Description
This is a PPT about the Asset liabilty management.
ASSET-LIABILITY MANAGEMENT
CONTENT
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Overview of bank balance sheet The nature of banking business; the source of asset liability mismatch How Assets and Liabilities impact NII an equity The scope of ALM : Market risk The meaning of liquidity & liquidity risk Working Funds Approach
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Maturity ladder approach Stress testing Bank leverage; importance of CRR/SLR and prudential norms Interest Rate Risk NII and MVE perspective NII management: IR gaps approach Stress testing MVE approach: duration gap approach Estimating MVE impact without from IR gap statement
Overview of bank balance sheet
LIABILITIES ? Capital ? Reserves
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? Statutory
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Reserves
Sec.17 of the BR Act, 1949 requires a bank to transfer 20% of net profits to statutory reserve
? Capital
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Reserves ? Share Premium
Revaluation reserves
? Revenue
reserves
Overview of bank balance sheet
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Deposits
? Demand
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deposits
Current Savings Term Recurring
? Time
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? „Inter-bank?
and „Others? (CDs)
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Borrowings
? RBI,
NABARD, SIDBI ? Borrowings do not include bonds
Overview of bank balance sheet
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Other liabilities and provisions
? Bonds ? Bills
payable ? Interest accrued ? Inter-office adjustments (net) ? Provisions for impaired assets ? Other provisions
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Contingent Liabilities
? Disputed
claims ? Outstanding guarantees, letters of credit ? Derivative positions that can devolve on the banks
Overview of bank balance sheet
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ASSETS
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Cash Balances with RBI
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Balances with banks Money at call at short notice Investments
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Government Securities and other approved securities Shares Bonds (other than above) Units of MFs Deposit with RIDF CPs Net of provision for depreciation
Overview of bank balance sheet
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Advances
? Bills
purchased/discounted ? Demand loans ? Term loans ? „Secured? and „Unsecured?
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Fixed Assets Other Assets
? Inter-office
adjustments (net) ? Interest accrued ? Non-banks asset acquired in satisfaction of claims
Profit and Loss A/c items
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Interest income
? Advances ? Investments
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Non-interest income
? Commission,
fees, brokerage etc. ? Treasury (trading) profits/losses ? Profit/loss on revaluation of investment ? Dividends
Profit and Loss A/c items
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Interest expenditure Operating expenses
? Employee ? Rents,
costs
lighting, taxes, printing, stationary, advertisement, depreciation on property
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Provisions against impaired loans and unpaid expenses Net Interest Income
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Profit and Loss A/c
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Net Interest Income Net Income Operating profit
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Net profit
Net Interest Margin Interest Spread
The Nature of Banking How money is created
Bank Money
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Banks create money by writing an accounting voucher
? Debit….
Loan A/c ? Credit… Customer?s Deposit A/c
Banks do not need you to deposit cash to give a loan ? It needs cash deposit only meet the probabilistic event of cash being withdrawn
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Bank Money
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If acceptance of (cash) deposits is seen as similar to buying cash; and making loans as selling cash, then banks are in the business of short-selling cash The difference between short selling stock and cash is that settlement is never demanded by bank?s customers except when there is breach in confidence Greater the credit creation higher the cash-short position (leverage) Credit creation makes financial system fragile CRR and SLR act as „margin money? with a centralized clearing house and limits the capacity of banks to roll over the same cash for making loans
Bank Money
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Bank credit is repayable Bank credit is “money + anti-money” For sustaining „demand? over a period of time fresh credit > repayment Leading to inexorably increasing debt to GDP ratio Excessive credit can be inflationary, and often results in asset inflation Central banks have a strong motivation to to limit bank credit beyond what?s considered safe
How A-L impact NII and MVE
Net Interest Income (NII)
Change in interest rates may cause some assets and some liabilities to re-price ? The impact may be different on interest income and interest expenditure ? Basis Risk ? Hence impact on NII
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Economic value of the balance sheet
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Economic value (c.f. market value) of any asset is the MV of Assets sum total of the present values of all its incomes MV of Liabilities
Interest rate sets the discounting rate This also applies to Liabilities Hence there exists a relationship between MV of equity
Time ---------------------->
Equity
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The Scope of ALM
Market Risk
Banking Book, Trading Book
Banking book relates to assets and liabilities not meant for trading, funding trading positions and derivatives for trading ? Derivatives positions meant to protect banking book items, relates to banking book ? ALM deals with the banking book
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Scope of ALM
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Market Risks (in the banking book)
? Liquidity
Risk ? Interest Rate Risk ? Exchange Risk
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Liquidity risks arises due to mismatch in maturity of assets and liabilities Interest Rate Risk arises from a mismatch in repricing schedules of assets and liabilities
Maturity mismatch
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Banks earn spread because of
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Interest rate
9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% 0 1 2 3 Years 4 5 6
Risk transformation Maturity transformation
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Rate of interest directly related to term Borrowing short Lending long
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Both are sources of risk
Borrow Lend
Why ALM?
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Maturity transformation
? Pricing
Mismatch ? Interest Rate Risk
Mismatch ? Liquidity Risk
? Liquidity
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Interest Rate Risk ? Affect profitability Liquidity Risk ? May lead to liquidation General Strategy
? Eliminate ? Manage
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Liquidity Risk
Interest Rate Risk
Conscious position taking
Liquidity
Three aspects of liquidity ? Realisability of assets
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? Liquidity
= Realizable value of asset Full value of the asset
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Ability to meet claims
? Expected
cash outflow Expected cash inflow
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Ability to make high quality loans
ALM - the two approaches
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Fundamental Approach
? Long
Term Liquidity
Cash flow Approach
? Helps
focus on short term liquidity, without losing view of liquidity
Fundamental Approach
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Eliminate long-term liquidity risk
? Adjusting
maturities of long term assets/ liabilities ? Asset Management ? Liability Management
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Asset Management (Application of Funds)
? Maintain
cash or near-cash balances to meet
liabilities
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Liability Management
? Borrow
from the market to fund asset creation opportunities
Fundamental Approach
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Asset Management (Deployment of Funds)
? Liabilities
are not volatile ? Liabilities are inflexible ? Flexible Assets ? Small banks
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Liability Management (Sources of Funds)
? Borrow
when you need ? Asset are long term ? Inflexible Assets ? Flexible liabilities ? Large banks
Fundamental Approach
Example: Balance sheet of public sector bank
Liabilities Rs.cr. Assets
Capital 294.34 Res.&Sur 4092.63 Deposits 66366.37 Borr. 625.33 Oth.Lib& Prov. 5039.17 ______ 76417.84 Rs.cr. Cash/RBI 3465.82 Call Mon. 3351,28 Advances 35348.08 Invstmt. 30179.38 Fix.Assets 697.32 Other Ast.3375.96 ______ 76417.84
Fundamental Approach
Example: ICICI Ltd. as at 31.3.96
Liabilities Rs.mi. Capital 11132.67 Res.&Sur. 41921.76 Re.loans 272534.88 FC Loans 101950.63 Cur. Lib & Provisions 31661.57 ______ Assets Rs.mi. Loans to industrial Concerns 287217.59 Investments (LT) 73300.01 Current Assets* 64509.10 Fixed Assets 31119.30 Misc. Expenses 3055.51 ______
459201.51 459201.51 *Of which cash & bank balances and securities held as stock in trade amount to Rs.29131 mi. t
Fundamental Approach
Example: ICICI Bank Ltd. as at 31.3.03
Liabilities Rs.mi. Capital 9626.60 Res.&Sur. 63206.54 Assets Rs.mi. LT Loans/Adv 489028.17 ST Loans/Adv 43765.97 Deposits@ 481693.06 Investments* 354623.00 Re.loans 284107.42 Cash+ST Assets# 64890.03 FC Loans 58916.78 Fixed Assets 40607.27 Cur. Lib & Other$ 75205.22
Provisions 170569.26
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1068119.66 @ Includes Rs. 406866.54 mi term deposits.
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1068119.66
*Of which Rs. 255485.75 mi. are G-secs. #Of which Rs. 45496.74 mi with RBI. $ $ Includes Rs.35866.83 mi illiquid assets.
Fundamental Approach
Example: ICICI Ltd. as at 31.3.96
Liabilities Rs.mi. Capital 11132.67 Res.&Sur. 41921.76 Re.loans 272534.88 FC Loans 101950.63 Cur. Lib & Provisions 31661.57 ______ Assets Rs.mi. Loans to industrial Concerns 287217.59 Investments (LT) 73300.01 Current Assets* 64509.10 Fixed Assets 31119.30 Misc. Expenses 3055.51 ______
459201.51 459201.51 *Of which cash & bank balances and securities held as stock in trade amount to Rs.29131 mi. t
Working Funds Approach
Focused on ability to meet liabilities ? Volatile, Vulnerable and Stable liabilities ? Maintain enough liquid assets to cover liabilities ? Requires a policy on liquid assets
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Example of WF approach
Liabilities Rs.crore Capital 400 Reserves 1200 Call money borr. 120 30 day deposits 800 Savings Deposits* 900 Fixed Deposits# 2200 Inter-branch a/c* 80 *50% stable ____ #Rs.300 crore maturing 5700
in 1 month, Rs.200 may be withdrawn anytime
Assets Rs. crore Cash 80 Bank balance** 320 Investments (LT) 800 Loans & Adv. 2100 Securities (ST) 1900 Fixed Assets 500
**Inlcudes Rs.194 crore CRR deposit with RBI ____ 5700
The bank maintains liquidity as: 100 % of Volatile Assets, 65% (± 5%) of Vulnerable Assets & 10% of Stable Assets (± 5%)
Cash flow approach
? Cash
Flows Approach
?Cash
flows over the planning horizon ?Actual (Structural) cash flows ?Projected (Dynamic) cash flows
? Cash
flow forecasts ? Forecasting costs money
?A
bank having large branch network
? Decide
periodicity of forecasts
Liquidity Gap Method
? Cash
Flow Approach
?Structural
Cash Flow ?In addition, banks will have to manage dynamic cash flow 0-90 days ?Bucketing concept ?Residual vs. Original maturity
STRUCTURAL LIQUIDITY STATEMENT AS ON -- (AN ILLUSTRATION )
ASSETS /LIABILITIES
over nigh t
0-7 days
714 d
14 d 1– 1m 3m
36m
6m1y
13y
3-5y
>5 y
TOT
CASH BANK BALANCE INVESTMENTS ADVANCES OTHERS TOT INFLOW (A) OWN FUNDS DEPOSITS BOROWINGS
OTHERS
TOT OUTFLOW (B) MISMATCH (A-B) =C CUMULATIVE (D) % OF C TO B
Gaps Approach
0d-14d 14d-28d 28d- 3m 3m-6m Cash Inflow Cash Outflow Gap Gap % Cumulative Gap Cum Gap %
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6m-1y 295 322 -27 -108
1y - 3y 375 445 -70 -178
3y - 5y Above 5y 430 480 -50 -228 525 560 -35 -6.67% -263 -50.10%
195 180 15 15 7.69%
210 240 -30 -15
230 261 -31 -46
250 285 -35 -81
7.69% -14.29% -13.48% -14.00%
-9.15% -18.67% -11.63%
-7.14% -20.00% -32.40% -36.61% -47.47% -53.02%
Borrowings can open negative gaps in future buckets Forward Payment Structure indicates a gathering liquidity crisis Long term strategic approach needed to correct an increasingly negative FPS
Gaps Approach
700 600 500 400 300 200 100 0 -100 -200 -300 -400
Gap Position
Outflows Inflows
Gap Values
0d-1
4d
28d-
3m
6m- 1 y
3y -
5y
FPS Time slots
Setting the gaps right
Restructure Assets ? Restructure Liabilities ? Grow the balance sheet ? Shrink the balance sheet ? Off-balance sheet hedge
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Restructuring assets
Ex.3 Gap Report
Please note down this balance sheet
0-1y 1-3y 3-5y 5yTot. Assets 100 150 200 550 1000 Liab. 200 200 400 200 1000 Gap -100 -50 -200 350 0 Cum. Gap -100 -150 -350 0 0 Cum. Gap as % of assets -10% -15% -35% 0% 0% Limit -5% - 15% - 20%
Move Rs.50 of assets from 5y- to 0-1y Move Rs.100 of assets from 5y- to 3-5y
Restructured balance sheet
Gap Report 0-1y 150 200 -50 -50 -5% -5% 1-3y 150 200 -50 -100 -10% -15% 3-5y 300 400 -100 -200 -20% -20% 5y400 200 200 0 0% Tot.
1000 1000
Assets Liab. Gap Cum. Gap Cum. Gap as % of assets Limit
0 0 0%
Restructuring liabilities
0-1y 1-3y 3-5y 5yTot. Assets 100 150 200 550 1000 Liab. 200 200 400 200 1000 Gap -100 -50 -200 350 0 Cum. Gap -100 -150 -350 0 0 Cum. Gap as % of assets -10% -15% -35% 0% 0% Limit -5% -15% -20%
Move Rs.50 of liabilities from 0-1y to 5yMove Rs.100 of liabilities from 3-5y to 5y-
Restructured balance sheet
Gap Report 0-1y 1-3y 3-5y 5y- Tot. 100 150 200 550 1000 150 200 300 350 1000 -50 -50 -100 200 0 -50 -100 -200 0 0 -5% -10% -20% 0% 0% - 5% -15% - 20%
Assets Liab. Gap Cum. Gap Cum. Gap as % of assets Limit
Grow the balance sheet
0-1y 1-3y Assets 100 150 Liab. 200 200 Gap -100 -50 Cum. Gap -100 -150 Cum. Gap as % of - 10% - 15% assets - 5% -15% Limit 3-5y 200 400 -200 -350 5y- Tot. 550 1000 200 1000 350 0 0 0
- 35% - 20%
0%
0%
Add assets of Rs.50 in 0-1y and add assets of Rs.100 in 3-5y. Fund them with Rs.150 liabilities in 5y-
Restructured balance sheet
Gap Report 0-1y 1-3y 3-5y 5y- Tot. 150 150 300 550 1150 200 200 400 350 1150 -50 -50 -100 200 0 -50 -100 -200 0 0 -4% -9% -17% 0% 0% - 5% -15% -20%
Assets Liab. Gap Cum. Gap Cum. Gap as % of assets Limit
Shrink the balance sheet
E x.3 G a p R e p o rt
0 -1 y 1 -3 y 3 -5 y 5 y T o t. A s s e ts 100 150 200 550 1000 L ia b . 200 200 400 200 1000 G ap -1 0 0 -5 0 -2 0 0 350 0 C u m . G a p -1 0 0 -1 5 0 -3 5 0 0 0 G ap as % of -1 0 % - 1 5 % - 3 5 % a s s e ts 0% 0% - 5 % - 15% -2 0 % L im it
Sell assets of Rs.200 from 5y- and repay Rs.60 liabilities of 0-1y and repay Rs.140 liabilities of 3-5y
Restructured balance sheet
Gap Report 0-1y 1-3y 3-5y 5y- Tot. Assets 150 150 300 350 950 Liab. 140 200 260 350 950 Gap 10 -50 40 0 0 Cum. Gap 10 -40 0 0 0 Cum. Gap as % of assets 1% -4% 0% 0% 0% - 5% - 15% - 20% Limit
Interest Rate Risk
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Interest Rate Risk Rate Sensitive Assets (RSA) Rate Sensitive Liabilities (RSL) Time buckets Re-pricing Maturity Residual Maturity Re-pricing effect of cash flow Bucketing principle
? Re-pricing
Maturity or Residual Maturity whichever is
earlier
Liquidity indicators
? ? ?
Cash position indicator:
? Balances ? Govt.
with banks and RBI / Total Assets
Liquid securities indicator:
Sec./ Total Assets
C/D ratio ? Pledged securities ratio
? Pledged
securities / Total holdings
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Hot money ratio:
? Money
market assets / MM liabilities
Liquidity indicators
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Liquid assets to sensitive liabilities ratio:
? Liquid
Assets / (Volatile + Vulnerable Liab.) deposits / Total deposits
Core Deposits ratio:
? Insured
Liquidity indicators
Composition of liabilities
? Retail
deposits more than 80% of total assets + No geo/sectoral/customer concentration Low Risk ? Retail deposits less than 50% of total assets or High geo/sectoral/customer concentration High Risk
Liquidity indicators
Quality of liabilities
? Stable
+ Low cost Low Risk ? Non-availability of funds or funds available at very high cost High Risk
Liquidity profile
? Quantum
and frequency of -ve gaps are low + No adverse impact on stress tests +contingency plans Low Risk ? [Quantum and frequency of -ve gaps are high or Highly adverse impact on stress tests] + No contingency plans High Risk
Liquidity management strategy
Short term Medium term Long term Strategy Deficit Surplus Surplus # Sell MT & LT assets to pay off ST liabilities. # Increase MT/LT borrowings/deposits # Issue bonds, shares etc
Deficit Deficit Surplus # Sell LT assets to repay MT/ST borrowings #Issue bonds , shares etc to correct ST deficit #Deploy proceeds partly in MT assets
Liquidity management strategy
Short term Medium term Long term Strategy
Surplus Deficit Surplus # Sell LT/ST assets to pay off MT liabilities. # Increase LT borrowings or issue capital and invest proceeds in MT assets
Surplus
Surplus
Deficit
# Prepay long term borrowings # Use ST/MT assets to increase LT borrowings
Liquidity management strategy
Short term Medium term Long term Strategy
Deficit Deficit Deficit
Plead for bail out, if that does not work, file bankruptcy
Interest Rate Risk
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Interest Rate Risk Rate Sensitive Assets (RSA) Rate Sensitive Liabilities (RSL) Time bands Re-pricing Maturity Residual Maturity Re-pricing effect of cash flow Banding principle
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Re-pricing Maturity or Residual Maturity whichever is earlier
Impact of interest rate changes on NII
GAP POS CHANGE IN INTT RATE CHANGE IN CHANGE IN INTT INCOME INTT EXP CHANGE IN NII
ZERO ZERO
INCREASE
INCREASE INCREASE DECREASE
NEUTRAL NEUTRAL
DECREASE DECREASE
+ VE + VE
INCREASE INCREASE DECRESE DECREASE
INCREASE DECREASE
INCREASE DECREASE
- VE - VE
INCREASE
INCREASE
INCREASE DECREASE
DECREASE INCREASE
DECREASE DECREASE
Impact of interest rate changes on NII
ASSET
LIAB
GAP ZERO POS NEG ZERO POS NEG ZERO
INT RATE
INT RATE CHANGE
INTT INCOM
INTT EXP
NII
400 400 300 400 400
400 300 400 400 300
10 10 10 11 11
0 0 0 +1 +1
40 40 30 44 44
40 30 40 44 33
NIL 10 -10 NIL 11
300 400 400 300
400 400 300 400
POS NEG
11 9 9 9
+1 -1 -1 -1
33 36 36 27
44 36 27 36
-11 NIL 9 -9
RBI GUIDELINES
Gap Ladder
Above 5 y 1y–3y 3 m – 6m Insensitive 3y–5y 6m–1y
Upto 3 m
Interest Rate Risk
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Situations where actual impact may be different from predicted impact
? Basis
Risk ? Mismatches within bucket ? Timing of rate changes ? Liquidation of assets/liabilities with off-market coupons
Interest Rate Risk
Estimating impact on NII ?
Quick method (example)
?3
month gap: Rs.10,000 ? Rate change: 1% ? Average impact ? 10000 x 1/100 x 1/2 x 1/4 = Rs.12.5 ? Assumptions
All assets/liabilities are spread evenly in the bucket ? Rate change is instantaneous
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Interest Rate Risk
Estimating impact on NII
? Quick
method (example)
?Maximum
Impact ? 10000 x 1/100 x 1/4 = Rs.25 ?Assumptions
? All
assets/liabilities are at lower end of the bucket ? Rate change is instantaneous
Interest Rate Risk
Estimating impact on NII ?
Quick method (example)
? Minimum
Impact ? 10000 x 1/100 x 0 = Rs. 0 ? Assumptions
All assets/liabilities are at higher end of the bucket ? Rate change is instantaneous
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Interest Rate Risk
Estimating impact on NII
Please note down the gap statement
Gap Statement 0-3 m 100 40 60 Rs. Lakh 3m-6m 6m-1y 0 150 0 210 0 -60
Assets Liabilities Gap
Interest rate changes by 1%
Interest Rate Risk
Estimating impact on NII
Impact for the quarter
12 - 1.5 =10.5 months 1.5
1.5
0
3
6
12
60,00,000 x 1/100 x 1.5 / 12 =
7500
Interest Rate Risk
Estimating impact on NII
Impact for the year
12 - 1.5 =10.5 months
1.5
0
3
6
12
60,00,000 x 1/100 x 10.5 / 12 =
52500
Interest Rate Risk
Estimating impact on NII
Example 0-1m Assets 300 Liabilities 200 Gap 100 1-3m 300 500 -200 3-6m 200 700 -500 '000 6m-1y 1-2y 1000 2200 1200 1400 -200 800
Interest rate goes up by 1% Estimate impact for the first quarter Estimate impact for the year
3 - 0.5 = 2.5
3-2=1
0.5
2.0
0 0-1 1-3 Total
1
3
6
100000 x 1/100 x 2.5/12 = 208.33 -200000 x 1/100 x 2.5/12= -166.67 41.67
Interest Rate Risk
Estimating impact on NII
12 - 0.5 =11.5 months 12 - 2.0 =10.0 months
12 - 4.5 =7.5 months 3
0.5
2.0
4.5
9.0
0
1
3
6
12
Effect on NII 0-1 100000 x 1/100 x 11.5/12 = 1-3 -200000 x 1/100 x 10.0/12 = 3-6 -500000 x 1/100 x 7.5/12 = 6-12 -200000 x 1/100 x 3.0/12 = Total
958.33 -1666.67 -3125.00 -500.00 -4333.33
Interest Rate Risk
Estimating impact on NII
Quarter Rates ? Gain Rs.41.66
Year
Loss
Rs.4333.54
Loss Rates ?
Gain
Rs.41.66
Rs.4333.54
Duration
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Price of a bond (or for that matter any financial asset) Duration is the effective maturity The coupons you receive leads to realization of your investment. Payback period of bullet loan will be exactly its maturity. Payback period of a coupon paying bond will always be less than maturity. Modified duration
Duration Versus Maturity
1.) 1000 loan, principal + interest paid in 20 years. 2.) 1000 loan, 900 principal in 1 year, 100 principal in 20 years. 1000 + int |-------------------|-----------------| 0 10 20
900+int 100 + int |--|-----------------|-----------------| 0 1 10 20
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What is the maturity of each? ? 20 years What is the "effective" maturity?
2.) = [(900/100) x 1]+[(100/1000) x 20] = 2.9 yrs
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Duration, however, uses a weighted average of the present values
Courtesy : Bank Management, 4th Ed., Koch & McDonald
Duration
Sum of the products of time & discounted cash inflows Duration (in half years)= Price of the bond (PV of cash inflows) Mod. Duration (in half years)=
Duration (in half years) [1 + (annual yield)/2]
Mod. Duration (in years)=
Duration (in years)
[1 + annual yield]
Duration
7% bond, maturity 5 years
Years
1
Duration 4.6 yr 2 3
4
5
Duration
7% bond, maturity 4 years
Years
1
Duration 4.6 years 2 3
4
5
Duration
20% bond, maturity 4 years
Years
Duration 3.5 yr 1 2
3
4
Duration
Zero coupon bond maturity 5 years
Years
1
2
3
4
5
Duration
Zero coupon bond maturity 5 years
Duration 5 years
Years
1
2
3
4
5
Duration ratio
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Duration Ratio = D (Assets) / D (Liabilities)
Duration Ratio
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Rs. 100 crore 1 year (duration) assets are funded by Rs.100 crore 3 month (duration) liabilities Duration ratio = 1/0.25 = 4 >1
0-3 months Assets Liab. Gap 0 100 -100 4-6 7 - 12 month month s s 0 0 0 100 0 100
NII & MVE
NII is Net Interest Income, MVE Market Value of Equity ? You can (explicitly) protect the NII by managing the gap between RSA and RSL ? Alternatively, you can (explicitly) protect MVE by using Duration Gap ? You cannot explicitly protect both at the same time
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NII & MVE
Protecting NII indirectly protects the balance sheet, since NII is the net of income from assets and cost of liabilities ? Protecting the MV of balance sheet indirectly protects the NII since value of an asset/liability is the PV of its earnings/cost ? RBI Guidelines aim at protecting NII
?
Duration Gap
DGAP = DA – (MVL / MVA) DL ? If DGAP is +ve ?Asset are more IR sensitive than liabilities ?If IR rises, asset values suffer more than liability values, hence MVE declines ?If IR falls, MVE rises by the same logic
?
Duration Gap
DGAP = DA – (MVL / MVA) DL ? If DGAP is -ve ?Liabilities are more IR sensitive than assets ?If IR rises, liability values fall more than asset values, hence MVE rises ?If IR falls, MVE falls by the same logic
?
Impact on MVE
? ?MVE
= DGAP*MVA*?y /(1+y)
= [DA–(MVL / MVA) DL]*MVA*?y/(1+y)
= (DA*MVA – DL*MVL)/MVA* MVA*?y /(1+y) =[(DA*MVA – DL*MVL) / (1+y)]*?y = If we divide the above expression with MVE =Modified Duration (Equity)*?y
Impact on MVE
EXAMPLE: Balance Sheet Duration Assets Rs (yrs) Cash 100 Business loans 400 Mortgage loans 500 1,000 Duration (yrs) Liabilities 0 1.25 7.0 4.0 Rs. Duration 1.0 5.0 2.33
Dep, 1 year 600 Dep, 5 year 300 Total liabilities 900 Equity 100 1,000
DGAP = 4.0 - (.9)(2.33) = 1.90 years Suppose interest rates increase from 11% to 12%. Now, ?E = (-1.90)*(0.01/1.11)*1000= - 17.27
Impact on MVE
? ? ? ? ?
?
? ? ? ? ?
M.Dur Business Loans = 1.25 /1.1 = 1.14 M.Dur Mortgage Loans = 7/1.1 = 6.36 Decrease in Business Loans = 1.14*1%*400= 4.56 Decrease in Mortgage Loans =6.36*1%*500= 31.80 Total change in assets = -36.36 M.Dur 1Y Dep = 1/1.1 = 0.91 M.Dur 5Y Dep = 5/1.1 = 4.54 Decrease in 1 y Dep=0.91*1%*600 = 5.46 Decrease in 3 y Dep=4.54*1%*300 = 13.62 Total Change in Liabilities = -19.08 Change in Equity = -36.36 – (-19.08) = - 17.28
Impact on MVE
M Dur of Equity = (MVA*DA – MVL*DL)/ [(1+y)*MVE] = [100*4 – 900*2.33] / [100*(1+0.10)] = (4000 – 2097)/(100*1.1) = 1903 / (100*1.1) = 17.30 That is for every 1% point change in the yield, equity changes by 17.3*1%=17.3% So if yield goes up from 11% to 12%, the decline in equity = 17.3%*100 = 17.30
?
Balance sheet duration - Leverage Hedging
Immunizing the balance sheet ? Leverage = Equity /Assets ? A change in interest rate should not affect leverage ? For achieving this, set duration of equity = duration of assets ? Buy receive-fixed or pay-fixed swap of required duration ? Duration of a swap
?
Thanks…
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doc_289975537.pptx
This is a PPT about the Asset liabilty management.
ASSET-LIABILITY MANAGEMENT
CONTENT
? ?
? ? ?
?
?
? ?
Overview of bank balance sheet The nature of banking business; the source of asset liability mismatch How Assets and Liabilities impact NII an equity The scope of ALM : Market risk The meaning of liquidity & liquidity risk Working Funds Approach
? ? ?
?
? ?
Maturity ladder approach Stress testing Bank leverage; importance of CRR/SLR and prudential norms Interest Rate Risk NII and MVE perspective NII management: IR gaps approach Stress testing MVE approach: duration gap approach Estimating MVE impact without from IR gap statement
Overview of bank balance sheet
LIABILITIES ? Capital ? Reserves
?
? Statutory
?
Reserves
Sec.17 of the BR Act, 1949 requires a bank to transfer 20% of net profits to statutory reserve
? Capital
?
Reserves ? Share Premium
Revaluation reserves
? Revenue
reserves
Overview of bank balance sheet
?
Deposits
? Demand
? ?
deposits
Current Savings Term Recurring
? Time
? ?
? „Inter-bank?
and „Others? (CDs)
?
Borrowings
? RBI,
NABARD, SIDBI ? Borrowings do not include bonds
Overview of bank balance sheet
?
Other liabilities and provisions
? Bonds ? Bills
payable ? Interest accrued ? Inter-office adjustments (net) ? Provisions for impaired assets ? Other provisions
?
Contingent Liabilities
? Disputed
claims ? Outstanding guarantees, letters of credit ? Derivative positions that can devolve on the banks
Overview of bank balance sheet
?
ASSETS
?
?
Cash Balances with RBI
? ? ?
Balances with banks Money at call at short notice Investments
? ? ?
?
? ? ?
Government Securities and other approved securities Shares Bonds (other than above) Units of MFs Deposit with RIDF CPs Net of provision for depreciation
Overview of bank balance sheet
?
Advances
? Bills
purchased/discounted ? Demand loans ? Term loans ? „Secured? and „Unsecured?
?
?
Fixed Assets Other Assets
? Inter-office
adjustments (net) ? Interest accrued ? Non-banks asset acquired in satisfaction of claims
Profit and Loss A/c items
?
Interest income
? Advances ? Investments
?
Non-interest income
? Commission,
fees, brokerage etc. ? Treasury (trading) profits/losses ? Profit/loss on revaluation of investment ? Dividends
Profit and Loss A/c items
? ?
Interest expenditure Operating expenses
? Employee ? Rents,
costs
lighting, taxes, printing, stationary, advertisement, depreciation on property
?
Provisions against impaired loans and unpaid expenses Net Interest Income
?
Profit and Loss A/c
? ? ?
Net Interest Income Net Income Operating profit
?
? ?
Net profit
Net Interest Margin Interest Spread
The Nature of Banking How money is created
Bank Money
?
Banks create money by writing an accounting voucher
? Debit….
Loan A/c ? Credit… Customer?s Deposit A/c
Banks do not need you to deposit cash to give a loan ? It needs cash deposit only meet the probabilistic event of cash being withdrawn
?
Bank Money
?
?
? ? ?
If acceptance of (cash) deposits is seen as similar to buying cash; and making loans as selling cash, then banks are in the business of short-selling cash The difference between short selling stock and cash is that settlement is never demanded by bank?s customers except when there is breach in confidence Greater the credit creation higher the cash-short position (leverage) Credit creation makes financial system fragile CRR and SLR act as „margin money? with a centralized clearing house and limits the capacity of banks to roll over the same cash for making loans
Bank Money
? ? ? ? ? ?
Bank credit is repayable Bank credit is “money + anti-money” For sustaining „demand? over a period of time fresh credit > repayment Leading to inexorably increasing debt to GDP ratio Excessive credit can be inflationary, and often results in asset inflation Central banks have a strong motivation to to limit bank credit beyond what?s considered safe
How A-L impact NII and MVE
Net Interest Income (NII)
Change in interest rates may cause some assets and some liabilities to re-price ? The impact may be different on interest income and interest expenditure ? Basis Risk ? Hence impact on NII
?
Economic value of the balance sheet
?
Economic value (c.f. market value) of any asset is the MV of Assets sum total of the present values of all its incomes MV of Liabilities
Interest rate sets the discounting rate This also applies to Liabilities Hence there exists a relationship between MV of equity
Time ---------------------->
Equity
?
?
?
The Scope of ALM
Market Risk
Banking Book, Trading Book
Banking book relates to assets and liabilities not meant for trading, funding trading positions and derivatives for trading ? Derivatives positions meant to protect banking book items, relates to banking book ? ALM deals with the banking book
?
Scope of ALM
?
Market Risks (in the banking book)
? Liquidity
Risk ? Interest Rate Risk ? Exchange Risk
? ?
Liquidity risks arises due to mismatch in maturity of assets and liabilities Interest Rate Risk arises from a mismatch in repricing schedules of assets and liabilities
Maturity mismatch
?
Banks earn spread because of
? ?
Interest rate
9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% 0 1 2 3 Years 4 5 6
Risk transformation Maturity transformation
?
? ?
Rate of interest directly related to term Borrowing short Lending long
?
Both are sources of risk
Borrow Lend
Why ALM?
?
Maturity transformation
? Pricing
Mismatch ? Interest Rate Risk
Mismatch ? Liquidity Risk
? Liquidity
? ? ?
Interest Rate Risk ? Affect profitability Liquidity Risk ? May lead to liquidation General Strategy
? Eliminate ? Manage
?
Liquidity Risk
Interest Rate Risk
Conscious position taking
Liquidity
Three aspects of liquidity ? Realisability of assets
?
? Liquidity
= Realizable value of asset Full value of the asset
?
Ability to meet claims
? Expected
cash outflow Expected cash inflow
?
Ability to make high quality loans
ALM - the two approaches
? ?
Fundamental Approach
? Long
Term Liquidity
Cash flow Approach
? Helps
focus on short term liquidity, without losing view of liquidity
Fundamental Approach
?
Eliminate long-term liquidity risk
? Adjusting
maturities of long term assets/ liabilities ? Asset Management ? Liability Management
?
Asset Management (Application of Funds)
? Maintain
cash or near-cash balances to meet
liabilities
?
Liability Management
? Borrow
from the market to fund asset creation opportunities
Fundamental Approach
?
Asset Management (Deployment of Funds)
? Liabilities
are not volatile ? Liabilities are inflexible ? Flexible Assets ? Small banks
?
Liability Management (Sources of Funds)
? Borrow
when you need ? Asset are long term ? Inflexible Assets ? Flexible liabilities ? Large banks
Fundamental Approach
Example: Balance sheet of public sector bank
Liabilities Rs.cr. Assets
Capital 294.34 Res.&Sur 4092.63 Deposits 66366.37 Borr. 625.33 Oth.Lib& Prov. 5039.17 ______ 76417.84 Rs.cr. Cash/RBI 3465.82 Call Mon. 3351,28 Advances 35348.08 Invstmt. 30179.38 Fix.Assets 697.32 Other Ast.3375.96 ______ 76417.84
Fundamental Approach
Example: ICICI Ltd. as at 31.3.96
Liabilities Rs.mi. Capital 11132.67 Res.&Sur. 41921.76 Re.loans 272534.88 FC Loans 101950.63 Cur. Lib & Provisions 31661.57 ______ Assets Rs.mi. Loans to industrial Concerns 287217.59 Investments (LT) 73300.01 Current Assets* 64509.10 Fixed Assets 31119.30 Misc. Expenses 3055.51 ______
459201.51 459201.51 *Of which cash & bank balances and securities held as stock in trade amount to Rs.29131 mi. t
Fundamental Approach
Example: ICICI Bank Ltd. as at 31.3.03
Liabilities Rs.mi. Capital 9626.60 Res.&Sur. 63206.54 Assets Rs.mi. LT Loans/Adv 489028.17 ST Loans/Adv 43765.97 Deposits@ 481693.06 Investments* 354623.00 Re.loans 284107.42 Cash+ST Assets# 64890.03 FC Loans 58916.78 Fixed Assets 40607.27 Cur. Lib & Other$ 75205.22
Provisions 170569.26
______
1068119.66 @ Includes Rs. 406866.54 mi term deposits.
______
1068119.66
*Of which Rs. 255485.75 mi. are G-secs. #Of which Rs. 45496.74 mi with RBI. $ $ Includes Rs.35866.83 mi illiquid assets.
Fundamental Approach
Example: ICICI Ltd. as at 31.3.96
Liabilities Rs.mi. Capital 11132.67 Res.&Sur. 41921.76 Re.loans 272534.88 FC Loans 101950.63 Cur. Lib & Provisions 31661.57 ______ Assets Rs.mi. Loans to industrial Concerns 287217.59 Investments (LT) 73300.01 Current Assets* 64509.10 Fixed Assets 31119.30 Misc. Expenses 3055.51 ______
459201.51 459201.51 *Of which cash & bank balances and securities held as stock in trade amount to Rs.29131 mi. t
Working Funds Approach
Focused on ability to meet liabilities ? Volatile, Vulnerable and Stable liabilities ? Maintain enough liquid assets to cover liabilities ? Requires a policy on liquid assets
?
Example of WF approach
Liabilities Rs.crore Capital 400 Reserves 1200 Call money borr. 120 30 day deposits 800 Savings Deposits* 900 Fixed Deposits# 2200 Inter-branch a/c* 80 *50% stable ____ #Rs.300 crore maturing 5700
in 1 month, Rs.200 may be withdrawn anytime
Assets Rs. crore Cash 80 Bank balance** 320 Investments (LT) 800 Loans & Adv. 2100 Securities (ST) 1900 Fixed Assets 500
**Inlcudes Rs.194 crore CRR deposit with RBI ____ 5700
The bank maintains liquidity as: 100 % of Volatile Assets, 65% (± 5%) of Vulnerable Assets & 10% of Stable Assets (± 5%)
Cash flow approach
? Cash
Flows Approach
?Cash
flows over the planning horizon ?Actual (Structural) cash flows ?Projected (Dynamic) cash flows
? Cash
flow forecasts ? Forecasting costs money
?A
bank having large branch network
? Decide
periodicity of forecasts
Liquidity Gap Method
? Cash
Flow Approach
?Structural
Cash Flow ?In addition, banks will have to manage dynamic cash flow 0-90 days ?Bucketing concept ?Residual vs. Original maturity
STRUCTURAL LIQUIDITY STATEMENT AS ON -- (AN ILLUSTRATION )
ASSETS /LIABILITIES
over nigh t
0-7 days
714 d
14 d 1– 1m 3m
36m
6m1y
13y
3-5y
>5 y
TOT
CASH BANK BALANCE INVESTMENTS ADVANCES OTHERS TOT INFLOW (A) OWN FUNDS DEPOSITS BOROWINGS
OTHERS
TOT OUTFLOW (B) MISMATCH (A-B) =C CUMULATIVE (D) % OF C TO B
Gaps Approach
0d-14d 14d-28d 28d- 3m 3m-6m Cash Inflow Cash Outflow Gap Gap % Cumulative Gap Cum Gap %
? ? ?
6m-1y 295 322 -27 -108
1y - 3y 375 445 -70 -178
3y - 5y Above 5y 430 480 -50 -228 525 560 -35 -6.67% -263 -50.10%
195 180 15 15 7.69%
210 240 -30 -15
230 261 -31 -46
250 285 -35 -81
7.69% -14.29% -13.48% -14.00%
-9.15% -18.67% -11.63%
-7.14% -20.00% -32.40% -36.61% -47.47% -53.02%
Borrowings can open negative gaps in future buckets Forward Payment Structure indicates a gathering liquidity crisis Long term strategic approach needed to correct an increasingly negative FPS
Gaps Approach
700 600 500 400 300 200 100 0 -100 -200 -300 -400
Gap Position
Outflows Inflows
Gap Values
0d-1
4d
28d-
3m
6m- 1 y
3y -
5y
FPS Time slots
Setting the gaps right
Restructure Assets ? Restructure Liabilities ? Grow the balance sheet ? Shrink the balance sheet ? Off-balance sheet hedge
?
Restructuring assets
Ex.3 Gap Report
Please note down this balance sheet
0-1y 1-3y 3-5y 5yTot. Assets 100 150 200 550 1000 Liab. 200 200 400 200 1000 Gap -100 -50 -200 350 0 Cum. Gap -100 -150 -350 0 0 Cum. Gap as % of assets -10% -15% -35% 0% 0% Limit -5% - 15% - 20%
Move Rs.50 of assets from 5y- to 0-1y Move Rs.100 of assets from 5y- to 3-5y
Restructured balance sheet
Gap Report 0-1y 150 200 -50 -50 -5% -5% 1-3y 150 200 -50 -100 -10% -15% 3-5y 300 400 -100 -200 -20% -20% 5y400 200 200 0 0% Tot.
1000 1000
Assets Liab. Gap Cum. Gap Cum. Gap as % of assets Limit
0 0 0%
Restructuring liabilities
0-1y 1-3y 3-5y 5yTot. Assets 100 150 200 550 1000 Liab. 200 200 400 200 1000 Gap -100 -50 -200 350 0 Cum. Gap -100 -150 -350 0 0 Cum. Gap as % of assets -10% -15% -35% 0% 0% Limit -5% -15% -20%
Move Rs.50 of liabilities from 0-1y to 5yMove Rs.100 of liabilities from 3-5y to 5y-
Restructured balance sheet
Gap Report 0-1y 1-3y 3-5y 5y- Tot. 100 150 200 550 1000 150 200 300 350 1000 -50 -50 -100 200 0 -50 -100 -200 0 0 -5% -10% -20% 0% 0% - 5% -15% - 20%
Assets Liab. Gap Cum. Gap Cum. Gap as % of assets Limit
Grow the balance sheet
0-1y 1-3y Assets 100 150 Liab. 200 200 Gap -100 -50 Cum. Gap -100 -150 Cum. Gap as % of - 10% - 15% assets - 5% -15% Limit 3-5y 200 400 -200 -350 5y- Tot. 550 1000 200 1000 350 0 0 0
- 35% - 20%
0%
0%
Add assets of Rs.50 in 0-1y and add assets of Rs.100 in 3-5y. Fund them with Rs.150 liabilities in 5y-
Restructured balance sheet
Gap Report 0-1y 1-3y 3-5y 5y- Tot. 150 150 300 550 1150 200 200 400 350 1150 -50 -50 -100 200 0 -50 -100 -200 0 0 -4% -9% -17% 0% 0% - 5% -15% -20%
Assets Liab. Gap Cum. Gap Cum. Gap as % of assets Limit
Shrink the balance sheet
E x.3 G a p R e p o rt
0 -1 y 1 -3 y 3 -5 y 5 y T o t. A s s e ts 100 150 200 550 1000 L ia b . 200 200 400 200 1000 G ap -1 0 0 -5 0 -2 0 0 350 0 C u m . G a p -1 0 0 -1 5 0 -3 5 0 0 0 G ap as % of -1 0 % - 1 5 % - 3 5 % a s s e ts 0% 0% - 5 % - 15% -2 0 % L im it
Sell assets of Rs.200 from 5y- and repay Rs.60 liabilities of 0-1y and repay Rs.140 liabilities of 3-5y
Restructured balance sheet
Gap Report 0-1y 1-3y 3-5y 5y- Tot. Assets 150 150 300 350 950 Liab. 140 200 260 350 950 Gap 10 -50 40 0 0 Cum. Gap 10 -40 0 0 0 Cum. Gap as % of assets 1% -4% 0% 0% 0% - 5% - 15% - 20% Limit
Interest Rate Risk
? ? ? ? ? ? ? ?
Interest Rate Risk Rate Sensitive Assets (RSA) Rate Sensitive Liabilities (RSL) Time buckets Re-pricing Maturity Residual Maturity Re-pricing effect of cash flow Bucketing principle
? Re-pricing
Maturity or Residual Maturity whichever is
earlier
Liquidity indicators
? ? ?
Cash position indicator:
? Balances ? Govt.
with banks and RBI / Total Assets
Liquid securities indicator:
Sec./ Total Assets
C/D ratio ? Pledged securities ratio
? Pledged
securities / Total holdings
?
Hot money ratio:
? Money
market assets / MM liabilities
Liquidity indicators
? ?
Liquid assets to sensitive liabilities ratio:
? Liquid
Assets / (Volatile + Vulnerable Liab.) deposits / Total deposits
Core Deposits ratio:
? Insured
Liquidity indicators
Composition of liabilities
? Retail
deposits more than 80% of total assets + No geo/sectoral/customer concentration Low Risk ? Retail deposits less than 50% of total assets or High geo/sectoral/customer concentration High Risk
Liquidity indicators
Quality of liabilities
? Stable
+ Low cost Low Risk ? Non-availability of funds or funds available at very high cost High Risk
Liquidity profile
? Quantum
and frequency of -ve gaps are low + No adverse impact on stress tests +contingency plans Low Risk ? [Quantum and frequency of -ve gaps are high or Highly adverse impact on stress tests] + No contingency plans High Risk
Liquidity management strategy
Short term Medium term Long term Strategy Deficit Surplus Surplus # Sell MT & LT assets to pay off ST liabilities. # Increase MT/LT borrowings/deposits # Issue bonds, shares etc
Deficit Deficit Surplus # Sell LT assets to repay MT/ST borrowings #Issue bonds , shares etc to correct ST deficit #Deploy proceeds partly in MT assets
Liquidity management strategy
Short term Medium term Long term Strategy
Surplus Deficit Surplus # Sell LT/ST assets to pay off MT liabilities. # Increase LT borrowings or issue capital and invest proceeds in MT assets
Surplus
Surplus
Deficit
# Prepay long term borrowings # Use ST/MT assets to increase LT borrowings
Liquidity management strategy
Short term Medium term Long term Strategy
Deficit Deficit Deficit
Plead for bail out, if that does not work, file bankruptcy
Interest Rate Risk
?
? ? ? ? ? ? ?
Interest Rate Risk Rate Sensitive Assets (RSA) Rate Sensitive Liabilities (RSL) Time bands Re-pricing Maturity Residual Maturity Re-pricing effect of cash flow Banding principle
?
Re-pricing Maturity or Residual Maturity whichever is earlier
Impact of interest rate changes on NII
GAP POS CHANGE IN INTT RATE CHANGE IN CHANGE IN INTT INCOME INTT EXP CHANGE IN NII
ZERO ZERO
INCREASE
INCREASE INCREASE DECREASE
NEUTRAL NEUTRAL
DECREASE DECREASE
+ VE + VE
INCREASE INCREASE DECRESE DECREASE
INCREASE DECREASE
INCREASE DECREASE
- VE - VE
INCREASE
INCREASE
INCREASE DECREASE
DECREASE INCREASE
DECREASE DECREASE
Impact of interest rate changes on NII
ASSET
LIAB
GAP ZERO POS NEG ZERO POS NEG ZERO
INT RATE
INT RATE CHANGE
INTT INCOM
INTT EXP
NII
400 400 300 400 400
400 300 400 400 300
10 10 10 11 11
0 0 0 +1 +1
40 40 30 44 44
40 30 40 44 33
NIL 10 -10 NIL 11
300 400 400 300
400 400 300 400
POS NEG
11 9 9 9
+1 -1 -1 -1
33 36 36 27
44 36 27 36
-11 NIL 9 -9
RBI GUIDELINES
Gap Ladder
Above 5 y 1y–3y 3 m – 6m Insensitive 3y–5y 6m–1y
Upto 3 m
Interest Rate Risk
?
Situations where actual impact may be different from predicted impact
? Basis
Risk ? Mismatches within bucket ? Timing of rate changes ? Liquidation of assets/liabilities with off-market coupons
Interest Rate Risk
Estimating impact on NII ?
Quick method (example)
?3
month gap: Rs.10,000 ? Rate change: 1% ? Average impact ? 10000 x 1/100 x 1/2 x 1/4 = Rs.12.5 ? Assumptions
All assets/liabilities are spread evenly in the bucket ? Rate change is instantaneous
?
Interest Rate Risk
Estimating impact on NII
? Quick
method (example)
?Maximum
Impact ? 10000 x 1/100 x 1/4 = Rs.25 ?Assumptions
? All
assets/liabilities are at lower end of the bucket ? Rate change is instantaneous
Interest Rate Risk
Estimating impact on NII ?
Quick method (example)
? Minimum
Impact ? 10000 x 1/100 x 0 = Rs. 0 ? Assumptions
All assets/liabilities are at higher end of the bucket ? Rate change is instantaneous
?
Interest Rate Risk
Estimating impact on NII
Please note down the gap statement
Gap Statement 0-3 m 100 40 60 Rs. Lakh 3m-6m 6m-1y 0 150 0 210 0 -60
Assets Liabilities Gap
Interest rate changes by 1%
Interest Rate Risk
Estimating impact on NII
Impact for the quarter
12 - 1.5 =10.5 months 1.5
1.5
0
3
6
12
60,00,000 x 1/100 x 1.5 / 12 =
7500
Interest Rate Risk
Estimating impact on NII
Impact for the year
12 - 1.5 =10.5 months
1.5
0
3
6
12
60,00,000 x 1/100 x 10.5 / 12 =
52500
Interest Rate Risk
Estimating impact on NII
Example 0-1m Assets 300 Liabilities 200 Gap 100 1-3m 300 500 -200 3-6m 200 700 -500 '000 6m-1y 1-2y 1000 2200 1200 1400 -200 800
Interest rate goes up by 1% Estimate impact for the first quarter Estimate impact for the year
3 - 0.5 = 2.5
3-2=1
0.5
2.0
0 0-1 1-3 Total
1
3
6
100000 x 1/100 x 2.5/12 = 208.33 -200000 x 1/100 x 2.5/12= -166.67 41.67
Interest Rate Risk
Estimating impact on NII
12 - 0.5 =11.5 months 12 - 2.0 =10.0 months
12 - 4.5 =7.5 months 3
0.5
2.0
4.5
9.0
0
1
3
6
12
Effect on NII 0-1 100000 x 1/100 x 11.5/12 = 1-3 -200000 x 1/100 x 10.0/12 = 3-6 -500000 x 1/100 x 7.5/12 = 6-12 -200000 x 1/100 x 3.0/12 = Total
958.33 -1666.67 -3125.00 -500.00 -4333.33
Interest Rate Risk
Estimating impact on NII
Quarter Rates ? Gain Rs.41.66
Year
Loss
Rs.4333.54
Loss Rates ?
Gain
Rs.41.66
Rs.4333.54
Duration
? ? ?
?
? ?
Price of a bond (or for that matter any financial asset) Duration is the effective maturity The coupons you receive leads to realization of your investment. Payback period of bullet loan will be exactly its maturity. Payback period of a coupon paying bond will always be less than maturity. Modified duration
Duration Versus Maturity
1.) 1000 loan, principal + interest paid in 20 years. 2.) 1000 loan, 900 principal in 1 year, 100 principal in 20 years. 1000 + int |-------------------|-----------------| 0 10 20
900+int 100 + int |--|-----------------|-----------------| 0 1 10 20
? ?
What is the maturity of each? ? 20 years What is the "effective" maturity?
2.) = [(900/100) x 1]+[(100/1000) x 20] = 2.9 yrs
?
Duration, however, uses a weighted average of the present values
Courtesy : Bank Management, 4th Ed., Koch & McDonald
Duration
Sum of the products of time & discounted cash inflows Duration (in half years)= Price of the bond (PV of cash inflows) Mod. Duration (in half years)=
Duration (in half years) [1 + (annual yield)/2]
Mod. Duration (in years)=
Duration (in years)
[1 + annual yield]
Duration
7% bond, maturity 5 years
Years
1
Duration 4.6 yr 2 3
4
5
Duration
7% bond, maturity 4 years
Years
1
Duration 4.6 years 2 3
4
5
Duration
20% bond, maturity 4 years
Years
Duration 3.5 yr 1 2
3
4
Duration
Zero coupon bond maturity 5 years
Years
1
2
3
4
5
Duration
Zero coupon bond maturity 5 years
Duration 5 years
Years
1
2
3
4
5
Duration ratio
?
Duration Ratio = D (Assets) / D (Liabilities)
Duration Ratio
?
?
Rs. 100 crore 1 year (duration) assets are funded by Rs.100 crore 3 month (duration) liabilities Duration ratio = 1/0.25 = 4 >1
0-3 months Assets Liab. Gap 0 100 -100 4-6 7 - 12 month month s s 0 0 0 100 0 100
NII & MVE
NII is Net Interest Income, MVE Market Value of Equity ? You can (explicitly) protect the NII by managing the gap between RSA and RSL ? Alternatively, you can (explicitly) protect MVE by using Duration Gap ? You cannot explicitly protect both at the same time
?
NII & MVE
Protecting NII indirectly protects the balance sheet, since NII is the net of income from assets and cost of liabilities ? Protecting the MV of balance sheet indirectly protects the NII since value of an asset/liability is the PV of its earnings/cost ? RBI Guidelines aim at protecting NII
?
Duration Gap
DGAP = DA – (MVL / MVA) DL ? If DGAP is +ve ?Asset are more IR sensitive than liabilities ?If IR rises, asset values suffer more than liability values, hence MVE declines ?If IR falls, MVE rises by the same logic
?
Duration Gap
DGAP = DA – (MVL / MVA) DL ? If DGAP is -ve ?Liabilities are more IR sensitive than assets ?If IR rises, liability values fall more than asset values, hence MVE rises ?If IR falls, MVE falls by the same logic
?
Impact on MVE
? ?MVE
= DGAP*MVA*?y /(1+y)
= [DA–(MVL / MVA) DL]*MVA*?y/(1+y)
= (DA*MVA – DL*MVL)/MVA* MVA*?y /(1+y) =[(DA*MVA – DL*MVL) / (1+y)]*?y = If we divide the above expression with MVE =Modified Duration (Equity)*?y
Impact on MVE
EXAMPLE: Balance Sheet Duration Assets Rs (yrs) Cash 100 Business loans 400 Mortgage loans 500 1,000 Duration (yrs) Liabilities 0 1.25 7.0 4.0 Rs. Duration 1.0 5.0 2.33
Dep, 1 year 600 Dep, 5 year 300 Total liabilities 900 Equity 100 1,000
DGAP = 4.0 - (.9)(2.33) = 1.90 years Suppose interest rates increase from 11% to 12%. Now, ?E = (-1.90)*(0.01/1.11)*1000= - 17.27
Impact on MVE
? ? ? ? ?
?
? ? ? ? ?
M.Dur Business Loans = 1.25 /1.1 = 1.14 M.Dur Mortgage Loans = 7/1.1 = 6.36 Decrease in Business Loans = 1.14*1%*400= 4.56 Decrease in Mortgage Loans =6.36*1%*500= 31.80 Total change in assets = -36.36 M.Dur 1Y Dep = 1/1.1 = 0.91 M.Dur 5Y Dep = 5/1.1 = 4.54 Decrease in 1 y Dep=0.91*1%*600 = 5.46 Decrease in 3 y Dep=4.54*1%*300 = 13.62 Total Change in Liabilities = -19.08 Change in Equity = -36.36 – (-19.08) = - 17.28
Impact on MVE
M Dur of Equity = (MVA*DA – MVL*DL)/ [(1+y)*MVE] = [100*4 – 900*2.33] / [100*(1+0.10)] = (4000 – 2097)/(100*1.1) = 1903 / (100*1.1) = 17.30 That is for every 1% point change in the yield, equity changes by 17.3*1%=17.3% So if yield goes up from 11% to 12%, the decline in equity = 17.3%*100 = 17.30
?
Balance sheet duration - Leverage Hedging
Immunizing the balance sheet ? Leverage = Equity /Assets ? A change in interest rate should not affect leverage ? For achieving this, set duration of equity = duration of assets ? Buy receive-fixed or pay-fixed swap of required duration ? Duration of a swap
?
Thanks…
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doc_289975537.pptx