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Through ALM banks try to match the assets and liabilities in terms of
Maturities and Interest Rates Sensitivities so as to minimize the
interest rate risk and liquidity risk.
guidelinessothatbankscanbepreventedfrombiglossesonaccountof
wideALMmismatches.
Thus as per October 2007 RBI guidelines, banks were advised that
the net cumulative negative mismatches during the next day, 2-7 days,
8-14 days and 15-28 days should not exceed 5%, 10%, 15% and 20% of
the cumulative outflows, respectively, in order to recognize the
cumulative impact on liquidity. Banks were also advised to undertake
dynamic liquidity management and prepare the statement of
structural liquidity on a daily basis. In the absence of a fully
networked environment, banks were allowed to compile the
statement on best available data coverage initially but were advised to
make conscious efforts to attain 100 per cent data coverage in a
timely manner. Similarly, the statement of structural liquidity was
to be reported to the Reserve Bank, once a month, as on the third
Wednesday of every month. The frequency of supervisory reporting
of the structural liquidity position was increased to fortnightly, with
effect from April 1, 2008. Banks are now required to submit the
statement of structural liquidity as on the first and third Wednesday
of every month to the Reserve Bank.
ProgressinAdoptionofTechniquesofALMbyIndianBanks:ALM
processinvolveinidentification,measurementandmanagementofrisk
Parameter.InitsoriginalguidelinesRBIaskedthebankstouse
traditionaltechniqueslikeGapanalysisformonitoringinterestratesand
liquidityrisk.AtthatRBIdesiredthatIndianBanksslowlymovetowards
sophisticatedtechniqueslikeduration,simulationandValueatriskin
future.Nowwiththepassageoftime,moreandmorebanksaremoving
towardstheseadvancedtechniques.
AssetLiabilityManagementTechniques:
ALMisbankspecificcontrolmechanism,butitispossiblethatseveral
banksmayemploysimilarALMtechniquesoreachbankmayuseunique
system.
i)Withintimebucketunderconsiderationisacashflow.
ii.)Theinterestrateresets/repricescontractuallyduringtimebuckets
iii.)Administeredratesarechangedand
iv.)Itiscontractuallyprepayableorwithdrawalallowedbefore
contractedmaturities.
Thus;
GAP=RSARSL
GAPRatio=RSAs/RSL
Mismatchescanbepositiveornegative
PositiveMismatch:M.A.>M.L.andviceversaforNegative
Mismatch
Incaseof+vemismatch,excessliquiditycanbedeployedinmoney
marketinstruments,creatingnewassets&investmentswapsetc.
Forvemismatch,itcanbefinancedfrommarket
borrowings(call/Term),Billsrediscounting,repos&deploymentof
foreigncurrencyconvertedintorupee.
Gapanalysiswaswidelyusedbyfinancialinstitutionsduring late1990s
andearlyyearsofpresentcenturyinIndia. Thetablebelowgivesyou
ideawhodoesapositiveornegativegapwouldimpactonNIIincasethere
isupwardordownwardmovementofinterestrates:
Gap
Impact on NII
Positive
Increases
Positive
Positive
Decreases
Negative
Negative
Increases
Negative
Negative
Decreases
Positive
DurationGapAnalysis:
This is an alternative method for measuring interest-rate risk. This
technique examines the sensitivity of the market value of the financial
institutions net worth to changes in interest rates. Duration analysis
is based on Macaulays concept of duration, which measures the
average lifetime of a securitys stream of payments.
We know that 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 basically refers to the average life of the asset or the
liability. DP /p =D ( dR /1+R) The above equation describes the
percentage fall in price of the bond for a given increase in the
required interest rates or yields.
The larger the value of the duration, the more sensitive is the price of
that asset or liability to changes in interest rates. Thus, as per this
theory, the bank will be immunized from interest rate risk if the
duration gap between assets and the liabilities is zero. The duration
model has one important benefit. It uses the market value of assets
and liabilities.
Durationanalysissummariseswithasinglenumberexposuretoparallel
shiftsinthetermstructureofinterestrates.
Itcanbenoticedthatbothgapanddurationapproachesworkedwellif
assetsandliabilitiescomprisedfixedcashflows.Howeveroptionssuchas
thoseembeddedinmortgagesorcallabledebtposedproblemsthatgap
analysiscouldnotaddress.Durationanalysiscouldaddressthesein
theory,butimplementingsufficientlysophisticateddurationmeasureswas
problematic.
ScenarioAnalysis:
Under the scenario analysis of ALM several interest rate scenarios
are created during next 5 to 10 years . Such scenarios might specify
declining interest rates , rising interests rates, a gradual decrease in
rates followed by sudden rise etc. Different scenarios may specify
the behavior of the entire yield curve, so there could be scenarios
with flattening yield curve, inverted yield curves etc. Ten to twenty
scenarios might be specified to have a holistic view of the scnario
analysis. Next assumptions would be made about the performances
of assets and liabilities under each scenario. Assumptions might
include prepayment rates on mortgages and surrender rates on
insurance products. Assumptions may also be made about the firms
performance . Based upon these assumptions the performance of the
firms balance sheet could be projected under each scenario. If
projected performance was poor under specific scenario the ALCO
might adjust assets or liabilities to address the indicated exposure . A
short coming of scenario analysis is the fact that it is highly
dependent on the choice of scenario. It also requires that many
assumptions be made about how specific assets or liabilities will
perform under specific scenario.
Value at Risk
VaR or Value ar 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 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.
Conclusion:
WecanconcludetosaythatALMisanimportanttoolformonitoring,
measuringandmanagingtheinterestraterisk,liquidityriskandforeign
currencyriskofabank.WiththederegulationofinterestregimeinIndia,
thebankingindustryhasbeenexposedtointerestraterisk/marketrisk.
Hencetomanagesuchrisk,ALMneedstobeusedsothatthemanagement
isabletoassesstherisksandcoversomeofthesebytakingappropriate
decisions.