Hiral Ved Kripa Agarwal Nikhita Garodia

28 39 54

Nikita Vedak

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Treasury Management in Banks

Part I Introduction
Treasury Mgt. in Banks, Integrated Treasury Functions of Treasury Dept. of Banks Structure of a Treasury Dept.

Part II Treasury Products

Money Market Instruments:
Call Money, T-Bill, Term Money, Certificate of Deposit, Commercial Paper, Repo, Commercial Bill.

Part III

Risk
What is risk?
Types of risks: Liquidity, Interest Rate, Market, Credit, Operational risks GAP Model Duration Gap Model (DGAP) VAR

Basic Concepts
NII, NIS, NIM, HTM, HFT, AFS, Banking Book, Trading Book, Off B/S Exposures, NDTL, CRR, SLR, PSL, CRAR, Bucketing

Debt Market Instruments: Mgt. of IRR:

Govt. Securities, Debentures Bonds,

Forex Market Instruments:

Spot, Forward, Swap

ALM:

3 Pillars of ALM, ALCO, Functions of ALCO

 Treasury management is the management of an

organizations liquidity to ensure that the right amount of cash resources are available in the right place in the right currency and at the right time in such a way as to maximize the return on surplus funds, minimize the financing costs of the business, and control interest rate risk and currency exposure to an acceptable level.
In other words, Treasury Management deals with ways and means of deploying surplus funds and raising funds to meet any shortage.
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Conventional Treasury

Integrated Treasury

Independent Domestic Treasury Role

Independent Forex Role

Domestic Treasury Role

Forex Role

Reserve Management and Investment Liquidity and Funds Management Asset Liability Management and Term Money Transfer Pricing Arbitrage Derivative products Risk Management
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Basic Concepts
= Interest Income Interest Expenses
E.g. Bank A NII = Interest Earned Interest Expanded 1786 = 7516 5730

= Nominal Avg. Lending Rate Nominal Avg. Borrowing Rate

E.g. A bank takes deposits from customers and pays 1% to those customers. The bank lends its customers money at 6%. The bank's net interest spread is 5%.
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Basic Concepts
= Net Interest Income (NII) Interest Earning Assets X100

E.g. A bank has Net Interest Income (NII) of Rs. 5 on outstanding average loans of Rs. 100. The bank's net interest margin is 5/100 = 5%

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Held-to-Maturity
Held-for-trading Available-for-sale

Basic Concepts
Trading Book Assets & Liabilities are normally held until maturity Accrual system of accounting is applied Banking Book Assets & Liabilities are normally held until maturity Accrual system of accounting is applied Off Balance Sheet Exposure These are contingent in nature such as letter of credit Exposed to liquidity risk, interest rate risk and market risk.
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 For measuring and managing liquidity risks, the banks determine the future cash inflows and cash outflows for various time periods (maturity profiles). Each time period is known as a time bucket. Bucketing is the process of determining the net funds requirement for each time bucket
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Next Day (Day 1) 2 to 7 days 8 to 14 days 15 to 28 days 29 days and up to 3 months Over 3 months and up to 6 months Over 6 months and up to 1 year Over 1 year and up to 3 years Over 3 years and up to 5 years Over 5 years

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 Liabilities of the banks may be towards banking system or towards others in the form of Demand and Time deposits or borrowings or other miscellaneous items of liabilities. Demand Liabilities
liabilities which are payable on demand (E.g. current deposits, balances in overdue fixed deposits, etc.)

Time Liabilities
which are payable otherwise than on demand (E.g. fixed deposits, cash certificates, etc.)
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 Other Demand & Time Liabilities (ODTL): It includes

interest accrued on deposits, bills payable, unpaid dividends, suspense account balances representing amounts due to other banks or public, net credit balances in branch adjustment account, any amounts due to the "Banking System" which are not in the nature of deposits or borrowing.
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 Certain portion of NDTL is to be deposited with RBI. Maintenance of CRR

Current CRR is 6 % of NDTL

Maintenance of Incremental CRR

Currently no incremental CRR to be maintained

Maintenance of CRR on daily basis

Minimum CRR balances upto 70 per cent of the total CRR requirement on all days of the fortnight
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 Payment of interest on eligible CRR balances

No interest is paid with effect from the fortnight beginning June 24, 2006

Penalties:
Penal interest to be charged from the fortnight beginning June 24, 2006 in case of:
Default in maintenance of CRR on daily basis Default in maintenance of CRR on fortnight basis

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 Certain portion of total DTL to be parked in

liquid investments Currently an amount equivalent to 24 % of total DTL is to be maintained as SLR

The amount is to be maintained in India in

Cash Gold valued at a price not exceeding the current market price, Unencumbered Approved Securities valued at a price as specified by the RBI from time to time.
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 Banks are allowed to invest in non-SLR

securities with prior approval of RBI as under:
Bonds of public sector undertakings Bonds/equity of All India Financial Institutions (AFIs) Total investment in (a) and (b) above should not exceed 10 % of the banks total deposits as on March 31 of the previous year, with a sub-ceiling of 5 per cent for investments covered under (a).

Penalties
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 Presently, the broad categories of priority sector for all SCBs are as under:
Agriculture (Direct and Indirect finance) Small Enterprises (Direct and Indirect Finance) Retail Trade Micro Credit Education loans Housing loans

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 State Financial Corporations (SFCs) / State Industrial Development Corporations (SIDCs) Small Industries Development Bank of India (SIDBI) The National Small Industries Corporation Ltd. (NSIC) Rural Electrification Corporation (REC) NABARD National Housing Bank (NHB) Housing & Urban Development Corporation (HUDCO) 23

 A bank should have sufficient capital to provide a stable resource to absorb any losses arising from the risks in its business. Capital Adequacy Ratio CAR= Tier 1 + Tier 2 Risk Weighted Assets Banks are required to maintain a minimum CAR of 9 % and NBFC CAR of 15%
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Example: National Bank of A does some transactions (loans, foreign exchange, etc.) in USD, but banks in A will only handle payments in INR. So NB of A opens a USD account at foreign bank, and instructs all counter-parties to settle transactions in USD at "account no. 123456 in name of NBA, at Bank B". NBA maintains its own records of that account, for reconciliation; this is its nostro account. Bank Bs record of the same account is the vostro account.
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SWIFT
Extensive use of the latest developments in telecommunications for transmitting as well settling forex transaction

Society for Worldwide Interbank Financial Telecommunication Co-operative society owned by About 250 banks in Europe and North America Communication network for International financial market transactions linking effectively more than 25,000 Financial institution throughout the world who have been allotted bank identifier codes Enables to transact : - International Payments - statements - other messages connected with International Banking

Treasury Products
TREASURY PRODUCTS

Money Market Instruments Instruments Call

Debt Market Instruments

FOREX Market Instruments

Government Securities

Spot

T- Bills

Bonds

Forward

Term Money

Debentures

Swaps

Certificate of deposit Commercial Paper

Repo

Commercial Bill

Money Market
A mechanism whereby on one hand borrowers manage to obtain short term loanable funds and on the other hand, lenders succeed in getting credit worthy borrowers for their money.
Call Money Treasury Bills Certificates of Deposit Commercial Paper Repo & Reverse Repo Commercial Bills Term Money

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Call Money
Transactions are carried out for one day Temporary cash surpluses of banks are made available to cash deficit banks. Maturity of call loans varies between 1 to 14 days.

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Call Money
Call Rates
-Calculated on daily basis -Rates vary from day to day

Purpose
-Cover up for short-term mismatches -To meet the CRR requirements -To discount commercial bills.

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Call Money
Limits
For borrowing :
Fortnightly basis : Cannot exceed 100 per cent of their capital funds. Daily basis : Cannot exceed 125 per cent.

For lending :
Fortnightly basis : to 25 per cent of their capital funds Daily basis : 50 per cent.
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Call Money
Participants
Scheduled commercial Banks (private sector, public sector and cooperative banks) Discount and Finance House of India (DFHI) Securities Trading Corporation of India Limited (STCI) Primary Dealers Financial Institutions Mutual Funds

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Treasury Bills
Issued in the form of promissory notes by the government to meet its deficits Issued at discount and redeemed at par It has distinct features like zero default risk, assured yield, highly liquid and easy availability Types: 91-day,182-day and 364-day Amount: Minimum amount of Rs.25,000 and in multiples of Rs. 25,000

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Treasury Bills
Issued in 2 different forms:
Physical form Dematerialized form

Investors:

Primary Dealers Financial Institutions (for primary cash management) Provident Funds (PFs) Insurance Companies Non-banking Finance Companies (NBFCs) Foreign Institutional Investors (FII) State Governments NRIs are allowed to invest only on non-repatriable basis
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Yield Calculation
Discounted Yield (Y) = (100-P) * 365 * 100 P*D

E.g. A cooperative bank wishes to buy 91 Days Treasury bill maturing on Dec. 6, 2002 on Oct. 12, 2002. The rate quoted by seller is Rs. 99.1489 per Rs. 100 face values The YTM can be calculated as following:
The days to maturity = 55 (October 20 days, November 30 days and December 5 days)

Certificate of Deposit
Promissory notes issued at a discount to the face value Issued by scheduled commercial banks Maturity period: 14 days to 1 year Amount: Minimum amount of Rs.5 lakh and in multiples of Rs.5 lakhs.
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Certificate of Deposit
InvestorsIndividuals Corporates Companies Associations Trusts NRIs

FeaturesHighly liquid and less risky It is issued at a discount to the face value.
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 Discount Calculation:

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Commercial Paper
Promissory note with fixed maturity, issued at a discount to face value. CPs are issued by corporates. Actively traded in the secondary market Maturity:15 days to1 year. Amount: Denomination of Rs. 5 lakh and multiples of 5 lakh and a minimum investment is Rs. 5 lakh per investor.

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Commercial Paper
Features:
Involve much less paper work. Have high liquidity.

Types of Commercial Papers:

Direct paper Dealers paper

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Commercial Paper
Investors:
Individuals, Banking companies, Other corporate bodies Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs) etc Private sector Co., Public sector unit, Non-banking Co., Primary dealers

Issuers:

Participants have to obtain credit rating to be eligible to issue CPs

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Commercial Paper
Discount Calculation:

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Repo & Reverse Repo

Two parties agree to sell and repurchase the same security The seller sells with an agreement to repurchase the security called as Repo The buyer purchases with an agreement to resell called as Reverse Repo

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Repo & Reverse Repo

Uses of Repo
Invest surplus cash It helps borrower to raise funds at better rates Way of adjusting SLR/CRR positions RBI uses Repo and Reverse repo as instruments for liquidity adjustment in the system.
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Repo & Reverse Repo

Trade date: 1st Aug 2004 Trade price: 108.5 Total Face value: Rs.100 *1000 = 100000 Security: 9.5 %, maturing on 22nd March 09 Repo rate: 4.5 % Repo term: 2 days

Debt/Securities Market
Debt Markets are markets for the issuance, trading and settlement in fixed income securities of various types and features

Government securities Bonds & Debentures Corporate Debt paper

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Government Securities
Issued by the Reserve Bank of India on behalf of Government of India Purpose: Finance its Fiscal deficit Eligibility: All entities registered in India like banks, financial institutions, Primary Dealers, firms, companies, corporate bodies, partnership firms, institutions, mutual funds, Foreign Institutional Investors, State Governments, Provident Funds, trusts are eligible
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Government Securities
Nomenclature:
E.g. 12.25% GOI 2012

Availability:
Available in primary as well as secondary markets

Repayment:
SGL account holders Gilt Account Holders Entities having a demat account
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Types
Dated Securities Zero Coupon bonds

Partly Paid Stock

Floating Rate Bonds Capital indexed Bonds
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Benefits of investing in government securities:

No tax deducted at source Additional Income Tax benefit u/s 80L of the Income Tax Act for Individuals Zero default risk Highly liquid

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G-Sec
Eg: A client purchases 7.40% GOI 2012 for face value of Rs. 10 lacs.@ Rs.101.80, i.e. the client pays Rs.101.80 for every unit of government security having a face value of Rs. 100/- The settlement is due on October 3, 2002. What is the amount to be paid by the client? The security is 7.40% GOI 2012 for which the interest payment dates are 3rd May, and 3rd November every year.

Debentures & Bonds

Debt security issued by a company which offers to pay interest in lieu of the money borrowed for a certain period Conventionally in India debentures issued by private sectors and bonds by public sector

Debentures are transferable only by registration whereas bonds are negotiable

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Corporate Debt Paper

Medium and long term bonds issued by corporate and financial institutions

Yields are higher than Gsec

Fairly active secondary market, hence they are liquid.
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Forex Market
It is the most liquid market Currencies, which are not fully convertible, have limited demand Information dissemination is very fast through electronic media such as Reuters, money line and Bloomberg.

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Spot Contracts
Mostly bought and sold in spot trades Settlement happens on a T+2 basis Settlement can happen on the same day (TOD) or the next day (TOM).

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Forward Contracts
Refers to purchase or sale of currency on a future date. The exchange rate of settlement is called as forward rate. Forward rate is the spot rate adjusted for the premium / discount Forward Rate = Spot Rate + / - premium or discount

Treasury gets into forward contracts with customers.

Treasury may get into forward market to make speculative gains.
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Forwards
The contracts are illiquid. If a party to a forward contract wants to reverse its position, the options are:
Re-negotiate with the counter party / parties to the contract and seek their consent. If they do not agree, the contract cannot be reversed. Enter into another forward contract for the opposite position with any party. In this case, the earlier contract and the new contract would be independent contracts that would need to be settled independently.
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Swaps
A Swap is in its simplest form an exchange of a series of cash flows between 2 parties. Swap is a Combination of spot and forward transaction.

Swap route is generally used for funding requirements, but there is also a profit opportunity from interest rate arbitrage.
E.g. If one has dollar funds, but needs rupee funds to invest in a commercial paper for 3 months, he may enter into a USD/INR swap deal to sell USD at spot rate (converting into rupee funds) and buying back the USD 3 months forward (with rupee funds on the maturity of the CP). If the interest earned on CP is higher than the cost of USD funds, the swap results in a profit.

 What is Risk? Classification of Risks

 Risk :It is the chance that an investment's actual return will be different than expected. This includes the possibility of losing some or all of the original investment

Risk management:It is a systematic process of identifying, analyzing and responding to project risk
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Types of Risk
Liquidity Risk

Operational Risks

Interest Rate Risks

Credit Risks

Market Risks

Liquidity Risk isthe risk of a funding crisis

It is potential that a bank will be unable to meet its obligation as they come due because of inability to liquidate assets or obtain adequate funding, without incurring unacceptable losses

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 Funding Risk- It arises due to inability to raise funds at normal cost. eg: Unanticipated Withdrawal of Deposits Time Risk- It arises due to the need to compensate for non-receipt of expected inflows of funds eg: performing assets turning into nonperforming assets Call Risk- It arises when bank is unable to undertake profitable business opportunities
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2] Interest Rate Risk

It is the exposure of a banks financial conditions to adverse movements of interest rates Associated with both funding and lending activities Measured from two perspective: Earning perspective Economic Value perspective Interest rate risk affects the value of

bonds directly than stocks

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(a) Gap Or Mismatch Risk

It arises from holding assets and liabilities and off balance sheet items with different principle amounts & maturity dates In turn creating unexpected changes in market interest rates For e.g.-There is a chance of gap risk when a stock's price closes at $50 and opens the following trading day at $40 even though no trade has happened in between.
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(b) Yield Curve Risk

The risk of experiencing an adverse shift in market interest rates associated with investing in a fixed income instrument. Risk associated with either a flattening or steepening of the yield curve

In a floating rate scenario, banks may price their assets and liabilities based on different benchmarks. Any non parallel movement in curve would affect the NII
Eg:- Suppose liability raised at a rate linked to say 91 days T bill is used to fund an asset linked to 364 days T bill. Due to non parallel shift in yield curve would affect in net interest income
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(c) Basis Risk

It can be defined as the change in the value of different assets, liabilities and off balance sheet items in different magnitude due to change in interest rates.

For e.g.- Asset interest rate may rise in different magnitude than the interest rate on corresponding liability creating a variation in NII.

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(d) Embedded Option Risk

It means possibility of alteration of cash flows due to the products offered with embedded options. Changes in interest rates results in encouraging prepayments of cash credit loans, term loans and exercise call/put option on bonds/debentures.

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(e) Reinvestment Risk

The risk that future proceeds will have to be reinvested at a lower potential interest rate

Generally associated in the context of bonds It is evident during periods of falling interest rates
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Effect on Bank
Change In Net Interest Income Change In Value of assets and Liabilities

Change in the economic value of a bank

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3] Market Risk
Risk of adverse deviations of the mark to market value of the trading portfolio, due to market movements

Risk of losses due to movements in financial markets variables such as Interest rates, Foreign exchange rates, security prices, etc.
Market risk is also referred as Price Risk
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(a) Foreign Exchange Risk

It is the risk that a bank may suffer losses as a result of adverse exchange rate movements during a period All assets and liabilities denominated in foreign exchange are exposed to foreign exchange risk

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(b) Market Liquidity Risk

Arises when a bank is unable to conclude a large transaction in particular instrument near the current market price.

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4] Credit/ Default Risk

It is defined as the potential of bank borrower or counterparty to fail to meet its obligation in accordance with agreed terms

Three types:
Counterparty Risk : Arises due to Counterpartys refusal or inability to perform Country Risk: Arises due to constrains or restrictions imposed by a country Credit Spread Risk: Arises due to nonrecovery of regular installment repayment

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5] Operational Risk
It is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. It can be summarized as human risk i.e. a risk of business operations failing due to human error.

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5] Operational Risk
(a) Transactional Risk: Risk arising from
fraud, both internal and external, failed business processes and the inability to maintain business continuity and manage information

(b) Compliance Risk: Risk of Financial and

Reputation loss due to failure to comply with necessary Laws, Rules and Regulation.
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Measurement of Risk
Interest rate risk: Gap Model Duration Gap Model Market Risk: VaR

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What is Gap Model?

Interest rate risk is measured by calculating GAP over different time intervals based on aggregate balance sheet data at fixed point in time GAP = RSA(inflows) RSL (outflows) Assets And Liabilities Are Sensitive If And Only If There is a cash flow Interest rate resets Regulatory changes Pre Payment/Withdrawal before the Maturity

Classification of Rate Sensitive Assets and Liabilities

Rate Sensitive Assets
1. 2. 3. 4. 5. 6. Balance with RBI Money at Call & short notice, Term deposits with other banks. Investments fixed, floating, zc Advances Leased Assets Reverse Repo

Rate Sensitive Liabilities

1. Savings Bank Deposit. 2. Term Deposits 3. Borrowings fixed, floating, zc 4. Refinance from Others. 5. Repos

Non Rate Sensitive Assets

1. 2. 3. 4. Cash Current a/c bal with other banks. Shares or units of MF Other Assets

Non Rate Sensitive Liabilities

1. Capital, R&S 2. Current Deposits 3. Other Liabilities & Provisions

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Steps for GAP Analysis

Management develops the interest rate forecast. Management selects the series of sequential time intervals for determining what amount of assets are rate sensitive within each time interval. Assets and liabilities are grouped into these time intervals or buckets according to time until the first pricing. The effects of any off balance sheet items positions are also added to the balance sheet position whether the item effectively represents the rate sensitive assets or rate sensitive liability. Management forecasts net interest income given the interest rate environment and assumed repricing characteristics of underlying instruments.

GAP Model
GAP = RSA(inflows) RSL (outflows) Example

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Gap Model
In case the negative gap exceeds the prudential limit of 20% of outflows, banks have to disclose how they plan to finance the gap. The gap can be financed from market borrowings, Bills Rediscounting, Refinance from RBI/others, Repos and deployment of foreign currency resources after conversion into rupees etc.
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Calculation of GAP
Description Rate Sensitive Assets 5000 Yield 8% Liabilities 6000 Int. Cost 4%

Fixed Rate Nonpaying/Non Earning Total

3500 1500

11%

2200 1000

6%

9200

Equity

800

Total

10000

10000

GAP

= RSA RSL

= 5000 6000 = -1000

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Here the GAP is negative i.e RSLs are more than RSAs.

Link between GAP and Net Interest Margin (NIM)

Target GAP = Allowable % change In NIM * (Expected NIM) Earning Assets Expected % change in interest rates

Given : Earning Assets : 50 million Expected NIM : 5% Allowable change in NIM : 20% Expected change in interest rate : 4% This means that as bank is willing to pay 20 percent variation in NIM sets the limit on GAP which would be allowed to vary from Rs. -12.5 million to Rs 12.5 million.

Advantages and Disadvantages

Advantages Of GAP
Simple to analyze Easy to implement Helps in future analyses of the interest rate risk Helps in projecting NII for the further analysis

Disadvantages Of GAP
Ignores the time value of assets & liabilities Doesnt consider the embedded options
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Duration GAP Model (DGAP)

Concept of Duration
Duration is defined as the weighted average maturity of a resource (assets or liabilities), where the NPV of the cash flows is used as weights

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Duration
Duration is a function of Term To Maturity Earning Capacity Current interest It is always shorter than Maturity Its a Weighted Average Its Additive
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Calculation Of Duration
The duration of a 3 year loan with 12% as a rate of simple interest & market value of Rs.700 is calculated as follows.

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Calculation Of Duration

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Calculation Of Duration
Duration = Total cumulative returns/ Market Value of loan = 1883.04/700 = 2.69 years

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Calculation of DGAP
Par Years 1000 % Coup Mat. Assets Cash Earning assets 3-yr Commercial loan 6-yr Treasury bond Total Earning Assets Non-cash earning assets Total assets Liabilities Interest bearing liabs. 1-yr Time deposit 3-yr Certificate of deposit Tot. Int Bearing Liabs. Tot. non-int. bearing Total liabilities Total equity Total liabs & equity 620 300 920 0 920 80 1000 5.00% 7.00% 1 3 1.00 2.81 100 700 12.00% 200 8.00% 900 0 1000 3 6 2.69 4.99 Dur.

2.88

1.59

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Calculation of DGAP
DA = (700 * 2.69 + 200 * 4.99)/1000 = 2.88 yrs DL = (620 * 1.00 + 300 * 2.81)/920 = 1.59 yrs DGAP = DA - [(TL/TA)* DL] DGAP = 2.88 - (920/1000) * 1.59 = 1.42 years

What does 1.42 years mean?

The average duration of assets > liabilities, hence in case of change in the interest rate, asset values change by more than liability values. Long term assets are funded through short term liabilities

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Market Risk - VAR

Value at Risk (VaR) is a useful tool for measuring and aggregating market and liquidity risk. It attempts to quantify the potential loss arising out of market movements for a given level of confidence for a given time period VaR indicates the risk that the Bank is exposed to, due to uncovered position of mismatch.

The given period could be one day or few days or few weeks or a year. VaR will change if the holding period of the position changes.

Total VaR is arrived at by adding the products of VaR and Gap amount for respective months.

Formula for calculating VAR

Daily volatility (Vd) = Annual Volatility (Va) sqrt t

VAR = Asset value * Vd *

is calculated using the level of confidence

Example
Data: Holding period:1 day Asset value: Rs.100000 Confidence levels:95% = 1.645 Annual Volatility = 6% Vd = 6/ 252 = 0.377 % VAR= 100000 * 0.377%* 1.645 = Rs.620

Asset Liability Management

Introduction
Asset liability management is the practice of managing risks that arise due to mismatches between the assets and liabilities (debts and assets) of the bank. It is a dynamic process of Planning, Organizing & Controlling of Assets & Liabilities- their volumes, mixes, maturities, yields and costs in order to maintain liquidity and NII.

Significance Of ALM
Basic significance banks should have enough assets to pay off its liabilities. Thus ALM is required to match the assets and liabilities and minimise liquidity and market risk. In a way you ensure that for every liability, there is an equivalent tenure and amount matching asset
Reasons for growing significance of ALM : Volatility Rapid Innovations Regulatory Environment

Management Recognition
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Purpose & Objective of ALM

Banks need to achieve acceptable risk/reward ratio. Banks need to manage the volume, mix, maturity, ratesensitivity, quality and liquidity of assets and liabilities as a whole. It primarily aims to stabilize the short- term profits, long-term earnings Following parameters are generally used for stabilizing the Asset Liability Mismatch of banks: Net Interest Income (NII) Net Interest Margin (NIM) Economic Equity Ratio
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Price Matching
Table I Table I (Rearranged)

Liabilities
Amt (%) Rate

Assets
Amt (%) Rate

Liabilities
Amt (%) Rate

Assets
Amt (%) Rate Spread (%) 0 12 7 10

15 25 30 30

0 5 12 13

10 20 50 20

0 12 15 18

10 5 15 10

0 0 5 5

10 5 15 10

0 12 12 15

30
10 20 100 8.75* 100 13.5* 100

12
13 13 8.75*

30
10 20 100

15
15 18 13.5*

3
2 5 4.75*

Maturity Matching
Table II Liabilities Maturing within (mnths) Assets Maturing within (mnths) Table II (Rearranged) Liabilities Assets Gap Cumulative Gap

10 5 8 4 45 20 8 100

1 3 6 12 24 36 >36

15 10 5 10 30 10 20 100

<1 3 6 12 24 36 >36

10 5 8 4 45 20 8 100

15 10 5 10 30 10 20 100

-5 -5 +3 -6 +15 +10 -12

-5 -10 -7 -13 +2 +12 0

Three Pillars of ALM

1) ALM Information System
Management Information System Information availability, accuracy, adequacy & expediency

2)

ALM Organization
The Board should decide the risk management policy of the bank and set limits for liquidity, interest rate, foreign exchange and equity price risks. 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 in line with the bank's budget and decided risk management objectives. The ALM desk should be responsible for analysing, 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.

3)

ALM Process

Risk parameters Risk identification Risk measurement Risk management Risk policies
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Asset Liability Management Committee

ALM is the most important aspect for the Financial Institutions to manage Balance Sheet Risk, especially for managing of liquidity risk and interest rate risk. 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.

Failure to identify the risks associated with business and failure to take timely measures in giving a sense of direction threatens the very existence of the institution.

Asset Liability Management Committee

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Functions Of ALCO
Balance sheet planning from risk return perspective Desired maturity profile & mix of incremental assets & liability Articulating, reviewing the funding policy & interest rate view of the bank Approving the pricing of various deposits & advances products. Monitoring the implementation of the policies Reviewing the results

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