ALM Guidelines Short

ASSET LIABILITY MANAGEMENT (ALM) History of bank failures in US 2012 - 23 2011 - 89 2010 - 157 2009 - 140 Components of a Bank Balance sheet Liabilities Assets Capital Reserve & Surplus Deposits Borrowings Other Liabilities Cash & Balances with RBI Bal With Banks & Money at Call and Short Notices Investments Advances Fixed Assets Other Assets Contingent Liabilities Business Risks • • • • • • • Operational Risk Credit Risk Market Risk Liquidity Risk Interest Rate Risk Foreign Exchange Risk Information Risk What is ALM ? Concerned with strategic Balance Sheet management Match between assets and liabilities in BS Risks stem from mismatch between A&L – credit, liquidity, interest, currency ALM is not to avoid risk but to manage risk, sustaining profitability What is ALM ? contd • Periodic monitoring of risk exposures involving collecting and analysing information • Ability to anticipate, forecast and act so as to structure bank’s business to profit Altering A & L portfolio in a dynamic way to manage risks • Involves judgement and decision making • Defining ALM ALM involves Planning, directing and Controlling the flow , mix, cost and yield of the consolidated funds of bank Assesses various asset mixes, funding combinations, price volume relations and their implications on Liquidity, Income and Capital ratio Planning procedure which accounts for all assets and liabilities of a bank by rate, amount and maturity Why ALM ? • Banks exposed to credit and market risks in view of asset-liability transformation • Risks increased with liberalisation and growing integration of domestic markets with external markets • Banks now operate in deregulated environment and are required to determine interest rates on various products Why ALM ? Contd • Need to maintain balance among spread, profitability and long-term viability • Increasing volatility in domestic interest rates as well as foreign exchange rates • New financial product innovation Why ALM ? Contd • Increased level of awareness among top management - market risks, interest rate movements • Intense competition for business involving both assets and liabilities Statement of structural liquidity Time buckets for maturity profile i 1-14 days ii 15-28 days iii 29 days and upto months iv Over months and upto months v Over months and upto year vi Over year and upto years vii.Over years and upto years viii.Over Over years Liquidity mismatches… contd • The mismatches during 1-14 & 15-28 days not to exceed 20% of cash outflows • Maturing liability is a cash outflow and maturing asset is a cash inflow • Tolerance level in mismatches to be determined based on asset-liability base, nature of business, future strategy etc • Banks to monitor their short term liquidity on a dynamic basis over a time horizon spanning from 1-90 days (short term dynamic liquidity statement) Estimation of short term dynamic liquidity Interest Rate Risk Interest rate risk is the risk where changes in the market interest rates might adversely affect a bank’s financial condition • Immediate impact would be on bank’s earnings by changing its NII • Long tem impact of changing interest rates would be on bank’s Net Worth • Interest rate risk is measured in terms of change in NII • Interest Rate Risk… • Traditional Gap analysis method is to be used now • Move over to modern techniques of Interest Rate Risk measurement like Duration Gap analysis, simulation, VAR gradually • Gap or Mismatch analysis measures gaps between rate sensitive assets and rate sensitive liabilities Interest Rate Risk-measurement • • • • • An asset or liability is considered rate sensitive if: Within the time interval under consideration there is a cash flow the interest rate resets/reprises contractually during the period RBI changes the interest rates It is contractually pre-payable or withdrawable before the stated maturity Interest rate sensitivity - Reporting format Interest Rate Risk-measurement • Gap report is generated by grouping the RSA, RSL into time buckets according to residual maturity or next reprising period, whichever is earlier • All investments, advances, deposits, borrowings, purchased funds etc that mature/reprise within a specified timeframe are interest rate sensitive Rate sensitive assets and liabilities Interest Rate Risk-Gap in time buckets  The gaps may be identified in the following time buckets i 1-28 days ii 29 days and upto months iii Over months and upto months iv Over months and upto year v Over year and upto years vi Over years and upto years vii Over years viii Non-sensitive Interest Rate Risk – Gap report • The gap is the difference between RSA and RSL for each time bucket • RSA>RSL - positive gap • RSA