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					stract: In the interest rate control conditions, changes in interest rates steady
and easy to forecast, interest rate risk is not a major risk of commercial banks,
interest rate management is a subsidiary of Commercial Bank Management
function. The interest rate market, the interest rate further by the market,
follow the laws of the market operation, frequent and unpredictable changes in
interest rates. Interest rate risk will also rise to the bank's major risk, interest
rate risk affects not only the profitability of commercial banks and the assets,
liabilities, market value due to changes in interest rates, and affect liquidity, and
thus lead to liquidity. Therefore, the strengthening of interest rate risk
monitoring has become a commercial bank asset-liability management

anks are a vital part of the global economy, and the essence of banking is asset-
liability management (ALM).

Using the capital market approach and the equity price data of 14 listed Chinese
banks, this empirical study finds that there is a positive relationship between
bank size and foreign exchange exposure. This relationship may reflect the
larger foreign exchange operations and trading positions of larger Chinese
banks and their significant indirect foreign exchange exposure arising from
impacts of the renminbi exchange rate movements on their customers. Empirical
evidence also suggests that the average foreign exchange exposures of state-
owned and joint-stock commercial banks in China are higher than those of
banks in Hong Kong, notwithstanding their limited participation in
international banking businesses compared with their Hong Kong counterparts.
It is also found that negative foreign exchange exposure is prevalent for larger
Chinese banks, suggesting that an appreciation of the renminbi tends to reduce
their equity value. It is therefore likely that the banking sector’s performance
will be hampered. Together with the fact that decreases in equity values
generally imply a higher default risk, the effects of different scenarios of
renminbi appreciation on the default risk of Chinese banks should therefore be
closely monitored.
                                       1. Introduction:

           Polonius, the character of Shakespeare, advised to his son that never be a
lender or an borrower, for loan often loses both itself and friend as well.

           In its everyday business, a bank has to depend upon borrowing and lending. I
the modern business word banking played a most important role. A well organized
banking system has become a necessity for industry as well as commercial progress: for
in these days industry and commerce are mostly built on credit and banks are the
dispensers of credit.

            Banks also provides facilities to its clients for the safe custody of their
valuables collect premium from the public for insurance companies and realizes
dividends and interest from other sources as well. It often acts as a correspondent and an
agent for other banks.

             The main objective of this report is to examine how banks response to interest
rate risks. Moreover, it also discusses how changing market interest rates also change the
market value of assets and liabilities.

              In the modern banking and financial institutions, Asset-Liability
management developed as one of the most significant and useful analytical tool. The
values of assets and liabilities affect the asset-liability risk. Each of them tends to be
greater than the capital. One of the greatest challenges of the asset-liability management
is interest rate risk. Because changing in interest rates affect the balance sheet as well as
the statement of income and expense of bank. The management of asset-liability is the
most important responsibility of the committee because it involves risk for depositors,
who invest their money in banks, as well as for the bank itself.

                  The ALM techniques are now used by many financial institutions as
well as non-financial institutions to address interest rate risk, foreign exchange risk and
liquidity risk. Gap analysis is used to match the difference between rate sensitive assets
and rate sensitive liabilities; commonly known as RSA and RSL.

               The key responsibilities of the ALCO are also highlighted by this report.
The aims and responsibilities of ALCO are:

      To manage interest rate risk and liquidity risk.
      To oversight market competition and position.
      Adopt proper and significant policies to avoid risk.
      The interest rate risk should be identified and measured on daily basis.
      To ensure adequate liquidity while managing the bank's spread between the
       interest income and interest expense.
      To consider investments and operational risks.
      ALCO meeting should be conducted quarterly to review the precious
       achievements and to make new strategies.
      Keep the board informed about the risk profile of the bank.
      Allocate cash and fund assets or manage liquidity.
      Maintain balance sheet to achieve balance between risk and reward.

                     The report, more specifically, highlights the affect of fluctuation of
interest rates in commercial banks of china. Commercial banks are also known as
business banks. They are financial intermediary type of bank. According to the reports,
by beating Germany China has become the world’s third largest economy in 2007.

                   After the Chinese civil war, China moved effectively to bring national
situation of finances under control and to freeze inflation. The banking system of China,
from its beginning, has exercise close control in the supply of money and over financial
transactions. China was among the pioneers in the use of money or paper representatives
of money value.
                   Although, chaina faces many problem during the crisi but in 1999 it
became the second largest economy after US. With 1.25 billion people and GDP of just
$3,800 per capita (PPP). According to a general estimate, the banks in China are already
operating the negative capital base. The operations of the commercial banks in china,
since 1994, have been marked by self-reliance. In China, the loan problems are still
prevailing. The banking sector of china is based on four state-owned commercial banks;
The Agricultural bank of China, The Bank of China, The China Construction Bank and
Commercial bank of China.

                   Bank of China is the largest of the three and has the longest history.
During the development of china this bank has different strategies of interest rate
hedging. It was the bank that takes part in the domestic and foreign commercial banks in
financial markets.

                                       2. Literature:

2.1 Banking:
           According to Meadows Taylor the laws of Manu disclose thoroughly the
science of banking was known 3,000 years ago. Then the fluctuations of money was
followed and understood by the bankers: they kept account books, day-books, and ledgers
by single and double entries. They charged simple and compound interest, as they made
insurances by sea and land: they granted bills of exchange. In short, the practices of
modern times which are little changed from that of ancient rules were followed by the

           In the present complex state of society banks has to perform manifold
functions. To create capital and to lend it, to borrow on a low rate of interest from those
who can spare and to give on a higher rate to those who need it, are its chief functions.
The difference between the rates of interest or the surplus of the interest thus saved is the
profit of the banks. This is the income that keeps the banks going
           Commercial banks are also known as business banks. They are financial
intermediary type of bank. Banks encourage thrift by inducing people to save something
from their income. The interest they offer to the depositors is a temptation. There are
people who want to save in order to provide their old age, marriage or education of their
children. There are others who save because they cannot earn all they earn. Due to the
fluctuation in the value of money they cannot save money in the shape of billions. More
so, they fine it difficult and unsafe to store the money with them. This opportunity is
given to them by the banks to deposit their savings, utilize these collections as capital in
lucrative and national concerns and instead for the service so rendered they pay interest.
The banks thus render much service to society

           Managing risk is the key business of banks. Of these, liquidity risk
management and interest rate risk management are extremely important for banks. These
risks are measured, monitor and manage by the assets-liability management.

2.2 Interest rate risk:

                In simple words, interest is a fee paid on borrowed asset or we can say that
it is a rent of money. These assets may include money, shares, and consumer good.
Interest is an amount charged by a lender for the money borrowed; whether fixed of
variable. Interest is paid to the depositor as a percentage on the money that is deposited.
And when money is borrowed this interest is paid to the lender as the percentage of the
amount owned. Fluctuations in interest rate give way to interest rate risk.

                Fluctuations in interest rate give way to interest rate risk. These changing in
interest rates, not only affects bank’s earning but also affects the value of bank’s assets
and liabilities. An effective risk management process that can examine and determine the
interest rate risk is essential to the safety of the bank.

2.3 NIM:

           Net interest margin measures the difference between the interest income of
bank and the amount of interest paid out to the lender, relative to the amount of interest
earning assets. It is a tool that examines the success of firm’s investment decision as
compared to its debt situations. The NIM is calculated in percentage, for example:

             If a bank has an interest expense of $2,000,000 with the return on investment
of $ 1,000,000 and average assets of $10,000,000, than its NIM would be -10%. It means
that the bank has lost more than money due to interest expenses than earned from

               NIM is different from the net interest swap in such a way that interest rate
spread in the average difference between the borrowing and the lending rates. The NIM
can be higher occasionally than the net interest spread. the more is the spread the higher
will be the profit of the financial institution; the lower the spread, the less profit will be
for the financial institute.

2.4 ALM:

           Assets-liability management is a risk management technique to provide a
comprehensive framework for managing, measuring and monitoring of interest rate,
foreign exchange, liquidity and commodity price of a bank. The ALM is also known as
Surplus management. It means that it is the management of structure of assets and
liability in such a way that it maximizes the net earning from interest of an institution.
ALM enables bank managements to take decisions in a more effective way, while
managing such risks that bank is exposed to

            The ALM process includes: ALM Information System; it manages the
accuracy and availability of information, ALM Organization; it take care of structure and
responsibilities of the system, and ALM Process, which include all the risk
identifications, parameters, measurement and management.

            Officials are actually involving in ALM when declares any decision of
dividends or change in interest rates on loans. These decisions not only affect liquidity
but also profitability. The dependence of ALM strategies is on the understanding of
officials and management, terms of loans and deposits, and credit unions capital

              Usually the position of ALM is analyses by the daily management. It not
only identifies the weaknesses and problems but also examine the ALM process that
could have a gloomy effect on the credit union’s financial position.

              Essentially, Banks used growth accounting for all their assets and liabilities.
The liabilities would take on deposits; annuities etc. and the investment through these
liabilities in assets would be loans, bonds or real estate.

             The values of assets and liabilities affect the asset-liability risk. Each of them
tends to be greater than the capital. Slight fluctuation in values of assets and liabilities
causes 50% reduction in capital. The focus of the managers of any financial institution is
on the asset-liability risk. The problem was not the increasing or decreasing of values of
assets or liabilities. But the main issue is the value of capital, which might be affected by
the fluctuation in the values of assets and liabilities. It has been seen that the capital of
most financial institutes is smaller than the firm’s assets and liabilities, it mean that the
small percentage changes in the assets or liabilities or any firm can be the cause of large
percentage change in their capital.

For example:

                The ALM techniques are now used by many financial institutions as well
as non-financial institutions to address interest rate risk, foreign exchange risk and
liquidity risk. To avoid the assets-liability risk, the financial institutions established
assets-liability committee, which comprised of senior manager of the company to address
the risk. And the technique of analyzing ALM risk is called Gap analysis.

2.5 Gap Analysis:

              The tool that of assets-liability management used to access the changes in
interest rate risk or liquidity risk is known as Gap analysis; which was adopted by the
financial institutions in nearly 1980’s. The gap analysis process is based upon the
determining, approving and documenting of the differences between the current
capabilities and the requirements of business. It the company is not using its hand on
capabilities in capital then it may be performing below its potential. This insight helps a
company to overcome its weaknesses and problems. For example: below in the diagram,
the lower line is where you will be if you do nothing for the improvement of your
business and the upper line is where you want to be

            More so, Gap analysis is used to match the difference between rate sensitive
assets and rate sensitive liabilities; commonly known as RSA and RSL. It is performed
on a spreadsheet. If both of them, RSA and RSL, are matched then the profit will be
maximized and the interest rate will be minimized. Although the implication of interest
rate risk and liquidity risk are different, but they are different in a little way. The loans or
investments with render which respond to the short-term changing in the interest rates are
RSA, where as the term that respond to short-term interests rates, in which money market
value or deposits certificates are included, are RSL.

             Gap analysis, when used to manage interest rate risk, it works as a unit with
duration analysis. It minimizes the exposure to parallel shifts in term structure of interest
rates. Although, gap analysis is not appreciated and applicable by many but it assesses the
exposure to a maximum of term structure movements.

                Negative or positive net cash flow give way to interest rate risk. Cash flow
matching is one of the most effective but an impractical way of eliminating interest rate
risk. For this purpose many bucketing schemes are used.

For example:

               Suppose a firm whose cash flow all mature in less then three years. Its
maturities in five predefined time interval (bucket) would be:

   0 - 3 months
   3 - 6 months
   6 - 12 months
   12 - 24 months
   24 - 36 months
Now if we gap analysis these buckets and supposing cash flow the result would be:

          Any net flow of a bucket is a gap, so in our hypothetical examination there is a
USD 100 MM gap for 3-6 month. It means that there is a negative gap of USD 30MM for
the 12-24 month bucket \

2.6 Assets-liability Committee:

                The integral part of banking system is ALM and it needs a systematic
process for the Management of Balance Sheet and more particularly Balance Sheet Risk
Management. More so, it also needs a structure that can take care of every possible risk
that a firm faces; interest rate risk, liquidity rate risk or any foreign exchange risk. The
committee that comprises of senior management of the bank that takes decisions related
to the balance sheet is generally known as the Asset Liability committee (ALCO)

                 The Asset-Liability Committee consists of the following people:
Permanent members are; Chairman, Managing Director, Financial Director, Risk
Manager, Treasury Manager, ALCO Officer, Divisional Managers. Where as Economists
and Risk Consultant is invited by the committee to take part in the ALCO meetings.

                 Whether at the Board or management level, the main function of the
senior management committee is to co-ordinate the institution’s borrowing and lending
strategy and to provide assistance to the firm on the profitability objective. The
management of asset-liability is the most important responsibility of the committee
because it involves risk for depositors, who invest their money in banks, as well as for the
bank itself.

                 ALCO meetings conducted at least quarterly to examine the bank’s
exposure to changing interest rates and also to review the level of management’s
compliance with bank’s policies; limits and ratios. It is the duty of the committee to
determine the most favorable asset-liability strategy, and set measurable targets to
achieve these strategies effectively. It also reviews the result of any target or decision that
was set up in previous ALCO meetings.

                           People’s Republic of China:

               China, also know as People’s Republic of china, is the most populous
country of the world. China is the world’s second largest by land area and the world’s
fourth largest by total area. China has become the world’s fastest growing major
economy, since the economic reform of 1978. Other than that, china is the world’s largest
exporter and the second largest importer throughout the world. Its poverty rate reduced
from 53% to 8 % in 2001

                 Apart from all these achievements, china is now facing many problems;
due to one-child policy aging population is increasing. The constitution of china gives
freedom to all the religions but religious practices are not appreciated. More so, china
always has the record of interfering with press freedom, and has been criticized by
NGO’s for its human right violations. With real power lying with Communist party,
china is one party state.

                  China has experienced a tremendous economies growth after 70’s. as a
result of economic liberalization policies the GDP increased significantly from the later
parts of 1978 to 2006. According to the reports, by beating Germany China has become
the world’s third largest economy in 2007. However, china has the great dependence on
export; it has to increase domestic consumption to diminish its economy’s dependence.
Moreover, the aim and objective of china should be to centralize political system with an
increasingly decentralized economic system.

                    Chinese economy, during 1990’s, continued grows rapidly at about
9.5% along with the low inflation. It is virtually important for china to become more
important and huge in the future. It is clearly a major contributor of world’s economy.
The financial crisis affected china with some pace. It has been said that almost 20 million
worker lost their jobs due to these financial crisis in China. However, china’s
commitment not to devalue had been major stabilizing factor for region. The main reason
that china affected was due to the huge drop in the growth of its exports and also the
decrease in the foreign investments. As shown is the figure, Chinese exports decline
drastically (

               Although, chaina faces many problem during the crisi but in 1999 it
became the second largest economy after US. With 1.25 billion people and GDP of just
$3,800 per capita (PPP)

           To deal with the danger and disaster of financial crisis china launched
Economic Stimulus Plan. This plan deals with the lower taxes; on real estate sales and
commodities, easing credit restrictions for mortgage, affordable housing and many
others. China started to recover by the end of the year 2009.

                                    Banking in china:

            The business dealing with money and transaction, that is banking, is not new in
China. China was among the pioneers in the use of money or paper representatives of
money value. Chinese industry was promoted, directly or indirectly, by the expansion of
modern banking system. The Buddhist monasteries, of the fifth century, were appeared to
be the first credit institution of China. It is believed that during that period merchants,
instead of using coins of gold or silver, carries with them a government-issued document
that was redeemable upon presentation at any of the provision
             After the Chinese civil war (1949-52), China moved effectively to bring
national situation of finances under control and to freeze inflation. As time passes, the
banking organizations were modified according to the changing situations and new

            At earlier, the banking system of china was controlled by the Ministry of
Finance which exercises firm control over all financial institutions; credit and the money
supply. It is during 1980’s that the banking activities of china rose up highly. The
banking system developed and diversified to meet the need of the new modern world.
State enterprises were required by the new budget procedures to abolish to the state only
tax on income and in the form of bank loan seek investment funds. The value of the bank
loans rose up to 260 percent where as the volume of deposits gain level during the period
of 1979 and 1985. By the end of the year 1987 china’s banking system included several
other banks. Some of them are; The People’s Bank of China, Bank of China, China
Investment Bank, China Industrial and Commercial bank, People’s Insurance Company
of China and many others

          The banking system of China, from its beginning, has exercise close control in
the supply of money and over financial transactions. All departments, whether
government or private; educational or social; political or public, were required to hold
bank deposits. Their all major business dealings were conducted through banks as they
are instructed to keep only enough cash to meet daily expenses. The need for money
minimize through this practice.

            During the last several years, the Republic of China has made sufficient
progress in the banking sector; improvement in credit management; bank supervision has
been improved; deregulation of the foreign currency over the current dealings has been
done successfully. Apart from all these improvements, china is still facing many

            One of the factors behind this transition is the conversion of four state owned
banks into commercial banks. Although, heavily regulated by the government, these
banks gradually becoming more commercial oriented. Further, there has been a rapid
growth in the number of non-banking financial institutes. The other factor is the
implication of the monetary policy that has been enhanced by the passage and
implementation of People’s Bank of China law. PBC, in 1998, abdicated the credit plan
applied to four state owned commercial banks.

             Furthermore, the changing of bank regulation from emphasis on economic
regulation which include credit plans and key financial ratios, to increasing emphasis on
the prudential regulation, is the another factor of the transition of China banking sector. A
set of provisional rules were set by the PBC to supervise the assets management and
quality of state-owned commercial banks. By adopting international classification
standards, it is also preparing to improve banks portfolio management. Several foreign
banks are also allowed by the government to engage in local currency and also relaxed
the foreign exchange control. However, actual operation level have not deluged by any
legal changes.

            According to a general estimate, the banks in China are already operating the
negative capital base. In terms of size and complex, the nonperforming assets problem is
very huge in Chinese banks. More so, it is closely related to the State owned enterprise.

             The operations of the commercial banks in china, since 1994, have been
marked by self-reliance; more freedom to make policy loans and a stronger legal frame.
But apart from all these achievements, Chinese banks still needs to become much more
commercial oriented to meet the goals and challenges of the world banking system.

                In China, the loan problems are still prevailing. It is because Chinese
banks still providing loans to unprofitable state-owned companies. To overcome this
problem, Chinese government established the China Cinda Asset Management CO.
             China’s asset management companies were established in 1999. The main
purpose of Chinese Government in building these companies is to manage the non-
performing assets of China’s financial institutions and other businesses.
               The banking sector of china is based on four state-owned commercial
banks; The Agricultural bank of China, The Bank of China, The China Construction
Bank and Commercial bank of China. China has quite a few number of banks in which
commercial banks are not much. But four state-owned banks have an extensive network
all around china. They are convenient for people who travel with in the country as they
can found branches of these banks any where in the country. . In china, foreign banks
have very limited banking system. There were only 191 foreign banking institutes in
2003. These foreign banks hold 1.2% of total bank assets. Although, their assets have
fallen down as they were restricted for commercial purposes only, they are still very
large. With total assets in the range of USD 2000 billion and over 700,000 employees,
these banks are among the largest banks of the world.

                                        Case Study

   Asset-Liability of Chinese banks and Analysis of Commercial Bank
                           Interest Rate Risk:

                The essence of banking is asset-liability management, as banks are the
vital part of global economy. China has four national banks and they are very common
banks as they have branches all around the country. These all four banks or state-owned
banks almost have the same services which cover asset management, loan and mortgage,
liability insurance, credit card, trust, lease, investment etc. personal and business services
both are provided by them.
                The China’s banking system has many problem is term of their asset
quality. In recent years the performance of china becomes worst in terms of capital
adequacy, loan-loss reserve relative asset and profitability. Particularly for the state-
owned banks, as they account more then 70% of the asset of the whole financial system.
In the past few years, Chinese asset-liability management also faces some

                 Bad loans are still the main problem for Chinese banks. They have the
largest share; nearly 59% on asset side. Whereas, rapid growth can also be seen in the
risky asset, they share 25% of total asset. More so, on the liability side, the share deposits
are growing 90% of the total liabilities. Apart from the bad loans the assets in the national
banks has fallen from 77% to 61%.
             Chinese four commercial banks; The Agricultural bank of China, The Bank
of China, The China Construction Bank and Commercial bank of China, in regard to
return on asset and bad loans, are the poorest among the banks of other countries. The
reason behind the poor performance of these banks is mainly due to the non-performing
assets, low interest rate assets and operational and management inefficiency.

             But as the time passes, china asset-liability management begins to grow. The
Chinese financial sector grows at a rate of 60% annually from past 3 years. In china none
is more tantalizing than asset management.

               Although Chinese GDP grew 8.9% in the third quarter of last year, the
officials and economists are cautious on the future of the economy. GDP growth of china
was peaked at 13% beginning the first quarter of 2007 but in 2008 during the third
quarter it fell down to 10%. More so, in the beginning of 2009 china’s GDP growth fell
more then the previous GDP; 6.1%. The officials set the target to grow by 8% for 1009.
The average growth of three quarters of 2009 reached to 7.6% but still 9% need to meet
the yearly target. The government officials have been firm about the need to maintain 8%
economic growth for the stability. If the liquidity started to loosen then there will be great
risk that economy will follow suit. From long term perspective, banks of china need to
maintain the imbalance between investment and consumption and also on the high saving

According to the chairman of China Merchant Group, Chinese banks have avoided the
massive recession and probably heading to another asset bybble and more financial
              Interest rate risk is influenced by many factors. This also goes with
Chinese banks. In china involvement of foreign banks plays an important role. A number
of forces must be taken before evaluating the current and future of interest rates. The
most important factor of the movement of interest rate is the US economy. When
economy is growing people can enjoy all the facilities like home and car loans, they have
good jobs and savings to lend through banks, and other finances through credit cards. But
as the economy goes down and the demand for funds increases, the interest rate rises up
and when the demand of funds go down interest rate also fell.

              In china commercial banks, the policy risk is much greater then the interest
rate risk. The impact of interest rate risk of commercial banks is of greater value.
However, the interest rate management of china concentrated in the State Department,
now People’s Bank of China is authorized. This results in adverse affect as the State
Department cut interest rates 8 times to reflect more adequately. Due to this the current
loan rate fell to the lowest point as the profitability ability of commercial banks has
dropped significantly.

             The one of the most influential factors in swapping interest rate is the
international forces. During the past few years many foreign investors have come to china
in terms of joint ventures or monitory stakes. They invest their money to supplement
domestic sources of funds which cause interest rate down. And when decide to reduce or
sell their holdings more funds required form the domestic sources which results in high
interest rate.

           The Bank of China joint hands with BlackRock, Inc. in 2009. Blackrock is a
provider of asset management, risk management and advisory services to individual and
institutional clients worldwide. BlackRock Solutions® offers risk management that
combines capital markets experienced advises with a full developed analytical system.
The mission of Bank of China in this joint venture is its ambition to participate in the
development of china financial industry and to built it more strong and biggest fund
management industry

            Because of the strict policy separation operation the business structure of
commercial banks of china are concentrated in loans, deposits, business interests and
non-interest income. More so, in interest rate adjustment, commercial banks suffered
direct losses. The other factors that involved in interest rate risk in Chinese banking
include the asset-liabilities of non equilibrium. The imbalance structure of assets-
liabilities is also subject to interest rate risk.

              In implementing government-directed fiscal policy, Bank of China had an
active role. But the regulatory influences were withdrawn as the economy stabilizing and
seemed to be sustaining. The increase and decrease of the interest rates have an effect on
the income and it will also have the impact on the business cycle. The role of the
management of Bank of China is to keep interest rates low in an attempt to aid the
economy on thee verge of failure, these low interests have many other and far-reaching
implications for the Chinese economy. The operations of BOC outside china accounted
for less than 4% of both activates; profit and assets. The bank accounted for 60% by
profit in china and by assets 76%, in the late 2005.

             Inflation is another factor which affects the movement of interest rate. In
china the inflation rate rose up to 2.7%. In the loan contract the rates paid on loans are
mostly fixed. But a lender who lends money for any period of time and in this period of
this the purchasing power of that money will be less when it is repaid the lender will
demand a higher rate. As well as in china the interest rates are higher because of inflation,
where as, deflation causes rates to decline.

              PBC is the decision making committee of Chinese banks. It means that PBC
has the responsibility to maintain the economic development of China. Moreover, to
ensure that the exchange rates at the reasonable level is also the duty of PBC. It also
controls two different benchmark interest rates, the benchmark lending rate and the
benchmark of central bank; the first of which is the one year PBC lending rate while the
other is the rediscount rate.

               Apart from the inflation, the other measures also affect the decision of PBC
in rising or decline of the interest rates. When the interest rates of Chinese banks rose up
in 1995, the inflation rate had already fallen from the peak. The interest rates cut many
times during 1997-1999 as inflation turned into deflation. But as the inflationary rate goes
up again in early 2002, the inflation rate rise up to 5% by PBC before the raise of interest
rate. The inflation rate had already turned down by that time. Interest rates were raised
twice in 2006 by PBC when the inflation rate was between 1.2%-1.3percent. As soon
inflation goes up the PBC raised rates. PBC cut rates continuously three times for four
month during the year 2008 when the inflation rate was 4%. This shows that PBC lower
interest rate when the economy was in danger
(China’s inflation rate as measured by the consumer price index and the change in the benchmark one-year lending rate).

              In Chinese banks there is a lack of competitive and efficient interest rate
management. The commercial banks of china have not yet established an interest rate risk
management. More so, the banking system of china lack in the decision making. In the
past few years, higher quality marketing loans become the main source of price
competition. For the operating procedures and pricing, commercial banks needs a
decision making body that can take decisions for control of interest rate risk.

                 China lacks in the interest risk measurement and assessments. The
evaluation system for the measurement of interest rate risk in commercial banks has not
been established; therefore, the identification of rate risk can not be measured or analyzed
correctly. The banks also lacks in; the effective interest rate risk hedging instrument,
interest rate risk reporting mechanism, the pricing of funds, the ineffective interest rate
risk compensation mechanism.

                 The key responsibility of the Board and directors of the bank is to make
sure that the management is working effectively and addressing the risk inherent in the
bank’s operations as in banking taking risk is fundamental. The various methods of
addressing these risks are various; pricing, capital and risk management system. It has
been noted that the interest rate go side by side with the loan or investment; the interest
rate should be higher only if the risk in a loan or investment is higher. Further more, the
risk management of banks have the responsibility to identify, monitor, and control risk.
The director, particularly, has the responsibility to provide a management, regarding risk,
to achieve these objectives.

                    The ALCO committee of the Bank of China maintains oversight of
interest rate risk and also takes favorable steps to formulated the policies and strategies
approved by the ALCO committee. The committee is consists of active board members
and senior management. The interest rate risk of Bank of China are mainly structure
based, such as the reprising risk; which includes the mismatching in the maturity period
of asset and liability periods, and the other risk is basic risk; it includes different pricing
basis for different businesses so on assets and cost of liabilities may change with different
amounts with the same reprising period. It has a system that helps to protect from any
dangerous or surprising event.

                    Using fixed income or interest rate swaps, interest rate risks can be
hedged. Buying of bonds with shorter duration can also reduced the interest rate risk as
they are the fixed income instruments. Asset and liabilities matching has a very confusing
role perhaps because of the very long term of sometimes negative duration measures of
net cash flow. Many banks and corporate organizations have lost millions because of
unregulated and poorly-controlled derivatives exercises. The proper derivatives use can
provide beneficial insurance against the worst and sudden interest rate movements and it
can also protect the bad effect that interest rate future can bring. In bank of china the
ALCO is responsible for establishing the policy derivatives and it also ensures the
achievement of optimal return and adequate levels of capital with proper risk control

                       If the interest income rises of any bank then it will push the interest
rates, as more assets than the liabilities will provide an increase in the interest rate. It
means that the bank has a positive gap but if a bank has a negative bank it will benefit
from falling of interest rates as rising in interest rate will cause damage it. The BOC
management has a goal to enable the bank to meet its goals and to fund its asset strategic
structure. Through asset-liability problem a bank can diminish its liquidity inherent in the
loan portfolio. It also has a negative impact on the bank’s capital. By using cash flow
analysis and by oversight of stability of deposits, the ALCO of the Bank of China
monitors the liquidity risks.

                      For asset and liability management interest rate swaps and interest
rate derivatives have become significant tools. Many banks and financial institutions use
these techniques to manage the interest rate risk of their lending portfolios. The
commercial banks of china have suffered mainly by the derivative transactions between
foreign dealers and Chinese corporations. These banks demands new terms when
conducting derivative transactions with foreign dealers.

                     In China, RMB interest rate swap was launched by the PBC on
experimental basis. The bank believes that RMB is a new stage for interest rate
liberalization and financial market construction and it also make reforms in interest rates
in stock exchange. Many market analysts consider it a good step for the financial industry
of china. Moreover, CNY derivatives also used to stabilize the interest rate risk.
Moreover, the Chinese banks want more security pledged for the repayment of a loan
from foreign banks as well as guarantee from the domestic banks on derivatives trades
that was conducted by foreign dealer. The demand of Chinese banks results derivatives
market in china ground to halt.

                       The export-import Bank of China raises funds for its credit card
business through RMB funds in domestic capital market. if the temporary liquidity
shortage occurs then the Bank can apply for re-loan from the PBC and also make short
term borrowings in inter bank markets.

                        In Chinese banks RMB mainly include the operation of bonds
business, inter-bank deposits and swaps. By making proper strategies banks make lots of
effort to increase profits as well as provide a flexible application to safe the liquidity of
treasury. The bank of china also makes flexible application of the services of RMB to
ensure the proper fund supply for business of credit card, avoid market risk and reduce
the facts that causes loss in interest rate. Through the bond funds, taken in good times, the
bank develop suitable and satisfying operations for its own fund demand and as well as
the investor’s requirement for appropriate treasury operations.

                      It is expected that in long-term RMB would be appreciated 4-5%
against the dollar, more than the NDF market pricing. Fast growing economy of china, as
can be seen through history, easily is appreciated by 30-70% in against all the mature
currencies due to rapid productivity increase. The long-term course of RMB creates
challenges for Chinese banks. By developing proper hedging procedures Chinese banks
managed their currency risk.

                       During the period of 2005 RMB was unpegged by dollar, which
allowed the currency to be appreciated. This also allows POBC to kept USD/CNY
unchanged for several years. Governor of central bank asserts that during this period of
time central bank will manage the exchange rate against a basket of currencies. More so,
it is also committed to reform long-term path of currency.

                      According to the analysts, Chinese banks are expected to rise with
huge margin in the coming year. They believe that it is due to the china’s reserve fiscal
policies that cause NIM to recover. They also noted that the potential interest rate hike
and rising margins help Chinese banks to recover their NIM. Moreover, the Chinese
banks also ensure that the coming year will be better then this year and the banks will be
more profitable.

                        As NIM is a measure of the difference between the interest
income and the amount of interest paid out to lender, it is similar to the gross margin of
any non-financial company. The NIM measured in percentage of earrings on loans in a
time period and other assets without the interest paid on borrowed funds. It is different
from the net interest spread in a way that NIM can be higher or lower than the net interest

                        In early 2009, the Chinese banks did the bidding of government.
They are compelled to extend credit to safe borrowers which include local government
investments and state-owned banks. During that time the lending rates on such loans were
very low. This factor influences the compression in NIM which was experienced by all
the banks in china. According to the analysts 2009 was the bad year for Chinese banks in
terms of low NIMs. They have estimated profit of 13% would rise in 2009, the slowest
pace, as compared to the previous years.

                    According to the Wu Yonggang, an analyst at Guotai Junan, during the
financial crisis, the banks of china have seen their net interest spreads narrow. It results
from the cut interest rates in 2008. China cut benchmark interest rates many times to
stabilize the economy during these financial crises. It is perhaps because of the drop of
mortgage lending rates and slipping bond yields in the market of inter-bank.

                   BOC latest research report pointed out that the current wave in the
banking of china reflects the growth in revenue and NIM turns better and scales also
grows. But it also predicted that the in 2010 Chinese banks will face the lack of powerful
growth momentum. The report points out that Chinese bank needs enough liquidity and
better forecast on the resumption of real economy.
                  Morgan Stanley, preeminent financial advisor to companies,
governments and investors from around the world, observes the positive NIM for Chinese
banks in coming days on loan mix, more deposits reprising than loans, higher market
rates. According to him, the capital requirements are focused on the quality of capital
instead of imminently. Morgan also suggested, following the NIM estimates hike, price
target for some of the banks of china which include:

                     He also asserts that there will be a combination of strong growth and
NIM support growth for Chinese banks in 2010. According to him, Chinese banks may
raise the equity by the end of the year or in the next year as pushed by CRBC. More so,
the stable asset quality should also supported 34% earnings growth of credit costs.
Morgan examines that the bank target price by the end of this year would be:

BOC (03988) HK$6.3
ICBC (01398) HK$8.1
CITIC (00998) HK$8.6

                    According to the government sources, Chinese banks are leading to
the higher NIM’s. Due to the uncertainties of the capital rising, the sector will range
bound in near future. It was also asserted that there will be the slower growth in loans and
NIMs will be higher than the opposite combination. It is estimated that 50bps hike
reduces NIM’s by 0.6bps and earnings by 0.4%.

                      The Credit Suisse Group , a financial services company, of Zurich,
Switzerland, survayed that the Citic Bank of China has an outperform rating with the
target price of HK$7.22. Whereas, the Bank of China believes that the lending would
remain reasonable level in 2010. It also predicted that the growth would be slower next
year as compared to this year. According to the president of the Bank of China, the Bank
will see the growth of loans in the coming year and the priority of the Bank is to make the
adjustment of lending structure. He also added that the economy will recover with
relatively huge figure. Bank of China rises 19% in the third quarter profit increased by
lending smash in the beginning of the year.
                   The main source of income for Chinese banks is NIM. After a hectic
year which faces decline of NIM Chinese banks began to improve and are expected to
rise by the end of this year and in coming year. Due to the Chinese banks strict monetary
policy, as analysts forecasted, the NIM is expected to increase up to 10 to 15 point to
2.5% by the end of this year. The banks include

Bank of China (3988.HK) (601988.SS)
Industrial and Commercial Bank of China (ICBC) (1398.HK) (601398.SS)
Bank of Communications (3328.HK) (601328.SS) and
China Construction Bank (0939.HK) (601939.SS)
                   As compared to the last year; 9.6 trillion Yuan, the new lending target
of this year is lower; 7.5 trillion Yuan, but still reasonable compared to the previous years

Standards & Poor, the financial rating agency, surveyed that in coming days bad loans
will be the problem for Chinese banks but as the banks are financially strong, they can
withstand the pressure on profits. The problem would be below 10% for the next one or
two years.



                              Qualitative Methodology:

                  The method of inquiry appropraited in many decsciplines like market
research or social sciences is known as Qukalitative Methodology. Qualitative
methodology can be use to gather information for general conclusion and also on
particular cases. It includes many diversified mthods, research designs and also many
procedures. Comparison and measurments are the main aime of qualitative methodology.
it is important, for behaviour or text unit, to have a single point as a starting point from
where comparison can be started as no comparison can be made without standards or
ordinary attributes. As qualitative methodology is the comparison and conclusions that
are infortative gusess, it can be used to verify which of the hypotheses are real and which
one is true.
               Since 1970 qualtitative methodology was used only for social sciences or
anthropology. It was during the end of 1970 and from the beginning of the 80s that this
methodology become a significant type of research in many fields like management
studies, consumer products studies, psychology,social work, diasability studies and many
more. More specifically, the qualitative methodology is the understanding of the social
world explored and investigated by the qualitative researchers. For that reason they adopt
a variety of methods

                  The qualitative methodology implies to reduce the compexity of the
context. It is the logic of standardization that makes possible to measure the attributes of
research object in question. There are many methods that are common in qualitative
research which include:

      Participant observation: it is the most common methods of gathering
       information in the qualitative methodology. it is also known as the subjective
       sociology perhaps because the aim of the researcher in this method is to observe
       or understand the natural world from the subjective point of view and to impose
       their own beliefs on the participant. It includes the observations and data
       collection that the researcher gather while becoming a participant himself. In this
       the researcher as a participantdiscusses the observations, stored data and also
       analysis it.

      Unstructured interview: it involves the interaction between researcher and a
       group or individual respodent. It contains some guiding questions of cocepts by
       the researchers. It does not have any formal or structured patren. In unstructured
       interview the researcher is free to take the conversion anywhere he wants.
       Moreso, each interview has a unique patren and they are all unstructured
       questions, it is difficult to analyse and compile the data that was collected thorugh
       the interview.

      Direct observation: it involves a more isolated perseption as it is different from
       the participant information in a number of ways. This method is more focused
       than participant observation. In direct observation,the researcher only observes
       particular situations or people instead of becoming the part of whole of the
       situation. this method is not appreciated by many because it is very time
       comsuming. More so, the validity and reliability of the information is also
       dooubtful as they does not provide complete information.

      Case study: this method is a more complex one as it involves more specific
       observation of any person or a situation.It develops problem solving skills and
       allows the exploration of solutions for the complex situations. Freud can be the
       bet example for this method. He studied several individuals for his psychological
       theory. The only problem with the case study method is that they does not provide
       sufficient information which can lead to inappropriate results.


                 A series of questions asked to individuals or group or people ro collect
information aboout the given situation of given topic is known as the Questionnaire. The
quaestionnaire are mostly used for the qualitative marketing research or for social
research. It is an expressive way to gather data and information on a larger scale.
Questionnaire is a vital instruments to gather information, data and by which statements
can be made about specific situations or specific people
                 It has been observed that questionnaires are, perhaps, the cheapest way to
collect and compare data as compare to other methods but it is more expensive in terms
of time, design and interpretation. It is important to remember that while developing the
questions for the questionnaire certain guidelines should be followed; properly
constructed and responsibly administered, to make sure that the parcitipant provide the
correct and useful information rather than the data which is not proper or not reliable. A
well constructed questionnaire allows to get effective data or information on overall
performance of the test systemand also for the specific components of the system (

                 Before designing questionnaire things there are several thing that should
be taken care:

      There should a brief introduction about the purpose of the questionnaire.

      Always include the information about how to complete the questionnaire.

      Question should not be difficult; make sure that respondents be able to answer the

      Question should not be personal; related to personal life or situations which
       become difficult for the respondent to answer.

      If questionnaire have multiple choice questions, make sure that all choices
       encompass the total areas of answer; they should not be confusing.

      Do not include so many questions.

      Except for the definition ask to elaborate to make respondent more constructive
       and more creative.

      Also include the question to get respondent’s impression about the questionnaire.
        Methods of collection:

Method              Benefits
                    This method has a low cost.
Postal              Survey participants can choose to remain anonymous.
                    It is not labor intensive.
                    Questionnaires can be conducted swiftly.
Telephone           Rapport with respondents
                    High response rate
                    This method has a low cost, and on most surveys costs nothing for the
                    participants and little for the surveyors.
                    Questionnaires can be conducted swiftly.
Electronic          Survey participants can choose to remain anonymous.
                    It is not labor intensive.
                    Questions can be more detailed, as opposed to the limits of paper or
                    Questions can be more detailed, as opposed to the limits of paper or
Personally          telephones.
Administered        Rapport with respondents
                    High response rate

                                  Interview Research:

                  The interview research method is a type of meeting, face to face, with
the researcher. In this method the researcher or interviewer asks a series of questions to
an individual or in some case to a group of people. They are generally used to find out the
facts behind the real experiences of participant. Moreover, the interview also used to
further investigate the information collected through the questionnaire. The main aim or
interview research is to understand the true meaning of respondent’s approach.
According to the Frey and Oishi, an interview is a purposeful conversation I which one
has to answer the questions prepared by the interviewer. Interview research is a useful
tool to gain information on a particular area and can lead to further research using
observations and experiments. It can be divided into two forms; structured and
                   Unstructured interviews can also be known as informal interviews.
This interview research contains the questions about the general interest and facts. In
unstructured interviews the interviewer or researcher adopts to remain as open as
possible; it goes with the flow. Furthermore, it allows more freedom and adaptability in
collecting more proper information from the participant.
                  Where as, the structured interview research is based on the questionnaire
which is proper and focused on the specific situation of topic. According to Nicholas, the
structured interview research is the range of proper answers of the questions. Due to the
fixed and strict order of order, there is not much space in these types of interviews. But
they can be easily analyzed and compared.
                    There is one more type of interview research method; Group
interview or focus group. This method is defined by the Wimmer and Dominick as a
strategy that can be use for understanding attitudes and behaviors or certain group of
people. The interview criteria can be structured or unstructured. It is important for this
type of research to have people of the same sex or share similar backgrounds. It is ideal if
they know each other before the interview research
                     According to some of the critics focus group method is not valid or
reliable research methodology as the affect of dominant participants could be negative on
other respondent. Moreover, it can also influence their comments.

      Types of Topics in Questions

There are several types of question that can be asked in an interview research and they
could be in past, present or future terms. They may include:

      Opinion or values: it is about the imagination and feeling of the participant; wht
       he thinks about the topic or situation.

      Knowledge: it I important to get the facts and opinion about the topic.

      Behavior: it is about what a person is doing to what he want to do.

      Sensory: related to the senses of participant or particular situation; what have been
       seen, touched, smelled etc.

      Background or demographics: it relates to the standard background questions.

                  The survey is a method of research which do not involve and
experiment or description. It is a conducting research in which the researcher goes out to
different places or to people and asked questions about the phenomenon of interest. This
method is useful to collect data that cannot be observed directly. It is used to assess
characteristic and attitudes of a huge number of people. Survey research can be employed
by any discipline as it does not belong to any particular field or any specific topic.
                    In survey research data is collected by using questionnaire or
interviewing. They can be use in qualitative and also quantitative measures. Concerns or
issues that to be remembered in conducting surveys are:

      Survey questions should be clear.

      Survey questions should directly address the research topic or situation.

      Respondents should be anonymous.

      Always calculate time factor; how much time will survey take, will time affect the
       results of the survey etc.

      Consider other sources through which survey results could be compared.


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