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Asset Liability Management (From Banking Perspective) By Siddhesh Acharekar CONFIDENTIAL © Mecklai Financial Services Asset Liability Management (From Banking Perspective) By Siddhesh Acharekar CONFIDENTIAL © Mecklai Financial Services Limited 2008. No part of this document can be circulated or reproduced in any form without prior approval of Mecklai Financial Services Limited

Outline § Concept and Objective § Evolution § Asset Liability Management Committee (ALCO) § Outline § Concept and Objective § Evolution § Asset Liability Management Committee (ALCO) § Rate Sensitive Assets/ Liabilities (RSA/RSL) § Net Interest Income/Net Interest Margin § Tools for ALM System § Gap Mismatch § Case

Concept and Objective § Concept – Risks faced due to mismatch between Assets and Concept and Objective § Concept – Risks faced due to mismatch between Assets and Liabilities – Matching differences between future cash inflows and outflows (Assets and Liabilities) • Maturity • Interest rate sensitivities § Objective – Framework used to measure, manage and monitor financial risks • Interest Rate Risk • Liquidity Risk • Credit Risk • Currency Risk

Evolution § RBI’s first guidelines came in Feb 1999 – Risk measurement, framework and Evolution § RBI’s first guidelines came in Feb 1999 – Risk measurement, framework and limits – 8 maturity buckets (1 -14 days, 15 -28 days, 29 -90 days, 91 -180 days, 181 -365 days, 1 -3 years and 3 -5 years and above 5 years) § Mandate of ALCO Committee § Sep 2007 -revision of buckets from 8 -10 (1 day, 2 -7 days and 814 days)

Maturity Buckets Maturity Buckets

Asset Liability Management Committee (ALCO) § Three-tier organizational set-up for ALM Implementation : – Asset Liability Management Committee (ALCO) § Three-tier organizational set-up for ALM Implementation : – Management Committee of the Board • Implementation, Reviews and Funding strategies – ALCO head by E. D. – Operational Team § Implementation of System – Monitor the risk levels – Articulate the Interest Rate Position & fix interest rate on Deposits & Advances • For example: Fix differential rate of interest rate on Bulk Deposits

ALM statements to be submitted to RBI § Statement of Structural Liquidity (Annexure - ALM statements to be submitted to RBI § Statement of Structural Liquidity (Annexure - I) [DSB Statement No. 8] – Rupee § Statement of Dynamic Liquidity (Annexure - III) § Statement of Interest Rate Sensitivity (Annexure - II) [DSB Statement No. 9] – Rupee § Statement of Maturity and Position (MAP) (Annexure - IV) [DSB Statement No. 10 ] – Forex § Statement of Sensitivity to Interest Rate (SIR)(Annexure - V)[DSB Statement No. 11] - Forex

Tolerance Limit Tolerance Limit

Structural layout ALM Framework (ALCO) Liquidity Risk Dynamic Risk Interest Rate Risk Structural Risk Structural layout ALM Framework (ALCO) Liquidity Risk Dynamic Risk Interest Rate Risk Structural Risk Credit Risk Currency Risk

Rate Sensitive Assets/ Liabilities (RSA/RSL) § Rate Sensitive Assets/ Liabilities (RSA/RSL) – RSA (Rate Rate Sensitive Assets/ Liabilities (RSA/RSL) § Rate Sensitive Assets/ Liabilities (RSA/RSL) – RSA (Rate Sensitive Assets) – Assets whose value is dependent on current interest rate – RSL (Rate Sensitive Liabilities) – Liabilities whose value is dependent on current interest rate

Net Interest Income/Net Interest Margin § Net Interest Income (NII) – Difference between revenues Net Interest Income/Net Interest Margin § Net Interest Income (NII) – Difference between revenues generated by assets and the cost of servicing liabilities – Typically Assets include commercial and personal loans, mortgages, construction loans and investment securities § Net Interest Margin (NIM) – Difference between the interest income generated by banks and the amount of interest paid out to their lenders § Calculation OF NII/NIM – NII: INT. EARNED-INT. EXPENDED – INT. EARNED: ADV+INVEST+BALANCE WITH RBI – INT. EXPENDED: DEPOSITS+INT. ON RBI BORROWINGS – NIM= (NII/TOT. EARNING ASSET)X 100

Impact on NII and NIM Impact on NII and NIM

Sensitivity of NII to respective Gaps Gap Interest rate Change Impact on NII Positive Sensitivity of NII to respective Gaps Gap Interest rate Change Impact on NII Positive Increases Positive Decreases Negative Increases Negative Decreases Positive

Tools for ALM System § Simulation § Value at Risk (Va. R) § Gap Tools for ALM System § Simulation § Value at Risk (Va. R) § Gap Analysis

Gap/Mismatch Risk § Rate sensitive assets and liabilities with different principal amounts, maturity/re-pricing rates Gap/Mismatch Risk § Rate sensitive assets and liabilities with different principal amounts, maturity/re-pricing rates § GAP Analysis – Maturity – Duration § Ways of computing GAP – Periodic GAP – Cumulative GAP

Case § Study Undertaken using GAP Analysis – Net effect on income – GAP Case § Study Undertaken using GAP Analysis – Net effect on income – GAP = RSA – RSL – GAP > 0 – Asset sensitive – GAP < 0 – Liability sensitive § 20 Indian banks- 10 private / 10 public § Assumption of parallel shift in the yield curve § Parameters considered for analysis ü Maturity profile of Deposits and Advances ü NII

Sensitivity of Banks-Impact by 0. 25% change Private Sector No. of banks 6 4 Sensitivity of Banks-Impact by 0. 25% change Private Sector No. of banks 6 4 2 0 0 -2% 2 -5% 5 -7% 7 -10% 10 -15% Public Sector No. of banks 7 6 5 4 3 2 1 0 0 -2% 2 -5% 5 -7% 7 -10% 10 -15%

Sensitivity of Banks-Impact by 0. 5% change Private Sector No. of banks 3 2. Sensitivity of Banks-Impact by 0. 5% change Private Sector No. of banks 3 2. 5 2 1. 5 1 0. 5 0 0 -2% 2 -5% 5 -7% 7 -10% 10 -15% Public Sector No. of banks 5 4 3 2 1 0 0 -2% 2 -5% 5 -7% 7 -10% 10 -15%

Conclusion § Deposits as well as advances are more in the 1 -3 year Conclusion § Deposits as well as advances are more in the 1 -3 year bucket – Borrowing and lending for short to mid term • Not much sure about the future movement of repo rates – Long term investments, advances and deposits are highly affected by changes in repo rates than short term ones • Cautious approach § Effect of interest rate changes on deposits and advances of banks – Change of 0. 25% in repo rates • NII of Private sector banks more affected than Public sector banks – Change of 0. 50% in repo rates • NII of both Private and Public sector banks affected respectively

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