Components of a

Bank Balance sheet

Liabilities Assets
1. Capital 1. Cash & Balances with RBI
2. Reserve & Surplus 2. Bal. With Banks & Money at
3. Deposits Call and Short Notices
4. Borrowings 3. Investments
5. Other Liabilities 4. Advances
5. Fixed Assets
6. Other Assets

Contingent Liabilities
Components of Liabilities

1.Capital:
Capital represents owners
contribution/stake in the bank.
- It serves as a cushion for depositors and
creditors.
- It is considered to be a long term sources
for the bank.
 Components of Liabilities
2. Reserves & Surplus
Components under this head includes:
I. Statutory Reserves
II. Capital Reserves
III. Share Premium
III. Revenue and Other Reserves
IV. Balance in Profit and Loss Account
 Components of Liabilities
3. Deposits
This is the main source of banks funds. The
deposits are classified as deposits payable on
demand and time. They are reflected in
balance sheet as under:
I. Demand Deposits
II. Savings Bank Deposits
III. Term Deposits
 Components of Liabilities
4. Borrowings
(Borrowings include Refinance /
Borrowings from RBI, Inter-bank & other
institutions)
I. Borrowings in India
i) Reserve Bank of India
ii) Other Banks
iii) Other Institutions & Agencies
II. Borrowings outside India
 Components of Liabilities
5. Other Liabilities & Provisions
It is grouped as under:

I. Bills Payable
II. Inter Office Adjustments (Net)
III. Interest Accrued
IV. Unsecured Redeemable Bonds
(Subordinated Debt for Tier-II Capital)
V. Others(including provisions income tax,
TDS, Interest Tax, Provisions etc.)
 Components of Assets
1. Cash & Bank Balances with RBI
I. Cash in hand
(including foreign currency notes)
II. Balances with Reserve Bank of India

In Current Accounts
In Other Accounts
 Components of Assets
2. BALANCES WITH BANKS AND MONEY AT
CALL & SHORT NOTICE
I. In India
i) Balances with Banks
a) In Current Accounts
b) In Other Deposit Accounts
ii) Money at Call and Short Notice
a) With Banks
b) With Other Institutions
II. Outside India
a) In Current Accounts
b) In Other Deposit Accounts
c) Money at Call & Short Notice
 Components of Assets
3. Investments
A major asset item in the banks balance sheet.
Reflected under 6 buckets as under:
I. Investments in India in : *
i) Government Securities
ii) Other approved Securities
iii) Shares
iv) Debentures and Bonds
v) Subsidiaries and Sponsored Institutions
vi) Others (UTI Shares , Commercial Papers, COD &
Mutual Fund Units etc.)
II. Investments outside India in **
Subsidiaries and/or Associates abroad
 Components of Assets
4. Advances
The most important assets for a bank.
A. i) Bills Purchased and Discounted
ii) Cash Credits, Overdrafts & Loans
repayable on demand
iii) Term Loans

B. Particulars of Advances :
i) Secured by tangible assets
(including advances against Book Debts)
ii) Covered by Bank/ Government Guarantees
iii) Unsecured
 Components of Assets
5. Fixed Asset
I. Premises
II. Other Fixed Assets (Including furniture and fixtures)

6. Other Assets
I. Interest accrued
II. Tax paid in advance / tax deducted at source
(Net of Provisions)
III. Stationery and Stamps
IV. Non-banking assets acquired in satisfaction of claims
V. Deferred Tax Asset (Net)
VI. Others
 Contingent Liability

Banks obligations under LCs, Guarantees,

Acceptances on behalf of constituents and Bills
accepted by the bank are reflected under this
heads.
It also includes Un-called part of Partly Paid
Investment.
 Banks Profit & Loss Account
A banks profit & Loss Account has
the following components:
I. Income: This includes Interest Income
and Other Income.
II. Expenses: This includes Interest
Expended, Operating Expenses and
Provisions & contingencies.
 Components of Income
1. INTEREST EARNED

I. Interest/Discount on Advances / Bills

II. Income on Investments
III. Interest on balances with Reserve Bank
of India and other inter-bank funds
IV. Others
 Components of Income
2. OTHER INCOME

I. Commission, Exchange and Brokerage

II. Profit on sale of Investments (Net)
III. Profit/(Loss) on Revaluation of Investments
IV. Profit on sale of land, buildings and other
assets (Net)
V. Profit on exchange transactions (Net)
VI. Income earned by way of dividends etc. from
subsidiaries and Associates abroad/in India
VII. Miscellaneous Income
 Components of Expenses

1. INTEREST EXPENDED

I. Interest on Deposits
II. Interest on Reserve Bank of India / Inter-Bank
borrowings
III. Others
 Components of Expenses
2. OPERATING EXPENSES

I. Payments to and Provisions for employees

II. Rent, Taxes and Lighting
III. Printing and Stationery
IV. Advertisement and Publicity
V. Depreciation on Bank's property
VI. Directors' Fees, Allowances and Expenses
VII. Auditors' Fees and Expenses (including Branch Auditors)
VIII. Law Charges
IX. Postages, Telegrams, Telephones etc.
X. Repairs and Maintenance
XI. Insurance
XII. Other Expenditure
 Provisions & Contingencies

Provision Made for:

- Bad & Doubtful debts
- Taxation
- Depreciation/Diminution in value of
Investment
- Other Provisions
 Assets Liability Management
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.
 Financial Intermediation-Qualitative Asset
Transformation

Liquidity and payment intermediation

Liquid deposits vs illiquid credits
Maturity intermediation
Short-term deposits vs long-term credits
Denomination intermediation
Small-denomination deposits vs large credits
Diversification intermediation
Investors have a claim against a well-diversified
portfolio
Information intermediation
FIs acquire information about the borrowers, provide
them with funds, and monitor their performance
Incentives for monitoring: rents or reputation
 Significance of ALM
Volatility
Product Innovations & Complexities
Integration of Markets
Regulatory Environment
Management Recognition
Purpose & Objective of ALM
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
 RBI DIRECTIVES
Issued draft guidelines on 10th Sept 1998.

Final guidelines issued on 10th Feb99 for implementation of ALM

w.e.f. 01.04.99.

To begin with 60% of asset & liabilities are covered; 100% from
01.04.2000.

Initially Gap Analysis was applied in the first stage of

implementation.

Disclosure to Balance Sheet on maturity pattern on Deposits,

Borrowings, Investment & Advances w.e.f. 31.03.01
With a view to adopt more granular approach to measurement of
liquidity risk, first time bucket (1-14 days) split into three time
buckets viz, Next Day, 2-7 days and 8-14 days wef 1.1.2008
 Liquidity Management

Banks liquidity management is the process

of generating funds to meet contractual or
relationship obligations at reasonable prices
at all times.
New loan demands, existing commitments,
and deposit withdrawals are the basic
contractual or relationship obligations that a
bank must meet.
Adequacy of liquidity position for
a bank
Analysis of following factors throw light on a
banks adequacy of liquidity position:
a. Historical Funding requirement
b. Current liquidity position
c. Anticipated future funding needs
d. Sources of funds
e. Options for reducing funding needs
f. Present and anticipated asset quality
g. Present and future earning capacity and
h. Present and planned capital position
Factors that may affect a banks liquidity include:

A decline in earnings
An increase in Non-Performing assets
Deposit concentration
A down grading by Rating Agencies
Expanded Business Opportunity
Acquisitions
New Tax initiatives
 Funding Avenues
To satisfy funding needs, a bank must perform
one or a combination of the following:

a. Dispose off liquid assets

b. Increase short term borrowings
c. Decrease holding of less liquid assets
d. Increase liability of a term nature
e. Securitization of Assets
f. Increase Capital funds
 Types of Liquidity Risk
Liquidity Exposure can stem from both
internally and externally.
External liquidity risks can be geographic,
systemic or instrument specific.
Internal liquidity risk relates largely to
perceptions of an institution in its various
markets: local, regional, national or
international
 Other categories of liquidity risk
Funding Risk
- Need to replace net outflows due to
unanticipated withdrawals/non-renewal
Arises due to:
Fraud Causing substantial loss
Systemic risk
Loss of Confidence
Liabilities in Foreign Currencies
Other categories of liquidity risk

Time Risk
- Need to compensate for non-receipt of
expected inflows of funds
Arises due to:
- Severe deterioration in asset quality
- Standard assets turning into NPA
- Temporary Problem in recovery
- Time involved in managing liquidity
Other categories of liquidity risk
Call Risk
- Crystallization of contingent liability
Arises due to:
- Conversion of non-fund based limit to fund
based limit
- Swaps and Options
 Measuring & Managing Liquidity
Risk
Steps necessary for managing liquidity
risks in Banks

1. Developing a structure for managing

liquidity risk
2. Setting tolerance level and limit for
liquidity risk
3. Measuring and Managing Liquidity Risk
 Setting tolerance level and limit for
liquidity risk

Limits could be set on the following lines:

1. Cumulative cash flow mismatches over particular period taking

conservative view of marketable liquid assets
2. Liquid assets as percentage of short-term liabilities
3. A limit on Loan to deposit ratio
4. A limit on loan to capital ratio
5. Primary sources for meeting funding needs should be quantified
6. Flexible liquidity provision to be maintained to sustain
operations
 Measuring and Managing
Liquidity Risk
Measuring and Managing funding requirement can
be done through two approaches:

1. Stock Approach

2. Flow Approach
 Stock Approach
This Approach is based on the level of assets
and liabilities as well as Off-Balance sheet
exposures on a particular date.
1. Ratio of Core Deposit to total Assets:
Core Deposit/Total Asset: More the ratio better it is
because core deposit treated to be the stable source of
liquidity.

2. Net Loans to Total deposits Ratio:

Net Loans/Total Deposit: It reflects the ratio of loans
to Public Deposits or core deposits. Lower the ratio is
the better.
 Stock Approach

3. Ratio of Time Deposit to Total Deposits:

Time Deposits/Total Deposits:
Higher the Ratio better
4. Ratio of Volatile liabilities to total assets
Volatile Liabilities/Total Assets
Lower the Ratio the Better
5. Ratio of Short Term Liabilities to Liquid
Assets:
Short Term Liabilities/Liquid Assets:
Lower the Ratio the better
 Stock Approach
6. Ratio of Liquid Assets to Total Assets:
Higher the Ratio the better
7. Ratio of Short Term Liability/Total Assets:
A lower ratio is desirable
8. Ratio of Prime Asset to Total Asset:
Higher the ratio the better
9. Ratio of Marketable liability to total asset:
Lower the ratio better
N.B>Indian Banks do not follow this approach
 Flow Approach

The Frame work for assessing and

managing bank liquidity through flow
approach has three major dimensions:

1. Measuring and Managing net funding

requirements
2. Managing market access, and
3. Contingency Planning
Statement of Structural Liquidity
All Assets & Liabilities to be reported as per their
maturity profile into 10 maturity Buckets:

i. Next Day (Day One)

ii. 2-7 days
iii. 8-14 days
iv. 15 to 28 days
v. 29 days and up to 3 months
vi. Over 3 months and up to 6 months
vii. Over 6 months and up to 1 year
viii. Over 1 year and up to 3 years
ix. Over 3 years and up to 5 years
x. Over 5 years
 STATEMENT OF
STRUCTURAL LIQUIDITY
Places all cash inflows and outflows in the
maturity ladder as per residual maturity
Maturing Liability: cash outflow
Maturing Assets : Cash Inflow
Classified in to 10 time buckets
Net Cumulative mismatches during the Next Day,
8-14 days and 15-28 days buckets should not
exceed 5%, 10%, 15% and 20% of the cumulative
cash outflows in the respective time buckets.
Shows the structure as of a particular date
Banks can fix higher tolerance level for other
maturity buckets.
 An Example of Structural Liquidity
Statement
15-28 30 Days- 3 Mths - 6 Mths - 1Year - 3 3 Years - Over 5
1-14Days Days 3 Month 6 Mths 1Year Years 5 Years Years Total

Capital 200 200

Liab-fixed Int 300 200 200 600 600 300 200 200 2600
Liab-floating Int 350 400 350 450 500 450 450 450 3400
Others 50 50 0 200 300
Total outflow 700 650 550 1050 1100 750 650 1050 6500
Investments 200 150 250 250 300 100 350 900 2500
Loans-fixed Int 50 50 0 100 150 50 100 100 600
Loans - floating 200 150 200 150 150 150 50 50 1100
Loans BPLR Linked 100 150 200 500 350 500 100 100 2000
Others 50 50 0 0 0 0 0 200 300
Total Inflow 600 550 650 1000 950 800 600 1350 6500
Gap -100 -100 100 -50 -150 50 -50 300 0
Cumulative Gap -100 -200 -100 -150 -300 -250 -300 0 0
Gap % to Total Outflow
-14.29 -15.38 18.18 -4.76 -13.64 6.67 -7.69 28.57
ADDRESSING THE MISMATCHES
Mismatches can be positive or negative

Positive Mismatch: M.A.>M.L. and Negative

Mismatch M.L.>M.A.

In case of +ve mismatch, excess liquidity can

be deployed in money market instruments,
creating new assets & investment swaps etc.

For ve mismatch,it can be financed from

market borrowings (Call/Term), Bills
rediscounting, Repos & deployment of foreign
currency converted into rupee.
 STRATEGIES
To meet the mismatch in any maturity
bucket, the bank has to look into
taking deposit and invest it suitably
so as to mature in time bucket with
negative mismatch.
The bank can raise fresh deposits of
Rs 300 crore over 5 years maturities
and invest it in securities of 1-29 days
of Rs 200 crores and rest matching
with other out flows.
 Maturity Pattern of Select Assets & Liabilities of A Bank
Liability/Assets Rupees In Percentage
(In Cr)

I. Deposits 15200 100

a. Up to 1 year 8000 52.63
b. Over 1 yr to 3 yrs 6700 44.08
c. Over 3 yrs to 5 yrs 230 1.51
d. Over 5 years 270 1.78
II. Borrowings 450 100
a. Up to 1 year 180 40.00
b. Over 1 yr to 3 yrs 00 0.00
c. Over 3 yrs to 5 yrs 150 33.33
d. Over 5 years 120 26.67
III. Loans & Advances 8800 100
a. Up to 1 year 3400 38.64
b. Over 1 yr to 3 yrs 3000 34.09
c. Over 3 yrs to 5 yrs 400 4.55
d. Over 5 years 2000 22.72
Iv. Investment 5800 100
a. Up to 1 year 1300 22.41
b. Over 1 yr to 3 yrs 300 5.17
c. Over 3 yrs to 5 yrs 900 15.52
d. Over 5 years 3300 56.90
 InterestRateSensitivityAnalysis
Structural Liquidity Statement is the
basis for IRS analysis. All off balance
sheet items are excluded except Repos,
Reverse Repos and SWAPs.
Non-sensitive assets / liabilities are
shifted to non-sensitive bucket (like
Capital, Reserves, Fixed Assets etc).
A perception of likely interest rate
scenario is formed. Accordingly, re-
pricing effect is assessed for all RSA /
RSL.
Rate sensitive gaps are assessed from
the analysis.
 STATEMENT OF
INTEREST RATE SENSITIVITY
Generated by grouping RSA,RSL & OFF-
Balance sheet items in to various (10)time
buckets.
RSA:
MONEY AT CALL
ADVANCES ( BPLR LINKED )
INVESTMENT
RSL
DEPOSITS EXCLUDING CD
BORROWINGS
 Balance Sheet looked at from Interest Rates:
Whether
Fixed /
Interest
Balance Sheet Items Floating Rate Remarks
bearing
Liabilities
Capital No
Reserves & Surplus No
Deposits
- Current Deposits No
- Savings Deposits Yes Fixed
Discretionary pricing
for High Value deposits
- Term Deposits Yes Fixed
& Inter bank items
Borrowings
- From within India Yes Fixed
Generally Sometimes, floating,
- From Outside India Yes
Fixed linked to LIBOR
Other Liabilities
- Interest Payable Yes Fixed
In a few cases, this is
- Subordinated Debts Yes Fixed
floating rate item
- Others NO
 Balance Sheet looked at from Interest Rates:
Whether
Fixed /
Interest
Balance Sheet Items Floating Rate Remarks
bearing
Assets
Cash on Hand No
Interest only on CRR
withdrawn since
Balances with RBI No
24-06-2006
Balances with Other
Banks
- in current accounts No
- Call money,
Reverse Repo etc Yes Fixed

However, shares etc do

Investments Yes Fixed not earn interest
Fixed /
Loans and Advances Yes Floating
Fixed Assets No
Other Assets No
 MATURITY GAP METHOD
(IRS)
THREE OPTIONS:
A) RSA>RSL= Positive Gap
B) RSL>RSA= Negative Gap
C) RSL=RSA= Zero Gap
 IRS & Interest Rate
Scenario
Impact of Interest Rate Changes on NII
Rising Interest Stable Interest Falling Interest
Rate Scenario Rate Scenario Rate Scenario

Negative Mis Matches in IRS Adverse No Impact Favourable

Mis Match in IRS is NIL No Impact No Impact No Impact

Positive Mis Matches in IRS Favourable No Impact Adverse

 Interest Rate Risk Management
Interest Rate risk is the exposure of a banks
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 banks earnings
and capital base.
Changes in interest rates also affect the
underlying value of the banks assets,
liabilities and off-balance-sheet item.
 Interest Rate Risk

Interest rate risk refers to volatility in Net

Interest Income (NII) or variations in Net
Interest Margin(NIM).
Therefore, an effective risk management
process that maintains interest rate risk
within prudent levels is essential to safety
and soundness of the bank.
 Sources of Interest Rate Risk
Interest rate risk mainly arises from:
Gap Risk
Basis Risk
Embedded Option Risk
Yield Curve Risk
Price Risk
Reinvestment Risk
 Measurement of Interest Rate Risk
Gap Analysis- Simple maturity/re-pricing
Schedules can be used to generate simple
indicators of interest rate risk sensitivity of both
earnings and economic value to changing interest
rates.
- If a negative gap occurs (RSA<RSL) in given
time band, an increase in market interest rates
could cause a decline in NII.
- conversely, a positive gap (RSA>RSL) in a
given time band, an decrease in market interest
rates could cause a decline in NII.
 Maturity Gap Models
Maturity Gap Models began in the late 1970s with the
invention of the cumulative 1-year gap model. The periodic
gap model soon followed. These models measure the
difference between the dollar volume of rate-sensitive assets
and rate-sensitive liabilities, the "Dollar Gap."
(i) Interest rate risk management with this tool typically
seeks to exploit the Dollar Gap, or by structuring the
portfolio so that it is zero.
(ii) While it produces a cheap and easily interpretable index
of interest rate risk, there is insufficient consideration of the
timing of repricing within the periods.
(iii) It hides risks, focuses on only one target account (net
interest income), produces gap patterns which are difficult to
interpret without computer simulation, neglects to consider
all of the investment alternatives which are available to
manage the risk, is non-incremental, and is sometimes dead
wrong.
 Interest Rate Risk
The risk that the returns on funds to be reinvested will
fall below the originally anticipated returns.

0 Liabilities 2 years

0 Assets 1 year
 Measurement of Interest Rate Risk

Duration Analysis: Duration is a measure

of the percentage change in the economic
value of a position that occur given a small
change in level of interest rate.
 Duration Model
Duration is an index which measures the interest rate sensitivity of any
series of cash flows.

(i) It takes into account both the timing and magnitude of cash flows.

(ii) The objective of managing with this tool is to match the average (not exact) magnitude
and timing of asset and liability cash flows.

(iii) Duration analysis can be performed separately on a large number of Target Accounts
thereby permitting better identification of the risks sought to be controlled and the affect
of a particular strategy on all of those accounts.

(iv) It permits analysis of a great number of asset/liability choices to achieve a particular risk
profile or meet other objectives.

(v) Duration can unambiguously indicate which transactions reduce current risk.

(vi) Correlated risks and unusual security types are more easily analyzed.

(vii) It is more management intensive and cannot simulate the influence of new business or
adjustment in business lines as assets/liabilities mature.
MARKET RISK: Measure, Monitor & Manage
Value at Risk
ValueatRisk
ValueatRiskisameasureofMarketRisk,
whichmeasuresthemaximumlossinthe
marketvalueofaportfoliowithagiven
confidence

Value at Risk

.022 433 VaRisdenominatedinunitsofacurrency

orasapercentageofportfolioholdings
.016 324.7

.011 216.5 Fore.g..,asetofportfoliohavingacurrent

valueofsayRs.100,000canbedescribed
.005 108.2
tohaveadailyvalueatriskofRs.5000at
.000 0 a99%confidencelevel,whichmeansthere
1.5 2.9 4.3 5.6
Certainty is 95.00% from 2.6 to +Infinity
7.0
isa1/100chanceofthelossexceedingRs.
5000/consideringnogreatparadigmshifts
intheunderlyingfactors.

Itisaprobabilityofoccurrenceandhenceis
astatisticalmeasureofriskexposure
 Simulation Model
Simulation Models were developed to correct several of the deficiencies in the Dollar Gap
models. Whereas Maturity and Duration Gap models are static, simulation is dynamic.

(i) They require more detailed assumptions about managerial behavior, probable loan and
deposit demand, and the path taken by interest rates.

(ii) Simulations help mangers anticipate the timing of future events an prepare managers to
neutralize the unwanted aspects thereof, increase the value of strategic and profitability
planning, and are easily understandable.

(iii) The two disadvantages are: (i) they cost more; and (ii) they measure current risk exposure
clumsily.

(iv) Risk adjustment is by trial and error which is tedious and voluminous. Summarizing the
results requires great skill.

(v) Because they rely heavily on econometric analysis, the suffer from the same problems as
econometric forecasting.

(vi) They focus on net interest income and can only be used to measure several target accounts
simultaneously with great limitations.
 The Success of ALM rests of
effective existence of:
ALM Information System
- Management Information System (MIS)
- Information Availability, Accuracy,
Adequacy and expediency

ALM Organization

ALM Process
 ALM Information System
Information is key to the ALM Process
Due to varied nature of business focus among
Public/Private/Foreign Banks, uniform practice of
ALM System not feasible
Data Accuracy, Quality & timeliness are key to
ALM information system
Banks with wide geographical reach and manual
system required to follow ABC Approach so as to
cover maximum assets and liabilities for analyzing
their behaviour.
The level of computerization, use of Core Banking
Solution will ease the ALM Information System.
 ALM Organization
ALCO Committee
Should be headed by CEO/CMD or ED
Members include head of Investment, Credit, Funds
& Treasury (Fx & Domestic), International Banking
and Economic Research can be members. In
addition, head of IT should also be an invitee for
building up of MIS/Computerization.
The Management Committee of the Board or any
other specific Committee constituted by the Board
should oversee the implementation of system &
review its functioning periodically.
 ALM Process
The Scope of ALM functions can be
described as follows:
- Liquidity Management
- Management of Interest Rate Risk/Market
Risk
- Funding & Capital Planning
- Profit planning and Growth Projections
- Trading Risk Management
 SUCCESS OF ALM IN BANKS :
PRE - CONDITIONS
1. Awareness for ALM in the Bank staff at all
levelssupportive Management & dedicated
Teams.
2. Method of reporting data from Branches/ other
Departments. (Strong MIS).
3. Computerization-Full computerization,
networking.
4. Insight into the banking operations, economic
forecasting, computerization, investment,
credit.
5. Linking up ALM to future Risk Management
Strategies.