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Asset Liability Management

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Asset Liability management in bank, asset liability mismatches and risk associated with it. tools for alm, factors for alm and conclusion.

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Asset Liability Management

  2. 2. What is assets & liabilities management?  It is a mechanism to address the risk faced by a bank due to a mismatch between assets & liabilities either due to liquidity or change in interest rates.  Bank and other financial institutions provide services which expose them to various kinds of risk like credit risk, interest risk and liquidity risk.  ALM Models enables institutions to measure and monitor risk & provide suitable strategies for their management.
  3. 3.  An effective Asset Liability Management Technique aims to manage the volume, mix, maturity, rate sensitivity, quality and liquidity of assets and liabilities as a whole so as to attain a predetermined acceptable risk/reward ratio.  It is aimed to stabilize short-term profits, long-term earnings and long- term substance of the bank.  The parameters for stabilizing ALM system are: 1. Net Interest Income (NII) 2. Net Interest Margin (NIM) 3. Economic Equity Ratio
  4. 4.  Globalization of financial markets  Deregulation of interest rates  Diversification of ALM products  Healthy competition in banking sector  Multi-currency Balance Sheet  Integration of markets  Narrowing of NIM/NII
  5. 5. ASSETS LIABILITIES Fixed Assets Capital Investments Reserve and surplus Advances Deposits Cash & balances with RBI Borrowings Balances with bank and money at call & short notice other liabilities Other Assets
  6. 6. When a bank provides the long term loans from much shorter maturity funds, the situation is called asset-liability mismatch. The consequences of such mismatches are as follows- 1. INTEREST RATE RISK-  Interest rate risk refers to volatility in Net Interest Income (NII) or variations in Net Interest Margin(NIM)  Interest Rate risk is the exposure of a bank’s financial conditions to adverse movements of interest rates  Though this is normal part of banking business, excessive interest rate risk can pose a significant threat to a bank’s earnings and capital base.  Changes in interest rates also affect the underlying value of the bank’s assets, liabilities and off-balance- sheet item.
  7. 7. 2. LIQUIDITY RISK-  Liquidity risk arises from funding of long term assets by short term liabilities, thus making the liabilities subject to refinancing  Funding risk arises due to unanticipated withdrawals of the deposits from wholesale or retail clients  Time risk arises when an asset turns into a NPA. So, the expected cash flows are no longer available to the bank.  Call risk Due to crystallisation of contingent liabilities and unable to undertake profitable business opportunities when available. 3. CURRENCY RISK  The increased capital flows from different nations following deregulation have contributed to increase in the volume of transactions.  Dealing in different currencies brings opportunities as well as risk.  To prevent this banks have been setting up overnight limits and undertaking active day time trading.
  8. 8.  GAP ANALYIS- Basically Assets and Liabilities both are rate sensitive in different degree. It is therefore necessary to identify the rate sensitivity among different groups of assets and liabilities and match identical groups of assets with liabilities. In the ALM process, Gap is generally used for quantifying the rate sensitive groups only (as compared to rate insensitive groups of liabilities like current deposits, float funds etc.)  DURATION METHOD- Under this method, impact of changes in interest rate on the market value of assets and liabilities is considered. Duration analysis is carried out with respect to cash flows and average maturity.  RISK MANAGEMENT- Under this process, the risk profiles of assets and liabilities are evaluated to ensure that they are within the acceptable levels of risk. The availability of hedging mechanisms (e.g. derivative instruments) would facilitate risk management.  VALUE-AT-RISK METHOD- This method is variant of the practice of ‘Market-to Market’ approved securities based on Yield- to Maturity
  9. 9.  ALM INFORMATION SYSTEM- Under the Information system banks are required to ensure development of information procuring system for measuring, monitoring, controlling and reporting the risks. The method is used to analyse the behaviour of assets and liability products to assess in which way the assets and liability would behave in the business of banking.  ALM ORGANISATION- The ALM Organisation guidelines insist that each bank at the top management level and Board of Directors should on the ongoing basis review the situation to ensure appropriate policies and procedures are adopted and implemented to timely arrest the prospective risks.  ALM PROCESS- The ALM process is meant to create parameters for managing the risks like, identification of risk, measurement of risk, management of risk, planning to mitigate the risk etc..
  10. 10.  Interest rate movement and outlook,  Pricing of assets and liabilities,  Review of investment portfolio and credit risk management,  Review of investment of foreign exchange operations,  Management of liquidity Risk,  Management of NIM and of balance sheet ratios, and  Formulation of budgets and operational planning.
  11. 11.  ALM technique aims to manage the volume mix, maturity, rate sensitivity, quality and liquidity of assets and liabilities as a whole to attain a predetermined acceptable risk or reward ratio.  In short, ALM helps in enhancing the asset quality, quantifying the risk associated with assets and liabilities and controlling them.  So a proper ALM system must be implemented in every banks for the effective functioning of a bank which reduces the exposure of risk chances in banks.