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ASSET-LIABILITY MANAGEMENT SYSTEM. ALM. Presented by c.s.balakrishnan. WHY ALM?. Globalisation of financial markets. Deregulation of Interest Rates. Multi-currency Balance Sheet. Prevalance of Basis Risk and Embedded Option Risk.

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ASSET-LIABILITY MANAGEMENT SYSTEM

ALM

Presented by

c.s.balakrishnan


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WHY ALM?

  • Globalisation of financial markets.

  • Deregulation of Interest Rates.

  • Multi-currency Balance Sheet.

  • Prevalance of Basis Risk and Embedded Option Risk.

  • Integration of Markets – Money Market, Forex Market, Government Securities Market.

  • Narrowing NII / NIM.


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ALM

  • ALM is the process involving decision making about the composition of assets and liabilities including off balance sheet items of the bank / FI and conducting the risk assessment.


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ASSET LIABILITY MANAGEMENT

  • Various risks affecting banks / FIs

    • Credit, Market, Operational

    • Deregulation & competition

  • Need to manage risk to protect NIM

  • Need for proper risk mgt policy

  • Liquidity planning, interest rate risk management

    • ALM guidelines issued for banks in Feb 1999 and for FIs in Dec 1999


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Concept of ALM

  • ALM is concerned with strategic management of Balance Sheet by giving due weightage to market risks viz. Liquidity Risk, Interest Rate Risk & Currency Risk.

  • ALM function involves planning, directing, controlling the flow, level, mix, cost and yield of funds of the bank

  • ALM builds up Assets and Liabilities of the bank based on the concept of Net Interest Income (NII) or Net Interest Margin (NIM).


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WHAT IS ALM

  • ALM is concerned with strategic Balance Sheet management involving all market risks

  • It involves in managing both sides of balance sheet to minimise market risk


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ALM Objectives

  • Liquidity Risk Management.

  • Interest Rate Risk Management.

  • Currency Risks Management.

  • Profit Planning and Growth Projection.


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LIQUIDITY RISK

  • What is liquidity risk?

    • Liquidity risk refers to the risk that the institution might not be able to generate sufficient cash flow to meet its financial obligations

      EFFECTS OF LIQUIDITY CRUNCH

  • Risk to bank’s earnings

  • Reputational risk

  • Contagion effect

  • Liquidity crisis can lead to runs on institutions

    • Bank / FI failures affect economy


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LIQUIDITY RISK

  • Factors affecting liquidity risk

    • Over extension of credit

    • High level of NPAs

    • Poor asset quality

    • Mismanagement

    • Non recognition of embedded option risk

    • Reliance on a few wholesale depositors

    • Large undrawn loan commitments

    • Lack of appropriate liquidity policy & contingent plan


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LIQUIDITY RISK

  • Tackling the liquidity problem

    • A sound liquidity policy

    • Funding strategies

    • Contingency funding strategies

    • Liquidity planning under alternate scenarios

    • Measurement of mismatches through gap statements


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LIQUIDITY RISK

  • METHODOLOGIES FOR MEASUREMENT

    • Liquidity index

    • Peer group comparison

    • Gap between sources and uses

    • Maturity ladder construction


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LIQUIDITY RISK

  • RBI GUIDELINES

    • Structural liquidity statement

    • Dynamic liquidity statement

    • Board / ALCO

      • ALM Information System

      • ALM organisation

      • ALM process (Risk Mgt process)

    • Mismatch limits in the gap statement

    • Assumptions / Behavioural study


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ALM SYSTEM

  • Liquidity Gap report – fortnightly

    • 1-14 d & 15 – 28 d – tolerance limit

    • Fix cumulative gap limits

  • IRS statements – monthly

    • Fix prudential limits

  • To compile currency wise liquidity and IRS reports


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MATURITY PROFILE-LIQUIDITY

  • Outflows

    • Capital, Reserves & Surplus

    • Deposits

    • Borrowings and bonds

    • Other liabilities


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MATURITY PROFILE-LIQUIDITY

  • Inflows

    • Cash

    • Balance with RBI

    • Balance with other banks

    • Investments

    • Advances


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IRR - Relevance in India

  • Deregulation of interest rates brought:

    • Volatility in rates - call, PLR, Govt. securities Yield Curve

    • Competition - free pricing of assets and liabilities

    • Pressure on NII / NIM, MVE


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RSA, RSL

  • RSA (Rate Sensitive Assets) – Assets whose value is dependent on current interest rate

  • RSL (Rate Sensitive Liabilities) – Liabilities whose value is dependent on current interest rate


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Gap/Mismatch Risk

  • It arises on account of holding rate sensitive assets and liabilities with different principal amounts, maturity/repricing rates

  • Even though maturity dates are same, if there is a mismatch between amount of assets and liabilities it causes interest rate risk and affects NII



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ALM ORGANISATION

Three-tier organizational set-up for ALM Implementation :

  • Management Committee of the Board (MC)

    • Oversees the ALM implementation by ALCO

    • Reviews the ALM implementation periodically

    • Funding strategies for correcting the mismatches in ALM Statements.


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ASSET-LIABILITY MANAGEMENT COMMITTEE (ALCO)

- ALCO headed by E.D.

- GM (T) – (Nodal Officer).

- GMs : Central Accounts, P&D, Credit, Risk Management International Division are the members.

- GM (IT) & AGM (Economist) are the invitees for ALCO meetings.


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FUNCTIONS OF ALCO

Implementation of ALM System

  • Monitor the risk levels of the Bank.

  • Articulate the Interest Rate Position & fix interest rate on Deposits & Advances.

  • Fix differential rate of interest rate on Bulk Deposits.

  • Facilitating and coordinating to put in place the ALM System in the Bank.


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ALM STATEMENTS TO BE SUBMITTED TO RBI

  • Statement of Structural Liquidity (Annexure - I) [DSB Statement No.8] - Rupee

  • Statement of Interest Rate Sensitivity (Annexure - II) [DSB Statement No. 9] - Rupee

  • Statement of Dynamic Liquidity (Annexure - III)

  • Statement of Maturity and Position (MAP) (Annexure - IV) [DSB Statement No.10 ] - Forex

  • Statement of Sensitivity to Interest Rate (SIR)(Annexure - V)[DSB Statement No.11] - Forex


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Tools for ALM System

  • Gap Analysis

  • Modified Gap Analysis

  • Duration Gap Analysis

  • Value at Risk (VaR)

  • Simulation


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LIQUIDITY RISKS

  • Broadly of three types:

  • Funding Risk: Due to withdrawal/non-renewal of deposits

  • Time Risk: Non-receipt of inflows on account of assets(loan installments)

  • Call Risk: contingent liabilities & new demand for loans

  • Dynamic liquidity is done to measure the liquidity risks


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STATEMENT OF STRUCTURAL LIQUIDITY

  • Placed all cash inflows and outflows in the maturity ladder as per residual maturity

  • Maturing Liability: cash outflow

  • Maturing Assets : Cash Inflow

  • Classified in to 8 time buckets

  • Mismatches in the first two buckets not to exceed 20% of outflows

  • Banks can fix higher tolerance level for other maturity buckets.


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ADDRESSING TO MISMATCHES

  • Mismatches can be positive or negative

  • Positive Mismatch: M.A.>M.L. and vice-versa for Negative Mismatch

  • In case of +ve mismatch, excess liquidity can be deployed in money market instruments, creating new assets & investment swaps etc.

  • For –ve mismatch,it can be financed from market borrowings(call/Term),Bills rediscounting,repos & deployment of foreign currency converted into rupee.


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DYNAMIC LIQUIDITY

  • Prepared every fortnight for ALCO

  • Projection is given for the next three months

  • Tools for assessing the day to day liquidity needs of the bank


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STATEMENT OF INTEREST RATE SENSITIVITY

  • Generated by grouping RSA,RSL & OFF-Balance sheet items in to various (8)time buckets.

  • Positive gap : Beneficial in case of rising interest rate

  • Negative gap: Beneficial in case of declining interest rate


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CALCULATION OF NII/NIM

  • NII: INT.EARNED-INT. EXPENDED

  • INT. EARNED: ADV+INVEST+BALANCE WITH RBI

  • INT. EXPENDED:DEPOSITS+INT. ON RBI BORROWINGS

  • NIM= (NII/TOT.EARNING ASSET)X100


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SUCCESS OF ALM IN BANKS :PRE - CONDITIONS

  • Awareness for ALM in the Bank staff at all levels–supportive Management & dedicated Teams.

  • Method of reporting data from Branches/ other Departments. (Strong MIS).

  • Computerization - Full computerization, networking.

  • Insight into the banking operations, economic forecasting, computerization, investment, credit.

    5. Linking up ALM to future Risk Management Strategies.



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