RISK MANAGEMENT & ASSET LIABILITY

MANAGEMENT AT UNION BANK OF INDIA

Origin and emergence of ALM
Post-liberalization: Deregulation in the banking sector.
Banks are free to determine their own interest rates on term deposits,
loans and advances & coupon rates on govt. securities and other financial
instruments are also market rated.
Intense competition with increasing volatility in domestic interest rate
as well as foreign exchange rates brought pressure on profitability and
long tenor for existence.
Banks needs to be alert and conscious of developments in money
market and accordingly take business decisions.

Here arose the need to address risk in a structured manner. I t attempts to
match the assets and liabilities in terms of their maturity and interest
rate sensitivity so that the risk arising out of such mismatches (interest
rate risk and liquidity risk) can be within the desired limit.
Asset Liability Management
ALM is the process involving decision making about the
composition of assets and liabilities including off balance
sheet items of the bank / FI and conducting the risk
assessment.

Concept of ALM

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

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

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

ALM Objectives
ALM in bank has mainly following objectives.
Liquidity Risk Management.
Interest Rate Risk Management.
Profit Planning and Growth Projection.

A fair ALM practice in a bank addresses to all these 3
objectives.

Risk and ALM

ALM is a risk management strategy. ALM addresses
to mainly 2 types of risks:

1. Liquidity Risk

2. Interest Rate Risk
2
Liquidity Risk

Liquidity of financial institution is its ability to increase
funding in assets and meet payment obligations, as they fall
due, both efficiently and economically.

It originates from the mismatches in the maturity pattern of
assets and liabilities. Banks take deposits for short term and
lend or invest for long term.

So, managing liquidity is among the most important
activities conducted by banks.
Interest Rate Risk

Interest Rate risk, as far as a financial institution is concerned, is the
risk that the value of its assets and liabilities and also its net interest
income may get adversely affected due to movements in interest
rates.
Any mismatch in cash flows or re-pricing dates of assets or
liabilities exposes banks Net Interest Income (NII) or Net interest
Margin (NIM) to variations.
Apart from an impact on NIM, interest rate risk also affects the
Market value of Equity (MVE) of the bank.

Calculation: NII = Interest Income Interest Expenses
NIM = NII / Total Assets

ALM and organization

BOARD OF DIRECTORS
The Board of directors of the bank decides the risk
management policy, its implementation and set the exposure
limits.
Asset - Liability Committee (ALCO)
ALCO consist of the bank's senior management including
CEO. They are responsible for ensuring adherence to the limits
set by the Board as well as for deciding the business strategy
of the bank.

Guidelines for ALCO by RBI

ALM and organization (contd.)
MID OFFICE

An effective Middle Office provides the independent risk
assessment which is critical to ALCO's key-function of
controlling and managing market risks in accordance with
the mandate established by the Board/Risk Management
Committee.

Some key concepts in ALM

Maturity buckets
Assets and liabilities are divided into different categories based on
their maturity. These categories of different maturity are called as
maturity buckets. It ensures that:
no liquidity issue arises to settle the liability.
the surplus assets in any categories are invested in a much more
profitable manner.
GAPS
A gap is created when there is difference between the assets and
liabilities in the maturity buckets.
3
Tools used in ALM and assessment of risk

1. Traditional Gap Analysis
2. Simulation Method
3. Duration Gap Method
4. Value at Risk
Company Profile
Public Sector Bank with a banking journey of 88 years
26,000 skilled employees
55.43% share capital held by the Government of India
IPO - August 20, 2002 & FPO - February 2006
Business mix of Rs 2,92,000 cr. i.e. US $ 65.18 billion
2800 plus branches across India
1135 networked ATMs
Tele-banking facility, Internet Banking, other value-added
services like Cash Management Service, Insurance, Mutual
Funds and Demat
ALM and Risk management in UNION
BANK OF INDIA

Board of Directors
Formulation and implementation of structures, policies and
procedures for risk management.
Board also sets limits by assessing risk appetite, skills
available for managing risk and risk bearing capacity.

Asset Liability Management Committee (ALCO)
The Committee decides on product pricing, mix of assets
and liabilities, stipulates liquidity and interest rate risk
limits, monitors them, articulates Banks interest rate view
and determines the business strategy of the Bank.


Risk Management Department
The department has the responsibility of identifying,
measuring, monitoring, reporting of risk positions and
making recommendations in developing the policies and
verifying the models that are used for risk measurement
from time to time.
ALM and Risk management in UNION
BANK OF INDIA (contd.)

Asset liability management in UNION
BANK OF INDIA

Short term objective: protecting the banks net interest
income

Long term objective: increasing market value of the equity
in the long run for enhancing shareholders wealth.

Risk includes liquidity management, interest rate risk
management and the pricing of assets and liabilities

Prepares reports such as Structural Liquidity, Interest Rate
Sensitivity, Fortnightly Dynamic Statement etc.
Duration Gap analysis, Contingency Funding Plan,
Contractual Maturity report etc. are generated at periodic
intervals for ALCO.

The Mid Office group positioned in treasury with
independent reporting structure on risk aspects ensure
compliance in terms of exposure analysis, limits fixed and
calculation of risk sensitive parameters like VaR, PV01,
Duration, Defeasance Period etc. and their analysis.

Asset liability management in UNION
BANK OF INDIA (contd.)

4
Maturity buckets in UNION BANK OF
INDIA

Sl.No Maturity Buckets
1 Upto 7 days
2 7 to 14 days
3 15 to 28 days
4 29 days to 3 months
5 Over 3 months upto 6 months
6 Over 6 months upto 1yaer
7 Over 1 year upto 3 year
8 Over 3 year upto 5 year
9 Above 5 years

Total of all assets in this bucket must match with all liability in the same
maturity. If there is a mismatch in the bucket where in liabilities are more
than we call it GAPS.
GAP FINANCING
Gap can be financed from
Market borrowings(call/ term)
Repos
LAF(Liquidity Adjustment Facility)
Refinance
Deployment of foreign currency
Resources after conversion into rupees (unswaped foreign
currency funds)

Fixation of Interest for Deposits and Loans
and ALM

When the gap limits exceed, bank will go for gap financing
and the cost in the maturity bucket will go up. So bank will
be forced to increase the lending rates or decrease the
deposit rates.

It is also seen that bank fixes attractive rates for loans and
deposits for certain tenure. This is to attract more
customers to the maturity bucket.
Risk management in UNION BANK OF
INDIA

LIQUIDITY RISK MANAGEMENT
The bank prepares the Statement of Structural Liquidity by
placing all cash inflows and outflows in the maturity ladder
according to the expected timing of cash flows.

maturing liability - cash outflow
maturing asset - cash inflow
INTEREST RATE RISK

Immediate impact - Net Interest Income.
Long term impact - Banks Net Worth.

MEASURING OF IRR
Earnings Perspective
Economic Value Perspective

In IRR also assets and liabilities are put under various
maturity buckets called as interest rate maturity buckets
and the maturity buckets are matched and managed.





MEASURING IRR
Earnings Perspective
Traditional GAP Analysis conducted on the monthly basis to
assess impact on changes in IR on banks earnings due to
changes in NII.

Economic Value Perspective
Conducted on quarterly basis to assess the long term
impact of changes in IR on market value of Banks equity or
net worth due to changes in the economic value of the
Banks assets, liabilities and off-balance sheet positions.