Asset Liability Management
Asset Liability Management
Assets
1. Cash & Balances with RBI 2. Investments 3. Advances 4. Fixed Assets 5. Other Assets
Income: This includes Interest Income and Other Income. Expenses: This includes Interest Expended, Operating Expenses and Provisions & contingencies.
Objectives of ALM
To protect and enhance the net worth of the institution. Formulation of critical business policies and efficient allocation of Capital. To increase the Net Interest Income (NII) It is a quantification of the various risks in the balance sheet and optimizing of profit by ensuring acceptable balance between profitability, growth and risks. ALM should provide liquidity management within the institution and choose a model that yields a stable net interest income consistently while ensuring liquidity. To actively and judiciously leverage the balance sheet to stream line the management of regulatory capital. Funding of banks operation through capital planning. Product pricing and introduction of new products. To control volatility of market value of capital from market risk. Working out estimates of return and risk that might result from pursuing alternative programs.
Interest rate risk: Interest risk is the change in prices of bonds that could occur as a result of change in interest rates. Liquidity risk: Liquidity Risk is the risk stemming from the lack of marketability of an investment that cannot be bought or sold quickly enough to prevent or minimize a loss. Liquidity risk broadly comprises three sub-types: Funding risk Time risk Call risk
Elements of ALM
Strategic framework Organisational framework Operational framework Analytical framework Technology framework Information reporting framework Performance reporting framework Regulatory compliance framework Control framework
analysing the behaviour of asset and liability products in the top branches as they account for significant business then making rational assumptions about the way in which assets and liabilities would behave in other branches The data and assumptions can then be refined over time as the bank management gain experience
ALM Organization
The board should have overall responsibilities and should set the limit for liquidity, interest rate, foreign exchange and equity price risk
ALM Process
Risk Parameters Risk Identification Risk Measurement Risk Management
Permanent members: Chairman Managing Director/CEO Financial Director Risk Manager Treasury Manager ALCO officer Divisional Managers By invitation: Economist Risk Consultants
Techniques of ALM
Maturity Gap Analysis Duration Simulation Value at Risk
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
The basic weakness with this model is that this method takes into account only the book value of assets and liabilities and
Duration analysis
It is the weighted average time to maturity of all the preset values of cash flows
The larger the value of the duration, the more sensitive is the price of that asset or liability to changes in interest rates per the above equation, the bank will be immunized from interest rate risk if the duration gap between assets and the liabilities is zero.
As
Simulation analysis
Basically simulation models utilize computer power to provide what if scenarios, for example: What if:
The absolute level of interest rates shift Marketing plans are under-or-over achieved Margins achieved in the past are not sustained/improved Bad debt and prepayment levels change in different interest rate scenarios There are changes in the funding mix e.g.: an increasing reliance on short-term funds for balance sheet growth
Refers to the maximum expected loss that a bank can suffer in market value or income: Over a given time horizon, Under normal market conditions, At a given level or certainty It enables the calculation of market risk of a portfolio for which no historical data exists. VAR serves as Information Reporting to stakeholders It enables one to calculate the net worth of the organization at any particular point of time so that it is possible to focus on long-term risk implications of decisions that have already been taken or that are going to be taken