RESEARCH REPORT ON

Theoritical & Practical Aspect Of Asset & Liability Management In Commercial Bank(HDFC)
Submitted in the partial fulfillment of the degree of the award of Master of Business Administration (MBA)

Submitted To

Submitted by:

Mrs. Vandana Nigam (Lecturer) (Sherwood College Of Management, Lucknow)

Mohd Salman Ahmad MBA 4th Semester Roll No.:1106170075

SHERWOOD COLLEGE OF MANAGEMENT SEC-25 INDIRANAGAR, LUCKNOW

SHERWOOD COLLEGE OF MANAGEMENT

Approved by AICTE. Ministry of HRD, Govt. of India & Affiliated to G.B. Technical University, Lucknow

(Under the Management of U.S. Srivastava Memorial Education Society)

Sector-25, Indra Nagar, Lucknow 226016. (U.P.) INDIA Ph.: (0522) 2716630
Fax: 0522-2716526, Phone: 0522-2716630, Website: www.sherwooindia.in, E-mail: scm@sherwooindia.in

Date: __________

CERTIFICATE
This is to certify that Mr .Mohd Salman Ahmad of Master of Business Administration session 2012-2013 has completed his Research Report on the Topic Theoritical & Practical Aspect of Asset & Liability Management in Commercial Bank(HDFC) for partial fulfillment for award of Master of Business Administration. The Report submitted by him is a genuine work done by him and the same is being submitted for evaluation.

(Dr. Vivek Inder Kochhar) Professor, Director

(Mrs. Vandana Nigam) Internal Guide

Place: Lucknow Date:

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PREFACE

Asset-Liability Management (ALM) can be termed as a risk management technique designed to earn an adequate return while maintaining a comfortable surplus of assets beyond liabilities. It takes into consideration interest rates, earning power, and degree of willingness to take on debt and hence is also known as Surplus Management. But in the last decade the meaning of ALM has evolved. It is now used in many different ways under different contexts. ALM, which was actually pioneered by financial institutions and banks, are now widely being used in industries too. The Society of Actuaries Task Force on ALM Principles, Canada, offers the following definition for ALM: "Asset Liability Management is the on-going process of formulating, implementing, monitoring, and revising strategies related to assets and liabilities in an attempt to achieve financial objectives for a given set of risk tolerances and constraints." The need of the study is to concentrates on the growth and performance of The Housing Development Finance Corporation Limited (HDFC) and to calculate the growth and performance by using asset and liability management. And to know the management of nonperforming assets. To know financial position of The Housing Development Finance Corporation Limited (HDFC)

The burden of the Risk and its Costs are both manageable and transferable. Financial service firms, in the addition to managing their own risk, also sell financial risk management to others. They sell their services by bearing customers financial risks through the products they provide. A financial firm can offer a fixed-rate loan to a borrower with the risk of interest rate movements transferred from the borrower to the . Financial innovations have been concerned with risk reduction then any other subject. With the possibility of managing risk near zero, the challenge becomes not how much risk can be removed.

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ACKNOWLEDGEMENT

During the entire research project work I have received endless help from my all teachers who encouraged me for developing ideas and supported me in each and every step for completing the whole project.

I am greatly thankful to Dr. Vivek Inder Kochhar (Prof. Director, SCM, Lucknow) and my project guide Mrs. Vandana Nigam (Lecturer, SCM, Lucknow) for assigning an innovative project that developed a feeling of fully practical work.

I owe my humble gratitude to all those treasures of knowledge that are equally responsible for the successful completion of this task.

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INDEX PAGE NO. Certificate Preface Acknowledgement Chapter-1: Introduction on topic Chapter 2 : Literature Review ii iii iv 1

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Chapter - 3 : Research Methodlogy Research Objective Research Design Sampling Plan Sampling Technique Sample Unit

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Chapter - 3 :Data Analysis and Findings Chapter 4: Suggestion and Recommendation Chapter 5: Conclusion

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Limitation of the Study Bibliography

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CHAPTER-I INTRODUCTION

INTRODUCTION

Asset Liability Management (ALM) is a strategic approach of managing the balance sheet dynamics in such a way that the net earnings are maximized. This approach is concerned with management of net interest margin to ensure that its level and riskiness are compatible with the risk return objectives. If one has to define Asset and Liability management without going into detail about its need and utility, it can be defined as simply management of money which carries value and can change its shape very quickly and has an ability to come back to its original shape with or without an additional growth. The art of proper management of healthy money is ASSET AND LIABILITY MANAGEMENT (ALM The Liberalization measures initiated in the country resulted in revolutionary changes in the sector. There was a shift in the policy approach from the traditionally administered market regime to a free market driven regime. This has put pressure on the earning capacity of co-operative, which forced them to foray into new operational areas thereby exposing themselves to new risks. As major part of funds at the disposal from outside sources, the management is concerned about RISK arising out of shrinkage in the value of asset, and managing such risks became critically important to them. Although co-operatives are able to mobilize deposits, major portions of it are high cost fixed deposits. Maturities of these fixed deposits were not properly matched with the maturities of assets created out of them. The tool called ASSET AND LIABILITY MANAGEMENT provides a better solution for this. ASSET LIABILITY MANAGEMENT (ALM) is a portfolio management of assets and liability of an organization. This is a method of matching various assets with liabilities on the basis of expected rates of return and expected maturity pattern In the context of ALM is defined as a process of adjusting s liability to meet loan demands, liquidity needs and safety requirements. This will result in optimum value of the same time reducing the risks faced by them and managing the different types of risks by keeping it within acceptable levels.

RBI REVISES ASSET LIABILITY MANAGEMENT GUIDELINES February 6/2012In the era of changing interest rates, Reserve Bank of India (RBI) has now revised its Asset Liability Management guidelines. Banks have now been asked to calculate modified duration of assets (loans) and liabilities (deposits) and duration of equity. This was stated by the executive director of RBI, V K Sharma, and here today. He said that this concept gives banks a single number indicating the impact of a 1 per cent change of interest rate on its capital, captures the interest rate risk, and can thus help them move forward towards assessment of risk based capital. This approach will be a graduation from the earlier approach, which led to a mismatch between the assets and liabilities. The ED said that RBI has been laying emphasis that banks should maintain a more realistic balance sheet by giving a true picture of their non performing assets (NPAs), and they should not be deleted to show huge profits. Though the banking system in India has strong risk management architecture, initiatives have to be taken at the bank specific level as well as broader systematic level. He also emphasized on the need for sophisticated credit-scoring models for measuring the credit risks of commercial and industrial portfolios. Emphasizing on a need for an effective control system to manage risks, he said that the implementation of BASEL II norms by commercial banks should not be delayed. He said that the banks should have a robust stress testing process for assessment of capital adequacy in wake of economic downturns, industrial downturns, market risk events and sudden shifts in liquidity conditions. Stress tests should enable the banks to assess risks more accurately and facilitate planning for appropriate capital requirements. Sharma spoke at length about the need to extend the framework of integrated risk management to group-wide level, especially among financial conglomerates. He said that RBI has already put in place a framework for oversight of financial conglomerates, along with SEBI and IRDA. He also said that at the systematic level

efforts are being made to create an enabling environment for all market participants in terms of regulation, infrastructure and instruments.

OVERVIEW OF THE INDUSTRY

HDFC is India's premier housing finance company and enjoys an impeccable track record in India as well as in international markets. Since its inception in 1977, the Corporation has maintained a consistent and healthy growth in its operations to remain the market leader in mortgages. Its outstanding loan portfolio covers well over a million dwelling units. HDFC has developed significant expertise in retail mortgage loans to different market segments and also has a large corporate client base for its housing related credit facilities. With its experience in the financial markets, a strong market reputation, large shareholder base and unique consumer franchise, HDFC was ideally positioned to promote a bank in the Indian environment. As on 31st December, 2009 the authorized share capital of the Bank is Rs. 550 crore. The paid-up capital as on said date is Rs. 455,23,65,640/- (45,52,36,564 equity shares of Rs. 10/- each). The HDFC Group holds 23.87 % of the Bank's equity and about 16.94 % of the equity is held by the ADS Depository (in respect of the bank's American Depository Shares (ADS) Issue). 27.46 % of the equity is held by Foreign Institutional Investors (FIIs) and the Bank has about 4,58,683 shareholders. The shares are listed on the Bombay Stock Exchange Limited and The National Stock Exchange of India Limited. The Bank's American Depository Shares (ADS) are listed on the New York Stock Exchange (NYSE) under the symbol 'HDB' and the Bank's Global Depository Receipts (GDRs) are listed on Luxembourg Stock Exchange under ISIN No US40415F2002. Mr. Jagdish Capoor took over as the bank's Chairman in July 2001. Prior to this, Mr. Capoor was Deputy Governor of the RBI

MANAGEMENT The Managing Director, Mr. Aditya Puri, has been a professional banker for over 25 years, and before joining HDFC Bank in 1994 was heading Citibank's operations in Malaysia.The Bank's Board of Directors is composed of eminent individuals with a wealth of experience in public policy, administration, industry and commercial banking. Senior executives representing HDFC are also on the Board. Senior banking professionals with substantial experience in India and abroad head various businesses and functions and report to the Managing Director. Given the professional expertise of the management team and the overall focus on recruiting and retaining the best talent in the industry, the bank believes that its people are a significant competitive strength.

BOARD OF DIRECTORS Mr. Jagdish Capoor, Chairman Mr. Keki Mistry Mrs. Renu Karnad Mr. Arvind Pande Mr. Ashim Samanta Mr. Chander Mohan Vasudev Mr. Gautam Divan Dr. Pandit Palande Mr. Aditya Puri, Managing Director Mr. Harish Engineer, Executive Director Mr. Paresh Sukthankar, Executive Director Mr. Vineet Jain (upto 27.12.2008)

REGISTERED OFFICE:-

HDFC Bank House, Senapati Bapat Marg, Lower Parel, Website: www.hdfcbank.com HDFC Bank offers a wide range of commercial and transactional banking services and treasury products to wholesale and retail customers. The bank has three key business segments Wholesale Banking Services:-

The Bank's target market ranges from large, blue-chip manufacturing companies in the Indian corporate to small & mid-sized corporates and agri-based businesses. For these customers, the Bank provides a wide range of commercial and transactional banking services, including working capital finance, trade services, transactional services, cash management, etc. The bank is also a leading provider of structured solutions, which combine cash management services with vendor and distributor finance for facilitating superior supply chain management for its corporate customers. Based on its superior product delivery / service levels and strong customer orientation, the Bank has made significant inroads into the banking consortia of a number of leading Indian corporates including multinationals, companies from the domestic business houses and prime public sector companies. It is recognised as a leading provider of cash management and transactional banking solutions to corporate customers, mutual funds, stock exchange members and banks.

Retail Banking Services:-

The objective of the Retail Bank is to provide its target market customers a full range of financial products and banking services, giving the customer a one-stop window for all his/her banking requirements. The products are backed by world-class service and delivered to customers through the growing branch network, as well as through alternative delivery channels like ATMs, Phone Banking, NetBanking and Mobile Banking. The HDFC Bank Preferred program for high net worth individuals, the HDFC Bank Plus and the Investment Advisory Services programs have been designed keeping in mind needs of customers who seek distinct financial solutions, information and advice on various investment avenues. The Bank also has a wide array of retail loan products including Auto Loans, Loans against marketable securities, Personal Loans and Loans for Two-wheelers. It is also a leading provider of Depository Participant (DP) services for retail customers, providing customers the facility to hold their investments in electronic form. HDFC Bank was the first bank in India to launch an International Debit Card in association with VISA (VISA Electron) and issues the Mastercard Maestro debit card as well. The Bank launched its credit card business in late 2001. By March 2009, the bank had a total card base (debit and credit cards) of over 13 million. The Bank is also one of the leading players in the merchant acquiring business with over 70,000 Point-of-sale (POS) terminals for debit / credit cards acceptance at merchant establishments. The Bank is well positioned as a leader in various net based B2C opportunities including a wide range of internet banking services for Fixed Deposits, Loans, Bill Payments, etc.

Treasury:Within this business, the bank has three main product areas - Foreign Exchange and Derivatives, Local Currency Money Market & Debt Securities, and Equities. With the liberalisation of the financial markets in India, corporates need more sophisticated risk management information, advice and product structures. These and fine pricing on various treasury products are provided through the bank's Treasury team. To comply with statutory reserve requirements, the bank is required to hold 25% of its deposits in government securities. 7

Awards and Achievements - Banking Services:2011 - Best Bank - Runner Up Outlook Money Best Bank Award 2011 Best Commercial Vehicle Financier Businessworld Best - Best Bank Bank award BCI Continuity & Resilience Award Financial Express Best Bank Survey 2010-11 CNBC TV18's Best - Best Bank Bank & Financial Institution Awards Dun & Bradstreet Banking Awards 2011 ISACA 2011 award Best practices in IT Governance and IT Security for IT Governance IBA Productivity Excellence Awards 2011 DSCI (Data Security Council of Security in Bank New Channel Adopter (Private Sector) Best Private Sector Bank - SME Financing - Mr. Aditya Puri, Outstanding Finance Professional - Best in Strength and Soundness - 2nd Best in the Private Sector - Most Effective Recovery of the Year - Driving Positive Change

India) Excellence Awards 2011 Euromoney Awards Best Bank in India for Excellence 2011 FINANCE ASIA Country Awards 2011: India Asian Banker BloombergUTV's Financial Leadership Awards 2011 IBA Banking Technology Awards 2010 Winner 1) Technology Bank of the Year 2) Best Online Bank 3) Best Customer Initiative 4) Best Use of Business Intelligence 5) Best Risk Management System Runners Up Best Financial Inclusion IDC FIIA Awards 2011 Excellence in Customer Experience - BEST BANK - BEST CASH MANAGEMENT BANK - BEST TRADE FINANCE BANK Strongest Bank in Asia Pacific Best Bank

2010 Global Finance Award 2 Banking Technology 1) Best Risk Management Initiative and 2) Best Use of Business Intelligence. Best Trade Finance Provider in India for 2010

Awards 2009 SPJIMR Marketing Impact Awards (SMIA) 2010 Business Today Best Employer Survey Listed in top 10 Best Employers in the country 2nd Prize

Corporate Governance:The bank was among the first four companies, which subjected itself to a Corporate Governance and Value Creation (GVC) rating by the rating agency, The Credit Rating Information Services of India Limited (CRISIL). The rating provides an independent assessment of an entity's current performance and an expectation on its "balanced value creation and corporate governance practices" in future. The bank has been assigned a 'CRISIL GVC Level 1' rating, which indicates that the bank's capability with respect to wealth creation for all its stakeholders while adopting sound corporate governance practices is the highest.We are aware that all these awards are mere milestones in the continuing, never-ending journey of providing excellent service to our customers. We are confident, however, that with your feedback and support, we will be able to maintain and improve our services. Technology:-

HDFC Bank operates in a highly automated environment in terms of information technology and communication systems. All the bank's branches have online connectivity, which enables the bank to offer speedy funds transfer facilities to its customers. Multi-branch access is also provided to retail customers through the branch network and Automated Teller Machines (ATMs). The Bank has made substantial efforts and investments in acquiring the best technology available internationally, to build the infrastructure for a world class bank. The Bank's business is supported by scalable and robust systems which ensure that

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our clients always get the finest services we offer. The Bank has prioritised its engagement in technology and the internet as one of its key goals and has already made significant progress in web-enabling its core businesses. In each of its businesses, the Bank has succeeded in leveraging its market position, expertise and technology to create a competitive advantage and build market share.

Mission and Business Strategy:Our mission is to be "a World Class Indian Bank", benchmarking ourselves against international standards and best practices in terms of product offerings, technology, service levels, risk management and audit & compliance. The objective is to build sound customer franchises across distinct businesses so as to be a preferred provider of banking services for target retail and wholesale customer segments, and to achieve a healthy growth in profitability, consistent with the Bank's risk appetite. We are committed to do this while ensuring the highest levels of ethical standards, professional integrity, corporate governance and regulatory compliance. Our business strategy emphasizes the following : Increase our market share in Indias expanding banking and financial services industry by following a disciplined growth strategy focusing on quality and not on quantity and delivering high quality customer service. Leverage our technology platform and open scaleable systems to deliver more products to more customers and to control operating costs. Maintain our current high standards for asset quality through disciplined credit risk management. Develop innovative products and services that attract our targeted customers and address inefficiencies in the Indian financial sector. Continue to develop products and services that reduce our cost of funds. Focus on high earnings growth with low volatility.

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HDFC Bank is headquartered in Mumbai. The Bank at present has an enviable network of 1,725 branches spread in 771 cities across India. All branches are linked on an online real-time basis. Customers in over 500 locations are also serviced through Telephone Banking. The Bank's expansion plans take into account the need to have a presence in all major industrial and commercial centres where its corporate customers are located as well as the need to build a strong retail customer base for both deposits and loan products. Being a clearing/settlement bank to various leading stock exchanges, the Bank has branches in the centres where the NSE/BSE have a strong and active member base. The Bank also has 3,898 networked ATMs across these cities. Moreover, HDFC Bank's ATM network can be accessed by all domestic and international Visa/MasterCard, Visa Electron/Maestro, Plus/Cirrus and American Express Credit/Charge cardholders.

AIMS: Continuous effort to improving the services. Evaluating individual skill trough training and motivations. Total involvement through participants management activities. Creating healthy and safe environment. Social development.

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ASSET LIABILITY MANAGEMENT (ALM) SYSTEM Asset-Liability Management (ALM) can be termed as a risk management technique designed to earn an adequate return while maintaining a comfortable surplus of assets beyond liabilities. It takes into consideration interest rates, earning power, and degree of willingness to take on debt and hence is also known as Surplus Management. But in the last decade the meaning of ALM has evolved. It is now used in many different ways under different contexts. ALM, which was actually pioneered by financial institutions and banks, are now widely being used in industries too. The Society of Actuaries Task Force on ALM Principles, Canada, offers the following definition for ALM: "Asset Liability Management is the on-going process of formulating, implementing, monitoring, and revising strategies related to assets and liabilities in an attempt to achieve financial objectives for a given set of risk tolerances and constraints."

Basis of Asset-Liability Management Traditionally, banks and insurance companies used accrual system of accounting for all their assets and liabilities. They would take on liabilities - such as deposits, life insurance policies or annuities. They would then invest the proceeds from these liabilities in assets such as loans, bonds or real estate. All these assets and liabilities were held at book value. Doing so disguised possible risks arising from how the assets and liabilities were structured. 13

Consider a bank that borrows 1 Crore (100 Lakhs) at 6 % for a year and lends the same money at 7 % to a highly rated borrower for 5 years. The net transaction appears profitable-the bank is earning a 100 basis point spread - but it entails considerable risk. At the end of a year, the bank will have to find new financing for the loan, which will have 4 more years before it matures. If interest rates have risen, the bank may have to pay a higher rate of interest on the new financing than the fixed 7 % it is earning on its loan. Suppose, at the end of a year, an applicable 4-year interest rate is 8 %. The bank is in serious trouble. It is going to earn 7 % on its loan but would have to pay 8 % on its financing. Accrual accounting does not recognize this problem. Based upon accrual accounting, the bank would earn Rs 100,000 in the first year although in the preceding years it is going to incur a loss. The problem in this example was caused by a mismatch between assets and liabilities. Prior to the 1970's, such mismatches tended not to be a significant problem. Interest rates in developed countries experienced only modest fluctuations, so losses due to asset-liability mismatches were small or trivial. Many firms intentionally mismatched their balance sheets and as yield curves were generally upward sloping, banks could earn a spread by borrowing short and lending long. Things started to change in the 1970s, which ushered in a period of volatile interest rates that continued till the early 1980s. US regulations which had capped the interest rates so that banks could pay depositors, was abandoned which led to a migration of dollar deposit overseas. Managers of many firms, who were accustomed to thinking in terms of accrual accounting, were slow to recognize this emerging risk. Some firms suffered staggering losses. Because the firms used accrual accounting, it resulted in more of crippled balance sheets than bankruptcies. Firms had no options but to accrue the losses over a subsequent period of 5 to 10 years. One example, which drew attention, was that of US mutual life insurance company "The Equitable." During the early 1980s, as the USD yield curve was inverted with short-term interest rates sky rocketing, the company sold a number of long-term Guaranteed Interest Contracts (GICs) guaranteeing rates of around 16% for periods up to 10 years. Equitable then invested the assets short-term to earn the high

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interest rates guaranteed on the contracts. But short-term interest rates soon came down. When the Equitable had to reinvest, it couldn't get even close to the interest rates it was paying on the GICs. The firm was crippled. Eventually, it had to demutualize and was acquired by the Axa Group. Increasingly banks and asset management companies started to focus on AssetLiability Risk. The problem was not that the value of assets might fall or that the value of liabilities might rise. It was that capital might be depleted by narrowing of the difference between assets and liabilities and that the values of assets and liabilities might fail to move in tandem. Asset-liability risk is predominantly a leveraged form of risk. The capital of most financial institutions is small relative to the firm's assets or liabilities, and so small percentage changes in assets or liabilities can translate into large percentage changes in capital. Accrual accounting could disguise the problem by deferring losses into the future, but it could not solve the problem. Firms responded by forming asset-liability management (ALM) departments to assess these assetliability risk.

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Techniques for assessing Asset-Liability Risk:Techniques for assessing asset-liability risk came to include Gap Analysis and Duration Analysis. These facilitated techniques of managing gaps and matching duration of assets and liabilities. Both approaches worked well if assets and liabilities comprised fixed cash flows. But cases of callable debts, home loans and mortgages which included options of prepayment and floating rates, posed problems that gap analysis could not address. Duration analysis could address these in theory, but implementing sufficiently sophisticated duration measures was problematic. Accordingly, banks and insurance companies started using Scenario Analysis. Under this technique assumptions were made on various conditions, for example:

Several interest rate scenarios were specified for the next 5 or 10 years. These specified conditions like declining rates, rising rates, a gradual decrease in rates followed by a sudden rise, etc. Ten or twenty scenarios could be specified in all.

Assumptions were made about the performance of assets and liabilities under each scenario. They included prepayment rates on mortgages or surrender rates on insurance products.

Assumptions were also made about the firm's performance-the rates at which new business would be acquired for various products, demand for the product etc.

Market conditions and economic factors like inflation rates and industrial cycles were also included. Based upon these assumptions, the performance of the firm's balance sheet

could be projected under each scenario. If projected performance was poor under specific scenarios, the ALM committee would adjust assets or liabilities to address the indicated exposure. Let us consider the procedure for sanctioning a commercial loan. The borrower, who approaches the bank, has to appraise the banks credit department on various parameters like industry prospects, operational efficiency, financial efficiency, management qualities and other things, which would influence the working of the company. On the basis of this appraisal, the banks would then prepare

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a credit-grading sheet after covering all the aspects of the company and the business in which the company is in. Then the borrower would then be charged a certain rate of interest, which would cover the risk of lending. But the main shortcoming of scenario analysis was that, it was highly dependent on the choice of scenarios. It also required that many assumptions were to be made about how specific assets or liabilities will perform under specific scenarios. Gradually the firms recognized a potential for different type of risks, which was overlooked in ALM analyses. Also the deregulation of the interest rates in US in mid 70 s compelled the banks to undertake active planning for the structure of the balance sheet. The uncertainty of interest rate movements gave rise to Interest Rate Risk thereby causing banks to look for processes to manage this risk. In the wake of interest rate risk came Liquidity Risk and Credit Risk, which became inherent components of risk for banks. The recognition of these risks brought Asset Liability Management to the centre-stage of financial intermediation. Today even Equity Risk, which until a few years ago was given only honorary mention in all but a few company ALM reports, is now an indispensable part of ALM for most companies. Some companies have gone even further to include Counterparty Credit Risk, Sovereign Risk, as well as Product Design and Pricing Risk as part of their overall ALM. Now a day's a company has different reasons for doing ALM. While some companies view ALM as a compliance and risk mitigation exercise, others have started using ALM as strategic framework to achieve the company's financial objectives. Some of the business reasons companies now state for implementing an effective ALM framework include gaining competitive advantage and increasing the value of the organization.

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Asset-Liability Management Approach:ALM in its most apparent sense is based on funds management. Funds management represents the core of sound bank planning and financial management. Although funding practices, techniques, and norms have been revised substantially in recent years, it is not a new concept. Funds management is the process of managing the spread between interest earned and interest paid while ensuring adequate liquidity. Therefore, funds management has following three components, which have been discussed briefly. Liquidity Management:Liquidity represents the ability to accommodate decreases in liabilities and to fund increases in assets. An organization has adequate liquidity when it can obtain sufficient funds, either by increasing liabilities or by converting assets, promptly and at a reasonable cost. Liquidity is essential in all organizations to compensate for expected and unexpected balance sheet fluctuations and to provide funds for growth. The price of liquidity is a function of market conditions and market perception of the risks, both interest rate and credit risks, reflected in the balance sheet and off-balance sheet activities in the case of a bank. If liquidity needs are not met through liquid asset holdings, a bank may be forced to restructure or acquire additional liabilities under adverse market conditions. Liquidity exposure can stem from both internally (institution-specific) and externally generated factors. Sound liquidity risk management should address both types of exposure. External liquidity risks can be geographic, systemic or instrument-specific. Internal liquidity risk relates largely to the perception of an institution in its various markets: local, regional, national or international. Determination of the adequacy of a bank's liquidity position depends upon an analysis of its:

Historical funding requirements Current liquidity position Anticipated future funding needs Sources of funds Present and anticipated asset quality Present and future earnings capacity

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Present and planned capital position As all banks are affected by changes in the economic climate, the monitoring

of economic and money market trends is key to liquidity planning. Sound financial management can minimize the negative effects of these trends while accentuating the positive ones. Management must also have an effective contingency plan that identifies minimum and maximum liquidity needs and weighs alternative courses of action designed to meet those needs. The cost of maintaining liquidity is another important prerogative. An institution that maintains a strong liquidity position may do so at the opportunity cost of generating higher earnings. The amount of liquid assets a bank should hold depends on the stability of its deposit structure and the potential for rapid expansion of its loan portfolio. If deposit accounts are composed primarily of small stable accounts, a relatively low allowance for liquidity is necessary. Additionally, management must consider the current ratings by regulatory and rating agencies when planning liquidity needs. Once liquidity needs have been determined, management must decide how to meet them through asset management, liability management, or a combination of both. Asset Management:Many banks (primarily the smaller ones) tend to have little influence over the size of their total assets. Liquid assets enable a bank to provide funds to satisfy increased demand for loans. But banks, which rely solely on asset management, concentrate on adjusting the price and availability of credit and the level of liquid assets. However, assets that are often assumed to be liquid are sometimes difficult to liquidate. For example, investment securities may be pledged against public deposits or repurchase agreements, or may be heavily depreciated because of interest rate changes. Furthermore, the holding of liquid assets for liquidity purposes is less attractive because of thin profit spreads. Asset liquidity, or how "salable" the bank's assets are in terms of both time and cost, is of primary importance in asset management. To maximize profitability, management must carefully weigh the full return on liquid assets (yield plus liquidity value) against the higher return associated with less liquid assets. Income derived

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from higher yielding assets may be offset if a forced sale, at less than book value, is necessary because of adverse balance sheet fluctuations. Seasonal, cyclical, or other factors may cause aggregate outstanding loans and deposits to move in opposite directions and result in loan demand, which exceeds available deposit funds. A bank relying strictly on asset management would restrict loan growth to that which could be supported by available deposits. The decision whether or not to use liability sources should be based on a complete analysis of seasonal, cyclical, and other factors, and the costs involved. In addition to supplementing asset liquidity, liability sources of liquidity may serve as an alternative even when asset sources are available. Liability Management:Liquidity needs can be met through the discretionary acquisition of funds on the basis of interest rate competition. This does not preclude the option of selling assets to meet funding needs, and conceptually, the availability of asset and liability options should result in a lower liquidity maintenance cost. The alternative costs of available discretionary liabilities can be compared to the opportunity cost of selling various assets. The major difference between liquidity in larger banks and in smaller banks is that larger banks are better able to control the level and composition of their liabilities and assets. When funds are required, larger banks have a wider variety of options from which to select the least costly method of generating funds. The ability to obtain additional liabilities represents liquidity potential. The marginal cost of liquidity and the cost of incremental funds acquired are of paramount importance in evaluating liability sources of liquidity. Consideration must be given to such factors as the frequency with which the banks must regularly refinance maturing purchased liabilities, as well as an evaluation of the bank's ongoing ability to obtain funds under normal market conditions. The obvious difficulty in estimating the latter is that, until the bank goes to the market to borrow, it cannot determine with complete certainty that funds will be available and/or at a price, which will maintain a positive yield spread. Changes in money market conditions may cause a rapid deterioration in a bank's capacity to borrow at a favorable rate. In this context, liquidity represents the ability to attract

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funds in the market when needed, at a reasonable cost vis-e-vis asset yield. The access to discretionary funding sources for a bank is always a function of its position and reputation in the money markets. Although the acquisition of funds at a competitive cost has enabled many banks to meet expanding customer loan demand, misuse or improper implementation of liability management can have severe consequences. Further, liability management is not riskless. This is because concentrations in funding sources increase liquidity risk. For example, a bank relying heavily on foreign interbank deposits will experience funding problems if overseas markets perceive instability in U.S. banks or the economy. Replacing foreign source funds might be difficult and costly because the domestic market may view the bank's sudden need for funds negatively. Again over-reliance on liability management may cause a tendency to minimize holdings of short-term securities, relax asset liquidity standards, and result in a large concentration of short-term liabilities supporting assets of longer maturity. During times of tight money, this could cause an earnings squeeze and an illiquid condition. Also if rate competition develops in the money market, a bank may incur a high cost of funds and may elect to lower credit standards to book higher yielding loans and securities. If a bank is purchasing liabilities to support assets, which are already on its books, the higher cost of purchased funds may result in a negative yield spread. Preoccupation with obtaining funds at the lowest possible cost, without considering maturity distribution, greatly intensifies a bank's exposure to the risk of interest rate fluctuations. That is why banks who particularly rely on wholesale funding sources, management must constantly be aware of the composition, characteristics, and diversification of its funding sources.

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Procedure for Examination of Asset Liability Management:In order to determine the efficacy of Asset Liability Management one has to follow a comprehensive procedure of reviewing different aspects of internal control, funds management and financial ratio analysis. Below a step-by-step approach of ALM examination in case of a bank has been outlined. Step 1 The bank/ financial statements and internal management reports should be reviewed to assess the asset/liability mix with particular emphasis on:

Total liquidity position (Ratio of highly liquid assets to total assets). Current liquidity position (Minimum ratio of highly liquid assets to demand liabilities/deposits).

Ratio of Non Performing Assets to Total Assets. Ratio of loans to deposits. Ratio of short-term demand deposits to total deposits. Ratio of long-term loans to short term demand deposits. Ratio of contingent liabilities for loans to total loans. Ratio of pledged securities to total securities.

Step 2 It is to be determined that whether bank management adequately assesses and plans its liquidity needs and whether the bank has short-term sources of funds. This should include: Review of internal management reports on liquidity needs and sources of satisfying these needs.

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Assessing the bank's ability to meet liquidity needs Step 3 The banks future development and expansion plans, with focus on funding and liquidity management aspects has to be looked into. This entails:

Determining whether bank management has effectively addressed the issue of need for liquid assets to funding sources on a long-term basis.

Reviewing the bank's budget projections for a certain period of time in the future.

Determining whether the bank really needs to expand its activities. What are the sources of funding for such expansion and whether there are projections of changes in the bank's asset and liability structure?

Assessing the bank's development plans and determining whether the bank will be able to attract planned funds and achieve the projected asset growth.

Determining whether the bank has included sensitivity to interest rate risk in the development of its long term funding strategy.

Step 4 Examining the bank's internal audit report in regards to quality and effectiveness in terms of liquidity management

23

Step 5 Reviewing the bank's plan of satisfying unanticipated liquidity needs by:

Determining whether the bank's management assessed the potential expenses that the bank will have as a result of unanticipated financial or operational problems.

Determining the alternative sources of funding liquidity and/or assets subject to necessity.

Determining the impact of the bank's liquidity management on net earnings position.

Step 6

Preparing an Asset/Liability Management Internal Control Questionnaire which should include the following: -

Whether the board of directors has been consistent with its duties and responsibilities and included: -

A line of authority for liquidity management decisions. A mechanism to coordinate asset and liability management decisions. A method to identify liquidity needs and the means to meet those needs. Guidelines for the level of liquid assets and other sources of funds in relationship to needs.

Does the planning and budgeting function consider liquidity requirements? Are the internal management reports for liquidity management adequate in terms of effective decision making and monitoring of decisions.

Are internal management reports concerning liquidity needs prepared regularly and reviewed as appropriate by senior management and the board of directors.

Whether the bank's policy of asset and liability management prohibits or defines certain restrictions for attracting borrowed means from bank related persons (organizations) in order to satisfy liquidity needs.

Does the bank's policy of asset and liability management provide for an adequate control over the position of contingent liabilities of the bank?

24

Is the foregoing information considered an adequate basis for evaluating internal control in that there are no significant deficiencies in areas not covered in this questionnaire that impair any controls?

Asset Liability Management in Indian Context:The post-reform banking scenario in India was marked by interest rate deregulation, entry of new private banks, and gamut of new products along with greater use of information technology. To cope with these pressures banks were required to evolve strategies rather than ad hoc solutions. Recognising the need of Asset Liability management to develop a strong and sound banking system, the RBI has come out with ALM guidelines for banks and FIs in April 1999.The Indian ALM framework rests on three pillars: ALM Organisation (ALCO):The ALCO or the Asset Liability Management Committee consisting of the banks senior management including the CEO should be responsible for adhering to the limits set by the board as well as for deciding the business strategy of the bank in line with the banks budget and decided risk management objectives. ALCO is a decision-making unit responsible for balance sheet planning from a risk return perspective including strategic management of interest and liquidity risk. The banks may also authorise their Asset-Liability Management Committee (ALCO) to fix interest rates on Deposits and Advances, subject to their reporting to the Board immediately thereafter. The banks should also fix maximum spread over the PLR with the approval of the ALCO/Board for all advances other than consumer credit.

25

ALM Information System:The ALM Information System is required for the collection of information accurately, adequately and expeditiously. Information is the key to the ALM process. A good information system gives the bank management a complete picture of the bank's balance sheet. ALM Process:The basic ALM processes involving identification, measurement and management of risk parameter .The RBI in its guidelines has asked Indian banks to use traditional techniques like Gap Analysis for monitoring interest rate and liquidity risk. However RBI is expecting Indian banks to move towards sophisticated techniques like Duration, Simulation, VaR in the future. For the accrued portfolio, most Indian Private Sector banks use Gap analysis, but are gradually moving towards duration analysis. Most of the foreign banks use duration analysis and are expected to move towards advanced methods like Value at Risk for the entire balance sheet. Some foreign banks are already using VaR for the entire balance sheet. ALM has evolved since the early 1980's. Today, financial firms are increasingly using market value accounting for certain business lines. This is true of universal banks that have trading operations. Techniques of ALM have also evolved. The growth of OTC derivatives markets has facilitated a variety of hedging strategies. A significant development has been securitization, which allows firms to directly address asset-liability risk by removing assets or liabilities from their balance sheets. This not only eliminates asset-liability risk; it also frees up the balance sheet for new business. Thus, the scope of ALM activities has widened. Today, ALM departments are addressing (non-trading) foreign exchange risks as well as other risks. Also, ALM has extended to non-financial firms. Corporations have adopted techniques of ALM to address interest-rate exposures, liquidity risk and foreign exchange risk. They are using related techniques to address commodities risks. For example, airlines' hedging of fuel prices or manufacturers' hedging of steel prices are often presented as ALM. Thus it can be safely said that Asset Liability Management will continue to grow in

26

future and an efficient ALM technique will go a long way in managing volume, mix, maturity, rate sensitivity, quality and liquidity of the assets and liabilities so as to earn a sufficient and acceptable return on the portfolio. ALM is a comprehensive and dynamic framework for measuring, monitoring and managing the market risk of a bank. It is the management of structure of balance sheet (liabilities and assets) in such a way that the net earning from interest is maximised within the overall risk-preference (present and future) of the institutions. The ALM functions extend to liquidly risk management, management of market risk, trading risk management, funding and capital planning and profit planning and growth projection. Benefits of ALM - It is a tool that enables bank managements to take business decisions in a more informed framework with an eye on the risks that bank is exposed to. It is an integrated approach to financial management, requiring simultaneous decisions about the types of amounts of financial assets and liabilities both mix and volume - with the complexities of the financial markets in which the institution operates

The concept of ALM is of recent origin in India. It has been introduced in Indian Banking industry w.e.f. 1st April, 1999. ALM is concerned with risk management and provides a comprehensive and dynamic framework for measuring, monitoring and managing liquidity, interest rate, foreign exchange and equity and commodity price risks of a bank that needs to be closely integrated with the banks business strategy. Therefore, ALM is considered as an important tool for monitoring, measuring and managing the market risk of a bank. With the deregulation of interest regime in India, the Banking industry has been exposed to the market risks. To manage such risks, ALM is used so that the management is able to assess the risks and cover some of these by taking appropriate decisions. The assets and liabilities of the banks balance sheet are nothing but future cash inflows or outflows. With a view to measure the liquidity and interest rate risk, banks use of maturity ladder and then calculate cumulative surplus or deficit of funds in different time slots on the basis of statutory reserve cycle, which are termed as time buckets.

27

As a measure of liquidity management, banks are required to monitor their cumulative mismatches across all time buckets in their Statement of Structural Liquidity by establishing internal prudential limits with the approval of the Board / Management Committee. The ALM process rests on three pillars: i. ALM Information Systems

Management Information Systems Information availability, accuracy, adequacy and expediency

ii.

ALM Organization

Structure and responsibilities Level of top management involvement

iii.

ALM Process

Risk parameters Risk identification Risk measurement Risk management Risk policies and tolerance levels.

As per RBI guidelines, commercial banks are to distribute the outflows/inflows in different residual maturity period known as time buckets. The Assets and Liabilities were earlier divided into 8 maturity buckets (1-14 days; 15-28 days; 29-90 days; 91-180 days; 181-365 days, 1-3 years and 3-5 years and above 5 years), based on the remaining period to their maturity (also called residual maturity). All the liability figures are outflows while the asset figures are inflows. In September, 2007, having regard to the international practices, the level of sophistication of banks in India, the need for a sharper assessment of the efficacy of liquidity management and with a view to providing a stimulus for development of the term-money market, RBI revised these guidelines and it was provided that

28

 the banks may adopt a more granular approach to measurement of liquidity risk by splitting the first time bucket (1-14 days at present) in the Statement of Structural Liquidity into three time buckets viz., next day , 2-7 days and 8-14 days. Thus, now we have 10 time buckets. After such an exercise, each bucket of assets is matched with the corresponding bucket of the liabililty. When in a particular maturity

bucket, the amount of maturing liabilities or assets does not match, such position is called a mismatch position, which creates liquidity surplus or liquidity crunch position and depending upon the interest rate movement, such situation may turnout to be risky for the bank. Banks are required to monitor such mismatches and take appropriate steps so that bank is not exposed to risks due to the interest rate movements during that period. The net cumulative negative mismatches during the Next day, 2-7 days, 8-14 days and 15-28 days buckets should not exceed 5 % ,10%, 15 % and 20 % of the cumulative cash outflows in the respective time buckets in order to recognise the cumulative impact on liquidity. The Boards of the Banks have been entrusted with the overall responsibility for the management of risks and is required to decide the risk management policy and set limits for liquidity, interest rate, foreign exchange and equity price risks. Asset-Liability Committee (ALCO) is the top most committee to oversee the implementation of ALM system and it is to be headed by CMD or ED. ALCO considers product pricing for both deposits and advances, the desired maturity profile of the incremental assets and liabilities in addition to monitoring the risk levels of the bank. It will have to articulate current interest rates view of the bank and base its decisions for future business strategy on this view.

29

Rate Sensitive Assets & Liabilities : -

An asset or liability is termed as rate sensitive when Within the time interval under consideration, there is a cash flow, The interest rate resets/reprices contractually during the interval, BI changes interest rates where rates are administered and, It is contractually pre-payable or withdrawal before the stated maturities. Assets and liabilities which receive / pay interest that vary with a benchmark rate are re-priced at pre-determined intervals and are rate sensitive at the time of repricing. INTEREST RISK: The phased deregulation of interest rates and the operational flexibility given to banks in pricing most of the assets and liabilities imply the need for the banking system to hedge the Interest-Rate Risk. Interest Rate Risk is the risk where changes in market interest rates might adversely affect the Banks Net Interest Income. The gap report should be generated by grouping interest rate sensitive liabilities, assets and off balance sheet positions into time buckets according to residual maturity or next reprising period, whichever is earlier. Interest rates on term deposits are fixed during their currency while the advance interest rates are floating rates. The gaps on the assets and liabilities are to be identified on different time buckets from 128 days, 29 days upto 3 months and so on. The interest changes should be studied vis-a-vis the impact on profitability on different time buckets to assess the interest rate risk. GAP ANALYSIS:The various items of rate sensitive assets and liabilities and off-balance sheet items are classified into time buckets such as 1-28 days, 29 days and upto 3 months etc. and items non-sensitive to interest based on the probable date for change in interest.The gap is the difference between Rate Sensitive Assets (RSA) and Rate Sensitive Liabilities (RSL) in various time buckets. The positive gap indicates that it has more

30

RSAS than 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 a position to benefit from declining interest rate by a negative Gap (RSL > RSA).

31

Chapter 2 LITERATURE REVIEW

32

LITERATURE REVIEW

Paper Title:-Sovereign Risk and Asset and Liability Management Conceptual Issues(SRALM) Authour:- G. Papaioannou, and Author Iva Petrova(2000) Findings:Country practices towards managing financial risks on a sovereign balance sheet continue to evolve. Each crisis period, and its legacy on sovereign balance sheets, reaffirms the need for strengthening financial risk management. This paper discusses some salient features embedded in in the current generation of sovereign asset and liability management (SALM) approaches, including objectives, definitions of relevant assets and liabilities, and methodologies used in obtaining optimal SALM outcomes. These elements are used in developing an analytical SALM framework which could become an operational instrument in formulating asset management and debtor liability management strategies at the sovereign level. From a portfolio perspective, the SALM approach could help detect direct and derived sovereign risk exposures. It allows analyzing the financial characteristics of the balance sheet,

identifying sources of costs and risks, and quantifying the correlations among these sources of risk. The paper also outlines institutional requirements in implementing an SALM framework and seeks to lay the ground for further policy and analytical work on this topic.JEL

Paper Title :- Integrating Asset-Liability Risk Management with Portfolio Optimization for Individual Investors II (IALRM) Author :- Travis L. Jones, Ph.D.(2002) Findings :-

A majority of private client practitioners rely on mean-variance optimization (MVO),rules of thumb, or model portfolios for making asset allocation recommendations. Considerations for income levels and other constraints figure into the typical approach. However, not enough attention is given to the nature of an investors multiple time horizons and implications for cash flows. These are the future demands placed upon the portfolio. The risks that these demands will not be met need

33

to be clearly understood in order to validate any asset allocation decision. This study presents an approach of incorporating MVO within a multi-horizon, asset-liability Management risk model. This approach allows for cash-flow matching of a portion of an investors portfolio within the optimization framework. This allows an individuals portfolio to provide short-term cash flow, as needed, while also considering the longer-term demands on the portfolio. Part Title :- Asset & liability management (ALM) modelling with risk control by stochastic dominance. Author name :- Xi Yang, Jacek Gondzi & Andreas Grothey(2001) Findings:An Asset Liability Management model with a novel strategy for controlling the risk of underfunding is presented in this article. The basic model involves multi-period decisions (portfolio rebalancing) and deals with the usual uncertainty of investment returns and future liabilities. Therefore, it is well suited to a stochastic programming approach. A stochastic dominance concept is applied to control the risk of underfunding through modelling a chance constraint. A small numerical example and an out-of-sample back test are provided to demonstrate the advantages of this new model, which includes stochastic dominance constraints, over the basic model and a passive investment strategy. Adding stochastic dominance constraints comes with a price. This complicates the structure of the underlying stochastic program. Indeed, the new constraints create a link between variables associated with different scenarios of the same time stage. This destroys the usual tree structure of the constraint matrix in the stochastic program and prevents the application of standard stochastic programming approaches, such as (nested) Benders decomposition and progressive hedging. Instead, we apply a structure-exploiting interior point method to this problem. The specialized interior point solver, object-oriented parallel solver, can deal efficiently with such problems and outperforms the industrial strength commercial solver CPLEX on our test problem set. Computational results on medium-scale problems with sizes reaching about one million variables demonstrate the efficiency

34

of the specialized solution technique. The solution time for these non-trivial asset liability models appears to grow sub linearly with the key parameters of the model, such as the number of assets and the number of realizations of the benchmark portfolio, which makes the method applicable to truly large-scale problems.

Paper Title:- An investigation of asset liability management practices in Kenya Commercial Banks(IALM) Author:- Macharia, & Irungu Peter(2003) Findings :Risk management practices in commercial banks are commonly known as asset liability management and it remains critical in ensuring safety of depositors' funds as well as investors' stake. Asset liability management is a requirement by the Central Banks of any country in order to ensure full compliance to the set risk management guidelines. This study was designed to establish the asset/liability management practices by Commercial Banks in Kenya and to find out the extent of asset-liability management by these banks. The study will be important to commercial banks, scholars and it will contribute more knowledge to the existing information on asset liability management. The population under study comprised of all Heads of Treasury Operations of the 43 Commercial Banks in Kenya. Census study was used because the population was relatively small for sampling and gave a better representation of the various risk management practices employed by various commercial banks as well as their asset liability management practices. Each respondent filled and submitted a self administered questionnaire that was dropped and picked later. The questionnaire responses were summarized and the results analyzed using Statistical data analysis programme (SPSS) to describe the relationship between the dependent and the independent variables. Findings were presented by way of charts, graphs and tables. Several deductions were drawn from the findings. These included: responding banks employed both conventional and bank-specific asset liability management practices. Most banks considered credit/default risk to be the most critical of all financial risk exposures though some empirical evidence shows that foreign exchange risk is the most critical risk for most firms. Majority of the banks did not find the Kenyan currency market to be information efficient: speculation and forecasting techniques were extensively used by most of them. Regular and systematic appraisal of

35

asset/liability management policies was a common practice amongst most banks. Most banks also indicated that their asset/liability management systems were governed by guidelines set by the management board which is a cross functional outfit covering all the major functions in the bank this showed that ALM is a highly strategic issue in the banks Most banks, regardless of their size, extensively utilized most of the conventional hedging instruments. Micro hedge approach, accounting and economic exposure measurement strategies, natural hedging and diversification were some of the most utilized strategies. Some hedging practices were considered by most banks to be more important than others. These included use of forward contracts and foreign currency options as hedging instruments, and use of matching/natural hedging strategy. Pper Title:Industry - with Asset Liability Management in Indian

Bankingspecial reference to Interest RateRisk Management in ICICI Bank Author:- Dr. B. Charumathi Findings:Assets and Liabilities Management (ALM) is a dynamic process of planning, organizing, coordinating and controlling the assets and liabilities their mixes, volumes, maturities, yields and costs in order to achieve a specified Net Interest Income (NII). The NII is the difference between interest income and interest expenses and the basic source of banks profitability. The easing of controls on interest rates has led to higher interest rate volatility in India. Hence, there is a need to measure and monitor the interest rate exposure of Indian banks. This paper entitled A Study on the Assets and Liabilities Management (ALM) Practices with special reference to Interest Rate Risk Management at ICICI Bank is aimed at measuring the Interest Rate Risk in ICICI Bank by using Gap Analysis Technique. Using publicly available information, this paper attempts to assess the interest rate risk carried by the ICICI bank in March 2005, 2006, & 2007. The findings revealed that the bank is exposed to interest rate risk .Index TermsInterest volatility, risk, Indian banks

36

Paper Title:- ASSET-LIABILITY MANAGEMENT UNDER BENCHMARK AND MEAN-VARIANCECRITERIA IN A JUMP DIFFUSION MARKET Author :- Yan ZENG(1), Zhongfei LI(2) Findings:Assets and Liabilities Management (ALM) is a dynamic process of planning, organizing, coordinating and controlling the assets and liabilities their mixes, volumes, maturities, yields and costs in order to achieve a specified Net Interest Income (NII). The NII is the difference between interest income and interest expenses and the basic source of banks profitability. The easing of controls on interest rates has led to higher interest rate volatility in India. Hence, there is a need to measure and monitor the interest rate exposure of Indian banks. This paper entitled A Study on the Assets and Liabilities Management (ALM) Practices with special reference to Interest Rate Risk Management at ICICI Bank is aimed at measuring the Interest Rate Risk in ICICI Bank by using Gap Analysis Technique. Using publicly available information, this paper attempts to assess the interest rate risk carried by the ICICI bank in March 2005, 2006, & 2007. The findings revealed that the bank is exposed to interest rate risk. Index TermsInterest volatility, risk, Indian banks

Pepar Title :- Optimal Asset Allocation in Asset Liability Management Author:- Jules H. van Binsbergen, Michael W. Brandt Findings :We study the impact of regulations on the investment decisions of a defined benefits pension plan. We assess the influence of ex ante (preventive) and ex post (punitive) risk constraints on the gains to dynamic, as opposed to myopic, decision making. We find that preventive measures, such as Value-at-Risk constraints, tend to decrease the gains to dynamic investment. In contrast, punitive constraints, such as mandatory additional contributions from the sponsor when the plan becomes underfunded, lead to very large utility gains from solving the dynamic program. We also show that financial reporting rules have real effects on investment behavior. For example, the current requirement to discount liabilities at a rolling average of yields, as opposed to at current yields, induces grossly suboptimal investment decisions.

37

Paper Title: IMPORTANCE OF ASSET AND LIABILITY MANAGEMENT IN THE NIGERIA BANKING INDUSTRY (A CASE STUDY OF EQUITY BANK NIGERIA LIMITED) Authors:- faloye and andrew Findings :This study examines the extent to which Asset and Liability management is crucial to the existence and survival of a bank. Banking is confidence driven and the extent to which this confidence is secured and retained depends on the efficiency with which Bank asset and liabilities are managed to the satisfaction of the various constituencies that the bank serves viz: Depositors, Borrowers, Shareholders, Regulatory Authorities and the Community. The scope of this survey is an in-depth study of the Assets and Liabilities Management in EquityBank of Nigeria Limited in the years before restructure (1993 to 1995) and after the re-structure (1996 to 1998). The survey will be limited to select Heads of Department and above. The survey would also cover both the surviving members of the Meridien Equity Bank, the restructuring management from Nigerian Intercontinental Merchant Bank Limited and new members of staff after the restructure. It was found out that the crisis of confidence in the financial system and its illiquidity is traced to the macro-economic and political problems of the country. Government's unsuccessful attempt to arrest the above through various measures as well as the massive looting of the treasury led to high loan defaults and exacerbated the financial crisis and the resulting mass liquidation of financial Institutions and commercial banks did not properly address the problem of effective Asset and liability management and this triggered off the bank failures already witnessed. It can therefore be concluded that effective asset and liability management is critical factor in a commercial bank. It is of utmost necessity that good asset and liability management policies should be in place in a capitalist society to mobilize available resources (liabilities) and divert them to profitable instruments (assets) to achieve bank viability and growth: Inefficient Asset and Liability Management could result in bank failure.

38

Paper title :-A Financial assets and liabilities management support system Author:- Yung-Hsin Wang, Ta-Hua Kuo Findings :This paper describes the design and implementation of a decision support system (DSS) based on the fund dispatching decision viewpoint from the financial division of a business group. An integrated data warehouse is established and the technique of online analytical processing (OLAP) is applied to analyze daily transaction data of an enterprise resource planning system with determined management goal. We adopt the Business Dimensional Lifecycle approach to accomplish the system design and development. The DSS system developed is to provide latest and timely information of financial asset and liability positions in each company within the case business group so that decision makers can have a clear decision support in fund dispatching. While most related researches on fund dispatching focused especially on efficient banking capital management and few studies were done for general financial department of traditional enterprise let alone for the business group, this study has made a progress in this issue and the resultant system is applicable to the similar business group .the interest rate changing adversely, this in turn protects the owner's equity of the bank. We use seven-day's reacquired interest rate data to estimate the frequency distribution of the fluctuation of the future market rate and solved the problem to describe the fluctuation of the interest rate with multi-factors.

39

Chapter 3 RESEARCH METHODOLOGY

40

OBJECTIVES OF THE STUDY

To study the concept of ASSET & LIABLITY MANAGEMENT in HDFC To study process of CASH INFLOWS and OUTFLOWS in HDFC To study RISK MANAGEMENT under HDFC To study RESERVES CYCLE of ALM under HDFC To study FUNCTIONS AND OBJECTIVES of ALM committee.

41

METHODOLOGY OF THE STUDY

The study of ALM Management is based on two factors.

1. Primary data collection.

2. Secondary data collection

PRIMARY DATA COLLECTION:

The sources of primary data were The chief manager ALM cell Department Sr. manager financing & Accounting System manager- ALM cell

Gathering the information from other managers and other officials of the organization.

SECONDARY DATA COLLECTION:

Collected from books regarding journal, and management containing relevant information about ALM and Other main sources were

Annual report of the HDFC Published report of the HDFC RBI guidelines for ALM.

42

Chapter 4 DATA ANALYSIS AND INTERPRETATION

43

RISK MANAGEMENT SYSTEM

Assuming and managing risk is the essence of business decision-making. Investing in a new technology, hiring a new employee, or launching a marketing campaign is all decisions with uncertain outcomes. As a result all the major management decisions of how much risk to take and how to manage the risk.

The implementation of risk management varies from business to business, from one management style to another and from one time to another. Risk management in the financial services industry is different from others. Circumstances, Institutions and Managements are different. On the other hand, an investment decision is no recent history of legal and political stability, insights into the potential hazards and opportunities.

Many risks are managed quantitatively. Risk exposure is measured by some numerical index. Risk cost tradeoff many tools are described by numerical valuation formulas.

Risk

management

can

be

integrated

into

risk

management system. Such a system can be utilized to manage the trading position of a small-specialized division or an entire financial institution. The modules of the system can be implemented with different degrees of accuracy and sophistication.

44

RISK MANAGEMENT SYSTEM

Dynamics of risk factors

Cash flows Generator

Arbitrage Pricing Model

Price and Risk Profile Of Contingent Claims

Dynamic Trading Rules

Risk Optimizer

Target Risk Profile

45

RISK MANAGEMENT SYSTEM

Arbitrage pricing models range from simple equations to large scale numerically sophisticated algorithms. Cash flow generators also vary from a single formula to a simulator that accounts for the dependence of cash flows on the history of the risk factors.

Financial engineers are continuously incorporating advances in econometric techniques, asset pricing models, simulation techniques and optimization algorithms to produce better risk management systems.

The important ingredient of the risk management approach is the treatment of risk factors and securities as an integrated portfolio. Analyzing the correlation among the real, financial and strategic assets of an organization leads to clear understanding of risk exposure. Special attention is paid to risk factors, which translate to correlation among the values of securities. Identifying the correlation among the basic risk factors leads to more effective risk management.

46

CONCLUSION
The burden of the Risk and its Costs are both manageable and transferable. Financial service firms, in the addition to managing their own risk, also sell financial risk management to others. They sell their services by bearing customers financial risks through the products they provide. A financial firm can offer a fixed-rate loan to a borrower with the risk of interest rate movements transferred from the borrower to the. Financial innovations have been concerned with risk reduction than any other subject. With the possibility of managing risk near zero, the challenge becomes not how much risk can be removed.

Financial services involve the process of intermediation between those who have financial resources and those who need them, either as a principal or as an agent. Thus, value breaks into several distinct functions, and it includes the intermediation of the following: Maturity Preference mismatch, Default, Currency Preference mis-match, Size of transaction and Market access and information.

RISK MANAGEMENT IN HDFC

Narasimham committee II , advised to address market risk in a structured manner by adopting Asset and Liability Management practices with effect from April 1st 1989.

Asset and liability management (ALM) is the Art and Science of choosing the best mix of assets for the firms asset portfolio and the best mix of liabilities for the firms liability portfolio. It is particularly critical for Financial Institutions.

For a long time it was taken for granted that the liability portfolio of financial firms was beyond the control of the firm and so

47

management concentrated its efforts on choosing the asset mix. Institutions treasury department used the funds provided by deposits to structure an asset portfolio that was appropriate for the given liability portfolio.

With the advent of Certificate of Deposits (CDs), a tool by which to manipulate the mix of liabilities that supported their Asset portfolios, which has been one of the active management of assets and liabilities.

Asset and liability management program evolve into a strategic tool for management, the main elements of the ALM system are: ALM INFORMATION. ALM ORGANISATION. ALM FUNCTION.

ALM INFORMATION:-

ALM is a risk management tool through which Market risk associated with business are identified, measured and monitored to maintain profits by restructuring Assets and Liabilities. The ALM framework needs to be built on sound methodology with necessary information system as back up. Thus the information is key element to the ALM process.

There are various methods prevalent worldwide for measuring risks. These range from the simple Gap statement to extremely sophisticate and data intensive Risk adjusted profitability measurement (RAPM) methods. The central element for the entire ALM exercise is the availability of adequate and accurate information.

However, the existing systems in many Indians do not generate information in manner required for the ALM. Collecting accurate data is the biggest challenge before, the particularly those having wide network of branches, but lacking full-scale computerization. 48

Therefore the introduction of these information systems for risk measurement and monitoring has to be addressed urgently.

The large network of branches and the lack of support system to collect information required for the ALM which analysis information on the basis of residual maturity and behavioral pattern, it would take time for s in the present state to get the requisite information. ALM ORGANISATION:Successful implementation of the risk management process requires strong commitment on the part of senior management in the to integrate basic operations and strategic decision making with risk management. The Board of Directors should have overall responsibility for management of risk and should decide the risk management policy of the, setting limits for liquidity, interest rate, foreign exchange and equity / price risk. The Asset Liability Management Committee (HDFC) consisting of the s senior management, including CEO/CMD should be responsible for ensuring adherence to the limits set by the Board of Directors as well as for deciding the business strategy of the risk management objective. The ALM support group consisting of operation staff should be responsible for analyzing, monitoring and reporting the risk profiles to the HDFC. The staff should also prepare forecasts (simulations) showing the effects of various possible changes in market condition related to the balance sheet and recommend the action needed to adhere to s internal limits, The HDFC is a decision-making unit responsible for balance sheet planning from a risk-return perspective including the strategic management of interest rate and liquidity risks. Each has to decide on the role of its HDFC, its responsibility as also the decision to be (on the assets and liabilities sides) in line with the s budget and decided

49

taken by it. The business and risk management strategy of the should ensure that the operates within the limits / parameters set by the Board. The business issues that an HDFC would consider, inter alia, will include product pricing for deposits and advances, desired maturity profile and mix of the incremental Assets and Liabilities, etc. in addition to monitoring the risk levels of the , the HDFC should review the results of and progress in implementation of the decisions made in the previous meetings. The HDFC would also articulate the current interest rate view of the and base its decisions for future business strategy on this view. In respect of this 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. floating rate funds, wholesale vs. retail deposits, Money markets vs. Capital market funding, domestic vs. foreign currency funding etc. Individuals will have to decide the frequency for holding their HDFC meetings.

TYPICAL BUSINESS OF HDFC

Reviewing of the impact of the regulatory changes on the industry. Overseeing the budgetary process; Reviewing the interest rate outlook for pricing of assets and liabilities (Loans and Deposits) Deciding on the introduction of any new loan / deposit product and their impact on interest rate / exchange rate and other market risks;

50

 Reviewing the asset and liability portfolios and the risk limits and thereby, assessing the capital adequacy; Deciding on the desired maturity profile of incremental assets and liabilities and thereby assessing the liquidity risk; and Reviewing the variances in actual and projected performances with regard to Net Interest Margin(NIM), spreads and other balance sheet ratios.

COMPOSITION OF HDFC:The size (number of members) of HDFC would depend on the size of each institution, business mix and organizational complexity, To ensure commitment of the Top management and timely response to market dynamics, the CEO/MD or the GM should head the committee. The chiefs of Investment, Credit, Resources Management or Planning, Funds Management / Treasury (domestic), etc., can be members of the committee. In addition, the head of the computer (technology) Division should also be an invitee for building up of MIS and related computerization. Some of may even have Sub-Committee and Support Groups.

ALM ORGANIZATION consists of following categories: ALM BOARD HDFC ALM CELL COMMITTEE OF DIRECT

51

ALM BOARD:-

The Board of management should have overall responsibility for management of risk and should decide the risk management policy of the and set limits for liquidity and interest rate risks.

HDFC:The bank has constituted an Asset- Liability committee (HDFC). The committee may consist of the following members.

i) General Manager

Head of Committee

ii) General Manager (Loans & Advances)

Member

iii) General Manager (CMI & AD)

Member

iv) AGM / Head of the ALM Cell

Member

The HDFC is a decision making unit responsible for ensuring adherence to the limits set by board as well as for balance sheet planning from risk return perspective including the strategic management of interest rate and liquidity risks, in line with the s budget and decided risk management objectives.

The Business issues that an HDFC would consider interalia, will include fixation of interest rates for both deposits and advances, desired maturity profile of the incremental assets and liabilities etc.

The HDFC would also articulate the current interest rate due of the and base its decisions for future business strategy on this view.

52

In respect of funding policy, for instance, its responsibility would be decided on source and mix of liability. Individuals will have to decide the frequency for their HDFC meetings. However, it is advised that HDFC should meet at least once in a fortnight. The HDFC should review results of and process in implementation of the decisions made in the previous meetings

ALM CELL:The ALM desk / cell consisting of operating staff should be responsible for analyzing, monitoring and reporting the profiles to the HDFC. The staff should also prepare forecasts (simulations) showing the effects of various possible changes in market conditions related to the balance sheet and recommend the action needed to adhere to the internal limits.

COMMITTEE OF DIRECTORS:They should also constitute professional, management and supervisory committee, consisting of three to four directors, which will oversee the implementation of the ALM system, and review its functioning periodically.

ALM PROCESS

The scope of ALM function can be described as follows: Liquidity Risk Management Interest Rate Risk Management Currency Risk Management Settlement Risk Management

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 Basis Risk Management The RBI guidelines mainly address Liquidity Risk Management and Interest Rate Risk Management.

The following are the concepts discussed for analysis of Asset-Liability Management under above mentioned risks.

Liquidity Risk

Maturity profiles

Interest rate risk

Gap analysis Liquidity Risk Management:-

Measuring and managing liquidity needs are vital activities of the Risk. By assuring a returns ability to meet its liability as they become due, liquidity management can reduce the probability of an adverse situation development. The importance of liquidity transcends individual institutions, as liquidity shortfall in one institution can have repercussions on the entire system. Liquidity risk management refers to the risk of maturing liability not finding enough maturing assets to meet these liabilities. It is the potential inability to meet the liability as they became due. This risk arises because borrows funds for different maturities in the form of deposits, market operations etc. and lock them into assets of different maturities.

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Liquidity Gap also arises due to unpredictability of deposit withdrawals, changes in loan demands. Hence measuring and managing operations. Liquidity measurement is quite a difficult task and usually the stock or cash flow approaches are used for its measurement. The stock approach used certain liquidity ratios. The liquidity ratios are the ideal indicators of liquidity of Operating in developed financial markets, the ratio do not reveal the real liquidity profile of s which are operating generally in a fairly illiquid market. The assets, which are commonly considered as liquid like Government securities, have limited liquidity when the market and players are in one direction. Thus analysis of liquidity involves tracking of cash flow mismatches. liquidity needs are vital for effective and viable

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.

The position of Assets and Liabilities are classified according to the maturity patterns a maturing liability will be a cash outflow while a maturing asset will be a cash inflows. The measuring of the future cash flows of s is done in different time buckets.

The time buckets, given the statutory Reserve cycle of 14 days may be distributed as under: 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

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MATURITY PROFILE LIQUIDITY:-

HEAD OF ACCOUNTS A.OUTFLOWS

1.Capital, Reserves and Surplus 2.Demand Deposits (Current & Savings Deposits)

Classification into time buckets

Over 5 years bucket. Demand Deposits may be classified into volatile and core portions, 25 % of deposits are generally withdraw able on demand. This portion may be treated as volatile. While volatile portion may be placed in the first time bucket i.e., 1-14 days, the core portion may be placed in 1-2 years, bucket.

3. Term Deposits

Respective maturity buckets.

4. Borrowings 5. Other liabilities and provisions (i) (ii) (iii) Bills Payable Inter-office Adjustment Provisions for NAPs a) sub-standard b) doubtful and Loss (iv) provisions for depreciation in Investments (v) provisions for NAPs in investment (vi) provisions for other purposes

Respective maturity buckets. (i) (ii) 1-14 days bucket Items not representing cash payable may be placed in over 5 years bucket (iii) a) 2-5 years bucket. b) Over 5 years bucket .(iv) (v) a) Over 5 years bucket. 2-5 years bucket.

b) Over 5 years bucket (vi) Respective buckets depending on the purpose.

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INFLOWS

1. Cash 2. Balance with others (i) Current Account

1-14 days bucket.

(i) Non-withdraw able portion on account of stipulations of minimum balances may be shown Less than 1-14 days bucket.

(ii)

Money at call and short Notice, Term Deposits and other Placements

(ii)

Respective maturity buckets.

3. Investments (i) Approved securities (i) Respective maturity buckets excluding the amount required to be reinvested to maintain SLR (ii) Respective Maturity buckets. (ii) Corporate Debentures bonds, CPs, CDs and and Investments classified as NPAs Should be shown under 2-5 years bucket (sub-standard) or over 5 years bucket (doubtful and loss). (iii) Over 5 years bucket.

redeemable shares, Mutual (close

preference units Funds ended). Etc. of

(iv) Over 5 years bucket.

(iii) Share / Units of Mutual Funds (open ended) (iii) Investment subsidiaries / Joint Ventures. in

4. Advances (performing / standard) (i) Bills Purchased and (i) Respective Maturity buckets.

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Discounted (including bills DUPN) (iii) Cash Credit / Overdraft (including TOD) and Demand Loan component of Working Capital. under

(ii) they should undertake a study of behavioral and seasonal pattern of a ailments based on outstanding and the core and volatile portion should be identified. While the volatile portion could be shown in the respective maturity bucket. The core portion may be shown under 1-2 years bucket.

(iii)

Term Loans

(iii) Interim cash flows may be shown under respective maturity buckets.

5. NPAs a. Sub-standard b. Doubtful and Loss 6. Fixed Assets 7. Other-office Adjustment (i) Inter-office Adjustment (i) As per trend analysis, Intangible items or items not representing cash receivables may be shown in over 5 years bucket. (ii) Others (i) Respective maturity (I) 2-5 years bucket. (ii) Over 5 years bucket. Over 5 years bucket.

buckets. Intangible assets and assets not representing cash receivables may be shown in over 5 years bucket.

Terms used:-

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CDs: Certificate of Deposits.

CPs: Commercial Papers. DTL PROFILE: Demand and Time Liabilities. Inter office adjustment:

Outflows: Net Credit Balances

Inflows: Net Debit Balances

Other Liabilities: Cash payables, Income received in advance, Loan Loss and Depreciation in Investments. Other assets: Cash Receivable, Intangible Assets and Leased Assets. Interest Rate Risk:Interest Rate Risk refers to the risk of changes in interest rates subsequent to the creation of the assets and liabilities at fixed rates. The phased deregulations of interest rates and the operational flexibility given in pricing most of the assets and liabilities imply the need for system to hedge the interest rate risk. This is a risk where changes in the market interest rates might adversely affect financial conditions.

The changes in interest rates affects in large way. The immediate impact of change in interest rates is on earnings by changing its Net Interest Income ( NII). A long term impact of changing interest rates is on Market Value of Equity (MVE) or net worth as the economic value of assets, liabilities and off-balance sheet positions get affected due to variation in market interest rates.

The risk from the earnings perspective can be measured as changes in the Net Interest Income (NII) OR Net Interest Margin (NIM).

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There are many analytical techniques for measurement and management of interest rate risk. In MIS of ALM, slow pace of computerization in and the absence of total deregulation, the traditional GAP ANALYSIS is considered as a suitable method to measure the interest rate risk.

Data Interpretation Gap Analysis:The Gap or mismatch risk can be measured by calculating Gaps over different time buckets as at a given date. Gap analysis measures mismatches between rate sensitive liabilities and rate sensitive assets including off-balance sheet position.

An asset or liability is normally classified as rate sensitive if: If there is a cash flow within the time interval. The interest rate resets or reprocess contractually during the interval. RBI changes the interest rates i.e., on saving deposits, export credit, refinance, CRR balances and so on, in case where interest rate are administered. It is contractually pre-payable or withdraw able before the stated maturities

The Gap is the difference between Rate Sensitive Assets (RSA) and Rate sensitive Liabilities (RSA) for each time bucket.

The positive GAP indicates that RSAs are more than RSLs (RSA>RSL).

The negative GAP indicates that RSAs are more than RSALs (RSA<RSL).

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They can implement ALM policies for the better identification of the mismatch, risk and for the implementation of various remedial measures.

GENERAL:The classification of various components of assets and liabilities into different time buckets for preparation of Gap reports (Liquidity and interest rate sensitivity) may be done as indicated in Appendices I & II as a sort of bench mark, which are better equipped to reasonably estimate the behavioral pattern, embedded options, rolls-in and rolls-out etc of various components of assets and liabilities on the basis of past date. Empirical studies could classify them in the appropriate time buckets, subject to approval from the HDFC / Board. A copy of the note approved by the ALOC / Board may be sent to the Department of Supervision.

The present framework does not capture the impact of embedded options, i.e., the customers exercising their options (premature closure of deposits and prepayment of loans and advances) on the liquidity and interest rate risks profile. The magnitude of embedded option risk at times of volatility in market interest rates is quite substantial should, therefore evolve suitable mechanism, supported by empirical studies and behavioral analysis to estimate the future behavior of assets; liabilities and off-balance sheet items to changes in market variables and estimate the embedded options. A scientifically evolved internal transfer pricing model by assigning values on the basis of current market rates to funds provided and funds used is an imported component for elective implementation of ALM systems. The transfer price mechanism can enhance the management of margin i.e., landings or credit spread the funding or liability spread and mismatch spread. It also helps centralizing interest rate risk at one place which facilitates effective control and management of interest rate risk. A well defined transfer pricing system also provides a rational framework for pricing of assets and liabilities.

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COMPARATIVE ASSET LIABILITY AS ON 31ST MARCH 2011-12

As at 31-Mar-12

As at 31-Mar-11

ABSOLUTE INCREASE/ DECREAES

CHANGE IN %

CAPITAL AND LIABILITIES Capital Reserves and Surplus Employees Stock Options (Grants) Outstanding Deposits Borrowings Other Liabilities and Provisions 2,773,525,565 ASSETS Cash and Balances with Reserve Bank of India Balances with Banks and Money at Call and Short notice Investments Advances Fixed Assets Other Assets 709,293,656 1,599,826,654 21,706,480 146,010,773 2,773,525,912 Contingent Liabilities Bills for Collection 5,751,224,839 134,284,924 586,076,161 1,258,305,939 21,228,114 59,551,495 2,224,585,697 4,790,515,044 81,248,646 123,217,495 341,520,715 478,366 86,459,278 548,940,215 960,709,795 53,036,278 21.02414382 27.14130995 2.253455017 145.1840596 24.67606511 20.05441557 65.27650688 45,680,191 144,591,147 -98,910,956 -68.40733894 251,008,158 154,832,841 96,175,317 62.11557986 2,224,585,697 548,939,868 24.67604951 143,940,610 289,928,565 129,156,925 206,159,441 14,783,685 83,769,124 11.44629682 40.63317382 4,652,257 249,111,291 2,085,864,054 4,577,433 210,618,369 1,674,044,394 74,824 38,492,922 411,819,660 1.634627967 18.27614665 24.60028309

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7,000,000,000 6,000,000,000 5,000,000,000 4,000,000,000 3,000,000,000 2,000,000,000 1,000,000,000 0 -1,000,000,000 As at 31-Mar-10 As at 31-Mar-11

Interpretation:

The total current liabilities for the year are Rs.206159441 is less than the total assets for the year are Rs.2224585697. Therefore the assets are more than the liabilities. So there is a positive gap of Rs.548939688 i.e 24.67%

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COMPARATIVE ASSET LIABILITY AS ON 31ST MARCH 2010-11

As at 31-Mar-11

As at 31-Mar-10

ABSOLUTE INCREASE/ DECREAES

CHANGE IN %

CAPITAL AND LIABILITIES Capital Equity Share Warrants Reserves and Surplus Employees Stock Options (Grants) Outstanding Deposits Borrowings Other Liabilities and Provisions 1,674,044,394 129,156,925 206,159,441 2,224,585,697 ASSETS Cash and Balances with Reserve Bank of India Balances with Banks and Money at Call and Short notice Investments Advances Fixed Assets Other Assets 586,076,161 1,258,305,939 21,228,114 59,551,495 2,224,585,697 Contingent Liabilities Bills for Collection 4,790,515,044 81,248,646 588,175,488 988,830,473 17,067,290 63,568,314 1,832,707,732 4,059,816,885 85,522,390 -2,099,327 269,475,466 4,160,824 -4,016,819 391,877,965 730,698,159 -4,273,744 -0.356921878 27.25193786 24.37893772 -6.318901269 21.38245822 17.99830336 -4.997222365 144,591,147 39,794,055 104,797,092 263.3486133 154,832,841 135,272,112 19,560,729 14.4602821 1,428,115,800 91,636,374 162,428,229 1,832,707,732 245,928,594 37,520,551 43,731,212 391,877,965 17.22049388 40.9450411 26.92340628 21.38245822 210,618,369 29,135 4,577,433 4,253,841 4,009,158 142,209,460 54,870 323,592 -4,009,158 68,408,909 -25,735 7.607054424 -100 48.10433075 -46.90176781

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6,000,000,000 5,000,000,000 4,000,000,000 3,000,000,000 2,000,000,000 1,000,000,000 0 -1,000,000,000 As at 31-Mar-10 As at 31-Mar-09 ABSOLUTE INCREASE/ DECREAES

Interpretation:

The total current liabilities for the year are Rs.43731212 is less than the total assets for the year are Rs.1832707732. Therefore the assets are more than the liabilities. So there is a positive gap of Rs. 391877965 i.e 21.38%

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COMPARATIVE ASSET LIABILITY AS ON 31ST MARCH 2009-10

As at 31-Mar-10

As at 31-Mar-09

ABSOLUTE INCREASE/ DECREAES

CHANGE IN %

CAPITAL AND LIABILITIES Capital Equity Share Warrants 4,253,841 4,009,158 3,544,329 709,512 20.01823

Reserves and Surplus Employees Stock Options (Grants) Outstanding Deposits Borrowings Other Liabilities and Provisions

142,209,460 54,870

111,428,076 30,781,384 27.62444

1,428,115,800 26,858,374 227,206,229

1,007,685,910 420,429,890 45,949,235 -19,090,861 163,158,482 64,047,747 39.25493 37.61484 -41.5477 41.72232

1,832,707,732 ASSETS Cash and Balances with Reserve Bank of India Balances with Banks and Money at Call and Short notice Investments Advances Fixed Assets Other Assets 588,175,488 988,830,473 17,067,290 63,568,314 1,832,707,732 Contingent Liabilities Bills for Collection 4,059,816,885 85,522,390 39,794,055 135,272,112

1,331,766,032

500,941,700

125,531,766 9,740,346 22,251,622 7.759268

17,542,433 493,935,382 94,240,106 634,268,934 354,561,539 11,750,917 5,316,373 44,027,411 19,540,903 1,331,766,032 500,941,700 5,930,080,864 -1,870,263,979 69,207,148 16,315,242

78.83665 19.07944 55.90082 45.2422 44.38349 37.61484 -31.5386 23.5745

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7,000,000,000 6,000,000,000 5,000,000,000 4,000,000,000 3,000,000,000 2,000,000,000 1,000,000,000 0 -1,000,000,000 -2,000,000,000 -3,000,000,000 As at 31-Mar-08 As at 31-Mar-09

Interpretation:

The total current liabilities for the year are Rs.64047747 is less than the total assets for the year are Rs.1331766032. Therefore the assets are more than the liabilities. So there is a positive gap of Rs. 500941700 i.e 37.61%

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COMPARATIVE ASSET LIABILITY AS ON 31ST MARCH 2008-09

As at 31Mar-09

As at 31Mar-08

ABSOLUTE INCREASE/ DECREAES

CHANGE IN %

CAPITAL AND LIABILITIES Capital Reserves and Surplus Deposits Borrowings Other Liabilities and Provisions 133,176,60 ASSETS Cash and Balances with Reserve Bank of India Balances with Banks and Money at Call and Short notice Investments Advances Fixed Assets Other Assets 49,393,54 63,426,90 1,175,13 4,402,69 30,564,80 46,944,78 966,67 3,712,71 1882874 1648212 20846 68998 61.602693 35.10959 21.564753 18.584269 2,225,16 3,971,40 -174624 -43.970388 12,553,18 5,075,25 747793 147.34112 91,235,61 4194099 45.969978 100,768,60 4,478,86 16,431,91 68,297,94 2,815,39 13,689,13 3247066 166347 274278 47.542664 59.084887 20.036189 354,43 11,142,80 319,39 6,113,76 3504 502904 10.970913 82.257727

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133,176,60 Contingent Liabilities Bills for Collection 6,920,71 593,008

91,235,61 328,148,24

4194099 -32221816

45.969978 -98.192866

4,60683

231388

50.227163

40000000 30000000 20000000 10000000 CAPITAL AND LIABILITIES Capital Reserves and Surplus Deposits Borrowings Other Liabilities and Provisions ASSETS Cash and Balances with Balances with Banks and Investments Advances Fixed Assets Other Assets 0 -10000000 -20000000 -30000000 -40000000 As at 31-Mar-08 Contingent Liabilities Bills for Collection As at 31-Mar-07 ABSOLUTE INCREASE/ DECREAES

Interpretation:

The total current liabilities for the year are Rs.1368913 is less than the total assets for the year are Rs.9123561. Therefore the assets are more than the liabilities. So there is a positive gap of Rs. 4194099 i.e 45.96%

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Chapter 5

SUGGESTION/ RECOMMENDATION

70

SUGGESTION

They should strengthen its management information system (MIS) and computer processing capabilities for accurate measurement of liquidity and interest rate Risks in their Books. In the short term the Net interest income or Net interest margins (NIM) creates economic value of the which involves up gradation of existing systems & Application software to attain better & improvised levels. It is essential that remain alert to the events that effect its operating environment & react accordingly in order to avoid any undesirable risks. HDFC requires efficient human and technological infrastructure which will future lead to smooth integration of the risk management process with effective business strategies.

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Chapter 6 CONCLUSION

72

CONCLUSION

The purpose of ALM is not necessarily to eliminate or even minimize risk. The level of risk will vary with the return requirement and entitys objectives. Financial objectives and risk tolerances are generally determined by senior management of an entity and are reviewed from time to time. All sources of risk are identified for all assets and liabilities. Risks are broken down into their component pieces and the underlying causes of each component are assessed. Relationships of various risks to each other and/or to external factors are also identified. Risk exposure can be quantified 1) relative to changes in the component pieces, 2) as a maximum expected loss for a given confidence interval in a given set of scenarios, or 3) by the distribution of outcomes for a given set of simulated scenarios for the component piece over time. Regular measurement and monitoring of the risk exposure is required. Operating within a dynamic environment, as the entitys risk tolerances and financial objectives change, the existing ALM strategies may no longer be appropriate. Hence, these strategies need to be periodically reviewed and modified. A formal, documented communication process is particularly important in this step.

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LIMITATIONS:

This subject is based on past data of HDFC The analysis is based on structural liquidity statement and gap analysis. The study is mainly based on secondary data. Approximate results: The results are approximated, as no accurate data is Available. Study takes into consideration only LTP and issue prices and their difference for Concluding whether an issue is overpriced or under priced leaving other. The study is based on the issues that are listed on NSE only.

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BIBLOGRAPHY

Title of the Books

Author

Publications

1. Risk management Thomson learning(2001) 2. India financial system Hill Sth Edition 3. Management Research magazine

Gustavson hoyt sout western, division of

M.Y. Khan

Mcgraw

P.M.Dileep Kumar

Web sites www.hdfc.com www.investoros.com www.financeindia.com www.google.com

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