INTRODUCTION OF BANKING

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

Renaissance by Florentines bankers, who used to make their transactions

above a desk covered by a green tablecloth.

Banking" means the accepting, for the purpose of lending or investment, of

deposits of money from the public, repayable on demand or otherwise, and

withdrawable by cheque, draft, and order.

"Banking Company" means any company which transacts the business of

banking in India and includes the State Bank, but does not include the Industrial

Investment Corporation Limited. Explanation.--Any company which is engaged in

the manufacture of goods or carries on any trade and which accepts deposits of

money from the public merely for the purpose of financing its business as such

manufacturer or trader shall not be deemed to transact the business of banking.

Banking India

Banking in India has its origin as early as the Vedic period and form the economy

point of view, the major task of banks is to act as intermediaries channeling

saving to investment requirement of savers are reconciled with the credit need of

investors and consumers .

A bank is a business which provides financial services for profit. Traditional

banking services include receiving of money, lending money and processing

transactions.Some banks (called Banks of issue) issue as legal tender. Many

banks offer ancillary financial services to make additional profit; for example:

selling Insurance Product ,Investment product & stock broking.

The Indian Banking Industry can be categorized into non-scheduled banks and

scheduled banks. Scheduled banks constitute of commercial banks and co-

operative banks. There are about 67,000 branches of Scheduled banks spread

across India. During the first phase of financial reforms, there was a

nationalization of 14 major banks in 1969. This crucial step led to a shift from

Class banking to Mass banking. Since then the growth of the banking industry in

India has been a continuous process.

As far as the present scenario is concerned the banking industry in India is in a

transition phase. The Public Sector Banks (PSBs), which are the foundation of

the Indian Banking system account for more than 78 per cent of total banking

industry assets. Unfortunately they are burdened with excessive Non Performing

assets (NPAs), massive manpower and lack of modern technology. On the other

hand the Private Sector Banks are witnessing immense progress. They are

leaders in Internet banking, mobile banking, phone banking, ATMs. On the other

hand the Public Sector Banks are still facing the problem of unhappy employees.

There has been a decrease of 20 percent in the employee strength of the private

sector in the wake of the Voluntary Retirement Schemes (VRS). As far as foreign

banks are concerned they are likely to succeed. Indusland Bank was the first

private bank to be set up in India. IDBI, ING Vyasa Bank, SBI Commercial and

International Bank Ltd, Dhanalakshmi Bank Ltd, Karur Vysya Bank Ltd, Bank of

Rajasthan Ltd etc are some Private Sector Banks. Banks from the Public Sector

include Punjab National bank, Vijaya Bank, UCO Bank, Oriental Bank, Allahabad

Bank, Andhra Bank etc.

Currently in most jurisdictions the business of banking is regulated and banks

require permission to trade. Authorization to trade is granted by Bank regulatry

authorities and provide rights to conduct the most fundamental banking services

such as accepting deposist and making loans.

History of Banking in India

Without a sound and effective banking system in India it cannot have a healthy

economy. The banking system of India should not only be hassle free but it

should be able to meet new challenges posed by the technology and any other

external and internal factors.

For the past three decades India's banking system has several outstanding

achievements to its credit. The most striking is its extensive reach. It is no longer

confined to only metropolitans or cosmopolitans in India. In fact, Indian banking

system has reached even to the remote corners of the country. This is one of the

main reasons of India's growth process.

The first bank in India, though conservative, was established in 1786. From 1786

till today, the journey of Indian Banking System can be segregated into three

distinct phases. They are as mentioned below:

Early phase from 1786 to 1969 of Indian Banks

Nationalization of Indian Banks and up to 1991 prior to Indian banking

sector Reforms.

New phase of Indian Banking System with the advent of Indian Financial &

Banking Sector Reforms after 1991. To make this write-up more

explanatory, I prefix the scenario as Phase I, Phase II and Phase III.

Phase I

The General Bank of India was set up in the year 1786. Next came Bank of

Hindustan and Bengal Bank. The East India Company established Bank of

Bengal (1809), Bank of Bombay (1840) and Bank of Madras (1843) as

independent units and called it Presidency Banks. These three banks were

amalgamated in 1920 and Imperial Bank of India was established which started

as private shareholders banks, mostly Europeans shareholders.

During the first phase the growth was very slow and banks also experienced

periodic failures between 1913 and 1948. There were approximately 1100 banks,

mostly small. To streamline the functioning and activities of commercial banks,

the Government of India came up with The Banking Companies Act, 1949 which

was later changed to Banking Regulation Act 1949 as per amending Act of 1965

(Act No. 23 of 1965). Reserve Bank of India was vested with extensive powers

for the supervision of banking in India as the Central Banking Authority.

During those day’s public has lesser confidence in the banks. As an aftermath

deposit mobilization was slow. Abreast of it the savings bank facility provided by

the Postal department was comparatively safer. Moreover, funds were largely

given to traders.

Phase II

Government took major steps in this Indian Banking Sector Reform after

independence. In 1955, it nationalized Imperial Bank of India with extensive

banking facilities on a large scale especially in rural and semi-urban areas. It

formed State Bank of India to act as the principal agent of RBI and to handle

banking transactions of the Union and State Governments all over the country.

Seven banks forming subsidiary of State Bank of India was nationalized in 1960

on 19th July, 1969, major process of nationalization was carried out. It was the

effort of the then Prime Minister of India, Mrs. Indira Gandhi. 14 major

commercial banks in the country were nationalized.

Second phase of nationalization Indian Banking Sector Reform was carried out in

1980 with seven more banks. This step brought 80% of the banking segment in

India. The following are the steps taken by the Government of India to Regulate

Banking Institutions in the Country:

1949: Enactment of Banking Regulation Act.

1955: Nationalization of State Bank of India.

1959: Nationalization of SBI subsidiaries.

1961: Insurance cover extended to deposits.

1969: Nationalization of 14 major banks.

1971: Creation of credit guarantee corporation.

1975: Creation of regional rural banks.

1980: Nationalization of seven banks with deposits over 200 crore. After

the nationalization of banks, the branches of the public sector bank India

raised to approximately 800% in deposits and advances took a huge jump

by 11,000%.Banking in the sunshine of Government ownership gave the

public implicit faith and immense confidence about the sustainability of

these institutions.

Phase III

This phase has introduced many more products and facilities in the banking

sector in its reforms measure. In 1991, under the chairmanship of M

Narasimham, a committee was set up by his name which worked for the

liberalization of banking practices.

The country is flooded with foreign banks and their ATM stations. Efforts are

being put to give a satisfactory service to customers. Phone banking and net

banking is introduced. The entire system became more convenient and swift.

Time is given more importance than money.

The financial system of India has shown a great deal of resilience. It is sheltered

from any crisis triggered by any external macroeconomics shock as other East

Asian Countries suffered. This is all due to a flexible exchange rate regime, the

foreign reserves are high, the capital account is not yet fully convertible, and

banks and their customers have limited foreign exchange exposure.

INDIAN BANKING STRUCTURE

SBI

Group Nationalized Regional Banks Rural Bank

Foreign Commercial

Banks in India

Public Indian Sector Scheduled

Commercial Commercial BanksBanks Banks

Private Sector

Non- Scheduled Banks

Co-operative State Central PrimaryBanks Co-operative Co-operative Credit

Banks Banks Banks

IFCI, IRBISFC, NSIC

Industrial ICICI, IDBISIDC/SIIC

DICGC

Development Insurance Banks and Credit Agricultural NABARD Guarantee AFC

Investment LIC, GIC UIT

Housing NHB Export EXIM Banks

Import ECGC

RBI

Services typically offered by banks

Although the type of services offered by a bank depends upon the type of bank

and the country, services provided usually include:

Taking deposits from their customers and issuing Checking and Saving

accounts to individuals and businesses.

Extending Loans to individuals and businesses.

Cashing Cheques

Facilitating money transactions such as Wire Transfer and cashier

checks.

Issuing Credit cards, ATM crads & debit crads

Storing valuables, particularly in a Safe Deposits Box.

Cashing and distributing Bank rolls.

Financial Transactions can be performed through many different

Channels

o Branch

o ATM

o Mail

o Telephone Banking

o Online Banking

INNOVATIONS IN BANKING IN INDIA

o Internet Banking

o Mobile Banking

o Payment Systems

o Benefits of Technology in Banking

BANKING BEYOND BANKING

o Personal Banking

o Retail Banking

o NRI Services

o Any Branch Banking

Types of banks

Banks' activities can be characterized as retail banking dealing directly with

individuals and small businesses, 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 making.

Indian Banking system can be roughly classified into three broab categories viz.

Commercial Banks

Development Banks

Co-operative Banks

Commercial Banks

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 markets

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.

Today commercial banking system in india may be distinguished

1. Public Sectors Banks

2. Private Sector Banks.

Development Banks

This type of bank provide long term finance to Industries and Trade.Development

banking sectors are as above-

1. Industrial Finance Corporation Of India

2. Industrial development bank of india

3. Industrial Credit And Investment Bank Of India

4. Small Industrial Development Banks Of India

5. National Bank for Agriculture And Rural Development

6. Exprot Import And Of India

Co-operative Banks

The Co operative banks in India started functioning almost 100 years ago. The

Cooperative bank is an important constituent of the Indian Financial System,

judging by the role assigned to co operative, the expectations the co operative is

supposed to fulfill, their number, and the number of offices the cooperative bank

operate. Though the co operative movement originated in the West, but the

importance of such banks have assumed in India is rarely paralleled anywhere

else in the world. The cooperative banks in India play an important role even

today in rural financing. The businesses of cooperative bank in the urban areas

also have increased phenomenally in recent years due to the sharp increase in

the number of primary co-operative banks. Co operative Banks in India are

registered under the Co-operative Societies Act. The cooperative bank is also

regulated by the RBI. They are governed by the Banking Regulations Act 1949

and Banking Laws (Co-operative Societies) Act, 1965.

Co-operative Sectors

1. State Co-operative Bank

2. Central Co-operative Bank

3. Primary Agriculture Credit Societies

4. Urban Co-operative Bank

5. Primary Land Development Bank

6. State Land Development Bank

Values & Principles of Co-Operative Bank

Co-operatives are based on the values of self-responsibility, democracy, equality

and Solidarity. In the tradition of their founders, co-operative members believe in

the ethical values of honesty, openness, social responsibly and caring others.

Principles

1. Voluntary and open membership – Co-operative are voluntary

organizations, open to all persons able to use their services and willing to

accept the responsibility of membership without gender, social, racial,

political discrimination.

2. Democratic member control – Co-operative are democratic organization

control by their members, who actively participate in setting their polices

and making decision, men and women serving as elected representative

are accountable to the membership. In co-operatives, members have

equal voting rights and co-operative at other levels are also organized I a

democratic manner.

3. Member’s economic participation – Members contributes equitably to

and democratically controls the capital of their co-operative. At least part

of capital is usually the common property of the co-operative.

4. Autonomy and independence – Co-operatives are autonomous, self

help organization control by their members.

5. Education training and information – Co-operative provides education

and training for their members, elected representatives, mangers and

employees so that they can contribute effectively to the development of

their co-operative.

6. Concern for community – Co-operative work for their substantial

development of their communities through policies approved by their

members.

Some facts about Cooperative banks in India

1. Some cooperative banks in India are more forward than many of the state

and private sector banks.

2. According to NAFCUB the total deposits & landings of Cooperative Banks

in India is much more than Old Private Sector Banks & also the New

Private Sector Banks.

3. This exponential growth of Co operative Banks in India is attributed mainly

to their much better local reach, personal interaction with customers, and

their ability to catch the nerve of the local clientele.

Cooperative banks in India finance rural areas under:

1. Farming

2. Cattle

3. Milk

4. Hatchery

5. Personal finance

Cooperative banks in India finance urban areas under

1. Self-employment

2. Industries

3. Small scale units

4. Home finance

5. Consumer finance

6. Personal finance

Developments in Co-operative Banking

Co-operative banking has passed through many phases since the enactment of

the Agricultural Credit Co-operative Societies Act in 1904. Co-operative banks,

developed largely as an offshoot of official policy, expanded rapidly in the post-

independence era and played an important role in implementation of various

Government schemes. Their business is now binger-engineered to strengthen

their role in contributing to financial inclusion and deepening banking penetration

in an increasingly competitive financial landscape.

The co-operative Banking system, with two broad systems of Urban and Rural

co-operative, forms and integral part of India finical system with a wide network

and extensive coverage, these institutions have played an important role in

enlarging the ambit of institutional credit by way of including banking habits

among the poor and those in remote areas. In recent time, co-operative banks

have tried to improve credit deliveries through some financial innovation.

Urban Co-operative Banks

The term Urban Co-operative Banks (UCBs), though not formally defined, refers

to primary cooperative banks located in urban and semi-urban areas. These

banks, till 1996, were allowed to lend money only for non-agricultural purposes.

This distinction does not hold today. These banks were traditionally centered on

communities, localities work place groups. They essentially lent to small

borrowers and businesses. Today, their scope of operations has widened

considerably.

The origins of the urban cooperative banking movement in India can be traced to

the close of nineteenth century when, inspired by the success of the experiments

related to the cooperative movement in Britain and the cooperative credit

movement in Germany such societies were set up in India. Cooperative societies

are based on the principles of cooperation, - mutual help, democratic decision

making and open membership. Cooperatives represented a new and alternative

approach to organization as against proprietary firms, partnership firms and joint

stock companies which represent the dominant form of commercial organization.

The Beginnings (UCBs)

The first known mutual aid society in India was probably the ‘Anyonya Sahakari

Mandali’ organized in the erstwhile princely State of Baroda in 1889 under the

guidance of Vithal Laxman also known as Bhausaheb Kavthekar. Urban co-

operative credit societies, in their formative phase came to be organized on a

community basis to meet the consumption oriented credit needs of their

members. Salary earners’ societies inculcating habits of thrift and self help

played a significant role in popularizing the movement, especially amongst the

middle class as well as organized labour. From its origins then to today, the

thrust of UCBs, historically, has been to mobilize savings from the middle and

low income urban groups and purvey credit to their members - many of which

belonged to weaker sections.

The Cooperative Credit Societies Act, 1904 was amended in 1912, with a view to

broad basing it to enable organization of non-credit societies. The Maclagan

Committee of 1915 was appointed to review their performance and suggest

measures for strengthening them. The committee observed that such institutions

were eminently suited to cater to the needs of the lower and middle income strata

of society and would inculcate the principles of banking amongst the middle

classes. The committee also felt that the urban cooperative credit movement was

more viable than agricultural credit societies. The recommendations of the

Committee went a long way in establishing the urban cooperative credit

movement in its own right.

In the present day context, it is of interest to recall that during the banking crisis

of 1913-14, when no fewer than 57 joint stock banks collapsed, there was a there

was a flight of deposits from joint stock banks to cooperative urban banks.

Maclagan Committee chronicled this event thus:

“As a matter of fact, the crisis had a contrary effect, and in most provinces, there

was a movement to withdraw deposits from non-cooperatives and place them in

cooperative institutions, the distinction between two classes of security being well

appreciated and a preference being given to the latter owing partly to the local

character and publicity of cooperative institutions but mainly, we think, to the

connection of Government with Cooperative movement”.

UCBs are unique in terms of their clientele mix and channels of credit delivery.

UCBs reorganized with the objective of promoting thrift and self-help among the

middle class/lower middleclass population and providing credit facilities to the

people with small means in the urban/semi urban centers. On account of their

local feel and familiarity, UCBs are important for achieving greater financial

inclusion. In recent times, however, UCBs have shown several weaknesses,

particularly related to their financial health.Recognising their important role in the

financial system, it has been the endeavor of the Reserve Bank to promote their

healthy growth. However, the heterogeneous nature of the sector has called For

a differentiated regime of regulation. In recent years, therefore, the Reserve Bank

has provided regulatory support to small and weak UCBs, while the same time

strengthening their supervision.

Recent Developments(UCBs)

Over the years, primary (urban) cooperative banks have registered a significant

growth in number, size and volume of business handled. As on 31st March, 2003

there were 2,104 UCBs of which 56 were scheduled banks. About 79 percent of

these are located in five states, - Andhra Pradesh, Gujarat, Karnataka,

Maharashtra and Tamil Nadu. Recently the problems faced by a few large UCBs

have highlighted some of the difficulties these banks face and policy endeavors

are geared to consolidating and strengthening this sector and improving

governance.

STRUCTURE OF CO-OPERATIVE BANK

Co-Operative Credit Structure

Non-Agricultural CreditAgricultural Credit

Long TermShort-term & Medium Term

StateCo-operative

Banks

CentralCo-operative

Banks

Primary CreditSocieties

1. PACS2. FSS3. L-SCS4. LAMPS

5. Service Co- 6. M-p Soc.7. Grain Banks

State ARDBs

Primary ARDBS

State Co-operative Banks

Central Co-operative Banks

Primary Credit Societies

UrbanCo-

operativeBanks

EmployeeCo-

operativeSocieties

OtherSocieties

Features of Cooperative Banks

Co-operative Banks are organized and managed on the principal of co-operation,

self-help, and mutual help. They function with the rule of "one member, one

vote". Function on "no profit, no loss" basis. Co-operative banks, as a principle,

do not pursue the goal of profit maximization.

Co-operative bank performs all the main banking functions of deposit

mobilization, supply of credit and provision of remittance facilities. Co-operative

Banks provide limited banking products and are functionally specialists in

agriculture related products. However, co-operative banks now provide housing

loans also.

UCBs provide working capital loans and term loan as well. The State Co-

operative Banks (SCBs), Central Co-operative Banks (CCBs) and Urban Co-

operative Banks (UCBs) can normally extend housing loans up to Rs 1 lakh to an

individual. The scheduled UCBs, however, can lend up to Rs 3 lakh for housing

purposes. The UCBs can provide advances against shares and debentures also.

Co-operative bank do banking business mainly in the agriculture and rural sector.

However, UCBs, SCBs, and CCBs operate in semi urban, urban, and

metropolitan areas also. The urban and non-agricultural business of these banks

has grown over the years. The co-operative banks demonstrate a shift from rural

to urban, while the commercial banks, from urban to rural.

Co-operative banks are perhaps the first government sponsored, government-

supported, and government-subsidized financial agency in India. They get

financial and other help from the Reserve Bank of India NABARD, central

government and state governments. They constitute the "most favored" banking

sector with risk of nationalization. For commercial banks, the Reserve Bank of

India is lender of last resort, but co-operative banks it is the lender of first resort

which provides financial resources in the form of contribution to the initial capital

(through state government), working capital, refinance.

Co-operative Banks belong to the money market as well as to the capital market.

Primary agricultural credit societies provide short term and medium term loans.

Land Development Banks (LDBs) provide long-term loans. SCBs and CCBs also

provide both short term and term loans.

Co-operative banks are financial intermediaries only partially. The sources of

their funds (resources) are (a) central and state government, (b) the Reserve

Bank of India and NABARD, (c) other co-operative institutions, (d) ownership

funds and, (e) deposits or debenture issues. It is interesting to note that intra-

sectoral flows of funds are much greater in co-operative banking than in

commercial banking. Inter-bank deposits, borrowings, and credit from a

significant part of assets and liabilities of co-operative banks. This means that

intra-sectoral competition is absent and intra-sectoral integration is high for co-

operative bank.

Some co-operative bank is scheduled banks, while others are non-scheduled

banks. For instance, SCBs and some UCBs are scheduled banks but other co-

operative bank is non-scheduled banks. At present, 28 SCBs and 11 UCBs with

Demand and Time Liabilities over Rs 50 crore each included in the Second

Schedule of the Reserve Bank of India Act. Co-operative Banks are subject to

CRR and liquidity requirements as other scheduled and non-scheduled banks

are. However, their requirements are less than commercial banks. Since 1966

the lending and deposit rate of commercial banks have been directly regulated by

the Reserve Bank of India. Although the Reserve Bank of India had power to

regulate the rate co-operative bank but this have been exercised only after 1979

in respect of non-agricultural advances they were free to charge any rates at their

discretion. Although the main aim of the co-operative bank is to provide cheaper

credit to their members and not to maximize profits, they may access the money

market to improve their income so as to remain viable.

PRUDENTIAL NORMS AND ASSETS-LIABILITY

MANAGEMENT GUILDLINES FOR UCBS.

The reserve bank continued with its efforts to enhance the financial health of

UCBs. In pursuance, certain policy changes were made in regard to prudential

norms on capital adequacy, income recognition, Assets classification and

provisioning in respect of UCBs.Capital adequacy requirement for UCBs are at

present lower then those prescribed for commercial banks. By March 31st, 2005

UCBs. Would have to fall in line with the discipline applicable to commercial

banks. Accordingly, they are required to adhere to capital adequacy standards in

a phased manner over a period of three years.

CRAR ratio For UCBs.

AS ON 31ST MARCH CRAR FOR

SCHEDULED UCBS

CR A R FOR NON -

SCHEDULED UCBS

CRAR FOR

COMMERCIAL

BANKS

2002 8 6 9

2003 9 7 9

2004 As applicable to

commercial bank

9 9

2005 As applicable to

commercial bank

As applicable to

commercial bank

2006 As applicable to

commercial bank

As applicable to

commercial bank

EXTENTION OF 90 DAYS NPA NORMS

RBI has been tightening prudential norms in line with the best international

practices in recent years. Accordingly, to ensure greater transparency, the time

period for reckoning as advance as non performing would be reduced from the

existing 180 days to 90 days with effect from March 31st, 2004. In this connection

banks were instructed to move over to charging of interest at monthly rates, with

effect from April 1, 2002.However, “gold” loans and “small” loans up to Rs.

100000 will continue to be covered by the 180 days norms for recognitions of

loan impairment.

LICENSING OF NEW BANKS

The number of UCBs has been rising rapidly recent years. The RBI has

constituted a screening committee of eminent external exports to examine not

only the background and credentials of promoters but also to consider but also

considering the environment / business projections submitted by the promoters

and other factors influencing the viability of the proposed bank. During the year

under review, the committee considered 90 proposals for the organization of the

new banks, and granted “in principle” approval in two cased. In addition, 22

proposals were closed, as the promoters of the proposed banks failed to comply

with the stipulated eligibility requirements. During the period under review, 131

licenses were issued for opening new branches.

WEAK BANKS

Based on new classification, the number of UCBs classifies under the class II / III

/ IV category as on March 31st, 2003 stood at 944. During the period under

review 142 weak banks could not comply with the stipulated minimum capital

requirements.

CHALLENGES FACED BY UCBs.

After a relatively fast growth during the priod,1993 to 1999 the sector saw a

substantial number of new urban co-operative banks coming up and growth rate

of the banks being consistently higher than the all India average for all banks,

the period of the year 2000-2001 till now has been that of sluggish growth and

difficulties for the sector. The share of urban banks in terms of resources grew

from around 4% in 1993-1994 to over (% in 2001-2002. The size of a large of

2000 strong urban banks also grew at a fast pace during this period. However,

involvement of one of the largest urban co-operative banks in Gujarat in the stock

market scam of 2001 sent stock waves in the entire urban co-operative banking

sector and affected the sector’s public image very badly. Since a very large

number of smaller urban banks in Gujarat were having deposits with

Madhaupura Mercantile Co-operative bank (MMCB), which got involved in the

scam, the public confidence, which had come down very badly, has not been

restored till date. Similarly during these times there were some problems in a few

banks in Maharashtra on account of bad management. The responses of the

regulators have been by way of imposition of further stringent norms and rules in

order for them to be on par with those applied to commercial bank.

In the back drop of the developments that have taken place in the urban co-

operative banking sector during the last 4-5 years, the following could be

identified as main challenges to the sector in the coming years.

STRENTENING THE PUBLIC IMAGE

Among all the section of banking industry urban co-operative banks constitute

the largest section in terms of number of institutions. They also constitute the

most unevenly distributed group among all section of the banking industry. Out of

over 2000 urban co-operative banks in the country, over 70% are concentrated in

three states of Maharashtra, Gujarat and Karnataka. Their compositions in terms

of size also vary vastly. While there are banks with over Rs.2000 Corore

deposits, a sizable number of banks are most advanced and technologically

being members of RTGS etc., a large number of them are in the initial stages of

computerization. Even the management styles, levels of professionalisation and

competence levels of staff also vary form bank to bank.

Urban co-operative banks in any town are typically promoted by prominent

members of the society there. They are usually businessman, traders,

landowners, teachers, lawyers, social workers etc., and while in small places, the

reputation of the bank generally is in keeping with the standing of the promoters

and the board members. And the society in that area, in larger cities the

members and the clients look at the banks and assess them largely on their

public image by focusing on two factors.

o Ensuring that the board members are persons of integrity and of good

standing in the society who have fair understanding of banking systems.

o Following principals of take adventurous decision to grow at a faster pace

than others.

While these are internal factors that are within the competence of the bank, there

are certain aspects on which it would not have much control but they would

nevertheless have important bearing on the public image of the bank. If there are

a number of urban co-operative banks in town, it has been observed that any

problem with one bank has a contagion effect on other banks also,

notwithstanding the fact that these other banks, Bering a few are not large

enough to have a brand name and an identity by which general public could

distinguish one from the other while taking decision on whether to keep moneys

in a particular bank or not .Today, the publics perception is that deposits with

only public sector banks are safe and that there is always an element of risk

involved when the deposits are with either smaller private sector banks or with

the co-operative banks, while it is not easy to change this perception, much can

be done by the urban co-operative banks by adhering strictly to the prudential

norms and following the disclosure requirements so that the depositors have

access to the true state of health of the bank. Following the disclosure norms

become easy if the banks has no weakness to hide. A very striking difference

between a co-operative bank and a commercial bank is the involvement of the

co-operative bank in social activities of the area of its operation. There are a

large number of well managed and sound co-operative banks who are involved in

many socially relevant activities in the field of health, education and at the time of

emergencies like natural calamities. These activities improve the image and

esteem of the bank in the eyes of the local citizens.

MANGING THE GROWTH

It is possible to mange a small size bank with common sense and sincerity.

However, it requires professional approach and specialized financial knowledge

to mange a financial institution that is growing a very fast clip. It has been

observed that many of the urban co-operative banks which were in the range of

25-50 crores deposits have within a span of five years grown to banks with 300-

500 crores deposits. This phenomenal growth brings in its wake enormous

challenges. The board of directors, however well meaning they might be find it

very difficult to run the bank unless they are supported by professionals. The

challenge before the board would be to put a professional management team in

place and also to be able to work with that team, so that the synergies of the

board members in the form of the local feel and knowledge about the area in

which the bank operating is complimented with professional and technical

knowledge of the management team to get the best result for the bank. This

scenario would necessitate the board to drastically change its style of

functioning, introduce formal systems of accountability and also familiarize with

the management information systems. To bring about this change, there should

be complete willingness on the part of the board members to work hard towards

it.

Managing growth also involves constant efforts to look out for changes in

business profiles to maximize the return out of the growth and at the same time

to keep the risk management aspect in mind.

As the urban co-operative banks like any other institution in the co-operative

sector are democratic organizations, there is always involvement of local leaders

who invariably owe allegiance to one political party or the other. The challenge

before the urban co-operative banks is to utilize the strength of political

connections or allegiance of its members/promoters/directors to the benefit of the

institution rather than its detriment as it has often been observed in the history of

co-operative banks. These co-operative leaders must firmly put the interest of the

banks above any political consideration so that health of co-operative banks is in

way compromised. To elaborate, people in public life generally tend to oblige

others, and if this tendency is carried to the board room of the bank, the

institution could be put into difficulties on account of unprofessional decision.

REGULAATION OF COMMUNITY BASED FINACIAL

INSTITUTION

This subject perhaps constitutes the most formidable challenge to the regulators,

the stockholders and the government. In setting out to meet the challenge of

regulating community based institutions like urban, co-operative banks, one must

first Cleary perceive institutions to be different from the commercial banks for the

simple reasons that the client base of co-operative banks is different from the

commercial banks. Commercial banks have the reach, the middle class and the

small section of the lower middle class as their depositors, large and medium

industries, SSIs, exporters and traders as their borrows, while the co-operative

banks have only the middle and lower middle class and weaker section as their

depositors and their borrowers. While commercial banks are speared over entire

geographical region with branches in large metros, town as well as villages, A

very large number of co-operative banks have their branches confine to a single

town, which may be a small urban area or Sámi rural place. The commercial

banks collect deposits from various centers to deploy them at other centers. The

urban co-operative banks usually deploy funds collected form one place for the

benefit of borrowers in that place only. While the commercial banks on account of

their resources and technology are in the position to offer a wide range of

services to their clients, the urban co-operative banks on the other hand by and

large, can offer only limited service to their customers.

In view of this significant difference in the working of co-operative banks ands

that of commercial banks, a uniform prescription of norms, particularly the

application of prudential norms will not yield the desire results. In the last 3 years

no worth while attempt has been made to define the role of urban co-operative

banks as a sections of community based banking systems, to ascertains in

details the impact of these banks in states where they are well establishes, the

need or otherwise for promoting such institutions in other states, and above all to

develop a system of regulation and supervision that will bring the best out of the

urban co-operative banks. This is a real challenge before the regulators. They

must recognize this challenge and work upon it. If the regulators continue to what

they have been ding during the last few years, and only concentrate on

imposition of norms that are not attainable by almost half of the total number of

urban co-operative banks, they would only be succeeding only in presiding over

closure of large number of them every year.

SURAT PEOPLE’S CO-OPERATIVE BANK LTD

With the advent of 20th century, co-operative movement gathering momentum in

our country. In the early years of the century, there were only a few banks ran by

solely profit conscious foreign managements, absolutely unmindful of their social

obligation. Further there was also widespread economics exploitation of the

common man in general and of socially and economically weaker sections of the

society in particular by the money lenders who were lending money to them at

exorbitant rates of interest with stringent conditions subjected them to crushing

indebtedness. In such a socio-economic at the time, co-operative banks were

looked upon to play a vital role.

Inspired by the exhortation of late autorothfield, the then register of co-

operatives, Bombay province, that a large number of co-operative banks should

be established to cater to the banking needs of the common man, late

REVSAHEB VRUNDAVANDAS JADAV, A VISIONARY dreamt of establishing

a co-operative bank. this, dream of his turned into reality when he, ably aided by

late CHUNILAL SAPAIYA, a seasoned banker founded a co-operative bank in

the name and style of “ The Surat People's Co-operative Bank Ltd’’.in the year

1922 at SURAT . To be precise, it was registered on 10th march, 1922 and

started functioning with effect from 22nd April, 1922. It enjoys the distinction of

being the “first urban co-operative bank of India’’. The Surat People's Co-

operative Bank Ltd was popularly known as JADAVSAHEB’S BANK, reason

being that one or the other of the four member of Jadav family were associated

with it in some way or other during a span of six decades. Late REVSAHEB

VRUNDAVANDAS JADAV, apart from being the founder of the bank, was also its

managing director since its inception till the year 1955. Late TAKOREBHAI

brother of REVSAHEB JADAV was honorary secretary and manager of the bank

since its inception till the year 1950.Whereas late SUDHIRBHAI JADAV, son of

late REVSAHEB JADAV , was the Managing Director of the bank form the year

1961 to 1985. After his retirement form the bank’s service, he was on BOARD

OF DIRECTORS of the bank for one year.

Progressively marching ahead THE SURAT PEOPLE’S CO-OPERATIVE BANK

acquired the status of 'Scheduled Bank' on 1st September, 1988. The bank has

been catering to the needs of small entrepreneurs, artisans, professionals, and

weaker section of the society to become a co-operative bank in letter and spirit.

Over the year, the SPCBL has set its eyes on strategic planning for the future in

order to arm itself to face competition in wake of sea change that the banking

industry has been witnessing on account of policy of liberalization of economy.

ORGANISATION STRUCTURE

There are two AGMs in the bank. Under each AGM there is one Executive.

Under executive there are three managers, similarly under managers there are

two officers and there are three clerks.

President

Asst. General Manager

Director

Manager

Deputy General Manager

General Manager

Vice Director

Officers

Clerks

OBJECT OF THE BANKS:

The objects of the bank are as under:

To encourage thrift and mutual co-operative among its members.

To create funds to be lent at moderate rate of interest to the members of

the banks in accordance with procedure specified in bye laws.

To give possible help and necessary guidance to traders who are

members of the banks, in the conduct of their business.

To do HUNDI business

To lend money on security to member.

With previous permission of the registrar, to purchase any property for the

business of or for the use of bank to construct it or to make suitable

alterations as may be necessary and to maintain the same.

To perform any function as may be deemed lawful for the bank and that as

the central Government or State Government may direct.

To do every kind of trust and agency business and particularly do the work

of investment of funds, sale of properties and of recovery or acceptance of

money.

To undertake the management of trusts and for that purpose to accept any

office of trustees executors or any office to perform duties of such a

confidential nature either independently or jointly with some other person

as the Bord deems its.

To undertake every kind of banking and sharafi business and also to

undertake of giving guarantee and letter credit on behalf of members.

STRENGTHS

The bank was the first “ First Registered Urban Co-operative Bank” of

India

Among the first 13 Co-operative Bank to get the “Scheduled Bank”

Status.

The bank introduced "Total Branch Automation" in the 1992-93.

Presently, all the branches are computerized.

Bank has started its own “Training Centre” to provide training to the

employees of other co-operative banks since 1995-96.

The first Bank to provide the "Depository Participant Services" in South

Gujarat.

The Bank with "A" Rank.

The Bank has implemented “Tele Banking Facility” and “view Account

Terminal” [VAT] facility at all branches for providing better customer

service.

PAST PERFORMANCE

Financial Position As on 31-3-2006

Detail Amount In Rs.

Authorized Share Capital

25,00,00,000.00

Paid up Share Capital

16,44,64,100.00

Reserve Fund 54,17,29,574.75

Other Reserves and Funds

179,44,28,238.25

Deposits 720,16,49,931.56

Advances 359,13,32,357.81

Investments 449,74,69,866.70

Working Capital 1009,66,95,577.50

Net Profited 9,75,12,937.42Net Non Performing

Assets0.00

Audit Class "A"

NUMBERS OF MEMBERS

Total Numbers have increased by 20% since 2001

PAID UP SHARE CAPITAL

Paid up Share capital has increased by nearly 60% since 2001

1 2 3 4 5 60

10000

20000

30000

40000

50000

60000

70000

2001 2002 2003 2004 2005 2006

50,523 53,687 55,979 57,470 58,158 59,369

Year

No

. O

f M

emb

ers

1 2 3 4 5 6 70

20000000400000006000000080000000

100000000120000000140000000160000000180000000

Year

Pa

id U

p S

ha

re C

ap

ita

l

RESERVE FUND

Reserved Fund has increased by nearly 42% since 2001

DEPOSITS

Deposits have increased by approximately 25% over 4 years since

2001

1 2 3 4 5 6 70

100000000

200000000

300000000

400000000

500000000

600000000

Year

Re

se

rve

d F

un

d

1 2 3 4 5 60

10000000002000000000300000000040000000005000000000600000000070000000008000000000

Year

De

po

sit

s

ADVANCES

Advances have increased by nearly 22% since 2001

The above charts and analysis shows the overall positive growth of the Surat

People’s Co-operative Bank.

1 2 3 4 5 60

500000000

1000000000

1500000000

2000000000

2500000000

3000000000

3500000000

4000000000

Year

Ad

va

nc

es

AWARDS

As per @1st Annual Report (1996-97) of NAFCUB - New Delhi. The Bank

was awarded rank as under for :

                                                                    Net Profit : 6th

                                                                    Deposits   : 8th

                                                                    Advances : 9th

 Bank achieved the coveted "Award of Excellence"   from NAFCUB,

New Delhi at their 8th all India      conference of Urban Co-operative

Banks & Credits Societies.

Surat Jilla Sahakari Sangh declared our bank as the best "Urban Co-

operative Bank” for the year 1999-2000 in Surat district.

The bank with "A" Rank.

SERVICES

Safe Deposit Lockers:

We are offering you safe deposit lockers for safety of your valuable

things like gold, silver, hard cash, diamonds, important documents. We offer our

customer safe deposit vault or locker at a large no of branches. There is a

nominal annual charge which depends on the size of lockers. Basically use of

lockers is to make your most valuable thing secure.

Your family is going out of station, or there 2 to 3 family member at your home

so at that there is fear of thief , and even for make your self tension free you

should go for safe deposit lockers. and this all things when ever you want back

you can take back instantly from bank and again if your purpose will be solve

again you can give it back.

VAT (View Account Terminal) Services

You can easily have information about your account. You

can come to know account status like balance, latest transaction,

using just touch screen. VAT machine is available at our all branches.

Letter of Credit Service:

Document, consisting of specific instructions by a

buyer of goods, that is issued by a bank to the seller who is authorized to draw a

specified sum of money under certain conditions, i.e., the receipt by the bank of

certain documents within a given time. An irrevocable L/C provides guarantee by

the issuing bank in the event that all terms and conditions are met by the buyer

(or drawee). A revocable L/C can be canceled or altered by the drawee after it

has been issued by drawee's bank.

SMS banking Services :

We are providing tele banking service at our all the branches. Using SMS

banking you can have current information about your status of account. Like

balance of your account in English and gujrati language both. Even you can

come to know status about all kinds of account. Like (Current account, Savings

account, Loan Account, Overdraft). Even, we are giving facility of tale fax also.

So you can have your account statement on your fax.

Fund Transfer

In this facility, Bank gives facility of fund transfer of fund transfer between two

different branches. Bank provides this service at free charges. In this facility

customer has account in one branch of the bank, and he wants that money in

other branch of the bank then customer can get his/her money form other branch

without any risk or charges. It is not necessary customer has also account in

other branch but that branch where he deposited money; he has account in that

branch.

ATM

In these facilities, Bank provides a service to customer of fastest transaction

in account. It is 24 hour services. Whenever customer require to withdraw

money form his account in off time of bank, customer can easily withdraw

money form their account, Even customer can easily get information about his

account like, account balace,statement of last 5 to 6 transaction. In SPCBL,

among 19 branches this service is providing in 9 branches.

Pay Order Service:

Pay order is most secure way to make payment to your party. Pay order can be

make of your party's name. And it is best proof that you made a payment of this

amount and on this date. So, instead of giving cheque you can make pay order

from bank and bank will make a payment from your account. There is no charge

of pay order. It is absolutely free service.

Demand Draft

Demand Draft is a less expensive way for remitters to transfer money to your

party's account.

People's bank draft is a law-cost, convenient method of making non-urgent

payments.

Bank will charge you only Rs. 20/- to make Demand draft of any amount

VISION 2010

Home banking,

Any Window concept

Inter branches connectivity [Branchless banking]

Global banking facility through interest banking

Bank’s presence in metros

No.1 UBRAN Co-Operative BANK for business and profit per employee

Patronage for development of Surat city.

Introduction of full fledged specialized branch viz. foreign exchange,

agriculture advances & industries advances.

Functioning as merchant banker.

Technically qualified staff to meet challenges of high tech banking.

PRODUCTS

A demand draft is more secure than a normal cheque as it can only be credited

to a specific payee's account, and a customer can only be reimbursed under

indemnity if the cheque is lost or stolen. It is secure and safe. It offers a

convenient way to settle your trade business when documentation is required.

DEPOSITS:

1. Current Account

2. Savings Account

3. Recurring Deposits

4. Fixed Deposits

5. Cash Certificate

6. Vashudhara Pension Plan

7. Monthly Income Plan

8. Vashudhara Deposit

LOANS:

1. Vashudhara Awas Yojna (Home Loan)

2. Personal Loan

3. Loan for Self Employed and Professionals

4. Business or Industrial Loan

5. Consumer Loan

6. Vehicle Loan

- For Personal Vehicle (two Wheeler/Car Loan)

- For Commercial Loan – Vehicle using for commercial purpose.

7. Education Loan

8. Loan against N.S.C./K.V.P./ Gov. Security/ L.I.C. Policy

9. Mortgage Loan

10.Technology Up gradation Fund

Social Contribution

In this global jubilee years-

The SPCP Memorable Trust with a fund of Rs 10 lakh was farmed in its

golden jubilee year.

Fund stands at Rs.2.60 crror on 31st march 2001

Trust donates from its interest incomes to various instantiations engaged

in –Social education & Medical services.

DONATIONS

Bank, too, donates. Form its charity funds to various institutions.

Bank’s civic contribution Swami Vivekananda Traffic, Island at makkai

pool, Nanpura, Surat.

Surat People’s bank senate Hall at VNSGU, Surat.

Surat people’s bank English Medium College Of Commerce Surat.

Surat P.B.Mahavir C.T.Scan Centers Surat.

Benefits for share holders

Insurance cover of Rs. 1 lakh 2 share holder in case death by accidents.

Awards to children of shareholders on achievements of examinations.

Purpose of Study

We know that the basic function of bank is to accepting deposits for purpose

deposits for the purpose of lending and to make investments. It involves the

pricing mechanism to sustain in the market and to enhance the value creation for

shareholders and deposit holders of bank. In fact there is keen competition in

banking after the introduction of economic reforms lending to liberalization of

financial and banking sector. The changes that had taken place in the operational

side of banking in the form of diversification of products/services, free to choose

products/market segments, emphasis on customer service adoption of

sophisticated technology etc.

So we have to accept that now a day’s scenario of banking is changed and

bankers are forced to come the edge of their seats rather than sit easily and do

the business. They have to keeping keen eye on each and every movement of

market, industry, economy and politics. Main thing for bankers to manage the

bank’s assets and liabilities in order to maintain both liquidity and profitability.

ALM is the main and most important tools for banks management. An effective

ALM implementation makes the banker more alert in managing the assets and

liabilities by considering their respective maturity profiles to take necessary

initiatives. We all know that now a day’s co-operative banking sector is passing

through crucial stage and for that main responsible factor is mis-management of

their Assets-liability. So as a member of co-operative banking family I have tried

my best to Focus on the most important subject and that is Assets and Liability

Management.

OVERVIEW ON ALM

Banking is the business which deals mainly with other people’s money by way of

mobilizing deposits and deployment of funds through lending and investment.

Increasing the “spread” is an important object and out of which the bank has to

cover the Cost of Management (COM) and Risk Cost (RC) to earn net profit. It

increases the loan and investment portfolio, the liquidity will be affected and as

against this, if the high degree of liquidity is maintained the profitability may be

deteriorate. Therefore the position of a banker is between the “Devil and Deep

Sea” and it becomes crucial task of managing funds effectively. The bank must

give weight to the principals of safety, liquidity and profitability while managing its

affairs of business, therefore fund management is crucial task for banking

industry and ALM is main tool of fund management.

The deregulation and globalization of economy has changed the canvas

significantly. These changes led to major transformation in both the

administrative and operational side of the banking. These developments have

resulted in tough competition and more risk. The banks are moving towards

designing new innovative financial products/services to attract more and more

customers and moving in new direction along with their conventional banking. In

this backdrop, the status of co-operative banks is crucial and it is a big struggle

for them to retain their existence in the industry. They have to be

professionalized in their functions and operations especially in field of fund

management by adopting some standard tools and techniques like ALM. ALM is

a technique available for the bankers to manage the bank’s assets liability order

to maintain both liquidity and spread on the basis of their respective maturity

period.

Considering the fact that the deregulated environment has brought the bank on

the subtle line of leeway where any error may prove to be very fatal and the fact

that it very to err. Assets and Liabilities management has to be foreseen as a

most vital component of banking industry and management.

DEFINATION AND MEAMING OF ALM

Assets

Items having realizable value owned by the business are known as assets.

Assets owned by the business are known as business assets. Cash, land,

building, machinery, stock, furniture, goodwill, patent, copyright, trademark,

etc.are included in assets.

Assets are classified into three types

Fixed assets,

Current assets,

Fictitious assets

Liability

Any amount payable by the business to any outsiders is known as liability. By

credit purchase of goods, the amount becomes payable or liability is created.

Sometimes, liability is also created by borrowing funds.

There are two types of liabilities

Current liability

Long-term liability

Assets and liabilities, for not only facing the challenges ahead but also for

improving its bottom lines and thereby to improve the net worth of the bank. The

technique of mangeing assts and liabilities together know as Assets Liability

management (ALM) Through ALM banks not only equip themselves to price their

assets and liabilities at appropriate levels by also manage the related risks too.

Eventually role of the banks form mere deposit takers and distribute through

asset liability management in the coming years

Assets Liability Management

Asset-Liability Management has been defined as a continuous process planning,

organizing, and controlling Asset and Liability volumes, maturities, rates and

yields. In the present Environment it is defined as process of adjusting bank

liabilities to meet loan demands, liquidity needs and safety requirements. To put

it simply, assets-liability management is the management of total balance-sheet

dynamics with regard to its size and quality. It involves

Quantification of risk and

Conscious decision making with regard to assets-liability structure in order

to maximize interest earning within framework of perceived risk.

In other words ALM can be defined as the process of managing the net interest

margin (NIM) within the overall risk bearing capacity of a bank. Thus it calls for

an integrated approach towards financial management conditioned to

simultaneous decision making with regard to types and size of financial assets

and liabilities, their mix and volumes so as to insulate the spread from adverse

direction. Thus, the secret of successful banking under deregulated and

competitive environment hinges on matching of assets and liabilities in terms of

rate and maturity with a view to obtaining optimum yield.

In other way we said Assets liability management has been organizing and

controlling asset and liability volumes, maturities, rates and yields. Simply put,

assets liability management (ALM) is a tool that enables bank management, to

take business decision in a more informed framework. The ALM function informs

the manager what the current market risk profile of the bank is and the impact

that various alternative business decision would have on the future risk profile.

The manger can then choose the best course of action depending on his bord’s

risk appetite. Consider for example, a situation where the chief of bank’s retail

deposit mobilization function wants to know the kind of deposits that the

branches should be told to encourage. To answer this question correctly he

would need to know inter alia the exiting cash flow profile of the bank. Let us

assume that the structure of the existing assets and liabilities of the bank are

such that at the aggregate the maturity of assets is longer than maturity of

liabilities. This would expose the bank interest rates risk [if interest rates were to

increase it would adversely affect the banks net interest income] In order to

reduce the risk the bank would have to either reduce the average maturity of its

assets perhaps by decreasing its holding of Government securities or decrease

the average maturity of its assets, perhaps by reducing its dependence on call

money market funds. Thus, give the above information on the exiting risk profile

of the bank, the retail deposits chief knows that the bank can reduce its future

risk by marketing its long-term deposits products more aggressively. If necessary

he may offer increased rates on long-term deposits and or decreasing rates on

the shorter term deposits.

The above example illustrates how correct business decision making can be

added by the interest rate risk related information. The real world of banking is of

course more complicated. The risk related information is just one of many pieces

of information required by a manger to take decision. In the above example itself

the retail deposits chief would also have considered a host of other factors like

competitive pressures, demand and supply factors, impact of the decision on the

banks retail lending products, ECT before taking a final decision. The important

thing; however is that ALM is a tool that encourages business decision making in

a more disciplined framework with an eye on the risk that the bank is exposed to

ALM is thus a comprehensive and dynamic framework for measuring, monitoring

and managing the market risk, i.e., Liquidity interest and exchange rate risk of a

bank. It has to be closely integrated with the bank’s business strategy as this

affects the future risk profile of the bank. This framework needs to be built around

a foundation of sound methodology and human and technology infrastructure. It

has to be supported by the bord’s risk philosophy, which clearly specifies the risk

policies and tolerance limits.

OBJECTIVES OF ALM IN THE BANK

Main objectives of the ALM are:

1. To Protect / enhance the market value of the net worth

2. To increase the net interest income

3. To maintain / protect spreads or Net Interest Margin

The primary objective of the asset-liability management is not to eliminate risk,

but to manage it in such a way that the volatility of net interest income is

minimized in the short-term horizon. Broadly the objectives would include

controlling the volatility of net income, net interest margin, capital adequacy, and

liquidity risk and finally ensuring an acceptable balance between profitability,

growth and risk. In other words, the ultimate objective of ALM is profitability and

long term operating viability of the organization in risky environment.

Scope of ALM

A sound ALM should focus on

1. Review of interest rate outlook.

2. Fixation of interest / product pricing on both assets and liabilities.

3. Examining loan portfolio.

4. Examining investment portfolio.

5. Measuring foreign exchange risk.

6. Managing liquidity risk.

7. Review of actual performance vis-à-vis projections in respect of net profit,

interest spread and other balance sheet ratios.

8. Budgeting and strategic planning.

9. Examining the profitability of new products.

10.Review of transfer pricing

RBI GUIDELINES ON ASSETS LIABILITY MANAGEMENT

RBI had issued guidelines in February 1999 for putting in place Assets Liability

Management System in banks. These guidelines where issued for managing

liquidity risk, interest rate risk and currency risk. Banks were asked to set up an

internal assets liability committee (ALCO) headed by chief executive office / CMD

or the executive director. The managing committee of the board was also to

oversee the implementation of the system and also to review periodically.

Keeping in view the level of computerization and MIS system in banks adoption

of uniform Assets Liability Management System for all banks was considered not

to be feasible. To begin with, banks were directed to endeavor to cover at least

60% of the asset and liabilities for analysis and were required to set target for

coverage of 100% data by April 2000.

As banks are aware, interest rate risk is the risk where changes in market

interest rates might adversely affect a bank’s financial condition. The immediate

impact of changes in interest rates is on bank’s earnings (i.e. reported profits)

through changes in its Net Interest Income (NII). A long-term impact of changes

in interest rates is on bank’s Market Value of Equity (MVE) or Net Worth through

changes in the economic value of its assets, liabilities and off-balance sheet

positions. The interest rate risk, when viewed from these two perspectives, is

known as ‘earnings perspective’ and ‘economic value’ perspective,

respectively.

The present guidelines to banks approach interest rate risk measurement from

the ‘earnings perspective’ using the traditional Gap Analysis (TGA). To

begin with, the TGA was considered as a suitable method to measure Interest

Rate Risk. Reserve Bank had also indicated then its intention to move over to

modern techniques of Interest Rate Risk measurement like Duration Gap

Analysis (DGA), Simulation and Value at Risk over time, when banks acquire

sufficient expertise and sophistication in acquiring and handling MIS.

Reserve Bank had advised banks on June 24, 2004 to assign explicit capital

charge for interest rate risk in the trading book applying the standardized duration

gap approach advocated by the Basel Committee on Banking Supervision. Since

banks have gained considerable experience in implementation of the TGA and

also become familiar with the application of the DGA to their trading books, it is

felt that this would be an opportune time for banks to graduate to the Duration

Gap Analysis for management of Interest Rate Risk in its entirety. With this

move, banks would fully migrate to application of the ‘economic value

perspective’ to interest rate risk management.

The salient features of the draft guidelines furnished in the

. Banks shall adopt the DGA for interest rate risk management in addition to the

TGA followed presently.

The proposed framework, both DGA and TGA, will be applied to all

assets, liabilities and off balance sheet items of the bank.

Keeping in view the level of computerization and the current MIS in banks,

adoption of a uniform ALM System for all banks may not be feasible. The

proposed guidelines have been formulated to serve as a benchmark for

banks. Banks which have already adopted more sophisticated systems

may continue their existing systems but they should fine-tune their current

information and reporting system so as to be in line with the ALM System

suggested in the Guidelines.

Banks should adopt the modified duration gap approach while applying

the DGA to measure interest rate risk in their balance sheet from the

economic value perspective. In view of the evolving state of

computerization and MIS in banks, a simplified framework has been

suggested, which allows banks to

o group assets and liabilities under the broad heads indicated in

Appendix I under various time buckets; and

o compute bucket-wise Modified Duration of these groups of assets/

liabilities using the suggested common maturity, coupon and yield

parameters;

Reserve Bank is aware that measurement of interest rate risk with the

above approximations does not reflect the true level of risk and hence

would expect banks to migrate over time to application of the modified

duration approach to each item of asset/ liability/ off-balance sheet item

instead of applying it at the ‘group’ level. However, banks with the

necessary IT support, MIS and skill capabilities may straightaway

implement the more granular DGA by computing the Modified Duration of

each item of asset, liability and off-balance sheet item.

Each bank should set appropriate internal limits for interest rate risk based

on its risk bearing and risk management capacity, with the prior approval

of its Board / Risk Management Committee of the Board.

Banks should compute the volatility of earnings (in terms of impact on Net

Interest Income) and volatility of equity (in terms of impact on it –book

value of net worth) under various interest rate scenarios.

Banks should adopt a more granular approach to measurement of liquidity

risk by splitting the first time bucket (1-14 days as at present) in the

Statement of Structural Liquidity by dividing into two buckets viz. 1-7 days

and 8-14 days. In addition to the existing prudential limits operating for the

1-14 days bucket and the 15-28 days bucket, the negative mismatch

during the 1-7 days bucket should not exceed 20% of the cash outflows in

that bucket. The frequency of supervisory reporting of the Structural

Liquidity position shall be fortnightly instead of monthly, as at present.

While determining the likely cash inflow / outflows, banks have to make a

number of assumptions according to their assets liability profile. Indian banks

with large branch network can (on the stability of their deposit base as most

deposits are rolled over) afford to have large tolerance level in mismatch in

the long term if their term deposits base is quite high. While determining

tolerance level the banks may take into account all relevant factors based on

their assets liability base, nature of business, future strategy, etc.

NEED FOR IMPLEMENTING ALM SYSTEM IN

CO.OPERATIVE BANKS.

Banking industry in India has undergone many changes, By the introduction of

banking sector reforms, deregulation of interest rates, and competition in the

industry focus on customer relationship ect. The co-operative banks woke up and

started evolving strategies and practices to make sure of their presence. The

changes and development that took place in the industry’s business practice

specially the field of fund management. Some initiatives were necessary to

improve further. Co-operative banks should not be exempted form such

developments and in fact it is essential for them to proceed on the professional

way with the objective of widening the interest spread. The co-operative banks

began to modify their resource pool particularly the deposit mix by accepting

more short term deposits to reduce the cost of funds and finally the short term

liabilities are the higher side then long term liabilities. This situation has caused

for the mis-matches in two ways:

Maturity mis match between assets and liabilities, and

Interest rate mis match between interest rate sensitive assets and interest

sensitive liabilities. The second factor gets direct impact on profitability.

The co-operative having local footing with strong membership base and at the

same time they have provided the required level of service to their members.

Therefore to gain the member confidence, as they are the investors, it is the duty

of co-operative banks to maintain sufficient liquidity by honoring their demands in

time. As a business proposition the co-operative banks also has to earn some

profit to meet other cost such as establishment cost and risk cost. With the

improved lines of business and diversified landing and investment portfolio in big

way, the co-operative banks are going to bear the impact of risk to greater extent

in the forth-coming days. Therefore the co-operative banks must evolve a

suitable ALM system as suggested by RBL (Based committee on banking

supervision) to their funds management practices. Implementing a suitable ALM

mechanism in co-operative banks provide the scope for exercising selective

control on assets and liabilities and also offer the following benefits.

Striking a right balance between liquidly and profitability.

Analyzing both the time and rate sensitivity of assets and liabilities.

Supplying adequate data input to the budgeting and decision making

process of bank especially in the re-alignment of Assets Liability

composition.

Leveling of funds in the long-run perspective by identifying the

surplus/deficit at regular intervals.

Reducing interest rate risk (IRR) and liquidity risk (LR).

The very nature of the banking business is incurring risk to earn profit. The risk

factor is inherent in the banking business. The risks encountered by the banks

are as under:-

Liquidity Risk

Interest Rate Risk

Credit Risk

Market Risk

Capital Risk

Commercial Risk

Price Risk

Operational Risk

Solvency Risk

Exchange Rate Risk

Political Risk

Human Risk

Technology Risk

Legal Risk

ALM SYSTEM

The frame work of Assets Liability management in bank generally includes their

main divisions Viz. Information system process and committee which is illustrated

in the Figure – 1. The information system is the basic requirement for the ALM

technique, as the continuous supply of adequate data and information is always

needed.

The ALM process is an analytical framework, which enables to study the

dimensions of assets and liabilities and also to find liquidity and sensitivity

gaps. The ALM process gives weight to the following five elements.

o Risk Parameters.

o Risk Identification.

o Risk Measurement.

o Risk management.

o Risk Policies and Tolerance Level.

Third segment of ALM is the ALM committee (ALCO), which is responsible for

the successful implementation of system. The structure of the committee and the

level of Top management involvement should be well defined to excise proper

control over the whole system.

HOW TO WORK ALM

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

1

2

3

4

ALM MIS ALM PROCESS ALCO ---------------------------------- ------------------------------------------ ----------------------

o ISM Interest Spread Management.o LGM Liquidity Gap Managemento IRRM Interest Rate Risk Management

1. Developing implementation and managing annual budget.2. Review of reports and monitoring the performance.3. Risk management program.4. Management reporting.

ALM INFORMATION SYSYEM (ALMMIS)

SELECTEDBRANCH

MONEYMARKET

Ho

A

L

C

O

DATABANK

ISM LGM IRRM

The implementation of ALM system necessitates the banks to conceive a

suitable management information system. The ALMMIS must ensure the

availability, accuracy, adequacy and expediency of information. The head office

should collect required data in a structural format and other information at a

regular interval from benches and it should be centralized into a databank. The

data must be accessible to make it easily available to suit the requirements of

ALM committee (ALCO)

The nature of data required is normally in the form of maturity wise pattern of

various assets and liabilities, into various time bands, needs some bases and this

process can be done through the past experience of bank. In these regard the

bank may collect information relating to the behaviors and maturity pattern of

deposits and advances form selected branches who contribute mainly to the

volume of business. This data collection serves the bank to make some rational

assumption for GAP analysis and report preparation. Reliable and authentic

information should also be collected from the money market. Therefore the MIS

must ensure the supply of timely adequate and accurate data and information

through reports collected from various terminals in order to make the ALM more

effective.

The problem of ALM needs to be addressed by following on ABC approach i.e.

analyzing the behavior of assets and liability products in the top branches

accounting for significant business and then making rational assumption about

the way in which assets and liabilities would behave in other branches. In respect

of foreign exchange investment functions it would be much easier to collect

reliable information. The data and assumptions can be refined over time as the

bank management gain experience of conduction business within an ALM

framework. The spread of computerization will also help banks in accessing data.

ALM ORGANIZATION (ALM COMMITTEE)

Successful implementation of the risk management process would require strong

commitment on the part of their boards and senior management. The board

should have overall responsibility for management of risks and should decide the

risk management policy and procedures, set prudential limits, auditing, reporting

and review mechanism in respect of liquidity rate and forex risks.

The Asset-Liability Committee (ALCO) consisting of bank’s senior management

including CEO should be responsible for deciding the business strategy [on the

assets and liabilities sides] in line with the bank’s business and risk management

objectives.

The ALM desk consisting of operating staff should be responsibilities for

analyzing, monitoring and reporting the risk profiles to the risk profile to the

ALCO. The staff should also prefer forecasts [simulation] showing the effects of

various possible changes in market conditions related to the balance sheet and

recommend the action to adhere to bank’s internal limits.

The ALCO is decision making unit responsible for balance sheet planning from

risk-return perspective including the strategic management of liquidity, interest

rate and forex risks. The business and risk management strategy of the bank

should ensure that the bank operates within the limits/parameters set by the

board. The business issues that an ALCO considers, inter alia, includes pricing of

both deposits and advances, desired maturity profile and mix of incremental

assets and liabilities etc. in addition to monitoring the risk levels of the bank, the

ALCO should review the result of and progress in implementation of the decision

made in the previous meeting. The ALCO’s future business strategy decision

should be based on the banks view on current interest rates. In respect of the

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. floting rate funds, wholesale vs. retail deposits, short term vs.

long term deposits etc,

Individual bank will have to decide the frequency for holding their ALCO meeting.

This committee meets regularly, at least once a month, through ideally it should

be once a fortnight , to review the liquidity potential vis-à-vis market conditions

and determines the strategies to maintain adequate liquidity, decides on raising

resources having regard to the cost in tune with the market condition, and

deployment of resources in profitable avenues.

RESPONSIBILITIES OF ALCO

Assessment of future interest rate scenario.

Assessment of the liquidity profile of the bank.

Assessment various risks, if any, in the balance sheet and drawing

strategies.

Monitoring spreads based on the changing scenario.

Drawing strategies to hedge risks perceived.

Guidance to the policies / strategies implemented and to alter/ change if

situation needs.

Review of actual performance vis-à-vis corporate projections.

Budgeting and planning.

Drawing short term as well as long term strategies depending on the

situation.

COMPOSITION OF ALCO

ALCO STRATEGIESASSESSMENT

REVIEWMONITORING

GUIDANCE

BUDGTING

PERCEIVEDPROJECTION

The size [number of members] of ALCO would depend on the size of each

institution, level of business and organization structure. The responsibility of

Asset Liability Management is on the treasury Department of the bank. To ensure

commitment of Top management and timely response to market dynamics, the

CEO or the Secretary should head the committee. The Chief of

investment/Treasury including forex, credit, planning etc, can be members of the

committee. In addition, the head of the Information Technology Division if a

separate division exists should also be invitee for building up of Management

Information System [MIS and related IT network. Some banks, large banks, may

even have sub-committees and supported Groups. The ALCO agenda consist of

comprehensive data on market conditions particularly with focus on liquidity in

Market ongoing interest rates fir sources and deployment avenues, the reserve

position, the yield pattern, spread, fee based income and overall profitability, the

avenues for raising resources and deployment, the classified data on maturity

pattern on assets and liabilities in different buckets [block/periods] as well as

classified data on interest rate sensitive assets and liabilities. The ALCO

considers maturity mismatches and ascertains gaps of creating liquidity in those

time buckets. While doing so Alco considers interest rate sensitive of respective

liabilities, if the resources are to be raised or respective assets, if surplus is to be

deployed. Major concern of ALCO in a sense, will be managing interest rate risk

and in the process, liquidity risk.

ALCO FUNCTION

ALCO meets periodically to assess the information of each department in detail.

Generally ALCO fixes the time horizon for planning. ALCO meets frequently

when market is volatile, sensitive, ect, so that prompt policy decision and

strategies can be planned.

During its meeting ALCO review;

a) Minutes of the previous meeting.

b) Review of fund gap reports and other reports.

c) Current commercial and market rates, to ensure that loans are priced

appropriately.

d) Current liability and deposit pricing matrixes so as to ensure that funds are

priced in accordance with overall funding policy.

e) Prospective assessment of accessibility of funds at a price that will give a

reasonable and consistent return on investment.

f) Results of the implementation of funding strategies which are designed to

ensure that the bank has adequate funds for credit, investment and

deposit repayment.

ALM committee at Surat People’s bank include

General Manger

Deputy General Manger

Assistant General Manger

Investment Department Executive

EDP executive

ALM PROCESS

In comparison with the commercial bank the scope of business and line of

banking operation of co-operative banks are limited. BY considering the ways

and means of resources mobilization and also based on the degree of exposure

to new risk related lending and investment portfolio of co-operative banks

exclusively focus on the following three major areas.

A. Identification of Risk

B. Measurement of Risk

C. Management of Risk

The identification stage intensifies different types of risk encountered by bank

due to interest rate fluctuations.

In the next stage bank tries to measure those risk using different models

suggested by RBI.

And finally bank takes various steps for the management of risk.

Now let us see each step in detail.

STAGE 1- IDENTIFICATION OF RISK

There are different types of risk faced by the bank. In this first stage bank tries to

identify those risk, which causes gap in Assets and Liabilities.

The uncertainty of interest rate movements gave rise to interest rate risk thereby

causing banks to look for processes to manage their risk. In the wake of interest

rate risk came with liquidity risk as inherent components of risk for banks. The

recognition of these risks brought Assets Liability Management to the centre-

stage of financial intermediation.

Now let us see about both the risk which causes mismatch in ALM.

1. Interest Rate Risk

CATGORIES OF INTEREST RATE RISK AND THEIR IMPACT

MISMATCH RISK

Banks, as apart of their business of intermediation between the savers and the

investors in the economy, assume liabilities and create assets, which are of

different maturities and sizes. The liabilities and assets are priced differently and

the difference between the interest received on assets and interest paid on

liabilities is bank’s net interest income. Essentially, assets and liabilities mature

or fall due for reprising at different time intervals. Obliviously, there is a reprising

mismatch between assets and liabilities. The deposits have to be reprised, may

be at higher interest rates, at the end of one year while assets will continue to

provide fix return. If interest rates rise by the time the deposit is due to mature,

bank will be able to raise new deposit only at higher interest rates prevailing in

the market. This will result in interest spread between deposits and investment

getting reduced and adversely affecting Net Interest Income (NII) of the bank.

Also, mere maturity matching between assets and liabilities need not necessarily

protect bank from mismatch risk, the reprising may be at shorter interval and can

create mismatch in reprising and resultant interest rate risk.

BASIS RISK

The risk of interest rates attached to different group of banks assets and liabilities

changing by different degrees are called basis risk. Further, changes in deposit

interest typically lag behind loan rates. The complex linkages between interest

rates in different segment of the market (Call, Repos, CDs. Inter bank Term

Money, etc.) contribute to the basis risk. Typically, in a falling interest rate

scenario, it is possible that interest rate on assets may be lowered generally

while the deposit may continue at the contracted higher interest rates The

following illustration will make the concept of basis risk clear.

(Interest sensitivity Gap Position 1-30 days Bucket)

LIABILITIES ASSETS

Call Money 50 Treasury Bills 30

Repo 50 Advances 120

Deposits 100

Total 200 Total 150

Negative Gap 50

If the interest rate rises by 1% bank will lose 0.5 crore per year assuming that the

rise in interest will be uniformly applicable to all the time items of assets and

liabilities. But in real world interest rates on assets and liabilities do not change in

same proportions. For instance, Call may go up 1%, Repo by 0.5%, Deposits by

0.25%, T-Bills by 1% and advances by 0.75%. The following table shows that if

interest rate the impact on net interest income will be gain of 0.2% crore instead

of loss of 0.5% crore as in the above case when on basis risk was taken into

account.

INCREASE IN (LOSS) / GAIN

INTEREST RATE DUE TO

INTEREST

RATE RISE

Call Money 50 0.01 (0.5)

Repo 50 0.005 (0.25)

Deposits 100 0.0025 (0.25)

Total (1)

Treasury Bills 30 0.01 0.3

Advances 120 0.0075 0.9

Total 1.2

Net Impact On NII 0.2(1.2-1)

YIELD CURVE RISK

On account of volatility in interest rates, the yields curve unpredictability and

often substantially, change in shape. If the interest rates on assets and liabilities

are pegged to the bench mark rates (like T-bills cut off rates), there is the risk

that the interest spread may decreases as term spread narrows down. Assume

that the bank has raised a floating rate deposit, which will be reprised 1% above

the 91 day T-Bills cutoff and invested the amount in a floating rate loan of same

reprising interval but a spread of involved, as the spread between the two

maturities of T-Bills narrowed.

Period 91Days Tb 364 Days

Tb

Term

spread

Interest

Spread

Between

Deposit

And Loan.

April 2005 6.26 6.82 0.56% 1.56%

June 2005 6.34 6.98 0.64% 1.64%

August 2005 6.56 7.12 0.56% 1.56%

March 2007 6.89 7.34 0.45% 1.45%

EMBEDDED OPTION RISK

Traditionally, Banks provide an option to depositors to prematurely close the

deposits and to borrowers to prepay the advances. Banks customers would be

exercising the option at the time most unfavorable to the bank in other words,

depositors may prematurely close the deposits when interest rates increase and

redeposit at higher rates and when interest rate decline borrowers may option to

prepay the loans and renew the same at the lower rate. In both cases banks NII

is adversely affected.

REINVESTMENT RISK

The expected yield on investment, generally indicated by yield to maturity, is

based on the important assumption that the bond will be held till maturity during

the life of the bond, the periodic coupons received will be reinvested at an

interest rate equal to YTM. These assumption can go wrong in which case

income from investments by way of coupons get reinvested at lower rates incase

the interest rate decline.

NON-PAYING LIABILITIES

The NII of the bank would be buoyant if it has more non-paying liabilities like

current deposits, float funds, etc, the volume of such deposits become volatile

and may even decline if the corporate undertake final cash management. With

the prospect of improvement in the payment and settlement infrastructure, such

idle balances left in the account by clients are likely to decline. The bank would

therefore be required to replace such liabilities with interest paying liabilities and

these would enhance the interest rate and sensitivity in the banks balance sheet.

Thus the volatility in the levels of non-paying liabilities would cause the risk to the

NII of the bank.

PRICE RISK

The values of investments change inversely to interest rates. Thus if interest rate

in the market increase, investment suffers depreciation and if interest rate

declines investment in bank portfolio gain in value. The price changes in

investments are on account of present values of each cash flow being altered

when discounted by the new interest rate. However, we can generalize the

concept and extend the same to all items of assets and liabilities of bank balance

sheet, which conceptually constitute series of expected cash flows and as such,

have present values (market values) which vary with market interest rates. It

follows thus, that all items of assets and liabilities for a bank are exposed to price

risk. Price risk will impact the values for assets and liabilities and in turn, market

value of net worth which the difference between markets value of assets and

liabilities.

Sound Interest Rate Risk Management

Sound interest rate risk management involves the application of four basic

elements in the management of assets and liabilities and off-balance sheet

instruments.

o Appropriate board and senior management oversight.

o Adequate risk management policies and procedures.

o Appropriate risk measurements, monitoring and control Function,

o Comprehensive internal controls and independent audits.

The specific manner in which a bank applies these elements in managing

its interest rate will depend upon the complexity and nature of its holding and

activities as well as on level of interest rate risk exposure. What constitutes

adequate interest rate risk management practices can therefore very

considerably For Example, Less complex banks, whose senior managers are

active involved in details of day to day operations may be able to rely on

relatively base interest rate risk management process. However, other

organization that has more complex and wide-ranging activities are likely to

require more elaborate and formal interest rate risk management processes. To

address their broad range of financial activities and to provide senior

management with the information they need to monitor and direct day to day

activities. Moreover the complex interest rate risk management process

employed at such banks require adequate internal controls that include audits or

other appropriate oversight mechanisms to ensure the integrity of the

information used by senior officials in overseeing compliance with political and

limit. The duties of the individual involved in the risk measurement, monitoring

and control functions must be sufficiently separate and independent from the

business marks and positions takers to ensure the avoidance of conflict of

interest

As other risk factor categories, the committee believes that interest rate

risk should be monitored on a consolidated, comprehensive basis to

include interest rate exposures in subsidiaries. At the same time however,

institutions should fully recognize any legal distinctions and possible

obstacles to cash flow movements among affiliates and adjust their risk

management process accordingly. While consolidation may provide a

comprehensive measure in respect of interest rate risk, it may also

underestimate risk when positions in one affiliate are used to offset

position in another affiliate. This is because a conventional accounting

consolidation may allow theoretical offsets between such position form

which a bank may not in practice be able to benefit because of legal or

operational constraints. Management should recognize the potential for

measures to undertake risks under such circumstances.

.

INTEREST RATE RISK: REGULATIORY ASPECTS

RBI Guidelines:-

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

banks in pricing most of the assets and liabilities have exposed the banking

system to Interest Rate Risk. Interest rate risk is the risk where changes in

market interest rates might adversely affect a bank's financial condition. Changes

in interest rates affect both the current earnings (earnings perspective) as also

the net worth of the bank (economic value perspective). The risk from the

earnings' perspective can be measured as changes in the Net Interest Income

(Nil) or Net Interest Margin (NIM). In the context of poor MIS, slow pace of

computerization in banks and the absence of total deregulation, the traditional

Gap analysis is considered as a suitable method to measure the Interest Rate

Risk. It is the intention of RBI to move over to modern techniques of Interest Rate

Risk measurement like Duration Gap Analysis, Simulation and Value at Risk at a

later date when banks acquire sufficient expertise and sophistication in MIS. The

Gap or Mismatch risk can be measured by calculating Gaps over different time

intervals as at a given date. Gap analysis measures mismatches between rate

sensitive liabilities and rate sensitive assets (including off-balance sheet

positions). An asset or liability is normally classified as rate sensitive if:

within the time interval under consideration, there is a cash flow;

the interest rate resets/reprises contractually during the interval;

RBI changes the interest rates (i.e. interest rates on Savings Bank Deposits,

advances upto Rs.2 lakh, DRI advances, Export credit, Refinance, CRR

balance, etc.) in cases where interest rates are administered ; and

it is contractually pre-payable or withdrawable before the stated maturities

2. LIQUIDITY RISK

CONCEPT OF LIQUDITY

Liquidity is the ease with which an individual, business firm or financial institution

can obtain cash by selling non-cash assets. Access to cash is important in

financial management of all business enterprises as it helps in ensuing smooth

function of the enterprises.

Providing liquidity to the customers is one of the intermediation functions of

banks. It is therefore important that bank’s own liquidity is at a comfortable level.

Bank Liquidity may be defined as ability to raise a certain amount of funds at

certain within a certain amount of time. If a bank is in a position to raise addition

funds at a cheaper rate in a short period compared to another bank, then the

liquidity position of that bank is considered better than the other bank.

Liquidity needs of an individual bank are to be related to the demands made or

likely to made by both depositors and borrowers for funds over a period of time.

Looking to the varied customer profile of banks needs to assess its liquidity

needs based on the nature and composition of its Assets and liabilities.

A bank is liquid if it can meet all the demands made for cash against it at

precisely those items when cash is demanded. Moreover whatever sources

funds bank may choose to upon must be available at a reasonable cost and time.

The liquidity of an individual bank is different form the liquidity in the financial

system. While the overall liquidity in the financial system is dependent on various

macroeconomic variables and policy stance by Reserve Bank of India (RBI),

which is the Central bank liquidity of an individual bank can be managed through

careful planning and anticipation of deposits and loan changes.

Liquidity is different form liquidation of an enterprise refers to its ability to meet its

obligation as a going concern while liquidation is the process of disposal of

assets meeting its liabilities and essentially involves winding up of business

enterprise. Liquidity refers to the realizable value of units’ assets and whether it

will be sufficient to meet liabilities.

LIQQUIDITY RISK

Liquidity Risk is the possibility the possibility that an institution may be unable to

meet its maturing commitments or may do so only by borrowing funds at

prohibitive costs or by disposing assets at rock bottom prices.

It originates form the mismatches in the maturity pattern of assets and liabilities.

Analysis of liquidity risk involves the measurement of not only the liquidity

position of the bank on on-going basis but also examination of how funds

requirements are likely to be affected, under crisis scenarios.

The liquidity risk in banks manifests itself in different dimensions.

Funding Risk - need to replace net outflows due to unanticipated

Withdrawal / non-renewal of deposits (wholesal and retail)

Time Risk - need to compensate for non-receipt of expected inflows of

Funds, i.e. performing Assets turning into non-per morning

Assets.

Call Risk - due to crystallization of contingent liabilities and unable to

Undertake profitable business opportunities when desirable.

NEED FOR LIQUIDITY BY BANKS

Liquidity has two separate and mutually exclusive purposes. One need for

liquidity is to provide funds to meet net decline in deposits. Other is to provide

and to meet increase in loans and investments that are rising faster than

deposits.

Demand form depositors :

On the liability side of the balance sheet, deposit withdrawals represent an

important factor requiring banks to be liquid. Banks are able to attract deposits

from public not only by promising some return on their money but also by

committing themselves to repayment on demand. Banks must therefore build

adequate amount of liquidity in their assets portfolio so that they may in case of

necessity meet any claims upon them in cash on demand. If the depositors’

cheque is not honored, the bank will lose confidence of the public, which may

result in mass run on the banks counters. The very arrival of bank is thus

endangered.

Demand form Borrowers :

On the asset side of the balance sheet, demands for loans form customers have

to be accommodated as these accounts have a substantial impact upon the

banks profit. High value borrowers enjoy large borrowing limit form banks which

are not always fully drawn banks require to maintain sufficient liquidity to

accommodate requests for fresh loans as also provision for full utilization of

credit limits already sanctioned.

Statutory Requirements :

Under section 24 of banking regulation Act, 1949 all scheduled Commercial

banks are required to maintain on a daily basis a proportion of net demand and

time liabilities in the form of securities approved by RBI. At present, commercial

banks are required to maintain Cash Reserve Ratio (CRR) to the extent of 6% of

net demand and time abilities in the form of deposits in the account maintained

with RBI. Banks have also to maintain Statutory Liquidity Ratio (SLR) to the

extent of 25% of net demand and time abilities in the form of approved securities.

Thus a scheduled commercial bank must maintain CRR and SLR as these are

considered as most liquid assets. However in practice these assets can be used

only for a brief period to take care of temporary liquidity, as have to be replaced

immediately to maintain prescribed levels.

LIQUIDITY MANAGEMNT: REGULATIORY ASPECTS

RBI Guidelines:-

RBI had issued guidelines in February 1999 for putting in place Asset Liability

Management System in Banks. These guidelines were issued for managing

Liquidity Risk, Interest Rate Risk and Currency Risk. Banks were asked to set up

an internal Assets Liability Committee (ALCO) headed by Chief Executive Officer

/ CMD or the Executive Director. The Managing Committee or any specific

committee of the Board was also to oversee the implementation of the system

and review functioning periodically.

Measuring and managing liquidity needs are vital activities of commercial banks.

By assuring a bank's ability to meet its liabilities as they become due, liquidity

management can reduce the probability of an adverse situation developing. The

importance of liquidity transcends individual institutions, as liquidity shortfall in

one institution can have repercussions on the entire system. Bank management

should measure not only the liquidity positions of banks on an ongoing basis but

also examine how liquidity requirements are likely to evolve under crisis

scenarios. Experience shows that assets commonly considered as liquid like

Government securities and other money market instruments could also become

illiquid when the market and players are unidirectional. Therefore liquidity has to

be tracked through maturity or cash flow mismatches. For measuring and

managing net funding requirements, the use of a maturity ladder and calculation

of cumulative surplus or deficit of funds at selected maturity dates is adopted as

a standard tool.

The Maturity Profile as given in Appendix I could be used for measuring the

future cash flows of banks in different time buckets. The time buckets given the

Statutory Reserve cycle of 14 days may be distributed as under:

1) 1 to 14 days

2) 15 to 28 days

3) 29 days and upto 3 months

4) Over 3 months and upto 6 months

5) Over 6 months and upto 12 months

6) Over 1 year and upto 2 years

7) Over 2 years and upto 5 years

8) Over 5 years

Within each time bucket there could be mismatches depending on cash inflows and

outflows. While the mismatches upto one year would be relevant since these

provide early warning signals of impending liquidity problems, the main focus should

be on the short-term mismatches viz., 1-14 days and 15-28 days. Banks, however,

are expected to monitor their cumulative mismatches (running total) across all time

buckets by establishing internal prudential limits with the approval of the Board /

Management Committee. The mismatch during 1-14 days and 15-28 days should

not in any case exceed 20% of the cash outflows in each time bucket. If a bank in

view of its asset -liability profile needs higher tolerance level, it could operate with

higher limit sanctioned by its Board / Management Committee giving reasons on the

need for such higher limit. A copy of the note approved by Board / Management

Committee may be forwarded to the Department of Banking Supervision, RBI. The

discretion to allow a higher tolerance level is intended for a temporary period, till the

system stabilizes and the bank are able to restructure its asset -liability pattern.

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. A

maturing liability will be a cash outflow while a maturing asset will be a cash inflow.

It would be necessary to take into account the rupee inflows and outflows on

account of forex operations including the readily available forex resources ( FCNR

(B) funds, etc) which can be deployed for augmenting rupee resources.

While determining the likely cash inflows / outflows, banks have to make a number

of assumptions according to their asset - liability profiles. For instance, Indian banks

with large branch network can (on the stability of their deposit base as most

deposits are renewed) afford to have larger tolerance levels in mismatches if their

term deposit base is quite high. While determining the tolerance levels the banks

may take into account all relevant factors based on their asset-liability base, nature

of business, future strategy etc. The RBI is interested in ensuring that the tolerance

levels are determined keeping all necessary factors in view and further refined with

experience gained in Liquidity Management.

In order to enable the banks to monitor their short-term liquidity on a dynamic basis

over a time horizon spanning from 1-90 days, banks may estimate their short-term

liquidity profiles on the basis of business projections and other commitments. An

indicative format for estimating Short-term Dynamic Liquidity is enclosed.

Basel Committee for Banking Supervision (BCBS) Principles

for the assessment of liquidity management in banks:

The Basel Committee for Banking Supervision has focused on developing greater

understanding by Commercial banks to manage their liquidity on a global

consolidated basis. The recent technological and financial innovations have

provided banks with risk control tools for managing their liquidity. The declining

ability of banks in developed markets to rely on core deposits and their increased

reliance on wholesale funds has put pressure on liquidity.

According to Basel Committee, the process used to manage liquidity depends on

the size and sophistication of the bank as well as nature and complexity of its

activities.

SOURCES OF LIQUIDITY

The primary sources of liquidity can be classified in to two categories. The first

category consists of assets in which funds are temporarily invested with the

assurance that they will either mature or will be paid when liquidity is readily

saleable, without material loss before maturity. The second category includes the

various methods by which banks can borrow or otherwise obtain funds.

Assets that can be classified as liquid assets and serve as primary source of

liquidity be of high credit quality. They should be either of short maturity or easily

marketable with little chance of loss. The amount of liquid assets may be limited

by the willingness of bank to hold such Assets generally earn less than loans or

less liquid Assets. The sources of bank liquidity are mostly available through

money market and bank really on it for meeting liquidity needs in the are normal

course of business.

The potential sources of bank liquidity are as under –

Money at call and short notice

Short Term Central Government Securities

Other Marketable Short Term Securities

Securities purchased under agreement to resell

Refinance form RBI

Bills Rediscounting.

SOURCES OF LIQUIDITY RISK

Liquidity Risk in banks may be attributed to following factors

Mismatch in Tenor profile of Assets and Liabilities:

Advances and investments form a major chunk on the assets side of a bank’s

balance sheet. Banks in an effort to diversify their credit portfolio have started

lending and investing in various projects with long repayment periods. Banks due

to yield considerations have also been investing in government securities with

maturity as long as 30 years. However deposits of the bank are repayable on

demand or generally are for a maturity of 1-5 years. Thus banks have their long-

term assets financed out of liabilities, which are predominantly of short term. This

mismatch in tenor profile of assets and liabilities is likely to create liquidity risk in

a situation when roll over of deposits is rendered difficult.

Embedded Options:

Banks provide option to term depositors for prepayment of deposits on recovery

of certain penalty. Similarly borrowers are allowed by some banks to prepay

loans. Both borrowers and depositors may use this option in a changing interest

rate scenario to take advantage of these changes. These embedded options

available both to depositors and borrowers make liquidity management a difficult

task for the bank.

Non-Performing Assets:

Banks are faced with the problem of non-performing assets. Loan that default in

payment of interest and principal amount with a delay exceeding two quarters are

classified as Non-Performing Assets by banks. Such assets deprive banks of

cash inflows originally envisaged at the time of sanction. Banks that have got

substantial funds blocked in non-performing Assets are likely to face liquidity

problems.

Undrawn credit limits:

Banks provide cash credit / Overdraft facilities to borrowers for meeting working

capital requirements. These facilities are in the form of running account and

borrowers depending on need withdraw funds. Banks have to maintain sufficient

liquidity to take care of utilization of undrawn credit facilities by the borrows.

OBJECTIVE AND POLICIES

Objectives:

The objective if Liquidity Management is to maintain statutory prescriptions, meet

contractual and maturing cash outflows and to profitable deploy surplus cash.

Sound liquidity management involves prudently managing cash flows as also

concentration of assets and liabilities (both on and off balance sheet) with a view

to satisfy that cash inflows have an appropriate relationship to approaching cash

outflows.

Holding excess liquidity has a bearing on profitability because liquid assets in the

form of cash and short-term securities generate lower yields. A trade off between

liquidity needs and profitability necessitates determination of optimum level of

liquidity. This will have to be supported by liquidity planning that assesses

potential future liquidity needs taking into account changes in economic, political,

regulatory and other operating conditions.

The primary objectives of liquidity management are to ensure

An optimum liquidity position.

Avoid concentration of funding that May leave the bank vulnerable to

potential liquidity problems.

Policies:

Banks are required to formulate Assets Liability Management Policy for

management of market risk including risk. Liquidity Management is part of the

banks Asset Liability Management Policy and Investment Policy for liquidity

management should provide broad framework for identification, measurement

and assessment of liquidity needs.

The policy may broadly include following aspects:

It should provide for the establishment of Asset Liability Committee

(ALCO), the committee’s membership and role as also periodicity of the

meetings to be held by the committee.

The Policy may define reporting mechanism of the decisions taken by

ALCO to the Bank’s Board / senior management and feed back to be

received form the Bank’s Board.

The policy needs to specify authority structure for making liquidity and

funds management decisions.

The policy may provide for periodic review of the bank’s deposit structure.

The review to include the colume and trend of the various types of

deposits offered, maturity distribution of time deposits, interest rates being

paid on each type of deposits and caps on large deposits.

The policy to address funding concentration or excessive reliance on any

single source or type of funding.

The policy in conjunction with the bank’s Investment policy should

determine which type of investment is permitted, the desired mix and the

maturity distribution.

Conveys the Board’s risk tolerance and establishes target liquidity ratios

such as loan to deposit ratio, long-term assets funded by less stable

funding sources, individual and aggregated limits on borrowed funds by

type and source.

The policy to specify the mechanism for periodic review of compliance

with policy guidelines such as established limits and legal reserves

requirements by senior management

The policy to include contingency plan that addresses alternative source

of funds if initial projections of funding source and uses undergo any

change or if a liquidity crisis arises.

The policy to formulate a process for measuring and monitoring liquidity

through cash flow projections or using models.

The policy to provide authority and procedures for access to wholesale

funding sources and to establish a process for measuring and monitoring

unused borrowing capacity.

The policy to focuses on satisfying the liquidity requirements that are

prescribed by RBI as part of regulatory mechanism.

The policy to consider putting in place certain limits on duration of

liabilities and investment portfolio.

Commitment ratios – Track the total commitment given to corporate /

banks and other financial institutions and to limit the off balance sheet

exposure.

Limit on maximum cumulative outflow across all time bands.

LIQUIDITY MANGEEMNT: PLAN

All banks should have board approved written policies and procedures for the

day-today management of liquidity. The liquidity strategy and policies should be

communicated throughout the bank. The board of directors should be informed

regularly on the liquidity situation of the bank and the board should ensure that

senior management monitors and controls liquidity risk.

Bank management should have in place appropriate policies and procedures that

set and provide for the regular review of the limits on the sizes of liquidity

positions over particular time horizon. Management information adequate to

measure, monitor, control and report liquidity risk should be in place.

As part of the process for the on-going measurement of funding requirements,

banks should analyze liquidity under various scenarios and the underlying

assumptions for such scenarios should be reviewed periodically.

Relationship with lenders, other liability holders and market participants should

be diversified and reviewed periodically to ensure a capacity to access funding

either through new borrowings or the sale of assets.

Contingency plans should be in force and should include strategies for handling

liquidity crisis and procedures for addressing cash flow shortfalls in emergency

situations.

The bank should maintain an adequate system of internal control that involves

regular independent reviews and evaluations of the effectiveness of the liquidity

management system and ensuring that appropriate remedial steps are taken.

Other Risk

A. Credit Risk

It arises due to failure of borrowers to discharge their repayment obligation as per

contracted terms. This is the oldest & most important risk for the bankers. It

originates out of commercial choice of customer and is closely related to the

business police of the people implementing the policy. Credit risk is very critical

to banks since the defaulter of a small number of large borrowers could get into

strophic losses. Similar highly volatile interest rate environment may lead to

deterioration in the quality of credit portfolio. Traditional credit risk is a primary

challenge for financial institution and such risk are related to lay down credit

policy of the bank. The misjudgment of these risks may lead to eventual failure of

the banks, through the respective credit policies is highly interrelated with the

market risk.

The credit risk is caused by market risk variables. Management of such risks is

also a vital responsibility of the bank. In a highly volatile interest rate environment

loan defaults may increase the risk by deteriorating the credit policy.

B. Market Risk

It is a risk to bank’s financial condition that would result form adverse movement

in the market places. It is the risk of adverse deviations of the market to market

value of the trading portfolio during the period required to liquidate the tractions

or revaluing the portfolio for balance sheet purposes. Primarily the impact on the

market risk is observed in the movement of portfolio value. Any decline in value

therefore will result in a market loss. This gets further aggravated adequacy

norms by the regulatory authorities. Accidentally the market risk could prove to

be dangerous for the banks.

C. Foreign Exchange Rate Risk & Currency Risk

It is the risk to the bank due to the fluctuation in the exchange rate of foreign

currency viz a viz –Indian currency. The impact of the movement of the rate of

exchange shall reflect directly on the fore portfolio of the bank resulting in the

change in the value of foreign exchange assets. Generally co-operative banks

are not in this type on business so this risk is not that much affected to them.

Floating exchange rate arrangement has brought in its wake pronounced

volatility adding a new dimension to the risk profile of banks' balance sheets. The

increased capital flows across free economies following deregulation have

contributed to increase in the volume of transactions. Large cross border flows

together with the volatility has rendered the banks' balance sheets vulnerable to

exchange rate movements.

Dealing in different currencies brings opportunities as also risks. If the liabilities in

one currency exceed the level of assets in the same currency, then the currency

mismatch can add value or erode value depending upon the currency

movements. The simplest way to avoid currency risk is to ensure that

mismatches, if any, are reduced to zero or near zero. Banks undertake

operations in foreign exchange like accepting deposits, making loans and

advances and quoting prices for foreign exchange transactions. Irrespective of

the strategies adopted, it may not be possible to eliminate currency mismatches

altogether. Besides, some of the institutions may take proprietary trading

positions as a conscious business strategy.

DRIVERS OF UNEXPECTED OUT– COMES

Uncertainty Lack of Information Un expected out comes. Mis match in ALM

Risk Lack of Knowledge

Equivocal Lack of Judgment

Error Lack of care

GOLDEN RULES ABOUT RISK

No risk is separated in watertight compartments.

The final effect is through interplay of these risks.

Risk is associated with product or position.

Risk can reduce by increased knowledge.

Avoiding risk means avoiding encashment of the opportunities.

PROBLEM IDENTIFICATION

Management Dilemma

Management dilemma is usually the symptom of an actual problem. Asset –

Liability Mismatch is often the biggest problem in a bank, hence its Management

is a bigger concern. For this study Management dilemma found was:

“Mismatch of Assets and Liabilities at Surat People’s Co-operative Bank”

Management Question

Management question restates the dilemma in question form. Here the

management question was:

“How the Assets and Liabilities mismatch can be managed.”

Problem Statement

The management question generated led to the formulation of the following

problem statement.

“Asset – Liability Management at Surat People’s Co-operative Bank”

RESEARCH OBJECTIVES

1. I have to Measurement and Management of Risk which affect the banks

Asset – Liability position.

2. To study how the interest rate and liquidity risks affect assets and

Liabilities of the Bank.

SCOPE OF THE STUDY

1. The scope of the study includes: In depth study of Asset – Liability

statement as 22 / 12 / 2006 of Surat People’s Co-operative Bank for the

measurement of interest rate risk.

2. Study of Asset – Liability statement as on 26 / 12 / 2003 and as on 22 /

12 / 2006 for the purpose of measurement of liquidity risk.

3. The scope also includes study of cash flow statement of 2003 to 2006 for

calculation of ratios.

BENEFITS OF THE STUDY

1. Bank could also know about the causes of mismatch in Assets and

Liabilities.

2. Bank could also know different types of risks as well as how to measure

and mange them which cause the mismatch.

RESEARCH DESIGN

“Research design is the plan, structure and strategy of investigation conceived so

as to obtain answers to research questions and to control variance.”

This study can classify as exploratory study. Exploration was needed at three

different stages.

Initially exploration was needed just to learn something about

management dilemma.

In the next step exploration was needed to find out how different risk

affects Assets and Liability position of the bank.

Finally exploration was needed to find out the measures to manage the

mismatch.

SAMPLE DESIGN

ALCO committee is consulted by one General Manager, one Deputy General

Manager, two Asst. General Manager and one Executive. In this study five

members from ALCO committee, 35 members from Loan Department and 4

members from Investment Department. All the members of ALCO committee,

members of loan department and members of investment department were

selected as the samples of this study.

Further in this study, type of the sample selected was non-probabilistic

systematic sampling method. Since the study was about Measurement and

Management of Risk at Surat People’s Co-operative bank, the information about

various risks was available from employees of Investment Department as well as

Loan Department.

Primary Data collection

The primary data is seeking information from the persons experienced in the

area of the study. We interviewed bank employees and agents for more detailed

information. Interviewing them bought us to light many aspects, which were

important across the range of the subject. Through experience survey we got

data, which we couldn’t get through secondary data analysis.

DATA COLLECTION

The objectives of the exploration may be accomplished with different exploratory

techniques used in this study were:

SOURCE OF INFORMATION

INTERNAL SOURCE EXTERNAL SOURCE

BUOCHURE MANUALS ANNUAL REPORTS WWW.SPCB.COM ASSET – LIABILITY STATEMENTFINANCIAL STATEMENTS

WWW.RBI.COMRBI MANUALSALM SYSTEM IN BANKS GUDILINES- RBI BOOKALM IN BANKS – DILIP KUMAR SARMA (ECONOMIST) SBH

When I just started with the project I first went on for Bank’s internal data

sources. I visited bank’s website www.spcb.com.Then I also reffed to manual’s

broachers, product prostrations, etc. This gave me general information about

bank and the banking industry. Then for further details I went on for external

sources. I went on for external sources. We referred to books of economist –

Dilip Kumar Sarma, RBI manuals for guidelines, website of RBI.

ANALYTICAL TOOL

In this project Microsoft Excel as well as different types of the charts are used as

the analytical tool.

1. Excel Sheet - Excel sheet is used to make various calculations while

measuring the interest rate risk by using the formula bar.

2. Column Charts – Column charts compare the values across the

categories. They are used to show the past performance of the bank.

3. Percentage – percentage is used to calculated liquidity ratio.

LIMITATIONS OF THE STUDY

1. The weights of the standardized gap are based on the forecast which is in

turn based on the individual perception.

2. In addition to interest rate risk and liquidity risk there are some other risks

such as credit risk which fall within the ALM framework but they are not

considered in the study because they have negligible impact on mismatch

of Assets and Liabilities.

3. Value at Risk Method is new method for quantification of risks. Through

this method, the current economic value of assets and liabilities are

arrived at by depreciation and appreciation of the original period value of

the product with the corresponding movements of the interest rates. – This

type of method does not take bank in their measurement of risk.

STAGE 2 – MEASUREMENT OF RISK

INTEREST RATE RISK

Interest rate risk can be measured by 3 methods:

1. Traditional Gap Method

2. Standardized Gap Method

3. Duration Gap Method

Traditional Gap Method

John Clifford in 1975 originally formulated the concept of IRRM in an article

entitled “A perspective on Assets Liability Management” Both assets and

liabilities were divided into three pools of funds – variable, fixed and non-rate

funds.

Traditional gap analysis involves an analysis in management of banks position in

interest sensitive assets, liabilities and off-balance sheet items with reference to

the existing interest sensitivity exposure of the bank as on a particular day. The

gap analysis usually covers the performance period adopted by the bank for its

performance planning. While ideally such repricing gaps may be worked out on a

daily basis factoring the projected business over a given period of time, a simpler

method is adopted in practice where by assets and liabilities as on the reference

date are grouped as per the repricing maturities under predefined time buckets.

The choice of the length and number of time buckets depend upon the nature of

activity of the financial institutions.

Rate Sensitive Gaps

ASSETS LIABILITY

--------------------------- Rate

--------------------------- Sensitive Gap

---------------------------- Rate

--------------------------- Sensitive Gap

Sensitive

Rate sensitive gap =Controllable + Non-Controllable gap

VariableRate

FixedRate

Non Rate

VariableRate

FixedRate

Non Rate

The Gap is the difference between Rate Sensitive Assets (RSA) and Rate

Sensitive Liabilities (RSL) for each time bucket. The Positive Gap indicates that it

has more RSAs then RSLs whereas the Negative Gap indicates that 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 in

a position to benefit from declining interest rates by a negative Gap (RSL > RSA).

The Gap can, therefore, be used as a measure of interest rate sensitivity.

If management feels that in any bucket the repricing gap is high and signifies a

higher interest rate risk exposure, it will try to reduce such gaps. Thus, bank can

hedge itself against interest rate changes no matter which way the rates the rates

move, by making sure for each time bucket that the volume of repriceable

liabilities.

The Gap analysis address the problem of impact on Net Interest Income (NII) as

such is carried out for the planning horizon and confines itself to the possible

changes in the interest rate occurring during such time horizon. The starting point

for the gap analysis is therefore to decide on the time buckets and the

identification of the interest rate sensitive assets and liabilities. An item of

assets / liabilities is the interest rate sensitive if it matures or contractually falls

due for repricing during the time bucket. Thus the proceeds for the maturing loan

can be reinvested in the another assets at yield related to the yield currently

available on similar assets and liabilities like cash on hand, premises, current

account balances are obviously kept out as they are not subject to repricing. If

the amount of repriceable assets is not equal to the amount of repriceable

liabilities the gap is said to be exist.

If the interest rate rises, the banks NII will increase, because more of bank’s

assets will reprice at a higher rate than liabilities and therefore, revenue will

increase more than the cost of borrowed funds. On the other hand, if the interest

rate falls when the bank is asset sensitive the banks NII will decline as interest

revenues form the reprised assets drop by more then interest rate expenses

associated with the repriced liabilities. Similarly, if the interest sensitive liabilities

exceed the interest sensitive assets due for repricing in a particular time bucket,

the bank is said to be liability sensitive or negatively gapped during that time

bucket. The impact on NII resulting form the changes in the interest rate will be

exactly opposite to those discussed for the positive gap. The important

assumption is that the extent of rise in interest rate both on asset and liability side

will be same and concurrent across the time.

When Gap =1, RSA is perfectly matched with RSL. An increase in the interest

rates will have equal impact on assets and liabilities and thus net interest margin

will be maintained, assuming spread of returns on assets over liability costs was

positive at the beginning of the period.

When Gap >1, there are more RSA than RSL. When the interest rate rises, the

margin will also increase and opposite is true when the interest rate declines.

On the other hand, if Gap <1, and interest rate rises, the cost of funding will

increase and reduce the interest margin a declining interest rate scenario, the

funding cost will fall faster, thus raising the margin.

The relationship between interest rate changes and their impact on net interest

income are shown in below table:

GAP INTEREST RATE IMPACT ON NII

CHANGE

Positive Increase Positive

Positive Decrease Negative

Negative Increase Negative

Negative Decrease Positive

The adverse impact on NII is calculated by multiplying the gaps with the

expected change in the interest rates.

Assumptions

1. The repricing item is spread over, within the buckets, uniformly and as such

the mid point of bucket can be taken as an approx. Point at which the

repricing takes place.

2. The assets or a liability repriced continues to remain in the balance sheet

yielding income / incurring cost at the repriced rate during the remaining

period of the performance horizon.

3. Further, the change in rate is assumed be equal for all items of assets and

liabilities.

Shortcoming of Gap method

1. Basically a balance sheet concept and captures only principal assets and

liabilities revenue flows are ignored

2. Static analysis: business growth is not taken in to account

3. Assumes parallel shift in the yield curve

4. Dose not take into account time value of money

5. Emphasis on short term and NII

6. Forecasting of interest rates difficult through essential

7. The simple Traditional Gap Analysis does not reckon Basis Risk

8. Simplifying assumptions are made about the time of repricing of assets

and liabilities within the bucket.

9. The Bucketing is rather arbitrary and there could be mismatch within the

time buckets.

Gap position of Surat people’s Co-operative Bank as on 22 / 12 / 2006 (In

Crores)

Up to3

Month

Over 3Months

AndUp to 6Month

Over 6Months

AndUp to 1

Year

Over 1YearAnd

Up to 3Years

Over3YearAnd

Up to 5Years

Over 5Years

Non –SensitiveAssets

Total

TotalLiabilities

65.15 66.30 73.19 223.48 48.02 7.71 568.56 1052.41

TotalAssets 52.07 95.16 62.01 221.51 192.49 376.89 63.89 1064.02

Interest Rate Sensitive

Gap (Repricable

Asset-RepricableLiabilities)

_13.08 28.86 -11.18 -1.97 144.47 369.18 -504.67 11.61

Cumulative Gap

_13.08 15.78 4.60 2.63 147.10 516.28 11.61

If Interest Rate

Increases By 1 %

_13.08 0.2886 0.1118

-0.01971.4447 3.6918 -5.0467

If Interest Rate

DecreasesBy 1 %

0.131 -0.289 -0.112 0.0197 -1.4447 -3.6918 5.0467

If the first Gap -13.08 is left unattended would entail a deduction in NII by

-13.08 * 0.01 * (12 / !2) = -13.08 crore if interest rate increases similar

calculation are made in respect of other relevant gaps also as shown in the

above table.

Approximate Overall Size of the x Overall change in

Change in Banks NII = Cumulative gap the interest rates

= 11.61 x 0.01

= 0.1161 crores.

STANDISED GAP METHOD

Traditional gap analysis would lead to conclusion that if banks gap is zero its NII

is protected form interest rate risk. However, in really zero gap does not eliminate

all interest rate risk because the interest rate attached to banks assets and

liabilities do not change in unison and to the same degree. Thus, to a particular

course in the market leading to change in the interest rate, different segments

(loans, call money, CDs, ect) respond to the changes in the macro indicators like

bank rate. But changes in the interest rates on loans and deposits follow with

lags and in-different magnitudes.

In order to obviate the above problem of basis risk, the traditional gap analysis

can be modified by weighting the classes of liabilities / assets with the elasticity

of interest rate unique to the that class with reference to the bench market

interest rate.

Shortcoming of Standardized Gap method

1. Basically a balance sheet concept and captures only principal assets and

liabilities revenue flows are ignored

2. Static analysis: business growth is not taken in to account

3. Assumes parallel shift in the yield curve

4. Dose not take into account time value of money

5. The Bucketing is rather arbitrary and there could be mismatch within the

time buckets.

Weighted Rate sensitive items of ALM statement as on December 2006

Rate Sensitive Liabilities/

Assets Maturing/ Repricing

During the Time Bucket

Upto 3 Months

Nominal

Value

(1)

Change In

Interest rate

(Weights)

(2)

Balance sheet

Refigured to Reflect

Rate Sensitive

(1 * 2)

Rate Sensitive Liabilities

Total Borrowings 0.00 0.50 0

Term Deposits 65.15 0.50 32.575

Saving Deposits 0.00 0.25 0

Total (B) 32.58

Rate Sensitive

Assets

Balance With RBI 0.00 1.0 0

Balance With Other Bank

Call Money 15.00 1.50 22.5

Term Deposit 8.50 0.50 4.25

Investment in

Government Securities 18.24 1.50 27.36

Advances 7.36 1.50 11.04

Total (A) 65.15

Total Interest Sensitive 32.57

Gap(A-B)

Rate Sensitive Liabilities/

Assets Maturing/ Repricing

During the Time Bucket 3-6

Month

Nominal

Value

(1)

Change In

Interest rate

(Weights)

(2)

Balance sheet

Refigured to Reflect

Rate Sensitive

(1 * 2)

Rate Sensitive Liabilities

Total Borrowings 0.00 0.50 0

Term Deposits 42.55 0.50 21.28

Saving Deposits 23.75 0.25 5.94

Total (B) 27.22

Rate Sensitive

Assets

Balance With RBI 6.28 1.0 6.28

Balance With Other Bank

Call Money 0.00 1.50 0

Term Deposit 53.00 0.50 26.5

Investment in

Government Securities 16.48 1.50 24.72

Advances 14.2 1.50 21.3

Total (A) 78.8

Total Interest Sensitive

Gap(A-B)51.58

Rate Sensitive Liabilities/

Assets Maturing/ Repricing

During the Time Bucket

Upto 6 Month to 1 year

Nominal

Value

Change In

Interest rate

(Weights)

Balance sheet

Refigured to Reflect

Rate Sensitive

(1 * 2)

(1) (2)

Rate Sensitive Liabilities

Total Borrowings 0.00 0.50 0

Term Deposits 73.19 0.50 36.60

Saving Deposits 0.00 0.25 0

Total (B) 36.60

Rate Sensitive

Assets

Balance With RBI 0.00 1.0 0

Balance With Other Bank

Call Money 0.00 1.50 0

Term Deposit 26.33 0.50 13.17

Investment in

Government Securities 2.82 1.50 4.23

Advances 32.86 1.50 49.29

Total (A) 66.69

Total Interest Sensitive

Gap(A-B)30.09

Rate Sensitive Liabilities/

Assets Maturing/ Repricing

During the Time Bucket

Upto 1 Year to 3 years

Nominal

Value

(1)

Change In

Interest rate

(Weights)

(2)

Balance sheet

Refigured to Reflect

Rate Sensitive

(1 * 2)

Rate Sensitive Liabilities

Total Borrowings 0.00 0.50 0

Term Deposits 223.48 0.50 111.74

Saving Deposits 0.00 0.25 0

Total (B) 111.74

Rate Sensitive

Assets

Balance With RBI 0.00 1.0 0

Balance With Other Bank

Call Money 0.00 1.50 0

Term Deposit 9.84 0.50 4.92

Investment in

Government Securities 68.92 1.50 103.38

Advances 142.75 1.50 214.13

Total (A) 322.43

Total Interest Sensitive

Gap(A-B)210.69

Rate Sensitive Liabilities/

Assets Maturing/ Repricing

During the Time Bucket

Upto 3 Year to 5 years

Nominal

Value

(1)

Change In

Interest rate

(Weights)

(2)

Balance sheet

Refigured to Reflect

Rate Sensitive

(1 * 2)

Rate Sensitive Liabilities

Total Borrowings 0.00 0.50 0

Term Deposits 48.02 0.50 24.01

Saving Deposits 0.00 0.25 0

Total (B) 24.01

Rate Sensitive

Assets

Balance With RBI 0.00 1.0 0

Balance With Other Bank

Call Money 0.00 1.50 0

Term Deposit 15.42 0.50 7.71

Investment in

Government Securities 50.72 1.50 76.08

Advances 126.35 1.50 189.53

Total (A) 273.32

Total Interest Sensitive

Gap(A-B)249.31

Rate Sensitive Liabilities/

Assets Maturing/ Repricing

During the Time Bucket

Over 5 Years

Nominal

Value

(1)

Change In

Interest rate

(Weights)

(2)

Balance sheet

Refigured to Reflect

Rate Sensitive

(1 * 2)

Rate Sensitive Liabilities

Total Borrowings 0.00 0.50 0

Term Deposits 7.71 0.50 3.86

Saving Deposits 0.00 0.25 0

Total (B) 3.86

Rate Sensitive

Assets

Balance With RBI 0.00 1.0 0

Balance With Other Bank

Call Money 0.00 1.50 0

Term Deposit 2.56 0.50 1.28

Investment in

Government Securities 301.36 1.50 452.04

Advances 72.97 1.50 109.46

Total (A) 562.78

Total Interest Sensitive

Gap(A-B)558.92

Summary of Standardized Gap Method

Up to3

Month

Over 3Months

AndUp to 6Month

Over 6Months

AndUp to 1

Year

Over 1YearAnd

Up to 3Years

Over3YearAnd

Up to 5Years

Over 5Years

Interest Rate Sensitive

Gap (RepricableAsset-Repricable

Liabilities) 32.57 51.58 30.09 210.69 249.31 558.92

Cumulative Gap 32.57 84.15 114.24 324.93 574.24 1133.16If Interest Rate

Increases By 1 % 0.3257 0.5158 0.3009 2.1069 2.4931 5.5892If Interest Rate

DecreasesBy 1 %

-0.3257 -0.5158 -0.3009 -2.1069 -2.4931 -5.5892

If the first (-) 0.3257 is left unattended would entail a reduction in NII

by 32.57 * 0.01 * (12/12) = (-) 0.3257 crore if interest rate deceases

by 1%. Similar calculations are made in respect of other relevant

gaps also as shown in the above table.

Approximate Overall Size of the x Overall change in

Change in Banks NII = Cumulative gap the interest rates

= 1133.16 x 0.01

= 11.3316 crores.

Traditional Method Vs Standardized Method

Up to3

Month

Over 3Months

AndUp to 6Month

Over 6Months

AndUp to 1

Year

Over 1YearAnd

Up to 3Years

Over3YearAnd

Up to 5Years

Over 5Years

Traditional

GAP

Method

Interest Rate Sensitive

Gap (Repricable

Asset-RepricableLiabilities)

_13.08 28.86 -11.18 -1.97 144.47 369.18

If Interest Rate

Increases By 1 %

_13.08 0.2886 0.1118

-0.01971.4447 3.6918

Standardized

GAP

Method

Interest Rate Sensitive

Gap (Repricable

Asset-RepricableLiabilities)

32.57 51.58 30.09 210.69 249.31 558.92

If Interest Rate

Increases By 1 %

0.3257 0.5158 0.3009 2.1069 2.4931 5.5892

As may be seen From above that as per the Tradition Gap Method, if there is one

percent increase in bank rate impact on NII in Up to 3 months” time bucket is

Negative but in Standardized Gap Method the Impact on NII is Positive. The

reason for this difference is that Standardized Gap Method takes care of Basic

Risk also. In order to take care of basis risk, it is necessary that bank should be

in a position to forecast not only the direction of interest rate movements but

also the changes in different assets segments.

Duration Gap Method

Duration method measures the impact of the changes of interest rates on the

market value of assets and liabilities. The origin of such a method goes back to

the practice existed for calculating current value of bonds. The existing method

for such calculation was based on cash flows and average maturity. But

calculation of average maturity implicitly assumes no time value for money,

whereas in practice early receipts are of more value than latter receipts. Duration

method takes care of this by weighting all cash flows by the time at which they

occur.

So if the duration of a financial instrument is known, the change in the price of

that instrument in response to a given change in interest rate can be calculated.

Another feature of this method is that it is additive.

Duration is measure of the percentage change in the economic value of a

position that will occur given a small change in level of interest rates. It reflects

the timing and size of cash flows that occur before maturity, the higher the

Duration (in absolute value). Higher duration implies that a given change in the

level of interest rates will have a larger impact on economic value.

Duration – based weight can be used in combination with a maturity / repricing

schedule to provide a rough approximation of the change in a bank’s economic

value that would occur given a particular change in the level of market interest

rates.

Alternatively, an institution could estimate the effect of changing market rates by

calculating the pricies duration of each assets, liability, and then deriving the net

position for the bank based on these more accurate measures, rather than by

applying an estimated average duration weight to all positions in a given time

band. This would eliminate potential errors occurring when aggregating cash

flows.

As Duration is the direct outcome of interest rate and maturity, it may also be

defined as the measure of price sensitivity to its change in interest rates.

PROPERTIES OF DURATION

1. Duration is less than its maturity. This is because of the

intermediary cash flows which reduce its effective maturity.

2. Duration is directly related to maturity. Longer the maturity larger

will be the duration.

3. Duration is inversely related to the market interest rates or Yield.

4. Duration of portfolio is equal to the weighted average duration of all

the items in the portfolio.

5. Higher frequency of intermediary cash flow reduces duration.

Duration Gap

Steps in Computation Of Duration

1. Ascertain timing a calculate magnitude of cash flows

2. Find present value of each cash flow (Using discount factors)

3. Find time- weighted PV of each cash flow

4. Find total of all TWPVs

5. Divide total in step 5 by total in step 3

When the market interest rates are expected to change it will cause the change

in value of assets portfolio as well as liability portfolio. This will in turn have the

impact on the net worth of the bank.

Net Worth = Assets – Liabilities.

Change in Net Worth = Change in value - Change in value of

Of assets Liabilities

% Change in Value = Duration x Change in Yield.

To protect the negative impact on net worth due to interest rate changes bank

can follow the following steps of duration Gap analysis.

STEPS IN DURATION GAP ANALYSIS

Management develops in interest rate forecast.

Management estimates the weighted duration of Assets (DA) and

weighted duration of liabilities(DL)

Management calculates DGAP

DGAP = DA – DL

The positive DGAP indicates that duration of assets is greater than

duration of liabilities.

The negative DGAP indicates that duration of assets is less than

duration of liabilities.

The zero DGAP indicates that duration of assets and duration liabilities

are equal.

The impact of changing market interest rates on the bank’s net worth is indicated

given below:

Nature Of DGAP Direction of interest rates

movement

Impact on bank’s net worth

Positive Rise Decrease

Fall Increases

Negative Rise Increases

Fall Decrease

Zero Rise No change

Fall No Change

Duration Gap at Surat People’s Bank

Duration of Assets (DA) = Sum of Product of Asset’s Duration

= 4.6463 Years

Duration of Liabilities (DL) = Sum of product of Liability’s Duration

= 4.2438Years

Assets Liabilities

A Portfolio of Assets with a

Duration of 4.64 years

1064.02 A Portfolio of Liabilities with a

Duration of 4.24years

794.85

Equity + Reserves 269.17

1064.02 1064.02

Duration Gap = DA – Liabilities / Assets * DL

= 4.64 – (794.85 / 1064.02) * 4.24

= 4.64 -3.18

= 1.46

Here the duration Gap is positive. Hence impact of change in interest rates on

Net Worth of the Bank will be as follows

Nature Of DGAP Direction of interest rates

movement

Impact on bank’s net worth

Positive Rise Decrease

Fall Increases

Now we see how the value of net worth is affected through change in value of

assets and liabilities if interest rate moves in either direction.

Interest rate rises by 1%

% Change in value of Assets = -DA X Change in Yield

= -4.64 x 0.01

= 0.0464 or 4.64%

Therefore, Change in value of Assets = 1064.02 - 4.64%

= 1064.02 - 49.37

= 1014.65

% Change in value of Liabilities = -DL x Change in Yield

= - 4.24 x 0.01

= - 0.0424 or 4.24%

Therefore, Change in value of Liabilities =794.85 - 4.24%

= 794.85 – 33.70

= 761.15

Change in Net Worth = Change in value - Change in value Of Assets of liabilities

= 49.37 – 33.70

= 15.67 crores

Assets Liabilities

A Portfolio of Assets with a

Duration of 4.64 years

1014.65 A Portfolio of Liabilities with a

Duration of 4.24years

761.15

Equity + Reserves

269.17 – 15.67253.5

1014.65 1014.65

Thus, the net worth will decrease by 15.67 crores

Interest rate decreases by 1%

% Change in value of Assets = -DA X Change in Yield

= -4.64 x 0.01

= 0.0464 or 4.64%

Therefore, Change in value of Assets = 1064.02 + 4.64%

= 1064.02 + 49.37

= 1113.39

% Change in value of Liabilities = -DL x Change in Yield

= - 4.24 x 0.01

= - 0.0424 or 4.24%

Therefore, Change in value of Liabilities =794.85 + 4.24%

= 794.85 + 33.70

= 828.55

Change in Net Worth = Change in value - Change in value Of Assets of liabilities

= 49.37 – 33.70

= 15.67 crores

Assets Liabilities

A Portfolio of Assets with a

Duration of 4.64 years

1113.39 A Portfolio of Liabilities with a

Duration of 4.24years

828.55

Equity + Reserves

269.17+15.67284.84

1113.39 1113.39

Thus, the net worth will increase by 15.67 crores

LIQUIDITY RISK

Liquidity Risk can be calculated through various Liquidity Ratios such as:-

1. Liquid Assets to Total Assets

2. Loans to Deposit

3. Loans to Assets

4. Loans to Investment

5. Commitments to Total Assets

6. Net Cash Flow to Total Assets

7. Net Cash Flow to Total Liabilities

8. Net Cash Flow to Core Deposits

9. Net Cash Flow to Volatile Deposits

LIQUIDTY RATIO AT SURAT PEOPLE’S CO-OPERATIVE BANK

Liquidity ratios provide the primary means of judging a bank’s liquidity position.

For business firms, as we are aware “Current Ratio” (current assets divided by

current liabilities) forms the primary ratio to measure liquidity. However for banks

there are no universally recognized liquidity ratios. One reason for this is that

liabilities of non-financial firms are highly predictable because they have fixed

maturities while a large proportion of bank’s liabilities are repayable on demand.

Following liquidity ratios are generally analyzed by bank.

Liquid Assets To Total Assets

LIQUID ASSETS 2003 2004 2005 2006

Cash 8.47 6.41 7.68 6.89

Balance With RBI 31.80 31.90 34.55 41.02

Balance With Other Banks 135 90.83 95.04 137.04

Investment available for sales 285.02 375.80 357.47 289.97

Money market instrument 0 6.75 6.00 6.00

TOTAL 460.29 511.70 500.74 480.92

Total Assets 899.37 865.78 942.07 1064.02

Liquid Assets to Total Assets 51.18% 59.10% 53.15% 45.20%

Liquid Assets as a percent of total assets show the percentage of liquid assets in

the asset structure of the bank. So we can say that higher the proportion of

Liquid Assets in the Total assets, higher the liquidity of the bank.

For the Surat People’s Co-operative Bank, Liquid Assets to Total Assets as on

December 2003 was 51.18% While as on Dec 2004 it is 59.10% These assets

are presumed to be immediately convertible in to cash in case of any liquidity

requirements and the amounts provide a measure of liquidity position of the

bank. Thus on Dec 2005 was 53.15% while as on Dec 2006 was 45.20%.These

Assets are presumed to be as compared with last two years not to increases but

as compare it decrease it not good for bank but compare with other co-operative

bank its position of the bank is improving which shows the strong liquidity

position of the bank.

Loan to Deposits

2003 2004 2005 2006

Loans 323.02 339.86 337.63 396.49

Total Deposits 681.11 623.04 682.06 783.83

Loans to Total Deposits 47.42% 54.55% 49.50% 50.58%

Loans to deposits ratio indicates the degree to which the bank has already used

up its available resources to accommodate the credit needs of the customers.

The presumption is that the higher the ratio of loans to deposits, the less able the

bank will be to make addition loans. This ratio is normally 60% which indicate is

the good position. A high loan deposits ratio indicates that a bank has a large

proportion of its interest earning assets in loans and small percent in securities.

As loans are not easily saleable like securities, a high loan deposits ratio

indicates that a bank will have comparatively low liquidity.

However this ratio indicates nothing about the liquidity of the remaining assets or

the nature of bank are other liabilities, which could be a source of great liquidity.

In spite of this shortcoming, the loan to deposits ratio is useful as one in group of

liquidity ratios. The loan deposit ratio undoubtedly has a psychological impact on

bank management. As the ratio increases, lending policies may become more

cautious and selective. Obviously the total of loanable funds, roughly measured

as percentage of deposits, sets an upper limit to a bank’s ability to make

additional loans without recourse to more or less continuous borrowings.

Since loans to total deposits ratio has increased in 2006 as compared to previous

year, bank as comparatively low liquidity. But still difference is very less and bank

is till in good liquidity position.

Loan to Assets

2003 2004 2005 2006

Loans 323.02 339.86 337.63 396.49

Assets 899.37 865.78 942.07 1064.02

Loan to Assets 35.92% 39.25% 35.84% 37.26%

The loans, being liquid assets for a bank, this ratio indicate the percentage of

liquid assets to total assets. Arise in this ratio would indicate lower liquidity and

the need to evaluate other liquidity ratios. Loans to total assets for both-2005 &

2006 the year is nearly equal, thus bank has maintain its liquid position.

Loan to Investment

2003 2004 2005 2006

Loans 323.02 339.86 337.63 396.49

Investment 376.56 371.40 444.79 458.54

Loan to Investment 85.78% 91.50% 75.91% 86.47%

Bank has got two main channels for deployment of resources viz, loans and

investments. While loans are expected to provide higher returns compared to

investments, these suffer form higher credit risk and more illiquid then

investments. Thus a proper mix of loans and investments keeping in view

liquidity and yield considerations needs to be fixed.

Here ratio has increased from 85.78% in 2003 to 91.51% in 2004. Then it

decreases from 75.91% in 2005 & then it anginas increased 86.47%. Thus bank

is improving its position by maintain a good mix of loans and investment in the

portfolio.

Commitments to Total Assets

2003 2004 2005 2006

Commitments 217.28 467.82 432.52 296.72

Assets 899.37 865.78 942.07 1064.02

Commitments to total Assets 24.16% 54.03% 45.91% 27.89%

Commitments are total limits sanctioned for letters of credit, bank guarantees and

committed lines of credit. If a bank has a high level off of balance sheet exposure

compared to its total assets, it can create liquidity risk. Higher the ratio creates

the problem for bank in future.

Here ratio increased from 24.16% in 2003 to 54.03% in 2004. Thus it increased

more than double so it gives signal for liquidity problem in next year or in future

but bank can decreased their ratio from 45.91 in 2005 to from 27.89% in 2006 its

good for future.

Cash flow associated liquidity ratios.

The net cash flow or mismatch in cash inflow and outflows over a particular time

period serve as the basic parameter to assess the liquidity position of the bank.

Following ratio could be estimated for liquidity measurement.

Net Cash flow to total Assets

2003 2004 2005 2006

Net Cash Flow 26.66 32.59 7.01 23.32

Assets 899.37 865.78 942.07 1064.02

Net Cash flow to total Assets 2.96% 3.76% 0.74% 2.19%

Net cash flow to total assets will help in judging the impact of cash flow mismatch

on liquidity. A ratio of 10% – 15% may be considered a tolerable level. Since

here these percentages are only 2.96%, 3.76%, 0.74% and 2.19% for 2003,

2004, 2005 and 2006 respectively bank in not in a good position.

Net Cash flow to total Liabilities

2003 2004 2005 2006

Net Cash Flow 26.66 32.59 7.01 23.32

Liabilities 881.78 849.26 929.08 1052.41

Net Cash flow to total

Liabilities

3.02% 3.84% 0.75% 2.22%

Similarly, net cash flow to total liabilities will measure liquidity under conditions

when fluctuations in liabilities are major concern for meeting liquidity. A ratio of

10% - 15% may be considered a tolerable level. Since here these percentage are

3.02%, 3.84%, 0.75% and 2.22% respectively bank in not in good position.

Net Cash flow to Core Deposits

2003 2004 2005 2006

Net Cash Flow 26.66 32.59 7.01 23.32

Core Deposits 597.18 654.42 547.74 626.18

Net Cash flow to total Core

Deposits

4.46% 4.98% 1.29% 3.72%

The bank has to maintain sufficient liquidity to meet payment obligations on

withdrawal of these Deposits. This Ratio indicates the extent to which cash flows

are able to meet the demand from Depositors. A bank should not require a high

level of positive mismatch (Net cash flow) because core deposits are those which

remain with bank for considerable period of time. Here the ratios are nearly 4% -

5% for three years, which are sufficient to meet liabilities.

Net Cash flow to Volatile Deposits

2003 2004 2005 2006

Net Cash Flow 26.66 32.59 7.01 23.32

Volatile Deposits 26.73 28.19 22.66 23.97

Net Cash flow to total Volatile

Deposits

99.73% 115% 30.94% 97.29%

The bank has to maintain sufficient liquidity to meet payment obligations on

withdrawal of these Deposits. This ratio indicates the extent to which cash flows

are able to meet the demand form Depositors.

A bank should require a high level of positive mismatch (Net cash flow) because

volatile deposits are those, which are not remains with bank for considerable

period of time. Here the ratios are 99.73% for the year 2003 that is adequate, but

for the year 2004 it is 115%, which is not needed. Bank reduced the ratio in 2005

it is 30.94% then it increases for the year 2006 it is 97.29% its good for the bank.

The ratio must maintain the level up to 100%.

STAGE 3 – MANAGEMENT OF RISK

TRADITIONAL GAP METHOD

The bank should mange the gaps as close to zero as possible thus performing

Defensive Interest Sensitive Gap management.

However, a profit maximization approach, by taking positions in gaps based on a

view on interest rates would be considered Aggressive Management of Gaps.

Under this approach, the bank should try to reduce or increase the size of the

gaps according to their view on interest rate movements. But this involves

considerable risk for the banks in the event of the interest rate view turning to be

incorrect. Thus bank can mange gap by adopting following strategy.

1. If Interest rates are expected to increase in near future then Bank

should try to maintain Positive Gap (i.e. rate Sensitive assets are

more than the Rate Sensitive Liabilities) So that there will positive

impact on NII.

2. If interest rates are expected to Decrease in near future then Bank

should try to Maintain Negative Gap (i.e. Rate Sensitive Liabilities

are more than the Rates Assets) so that there will be a positive

impact on NII.

STANDARDIZED GAP METHOD

Gap model suggest that a bank which chooses not to speculate on future interest

rates can reduce interest rate risk by obtaining a Zero Gap. Then bank is fully

hedged because its interest rate risk is negligible. Alternatively, a bank may

choose to speculate on future interest rates and actively mange the Gap.

The bank should mange the gaps as close to zero as possible performing

Defensive Interest Sensitive Gap Management.

However, a profit maximization approach, by taking positions in gaps based on a

view on interest rates would be considered Aggressive Management of Gaps.

Under this approach, the bank should try to reduce or increase the size of the

gaps according to their view on interest rate movements. But this involves

considerable risk for the banks in the event of the interest rate view turning to be

incorrect. Thus bank can mange gap by adopting following strategy.

1. If Interest rates are expected to increase in near future then Bank should

try to maintain Positive Gap (i.e. rate Sensitive assets are more than the

Rate Sensitive Liabilities) So that there will positive impact on NII.

2. .If interest rates are expected to Decrease in near future then Bank should

try to Maintain Negative Gap (i.e. Rate Sensitive Liabilities are more than

the Rates Assets) so that there will be a positive impact on NII.

DURATION GAP METHOD

NATURE OF BANK INTEREST RATE

VIEW

MANAGEMENT

ACTION

POSSIBLE

OUTCOME IF VIEW

TURNS RIGHT

Risk Averse Rates will rise or fall Move Gap to Zero Net worth remains

unchanged

Risk Taker Rates will rise Move to Negative

Duration Gap

Net Worth increase

Risk Taker Rates will fall Move to positive

Duration Gap

Net Worth Increase

LIQUIDITY RISK

It can be known form the calculation of above liquidity Ratios that except few

ratios all the ratios are showing positive sign for liquidity position of the bank. The

ratios like liquid assets to total assets, loans to deposits, loan to total assets,

loans to investment and net cash flows to volatile deposits are showing good sign

for bank liquidity. So the bank should maintain such liquidity position. On the

other side bank has to focus on ratio, which is not favorable for liquidity position

of the bank.

CONCLUSION

After having training at Surat People’s Co-operative Bank I have found that

although today in the banking sector, Co-operative banks have failed in winning

the trust of the people, Surat People’s Co-operative Bank is successful in doing

so. It is having strong capital base which is the main strength of the bank.

Moreover, Bank has qualified, customer oriented and co-operative staff who can

take right action at right time which the basic requirement in today’s competitive

world.

After doing analysis about Assets-liability management. It was found that:

Bank has good liquidity position. Hence mismatch in Assets – Liability will

not match affected by the liquidity risk if bank maintain the same position

in future.

Although much wide Gap in assets and liabilities still the Interest rates

fluctuation, being beyond the control of the bank may pose problem for the

Assets – Liability Management of the bank.

RECOMMENDATION

To manage Interest rate risk bank should be allowed to deal in derivatives

for hedging purpose.

Bank can use various models and ratios suggested in this report for

interest rate risk and liquidity risk measurement.

Bank can follow risk management Techniques suggested for Assets –

liability Management.

Value at Risk Method is new method for quantification of risks. Through

this method, the current economic value of assets and liabilities are

arrived at by depreciation and appreciation of the original period value of

the product with the corresponding movements of the interest rates. – This

type of method does not take bank in their measurement of risk.

BIBLIOGRAPHY

References:

1. Business Research Methods

-Cooper and Shindler

2. Annual Reports of the Bank.

3. Risk Management – CAIIB

4. RBI – Report of ALM

- B. Raghavendran

5. State Bank of Hyderabad for ALM

– Report of Dilip Sarma (Economist)

Websites:

1. www.spcbl.com.

2. www.rbi.com.