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Asset Liability Management in Banks. [Module A]. Live Interactive Learning Session- 16-04-2007. Presentation by S P Dhal, Faculty Member, SPBT College. Components of a Bank Balance sheet. Contingent Liabilities . Components of Liabilities . Capital :

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presentation by s p dhal faculty member spbt college

Asset Liability Management

in Banks

[Module A]

Live Interactive Learning Session- 16-04-2007

Presentation by S P Dhal, Faculty Member, SPBT College

components of a bank balance sheet
Components of a Bank Balance sheet

Contingent Liabilities

components of liabilities
Components of Liabilities
  • Capital:
  • Capital represents owner’s contribution/stake in the bank.
  • It serves as a cushion for depositors and creditors.
  • It is considered to be a long term sources for the bank.
components of liabilities1
Components of Liabilities

2. Reserves & Surplus

Components under this head includes:

I. Statutory Reserves

  • Capital Reserves
  • Share Premium

III. Revenue and Other Reserves

IV. Balance in Profit and Loss Account

components of liabilities2
Components of Liabilities

3. Deposits

This is the main source of bank’s funds. The deposits are classified as deposits payable on ‘demand’ and ‘time’. They are reflected in balance sheet as under:

I. Demand Deposits

II. Savings Bank Deposits

III. Term Deposits

components of liabilities3
Components of Liabilities

4. Borrowings

(Borrowings include Refinance / Borrowings from RBI, Inter-bank & other institutions)

I. Borrowings in India

i) Reserve Bank of India

ii) Other Banks

iii) Other Institutions & Agencies

II. Borrowings outside India

components of liabilities4
Components of Liabilities

5. Other Liabilities & Provisions

It is grouped as under:

I. Bills Payable

II. Inter Office Adjustments (Net)

III. Interest Accrued

IV. Unsecured Redeemable Bonds

(Subordinated Debt for Tier-II Capital)

V. Others(including provisions income tax, TDS, Interest Tax, Provisions etc.)

components of assets
Components of Assets
  • Cash & Bank Balances with RBI

I. Cash in hand

(including foreign currency notes)

II. Balances with Reserve Bank of India

In Current Accounts

In Other Accounts

components of assets1
Components of Assets


I. In India

i) Balances with Banks

a) In Current Accounts

  b) In Other Deposit Accounts

ii) Money at Call and Short Notice

a) With Banks

  b) With Other Institutions

II. Outside India

a) In Current Accounts

b) In Other Deposit Accounts

c) Money at Call & Short Notice

components of assets2
Components of Assets

3. Investments

A major asset item in the bank’s balance sheet. Reflected under 6 buckets as under:

I. Investments in India in : *

i) Government Securities

ii) Other approved Securities

iii) Shares

iv) Debentures and Bonds

v) Subsidiaries and Sponsored Institutions

vi) Others (UTI Shares , Commercial Papers, COD &

Mutual Fund Units etc.)

II. Investments outside India in **

Subsidiaries and/or Associates abroad

components of assets3
Components of Assets

4. Advances

The most important assets for a bank.

A. i) Bills Purchased and Discounted

ii) Cash Credits, Overdrafts & Loans

repayable on demand

iii) Term Loans

B.Particulars of Advances :

i) Secured by tangible assets

(including advances against Book Debts)

ii) Covered by Bank/ Government Guarantees

iii) Unsecured

components of assets4
Components of Assets

5. Fixed Asset

I. Premises

II. Other Fixed Assets (Including furniture and fixtures)

6. Other Assets

I.Interest accrued

  II. Tax paid in advance / tax deducted at source

(Net of Provisions)

  III. Stationery and Stamps

  IV. Non-banking assets acquired in satisfaction of claims

  V. Deferred Tax Asset (Net)

 VI. Others

contingent liability
Contingent Liability

Bank’s obligations under LCs, Guarantees, Acceptances on behalf of constituents and Bills accepted by the bank are reflected under this heads.

It also includes Un-called part of Partly Paid Investment.

banks profit loss account
Banks Profit & Loss Account

A bank’s profit & Loss Account has the following components:

  • Income: This includes Interest Income and Other Income.

II. Expenses: This includes Interest Expended, Operating Expenses and Provisions & contingencies.

components of income
Components of Income

I. Interest/Discount on Advances / Bills

 II. Income on Investments

 III. Interest on balances with Reserve Bank

of India and other inter-bank funds

 IV. Others

components of income1
Components of Income


I. Commission, Exchange and Brokerage

II. Profit on sale of Investments (Net)

III. Profit/(Loss) on Revaluation of Investments

IV. Profit on sale of land, buildings and other

assets (Net)

V. Profit on exchange transactions (Net)

VI. Income earned by way of dividends etc. from subsidiaries and Associates abroad/in India

VII. Miscellaneous Income

components of expenses
Components of Expenses

I. Interest on Deposits

II. Interest on Reserve Bank of India / Inter-Bank


III. Others

components of expenses1
Components of Expenses


I. Payments to and Provisions for employees

II. Rent, Taxes and Lighting

 III. Printing and Stationery

IV. Advertisement and Publicity

 V. Depreciation on Bank's property

VI. Directors' Fees, Allowances and Expenses

 VII. Auditors' Fees and Expenses (including Branch Auditors)

 VIII. Law Charges

  IX. Postages, Telegrams, Telephones etc.

  X. Repairs and Maintenance

  XI. Insurance

 XII. Other Expenditure

provisions contingencies
Provisions & Contingencies
  • Provision Made for:

- Bad & Doubtful debts

- Taxation

- Depreciation/Diminution in value of Investment

- Other Provisions

assets liability management


Assets Liability Management

It is a dynamic process of Planning, Organizing & Controlling of Assets & Liabilities- their volumes, mixes, maturities, yields and costs in order to maintain liquidity and NII.


Financial Intermediation-Qualitative Asset Transformation

  • Liquidity and payment intermediation
    • Liquid deposits vs illiquid credits
  • Maturity intermediation
    • Short-term deposits vs long-term credits
  • Denomination intermediation
    • Small-denomination deposits vs large credits
  • Diversification intermediation
    • Investors have a claim against a well-diversified portfolio
  • Information intermediation
    • FIs acquire information about the borrowers, provide them with funds, and monitor their performance
    • Incentives for monitoring: rents or reputation
significance of alm
Significance ofALM
  • Volatility
  • Product Innovations & Complexities
  • Integration of Markets
  • Regulatory Environment
  • Management Recognition
purpose objective of alm
Purpose & Objective of ALM

An effective Asset Liability Management Technique aims to manage the volume, mix, maturity, rate sensitivity, quality and liquidity of assets and liabilities as a whole so as to attain a predetermined acceptable risk/reward ratio.

It is aimed to stabilize short-term profits, long-term earnings and long-term substance of the bank. The parameters for stabilizing ALM system are:

1. Net Interest Income (NII)

2. Net Interest Margin (NIM)

3. Economic Equity Ratio

rbi directives
  • Issued draft guidelines on 10th Sept 1998.
  • Final guidelines issued on 10th Feb’99 for implementation of ALM w.e.f. 01.04.99.
  • To begin with 60% of asset & liabilities are covered; 100% from 01.04.2000.
  • Initially Gap Analysis was applied in the first stage of implementation.
  • Disclosure to Balance Sheet on maturity pattern on Deposits, Borrowings, Investment & Advances w.e.f. 31.03.01
liquidity management
Liquidity Management

Bank’s liquidity management is the process of generating funds to meet contractual or relationship obligations at reasonable prices at all times.

New loan demands, existing commitments, and deposit withdrawals are the basic contractual or relationship obligations that a bank must meet.

adequacy of liquidity position for a bank
Adequacy of liquidity position for a bank

Analysis of following factors throw light on a bank’s adequacy of liquidity position:

  • Historical Funding requirement
  • Current liquidity position
  • Anticipated future funding needs
  • Sources of funds
  • Options for reducing funding needs
  • Present and anticipated asset quality
  • Present and future earning capacity and

h. Present and planned capital position

factors that may affect a bank s liquidity include
Factors that may affect a bank’s liquidity include:
  • A decline in earnings
  • An increase in Non-Performing assets
  • Deposit concentration
  • A down grading by Rating Agencies
  • Expanded Business Opportunity
  • Acquisitions
  • New Tax initiatives
funding avenues
Funding Avenues

To satisfy funding needs, a bank must perform one or a combination of the following:

  • Dispose off liquid assets
  • Increase short term borrowings
  • Decrease holding of less liquid assets
  • Increase liability of a term nature
  • Securitization of Assets

f. Increase Capital funds

types of liquidity risk
Types of Liquidity Risk
  • Liquidity Exposure can stem from both internally and externally.
  • External liquidity risks can be geographic, systemic or instrument specific.
  • Internal liquidity risk relates largely to perceptions of an institution in its various markets: local, regional, national or international
other categories of liquidity risk
Other categories of liquidity risk
  • Funding Risk

- Need to replace net outflows due to unanticipated withdrawals/non-renewal

Arises due to:

      • Fraud Causing substantial loss
      • Systemic risk
      • Loss of Confidence
      • Liabilities in Foreign Currencies
other categories of liquidity risk1
Other categories of liquidity risk
  • Time Risk

- Need to compensate for non-receipt of expected inflows of funds

Arises due to:

- Severe deterioration in asset quality

- Standard assets turning into NPA

- Temporary Problem in recovery

- Time involved in managing liquidity

other categories of liquidity risk2
Other categories of liquidity risk
  • Call Risk
      • Crystallization of contingent liability

Arises due to:

        • Conversion of non-fund based limit to fund based limit
        • Swaps and Options
measuring managing liquidity risk
Measuring & Managing Liquidity Risk

Steps necessary for managing liquidity risks in Banks

  • Developing a structure for managing liquidity risk
  • Setting tolerance level and limit for liquidity risk
  • Measuring and Managing Liquidity Risk
setting tolerance level and limit for liquidity risk
Setting tolerance level and limit for liquidity risk

Limits could be set on the following lines:

  • Cumulative cash flow mismatches over particular period taking conservative view of marketable liquid assets
  • Liquid assets as percentage of short-term liabilities
  • A limit on Loan to deposit ratio
  • A limit on loan to capital ratio
  • Primary sources for meeting funding needs should be quantified
  • Flexible liquidity provision to be maintained to sustain operations
measuring and managing liquidity risk
Measuring and Managing Liquidity Risk

Measuring and Managing funding requirement can be done through two approaches:

  • Stock Approach
  • Flow Approach
stock approach
Stock Approach

This Approach is based on the level of assets and liabilities as well as Off-Balance sheet exposures on a particular date.

  • Ratio of Core Deposit to total Assets:

Core Deposit/Total Asset: More the ratio better it is because core deposit treated to be the stable source of liquidity.

  • Net Loans to Total deposits Ratio:

Net Loans/Total Deposit: It reflects the ratio of loans to Public Deposits or core deposits. Lower the ratio is the better.

stock approach1
Stock Approach
  • Ratio of Time Deposit to Total Deposits:

Time Deposits/Total Deposits:

Higher the Ratio better

  • Ratio of Volatile liabilities to total assets

Volatile Liabilities/Total Assets

Lower the Ratio the Better

  • Ratio of Short Term Liabilities to Liquid Assets:

Short Term Liabilities/Liquid Assets:

Lower the Ratio the better

stock approach2
Stock Approach
  • Ratio of Liquid Assets to Total Assets:

Higher the Ratio the better

  • Ratio of Short Term Liability/Total Assets:

A lower ratio is desirable

  • Ratio of Prime Asset to Total Asset:

Higher the ratio the better

  • Ratio of Marketable liability to total asset:

Lower the ratio better

N.B>Indian Banks do not follow this approach

flow approach
Flow Approach

The Frame work for assessing and managing bank liquidity through flow approach has three major dimensions:

  • Measuring and Managing net funding requirements
  • Managing market access, and
  • Contingency Planning
statement of structural liquidity
Statement of Structural Liquidity

All Assets & Liabilities to be reported as per their maturity profile into 8 maturity Buckets:

  • 1 to 14 days
  • 15 to 28 days
  • 29 days and up to 3 months
  • Over 3 months and up to 6 months
  • Over 6 months and up to 1 year
  • Over 1 year and up to 3 years
  • Over 3 years and up to 5 years
  • Over 5 years
statement of structural liquidity1
  • Places 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
  • Shows the structure as of a particular date
  • Banks can fix higher tolerance level for other maturity buckets.
addressing the mismatches
  • Mismatches can be positive or negative
  • Positive Mismatch: M.A.>M.L. and Negative Mismatch M.L.>M.A.
  • 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.
  • To meet the mismatch in any maturity bucket, the bank has to look into taking deposit and invest it suitably so as to mature in time bucket with negative mismatch.
  • The bank can raise fresh deposits of Rs 300 crore over 5 years maturities and invest it in securities of 1-29 days of Rs 200 crores and rest matching with other out flows.
maturity pattern of select assets liabilities of a bank



(In Cr)

In Percentage

I. Deposits

a. Up to 1 year

b. Over 1 yr to 3 yrs

c. Over 3 yrs to 5 yrs

d. Over 5 years











II. Borrowings

a. Up to 1 year

b. Over 1 yr to 3 yrs

c. Over 3 yrs to 5 yrs

d. Over 5 years











III. Loans & Advances

a. Up to 1 year

b. Over 1 yr to 3 yrs

c. Over 3 yrs to 5 yrs

d. Over 5 years











Iv. Investment

a. Up to 1 year

b. Over 1 yr to 3 yrs

c. Over 3 yrs to 5 yrs

d. Over 5 years











Maturity Pattern of Select Assets & Liabilities of A Bank

Interest Rate Sensitivity Analysis

  • Structural Liquidity Statement is the basis for IRS analysis. All off balance sheet items are excluded except Repos, Reverse Repos and SWAPs.
  • Non-sensitive assets / liabilities are shifted to non-sensitive bucket (like Capital, Reserves, Fixed Assets etc).
  • A perception of likely interest rate scenario is formed. Accordingly, re-pricing effect is assessed for all RSA / RSL.
  • Rate sensitive gaps are assessed from the analysis.
statement of interest rate sensitivity
  • Generated by grouping RSA,RSL & OFF-Balance sheet items in to various (8)time buckets.




maturity gap method irs
  • A) RSA>RSL= Positive Gap
  • B) RSL>RSA= Negative Gap
  • C) RSL=RSA= Zero Gap
interest rate risk management
Interest Rate Risk Management
  • Interest Rate risk is the exposure of a bank’s financial conditions to adverse movements of interest rates.
  • Though this is normal part of banking business, excessive interest rate risk can pose a significant threat to a bank’s earnings and capital base.
  • Changes in interest rates also affect the underlying value of the bank’s assets, liabilities and off-balance-sheet item.
interest rate risk
Interest Rate Risk
  • Interest rate risk refers to volatility in Net Interest Income (NII) or variations in Net Interest Margin(NIM).
  • Therefore, an effective risk management process that maintains interest rate risk within prudent levels is essential to safety and soundness of the bank.
sources of interest rate risk
Sources of Interest Rate Risk
  • Interest rate risk mainly arises from:
    • Gap Risk
    • Basis Risk
    • Embedded Option Risk
    • Yield Curve Risk
    • Price Risk
    • Reinvestment Risk
measurement of interest rate risk
Measurement of Interest Rate Risk
  • Gap Analysis- Simple maturity/re-pricing Schedules can be used to generate simple indicators of interest rate risk sensitivity of both earnings and economic value to changing interest rates.

- If a negative gap occurs (RSA<RSL) in given time band, an increase in market interest rates could cause a decline in NII.

- conversely, a positive gap (RSA>RSL) in a given time band, an decrease in market interest rates could cause a decline in NII.


Interest Rate Risk

  • The risk that the returns on funds to be reinvested will fall below the originally anticipated returns.



2 years



1 year

measurement of interest rate risk1
Measurement of Interest Rate Risk
  • Duration Analysis: Duration is a measure of the percentage change in the economic value of a position that occur given a small change in level of interest rate.

MARKET RISK: Measure, Monitor & Manage

– Value at Risk


Value-at-Risk is a measure of Market Risk, which measures the maximum loss in the market value of a portfolio with a given confidence

VaR is denominated in units of a currency or as a percentage of portfolio holdings

For e.g.., a set of portfolio having a current value of say Rs.100,000- can be described to have a daily value at risk of Rs. 5000- at a 99% confidence level, which means there is a 1/100 chance of the loss exceeding Rs. 5000/- considering no great paradigm shifts in the underlying factors.

It is a probability of occurrence and hence is a statistical measure of risk exposure


The Success of ALM rests of effective existence of:

  • ALM Information System

- Management Information System (MIS)

- Information Availability, Accuracy, Adequacy and expediency

  • ALM Organization
  • ALM Process

ALM Information System

  • Information is key to the ALM Process
  • Due to varied nature of business focus among Public/Private/Foreign Banks, uniform practice of ALM System not feasible
  • Data Accuracy, Quality & timeliness are key to ALM information system
  • Banks with wide geographical reach and manual system required to follow ABC Approach so as to cover maximum assets and liabilities for analyzing their behaviour.
  • The level of computerization, use of Core Banking Solution will ease the ALM Information System.

ALM Organization

  • ALCO Committee
    • Should be headed by CEO/CMD or ED
    • Members include head of Investment, Credit, Funds & Treasury (Fx & Domestic), International Banking and Economic Research can be members. In addition, head of IT should also be an invitee for building up of MIS/Computerization.
    • The Management Committee of the Board or any other specific Committee constituted by the Board should oversee the implementation of system & review its functioning periodically.

ALM Process

  • The Scope of ALM functions can be described as follows:

- Liquidity Management

- Management of Interest Rate Risk/Market Risk

- Funding & Capital Planning

- Profit planning and Growth Projections

- Trading Risk Management



  • 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.

tea break


We will be back in 10 minutes