ASSET AND LIABILITY MANAGEMENT IN BANKS

CHAPTER 1
INTRODUCTION

Indian banking industry is going through a transformation process in its

transitional journey from the era of protected economy to the tough world of
market economy. Banks are expanding their operations, entering new market
and trading in new asset types. The change in financial products, system and
structures have created new opportunities along with new risks.
Risk management has become an internal part of financial activities of banks
and other market participants. These risks cannot be ignored and either have to
be managed by market participants as part of Asset-Liability Management
(ALM) or hedged. Under these circumstances, creating an environment that
promotes risk management assumes critical importance. This requires
addressing certain policy and institutional issues in developing a market for
risk-sharing and risk-diversification in India.
First and foremost, a well-developed market, repo market constitutes an
important prerequisite for the promotion of risk management practices among
market participant. Regulatory gaps and overlaps in debt markets need to be
sorted out quickly to facilitate the repeal of the 1969 notification which has
banned forward trading securities, which will go a long way in aiding the
process of ALM for banks, Indian conditions are suitable for the introduction of
asset-liability based derivatives.
There is vast scope for assets based securitisation in India. There is also scope
for assets based securitisation in India. There is also scope for the introduction
of credit default swaps in India. It offers advantages of hedging credit risk
without impairing the relationship with the borrower. Forward rate agreements
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ASSET AND LIABILITY MANAGEMENT IN BANKS

and interest rate swaps enable users to lock into spreads. The RBI has already
permitted interest rate swaps. A major reason for lack of term money market is
the absence of the practice of ALM system along bank for identifying
mismatches in various time periods.
The recent guidelines on ALM are expected to contribute to the evolution of an
ALM system, which would help banks to take decisions to lend on a term and
also offer two way quotes in the market. The Advisory Group on Banking
Supervision (2001) constituted by RBI recommended greater orientation of the
bank`s management and their Boards towards a better understanding of risks
and their management.
OECD principles of Corporate Governance (2004) recognised the risk
management as an area of increasing importance for Boards, which is closely
related to corporate strategy.

ASSET AND LIABILITY MANAGEMENT IN BANKS

CHAPTER 2
ASSET-LIABILITY MANAGEMENT (ALM)

In a regulated economy, the interest spread is primarily a function of central

bank of the country because banks accept deposits of regulated rate and lend at
the regulated rate and earn the stipulated spread.
In a globalised environment, intense competition for business and increasing
fluctuations in both domestic interest rates as well as foreign exchange rate put
pressure on the management of banks to maintain spreads profitability and longterm viability without increasing market risk.
There are two major types of risks that commercial banks are exposed to in the
course of their operation i.e. credit risk and market risk.

ASSET AND LIABILITY MANAGEMENT IN BANKS

Banking business itself is a credit risk. Market risk arising out of fluctuations in
interest rates, foreign exchange rates, equity price risk and commodity price risk
is virtually not existent in such a regime where market rates and prices are
stable for relatively long periods of time. Banks are exposed to market risk in
market drive and liberalised environment. Therefore, banks have to manage not
only credit risk but also market risk. They require a managerial approach to
control the viability of market risk.
Thus, Asset Liability Management is a strategic response of banks to
inflationary pressures, volatility in interest rates and severe recessionary trends
in the global economy. The commercial banks in India began to face
tremendous problems of Asset-liability mismatch leading to deregulation of
interest rate and free play of market forces, entry of new players, emergence of
new instruments and new products at competitive rates and enhancement of
risks.
The banks witnessed the vulnerability of mismatches during 1995-96. The
banks which funded term assets through short term loans with low interest rates
were caught napping when the call money rates increased to 80% to 90% or
even higher, with growing tendency of greater integration of money market
foreign exchange market and capital market and greater volatility in the market
condition with the emergence of an active debt-market.
Indian commercial banks were under pressure to adopt the new approach of
asset-liability

management.

Therefore,

asset-liability

management

has

recognised in India as a strategic approach of making business decision in more

comprehensive and disciplined framework to control asset-liabilities mismatch
with an eye on the risks that the banks are exposed to.

ASSET AND LIABILITY MANAGEMENT IN BANKS

OBJECTIVES OF ASSET LIABILITY MANAGEMENT

According to Dynamic Business Analyst, (2011) a vital issue in strategic bank
planning is asset and liability management, which is the assessment and
management of endogenous-financial, operational, business and exogenous
risks.
The objective of ALM is to maximize profit through efficient fund allocation
given an acceptable risk structure. ALM is a multidimensional process,
requiring simultaneous interactions among different dimensions. If the
simultaneous nature of loan management is discarded the decreasing risk in one
dimension may result in unexpected increases in other risks.
ALM has changed significantly in the past two decades with the growth and
integration of financial institutions and the emergence of new financial products
services which has influenced the target profit of most industries in Ghana. New
information-based activities and financial innovation increased types of
endogenous and exogenous risks as well as the correlation between these.
Consequently, the structure of balance sheet instruments has become more
complex and the volatility in the banking system has increased. These
developments necessitate the use of quantitative skills to manage risks more
objectively and improve performance.
Diversity in financial institution decision makers attitudes toward risk results
in diverse credit management strategies to sustain target or maximized profit.
Risk taker decision makers are willing to accept higher risk for higher returns
whereas risk-averse managers accept lower level of risks for lower return.
Consequences of high risk taking strategies might be more devastating in
unstable macroeconomic environments such as emerging financial markets. On
the other hand, financial risks may also increase a firm`s overall risk.

ASSET AND LIABILITY MANAGEMENT IN BANKS

CONCEPT OF ASSET-LIABILITY MANAGEMENT

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 earnings from
interest is maximized 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.
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.
Asset-liability management basically refers to the process by which an
institution manages its balance sheet in order to allow for alternative interest
rate and liquidity scenarios. Asset liability management is an integrated
strategic managerial approach of managing total balance sheet dynamics having
regard to its size and quality in such a way that the net earnings from interest are
maximised with the overall risk preference of the bank.
It is concerned with management of net interest margin to ensure that its level
and riskiness are compatible with the risk-return objectives of the bank. This is
done by matching of liabilities and assets in terms of maturity, cost and yield
rates. The maturity mismatches and disproportionate changes in the level of
assets and liabilities can cause both liquidity and interest rate risk. ALM is more
than just managing asset-liability items of the bank`s Balance Sheet.
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ASSET AND LIABILITY MANAGEMENT IN BANKS

However, it is an integrated approach to financial management requiring

simultaneously decisions about types of amounts of financial assets and
liabilities so as to insulated the spread from moving in opposite direction. ALM
is closely integrated with the bank`s business strategy as it has bearing upon the
interest risk profile of the bank.
The focus of ALM is not on building up of deposits and loans in isolation but on
net income and recognising interest rate and liquidity risks. Thus, ALM is
essentials a guide for survival of a bank in a deregulated environment.

ASSET AND LIABILITY MANAGEMENT IN BANKS

NEED OF ALM IN BANKS

Before 1970 in the industrial countries banks were heavily regulated. They
followed 3-6-3 banking.
3-6-3 banking: Accepting deposits at 3%, lending at 6% and leave for
golf club at 3pm.
Due to high regulations and controls, at that time credit risk was the only aspect
management had to manage. But after 1970 due to deregulation of interest rates
market risks were came in to picture (especially interest rate risk).
Factors which caused changes in banking scenario:
Financial products starting from simple forward contracts to highly
complex instruments came into existence to transfer risk.
Invention of powerful machines to store and process data. The incredible
capacity of these machines raised analysis of information to very high
planes in tern leading to development of new products.
Deregulation of interest rates, technology changes provides both
opportunities and threats.

Banking business has been transformed from mere deposit taking and lending
into a complex world of innovations and risk management.
With the liberalization in Indian financial markets and growing integration of
domestic markets with external markets, the risk associated with banks
operations have become complex and large, requiring strategic management.
Banks are now operating in a fairly deregulated environment and are required to
determine on their own interest rates on deposits and advances in both domestic
and foreign currencies on a dynamic basis.
The interest rates on banks investments in government and other securities are
also now market related. Intense competition for business involving both the
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ASSET AND LIABILITY MANAGEMENT IN BANKS

assets and liabilities together with increasing volatility in domestic interest rates
as well as foreign exchange rates has bought pressure on management of banks
to maintain a good balance among spreads, profitability and long term viability.
Imprudent liquidity management can puts banks earnings and reputation at great
risk. These pressures called for structured and comprehensive measures and not
just add hoc actions.
Banks need to address these risks in a structured manner by upgrading their risk
management and adopting more comprehensive ALM practices than that has
been done hitherto. ALM is concerned with risk management and provides a
comprehensive and dynamic framework for measuring, monitoring and
managing liquidity, interest rate, foreign exchange and commodity price risks of
a bank that needs to be closely integrated with the business strategy. ALM
involves assessment of various types of risks and altering the asset-liability
portfolio in a dynamic way in order to manage risk.

ASSET AND LIABILITY MANAGEMENT IN BANKS

CHAPTER 3
FUNCTION OF ALM

The basic function of ALM is to guide the management in establishing optimal

match between the assets and liabilities of the bank in such a way as to
maximise its net income and minimise the market risk. This is to be done by
analysing the current market risk profile of the bank and its impact on the future
risk profile. The manager has to choose the best course of action depending on
the risk preferences of the management.
Asset Management : The asset management includes the following:
i.

Cash Management : Cash management is a dynamic function that needs

to be dealt with effectively at various levels. Cash balances are the idle
assets of the bank; hence cash should be kept at a bare minimum level.
The banks need to manage their cash balances in order to meet their
customer requirements of their demand deposits.

ii.

Reserve and Investment Management : Reserve requirements

constitute the first charge on any bank`s funds and the balance can be
used for advances and other income generating assts. The reduction in
statutory liquidity ratio helps the banks to invest more resources in
profitable avenues. The banks should plan their requirements properly.

iii.

Credit Management : A major portion of bank`s income is derived from

returns on advances and credit expansion. Managing credit is a critical

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ASSET AND LIABILITY MANAGEMENT IN BANKS

function of any bank. Effective credit management is necessary to ensure

that the advances remain performing and the income is maximised.

iv.

Management of Other Assets : The banks have to invest in other assets

in order to generate more income and not to keep idle assets. It can invest
in real estate, government securities, money market etc. However, the
creation of other assets should generate additional income to the bank.

Liability Management : The liability management includes the

following:

i.

Owned Funds : The bank`s owned funds are capital and reserve and
surplus. Capital is raised by offering equity to the public. It can also be
achieved through increasing reserves. Capital adequacy has to be
maintained by the banks. It is considered as a financial barometer for the
stability and soundness of a bank.

ii.

Deposits : A major source of asset creation of a bank is mobilisation of

deposits. It has become a challenging task for banks in these days. Banks
collect funds through different types of deposits having different
maturities. There are some demand deposits also. The banks have to see
that these deposits are repaid on time.

iii.

Borrowings : Whenever there is a shortage of funds, banks can borrow

from RBI, financial institutions, and markets. It is also a major source of
raising funds. However, the banks have to consider the rate of interest,
maturity and other statutory requirements, while borrowing from outside.

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ASSET AND LIABILITY MANAGEMENT IN BANKS

iv.

Floating Funds : The banks have floating funds with them in the form of
bills payables, draft payables. These funds are available for short and
temporary period. These funds have no costs. However, proper
management of these funds requires network of branches, speed in
delivery of service and technological advancement.

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ASSET AND LIABILITY MANAGEMENT IN BANKS

CHAPTER 4
CATEGORIES OF RISK
Risk in a way can be defined as the chance or the probability of loss or damage.
In the case of banks, these include credit risk, capital risk, market risk, interest
rate risk, and liquidity risk. These categories of financial risk require focus,
since financial institutions like banks do have complexities and rapid changes in
their operating environments.

CREDIT RISK: The risk of counter party failure in meeting the payment
obligation on the specific date is known as credit risk. Credit risk
management is an important challenge for financial institutions and
failure on this front may lead to failure of banks. The recent failure of
many Japanese banks and failure of savings and loan associations in the
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ASSET AND LIABILITY MANAGEMENT IN BANKS

1980s in the USA are important examples, which provide lessons for
others. It may be noted that the willingness to pay, which is measured by
the character of the counter party, and the ability to pay need not
necessarily go together.
The other important issue is contract enforcement in countries like India.
Legal reforms are very critical in order to have timely contract
enforcement. Delays and loopholes in the legal system significantly affect
the ability of the lender to enforce the contract.
CAPITAL RISK: One of the sound aspects of the banking practice is the
maintenance of adequate capital on a continuous basis. There are attempts
to bring in global norms in this field in order to bring in commonality and
standardization in international practices. Capital adequacy also focuses
on the weighted average risk of lending and to that extent, banks are in a
position to realign their portfolios between more risky and less risky
assets.
MARKET RISK: Market risk is related to the financial condition, which
results from adverse movement in market prices. This will be more
pronounced when financial information has to be provided on a markedto-market basis since significant fluctuations in asset holdings could
adversely affect the balance sheet of banks. In the Indian context, the
problem is accentuated because many financial institutions acquire bonds
and hold it till maturity. When there is a significant increase in the term
structure of interest rates, or violent fluctuations in the rate structure, one
finds substantial erosion of the value of the securities held.
INTEREST RATE RISK: Interest rate risk is the risk where changes in
market interest rates might adversely affect a banks financial condition.
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ASSET AND LIABILITY MANAGEMENT IN BANKS

The immediate impact of changes in interest rates is on the Net Interest

Income (NII). A long term impact of changing interest rates is on the
banks net worth since the economic value of a banks assets, liabilities
and off-balance sheet positions get affected due to variation in market
interest rates. The interest rate risk when viewed from these two
perspectives is known as earnings perspective and economic value
perspective, respectively.
As specified, changes in market interest rates have dual impact for a
bank: on its Net Interest Income (NII) and on its net-worth. Management
of interest rate risk aims at capturing the risks arising from the maturity
and re-pricing mismatches and is measured both from the earnings and
economic value perspective.
Earnings perspective involves analyzing the impact of changes in interest
rates on accrual or reported earnings in the near term. This is measured by
measuring the changes in the Net Interest Income (NII) or Net Interest
Margin (NIM) i.e. the difference between the total interest income and
the total interest expenditure.
Economic Value perspective involves analyzing the changes of impact of
interest on the expected cash flows on assets minus the expected cash
flows on liabilities plus the net cash flows on off-balance sheet items. It
focuses on the risk to net-worth arising from all re-pricing mismatches
and other interest rate sensitive positions. The economic value
perspective identifies risk arising from long-term interest rate gaps.

LIQUIDITY RISK: Liquidity risk is the potential inability to meet the

banks liabilities as they become due.
It arises when the banks are unable to generate cash to cope with a
decline in deposits or increase in assets. It originates from the mismatches
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ASSET AND LIABILITY MANAGEMENT IN BANKS

in the maturity pattern of assets and liabilities. The liquidity risk in banks
manifest in different dimensions:
Funding Risk: The need to replace net outflows due to unanticipated
withdrawal/non-renewal of deposits
Time Risk: The need to compensate for non-receipt of expected inflows
of funds i.e., performing assets turning into NPAs
Call Risk: Due to crystallization of contingent liabilities and inability to
undertake profitable business opportunities when desirable.
FOREIGN EXCHANGE RISK : The risk that a bank may suffer losses
as a result of adverse exchange rate movements during a period in which
it has an open position, either spot or forward, or a combination of the
two, in an individual foreign currency.

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ASSET AND LIABILITY MANAGEMENT IN BANKS

CHAPTER 5
ELEMENTS OF ALM IN BANK

There are nine elements related to ALM and they are as follows:
Strategic framework: The Board of Directors are responsible for setting
the limits for risk at global as well as domestic levels. They have to decide
how much risk they are willing to take in quantifiable terms. Also it is
necessary to determine who is in chare of controlling risk in the
organization and their responsibilities.
Organizational framework: All elements of the organization like the
ALM Committee, subcommittees, etc., should have clearly defined roles
and responsibilities. ALM activities should be supported by the top
management with proper resource allocation and personnel committee.
Operational framework: There should be a proper direction for risk
management with detailed guidelines on all aspects of ALM. The policy
statement should be well articulated providing a clear direction for ALM
function.
Analytical framework: Analytical methods in ALM require consistency,
which includes periodic review of the models used to measure risk to
avoid miscalculation and verifying their accuracy. Various analytical
components like Gap, Duration, Stimulation and Value-at-Risk should be
used to obtain appropriate insights.

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ASSET AND LIABILITY MANAGEMENT IN BANKS

Technology framework: An integrated technological framework is

required to ensure all potential risks are captured and measured on a
timely basis. It would be worthwhile to ensure that automatic information
feeds into the ALM systems and he latest software is utilized to enable
management perform extensive analysis, planning and measurement of all
facets of the ALM function.
Information reporting framework: The information reporting
framework decides who receives information, how timely, how often and
in how much detail and whether the amount and type of information
received is appropriate and necessary for the recipients task.
Performance reporting framework: The performance of the traders and
business units can easily be measured using valid risk measurement
measures. The performance measurement considers approaches and ways
to adjust performance measurement for the risks taken. The profitability of
an institution comes from three sources: Asset, Liabilities and their
efficient management.
Regulatory compliance framework: The objective of regulatory
compliance element is to ensure that there is compliance with the
requirements, expectations and guidelines for risk based capital and
liquidity ratios.
Control framework: The control framework covers the control over all
processes and systems. The emphasis should be on setting up a system of
checks and balances to ensure the integrity of data, analysis and reporting.
This can be ensured through regular internal / external reviews of the
function.
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ASSET AND LIABILITY MANAGEMENT IN BANKS

CHAPTER 6
ALM-PROCESS
The ALM process rests on three pillars:
ALM Information Systems
i.

Management Information Systems

ii.

Information availability, accuracy, adequacy and expediency

ALM Organization
i.

Structure and responsibilities

ii.

Level of top management involvement

ALM Process
i.

Risk parameters

ii.

Risk identification

iii.

Risk measurement

iv.

Risk management

v.

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
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ASSET AND LIABILITY MANAGEMENT IN BANKS

development of the term-money market, RBI revised these guidelines and it was
provided that
(a) 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 liability. 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 turn out 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.
(b) 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
recognize 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, and 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 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.

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ASSET AND LIABILITY MANAGEMENT IN BANKS

CHAPTER 7
CLASSIFICATION OF ALM IN BANKS
(Referred from Asset - Liability Management System in banks Guidelines by
RBI)

OUTFLOWS:
Capital
Reserves and surplus
Deposits
i. Current deposits
ii. Savings bank deposits
iii. Term deposits
iv. Certificates of deposits
Borrowings
i. Call and short notice
ii. Interbank(term)
iii. Refinances
iv. Others
Other liabilities and provisions
i. Bills payable
ii. Inter office adjustments
iii. Provisions for depreciation and unrecoverable loans etc
iv. Others
Lines of credit committed to
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ASSET AND LIABILITY MANAGEMENT IN BANKS

i. Institutions
ii. Customers
Letters of credit/ guarantees (contingent liabilities)
Repos
Bills rediscounted
Swaps (buy/sell) /maturing forwards
Interest payable
Others- if any

INFLOWS:
Cash
Balances with RBIfor CRR
Balances with other banks
i. Current account
ii. Money at call and short notice, term deposits etc
Investments
i. Approved securities
ii. Corporate debentures and bonds, CDs, redeemable preference shares,
units of mutual funds
iii. Investments in subsidiaries/ joint ventures
Advances (performing)
i. Bills Purchased and Discounted (including bills under DUPN)
ii. Cash Credit/Overdraft (including TOD) and Demand Loan component
of Working Capital.
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ASSET AND LIABILITY MANAGEMENT IN BANKS

iii. Term Loans

NPAs
i. Sub-standard
ii. Doubtful and Loss
Fixed Assets
Other Assets
i. Inter-office Adjustment
ii. Others
Reverse repo
Interest receivable
Swaps (sell/buy)/ maturing forwards
Committed lines of credit
Bills rediscounted(DUPN)
Others

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ASSET AND LIABILITY MANAGEMENT IN BANKS

TIME BUCKETS
RBI was divided future cash flows into different time buckets. While preparing
structural liquidity statement and interest rate sensitivity statement cash flows
were placed in different time buckets based on their maturity period or repricing
period.
i) 1 to 14 days
ii) 15 to 28 days
iii) 29 days and upto 3 months
iv) Over 3 months and upto 6 months
v) Over 6 months and upto 12 months
vi) Over 1 year and upto 2 years
vii) Over 2 years and upto 5 years
viii) Over 5 years
The first time bucket (1-14 days at present) is further divided into three time
buckets for more granular approach to measurement of risk.
i.

Next day

ii.

2-7 days

iii.

8-14 days

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ASSET AND LIABILITY MANAGEMENT IN BANKS

RISK MEASUREMENT TECHNIQUES

There are various techniques for measuring exposure of banks to interest rate
risks:
GAP ANALYSIS MODEL
Measures the direction and extent of asset-liability mismatch through either
funding or maturity gap. It is computed for assets and liabilities of differing
maturities and is calculated for a set time horizon. This model looks at the
repricing gap that exists between the interest revenue earned 9n the bank's assets
and the interest paid on its liabilities over a particular period of time (Saunders,
1997).
It highlights the net interest income exposure of the bank, to changes in interest
rates in different maturity buckets. Repricing gaps are calculated for assets and
liabilities of differing maturities. A positive gap indicates that assets get
repriced before liabilities, whereas, a negative gap indicates that liabilities get
repriced before assets. The bank looks at the rate sensitivity (the time the bank
manager will have to wait in order to change the posted rates on any asset or
liability) of each asset and liability on the balance sheet. The general formula
that is used is as follows:
NIIi = R i (GAPi)
While NII is the net interest income, R refers to the interest rates impacting
assets and liabilities in the relevant maturity bucket and GAP refers to the
differences between the book value of the rate sensitive assets and the rate
sensitive liabilities. Thus when there is a change in the interest rate, one can
easily identify the impact of the change on the net interest income of the bank.
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

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ASSET AND LIABILITY MANAGEMENT IN BANKS

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 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).
The immediate focus of ALM is interest-rate risk and return as measured by a
banks net interest margin
NIM = (Interest income Interest expense) / Earning assets
A banks NIM, in turn, is a function of the interest-rate sensitivity, volume, and
mix of its earning assets and liabilities. That is, NIM = f (Rate, Volume, Mix)

Sources of interest rate risk : The primary forms of interest rate risk include
repricing risk, yield curve risk, basis risk and optionality.

Effects of interest rate risk: Changes in interest rates can have adverse effects
both on a banks earnings and its economic value.
The earnings perspective: From the earnings perspective, the focus of analyses
is the impact of changes in interest rates on accrual or reported earnings.
Variation in earnings (NII) is an important focal point for IRR analysis because
reduced interest earnings will
threaten the financial performance of an institution.

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ASSET AND LIABILITY MANAGEMENT IN BANKS

Economic value perspective: Variation in market interest rates can also affect
the economic value of a banks assets, liabilities, and Off Balance Sheet (OBS)
positions. Since the economic value perspective considers the potential impact
of interest rate changes on the present value of all future cash flows, it provides
a more comprehensive view of the potential long-term effects of changes in
interest rates than is offered by the earnings perspective.
Interest rate sensitivity and GAP management: This model measures the
direction and extent of asset-liability mismatch through a funding or maturity
GAP (or, simply, GAP). Assets and liabilities are grouped in this method into
time buckets according to maturity or the time until the An insightful view of
ALM is that it simply combines portfolio management techniques into a
coordinated process.

Gap
Positive

Cause

Interest Rate

RSA > RSL

(Asset)
Negative

RSA < RSL

(Liability)
Zero

RSA = RSL

Profit (NII)

Rise

Rise

Fall

Fall

Rise

Fall

Fall

Rise

Rise

No Effect

Fall

No Effect

first possible resetting of interest rates. For each time bucket the GAP equals the
difference between the interest rate sensitive assets (RSAs) and the interest rate
sensitive liabilities (RSLs). In symbols:
GAP = RSAs RSLs
When interest rates change, the banks NII changes based on the following
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ASSET AND LIABILITY MANAGEMENT IN BANKS

interrelationships:
NII = (RSAs - RSLs) x r
NII = GAP x r
A zero GAP will be the best choice either if the bank is unable to speculate
interest
rates accurately or if its capacity to absorb risk is close to zero. With a zero
GAP, the bank is fully protected against both increases and decreases in interest
rates as its NII will not change in both cases.
As a tool for managing IRR,
GAP management suffers from three limitations:
Financial institutions in the normal course are incapable of outpredicting the markets, hence maintain the zero GAP.
It assumes that banks can flexibly adjust assets and liabilities to
attain the desired GAP.
It focuses only on the current interest sensitivity of the assets and
liabilities, and ignores the effect of interest rate movements on the value
of bank assets and liabilities.

Cumulative GAP model : In this model, the sum of the periodic GAPs is equal
to the cumulative GAP measured by the maturity GAP model. While the
periodic GAP model corrects many of the deficiencies of the GAP model, it
does not explicitly account for the influence of multiple market rates on the
interest income.

DURATION MODEL: Duration is an important measure of the interest rate

sensitivity of assets and liabilities as it takes into account the time of arrival of
cash flows and the maturity of assets and liabilities. It is the weighted average
time to maturity of all the preset values of cash flows.
Duration basic -ally refers to the average life of the asset or the liability.
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ASSET AND LIABILITY MANAGEMENT IN BANKS

DP p = D (dR /1+R)
DGAP directly indicates the effect of interest rate changes on the net worth of
the
institution. The funding GAP technique matches cash flows by structuring the
short-term maturity buckets. On the other hand, the DGAP hedges against IRR
by structuring the portfolios of assets and liabilities to change equally in value
whenever the interest rate changes. If DGAP is close to zero, the market value
of the banks equity will not change and, accordingly, become immunised to
any changes in interest rates.
DGAP analysis improves upon the maturity and cumulative GAP models by
taking into account the timing and market value of cash flows rather than the
horizon maturity. It gives a single index measure of interest rate risk exposure.
The application of duration analysis requires extensive data on the specific
characteristics and current market pricing schedules of financial instruments.
However, for institutions which have a high proportion of assets and liabilities
with embedded options, sensitivity analysis conducted using duration as the sole
measure of price elasticity is likely to lead to erroneous results due to the
existence of convexity in such instruments.
Apart from this, duration analysis makes an assumption of parallel shifts in the
yield curve, which is not always true. To take care of this, a high degree of
analytical approach to yield curve dynamics is required. However,
immunisation through duration eliminates the possibility of unexpected gains or
losses when there is a parallel shift in the yield curve. In other words, it is a
hedging or risk-minimisation strategy; not a profit-maximisation strategy.

VALUE AT RISK: Refers to the maximum expected loss that a bank can
suffer over a target horizon, given a certain confidence interval. It enables the
calculation of market risk of a portfolio for which no historical data exists. It
enables one to calculate the net worth of the organization at any particular point
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ASSET AND LIABILITY MANAGEMENT IN BANKS

of time so that it is possible to focus on long-term risk implications of decisions

that have already been taken or that are going to be taken. It is used extensively
for measuring the market risk of a portfolio of assets and/or liabilities.

SIMULATION: Simulation models help to introduce a dynamic element in the

analysis of interest rate risk. Gap analysis and duration analysis as stand-alone
too15 for asset-liability management suffer from their inability to move beyond
the static analysis of current interest rate risk exposures. Basically simulation
models utilize computer power to provide what if scenarios

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ASSET AND LIABILITY MANAGEMENT IN BANKS

CHAPTER 8
ALM-REPORTS
The following reports are used for ALM:
Structural Liquidity Profile (SLP);
Interest Rate Sensitivity
Maturity and Position (MAP)
Statement of Interest Rate Sensitivity (SIR)

STRUCTURAL LIQUIDITY PROFILE (SLP)

All Assets & Liabilities to be reported as per their maturity profile into 8
maturity Buckets
1. 1 to 14 days
2. 15 to 28 days
3. 29 days and up to 3 months
4. Over 3 months and up to 6 months
5. Over 6 months and up to 1 year
6. Over 1 year and up to 3 years
7. Over 3 years and up to 5 years
8. Over 5 years

STATEMENT
Places all cash inflows and outflows in the maturity ladder as per residual
maturity
Maturing Liability: cash outflow
Maturing Assets : Cash Inflow
Classified in to 8 time buckets
Mismatches in the first two buckets not to exceed 20% of outflows
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ASSET AND LIABILITY MANAGEMENT IN BANKS

Shows the structure as of a particular date

Banks can fix higher tolerance level for other maturity buckets.
INTEREST RATE SENSITIVITY
Generated by grouping RSA, RSL & OFF-Balance sheet items in to various (8)
time buckets.
RSA
MONEY AT CALL
ADVANCES ( BPLR LINKED )
INVESTMENT RSL
DEPOSITS EXCLUDING CD
BORROWINGS

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PERFORMANCES MEASUREMENT AND BENCHMARKING

Performance measurement is a fundamental tool used to determine whether

various parts of an organization are meeting or exceeding their objectives, and it
is also critical element of ALM. Within an institutional framework, ALM is
often practiced under explicit constraints. In order for it to succeed, the
organization must be able to measure the extent to which ALM is
accomplishing its goals by sustaining target profit or maximizing profitability.
While performance measurement is most commonly associated with portfolio
managers, it is just as relevant to other decision-making entities in the
organization. In many cases, investment related decisions made by other parts
of the organization may have a more significant impact on profitability than the
portfolio manager.
In most organizations there is a hierarchy of investment related decisionmaking, which includes:

Liability Driven: The strategic asset allocation, determined by the product

manager or investment committee, is driven by the liabilities and this has a
direct impact on the profitability of the organization. Firm Driven: the chief
investment officer (CIO) may determine the tactical asset allocation. It includes
consideration of the timing of portfolio rebalancing, timing of the investment of
surplus cash or raising cash in anticipation of payouts, opportunistic
investments in application of market moves and hedging decisions and this will
indicate the profit margin of the company future.

Style: The selection of investment styles, such as growth or value equity

portfolios after considering the external opportunities, and the associated

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ASSET AND LIABILITY MANAGEMENT IN BANKS

portfolio managers. This decision may include the participation of an outside

consultant.
Security selection: The selection, purchased and sales of individual securities
by the individual portfolio manager. In order to evaluate the effectiveness of
these investment decisions, the related performance must be compared with
immediate competitors or benchmark that is appropriate. Some examples of
appropriate benchmarks to evaluate the asset allocation decision include: a
portfolio that has very similar cash flow characteristics as the liabilities;
Asset index returns allocated according to the strategic asset allocation. The
performance for the tactical asset allocation decision can be the market index
returns applied to the actual portfolio allocation; The style/manager selection
performance can be evaluated by comparing the performance of style-specific
or manager-specific benchmarks with the broad market indexes for the asset
class chosen for the strategic asset allocation and Portfolio management can be
evaluated against style specific or manager specific benchmarks.
It may also be desirable to compare investment performance of individual
managers with appropriate peer group averages to determine the quality of the
manager versus others with similar objectives. It may also be desirable to
calculate performance relative to other institutions with similar liability profiles
in order to compare returns on the actual asset portfolio against a national
portfolio that has similar expected cash flow characteristics as the underlying
liabilities to assist in competitive evaluation and pricing decisions.

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CHAPTER 9
ASSET LIABILITY COMMITTEE ALCO
The Asset-Liability Committee (ALCO) consisting of the bank's senior
management including CEO should be responsible for ensuring adherence to the
limits set by the Board as well as for deciding the business strategy of the bank
(on the assets and liabilities sides) in line with the bank's budget and decided
risk management objectives.
The ALM desk consisting of operating staff should be responsible for
analyzing, monitoring and reporting the risk profiles to the ALCO. 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 bank's internal limits.
The ALCO is a decision making unit responsible for balance sheet planning
from risk-return perspective including the strategic management of interest rate
and liquidity risks. Each bank will have to decide on the role of its ALCO, its
responsibility as also the decisions to be taken by it. The business and risk
management strategy of the bank should ensure that the bank operates within
the limits/parameters set by the Board. The business issues that an ALCO would
consider, inter alia, will include product pricing for both deposits and advances,
desired maturity profile of the incremental assets and liabilities, etc. In addition
to monitoring the risk levels of the bank, the ALCO should review the results of
and progress in implementation of the decisions made in the previous meetings.
The ALCO would also articulate the current interest rate view of the bank and
base its decisions for future business strategy on this view. In respect of the
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
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ASSET AND LIABILITY MANAGEMENT IN BANKS

view on future direction of interest rate movements and decide on a funding mix
between fixed vs floating rate funds, wholesale vs retail deposits, money market
vs capital market funding, domestic vs foreign currency funding, etc. Individual
banks will have to decide the frequency for holding their ALCO meetings.
Top Management, the CEO/CMD or ED should head the Committee. The
Chiefs of Investment, Credit, Funds Management/Treasury (forex and
domestic), International banking and Economic Research can be members of
the Committee. In addition the Head of the Information Technology Division
should also be an invitee for building up of MIS and related computerization.
Some banks may even have sub-committees.
The size (number of members) of ALCO would depend on the size of each
institution, business mix and organizational complexity.
Committee composition
Permanent members:
Chairman
Managing Director/CEO
Financial Director
Risk Manager
Treasury Manager
ALCO officer
Divisional Managers
By invitation:
Economist
Risk Consultants
Purposes and Tasks of ALCO:

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ASSET AND LIABILITY MANAGEMENT IN BANKS

Formation of an optimal structure of the Banks balance sheet to provide the

maximum profitability, limiting the possible risk level;
Control over the capital adequacy and risk diversification;
Execution of the uniform interest policy;
Determination of the Banks liquidity management policy;
Control over the state of the current liquidity ratio and resources
of the Bank;
Formation of the Banks capital markets policy;
Control over dynamics of size and yield of trading transactions
(purchase/sale of currency, state and corporate securities, shares,
derivatives for such instruments) as well as extent of diversification
thereof;
Control over dynamics of the basic performance indicators (ROE,
ROA, etc.) as prescribed in the Bank's policy.

Process of ALCO

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ASSET AND LIABILITY MANAGEMENT IN BANKS

CHAPTER 10
ALM 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.
1. LIQUIDITY RISK MANAGEMENT
Banks liquidity management is the process of generating funds to meet
contractual or relationship obligations at reasonable prices at all times. New
loan demands, existing commitments, and deposit withdrawals are the basic
contractual or relationship obligations that a bank must meet.
Liquidity Tracking
Measuring and managing liquidity needs are vital for effective operation of the
Company. By assuring the Companys ability to meet its liabilities as they
become due, liquidity management can reduce the probability of an adverse
situation. The importance of liquidity transcends individual institutions, as
liquidity shortfall in one institution can have repercussions on the entire system.
The ALCO should measure not only the liquidity positions of the Company on
an ongoing basis but also examine how liquidity requirements are likely to
evolve under different assumptions. Experience shows that assets commonly
considered being liquid, such as govt. securities and other money market
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ASSET AND LIABILITY MANAGEMENT IN BANKS

instruments, could also become illiquid when the market and players are
unidirectional. Therefore, liquidity has to be tracked through maturity or cash
flow mismatches. For measuring and managing net funding requirement, the use
of a maturity ladder and calculation of cumulative surplus or deficit of funds at
selected maturity dates is adopted as a standard tool.
Analysis of following factors throws light on a banks adequacy of liquidity
position:
i.

Historical Funding requirement

ii.

Current liquidity position

iii.

Anticipated future funding needs

iv.

Sources of funds

v.

Options for reducing funding needs

vi.

Present and anticipated asset quality

vii.

Present and future earning capacity and

viii.

Present and planned capital position

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

following:
i.

Dispose off liquid assets

ii.

Increase short term borrowings

iii.

Decrease holding of less liquid assets

iv.

Increase liability of a term nature

v.

Increase Capital funds

Statement of Structural Liquidity

It Places all cash inflows and outflows in the maturity ladder as per residual
maturity. Maturity Liabilities are cash outflow and Maturity Assets are cash
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ASSET AND LIABILITY MANAGEMENT IN BANKS

inflows. The mismatches in the first two buckets cannot exceed 20% of
outflows. It shows the structure as of a particular date. Banks can fix the
tolerance level for other maturity buckets.

Assets and Liabilities to be reported as per their maturity profile into 8 maturity
buckets:
i.

1 to 14 days

ii.

15 to 28 days

iii.

29 days and up to 3 months

iv.

Over 3 months and up to 6 months

v.

Over 6 months and up to 1 year

vi.

Over 1 year and up to 3 years

vii.

Over 3 years and up to 5 years

viii.

Over 5 years

Addressing the Mismatches

Mismatches can be positive or negative

Positive Mismatch: Maturing Assets > Maturing Liabilities

Negative Mismatch: Maturing Liabilities > Maturing Assets

In case of positive mismatch, excess liquidity can be deployed in money

market instruments, creating new assets & investment swaps etc.

For negative mismatch, it can be financed from market borrowings

(Call/Term), Bills rediscounting, Repos & deployment of foreign
currency converted into rupee.

Strategies

To meet the mismatch in any maturity bucket, the bank has to look into
taking deposit and invest it suitably so as to mature in time bucket with
negative mismatch.
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ASSET AND LIABILITY MANAGEMENT IN BANKS

The bank can raise fresh deposits of Rs 300 crore over 5 years maturities
and invest it in securities of 1-29 days of Rs 200 crores and rest matching
with other out flows.

2. 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 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.
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ASSET AND LIABILITY MANAGEMENT IN BANKS

3. 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 funds in the market when needed, at a reasonable cost vis--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
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ASSET AND LIABILITY MANAGEMENT IN BANKS

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 that 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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ISSUES IN IMPLEMENTATION OF ALM

1. Policy: Lack of a coherent, documented and practical policy is a big hindrance

to ALM implementation. Most often, ALCO membership itself may not be
aware of implications of risks being measured and impact. Policies should
address all issues concerning the bank, all policies should be clearly explained
to all members of board, apart from ALCO and these must be documented.
Proper revisions to this document, a quarterly review needs to be organized as
well as parameters may be changing due to change in situations.

2. Understanding of complexities: Many people in a bank need to understand

risk measurements and risk mitigation procedures. Measurement of risk is a
fairly simple phenomenon and does go on regardless. Formalization of
understanding, especially at a top level, will be helpful as it would help in
decision making.
3. Organization and culture: ALM function needs to be separated clearly from
operations as it involves control and strategy functions. Risk organization in
banks generally land up reporting to treasury, as they are people who come
closest to understanding complex financial instruments. The fact that they are a
business unit, in charge of risk taking is overlooked. Risk Taking and Risk
management are generally two distinct parts of any organization and both must
report to a board completely independently. Openness and transparency are
essential to a proper risk organization. Most organizations react badly to some
positions going wrong by taking more risks and enter vicious cycle of risks.
Thus, it is required to follow policy implicitly in both letter and spirit.

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4. Data and Models: Data may not be available at all times in requisite format. It
must be remembered that many data items are assumptions and gaps must be
measured in perspective. There was a case of a manual branch of a bank that
was closed for 6 months in a year due to inclement weather and was largely
inaccessible. As data may not be obtained from this branch for 6 months,
appropriate assumptions have to be made in any event. The argument is that for
all other purposes, assumptions are being made. Sensible options need to be
chosen and manual branch without computer was an example. However, in
modern banking, it is mapping of models to zero coupon bonds that are an issue.
Once again, arguments are that this should exist within the bank. Based on
sophistication required, multiple models may be used to validate this
conversion. This is strictly outside ALM framework but integrates into ALM
framework.

5. Unrealistic goals: An ALCO secretary was seen desperately trying to tweak

with parameters to show less gaps in liquidity reports. A zero gap is not
practical. Returns are expected for taking risks. Banks assume market and credit
risk and hence they make returns. ALCOs job is to correctly determine
positions and put in place appropriate remedial measures using appropriate
risks. It is not to show things as good when they are not.

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Asset-liability management strategies for correcting mismatch

The strategies that can be employed for correcting the mismatch in terms of
D(A) > D(L) can be either liability or asset driven. Asset driven strategies for
correcting the mismatch focus on shortening the duration of the asset portfolio.
The commonly employed asset based financing strategy is securitization.
Typically the long-term asset portfolios like the lease and hire purchase
portfolios are securitized; and the resulting proceeds are either redeployed in
short term assets or utilized for repaying short-term liabilities.
Liability driven strategies basically focus on lengthening the maturity profiles of
liabilities. Such strategies can include for instance issue of external equity in the
form of additional equity shares or compulsorily convertible preference shares
(which can also help in augmenting the Tier I capital of finance companies),
issue of redeemable preference shares, subordinated debt instruments,
debentures and accessing long term debt like bank borrowings and term loans.
Strategies to be employed for correcting a mismatch in the form of D(A) < D(L)
(which will be necessary if interest rates are expected to decline) will be the
reverse of the strategies discussed above.
Asset driven strategies focus on lengthening the maturity profile of assets by the
deployment of available lendable resources in long-term assets such as lease
and hire purchase. Liability driven strategies focus on shortening the maturity
profile of liabilities, which can include, liquidating bank borrowings which are
primarily in the form of cash credit (and hence amenable for immediate
liquidation), using the prepayment options (if any embedded in the term loans);
and the call options, if any embedded in bonds issued by the company; and
raising short-term borrowings (e.g.: fixed deposits with a tenor of one year) to
repay long-term borrowings.

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Information technology and asset-liability management in

the Indian context
Many of the new private sector banks and some of the non-banking financial
companies have gone in for complete computerization of their branch network
and have also integrated their treasury, forex, and lending segments. The
information technology initiatives of these institutions provide significant
advantage to them in asset-liability management since it facilitates faster flow
of information, which is accurate and reliable. It also helps in terms of quicker
decision-making from the central office since branches are networked and
accounts are considered as belonging to the bank rather than a branch.
The electronic fund transfer system as well as demat holding of securities also
significantly alters mechanisms of implementing asset-liability management
because trading, transaction, and holding costs get reduced. Simulation models
are relatively easier to consider in the context of networking and also computing
powers. The open architecture, which is evolving in the financial system,
facilitates cross-bank initiatives in asset-liability management to reduce
aggregate unit cost. This would prove as a reliable risk reduction mechanism.
In other words, the boundaries of asset-liability management architecture itself
is changing because of substantial changes brought about by information
technology, and to that extent the operations managers are provided with
multiple possibilities which were not earlier available in the context of large
numbers of branch networks and associated problems of information collection,
storage, and retrieval.
In the Indian context, asset-liability management refers to the management of
deposits, credit, investments, borrowing, forex reserves and capital, keeping in
mind the capital adequacy norms laid down by the regulatory authorities.
Information technology can facilitate decisions on the following issues:
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ASSET AND LIABILITY MANAGEMENT IN BANKS

Estimating the main sources of funds like core deposits, certificates of

deposits, and call borrowings.
Reducing the gap between rate sensitive assets and rate sensitive
liabilities,
given a certain level of risk.
Reducing the maturity mismatch so as to avoid liquidity problems.
Managing funds with respect to crucial factors like size and duration.

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CHAPTER 11
CONCLUSION
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 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.

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CHAPTER 12
WEBILOGRAPHY

Asset Liability Management in Banks ICFAI

Bank Financial Management Indian Institute of Banking and Finance

www.rbi.org

www.investopedia.com

www.allbankingsolutions.com

www.iibf.org.in

www.fimmda.org

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