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![[ASSET
LIABILITY MANAGEMENT]
October
4, 2014
Asset Liability Mismatch or ALM is considered to be a comprehensive and dynamical framework for measurement, monitoring and managing the market risk of the Banks. Asset Liability Mismatch arises in the following situation: The Primary source of funds for the banks is deposits, and most deposts have a short- to medium-term maturities, thus need to be paid back to the investor in 3-5 years. In comparison, the banks usually provide loans for a longer period to borrowers. Out of them, the home loans and Infrastructure projects loans are of longest maturity. So when a bank provides the long term loans from much shorter maturity funds, the situation is called asset-liability mismatch. ALM creates Risk and Risk has to be managed. This is called Asset Liability Management. Consequences of the Asset Liability Mismatch The Interest rate risks (due to fluctuation) and Liquidity Risk (due to long maturity of loans) are two typical consequences of Asset Liability Mismatch. Interest Rate Risk: The banks would require to reprice the deposits faster than the loans and during this process if the bank has to pay a higher rate, the adjustment is difficult. Liquidity Risk: The banks would have to repay the depositors when their funds mature. But when they repay, the cannot recall their loans. In this situation, bank would require the new deposits. This may create a acute situation if there are no deposits available. In some cases, the bank may also need to be paying higher interests on new deposits. The asset-liability management in the Indian banks is still in its nascent stage. With the freedom obtained through reform process, the Indian banks have reached greater](https://image.slidesharecdn.com/alm-141008124602-conversion-gate01/85/alm-1-320.jpg)
![[ASSET
LIABILITY MANAGEMENT]
October
4, 2014
horizons by exploring new avenues. The government ownership of most banks resulted in a carefree attitude towards risk management. This complacent behavior of banks forced the Reserve Bank to use regulatory tactics to ensure the implementation of the ALM. Also, the post-reform banking scenario is marked by interest rate deregulation, entry of new private banks, and gamut of new products and greater use of information technology. To cope with these pressures banks were required to evolve strategies rather than ad hoc fire fighting solutions. Imprudent liquidity management can put banks’ earnings and reputation at great risk. These pressures call for structured and comprehensive measures and not just ad hoc action. The Management of banks has to base their business decisions on a dynamic and integrated risk management system and process, driven by corporate strategy. Banks are exposed to several major risks in the course of their business – credit risk, interest rate risk, foreign exchange risk, equity / commodity price risk, liquidity risk and operational risk. It is, therefore, important that banks introduce effective risk management systems that address the issues related to interest rate, currency and liquidity risks. 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.](data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7)
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- 1. [ASSET LIABILITY MANAGEMENT] October 4, 2014 Asset Liability Mismatch or ALM is considered to be a comprehensive and dynamical framework for measurement, monitoring and managing the market risk of the Banks. Asset Liability Mismatch arises in the following situation: The Primary source of funds for the banks is deposits, and most deposts have a short- to medium-term maturities, thus need to be paid back to the investor in 3-5 years. In comparison, the banks usually provide loans for a longer period to borrowers. Out of them, the home loans and Infrastructure projects loans are of longest maturity. So when a bank provides the long term loans from much shorter maturity funds, the situation is called asset-liability mismatch. ALM creates Risk and Risk has to be managed. This is called Asset Liability Management. Consequences of the Asset Liability Mismatch The Interest rate risks (due to fluctuation) and Liquidity Risk (due to long maturity of loans) are two typical consequences of Asset Liability Mismatch. Interest Rate Risk: The banks would require to reprice the deposits faster than the loans and during this process if the bank has to pay a higher rate, the adjustment is difficult. Liquidity Risk: The banks would have to repay the depositors when their funds mature. But when they repay, the cannot recall their loans. In this situation, bank would require the new deposits. This may create a acute situation if there are no deposits available. In some cases, the bank may also need to be paying higher interests on new deposits. The asset-liability management in the Indian banks is still in its nascent stage. With the freedom obtained through reform process, the Indian banks have reached greater
- 2. [ASSET LIABILITY MANAGEMENT] October 4, 2014 horizons by exploring new avenues. The government ownership of most banks resulted in a carefree attitude towards risk management. This complacent behavior of banks forced the Reserve Bank to use regulatory tactics to ensure the implementation of the ALM. Also, the post-reform banking scenario is marked by interest rate deregulation, entry of new private banks, and gamut of new products and greater use of information technology. To cope with these pressures banks were required to evolve strategies rather than ad hoc fire fighting solutions. Imprudent liquidity management can put banks’ earnings and reputation at great risk. These pressures call for structured and comprehensive measures and not just ad hoc action. The Management of banks has to base their business decisions on a dynamic and integrated risk management system and process, driven by corporate strategy. Banks are exposed to several major risks in the course of their business – credit risk, interest rate risk, foreign exchange risk, equity / commodity price risk, liquidity risk and operational risk. It is, therefore, important that banks introduce effective risk management systems that address the issues related to interest rate, currency and liquidity risks. 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.