Asset and Liability Management BS1

ASSET & LIABILITY MANAGEMENT IN COMMERCIAL BANKS
InstructorBlent enver bsenver@superonline.com
ALM bsenver@superonline.com
ALM
Assett
Liability
Asset Management
Liability Management
2
ASSET & LIABILITY MANAGEMENT (ALM)

DEFINITION ALM is continuously arranging and rearranging the assets and liabilities of the bank without infringing the liquidity and safety of the bank and with the purpose of maximizing the banks profits.
ALM bsenver@superonline.com 3
LIQUIDITY
The ability of a bank to fulfill its obligations, and after doing so having enough cash left to do its normal daily banking business.
SAFETY
The ability of a banks Share Holders Equity (SHI) to absorb the future possible losses that may arise and after doing so having enough SHI left to run the bank and to comply with the minimum Capital Requirements.
Capital protects your bank in rainy days!..

ALM DEVELPOMENT
1950s
ASSET MNG. LOAN PRODUCTS
1960s
LIABILITY MNG. DEPOSIT PRODUCTS
1970s
ASSET & LIABILITY MNG. LOAN & DEPOSIT BOTH
7
Internet Personal Training Office Automation Computerization Management Reorganization GAAP SC of Accounts Deregulations
Yesterday
Tomorrow
Arena
Services Organizatio n & Reporting Data

NEW DEVOPLEPMENTS
1. Deregulation of Interest Rates 2. Deregulation of Foreign Exchange Operations 3. Changes in Laws and Regulations 4. Increase in Deposit Interest Rates
NEW DEVELOPMENTS
5. Increase in Deposit Interest Rates 6. Change in Deposit Characteristics Increase in Term-Deposits Decrease in Demand-Deposits Increase in Short Terms
NEW DEVELOPMENTS
7. Increase in Personnel Expenses 8. Increase in Operating Expenses 9. Increase in Technology Investments 10. Frequent Changes in Interest Rates 11. Increase in Share Capital Requirements
NEW DEVELOPMENTS
12. Change in Asset Structure Increase in Government Bonds Increase in Treasury Bills Increase in Foreign Exch. Loans Increase in Short Term Loans Increase in Non-Performing Loans Increase in Consumer Loans
NEW DEVELOPMENTS
13. Decrease in S/H Equity Growth 14. Increase in Customer Expectations 15. New Service Points Small Branches ATM and POS Telephone and Internet Banking 16. 24 Hours 365 Days Banking
1950
SALES FORCE
1970
1980
RELATIONSHIP MANAGEMENT
1990
2000
BRANCH CALL CENTER OUTBOUND DIRECT MAIL CREDIT CARD ATM TELEPHONE BANKING DEB T CARD
IN-STORE BRANCH
SPACE SHARING
FRANCHISE BRANCHES
REMOTE RELATIONSHIP MANAGEMENT
CALL CENTER INBOUND
MAIL
DATABASE MARKETING SMART CARD INTERNET ATM SCREEN PHONES INTERACTIVE 15 TV VIDEO KIOSK
KIOSK
Kaynak: A.T.Kearney
PC INTERNET ALM BANKING BANKING bsenver@superonline.com
FINANCIAL STATEMENTS
1. BALANCE SHEET 2. STATEMENT OF INCOME 3. STATEMENT OF SHAREHOLDERS EQUITY 4. SOURCES & USES OF FUNDS STATEMENT
Balance Sheet
Assets
Loans
Income Statement
Interest Income
Deposits
Liabilities
Interest
Earning Assests
Interest
Bearing Treasury Bills Liabiliti es
Interest Expences
Debt
Net Interest Income

NonInterest Earning Assests NonInterest Bearing Liabiliti Share Holders es Equity
Total Assets
Total Liabilities ALM

bsenver@superonline.com
17
Balance Sheet
Assets Loans 100
Interest Earning Assests
Income Statement
Interest Income Deposits
120
Liabilities
36
Interest Expence
Treasury Bills 80
Interest Bearing Liabiliti es
Debt 60
Interest Rate Assets =
%20
Interest Rate Liabiliti es =
9
Net Interest Income
NonInterest Earnin g Assests
Non35
Interest Bearing Liabiliti Share Holders Equity es
30 35
27
%5
18
Total Assets
Total Liabilities
BALANCE SHEET SHOWS

The Financial Position of a Bank As at a specific date. As of Dec. 31,1998
19
BALANCE SHEET EQUATION

ASSETS 100 = Equals = = 100
LIABILITIES + Plus SHAREHOLDERS EQUITY
20
ASSET CLASSIFICATION
TOTAL ASSETS
NON INTEREST EARNING ASSETS INTEREST EARNING ASSETS
21
LIABILITY CLASSIFICATION
TOTAL LIABILITIES
INTEREST BEARING LIABILITIES NON INTEREST BEARING LIABILITIES
22
BALANCE SHEET Assets

Liquid Assets Loans Marketable Securities Investment Securities Fixed Assets Accrued Interest Other Assets Total Assets
150 400 200 50 100 70 80 1050

23
BALANCE SHEET Liabilities

Deposits Bank Borrowings Accrued Expenses Other Liabilities Bonds Issued Shareholders Equity Total Liabilities & S/HE
400 150 100 80 70 250 1050

24
SHAREHOLDERS EQUITY
Share Capital Legal Reserves Retained Earnings Revaluation Surplus Share Premiums Net Income Total S/H Equity
100 30 50 20 10 40 250
25
BALANCE SHEET DOES NOT SHOW

Interest Rates Interest Sensitivity Due Dates Foreign Currency breakdown Collateral
26
STATEMENT OF INCOME SHOWS

The results of operations of a bank. For the period between two dates. For the year ended Dec. 31 , 1998
27
NET PROFIT
NET PROFIT
TOTAL INCOME TOTAL EXPENSE
28
TOTAL INCOME
TOTAL INCOME
NET INTEREST INCOME NET NON-INTEREST INCOME
29
NET INTEREST INCOME

NET INTEREST INCOME
INTEREST INTEREST INCOME EXPENSE (+) (-)
interest income
net interest income net interest income
interest expense
time
31
NET INTEREST INCOME

NET INTEREST INCOME INTEREST INCOME P/L
INTEREST EARNING ASSETS B/S
INTEREST EXPENSE P/L INTEREST BEARING LIABILITIES B/S
32
NET NON-INTEREST NONINCOME

NET NON-INTEREST INCOME
NON NON INTEREST INTEREST INCOME EXPENCE (+) (-)
STATEMENT OF INCOME
Interest Income Interest Expense Net I.Income Non Interest Income Operating Expenses Pre-Tax Profit Tax Provision Net Income
1000 (700) 300 220 (450) 70 (30) 40

34
ANALYSIS OF PROFIT
NET PROFIT
(NP) PROFIT FROM BANKING OPERATIONS (NET OPERATING INCOME) (NOI) PROFIT FROM EXTRAORDINARY TRANSACTIONS (PEXT) PROFIT FROM SECURITY TRANNSACTIONS (PST)
35
BANKING RISKS
BANKING RISKS
C AMEL
A M E L
CAMEL
Capital
Adequacy
38
AMEL
Asset
Quality
39
CA
MEL
Management Quality
40
CAM
EL
Earnings
Efficiency
41
CAME
Liquidity
Risk
42
CAMEL RISKS
Capital Adequacy Asset Quality Management Earnings Liquidity
BANKING RISKS
1.2.3.4.5.CAMEL 6. Credit Risk 7. Interest Rate Risk 8. Interest Rate Sensitivity Risk 9. Foreign Exchange Availability Risk 10. F/X Position Risk
BANKING RISKS
11. Accounting & Reporting Risk 12. Computer Risk 13. Capital Market Operations Risk 14. Money Market Operations Risk 15. Country (Sovereign) Risk 16. Pricing Risk 17. Market Risk
BANKING RISKS
18. Theft Risk 19. Fraud & Defalcations Risk 20. Natural Disasters 21. Strategic Risk 22. Fiduciary Risk 23. Transaction Risk 24. Regulatory/Compliance
BANKING RISKS
25. Reputation Risk 26. Large Loans/Deposits Risk 27. Concentration Risk
47
RATIO ANALYSIS
Numerator ______________________ Denominator
RATIO ANALYSIS
Balance Sheet __________________ Balance Sheet
Income Statement ________________ Balance Sheet
49
RATIO ANALYSIS
What is the
What is the
LEVEL ?
TREND ?
50
RATIO ANALYSIS
1. Capital Adequacy 2. Asset Quality 3. Management 4. Earnings & Efficiency 5. Liquidity
51
RATIO ANALISIS CAPITAL ADEQUACY

The Capital of a Bank protects the Bank against unexpected future losses.
52
RATIO ANALYSIS CAPITAL ADEQUACY

1. Shareholders Equity -----------------------------------Total Assets
The ability of the present Capital to support the further growth of Assets

2. Shareholders Equity -----------------------------------Risk Weighted Assets
54

3. Shareholders Equity -----------------------------------Risk Weighted Assets + RW Contingent Liabilities

4. Total Debt -----------------------------------Shareholders Equity
The ability to raise additional Debt Capital


5. Financial Leverage : Total Assets -----------------------------------Shareholders Equity
57

6. Capital Formation Rate : Retained Net Income (RNI) ------------------------------------------------- Average Shareholders Equity RNI = Net Income - Dividends to be paid The internal growth of Equity Capital
RATIO ANALISIS ASSET QUALITY

1. Loans -------------------------------Total Assets
59

2. Non Performing Loans = a) Loans past due more than 90 days b) Loans not accruing interest c) Loans with low interest rates d) Loans on which repayment terms have been renegotiated.

3. Non Performing Loans ------------------------------------Total Loans
Indicates how much of the loan portfolio is non performing.
61

4. Reserves for Non Performing Loans --------------------------------------------- Non Performing Loans Indicates the ability of the loan loss reserve to absorb potential losses from currently non performing loans.

5. Loan Loss Provision ------------------------------------Average Loans
Shows current income reduction in anticipation of loan losses.
63

6. Net Charge - Offs ------------------------------------Average Loans
Shows current income reduction in anticipation of loan losses.
64

7. Interest Earning Assets ------------------------------------------------Total Assets
65

8. Non Interest Earning Assets ------------------------------------------------Total Assets
66
RATIO ANALISIS EARNINGS & EFFICIENCY

A Bank with no profit is like a human body with no blood.
67
THE PRIMACY OF EARNINGS

A bank can not sustain itself long without a positive cash flow. Earnings are essential to : 1.Absorb loan losses 2.Finance internal growth of capital 3.Attract investors to supply capital

1. Return on Assets ( ROA )
Net Income -------------------------------------------Total Average Assets


2. Return on Equity ( ROE )
Net Income -------------------------------------------Average Shareholders Equity


3. Return on Equity ( ROE ) ROE = ROA * Equity Multiplier
ROE = ( NI / AST ) * ( AST / SHEQ )
71

4.
Interest Income -------------------------------------------Average Interest Earning Assets


5.
Net Interest Income -------------------------------------------Average Total Assets


6.
Interest Income on Loans -------------------------------------------Average Total Loans


7.
Total Operating Expense ------------------------------------------------ Total Operating Income


8. Efficiency Ratio
Non Interest Expense --------------------------------------------------- Net Interest Income + Fees Commissions


9. Break Even Ratio
Total Expenses - Non Interest Income --------------------------------------------------- Total Average Interest Earning Assets

10. Net Free Funds Ratio Non Paying Liabilities - Non Earning Assets ------------------------------------------------- Interest Earning Assets
78

11. Interest Rate Sensitivity Gap : Interest Rate Sensitive Assets ( minus ) Interest Rate Sensitive Liabilities Shows the net amount to be effected by the future change of interest rates in the market

12. Interest Rate Sensitivity Gap Ratio : Interest Rate Sensitive Assets ------------------------------------------------Interest Rate Sensitive Liabilities
80
RATIO ANALYSIS LIQUIDITY

Inadequate Liquidity of a Bank may cause an accident similar to an airplane crash !
81
RATIO ANALISIS LIQUIDITY

1. Loans ------------------------Deposits
82

2. Liquid Assets ------------------------Deposits
83

3. Liquid Assets -------------------------------Deposits + Borrowings
84

4. Assets Due for the Period ----------------------------------------Liabilities Due for the Period
85

5. Net Large Liabilities ---------------------------------------- Net Earning Assets Both numerator & denominator are net of short-term assets. Measures the extent to which net earning assets would be effected by the loss of a banks large liabilities.

6. Liquid Assets ----------------------------------------Large Liabilities
Measures the assets readily available to cover a loss of large liabilities.
87

7. Core Deposits ----------------------------------------Earning Assets
Indicates the extend to which earning assets are funded by those deposits considered stable and not subject to interest rate disintermediation.

8. Brokered Deposits ----------------------------------------Earning Assets
Measures the extent to which a bank is funding assets with high-priced and volatile brokered deposits.
MATURITY ANALISIS
Days Cash Loans 0-10 100 200 300 Deposit 400 Borrow 150 550 10-30 200 500 700 300 200 500 30-60 300 200 500 800 200 1000 60-90 50 100 150 20 30 50
90
MATURITY ANALYSIS
Days Asset Liab 0-10 100 300 10-30 500 200 30-60 1000 1500 -500 +300
60-90 2000 700
Short - -200 Long +
1300
91
OFF - BALANCE SHEET RISK

1. Loan Commitments ----------------------------------------Average Assets
Shows the extent of a banks obligation to make loans.

OFF - BALANCE SHEET RISK

2.Contingent Liabilities & Commitments --------------------------------------------------- Average Assets Shows the extent of a banks commitments & contingent liabilities.
I manage
Assets!
% rates, due dates...
RISKS
I manage
Liabilities
% rates, due dates...
94
ASSET & LIABILITY MATCH
95
A & L Match
Amounts Currency Due Dates Interest Rates Interest Sensitivity Volatility
96
Foreign Exchange Position

USA $ Short Position $Liabilities>$Assets
USA $ Long Position $Assets>$Liabilities

F/X Position Strategy

Increasing F/X Rates Long Position YES Short Position NO
Decreasing F/X Rates
NO
YES
98
Interest Rate Sensitivity

Interest Rate Sensitive Assets/Liabilities IRSA/L are such assets and Liabilities whose interest rates will change before their due dates when there is a change in market interest rates.
99
Interest Rate Sensitivity

Interest Rate Sensitive Assets & Liabilities Interest Rate Non-Sensitive Assets & Liabilities
VARIABLE RATES
FIXED RATES
100
Interest Rate Sensitivity Gap

Positive Gap IRSA>IRSL IRS GAP = (IRSA IRSL) Negative Gap IRSL>IRSA
Interest Rate Sensitivity Strategy

Interest Rates Will Increase Positive IRS GAP Negative IRS GAP Interest Rates Will Decrease
YES
NO
NO
YES
102
INTEREST MARGIN
INCREASING THE
INTEREST MARGIN %
INCREASING INTEREST MARGIN

Interest Income..200 Interest Expense( 50 ) --------- INTEREST MARGIN.. 150 ----------
104
$ interest income +
net interest income net interest income interest expense
time
105
INCREASING THE INTEREST MARGIN

BANK STRATEGY TO
INCREASE THE INTEREST MARGIN
INCREASE SIZE
CHANGE INTEREST SPREAD
ALTER ASSET/LIABILITY MIX
106
INCREASING THE INTEREST MARGIN

BANK STRATEGY ACTION 1.Expand Assets 2.Reduce Fixed Assets 3.Increase Equity Base
Increase Size
107

BANK STRATEGY ACTION 1.Re-Price Asset Portfolio 2.Re-Price Liability Portfolio
Change Interest Spread
108

BANK STRATEGY ACTION 1.Plan Taxes 2.Reduce Liquidity 3.Increase Aggressiveness 4.Change Asset Yield Sensitivity 5.Change Liability Cost Sensitivity
109
Alter Asset / Liability Mix

BANK STRATEGY Increase Size ACTION Expand Assets IMPLEMENTATION 1.Offer new Products and Services 2.New Loans/Deposits 2.Open new Branches 3.Expand Promotion Budget 4.Reduce Interest Spread
110
EXPAND ASSETS
REPERCUSSION 1.Increase operating Expenses 2.Need for Capital 3.F/A Regulations 4.Decrease Capital Ratio 5.Reduce ROA IMPLEMENTATION 1.Offer new Products and Services 2.New Loans/Deposits 3.Open new Branches 4.Expand Promotion Budget 5.Reduce Interest Spread
111

BANK STRATEGY Increase Size ACTION Increase Equity Base IMPLEMENTATION 1.Reduce Dividend pay out 2.Offer Dividend reinvestment 3.Sell Stock 4.Establish Employee Stock Ownership PL
112
INCREASE EQUITY BASE

REPERCUSSIONS 1.Hurt shareholders 2.Double taxation S/H 3.Reduce ability to leverage ROA, dilution of earnings 4.Continued Employee Expectations IMPLEMENTATION 1.Reduce Dividend pay out 2.Offer Dividend reinvestment 3.Sell Stock 4.Establish Employee Stock Ownership PL
113
INCREASE INTEREST MARGIN

BANK STRATEGY Change Interest Spread ACTION Re-price Portfolio IMPLEMENTATION 1.Increase rates on Loans 2.Compound return more frequently 3.Reduce rates on Deposits 4.Compound cost less frequently
114
REPRICE PORTFOLIO
REPERCUSSIONS 1.Lose business Loan quality decrease 2.Increase operations Client dissatisfaction 3.Lose business Liquidity problem 4.Increase operations Client dissatisfaction IMPLEMENTATION 1.Increase rates on Loans 2.Compound return more frequently 3.Reduce rates on Deposits 4.Compound cost less frequently
115

IMPLEMENTATION BANK STRATEGY Alter Asset/Liability Mix 1.Minimize cash 2.Minimize due from 3.Sell Securities & Bonds 4.Increase short term Deposits
116
ACTION Reduce Liquidity
REDUCE LIQUIDITY
REPERCUSSION 1.Liquidity Risk 2.Lose correspondent 3.Incur book losses 4.Increase volatility of deposits IMPLEMENTATION 1.Minimize cash 2.Minimize due from 3.Sell Securities & Bonds 4.Increase short term Deposits
117

BANK STRATEGY Alter Asset/Liability Mix IMPLEMENTATION 1.Increase loan/deposit ratio 2.Increase highest yielding loans 3.Increase highest yielding securities
ACTION Increase Aggressiveness
118
INCREASE AGGRESSIVENESS
REPERCUSSION 1.Increase need for capital 2.Increase loan losses 3.Increase security losses IMPLEMENTATION 1.Increase loan/deposit ratio 2.Increase highest yielding loans 3.Increase highest yielding securities
119

BANK STRATEGY Alter Asset/Liability Mix IMPLEMENTATION 1.Increase S/T & variable rate assets if rates will increase 2.Decrease S/T & variable rate assets if rates will decrease
ACTION Change Asset Yield Sensitivity
120
CHANGE ASSET YIELD SENSITIVITY

REPERCUSSION 1.Wrong estimate of interest movement, thereby reducing interest spread IMPLEMENTATION 1.Increase S/T & variable rate assets if rates will increase 2.Decrease S/T & variable rate assets if rates will decrease
121

BANK STRATEGY Alter Asset/Liability Mix IMPLEMENTATION 1.Decrease S/T & variable rate liabilities if rates will increase 2.Increase S/T & variable rate liabilities if rates will decrease
ACTION Change Liability Cost Sensitivity
122
CHANGE LIABILITY COST SENSITIVITY

REPERCUSSION 1.Wrong estimate of interest movement, thereby reducing interest spread IMPLEMENTATION 1.Decrease S/T & variable rate liabilities if rates will increase 2.Increase S/T & variable rate liabilities if rates will decrease
123

Asset and Liability Management BS1

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ASSET & LIABILITY MANAGEMENT IN COMMERCIAL BANKS

InstructorBlent enver bsenver@superonline.com

ASSET & LIABILITY MANAGEMENT (ALM)

Capital protects your bank in rainy days!..

Services Organizatio n & Reporting Data

CALL CENTER INBOUND

PC INTERNET ALM BANKING BANKING bsenver@superonline.com

Net Interest Income

Total Liabilities ALM

Interest Bearing Liabiliti es

Interest Rate Assets =

NonInterest Earnin g Assests

BALANCE SHEET SHOWS

BALANCE SHEET EQUATION

LIABILITIES + Plus SHAREHOLDERS EQUITY

BALANCE SHEET Assets

150 400 200 50 100 70 80 1050

BALANCE SHEET Liabilities

400 150 100 80 70 250 1050

BALANCE SHEET DOES NOT SHOW

STATEMENT OF INCOME SHOWS

NET INTEREST INCOME

net interest income net interest income

NET INTEREST INCOME

INTEREST EXPENSE P/L INTEREST BEARING LIABILITIES B/S

NET NON-INTEREST NONINCOME

1000 (700) 300 220 (450) 70 (30) 40

Balance Sheet __________________ Balance Sheet

Income Statement ________________ Balance Sheet

RATIO ANALISIS CAPITAL ADEQUACY

RATIO ANALYSIS CAPITAL ADEQUACY

RATIO ANALYSIS CAPITAL ADEQUACY

RATIO ANALYSIS CAPITAL ADEQUACY

RATIO ANALYSIS CAPITAL ADEQUACY

The ability to raise additional Debt Capital

RATIO ANALYSIS CAPITAL ADEQUACY

RATIO ANALYSIS CAPITAL ADEQUACY

RATIO ANALISIS ASSET QUALITY

RATIO ANALISIS ASSET QUALITY

RATIO ANALISIS ASSET QUALITY

Indicates how much of the loan portfolio is non performing.

RATIO ANALISIS ASSET QUALITY

RATIO ANALISIS ASSET QUALITY

Shows current income reduction in anticipation of loan losses.

RATIO ANALISIS ASSET QUALITY

Shows current income reduction in anticipation of loan losses.

RATIO ANALISIS ASSET QUALITY

RATIO ANALISIS ASSET QUALITY

RATIO ANALISIS EARNINGS & EFFICIENCY

THE PRIMACY OF EARNINGS

RATIO ANALISIS EARNINGS & EFFICIENCY

Net Income -------------------------------------------Total Average Assets

RATIO ANALISIS EARNINGS & EFFICIENCY

Net Income -------------------------------------------Average Shareholders Equity

RATIO ANALISIS EARNINGS & EFFICIENCY

ROE = ( NI / AST ) * ( AST / SHEQ )

RATIO ANALISIS EARNINGS & EFFICIENCY

Interest Income -------------------------------------------Average Interest Earning Assets

RATIO ANALISIS EARNINGS & EFFICIENCY

Net Interest Income -------------------------------------------Average Total Assets

RATIO ANALISIS EARNINGS & EFFICIENCY

Interest Income on Loans -------------------------------------------Average Total Loans

RATIO ANALISIS EARNINGS & EFFICIENCY