ALM framework needs to be built on sound methodology with necessary information

system as back up. Thus the information is key element to the ALM process.

There are various methods prevalent worldwide for measuring risks. These range from the

simple Gap statement to extremely sophisticate and data intensive Risk adjusted profitability

measurement (RAPM) methods. The central element for the entire ALM exercise is the

availability of adequate and accurate information.

However, the existing systems in many Indians do not generate information in manner

required for the ALM. Collecting accurate data is the biggest challenge before, the particularly

those having wide network of branches, but lacking full-scale computerization.

Therefore the introduction of these information systems for risk measurement and

monitoring has to be addressed urgently.

The large network of branches and the lack of support system to collect information

required for the ALM which analysis information on the basis of residual maturity and

behavioral pattern, it would take time for s in the present state to get the requisite information.

ALM ORGANISATION:-

Successful implementation of the risk management process requires strong commitment on

the part of senior management in the to integrate basic operations and strategic decision making

with risk management.

The Board of Directors should have overall responsibility for management of risk and

should decide the risk management policy of the, setting limits for liquidity, interest rate, foreign

exchange and equity / price risk.

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The Asset Liability Management Committee (HDFC) consisting of the s senior

management, including CEO/CMD should be responsible for ensuring adherence to the limits set

by the Board of Directors as well as for deciding the business strategy of the (on the assets and

liabilities sides) in line with the s budget and decided risk management objective.

The ALM support group consisting of operation staff should be responsible for analyzing,

monitoring and reporting the risk profiles to the HDFC. The staff should also prepare forecasts

(simulations) showing the effects of various possible changes in market condition related to the

balance sheet and recommend the action needed to adhere to s internal limits,

The HDFC is a decision-making unit responsible for balance sheet planning from a risk-

return perspective including the strategic management of interest rate and liquidity risks. Each

has to decide on the role of its HDFC, its responsibility as also the decision to be taken by it. The

business and risk management strategy of the should ensure that the operates within the limits /

parameters set by the Board. The business issues that an HDFC would consider, inter alia, will

include product pricing for deposits and advances, desired maturity profile and mix of the

incremental Assets and Liabilities, etc. in addition to monitoring the risk levels of the , the

HDFC should review the results of and progress in implementation of the decisions made in the

previous meetings. The HDFC would also articulate the current interest rate view of the and base

its decisions for future business strategy on this view. In respect of this funding policy, for

instance, its responsibility would be to decide on source and mix of liabilities or sale of assets.

Towards this end, it will have to develop a view on future direction of interest rate movements

and decide on funding mixes between fixed vs. floating rate funds, wholesale vs. retail deposits,

Money markets vs. Capital market funding, domestic vs. foreign currency funding etc.

Individuals will have to decide the frequency for holding their HDFC meetings.

TYPICAL BUSINESS OF HDFC

Reviewing of the impact of the regulatory changes on the industry.

Overseeing the budgetary process;

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Reviewing the interest rate outlook for pricing of assets and liabilities (Loans and

Deposits)

Deciding on the introduction of any new loan / deposit product and their impact on

interest rate / exchange rate and other market risks;

Reviewing the asset and liability portfolios and the risk limits and thereby, assessing the

capital adequacy;

Deciding on the desired maturity profile of incremental assets and liabilities and thereby

assessing the liquidity risk; and

Reviewing the variances in actual and projected performances with regard to Net Interest

Margin(NIM), spreads and other balance sheet ratios.

COMPOSITION OF HDFC:-

The size (number of members) of HDFC would depend on the size of each institution,

business mix and organizational complexity, To ensure commitment of the Top management and

timely response to market dynamics, the CEO/MD or the GM should head the committee. The

chiefs of Investment, Credit, Resources Management or Planning, Funds Management / Treasury

(domestic), etc., can be members of the committee. In addition, the head of the computer

(technology) Division should also be an invitee for building up of MIS and related

computerization. Some of may even have Sub-Committee and Support Groups.

ALM ORGANIZATION consists of following categories:

ALM BOARD

HDFC

74

ALM CELL

COMMITTEE OF DIRECT

ALM BOARD:-

The Board of management should have overall responsibility for management of risk

and should decide the risk management policy of the and set limits for liquidity and

interest rate risks.

HDFC:-

The bank has constituted an Asset- Liability committee (HDFC). The committee may consist

of the following members.

i) General Manager Head of Committee

ii) General Manager (Loans & Advances) Member

iii) General Manager (CMI & AD) Member

iv) AGM / Head of the ALM Cell Member

The HDFC is a decision making unit responsible for ensuring adherence to the limits set by

board as well as for balance sheet planning from risk return perspective including the strategic

management of interest rate and liquidity risks, in line with the s budget and decided risk

management objectives.

75

The Business issues that an HDFC would consider interalia, will include fixation of interest

rates for both deposits and advances, desired maturity profile of the incremental assets and

liabilities etc.

The HDFC would also articulate the current interest rate due of the and base its decisions for

future business strategy on this view. In respect of funding policy, for instance, its responsibility

would be decided on source and mix of liability.

Individuals will have to decide the frequency for their HDFC meetings. However, it is

advised that HDFC should meet at least once in a fortnight. The HDFC should review results of

and process in implementation of the decisions made in the previous meetings

ALM CELL:-

The ALM desk / cell consisting of operating staff should be responsible for analyzing,

monitoring and reporting the profiles to the HDFC. The staff should also prepare forecasts

(simulations) showing the effects of various possible changes in market conditions related to the

balance sheet and recommend the action needed to adhere to the internal limits.

COMMITTEE OF DIRECTORS:-

They should also constitute professional, management and supervisory committee,

consisting of three to four directors, which will oversee the implementation of the ALM system,

and review it’s functioning periodically.

ALM PROCESS

The scope of ALM function can be described as follows:

Liquidity Risk Management

76

Interest Rate Risk Management

Currency Risk Management

Settlement Risk Management

Basis Risk Management

The RBI guidelines mainly address Liquidity Risk Management and Interest Rate Risk

Management.

The following are the concepts discussed for analysis of Asset-Liability Management

under above mentioned risks.

Liquidity Risk

Maturity profiles

Interest rate risk

Gap analysis

Liquidity Risk Management:-

Measuring and managing liquidity needs are vital activities of the Risk. By assuring a

returns ability to meet its liability as they become due, liquidity management can reduce the

probability of an adverse situation development. The importance of liquidity transcends

individual institutions, as liquidity shortfall in one institution can have repercussions on the

entire system.

77

Liquidity risk management refers to the risk of maturing liability not finding enough

maturing assets to meet these liabilities. It is the potential inability to meet the liability as they

became due. This risk arises because borrows funds for different maturities in the form of

deposits, market operations etc. and lock them into assets of different maturities.

Liquidity Gap also arises due to unpredictability of deposit withdrawals, changes in loan

demands. Hence measuring and managing liquidity needs are vital for effective and viable

operations.

Liquidity measurement is quite a difficult task and usually the stock or cash flow

approaches are used for its measurement. The stock approach used certain liquidity ratios.

The liquidity ratios are the ideal indicators of liquidity of Operating in developed

financial markets, the ratio do not reveal the real liquidity profile of s which are operating

generally in a fairly illiquid market. The assets, which are commonly considered as liquid

like Government securities, have limited liquidity when the market and players are in one

direction. Thus analysis of liquidity involves tracking of cash flow mismatches.

The statement of structural liquidity may be prepared by placing all cash inflows and

outflows in the maturity ladder according to the expected timing of cash flows.

The position of Assets and Liabilities are classified according to the maturity patterns a

maturing liability will be a cash outflow while a maturing asset will be a cash inflows. The

measuring of the future cash flows of s is done in different time buckets.

The time buckets, given the statutory Reserve cycle of 14 days may be distributed as under:

1 to 14 days

15 to 28 days

29 days and up to 3 months

Over 3 months and up to 6 months

Over 6 months and up to 1 year

Over 1 year and up to 3 years

Over 3 years and up to 5 years

78

MATURITY PROFILE – LIQUIDITY:-

HEAD OF ACCOUNTS

A.OUTFLOWS

Classification into time buckets

1.Capital, Reserves and Surplus Over 5 years bucket.

2.Demand Deposits (Current &

Savings Deposits)

Demand Deposits may be classified

into volatile and core portions, 25 % of

deposits are generally withdraw able

on demand. This portion may be

treated as volatile. While volatile

portion may be placed in the first time

bucket i.e., 1-14 days, the core portion

may be placed in 1-2 years, bucket.

3. Term Deposits Respective maturity buckets.

4. Borrowings Respective maturity buckets.

5. Other liabilities and provisions

(i) Bills Payable

(ii) Inter-office Adjustment

(iii) Provisions for NAPs

a) sub-standard

b) doubtful and Loss

(iv) provisions for depreciation

in Investments

(v) provisions for NAPs in

investment

(vi) provisions for other purposes

(i) 1-14 days bucket

(ii) Items not representing cash

payable may be placed in over 5

years bucket

(iii) a) 2-5 years bucket.

b) Over 5 years bucket

.(iv) Over 5 years bucket.

(v) a) 2-5 years bucket.

b) Over 5 years bucket

(vi) Respective buckets depending on

the purpose.

INFLOWS

79

1. Cash 1-14 days bucket.

2. Balance with others

(i) Current Account

(ii) Money at call and short Notice,

Term Deposits and other

Placements

(i) Non-withdraw able portion on

account of stipulations of

minimum balances may be shown

Less than 1-14 days bucket.

(ii) Respective maturity buckets.

3. Investments

(i) Approved securities

(ii) Corporate

Debentures and

bonds, CDs and CPs,

redeemable

preference shares,

units of Mutual

Funds (close ended).

Etc.

(iii) Share / Units of Mutual

Funds (open ended)

(iii) Investment in

subsidiaries /

Joint Ventures.

(i) Respective maturity buckets

excluding the amount required to

be reinvested to maintain SLR

(ii) Respective Maturity buckets.

Investments classified as NPAs

Should be shown under 2-5 years

bucket (sub-standard) or over 5

years bucket (doubtful and loss).

(iii) Over 5 years bucket.

(iv) Over 5 years bucket.

4. Advances (performing / standard)

(i) Bills Purchased and

Discounted

(i) Respective Maturity buckets.

(ii) they should undertake a study

80

(including bills under

DUPN)

(iii) Cash Credit / Overdraft

(including TOD) and

Demand Loan component of

Working Capital.

(iii) Term Loans

of behavioral and seasonal pattern

of a ailments based on outstanding

and the core and volatile portion

should be identified. While the

volatile portion could be shown in

the respective maturity bucket. The

core portion may be shown under

1-2 years bucket.

(iii) Interim cash flows may be

shown under respective maturity

buckets.

5. NPAs

a. Sub-standard

b. Doubtful and Loss

(I) 2-5 years bucket.

(ii) Over 5 years bucket.

6. Fixed Assets Over 5 years bucket.

7. Other-office Adjustment

(i) Inter-office Adjustment

(ii) Others

(i) As per trend analysis,

Intangible items or items

not representing cash

receivables may be shown

in over 5 years bucket.

(i) Respective maturity

buckets. Intangible assets

and assets not representing

cash receivables may be

shown in over 5 years

bucket.

81

Terms used:-

CDs: Certificate of Deposits.

CPs: Commercial Papers.

DTL PROFILE: Demand and Time Liabilities.

Inter office adjustment:

Outflows: Net Credit Balances

Inflows: Net Debit Balances

Other Liabilities: Cash payables, Income received in advance, Loan Loss and

Depreciation in Investments.

Other assets: Cash Receivable, Intangible Assets and Leased Assets.

Interest Rate Risk:-

Interest Rate Risk refers to the risk of changes in interest rates subsequent to the creation

of the assets and liabilities at fixed rates. The phased deregulations of interest rates and the

operational flexibility given in pricing most of the assets and liabilities imply the need for system

to hedge the interest rate risk. This is a risk where changes in the market interest rates might

adversely affect financial conditions.

The changes in interest rates affects in large way. The immediate impact of change in

interest rates is on earnings by changing its Net Interest Income (NII). A long term impact of

changing interest rates is on Market Value of Equity (MVE) or net worth as the economic value

of assets, liabilities and off-balance sheet positions get affected due to variation in market

interest rates.

The risk from the earnings perspective can be measured as changes in the Net Interest

Income (NII) OR Net Interest Margin (NIM).

82

There are many analytical techniques for measurement and management of interest rate

risk. In MIS of ALM, slow pace of computerization in and the absence of total deregulation, the

traditional GAP ANALYSIS is considered as a suitable method to measure the interest rate risk.

Data Interpretation

Gap Analysis:-

The Gap or mismatch risk can be measured by calculating Gaps over different time

buckets as at a given date. Gap analysis measures mismatches between rate sensitive liabilities

and rate sensitive assets including off-balance sheet position.

An asset or liability is normally classified as rate sensitive if:

If there is a cash flow within the time interval.

The interest rate resets or reprocess contractually during the interval.

RBI changes the interest rates i.e., on saving deposits, export credit, refinance, CRR

balances and so on, in case where interest rate are administered.

It is contractually pre-payable or withdraw able before the stated maturities

The Gap is the difference between Rate Sensitive Assets (RSA) and Rate sensitive Liabilities

(RSA) for each time bucket.

The positive GAP indicates that RSAs are more than RSLs (RSA>RSL).

The negative GAP indicates that RSAs are more than RSALs (RSA<RSL).

83

They can implement ALM policies for the better identification of the mismatch, risk and

for the implementation of various remedial measures.

GENERAL:-

The classification of various components of assets and liabilities into different time

buckets for preparation of Gap reports (Liquidity and interest rate sensitivity) may be done as

indicated in Appendices I & II as a sort of bench mark, which are better equipped to reasonably

estimate the behavioral pattern, embedded options, rolls-in and rolls-out etc of various

components of assets and liabilities on the basis of past date. Empirical studies could classify

them in the appropriate time buckets, subject to approval from the HDFC / Board. A copy of the

note approved by the ALOC / Board may be sent to the Department of Supervision.

The present framework does not capture the impact of embedded options, i.e., the

customers exercising their options (premature closure of deposits and prepayment of loans and

advances) on the liquidity and interest rate risks profile. The magnitude of embedded option risk

at times of volatility in market interest rates is quite substantial should, therefore evolve suitable

mechanism, supported by empirical studies and behavioral analysis to estimate the future

behavior of assets; liabilities and off-balance sheet items to changes in market variables and

estimate the embedded options.

A scientifically evolved internal transfer pricing model by assigning values on the basis of

current market rates to funds provided and funds used is an imported component for elective

implementation of ALM systems. The transfer price mechanism can enhance the management of

margin i.e., landings or credit spread the funding or liability spread and mismatch spread. It also

helps centralizing interest rate risk at one place which facilitates effective control and

management of interest rate risk. A well defined transfer pricing system also provides a rational

framework for pricing of assets and liabilities.

84

COMPARATIVE ASSET LIABILITY SHEET AS ON 31ST MARCH 2011-12

As at 31-Mar-12 As at 31-Mar-11 ABSOLUTE INCREASE/ DECREAES

CHANGE IN %

CAPITAL AND LIABILITIES

Capital 4,652,257 4,577,433 74,824 1.634627967

Reserves and Surplus 249,111,291 210,618,369 38,492,922 18.27614665

Employees’ Stock Options (Grants) Outstanding Deposits

2,085,864,054 1,674,044,394 411,819,660 24.60028309

Borrowings 143,940,610 129,156,925 14,783,685 11.44629682

Other Liabilities and Provisions

289,928,565 206,159,441 83,769,124 40.63317382

2,773,525,565 2,224,585,697 548,939,868 24.67604951

ASSETS

Cash and Balances with Reserve Bank of India

251,008,158 154,832,841 96,175,317 62.11557986

Balances with Banks and Money at Call and Short notice

45,680,191 144,591,147 -98,910,956 -68.40733894

Investments 709,293,656 586,076,161 123,217,495 21.02414382

Advances 1,599,826,654 1,258,305,939 341,520,715 27.14130995

Fixed Assets 21,706,480 21,228,114 478,366 2.253455017

Other Assets 146,010,773 59,551,495 86,459,278 145.1840596

2,773,525,912 2,224,585,697 548,940,215 24.67606511

Contingent Liabilities 5,751,224,839 4,790,515,044 960,709,795 20.05441557

Bills for Collection 134,284,924 81,248,646 53,036,278 65.27650688

85

-1000000000

0

1000000000

2000000000

3000000000

4000000000

5000000000

6000000000

7000000000

As at 31-Mar-11As at 31-Mar-10ABSOLUTE INCREASE/ DECREAESCHANGE IN %

Interpretation:

The total current liabilities for the year are Rs.206159441 is less than the total assets for the

year are Rs.2224585697. Therefore the assets are more than the liabilities. So there is a

positive gap of Rs.548939688 i.e 24.67%

86

COMPARATIVE ASSET LIABILITY SHEET AS ON 31 ST MARCH 2010-11

As at 31-Mar-11 As at 31-Mar-10 ABSOLUTE INCREASE/ DECREAES

CHANGE IN %

CAPITAL AND LIABILITIESCapital 4,577,433 4,253,841 323,592 7.607054424

Equity Share Warrants 4,009,158 -4,009,158 -100

Reserves and Surplus 210,618,369 142,209,460 68,408,909 48.10433075

Employees’ Stock Options (Grants) Outstanding

29,135 54,870 -25,735 -46.90176781

Deposits 1,674,044,394 1,428,115,800 245,928,594 17.22049388

Borrowings 129,156,925 91,636,374 37,520,551 40.9450411

Other Liabilities and Provisions 206,159,441 162,428,229 43,731,212 26.92340628

2,224,585,697 1,832,707,732 391,877,965 21.38245822

ASSETS

Cash and Balances with Reserve Bank of India

154,832,841 135,272,112 19,560,729 14.4602821

Balances with Banks and Money at Call and Short notice

144,591,147 39,794,055 104,797,092 263.3486133

Investments 586,076,161 588,175,488 -2,099,327 -0.356921878

Advances 1,258,305,939 988,830,473 269,475,466 27.25193786

Fixed Assets 21,228,114 17,067,290 4,160,824 24.37893772

Other Assets 59,551,495 63,568,314 -4,016,819 -6.318901269

2,224,585,697 1,832,707,732 391,877,965 21.38245822

Contingent Liabilities 4,790,515,044 4,059,816,885 730,698,159 17.99830336

Bills for Collection 81,248,646 85,522,390 -4,273,744 -4.997222365

87

CAPITAL A

ND LIABILIT

IES

Capita

l

Equity

Share

Warr

ants

Reserve

s and Su

rplus

Employe

es’ St

ock Options (

Grants)

Outst

an...

Deposit

s

Borrowings

Other Lia

bilities

and Pro

visions

ASSET

S

Cash an

d Balances

with

Reserve

Bank o

f India

Balances

with

Banks

and M

oney at

Call an

d Sh...

Investm

ents

Advances

Fixed

Assets

Other Asse

ts

Contingent L

iabiliti

es

Bills fo

r Colle

ction

-1000000000

0

1000000000

2000000000

3000000000

4000000000

5000000000

6000000000

As at 31-Mar-10

As at 31-Mar-09

ABSOLUTE INCREASE/ DECREAES

CHANGE IN %

Interpretation:

The total current liabilities for the year are Rs.43731212 is less than the total assets for the

year are Rs.1832707732. Therefore the assets are more than the liabilities. So there is a

positive gap of Rs. 391877965 i.e 21.38%

88

COMPARATIVE ASSET LIABILITY SHEET AS ON 31 ST MARCH 2009-10

As at 31-Mar-10 As at 31-Mar-09 ABSOLUTE INCREASE/ DECREAES

CHANGE IN %

CAPITAL AND LIABILITIESCapital 4,253,841 3,544,329

709,512 20.01823Equity Share Warrants 4,009,158 -

Reserves and Surplus 142,209,460 111,428,076

30,781,384 27.62444Employees’ Stock Options (Grants) Outstanding

54,870 -

Deposits 1,428,115,800 1,007,685,910

420,429,890 41.72232Borrowings 26,858,374 45,949,235

-19,090,861 -41.5477Other Liabilities and Provisions

227,206,229 163,158,482

64,047,747 39.254931,832,707,732 1,331,766,032

500,941,700 37.61484ASSETSCash and Balances with Reserve Bank of India

135,272,112 125,531,766

9,740,346 7.759268Balances with Banks and Money at Call and Short notice

39,794,055 22,251,622

17,542,433 78.83665Investments 588,175,488 493,935,382

94,240,106 19.07944Advances 988,830,473 634,268,934

354,561,539 55.90082Fixed Assets 17,067,290 11,750,917

5,316,373 45.2422Other Assets 63,568,314 44,027,411

19,540,903 44.383491,832,707,732 1,331,766,032

500,941,700 37.61484Contingent Liabilities 4,059,816,885 5,930,080,864

-1,870,263,979 -31.5386Bills for Collection 85,522,390 69,207,148

16,315,242 23.5745

89

-3000000000-2000000000-1000000000

01000000000200000000030000000004000000000500000000060000000007000000000

As at 31-Mar-09As at 31-Mar-08ABSOLUTE INCREASE/ DECREAESCHANGE IN %

Interpretation:

The total current liabilities for the year are Rs.64047747 is less than the total assets for the

year are Rs.1331766032. Therefore the assets are more than the liabilities. So there is a

positive gap of Rs. 500941700 i.e 37.61%

90

COMPARATIVE ASSET LIABILITY SHEET AS ON 31 ST MARCH 2008-09

As at 31-Mar-09 As at 31-Mar-08 ABSOLUTE INCREASE/ DECREAES

CHANGE IN %

CAPITAL AND LIABILITIES

Capital 354,43 319,39 3504 10.970913

Reserves and Surplus 11,142,80 6,113,76 502904 82.257727

Deposits 100,768,60 68,297,94 3247066 47.542664

Borrowings 4,478,86 2,815,39 166347 59.084887

Other Liabilities and Provisions

16,431,91 13,689,13 274278 20.036189

133,176,60 91,235,61 4194099 45.969978

ASSETS

Cash and Balances with Reserve Bank of India

12,553,18 5,075,25 747793 147.34112

Balances with Banks and Money at Call and Short notice

2,225,16 3,971,40 -174624 -43.970388

Investments 49,393,54 30,564,80 1882874 61.602693

Advances 63,426,90 46,944,78 1648212 35.10959

Fixed Assets 1,175,13 966,67 20846 21.564753

Other Assets 4,402,69 3,712,71 68998 18.584269

133,176,60 91,235,61 4194099 45.969978

Contingent Liabilities 593,008 328,148,24 -32221816 -98.192866

Bills for Collection 6,920,71 4,60683 231388 50.227163

91

-40000000

-30000000

-20000000

-10000000

0

10000000

20000000

30000000

40000000

As at 31-Mar-08

As at 31-Mar-07

ABSOLUTE INCREASE/ DECREAES

CHANGE IN %

Interpretation:

The total current liabilities for the year are Rs.1368913 is less than the total assets for the

year are Rs.9123561. Therefore the assets are more than the liabilities. So there is a positive

gap of Rs. 4194099 i.e 45.96%

92

CHAPTER-VI

FINDINGS

CONCLUSION

SUGGESTIONS

BIBILIOGRAPHY

93

FINDINGS

ALM technique is aimed to tackle the market risks. Its objective is to stabilize and

improve Net interest Income (NII).

Implementation of ALM as a Risk Management tool is done using maturity profiles and

GAP analysis.

ALM presents a disciplined decision making framework for s while at the same time

guarding the risk levels.

There has been a small reduction in Gross Sales and with the performance of prefab Division

the Gross Profit gap has narrowed and contributing to the EBIT. The Gross Profit has

increased considerably from 6584124 Cr in Last year to 968547 Cr in year. The interest

payment has increased by 6987Cr in the Current year and the Profit before Tax at 69857

when compared to 5874568 cr in Last year.

Perform Division realization has increased by 8% even the Turnover has come to 641.80 Cr

from 400.09 Cr in last year.

The profit After Tax has came 856996 Cr to 6584548 in Current year because of slope in

Cement Industry.

The PAT is in an increasing trend from 2008-2009 because of increase in sale prices and

also decreases in the cost of manufacturing. In 2010 and 2011even the cost of manufacturing

has increased by 5% because of higher sales volume PAT has increased considerably, which

leads to higher EPS, which is at 98.366 in 2010.

The company also increased considerably which investors in coming period. The company

has taken up a plant expansion program during the year to increase the production activity

and to meet the increase in the demand

94

CONCLUSION

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.

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 assessed.

Relationships of various risks to each other and/or to external factors are also identified.

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. 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.

95

Suggestions

They should strengthen its management information system (MIS) and computer

processing capabilities for accurate measurement of liquidity and interest rate

Risks in their Books.

In the short term the Net interest income or Net interest margins (NIM) creates

economic value of the which involves up gradation of existing systems &

Application software to attain better & improvised levels.

It is essential that remain alert to the events that effect its operating environment

& react accordingly in order to avoid any undesirable risks.

HDFC requires efficient human and technological infrastructure which will future

lead to smooth integration of the risk management process with effective business

strategies.

96

BIBILIOGRAPHY

Title of the Books Author Publications

1. Risk management Gustavson hoyt sout western, division of Thomson

learning(2001)

2. India financial system M.Y. Khan Mcgraw Hill Sth

Edition

3. Management Research magazine P.M.Dileep Kumar

Web sites

www.hdfc.com

www.investoros.com

www.financeindia.com

www.google.com

97