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  • pg 1
          MODULE A
• Bank’s Liabilities
  -The sources of funds for the lending and
   investment activities constitute liabilities side of
   balance sheet.
   Reserves and Surplus
   Other Liabilities and Provisions
   Contingent Liabilities.
Bank’s Assets are the funds mobilised by bank
 through various sources.
 -Cash and Bank balances with Reserve Bank
   Of India.
 -Balances with banks and money at call and
   short notice.
  -Fixed Assets
  -Other Assets.
Business of banking involves the
 identifying,measuring,accepting and
 managing the risk,the heart of bank financial
 management is risk management.One of the
 most important risk-managemnet functions in
 bank is Asset Liability Management.
Traditionally,administered interest rates were
 used to price the assets and liabilities of
 banks.However,in the deregulated
 environment,competition has narrowed the
 spreads of banks.
Asset Liability Management is concerned with
 strategic balance sheet management involving
 risks caused by changes in interest
 rates,exchange rate,credit risk and the liquidity
 position of bank.With profit becoming a key-
 factor,it has now become imperative for banks
 to move towards integrated balance sheet
 management where components of balance
 sheet and its different maturity mix will be
 looked at profit angle of the bank.
ALM is about management of Net Interest
 Margin(NIM) to ensure that its level and riskiness
 are compatible with risk/return objectives of the
 bank.It is more than just managing individual assets
 and liabilities.It is an integrated approach to bank
 financial management requiring simultaneous
 decision about types and amount of financial assets
 and liabilities it holds or its mix and volume.In
 addition ALM requires an understanding of the
 market area in which the bank operates.
If 50% of the liabilities are maturing within 1
 year but only 10% of the assets are maturing
 within the same period.Though the financial
 institution has enough assets,it may become
 temporarily insolvent due to a severe liquidity
Thus,ALM is required to match assets &
 liabilities and minimise liquidity as well as
 market risk.
Reasons for growing significance of ALM
  -Product Innovation
  -Regulatory Framework
  -Management Recognition
 An effective Asset Liability Management
   technique aims to manage the volume
   mix,maturity,rate sensitivity,quality and
   liquidity of assets and liabilities as a whole
   so as to attain a predetermined acceptable
    risk/reward ratio.
Purpose and objectives of asset liability
Review the interest rate structure and compare
 the same to the interest/product pricing of
 both assets and liabilities.
Examine the loan and investment portfolios in
 the light of the foreign exchange risk and
 liquidity risk that might arise.
Examine the credit risk and contingency risk
 that may originate either due to rate
 fluctuations or otherwise and assess the quality
 of assets.
Review,the actual performance against the
 projections made and analyse the reasons for
 any effect on spreads.
Aim is to stabilise the short-term profits,long-
 term earnings and long-term substance of the
 bank.The parameters that are selected for the
 purpose of stabilising asset liability
 management of banks are:
 -Net Interest Income(NII)
 -Net Interest Margin(NIM)
 -Economic Equity Ratio
 Net Interest Income-
 Interest Income-Interest Expenses.

 Net Interest Margin-
 Net InterestIncome/Average Total Assets

Economic Equity Ratio-
The ratio of the shareholders funds to the total
assets measures the shifts in the ratio of owned
funds to total funds.The fact assesses the
sustenance capacity of the bank.
ALM is required to match assets and liabilities
 to ---------liquidity risk as well as market risk.
The ratio of shareholders funds to the total
 assets is called-------.
Net Interest Margin is defined as net interest
 income divided by ---------.
Liquidity is ensured by grouping the
 assets/liabilities based on their ------.
The institution is in a position to benefit from
 rising interest rates when assets are ------ than
State True or False
Assets represent source of funds whereas
  liabilities denote the use of funds in a balance
Deregulated environment has narrowed
  spreads of the banks.
Asset liability management is only management
  of maturity mismatch and has no bearing on
  profit augmentation.
Net Interest Margin is known as ‘Spread’
Banks need liquidity to meet deposit
 withdrawal and to fund loan demands.
The variability of loan demands and variability
 of deposits determine bank’s liquidity needs.It
 represents the ability to accommodate
 decreases in liability and to fund increases in
It demonstrates the market place that the
 bank is safe and therefore capable of repaying
 its borrowings.
It enables bank to meet its prior loan
 commitments,whether formal or informal.
It enables bank to avoid the unprofitable sale
 of assets.
It lowers the size of the default risk premium
 the bank must pay for funds.
 Types of liquidity risk:
  -Funding Risk
  -Time Risk
  -Call Risk.
Funding Risk:
 Need to replace net outflows due to
 unanticipated withdrawal/non-renewal of
 deposits arises due to :
 -Fraud causing substantial loss
 -Systemic Risk
 -Loss of confidence
 -Liabilities in foreign currencies
Time Risk:
 Need to compensate for non-receipt of
 expected inflow of funds,arises due to,
  -Severe deterioration in the asset quality
  -Standard assets turning into non-performing
   -Temporary problems in recovery
   -Time involved in managing liquidity.
Call Risk:Crystallisation of contingent liabilities
 and inability to undertake profitable business
 oppurtunities when desirable,arises due to,
 -Conversion of non-fund based limit into fund
 -Swaps and options.
Measuring and Managing Liquidity Risk
Developing a structure for managing liquidity
Setting tolerance level and limit for liquidity
Measuring and managing liquidity risk.
Setting tolerance level for a bank:
 To manage the mismatch levels so as to avert
 wide liquidity gaps-The residual maturity
 profile of assets and liabilities will be such that
 mismatch level for time bucket of 1-14 days
 and 15-28 days remain around 20% of cash
 outflows in each time bucket.

  To manage liquidity and remain solvent by
  maintaining short-term cumulative gap up to
  one year(short term liabilities-short term
  assets at 15% of total outflow of funds.
 Measuring and Managing Liquidity Risk
  Stock Approach
  Flow Approach
  Stock Approach is based on the level of assets and
  liabilities as well as off balance sheet exposures on
  a particular date.The following ratios are calculated
  to assess the liquidity position of the bank:
  Ratio of core deposits to total assets
  Net loans to total deposits ratio
  Ratio of time deposits to total deposits
  Ratio of volatile liabilities to total assets
Ratio of short term liabilities to liquid assets
Ratio of liquid assets to total assets
Ratio of short term liabilities to total assets
Ratio of prime assets to total assets
Ratio of market liabilities to total assets.
 Flow Approach
 -Measuring and managing net funding
  -Managing Market Access
  -Contingency Planning
Measuring and Managing net funding
Flow method is the basic approach followed by
Indian Banks.It is called as gap method of
measuring and managing liquidity.It requires the
preparation of structural liquidity gap report.In
this method net funding requirement is
calculated on the basis of residual maturiries of
assets & liabilities.These residual maturities
represent net cash flows ie.difference between cash
outflow & cash inflow in future time buckets
These calculations are based on the past
 behaviour pattern of assets and liabilities as
 well as off balance sheetexposures.Cumulative
 gap is calculated at various time buckets.In
 case gap is negative bank has to manage the
The analysis of net funding requirements
 involves the construction of a maturity ladder
 and the calculation of a cumulative net excess
 or deficit of funds at selected maturity dates.
Objective of liquidity management is to
 a)Ensure profitability
 b)Ensure liquidity
 c)Either of two
 Banks need liquidity to
  a) Meet deposit withdrawal
  b) Fund loan demands
  c) Both of them
  d) None of them.
Adequacy of a bank’s liquidity position
 depends upon:
 a)Sources of funds
 b)Anticipated future funding needs
 c)Present and Future earnings capacity
 d)All the above
The need to replace net outflows due to
 unanticipated withdrawal of deposits is known
 as ---------risk.
The need to compensate for non-receipt of
 expected inflows of funds is classified as -----
Call risk arises due to crystallisation of ------.
Maturity ladders enables the bank to estimate
 the difference between-----and------in
 predetermined periods.
Liquidity management methodology of
 evaluating whether a bank has sufficient liquid
 funds based on the behaviour of cash flows
 under different what if scenarios is known as -
 The capability of bank to withstand a net
 funding requirement in a bank specific or
 general market liquidity crisis is denoted as----
Interest rate risk is the volatility in net interest
 income(NII) or in variations in net interest
Gap:The gap is the difference between the
 amount of assets and liabilities on which the
 interest rates are reset during a given period.
Basis risk:The risk that the interest rate of
 different assets and liabilities may change in
 different magnitudes is called basis risk.
Embedded option:Prepayment of loans and
 bonds and/or premature withdrawal of
 deposits before their stated maturity dates.
Yield curve:It is a line on a graph plotting the
  yield of all maturities of a particular
Changes in interest rates also affect the
underlying value of the bank’s--------
Rise in interest rates-----the market value of that
asset and fall in interest rate ----the market value
of assets or liabilities.
The gap is the difference between the amount
of assets and liabilities on which interest rates
are------during a given period
• Mismatch occurs when assets and liabilities
  fall due for -----in different periods
• The economic value of a bank can be viewed
   as the present value of the bank’s expected
   Estimates derived from a standard duration
  generally focus on just one form of interest
  rate risk exposure ie.-----
  The adverse impact on NII due to mismatches
  can be minimised by fixing appropriate ----on
  interest rate sensitivity gaps.
Management of Exchange Rate
• Foreign exchange risk-Risk arising out of
  adverse exchange rate movementsduring a
  period in which it has open position in an
  individual foreign currency.
• Transaction exposure:Change in the foreign
  exchange rate between the time the
  transaction is executed and the time it is
• Forwards-Agreement to buy or sell forex for a
  predetermined amount,at a predetermined
  rate on a predetermined date.
Open position:The extent to which
 outstanding contracts to purchase a currency
 exceed liabilities plus outstanding contractsto
 sell the currency & vice versa.
Overnight position-A limit on the maximum
 open position left overnight,in all major
Day-light position-A limit on maximum open
 position in all major currencies at any point of
 time during day.Such limits are generally
 larger than overnight positions.
• Options:It is a contract for future delivery of a
  currency in exchange for another,where the
  holder of the option has the right,without
  obligation to buy or sell the currency at an agreed
  price,the strike price or exercise price,on a
  specified future date.
• Call option;The right to buy under an option
• Put option:The right to sell under an option.
• Futures are forward contracts with standardized
  size,standardised maturity date governed by a set
  of guidelines stipulated by exchange concerned
  for settlements and payments.
An appreciation in domestic currency will----
value of assets and liabilities.
In a forward contract actual cash flow occurs on
the date of-----
Swaps can be of two types----and------
Any questions
Thank you

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