ASSET & LIABILITY MANAGEMENT IN COMMERCIAL BANKS

ALM [email protected]

1

ASSET & LIABILITY ASSET & LIABILITY MANAGEMENT IN MANAGEMENT IN

COMMERCIAL BANKS COMMERCIAL BANKS

Instructor……Bülent Şenver

[email protected]


2

Asset Management

Liability Management

ALMAssett

Liability


3

ASSET & LIABILITY MANAGEMENT (ALM)

• DEFINITION

• ALM is continuously arranging and rearranging the assets and liabilities of the bank without infringing the liquidity and safety of the bank and with the purpose of maximizing the bank’s profits.


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LIQUIDITY

• The ability of a bank to fulfill its obligations, and after doing so having enough cash left to do its normal daily banking business.


5

SAFETY

• The ability of a bank’s “Share Holder’s Equity” (SHI) to absorb the future possible losses that may arise and after doing so having enough SHI left to run the bank and to comply with the minimum “Capital Requirements”.


6

Capital protects your bank in rainy days!..


7

ALM DEVELPOMENT

1950’s 1960’s 1970’s

ASSET

MNG.

LIABILITY

MNG.

ASSET &

LIABILITY

MNG.

LOAN PRODUCTS

DEPOSIT

PRODUCTS

LOAN &

DEPOSIT BOTH


8DeregulationsSC of Accounts

GAAP

Reorganization

Management

Computerization

Office Automation

Personal Training

Internet


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Yesterday Tomorrow

Arena

Services

Organization &

Reporting

Data


10

NEW DEVOPLEPMENTS

• 1. Deregulation of Interest Rates

• 2. Deregulation of Foreign Exchange

Operations

• 3. Changes in Laws and Regulations

• 4. Increase in Deposit Interest Rates


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NEW DEVELOPMENTS

• 5. Increase in Deposit Interest Rates

• 6. Change in Deposit Characteristics

• Increase in Term-Deposits

• Decrease in Demand-Deposits

• Increase in Short Terms


12

NEW DEVELOPMENTS

• 7. Increase in Personnel Expenses

• 8. Increase in Operating Expenses

• 9. Increase in Technology Investments

• 10. Frequent Changes in Interest Rates

• 11. Increase in Share Capital

Requirements


13

NEW DEVELOPMENTS

• 12. Change in Asset Structure

• Increase in Government Bonds

• Increase in Treasury Bills

• Increase in Foreign Exch. Loans

• Increase in Short Term Loans

• Increase in Non-Performing Loans

• Increase in Consumer Loans


14

NEW DEVELOPMENTS

• 13. Decrease in S/H Equity Growth

• 14. Increase in Customer Expectations

• 15. New Service Points

• Small Branches

• ATM and POS

• Telephone and Internet Banking

• 16. 24 Hours 365 Days Banking


15

1950 1970 1980 1990 2000

SALES FORCE

BRANCH

CALL CENTERINBOUND

MAIL

CREDITCARD

ATM

TELEPHONEBANKING

PCBANKING

DIRECTMAIL

CALL CENTEROUTBOUND

DEBİTCARD

RELATIONSHIP MANAGEMENT

IN-STOREBRANCH

DATABASEMARKETING

SMART CARD

KIOSK

INTERNETBANKING

SCREEN PHONES

INTERNETATM

VIDEOKIOSK

INTERACTIVETV

SPACESHARING

FRANCHISEBRANCHES

REMOTERELATIONSHIPMANAGEMENT

Kaynak: A.T.Kearney


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FINANCIAL STATEMENTSFINANCIAL STATEMENTS

• 1. BALANCE SHEET

• 2. STATEMENT OF INCOME

• 3. STATEMENT OF SHAREHOLDER’S EQUITY

• 4. SOURCES & USES OF FUNDS STATEMENT


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Balance Sheet Income StatementAssets Liabilities

Loans

Treasury Bills

Interest Income

Interest Expences

Net Interest Income

Deposits

DebtInterest Earning Assests

Interest Bearing Liabiliti

es

Non-Interest Earning Assests

Non-Interest Bearing Liabiliti

esShare Holders’

Equity

Total Assets Total Liabilities=


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Balance Sheet Income StatementAssets LiabilitiesLoans

Treasury Bills

Interest Income

Interest Expence

Net Interest Income

Deposits

DebtInterest Earning Assests

Interest Bearing Liabiliti

es

Non-Interest Earnin

g Assests

Non-Interest Bearing Liabiliti

esShare Holders’

Equity

Total Assets Total Liabilities=

100

80

InterestRate

Assets=

%20

36

InterestRate

Liabilities=

%5

120

609

27353035


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BALANCE SHEET BALANCE SHEET SHOWSSHOWS

• The Financial Position of a Bank

• As at a specific date.

• As of Dec. 31,1998


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BALANCE SHEETBALANCE SHEETEQUATIONEQUATION

• 100 =

• ASSETS =• Equals

• = 100

• LIABILITIES• + Plus• SHAREHOLDER’S

EQUITY


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ASSET CLASSIFICATIONASSET CLASSIFICATION

N O N IN T ER EST EAR N IN GASSET S

IN T ER EST EAR N IN GASSET S

TOTALASSETS


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LIABILITY LIABILITY CLASSIFICATIONCLASSIFICATION

IN T ER EST B EAR IN GLIAB ILIT IES

N O N IN T ER EST B EAR IN GLIAB ILIT IES

TOTALLIABILITIES


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BALANCE SHEET AssetsBALANCE SHEET Assets• Liquid Assets 150

• Loans 400

• Marketable Securities 200

• Investment Securities 50

• Fixed Assets 100

• Accrued Interest 70

• Other Assets 80

• Total Assets 1050


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BALANCE SHEET LiabilitiesBALANCE SHEET Liabilities

• Deposits 400• Bank Borrowings 150• Accrued Expenses 100• Other Liabilities 80• Bonds Issued 70• Shareholder’s Equity 250• Total Liabilities & S/HE 1050


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SHAREHOLDER’S EQUITYSHAREHOLDER’S EQUITY

• Share Capital 100

• Legal Reserves 30

• Retained Earnings 50

• Revaluation Surplus 20

• Share Premiums 10

• Net Income 40

• Total S/H Equity 250


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BALANCE SHEETBALANCE SHEETDOES NOT SHOWDOES NOT SHOW

• Interest Rates• Interest Sensitivity• Due Dates• Foreign Currency

breakdown• Collateral


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STATEMENT OF INCOMESTATEMENT OF INCOMESHOWSSHOWS

• The results of operations of a bank.

• For the period between two dates.

• For the year endedDec. 31 , 1998


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NET PROFITNET PROFIT

TO TALIN C O M E

TO TALEXPEN SE

N ET PR OFIT


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TOTAL INCOMETOTAL INCOME

N ETIN TER ESTIN C O M E

N ETN O N -IN TER EST

IN C O M E

TOTALIN C OM E


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NET INTEREST INCOMENET INTEREST INCOME

IN TER ESTIN C O M E

(+)

IN TER ESTEXPEN SE

(-)

N ETIN TER ESTIN C OM E


31time

$interest income

interest expense

net interest income

net interest income

+

-


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NET INTEREST INCOMENET INTEREST INCOME

INTERESTEARNINGASSETS

B/S

IN TER ES TIN C O M E

P/L

IN TER ES TBE AR IN G

LIA B ILITIE SB /S

IN TER ES TEX PEN SE

P/L

N ETIN TER ES T

IN C O M E


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NET NON-INTEREST NET NON-INTEREST INCOMEINCOME

N O NIN TER ESTIN C O M E

(+)

N O NIN TER ESTEXPEN C E

(-)

N ETN ON -IN TER EST

IN C OM E


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STATEMENT OF INCOMESTATEMENT OF INCOME• Interest Income 1000

• Interest Expense (700)• Net I.Income 300• Non Interest Income 220• Operating Expenses (450)• Pre-Tax Profit 70• Tax Provision (30)• Net Income 40


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ANALYSIS OF PROFITANALYSIS OF PROFIT

PROFIT FROMBANKING OPERATIONS

(NET OPERATING INCOM E)(NOI)

PROFIT FROMEXTRAORDINARYTRANSACTIONS

(PEXT)

PROFIT FROMSECURITY

TRANNSACTIONS(PST)

NETPRO FIT

(NP)


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BANKINGBANKING

RISKSRISKS


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BANKING RISKSBANKING RISKS

•CC AMEL AMEL

• AA

• MM

• EE

• LL


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CAMEL

• CapitalCapital

AdequacyAdequacy


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CAMEL

• AssetAsset QualityQuality


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CAMEL

• ManagementManagement

QualityQuality


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CAMEL

• EarningsEarnings

EfficiencyEfficiency


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CAMEL• LiquidityLiquidity

RiskRisk


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CAMEL RISKS

• Capital Capital AdequacyAdequacy

• Asset QualityAsset Quality

• ManagementManagement

• EarningsEarnings

• LiquidityLiquidity


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• 1.2.3.4.5.CAMEL

• 6. Credit Risk

• 7. Interest Rate Risk

• 8. Interest Rate Sensitivity Risk

• 9. Foreign Exchange Availability Risk

• 10. F/X Position Risk


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• 11. Accounting & Reporting Risk

• 12. Computer Risk

• 13. Capital Market Operations Risk

• 14. Money Market Operations Risk

• 15. Country (Sovereign) Risk

• 16. Pricing Risk

• 17. Market Risk


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• 18. Theft Risk

• 19. Fraud & Defalcations Risk

• 20. Natural Disasters

• 21. Strategic Risk

• 22. Fiduciary Risk

• 23. Transaction Risk

• 24. Regulatory/Compliance


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BANKING RISKS

• 25. Reputation Risk

• 26. Large Loans/Deposits Risk

• 27. Concentration Risk


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RATIO ANALYSISRATIO ANALYSIS

Numerator

______________________

Denominator


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• Balance Sheet__________________Balance Sheet

• Income Statement________________Balance Sheet


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• What is the

• LEVEL ?

• What is the

• TREND ?


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• 1. Capital Adequacy

• 2. Asset Quality

• 3. Management

• 4. Earnings & Efficiency

• 5. Liquidity


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RATIO ANALISISCAPITALCAPITAL ADEQUACYADEQUACY

• “The Capital of a Bank protects the Bank against unexpected future losses.”


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RATIO ANALYSISCAPITAL ADEQUACYCAPITAL ADEQUACY

• 1.

• Shareholders’ Equity ------------------------------------

• Total Assets

• The ability of the present Capital to support the further growth of Assets


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• 2.


• Risk Weighted Assets


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• 3.


• Risk Weighted Assets + RW Contingent Liabilities


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• 4.

• Total Debt ------------------------------------

• Shareholder’s Equity

• The ability to raise additional Debt Capital


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• 5. Financial Leverage :

• Total Assets ------------------------------------

• Shareholder’s Equity


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• 6. Capital Formation Rate :

• Retained Net Income (RNI) --------------------------------------------------

• Average Shareholder’s Equity

• RNI = Net Income - Dividends to be paid

• The internal growth of Equity Capital


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RATIO ANALISISASSETASSET QUALITYQUALITY

• 1.

• Loans --------------------------------

• Total Assets


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• 2. Non Performing Loans =

• a) Loans past due more than 90 days

• b) Loans not accruing interest

• c) Loans with low interest rates

• d) Loans on which repayment terms have been renegotiated.

•


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• 3. Non Performing Loans -------------------------------------

• Total Loans

• Indicates how much of the loan portfolio is non performing.


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• 4. Reserves for Non Performing Loans ----------------------------------------------

• Non Performing Loans

• Indicates the ability of the loan loss reserve to absorb potential losses from currently non performing loans.


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• 5. Loan Loss Provision -------------------------------------

• Average Loans

• Shows current income reduction in anticipation of loan losses.


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• 6. Net Charge - Offs -------------------------------------

• Average Loans

• Shows current income reduction in anticipation of loan losses.


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• 7.

• Interest Earning Assets -------------------------------------------------

• Total Assets


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• 8.

• Non Interest Earning Assets -------------------------------------------------

• Total Assets


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RATIO ANALISISEARNINGSEARNINGS && EFFICIENCYEFFICIENCY

• “A Bank with no profit is like a human body with no blood.”


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THE PRIMACY OF THE PRIMACY OF EARNINGSEARNINGS

• A bank can not sustain itself long without a positive cash flow.

• Earnings are essential to :

• 1.Absorb loan losses

• 2.Finance internal growth of capital

• 3.Attract investors to supply capital


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• 1. Return on Assets ( ROA )

• Net Income --------------------------------------------

• Total Average Assets


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• 2. Return on Equity ( ROE )

• Net Income --------------------------------------------

• Average Shareholder’s Equity


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• 3. Return on Equity ( ROE )

• ROE = ROA * Equity Multiplier

• ROE = ( NI / AST ) * ( AST / SHEQ )


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• 4.

• Interest Income --------------------------------------------

• Average Interest Earning Assets


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• 5.

• Net Interest Income --------------------------------------------

• Average Total Assets


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• 6.

• Interest Income on Loans --------------------------------------------

• Average Total Loans


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• 7.

• Total Operating Expense -------------------------------------------------

• Total Operating Income


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• 8. Efficiency Ratio

• Non Interest Expense ----------------------------------------------------

• Net Interest Income + Fees Commissions


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• 9. Break Even Ratio

• Total Expenses - Non Interest Income

----------------------------------------------------

• Total Average Interest Earning Assets


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• 10. Net Free Funds Ratio

• Non Paying Liabilities - Non Earning Assets --------------------------------------------------

• Interest Earning Assets


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• 11. Interest Rate Sensitivity Gap :

• Interest Rate Sensitive Assets ( minus )

• Interest Rate Sensitive Liabilities

• Shows the net amount to be effected by the future change of interest rates in the market


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• 12. Interest Rate Sensitivity Gap Ratio :

• Interest Rate Sensitive Assets -------------------------------------------------

• Interest Rate Sensitive Liabilities


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RATIO ANALYSISLIQUIDITYLIQUIDITY

• “Inadequate Liquidity of a Bank may cause an accident similar to an airplane crash !”


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RATIO ANALISISLIQUIDITYLIQUIDITY

• 1.

• Loans -------------------------

• Deposits


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• 2.

• Liquid Assets -------------------------

• Deposits


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• 3.

• Liquid Assets --------------------------------

• Deposits + Borrowings


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• 4.

• Assets Due for the Period -----------------------------------------

• Liabilities Due for the Period


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• 5. Net Large Liabilities -----------------------------------------

• Net Earning Assets

• Both numerator & denominator are net of short-term assets.

• Measures the extent to which net earning assets would be effected by the loss of a bank’s large liabilities.


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• 6. Liquid Assets -----------------------------------------

• Large Liabilities

• Measures the assets readily available to cover a loss of large liabilities.


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• 7. Core Deposits -----------------------------------------

• Earning Assets

• Indicates the extend to which earning assets are funded by those deposits considered stable and not subject to interest rate disintermediation.


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• 8. Brokered Deposits -----------------------------------------

• Earning Assets

• Measures the extent to which a bank is funding assets with high-priced and volatile brokered deposits.


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MATURITY ANALISISMATURITY ANALISIS

Days 0-10 10-30 30-60 60-90 Cash 100 200 300 50 Loans 200 500 200 100 300 700 500 150 Deposit 400 300 800 20 Borrow 150 200 200 30 550 500 1000 50


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MATURITY ANALYSISMATURITY ANALYSIS

Days 0-10 10-30 30-60 60-90

Asset 100 500 1000 2000Liab 300 200 1500 700

Short - -200 -500Long + +300 1300


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OFF - BALANCE SHEET OFF - BALANCE SHEET RISKRISK

• 1. Loan Commitments -----------------------------------------

• Average Assets

• Shows the extent of a bank’s obligation to make loans.


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OFF - BALANCE SHEET OFF - BALANCE SHEET RISKRISK

• 2.Contingent Liabilities & Commitments ----------------------------------------------------

• Average Assets

• Shows the extent of a bank’s commitments & contingent liabilities.


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RISKS

I manage

Assets!% rates,

due dates...

I manage Liabilities

% rates,due dates...


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ASSET & LIABILITY MATCH


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A & L Match

• Amounts• Currency• Due Dates• Interest Rates• Interest Sensitivity• Volatility


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Foreign Exchange Position

• USA $ Short Position• $Liabilities>$Assets

• USA $ Long Position• $Assets>$Liabilities


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F/X Position Strategy

Increasing

F/X Rates

Decreasing

F/X Rates

Long Position

YES NO

Short Position

NO YES


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Interest Rate Sensitivity

• Interest Rate Sensitive Assets/Liabilities

• IRSA/L are such assets and Liabilities whose interest rates will change before their due dates when there is a change in market interest rates.


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Interest Rate Sensitivity

Interest Rate Sensitive

Assets & Liabilities

Interest Rate

Non-Sensitive

Assets & Liabilities

VARIABLE RATES FIXED RATES


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Interest Rate Sensitivity Gap

• IRS GAP =

• (IRSA – IRSL)

• Positive Gap• IRSA>IRSL

• Negative Gap• IRSL>IRSA


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Interest Rate Sensitivity Strategy

Interest Rates

Will Increase

Interest Rates

Will Decrease

Positive

IRS GAP YES NO

Negative

IRS GAP NO YES


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INTEREST MARGININTEREST MARGIN

INCREASING THE

INTEREST MARGIN %


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INCREASING INTEREST MARGIN

• Interest Income…………..200

• Interest Expense…………( 50 ) ----------

• INTEREST MARGIN….. 150 ----------


105time

$

interest income

interest expense

net interest income

net interest income

+

-


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INCREASING THE INCREASING THE INTEREST MARGININTEREST MARGIN

B A N K S TR A TE G Y TO

IN C R E A S ES IZ E

C H A N G EIN TE R E S TS P R E A D

A L TE RA S S E T/L IA B IL ITY

M IX

IN C R E A S E TH EIN TE R E S T M A R G IN


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INCREASING THEINCREASING THEINTEREST MARGININTEREST MARGIN

• BANK STRATEGY

• Increase Size

• ACTION

• 1.Expand Assets• 2.Reduce Fixed Assets• 3.Increase Equity Base


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INCREASE THEINCREASE THEINTEREST MARGININTEREST MARGIN

• BANK STRATEGY

• ChangeInterest Spread

• ACTION

• 1.Re-Price Asset Portfolio

• 2.Re-Price Liability Portfolio


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• BANK STRATEGY

• AlterAsset / LiabilityMix

• ACTION• 1.Plan Taxes• 2.Reduce Liquidity• 3.Increase

Aggressiveness• 4.Change Asset Yield

Sensitivity• 5.Change Liability

Cost Sensitivity


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• BANK STRATEGYIncrease Size

• ACTIONExpand Assets

• IMPLEMENTATION• 1.Offer new Products

and Services• 2.New Loans/Deposits• 2.Open new Branches• 3.Expand Promotion

Budget• 4.Reduce Interest

Spread


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EXPAND ASSETSEXPAND ASSETS

• REPERCUSSION• 1.Increase operating

Expenses• 2.Need for Capital• 3.F/A Regulations• 4.Decrease Capital

Ratio• 5.Reduce ROA

• IMPLEMENTATION• 1.Offer new Products

and Services• 2.New Loans/Deposits• 3.Open new Branches• 4.Expand Promotion

Budget• 5.Reduce Interest

Spread


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• BANK STRATEGYIncrease Size

• ACTIONIncreaseEquity Base

• IMPLEMENTATION• 1.Reduce Dividend

pay out• 2.Offer Dividend

reinvestment• 3.Sell Stock• 4.Establish Employee

Stock Ownership PL


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INCREASE EQUITY BASEINCREASE EQUITY BASE

• REPERCUSSIONS• 1.Hurt shareholders

• 2.Double taxation S/H3.Reduce ability to leverage ROA, dilution of earnings

• 4.Continued Employee Expectations

• IMPLEMENTATION• 1.Reduce Dividend

pay out• 2.Offer Dividend

reinvestment• 3.Sell Stock• 4.Establish Employee

Stock Ownership PL


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INCREASE INTEREST INCREASE INTEREST MARGINMARGIN

• BANK STRATEGYChange Interest Spread

• ACTIONRe-price Portfolio

• IMPLEMENTATION• 1.Increase rates on

Loans• 2.Compound return

more frequently• 3.Reduce rates on

Deposits• 4.Compound cost less

frequently


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REPRICE PORTFOLIOREPRICE PORTFOLIO

• REPERCUSSIONS• 1.Lose business

Loan quality decrease• 2.Increase operations

Client dissatisfaction• 3.Lose business

Liquidity problem• 4.Increase operations

Client dissatisfaction

• IMPLEMENTATION• 1.Increase rates on

Loans• 2.Compound return

more frequently• 3.Reduce rates on

Deposits• 4.Compound cost less

frequently


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• BANK STRATEGY• Alter Asset/Liability

Mix

• ACTION• Reduce Liquidity

• IMPLEMENTATION

• 1.Minimize cash• 2.Minimize due from• 3.Sell Securities &

Bonds• 4.Increase short term

Deposits


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REDUCEREDUCE LIQUIDITYLIQUIDITY

• REPERCUSSION

• 1.Liquidity Risk

• 2.Lose correspondent

• 3.Incur book losses

• 4.Increase volatility of deposits

• IMPLEMENTATION

• 1.Minimize cash• 2.Minimize due from• 3.Sell Securities &

Bonds• 4.Increase short term

Deposits


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Mix

• ACTION• Increase

Aggressiveness

• IMPLEMENTATION• 1.Increase loan/deposit

ratio• 2.Increase highest

yielding loans• 3.Increase highest

yielding securities


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INCREASE INCREASE AGGRESSIVENESSAGGRESSIVENESS

• REPERCUSSION• 1.Increase need for

capital• 2.Increase loan losses

• 3.Increase security losses

• IMPLEMENTATION• 1.Increase loan/deposit

ratio• 2.Increase highest

yielding loans• 3.Increase highest

yielding securities


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Mix

• ACTION• Change Asset Yield

Sensitivity

• IMPLEMENTATION• 1.Increase S/T &

variable rate assets if rates will increase

• 2.Decrease S/T & variable rate assets if rates will decrease


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CHANGE ASSET YIELD CHANGE ASSET YIELD SENSITIVITYSENSITIVITY

• REPERCUSSION• 1.Wrong estimate of

interest movement, thereby reducing interest spread

• IMPLEMENTATION• 1.Increase S/T &

variable rate assets if rates will increase

• 2.Decrease S/T & variable rate assets if rates will decrease


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Mix

• ACTION• Change Liability

Cost Sensitivity

• IMPLEMENTATION• 1.Decrease S/T &

variable rate liabilities if rates will increase

• 2.Increase S/T & variable rate liabilities if rates will decrease


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CHANGE LIABILITY COST CHANGE LIABILITY COST SENSITIVITYSENSITIVITY

• REPERCUSSION• 1.Wrong estimate of

interest movement, thereby reducing interest spread

• IMPLEMENTATION• 1.Decrease S/T &

variable rate liabilities if rates will increase

• 2.Increase S/T & variable rate liabilities if rates will decrease

ASSET & LIABILITY MANAGEMENT IN COMMERCIAL BANKS

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