Description
what is asset liability management, why is it required, what are the risks in the banking business, management of risks, risk measurement techniques, what are the peculiarities in Indian Banking and what are the attributes of an ideal risk measurement paramete
Asset Liability Management
in Indian Banks and Financial Institutions
Asset Liability Management and Indian Banks
• Why Asset Liability Management ?
• What is Asset Liability Management ?
• Risks in banking business
• Management of risks
• Risk measurement techniques
• Peculiarities in Indian Banking
• Attributes of an ideal risk measurement parameter
• Can we move forward ?
Why Asset Liability Management ?
• All financial institutions have a mismatch between
assets and liabilities
• Values of Assets and Liabilities change
• But values of Assets and Liabilities may fail to move
in tandem
• Since Capital is relatively small, even small %
changes in Assets and Liabilities translate into large %
changes in Net Worth
• Hence the need for a “balance-sheet” approach to risk
management – Asset Liability Management
What is Asset Liability Management ?
• ALM is the sub-set of risk management that focuses
on quantitative management of interest rate and
liquidity risks. Major areas include:
– Measurement and monitoring of liquidity and
interest rate risks
– Funding and control of the balance sheet contraints
– Hedging programs for both liquidity and interest
rate risks
(“Risk Management in Banks” by Joel Bessis)
What is Asset Liability Management ?
• ALM is the management of the structure of a bank?s
balance sheet in such a way that interest related
earnings are maximized within the overall risk
preferences of bank?s management.
“Asset Liability Management” Huzier
What is Asset Liability Management ?
The scope of ALM function can be described as
• Liquidity risk management
• Management of market risk
• Funding and capital planning
• Profit planning and growth projection
• Trading risk management
Reserve Bank of India
Risks in banking business
• Liquidity Risk
– maturity mismatch between assets and liabilities
• Credit Risk
– Risk of default
• Interest Rate Risk
– Income is sensitive to interest rate movements
– Value of Assets and Liabilities are sensitive to
interest rate movements
• Forex / Currency Risk
– Presence of multi currency Assets and Liabilities
Management of risks
• Identification
• Quantification
• Estimate of „risk appetite? or „risk bearing capacity?
• Management of risks
– Avoidance
– Hedge
– take exposures
• Monitor and evaluate position regularly
Risk measurement techniques
• Sensitivity Analysis
• Ratio of the variation of earnings to a given
variation of the underlying parameter
• Sensitivities to the same parameter are additive
• Volatility
• Statistical measure
• Variance & standard deviation
• Downside risk measurement
• Scenario analysis
Risk measurement techniques ( 2 )
• Gap Analysis
– Simple and intuitive tools
– Liquidity Gap
– Net cash inflow/outflow in future period
buckets
– Interest Rate Gap
– Net of “Rates Sensitive Assets” and “Rates
Sensitive Liabilities” in future period buckets
– Directly linked to “interest margin”
– However, this does not deal with price
variations of assets and liabilities
• RBI has adopted this approach
Risk measurement techniques ( 3 )
Duration
• Weighted average time to maturity
• Weights – ratios of PV of all cash flows to price of
the instruments
• Hence, duration is a measure of the price sensitivity
• Duration of portfolio = dollar value weighted average
• Easy to alter the portfolio duration to desired values
• Limitation
-applicable to Fixed Income Securities only
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Risk measurement techniques ( 4 )
Duration Gap
• Duration of portfolio = dollar value weighted avg
• Difference between Duration of Assets and
Liabilities can be considered as the duration of the
balance sheet and hence a measure of the risk of
the balance sheet
• Net Equity change:
( )
gap L A gap
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A
L
D D
i
i
A D E = |
.
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÷
+
A
÷ = A * where
1
* * * ) (
Risk measurement techniques ( 5 )
Value-at-Risk
• Over a given period of time with a given
probability, how much could the value of the
portfolio decline in a worst case scenario
• Combination of the two concepts of possible loss
and probability of occurrence
• Limitations
– Assumptions on the distribution of earnings
– Suited only for the “Trading Book” of the bank
• RBI has adopted this for the “Primary Dealers”
Liquidity Matrix
1-14d 14-28d 1-3m 3-6m 6m-1yr 1-3yrs 3-5yrs >5yrs
Capital
Deposits
Borrowings
Others `
OUTFLOW
Cash etc
Investment
Loans&Adv
Lendings
INFLOW
MISMATCH
Interest rate risk
• Changes in market interest rates might adversely affect a
FI's financial condition.
• Net Interest Income (NII)
– earnings perspective?
– Interest received - Interest paid out
– Increase in NII = ( RSA - RSL ) * change in interest rate
• Long-term impact of changing interest rates
- Market Value of Equity (MVE) or Net Worth as the
economic value of bank?s assets, liabilities- economic
value?
Interest rate risk
• Gap analysis
– measured by calculating Gaps over different time intervals
– mismatches between Rate Sensitive Liabilities (RSL)
and Rate Sensitive Assets (RSA)
• An asset or liability is normally classified as rate sensitive if:
• within the time interval under consideration, there is a cash flow;
• the interest rate resets/reprices contractually during the interval;
• it is contractually pre-payable or withdrawable before the stated
maturities;
• It is dependent on the changes in the Bank Rate by RBI
• residual maturity or next re-pricing period, whichever is earlier
• floating rates of interest
– assets and liabilities are rate sensitive at the time of re-pricing.
Interest Rate Sensitivity Gaps
1 m 1-3m 3-6m 6m-1y 1-5yr >5yr Non-Sen
Capital
Deposits
Borrowings
Others
LIABILITIES
Cash etc
Investment
Advances
Lendings
Assets
FRA/Swap
GAPS
Banks Balance Sheet
• Liabilities • Assets
Capital
L T Debt
Deposits
Current
Savings
Fixed
Floating Rate
I Bk Borrowings
Others
Cash/Bank/RBI
Loans /bills etc
Fixed Rate
Floating Rate
Investments
Debt
Equity
I Bk Assets
Fixed Assets / Others
Peculiarities in Indian Banking
• Deposits
– Premature withdrawal promised on all deposits
• Loans and Advances
– Cash Credit Accounts
• Used as checking accounts (interest on daily
balances)
– Prepayments generally with no penalty
• Investments
– Problems of ill-liquid G-Secs, Bonds &
Debentures
Attributes of an ideal risk measurement parameter
• A quantitative measurement of total risk
• Most techniques are well suited for a single asset or
one class of assets
• Duration - Fixed Income Securities
• Value-at-Risk – Investment portfolio
• Gap Analysis – Net Interest Income
• Advantages of duration
– Easy to to arrive at the duration of a portfolio
– Portfolio duration can easily be altered using fresh
assets/liabilities and derivatives
– With a forecast of interest rate using the fornula for change
in equity, suitable positions can be taken or hedging
undertaken
Can we move forward ?
• While duration analysis can be applied to the
“Treasury Book”, it is not possible to apply it to the
“Banking Book”
• Can we transform the Banking Book into something
similar to the treasury Book?
• If the cash flow patterns of the Banking Book can be
predicted with an acceptable degree of probability,
duration techniques can be adopted
• Duration techniques give us a quantitative measure of
risk and with a forecast of interest rates the net change
in equity formula can be used to take positions
Can we move forward ? ( 2 )
• Analyze, using statistical / quantitative
techniques, the behaviour of the deposits and
advances over a period of time in the past
• Estimate the pattern of repayment of all categories
of „Deposits? and „Loans & Advances?
– Represent the present deposit portfolio by a series of
future cash out flows
– Represent the present Loans & Advances portfolio by a
series of future cash out flows
• The „Banking Book? would then be a series of
cash out-flows and in-flows
- similar to a fixed income instrument
THANK YOU
doc_602401001.ppt
what is asset liability management, why is it required, what are the risks in the banking business, management of risks, risk measurement techniques, what are the peculiarities in Indian Banking and what are the attributes of an ideal risk measurement paramete
Asset Liability Management
in Indian Banks and Financial Institutions
Asset Liability Management and Indian Banks
• Why Asset Liability Management ?
• What is Asset Liability Management ?
• Risks in banking business
• Management of risks
• Risk measurement techniques
• Peculiarities in Indian Banking
• Attributes of an ideal risk measurement parameter
• Can we move forward ?
Why Asset Liability Management ?
• All financial institutions have a mismatch between
assets and liabilities
• Values of Assets and Liabilities change
• But values of Assets and Liabilities may fail to move
in tandem
• Since Capital is relatively small, even small %
changes in Assets and Liabilities translate into large %
changes in Net Worth
• Hence the need for a “balance-sheet” approach to risk
management – Asset Liability Management
What is Asset Liability Management ?
• ALM is the sub-set of risk management that focuses
on quantitative management of interest rate and
liquidity risks. Major areas include:
– Measurement and monitoring of liquidity and
interest rate risks
– Funding and control of the balance sheet contraints
– Hedging programs for both liquidity and interest
rate risks
(“Risk Management in Banks” by Joel Bessis)
What is Asset Liability Management ?
• ALM is the management of the structure of a bank?s
balance sheet in such a way that interest related
earnings are maximized within the overall risk
preferences of bank?s management.
“Asset Liability Management” Huzier
What is Asset Liability Management ?
The scope of ALM function can be described as
• Liquidity risk management
• Management of market risk
• Funding and capital planning
• Profit planning and growth projection
• Trading risk management
Reserve Bank of India
Risks in banking business
• Liquidity Risk
– maturity mismatch between assets and liabilities
• Credit Risk
– Risk of default
• Interest Rate Risk
– Income is sensitive to interest rate movements
– Value of Assets and Liabilities are sensitive to
interest rate movements
• Forex / Currency Risk
– Presence of multi currency Assets and Liabilities
Management of risks
• Identification
• Quantification
• Estimate of „risk appetite? or „risk bearing capacity?
• Management of risks
– Avoidance
– Hedge
– take exposures
• Monitor and evaluate position regularly
Risk measurement techniques
• Sensitivity Analysis
• Ratio of the variation of earnings to a given
variation of the underlying parameter
• Sensitivities to the same parameter are additive
• Volatility
• Statistical measure
• Variance & standard deviation
• Downside risk measurement
• Scenario analysis
Risk measurement techniques ( 2 )
• Gap Analysis
– Simple and intuitive tools
– Liquidity Gap
– Net cash inflow/outflow in future period
buckets
– Interest Rate Gap
– Net of “Rates Sensitive Assets” and “Rates
Sensitive Liabilities” in future period buckets
– Directly linked to “interest margin”
– However, this does not deal with price
variations of assets and liabilities
• RBI has adopted this approach
Risk measurement techniques ( 3 )
Duration
• Weighted average time to maturity
• Weights – ratios of PV of all cash flows to price of
the instruments
• Hence, duration is a measure of the price sensitivity
• Duration of portfolio = dollar value weighted average
• Easy to alter the portfolio duration to desired values
• Limitation
-applicable to Fixed Income Securities only
y
y
D
P
P
P
y P
t D
i
i
n
i
i
A
(
(
(
¸
(
¸
+
÷
=
A
+
=
¿
=
*
2
1
) 1 (
*
1
Risk measurement techniques ( 4 )
Duration Gap
• Duration of portfolio = dollar value weighted avg
• Difference between Duration of Assets and
Liabilities can be considered as the duration of the
balance sheet and hence a measure of the risk of
the balance sheet
• Net Equity change:
( )
gap L A gap
D
A
L
D D
i
i
A D E = |
.
|
\
|
÷
+
A
÷ = A * where
1
* * * ) (
Risk measurement techniques ( 5 )
Value-at-Risk
• Over a given period of time with a given
probability, how much could the value of the
portfolio decline in a worst case scenario
• Combination of the two concepts of possible loss
and probability of occurrence
• Limitations
– Assumptions on the distribution of earnings
– Suited only for the “Trading Book” of the bank
• RBI has adopted this for the “Primary Dealers”
Liquidity Matrix
1-14d 14-28d 1-3m 3-6m 6m-1yr 1-3yrs 3-5yrs >5yrs
Capital
Deposits
Borrowings
Others `
OUTFLOW
Cash etc
Investment
Loans&Adv
Lendings
INFLOW
MISMATCH
Interest rate risk
• Changes in market interest rates might adversely affect a
FI's financial condition.
• Net Interest Income (NII)
– earnings perspective?
– Interest received - Interest paid out
– Increase in NII = ( RSA - RSL ) * change in interest rate
• Long-term impact of changing interest rates
- Market Value of Equity (MVE) or Net Worth as the
economic value of bank?s assets, liabilities- economic
value?
Interest rate risk
• Gap analysis
– measured by calculating Gaps over different time intervals
– mismatches between Rate Sensitive Liabilities (RSL)
and Rate Sensitive Assets (RSA)
• An asset or liability is normally classified as rate sensitive if:
• within the time interval under consideration, there is a cash flow;
• the interest rate resets/reprices contractually during the interval;
• it is contractually pre-payable or withdrawable before the stated
maturities;
• It is dependent on the changes in the Bank Rate by RBI
• residual maturity or next re-pricing period, whichever is earlier
• floating rates of interest
– assets and liabilities are rate sensitive at the time of re-pricing.
Interest Rate Sensitivity Gaps
1 m 1-3m 3-6m 6m-1y 1-5yr >5yr Non-Sen
Capital
Deposits
Borrowings
Others
LIABILITIES
Cash etc
Investment
Advances
Lendings
Assets
FRA/Swap
GAPS
Banks Balance Sheet
• Liabilities • Assets
Capital
L T Debt
Deposits
Current
Savings
Fixed
Floating Rate
I Bk Borrowings
Others
Cash/Bank/RBI
Loans /bills etc
Fixed Rate
Floating Rate
Investments
Debt
Equity
I Bk Assets
Fixed Assets / Others
Peculiarities in Indian Banking
• Deposits
– Premature withdrawal promised on all deposits
• Loans and Advances
– Cash Credit Accounts
• Used as checking accounts (interest on daily
balances)
– Prepayments generally with no penalty
• Investments
– Problems of ill-liquid G-Secs, Bonds &
Debentures
Attributes of an ideal risk measurement parameter
• A quantitative measurement of total risk
• Most techniques are well suited for a single asset or
one class of assets
• Duration - Fixed Income Securities
• Value-at-Risk – Investment portfolio
• Gap Analysis – Net Interest Income
• Advantages of duration
– Easy to to arrive at the duration of a portfolio
– Portfolio duration can easily be altered using fresh
assets/liabilities and derivatives
– With a forecast of interest rate using the fornula for change
in equity, suitable positions can be taken or hedging
undertaken
Can we move forward ?
• While duration analysis can be applied to the
“Treasury Book”, it is not possible to apply it to the
“Banking Book”
• Can we transform the Banking Book into something
similar to the treasury Book?
• If the cash flow patterns of the Banking Book can be
predicted with an acceptable degree of probability,
duration techniques can be adopted
• Duration techniques give us a quantitative measure of
risk and with a forecast of interest rates the net change
in equity formula can be used to take positions
Can we move forward ? ( 2 )
• Analyze, using statistical / quantitative
techniques, the behaviour of the deposits and
advances over a period of time in the past
• Estimate the pattern of repayment of all categories
of „Deposits? and „Loans & Advances?
– Represent the present deposit portfolio by a series of
future cash out flows
– Represent the present Loans & Advances portfolio by a
series of future cash out flows
• The „Banking Book? would then be a series of
cash out-flows and in-flows
- similar to a fixed income instrument
THANK YOU
doc_602401001.ppt