M I M

L e a d e r s in
E
M a n a g e m e n t
& E n t r e p r e n e u r s h ip

SUMMER INTERNSHIP & RESEARCH

PROJECT 2010 ON

LIQUIDITY RISK MANAGEMENT

SMALL AND MEDIUM ENTERPRISES DEPARTMENT

BANGALORE

SUBMITTED BY: - NEETHU BAHULEYAN

ENROLLMENT NO: - 09MMA4109

UNDER THE SUPERVISION AND GUIDEANCE OF: - Prof. BRR

ACADEMIC YEAR: - 2009-2011

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 DECLARATION

I Neethu Bahuleyan hereby declare that the “Summer Internship” report

submitted in partial fulfillment of the requirement of Post Graduate Diploma in
Business management to MIME Leaders in Management & Entrepreneurship
under the guidance and supervision of Dr. BRR, MIME is my original work and
not submitted for the award of any other degree, diploma, fellowship or other
similar titles or prizes.

DATE:

PLACE: Bangalore

SIGN:

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 ACKNOWLEDGEMENT

It is my proud privilege to release the feelings of my gratitude to several persons

who helped me directly or indirectly to conduct this project work. I express my
heart full indebtness and owe a deep sense of gratitude to my faculty guide Dr.
BRR, Professor, MIME Leaders in management and Entrepreneurship, Bangalore,
for his invaluable guidance in this endeavor. I sincerely thank them for his
suggestions and help to prepare this report.

I am extremely thankful to the Dean and faculties of the Institute for their
coordination and cooperation and thankful for organizing summer internship
training for students.

I express deep sense of gratitude to my company guide Mr. Ramakrishna, Deputy

General Manager of SBI, for offering suggestions and help in successfully
completing my project. They have been a constant source of inspiration and
motivation.

Thanking you

Date: NEETHU BAHULEYAN

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 INDEX
Sr No. Particulars Page
No.
1. ABSTRACT
2. INTRODUCTION TO THE STUDY
2.1 Introduction
2.2 Framework for measuring and managing liquidity
2.3 Measuring and managing net funding requirements:
3. OBJECTIVES AND METHODOLOGY
3.1 Objectives
3.2 Methodology
3.3 Literature review
3.4 Explanation of concepts
4. INDUSTRY PROFILE
4.1 Introduction
4.2 Post Independence
4.2 Nationalization
4.3 Liberalization
4.5 Current Situation
4.6 Regional Banks
4.7 Recent Developments
4.8 Government Regulations
5. COMPANY PROFILE

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 5.1 History
5.2 Key area of operations
5.3 Management
5.4 SWOT Analysis
5.5 Competitors and other players
5.6 Awards
5.7 Products
6. ANALYSIS
6.1 Statement of interest rate sensitivity
6.2 Maturity gap method
6.3 Observations of the study
7. RECOMMENDATIONS
8. CONCLUSIONS

1. ABSTRACT:

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Today in the banking sector every bank nationalized or private are striving to
reach the pinnacle. Though in the national scenario the Govt./Nationalized banks
are leading bank in the metropolitan context the private banks are leading both in
business as well as service.

STATE BANK OF INDIA has built its leadership by making itself as India’s
largest commercial bank having largest retail lender with great brand image, high
market capitalization and also to find place in the fortune global 500 list.

The Broad objective of the project is to identify the liquidity risks faced by the
banks and Classification of assets and liabilities into different time buckets as per
RBI guidelines issued for liquidity management in banks. Analysis of liquidity
risk through Cash Flow Approach Method

This study is basically divided into eight major parts. The first part of the report
includes the introduction to the study. The second part deals with the banking
Industry. The third part includes the Introduction of State bank of India.
The fourth part is analysis then recommendations and conclusions.

2. INTRODUCTION TO THE STUDY

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2.1INTODUCTION TO LIQUIDITY RISK MANAGEMENT:

Banks are in the business of maturity transformation. They lend for longer time
periods, as borrowers normally prefer a longer time frame. But their liabilities are
typically short term in nature, as lenders normally prefer a shorter time frame
(liquidity preference). This results in long-term interest rates typically exceeding
short-term rates. Hence, the incentive for banks for performing the function of
financial intermediation is the difference between interest receipt and interest cost
which is called the interest spread. It is implicit, therefore, that banks will have a
mismatched balance sheet, with liabilities greater than assets in short term, and
with assets greater than liabilities in the medium and long term. These
mismatches, which represent liquidity risk, are with respect to various time
horizons. Hence, the concern of a bank is to maintain adequate liquidity

• Liquidity risk is the potential inability to meet the bank's liabilities as they
become due. It arises when banks are unable to generate cash to cope with
a decline in deposits or increase in assets. It originates from the mismatches
in the maturity pattern of assets and liabilities. Measuring and managing
liquidity needs are vital for effective operation of commercial banks. By
assuring a bank's ability to meet its liabilities as they become due, liquidity
management can reduce the probability of an adverse situation developing.

• Analysis of liquidity risk involves the measurement of, not only the
liquidity position of the bank on an ongoing basis but also examining how
funding requirements are likely to be affected under crisis scenarios. Net
funding requirements are determined by analyzing the bank's future cash
flows based on assumptions of the future behavior of assets and liabilities

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 that are classified into specified time buckets and then calculating the
cumulative net flows over the time frame for liquidity assessment.

• Future cash flows are to be analyzed under "what if" scenarios so as to

assess any significant positive/ negative liquidity swings that could occur
on a day-to-day basis and under bank specific and general market crisis
scenarios. Factors to be taken into consideration while determining
liquidity of the bank's future stock of assets and liabilities include: their
potential marketability, the extent to which maturing assets /liability will be
renewed, the acquisition of new assets/liability and the normal growth in
asset/liability accounts.

Factors affecting the liquidity of assets and liabilities of the bank cannot always be
forecast with precision. Hence, they need to be reviewed frequently to determine
their continuing validity, especially given the rapidity of change in financial
markets.

The liquidity risk in banks manifest in different dimensions:

• Funding Risk — need to replace net outflows due to unanticipated

withdrawal/non- renewal of deposits (wholesale and retail);
• Time Risk — need to compensate for non-receipt of expected inflows of
funds, i.e., performing assets turning into non-performing assets; and
• Call Risk — due to crystallization of contingent liabilities and inability to
undertake profitable business opportunities when desirable.

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2.2 FRAMEWORK FOR MEASURING AND MANAGING LIQUIDITY

• Measuring and managing liquidity needs are vital for effective operation of
commercial banks. By assuring a bank's ability to meet its liabilities as they
become due, liquidity management can reduce the probability of an adverse
situation developing. The importance of liquidity transcends individual
institutions, as liquidity shortfall in one institution can have repercussions
on the entire system. Bank managements should measure not only the
liquidity positions of banks on an ongoing basis, but also examine how
liquidity requirements are likely to evolve under different assumptions.
Experience shows that assets like government securities and other money
market instruments, which are generally treated as liquid could also
become illiquid when the market and players are unidirectional. Therefore,
liquidity has to be tracked through maturity or cash flow mismatches.

The framework for assessing and managing bank liquidity has three dimensions:

1. Measuring and managing net funding requirements

2. Managing market access and
3. Contingency planning.

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2.3 MEASURING AND MANAGING NET FUNDING REQUIREMENTS:

• The first step towards liquidity management is to put in place an effective

liquidity management policy, which, inter alia, should spell out the funding
strategies, liquidity planning under alternative scenarios, prudential limits,
liquidity reporting/reviewing, etc. Liquidity measurement is quite a difficult
task and can be measured through stock or cash flow approaches. The key
ratios, adopted across the banking system are: loans to total assets, loans to
core deposits, large liabilities (minus) temporary investments to earning
assets (minus) temporary investments, purchased funds to total assets, loan
losses/net loans, etc.

• While liquidity ratios are the ideal indicators of liquidity of banks operating
in developed financial markets, the ratios do not reveal the intrinsic
liquidity profile of Indian banks which are operating generally in an illiquid
market. Experiences show that assets like government securities, other
money market instruments, etc., commonly considered as liquid have
limited liquidity as the market and players are unidirectional. Thus, analysis
of liquidity involves tracking of cash flow mismatches.

• For measuring and managing net funding requirements, the use of a

maturity ladder and calculation of cumulative surplus or deficit of funds at
selected maturity dates is adopted as a standard tool. The maturity profile
could be used for measuring the future cash flows of banks in different time
buckets. The time buckets, given the Statutory Reserve Cycle of 14 days,
which are generally treated as liquid may be distributed as under:

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1. 1 to 14 days
2. 15 to 28 days
3. 29 days and up to 3 months
4. 3 months and up to 6 months
5. 6 months and up to 1 year
6. 1 year and up to 3 years
7. 3 years and up to 5 years
8. Above 5 years.
• The investments in SLR securities and other investments are assumed as
illiquid due to lack of depth in the secondary market and are, therefore,
required to be shown under the respective maturity buckets, corresponding
to the residual maturity. However, some of the banks may be maintaining
securities in the `Trading Book', which are kept distinct from other
investments made for complying with the Statutory Reserve Requirements
and for retaining relationship with customers. Securities held in the
`Trading Book' are subject to certain preconditions like:
1. Clearly defined composition and volume;
2. Maximum maturity/duration of the portfolio is restricted;
3. The holding period not to exceed 90 days;
4. Cut-loss limit prescribed;
5. Defeasance periods (product-wise) , i.e., time taken to liquidate the position
on the basis of liquidity in the secondary market are prescribed;
6. Marking to market on a daily/weekly basis and the revaluation gain/loss
charged to the profit and loss account, etc.
• Banks which maintain such `Trading Books' and comply with the above
standards are permitted to show the trading securities under 1-14 days, 15-
28 days and 29-90 days buckets on the basis of the defeasance periods. The
Board/ALCO of the banks should approve the volume, composition,
holding/defeasance period, cut loss, etc., of the `Trading Book' and copy of

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 the policy note thereon should be forwarded to the Department of Banking
Supervision, RBI.

• Within each time bucket, there could be mismatches depending on cash

inflows and outflows. While the mismatches up to one year would be
relevant since these provide early warning signals of impending liquidity
problems, the main focus should be on the short-term mismatches, viz., 1-
14 days and 15-28 days. Banks, however, are expected to monitor their
cumulative mismatches (running total) across all time buckets by
establishing internal prudential limits with the approval of the
Board/Management Committee. The mismatches (negative gap) during 1-
14 days and 15-28 days in normal course may not exceed 20% of the cash
outflows in each time bucket. If a bank, in view of its current asset-liability
profile and the consequential structural mismatches, needs higher tolerance
level, it could operate with higher limit sanctioned by its Board
/Management Committee, giving specific reasons on the need for such
higher limit.

• The Statement of Structural Liquidity (Annexure I) may be prepared by

placing all cash inflows and outflows in the maturity ladder according to
the expected timing of cash flows. A maturing liability will be a cash
outflow while a maturing asset will be a cash inflow. It would also be
necessary to take into account the rupee inflows and outflows on account of
Forex operations. While determining the likely cash inflows/ outflows,
banks have to make a number of assumptions according to their asset-
liability profiles. For instance, Indian banks with a large branch network
can (on the stability of their deposit base as most deposits are rolled-over)
afford to have larger tolerance levels in mismatches in the long-term, if

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 their term deposit base is quite high. While determining the tolerance
levels, the banks may take into account all relevant factors based on their
asset-liability base, nature of business, future strategy, etc. The RBI is
interested in ensuring that the tolerance levels are determined keeping all
necessary factors in view and further refined with experience gained in
Liquidity Management.

• "In order to enable banks to monitor their short-term liquidity on a dynamic

basis over a time horizon spanning from 1-90 days, they may estimate their
short-term liquidity profiles on the basis of business projections and other
commitments for planning purposes."

3. OBJECTIVES AND METHODOLOGY OF THE STUDY:

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Though Basel Capital Accord and subsequent RBI guidelines have given a
structure for Liquidity Management and Asset Liability Management (ALM) in
banks, the Indian banking system has not enforced the guidelines in total. The
banks have formed Asset-Liability Committees (ALCO) as per the guidelines; but
these committees rarely meet to take decisions.
Taking this as a base, this research is done to find out the status of Liquidity
Management in State Bank of India with the help of "Cash Flow Approach"
methodology for controlling liquidity risk. To achieve the main purpose, the
following objectives are set forth:

3.1OBJECTIVES

• To identify the liquidity risks faced by the banks.

• Classification of assets and liabilities into different time buckets as per RBI
guidelines issued for liquidity management in banks.
• Analysis of liquidity risk through Cash Flow Approach Method.

3.2METHIDOLOGY:

The study covers SBI's data for evaluation. The relevant data have been collected
from the published annual report of the bank for the period from March 2010.
In order to have effective liquidity management, bank need to undertake periodic
funds flow projections, taking into account movements in non-treasury assets and
liabilities [fresh deposits, maturing deposits (and maturing) and new term loans].
This enables forward planning for Cash Reserve Ratio (CRR) and Statutory
Liquidity Ratio (SLR) maintenance.

3.3CASH RESERVE RATIO:

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A scheduled bank is under the obligation to keep a cash reserve called the
Statutory Cash Reserve, with the Reserve Bank of India (RBI) under Section 42 of
the Reserve Bank of India Act, 1934. Every scheduled bank is required to
maintain with the Reserve Bank an average daily balance equal to least 3% of its
net demand and time liabilities. Average daily balances mean the average of
balances held at the close of business on each day of the fortnight. The Reserve
Bank is empowered to increase the rate of Statutory Cash Reserve from 3% to
20% of the Net Demand and Time Liabilities (NDTL). The rate of CRR in March
2010 was 5.75%.

Liabilities of a Scheduled bank exclude:

• Its paid-up capital and reserves

• Loans taken from the RBI or IDBI or NABARD
• The aggregate of the liabilities of a scheduled commercial bank to the State
Bank or its subsidiary bank, any nationalized bank or a banking company
or a cooperative bank or any financial institution notified by the Central
Government in this behalf shall be reduced by the aggregate of the
liabilities of all such banks and institutions to the concerned scheduled
bank.

Thus, the entire amount of interbank liability for the purpose of Section 42 is
excluded and the net liability of a scheduled bank to the entire banking system,
(i.e., after deducting the balance maintained by it with all other banks from its
gross liabilities to them) will be deemed to be its liabilities to the system.
The objective of maintaining a minimum balance with RBI is basically to ensure
the liquidity and solvency of the scheduled banks. Every reporting fortnight starts
on a Saturday, or, if it is a holiday, the next working day and ends on the
following second Friday (Thursday or the previous working day if Friday is a

15
holiday). Branches send their data to their Head Office. Preliminary NDTL returns
are due to the RBI in seven days of the close of a reporting fortnight, while final
returns must reach in 21 days.
The NDTL statement in Form A is prescribed by the RBI. There is a fixed format
in which branches send data to the CRR/SLR cell responsible for the RBI returns.

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3.4STATUTORY LIQUIDITY RATIO:

• Section 24(2A) of Banking Regulation Act, 1949, requires every banking

company to maintain in India in Cash, Gold or Unencumbered Approved
Securities or in the form of net balance in current accounts maintained in
India by the bank with a nationalized bank, equivalent to an amount which
shall not at the close of the business on any day be less than 25% or such
other percentage not exceeding 40% as the RBI may from time to time, by
notification in the Gazette of India, specify, of the total of its demand and
time liabilities in India as on the last Friday of the second preceding
fortnight, which is known as SLR. At present, all Scheduled Commercial
Banks are required to maintain a uniform SLR of 25% of the total of their
demand and time liabilities in India as on the last Friday of the second
preceding fortnight which is stipulated under Section 24 of the RBI Act,
1949.

• RBI can enhance the stipulation of SLR (not exceeding 40%) and advise
the banks to keep a large portion of the funds mobilized by them in liquid
assets, particularly government and other approved securities. As a result,
funds available for credit would get reduced.

• All banks have to maintain a certain portion of their deposits as SLR and
have to invest that amount in these Government securities.

• Government securities are sovereign securities. These are issued by the

RBI on behalf of the Government of India, in lieu of the Central
Government's market borrowing program.

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3.5 THE TERM GOVERNMENT SECURITIES INCLUDE:

1. Government Dated Securities, i.e., Central Government Securities

2. State Government Securities
3. Treasury Bills.
• The Central Government borrows funds to finance its fiscal deficit. The
market borrowing of the Central Government is raised through the issue of
dated securities and 364 days Treasury Bills, either by auction or by
floatation of fixed coupon loans.

• In addition to the above, Treasury Bills of 91 days are issued for managing
the temporary cash mismatches of the government. These do not form part
of the borrowing program of the Central Government.

• Based on the required CRR and SLR per day, the treasury department of
the bank ensures that sufficient balance is maintained in the Reserve Bank
(at its different branches). The fund manager calculates on a daily basis the
RBI balances based on opening RBI balances and taking into account
various inflows and outflows during the day. The fund manager takes the
summary of inflows and outflows and the net effect is added to/subtracted
from the opening RBI balances. By this method, an RBI balance of all the
14 days is arrived at. For instance, on the opening day of the fortnight, if
there is an anticipated surplus, banks can generally lend it at an average,
subject to subsequent inflows/outflows. Conversely, for a shortfall, the
bank may borrow the required amount in call/repo/Collateralized
Borrowings and Lending Obligations (CBLO) markets on a daily basis.

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 • Successful functioning of the funds department depends mostly on the
prompt collection of information from branches/other departments
regarding the inflow and outflow of funds. The information should also be
collected accurately and collated properly/correctly. Improper maintenance
of liquidity and CRR position by the fund manager may lead to either a
default or an excess which does not earn any interest for the bank.

3.6 MANAGING MARKET ACCESS:

Apart from the above cash flows, banks should also track the impact of
prepayments of loans, premature closure of deposits and exercise of options built
in certain instruments which offer put/call options after specified times. Thus, cash
outflows can be ranked by the date on which liabilities fall due, the earliest date a
liability holder could exercise an early repayment option or the earliest date on
which contingencies could be crystallized.
The difference between cash inflows and outflows in each time period, the excess
or deficit of funds becomes a starting point for a measure of a bank's future
liquidity surplus or deficit, at a series of points of time. Banks should also
consider putting in place certain prudential limits, as detailed below, to avoid
liquidity crisis:

• Cap on interbank borrowings, especially call borrowings

• Purchased funds vis-à-vis liquid assets
• Core deposits vis-à-vis Core Assets, i.e., CRR, SLR and Loans
• Duration of liabilities and investment portfolio
• Maximum Cumulative Outflows across all time bands

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 • Commitment Ratio — track the total commitments given to
corporate/banks and other financial institutions to limit the off-balance
sheet exposure; and
• Swapped Funds Ratio, i.e., extent of Indian Rupees raised out of foreign
currency sources.

Banks should also evolve a system for monitoring high-value deposits (other than
interbank deposits), say Rs. 1Cr, or more to track the volatile liabilities. Further,
the cash flows arising out of contingent liabilities in normal situation and the
scope for an increase in cash flows during periods of stress should also be
estimated. It is quite possible that market crisis can trigger substantial increase in
the amount of draw downs from cash credit/overdraft accounts, contingent
liabilities like letters of credit, etc.

The liquidity profile of the banks could be analyzed on a static basis, wherein the
assets and liabilities and off-balance sheet items are pegged on a particular day
and the behavioral pattern and the sensitivity of these items to changes in market
interest rates and environment are duly accounted for. Banks can also estimate the
liquidity profile on a dynamic way by giving due importance to:

• Seasonal pattern of deposits/loans;

• Potential liquidity needs for meeting new loan demands, unavailed credit limits,
potential deposit losses, investment obligations, statutory obligations, etc.

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3.7CONTINGENCY PLANNING:

• All banks are required to produce a Contingency Funding Plan (CFP).

These plans are to be approved by ALCO, submitted annually as part of the
Liquidity and Capital Plan, and reviewed quarterly. The preparation and the
implementation of the plan may be entrusted to the treasury.

• CFP are liquidity stress tests designed to quantify the likely impact of an
event on the balance sheet and the net potential cumulative gap over a 3-
month period. The plan also evaluates the ability of the bank to withstand a
prolonged adverse liquidity environment. At least two scenarios require
testing: Scenario A, a local liquidity crisis, and Scenario B, where there is a
nationwide problem or a downgrade in the credit rating if the bank is
publicly rated.

• The bank's CFP should reflect the funding needs of any bank managed
mutual fund whose own CFP indicates a need for funding from the bank.

• Reports of CFPs should be prepared at least quarterly and reported to

ALCO.

• If a CFP results in a funding gap within a 3-month time frame, the ALCO
must establish an action plan to address this situation. The Risk
Management Committee should approve the action plan.

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• At a minimum, CFPs under each scenario must consider the impact of
accelerated run off of large funds providers.

• The plans must consider the impact of a progressive, tiered deterioration, as

well as sudden, drastic events.

• Balance sheet actions and incremental sources of funding should be

dimensioned with sources, time frame and incremental marginal cost and
included in the CFPs for each scenario.

• Assumptions underlying the CFPs, consistent with each scenario, must be

reviewed and approved by ALCO.

• The Chief Executive/Chairman must be advised as soon as a decision has

been made to activate or implement a CFP. The Chief Executive or the
Risk Management Committee may call for implementation of a CFP.

• The ALCO will implement the CFP, amending it with the approval of the
Risk Management Committee, where necessary, to meet changing
conditions; daily reports are to be submitted to the Treasury Head,
comparing actual cash flows with the assumptions of the CFP.

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3.8FOREIGN CURRENCY LIQUIDITY MANAGEMENT:

• For banks with an international presence, the treatment of assets and

liabilities in multiple currencies adds a layer of complexity to liquidity
management for two reasons. First, banks are often less well-known to
liability holders in foreign currency markets. Therefore, in the event of
market concerns, especially if they relate to a bank's domestic operating
environment, these liability holders may not be able to distinguish rumor
from fact as well or as quickly as domestic currency customers. Second, in
the event of a disturbance, a bank may not always be able to mobilize
domestic liquidity and the necessary foreign exchange transactions in
sufficient time to meet foreign currency funding requirements. These issues
are particularly important for banks with positions in currencies for which
the foreign exchange market is not highly liquid in all conditions.

• Banks should, therefore, have a measurement, monitoring and control

system for liquidity positions in the major currency markets in which they
are active. In addition to assessing their aggregate foreign currency
liquidity needs and the acceptable mismatch in combination with their
domestic currency commitments, banks should also undertake separate
analysis of their strategies for each currency individually. When dealing in
foreign currencies, a bank is exposed to the risk that a sudden change in
foreign exchange rates or market liquidity, or both, could sharply widen the
liquidity mismatches. These shifts in market sentiment might result, either
from domestically generated factors or from contagion effects of
developments in other countries. In either event, a bank may find that the
size of its foreign currency funding gap has increased. Moreover, foreign
currency assets may be impaired, especially where borrowers have not
hedged foreign currency risk adequately. The Asian crisis of the late 1990s

23
 demonstrated the importance for banks to closely manage their foreign
currency liquidity position on a day-to-day basis.

• The particular issues to be addressed in managing foreign currency

liquidity will depend on the nature of the bank's business. For some banks,
the use of foreign currency deposits and short-term credit lines to fund
domestic currency assets will be the main area of vulnerability, while for
others; it may be the funding of foreign currency assets with domestic
currency. As with overall liquidity risk management, foreign currency
liquidity should be analyzed under various scenarios, including stressful
conditions.

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3.3 LITERATURE REVIEW

1. The article explains that in the year 2003 the Mortgage Backed Securities
Clearing Corporation (MBSCC) and the Government Securities Clearing
Corporation (GSCC) merged into the Fixed Income Clearing Corporation
(FICC) under the Depository Trust Clearing Corporation (DTCC) umbrella.
FICC continually searches for cost-effective ways to provide increased
liquidity, risk management and other dynamic processes that help firms
operate more efficiently as well as expand the population of firms that can
take advantage of these benefits. This paper will outline the motivations,
customer needs, regulatory interests and market dynamics behind these
initiatives, the benefits they will bring to the industry and the progress they
have made so far. In addition, the author has addressed some of the
challenges that currently face the industry and how FICC, along with its
members and partners, is fashioning solutions for those as well.

2. Developed countries and is becoming increasingly relevant for corporate

firms in India. This paper examines the practices and policies of foreign
exchange risk and interest rate risk management followed by the corporate
firms in India. The study reveals that Indian firms are aware of the risk
management techniques and many of them are using the same to manage
various risks. However, all the risks are not managed and the type of
ownership control significantly influences the usage of the techniques to
manage exchange rate risk and interest rate risk. 'Exposures are not large
enough' is the most widespread and prominent reason for not managing
risks. Risks inherent in derivatives are a significant reason in making the
firms using risk management techniques. The prominent barriers hindering
the routine use of derivatives are monitoring and evaluating the risk of

25
 derivatives, pricing, valuing and accounting in conjunction with credit and
liquidity risk. About two-fifths of the firms are risk averse but do not hedge
their full exposure. A majority of the firms follow cost-center approach
towards risk management. Ownership has been observed to be a significant
determinant of firms' strategy towards risk management. While a majority
of foreign controlled firms and private sector business group firms can be
characterized as partial hedgers, the majority of the public sector firms
belong to the category of negligible hedgers. In sum, the adoption of risk
management techniques is still in infancy. It is desirable that decision
makers and managers review their risk management practices afresh and
devise anticipatory and proactive policies in order to have competitive
advantages internationally.

3. Financial and insurance theories explain that large widely-held corporations

manage corporate risks if doing so is cost-effective to reduce frictional
costs such as taxes, agency costs and financial distress costs. A large
number of previous empirical studies, most in the U.S., have tested the
hypotheses underlying corporate risk management with financial derivative
instruments. In order to quantify corporate hedge demand, most previous
studies have used the ratio of principal notional amount of derivatives to
company size, although they recognize that company size is not an
appropriate proxy for financial risk. This paper analyzes the interest-rate-
risk hedge demand by Australian companies, measured through the ratio of
principal notional amount of interest rate derivatives to interest-rate-risk
bearing liabilities. Modern panel data methods are used, with two panel
data sets from 1998 to 2003 (1102 and 465 observations, respectively).
Detailed information about interest-rate-risk exposures was available after
manual data collection from financial annual reports, which was only

26
 possible due to specific reporting requirements in Australian accounting
standards. Regarding the analysis of the extent of hedge, their measurement
of interest-rate-risk exposures generates some significant results different
from those found in previous studies. For example, this study shows that
total leverage is not significantly important to interest-rate-risk hedge
demand and that, instead, this demand is related to the specific risk
exposure in the interest bearing part of the firm's liabilities. This study finds
significant relations of interest-rate-risk hedge to company size, floating-
interest-rate debt ratio, annual log returns, and company industry type
(utilities and non-banking financial institutions).

4. The article deals with the development of an efficient asset/liability

management (ALM) process at the bank. ALM is one of the most important
functions for creating an optimal risk/reward trade-off in community
banking. The successful implementation of the ALM process is the
differentiating factor with regard to profitability among community banks.
Frequently, ALM is narrowly considered as market risk or interest rate risk
management. The committee responsible for managing the balance sheet is
called the Asset/Liability Management Committee (ALCO). The role of
ALCO is to manage assets, liabilities and capital along with managing
balance sheet risk.

5. The article explains how building connections between stress-testing and

contingency planning work in the liquidity risk management at financial
institutions. Three lines of defense employed by institutions to address
liquidity risk are key risk indicators, contingency planning and scenario-
based stress testing. Uses of scenario-based stress testing are tactical risk
management decisions, identification of potential weaknesses and

27
 vulnerabilities, contingency planning process, and setting limits and
comparing forecasted risk exposures to the risk limits

6. The article focuses on the challenges faced by banks on their compliance

with the rules that concern liquidity risk management which were
established by regulators such as the Basel Committee on Banking
Supervision, Committee of European Banking Supervisors and the Great
Britain Financial Services Authority (FSA). It states that the primary
challenge that confronts some banks is the need to understand the
requirements of the regulators despite the inconsistency of the rules that
each of them imposed. It adds that the requirements to use the stress tests
and calculate the liquidity buffer in the measurement of liquidity risk offer
a challenge among banks. Moreover, despite the rules provided by
regulators in liquidity risk management, many banks still failed to meet the
requirement.

7. The article discusses the significance of liquidity risk management as a

regulation for credit control firms in Great Britain. The author noted how
Chief Executive Hector Sants of the Financial Services Authority (FSA)
stressed the importance of liquidity risk like a capital for managing of
firms. The author presented issues surrounding FSA's guidance for liquidity
policies such as the systems and controls requirements and contingency
funding plan.

28
4. INDUSTRY PROFILE

4.1 INTRODUCTION

Banks in India as modern senses emerged only till 18th century. During the time of
the American Civil War, the supply of cotton to Lancashire stopped from
Americas. At that time some banks were opened, which functioned as entities to
finance industry, including speculative trades in cotton. Most of the banks opened
in India during that period could not survive and failed because of the high risk
which came with large exposure to speculative trades in cotton. In India in the
year 1786, The General Bank of India was the first bank to come into existence in
India and then in the year 1870 which is almost after a century The Bank of
Hindustan became the 2nd bank in India.

In India at least 94 banks failed during the years 1913 to 1918. This was really a
turbulent time for the world as a whole and the banking sector in India specially.
This was the period which witnessed the First World War (1914-1918). Since then
through the end of the Second World War (1939-1945), and two years thereafter
until India achieved independence, were very challenging period for Indian
banking. The years of the First World War were turbulent, and it took toll on
many banks which simply collapsed despite the Indian economy gaining indirect
boost due to war-related economic activities. There were at least 106 numbers of
banks which downed shutters during that period. Following is a table giving year
wise closed banks’ detail during the period:

29
 Number of Banks Authorised capital Paid-up Capital
Years
that failed (Rs Lakhs) (Rs. Lakhs)

1913 12 274 35

1914 42 710 109

1915 11 56 5

1916 13 231 4

1917 9 76 25

1918 7 209 1

30
4.2POST-INDEPENDENCE:

The partition of India bought about a social unrest throughout India in 1947. Riot
and chaos ruled. The most adversely impacted provinces were the Punjab and
West Bengal. So did the economies of both these provinces. As a result, the
banking activities had remained paralyzed for months. Till then the banking sector
was wide open and there were almost no regulation. Most of the promoters were
private players. With Independence, things started changing. Rather the
independence marked the end of a regime of the Laissez-faire for the Indian
banking. The new government initiated a process of playing an active role in the
economy of the nation. The Industrial Policy Resolution adopted by the
government in 1948 was the first step towards it. The resolution opted for a mixed
economy. This resulted into greater control and involvement of the state in
different segments of the economy, more so, in the sensitive sectors including
banking and finance. The important banking regulatory steps were as follows:

In 1948, India's central banking authority the Reserve Bank of India got
nationalized, and it became an institution owned by the Government of India.

With the enactment of the Banking Regulation Act in 1949, the Reserve Bank of
India (RBI) got empowered "to regulate, control, and inspect the banks in India."

The Banking Regulation Act also provided that no new bank or branch of an
existing bank may be opened without a license from the RBI, and no two banks
could have common directors.

Interestingly, despite these provisions, control and regulations, almost all banks in
India except the State Bank of India, continued to be owned and operated by

31
private persons. However, the situation changed dramatically with the
nationalization of major banks in India on 19th July, 1969.

4.3NATIONALISATION:

From Independence, it took some years for the banking sector to mature. By
1960s, the Indian banking industry did occupy an important position to facilitate
the development of the Indian economy. Moreover, it did employ a quantum
volume which could affect national economy. It resulted in a debate about the
possibility to nationalize the banking industry. At that point, during the annual
conference of the All India Congress Meeting, in a paper entitled "Stray thoughts
on Bank Nationalization", Indira Gandhi, the-then Prime Minister of India
expressed the intention of the GOI favouring nationalisation. The paper was
received with positive enthusiasm. Thereafter, in a swift and sudden move, the
GOI issued an ordinance and nationalised the 14 largest commercial banks with
effect from the midnight of July 19, 1969. The decision was even termed as a
"masterstroke of political sagacity" by non other than a leader of the stature of
Jaypraksh Narayan. Then, within the next fortnight of issuing the ordinance, the
Parliament passed the Banking Companies (Acquisition and Transfer of
Undertaking) Bill. The bill finally received the presidential approval on 9th
August, 1969.

In 1980, there came the second phase of nationalisation of 6 more commercial

banks. The reason forwarded for this was to have more control of credit delivery
by the government. By the time, GOI effectively got hold of 91% control of the
total banking business of India.

Till 1990s, all nationalised banks grew at a pace of around 4%, similar to the
average growth rate of the Indian economy.

32
4.4LIBERALIZATION:

• Since the launch of the economic liberalisation and global programme in 1991,
India has considerably relaxed banking regulations and opened the financial
sector for foreign investment. India is also committed to further open the
banking sector for foreign investment in pursuance to its commitment to the
World Trade Organsation(WTO)

• Licenses were issued to a small number of private banks, such as Global Trust
Bank (the first of such new generation banks to be set up)which later
amalgamated with Oriental Bank of Commerce, UTI Bank(now re-named as
Axis Bank), ICICI Bank and HDFC Bank. These banks also came to be known
as New Generation tech-savvy banks because of their improved service
condition and their extensive use of IT in the operations.

• This move instigated competition, resulting increased efficiency and

performance and did a lot of good to the banking sector. The rapid growth in
the economy of India, again as a result of liberalisation, also did help transform
the sector to this new look. The new situation shifted many goal posts. Till
then, the widely used method of 4-6-4 (Borrow at 4%; Lend at 6%; Go home
at 4) of functioning by the banks become redundant. Technology, competition,
change in customer behaviour, macro-economic conditions, government
policies, resultant of all together ushered a new modern, efficient and
innovating banking environment in India. People started receiving more from
the banks and also constantly started demanding more. Retail banking boom
can be attributed to this phenomenon.

33
• With the second phase of economic reforms, the next stage for the Indian
banking has been setup with the proposed relaxation in the norms for Foreign
Direct Investment, where all Foreign Investors in banks may be given voting
rights which could exceed the present cap of 10%. It’s notable that FDI
permissible limit, at present, has gone up to 49% with some restrictions.

34
4.5CURRENT SITUATION:

• Today, the banking sector in India is fairly mature in terms of supply,

product range and reach. As far as private sector and foreign banks are
concerned, the reach in rural India still remains a challenge. In terms of
quality of assets and capital adequacy, Indian banks are considered to have
clean, strong and transparent balance sheets relative to other banks in
comparable economies in its region. The Reserve Bank of India is an
autonomous body, with minimal pressure from the government. The stated
policy of the Bank on the Indian Rupee is to manage volatility but without
any fixed exchange rate. Till now, there is hardy any deviation seen from
this stated goal which is again very encouraging.

• With passing time, Indian economy is further expected to grow and be

strong for quite some time-especially in its services sector. The demand for
banking services, especially retail banking, mortgages and investment
services are expected to grow stronger. Therefore, it is not hard to forecast
few M&As, takeovers, and asset sales in the sector. Consolidation is going
to be another order of the day.
• The significant change in the policy and attitude that is currently being seen
is encouraging for the banking sector growth. In March 2006, the Reserve
Bank of India allowed Warburg Pincus, a private foreign investor, to
increase its stake in Kotak Mahindra Bank to 10%. Notably, this is the first
time that a foreign individual investor has been allowed to hold more than
5% in a private sector bank since 2000. Earlier, The RBI in 2005
announced that any stake exceeding 5% by foreign individual investors in
the private sector banks would need to be vetted by them.

35
• “Currently, India has 88 scheduled commercial banks (SCBs) - 28 public
sector banks (that is with the Government of India holding a stake), 29
private banks (these do not have government stake; they may be publicly
listed and traded on stock exchanges) and 31 foreign banks. They have a
combined network of over 53,000 branches and 17,000 ATMs. According
to a report by ICRA Limited, a rating agency, the public sector banks hold
over 75 percent of total assets of the banking industry, with the private and
foreign banks holding 18.2% and 6.5% respectively.”

• Despite the current global slowdown, despite the fear of US economic

recession, despite the volatility of Indian stock markets, every informed
observer is more or less optimistic about the 8% to 10% growth per annum
for the Indian economy till the next few years. Therefore, it can safely be
said that the banking industry in India will only surge ahead in coming
years. We can also expect to see many other sea changes in terms of their
operations, funding and structures. As they say, this is just the beginning!

• India has a strong and vibrant banking sector comprising state-owned

banks, private sector banks, foreign banks, financial institutions and
regional banks including cooperative banks, rural banks and local area
banks. In addition there are non-banking financial companies (NBFCs),
housing finance companies, Nidhi companies and chit fund companies.

• As monetary authority of the country, the Reserve Bank of India (RBI)

regulates the banking industry and lays down guidelines for day-to-day
functioning of banks within the overall framework of the Banking
Regulation Act, 1949, Foreign Exchange Management Act, 1999 and

36
 Foreign Direct Investment (FDI) policy of the government state owned
banks.

• The Indian banking sector is dominated by 28 state-owned banks which

operate through a network of about 50,000 branches and 13,000 ATMs.
The State Bank of India (SBI) in the largest bank in the country and along
with its seven associate banks has an asset base of about Rs. 7,000 billion
(approximately US$150 billion).

• The other public sector banks are Punjab National Bank, Bank Of Baroda,
Canara Bank, Bank Of India, IDBI Bank.

• The public sector banks have overseas operations with Bank of Baroda
topping the list with 51 branches, subsidiaries, joint ventures and
representative offices outside India, followed by SBI (45 overseas
branches/offices) and Bank of India (26 overseas branches/offices). Indian
banks, including private sector banks, have 171 branches and offices
abroad.

• SBI is present in 29 countries, Bank of Baroda in 20 countries and Bank of

India in 14 countries.

• Private sector banks India has 29 private sector banks including nine new
banks which were granted licenses after the government liberalised the
banking sector. Some of the well known private sector banks are ICICI
Bank, HDFC Bank and IndusInd Bank and the latest Yes Bank has recently
entered the private sector bank. In terms of reach the private sector banks

37
 with an asset of over Rs 5,700 billion (about US$124 billion) operate
through a network of 6,500 branches and over 7,500 ATMS.

• Foreign banks As many as 29 foreign banks originating from 19 countries

are operating in India through a network of 258 branches and about 900
ATMs. With total assets of more than Rs 2,000 billion (about 44 billion US
dollars) they are present in 40 centers across 19 Indian states and Union
Territories. Some of the leading international banks that are doing brisk
business in India include Standard Chartered Bank.

Foreign banks operating in India:

1. ABN-AMRO Bank N.V. (24 branches)

2. Abu Dhabi Commercial Bank Ltd. (2 branches)

3. Arab Bangladesh Bank Ltd. (1 branch)

4. American Express Bank (7 branches)

5. Antwerp Diamond Bank N.V. (1 branch)

6. Bank International Indonesia (1 branch)

7. Bank of America (5 branches)

8. Bank of Bahrain & Kuwait (2 branches)

38
9. Bank of Nova Scotia (5 branches)

10. Bank of Tokyo-Mitsubhai UFJ Ltd. (3 branches)

11. BNP Paribas (8 branches)

12. Bank of Ceylon (1 branch)

13. Barclays Bank Plc. (1 branch)

14. Calyon Bank (5 branches)

15. Citi Bank N.A. (39 branches)

16. Shinhan Bank (1 branch)

17. Chinatrust Commercial Bank (1 branch)

18. Deutsche Bank (8 branches)

19. DBS Bank (2 branches)

20. HSBC Ltd. (45 branches)

21. JP Morgan Chase Bank N.A. (1 branch)

22. Krung Thai Bank Public Co. Ltd. (1 branch)

23. Mizuho Corporate Bank Ltd. (2 branches)

39
24. Mashreq Bank PSC (2 branches)

25. Oman International Bank SAOG (2 branches)

26. Standard Chartered Bank (81 branches)

27. Sonali Bank (2 branches)

28. Societe General (2 branches)

29. State Bank of Mauritius (3 branches) The Netherlands-based ING Group has
taken over the management of the Indian private sector Vysya Bank Ltd. in
October 2002 and is operating as ING Vysya Bank Ltd.

40
4.6REGIONAL BANKS:

Rural areas in India are served through a network of Regional Rural Banks, urban
cooperative banks, rural cooperative credit institutions and local area banks. Many
of these banks are not doing well financially and the government is currently
engaged in restructuring and consolidating them. Local area banks were of recent
origin as on March 31, 2006 four such banks were operating in the country.

Financial institutions in India have seven major state-owned financial institutions

which include Industrial Development Bank of India, Industrial Financial
Corporation of India, tourism Finance Corporation of India, Exim Bank, Small
Industries Development Bank of India, National Bank for Agriculture and Rural
Development and National Housing Bank. These institutions provide term loans
and arrange refinance. These are also specialized institutions like the power
Finance Corporation, Indian Railway Finance Corporation, Infrastructure
Development Finance Company and state-level financial corporations.

India also has a vibrant NBFC sector comprising 13,000 NBFCs that are
registered with the RBI and fund activities like equipment leasing, hire purchase
etc. Out of the total about 450 NBFCs are allowed by the RBI to collect funds
from the public. Large NBFCs have an asset base of about Rs 3,000 billion

41
4.7 RECENT DEVELOPMENTS:

• State Bank of India has acquired 76% stake in Giro Commercial Bank, a
Kenya bank.
• Bank of Baroda is planning to acquire a bank in Africa to consolidate its
presence in the continent.
• Canara Bank is helping Chinese banks recover their huge non-performing
assets.
• ICICI banks is in the process of taking over Sangli Bank, a private sector
bank in Maharashtra.
• The RBI has recently allowed the commonwealth Bank of Australia,
Banche Popolari uniote S.c.r.l (based in Italy), Vneshtorgbank (Russia
trade bank), Prmsvyazbank (Russian commercial bank), Banca Popolare Di
VIcenza (Italian bank), Monte Dei Paschi Di Siena (Italian bank) and
Zurcher Kantonalbank (Swiss bank) to set up representative office in India.

42
4.8GOVERNMENT REGULATIONS:

Even though banking companies are registered under the companies Act, 1956
they are regulated by the RBI which grants license to companies for operating a
bank , operating branches and ff sit ATMs, fixes statutory liquidity ratio (SLR)
and cash reserve ratio , and lays down other conditions for day-to-day operations.
The RBI permission is also needed for board level appointments in banks. With
regard to interest rates, individual banks are free to fix rates with the expectation
of savings bank rate which is decided by the RBI. The individual banks are free to
fix lending rates.

43
5. COMPANY PROFILE

State Bank of India (SBI), Mumbai Main Branch

5.1HISTORY

The state Bank of India was established in 1955, its predecessor, the Imperial
Bank of India, was established in 1921, as a result of the amalgamation of the
three banks including Bank of Bengal, Bank of Bombay and Bank of Madras.
Since 1973, the bank has been involved in a non-profit activity called commodity
service banking. All the branches and administrative offices throughout the
country sponsor and participate in a large number of welfare activities and social
causes. State Bank of India opened its first offshore banking unit (OBU) in 2003.

44
The bank entered into an agreement with western union’s Kouni Travels to offer
inward remittance facilities in 2005. During2006, the bank faced huge disruptions
in its services on account of a week long strike by over 200,000 employees,
demanding upward revision of their pension benefits. Later the same year, the
bank announced that it would securitize 25-30% of its loan assets over the next
few years as an alternative source of funds. The bank also announced that it would
increase its overseas presence and would set up 60 new overseas offices in two
years.

SBI entered into wealth management and financial planning services to clients
who have INR0.5million or more in their accounts. SBI announced plan to roll out
banking services in 50,000 unbanked villages by March 2010. In2009, the bank
announced that got a full banking license from the regulator, the Dubai Financial
Services Authority.

45
5.2KEY AREAS OF OPERATIONS
The business operations of SBI can be broadly classified into the key income
generating areas such as National Banking, International Banking, Corporate
Banking, & Treasury operations.

46
5.3MANAGEMENT

The bank has 14 directors on the Board and is responsible for the management of
the Bank’s business. The board in addition to monitoring corporate performance
also carries out functions such as approving the business plan, reviewing and
approving the annual budgets and borrowing limits and fixing exposure limits. Mr.
O. P. Bhatt is the Chairman of the bank. The five-year term of Mr. Bhatt will
expire in March 2011. Prior to this appointment, Mr. Bhatt was Managing
Director at State Bank of Travancore. Mr. Bhatt has more than 30 years of
experience in the Indian banking industry and is seen as futuristic leader in his
approach towards technology and customer service. Mr. Bhatt has had the best of
foreign exposure in SBI. We believe that the appointment of Mr. Bhatt would be a
key to SBI’s future growth momentum. Mr. T S Bhattacharya is the Managing
Director of the bank and known for his vast experience in the banking industry.
Recently, the senior management of the bank has been broadened considerably.
The positions of CFO and the head of treasury have been segregated, and new
heads for rural banking and for corporate development and new business banking
have been appointed. The management’s thrust on growth of the bank in terms of
network and size would also ensure encouraging prospects in time to come.

47
5.4SWOT ANALYSIS

State Bank of India (SBI) is the leading commercial bank in India, offering
services such as retail banking, commercial banking, international banking and
treasury operations. Low cost CASA and reduced reliance on bulk deposits help
the bank reduce the cost of funds and thus improve profitability, but increasing
competition and tepid global interbank market could affect the bank’s market
share and financial performance.

48
STRENGTHS WEAKNESS
• The largest public sector bank in • Compared to foreign banks in
India and also one of the world’s India, SBI’s
top 100 banks in the world • overseas presence is minuscule
• Low cost CASA and reduced • Susceptible to political
reliance on bulk deposits interventions
• Prudent lending practices helping
control NPAs
OPPORTUNITIES THREATS

• New licenses and approvals • Opening of banking sector

likely to expand revenue and in2009 will cause intense
profits competition
• Investments in information • Teid global interbank lending
technology will decrease could derail overseas expansion.
transaction costs of SBI
• Growth in general insurance
industry will help SBI to increase
the market share
• SBS merger further hastens SBI
and its
• associate banks merger and
helping defend its leadership
position

49
5.5COMPETITORS AND OTHER PLAYERS:

TOP PERFORMING PUBLIC SECTOR BANKS

• Andhra Bank
• Allahabad Bank
• Punjab National Bank
• Dena Bank
• Vijaya Bank

TOP PERFORMING PRIVATE SECTOR BANKS

• HDFC
• ICICI Bank
• AXIS Bank
• Kotak Mahindara Bank
• Centurion Bank of Punjab

TOP PERFORMING FOREIGN BANKS

• Citi Bank
• Standard Chartered
• HSBC Bank
• ABN AMRO Bank
• American express

50
5.6 AWARDS

51
5.7DIFFERENT PRODUCTS OF SBI

DEPOSIT LOANS CARDS DIFFERENT

CREDIT CARDS

Savings Home Consumer SBI international

Account Loans Cards card
Life Plus Loan Credit Card SBI Gold Cards
Senior Citizens Against
Savings Property
Account
Fixed Deposits Personal Loans Travel Card SBI Gold Master
Cards
Security deposits Car Loan Debit Card Partnership Cards
Recurring Loan Against Commercial Card SBI employee
Deposits Securities Cards
Tax- Saver Fixed Two Wheeler Corporate Card
Deposits Loan
Salary Account Preapproved Loan Prepaid Card

Advantage Retail Asset Purchase Card

Woman Savings
account
Rural savings Farmer Finance Distribution Card
account
People’s Saving Business Business Card
Account Installment Loans
Freedom Savings Flexi Cash Merchant Services
Account

6. ANALYSES

52
MATURITY GAP ANALYSIS FOR LIQUIDITY RISK (SHORT TERM) THROUGH CASH FLOW APPROACH
(MARCH 200010)

1 to 14 15 to 28 29 days to Over 3 Over 6 Over 1 Over 3 Over 5

Days Days 3 Months Months to Months up Year up to Years up Years
6 Months to 1 Year 3 Years to 5 Years
Deposits 31,596.91 14,592.93 37,853.31 56,627.41 86,114.19 1,81,909.6 1,02,864.7 1,78,420.51
1 7

Borrowings 2,985.88 5,531.82 10,490.96 8,523.60 4,384.83 9,173.88 3,052.88 30537.79

FCL 4,319.68 9,152.31 14,704.28 15,303.10 14,831.34 17,878.41 6,550.34 1,677.01

Total Cash 38902.47 29,277.06 63,048.55 80,454.11 105,330.36 208,961.90 112,467.99 210,635.31
outflow(a)

Loans & 30,886.76 8,026.04 33,299.25 26,620.89 19,452.19 2,40,706.9 42,276.20 84,900.05
Advances 0

Investments 7,505.92 4,494.75 21,733.42 7,848.99 6,777.18 32,238.61 60,331.76 1,24,504.50

FCA 4,319.68 9,152.31 14,704.28 15,303.10 14,831.34 17,878.41 6,550.34 1,677.01

Total 77,918.80 38,851.45 117,740.48 91,696.97 75,344.24 290,823.92 157,984.84 211,081.56

Cash(b)

Gap(b-a) 39,016.33 9,574.39 54,691.93 11,242.86 -29,986.12 81,862.02 45,516.85 446.25

Cumulative 55,456.95 65,031.34 119,723.27 130,966.13 100,980.0 182,842.03 228,358.88 228,805.13

Gap

Total 9,64,432.0 9,64,432.0 9,64,432.0 9,64,432.0 9,64,432.0 9,64,432.0 9,64,432.0 9,64,432.08

Assets 8 8 8 8 8 8 8

Gap to 5.750 6.743 12.41 13.58 10.47 18.95 23.68 23.72

Total
Assets (%)

6.1STATEMENT OF INTEREST RATE SENSITIVITY

53
Generated by grouping RSA, RSL & OFF-Balance sheet items in to various (8)
time buckets.
RSA:
A) Money at call
B) Advances
C) Investment

RSL:
A) Deposits
B) Borrowings

6.2MATURITY GAP METHOD

Three options:
A) RSA>RSL= Positive Gap
B) RSL>RSA= Negative Gap
C) RSL=RSA= Zero Gap

6.3OBSERVATIONS OF THESTUDY

54
From the year ending March 31, 2000, banks are required to disclose the maturity
patterns of loans and advances, investments in securities, deposits and borrowings,
and foreign currency assets and liabilities. The data of the year ending March 31,
2010 has been used to conduct a Cash Flow Approach (short-term maturity gap)
analysis of assets and liabilities for different maturity buckets.

• The analysis of net funding requirements involves the construction of a

maturity ladder and the calculation of cumulative net excess or deficit of
funds at selected maturity dates. This is called "Cash Flow Approach" to
liquidity management.

• A maturity ladder of an 8 time bucket is used to compare SBI's future cash

inflows to its future cash outflows. Evaluating whether a bank is
sufficiently liquid depends in large measure on the behavior of cash flows
under different scenarios, such as normal conditions (going concern
scenario) or a bank specific crisis (the bank's liabilities cannot be rolled
over or replaced and will have to pay higher at maturity) or general market
crisis (liquidity affects all the banks or one or two markets).

• For evaluation of Cash Flow Approach, 1-14 days bucket, 15-28 days time
bucket and 29-90 days time buckets have been taken as the relevant time
frames for active liquidity management as it does not generally extend to
more than a few weeks. Since the SLR/CRR maintenance period is 14
days, meaningful information is arrived at by a short time horizon which is
stacked by many short periods (ranging up to 3 months by every week).

55
• In the year 2010, there was a positive gap in short-term liquidity, i.e., up to
6 months. Its short-term cash outflow was less than cash inflow which
means that SBI maintained a sound liquidity position, as shown in the
table.

• Other than in the bucket of 6 months to 1 year liquidity position shows

positive cumulative gap throughout its time. So its short-term liquidity was
maintained and during this period, SBI had a sound liquidity position.
• There was a negative gap between 6 months to 1 year (Rs. 29,986.12). But
at the end, i.e., in the 5 years ad above it had a positive cumulative gap
which shows that its medium-term liquidity risk could be maintained.

• Percentage of negative gap to cash out flow was 5.75 % in 1-14 days time
bucket, 6.74%in 15-28 days time bucket, 12.41% 29 to 3 months, 13.58%
3months to 6 months, 10.47% 6 months to 1 year, 18.95% 1 year to 3
years, 23.68%3 years to 5 years, 23.72% 5 years.

• Here RSA > RSL so it’s a positive gap.

56
6.4LIQUIDITY MANAGEMENT IN BANKS: THE CASH FLOW
APPROACH:

• Liquidity has been defined as the ability of an institution to replace liability run
off and fund asset growth promptly and at a reasonable price. Maintenance of
superfluous liquidity will, however, impact profitability adversely. It can also be
defined as the comprehensive ability of a bank to meet liabilities exactly when
they fall due or when depositors want their money back. This is a heart of the
banking operations and distinguishes a bank from other entities.

• Measuring and managing the liquidity needs are vital for effective operation of
commercial banks. By assuring a bank's ability to meet its liabilities as they
become due, liquidity management can reduce the probability of an adverse
situation developing. By measuring the liquidity positions of banks on an ongoing
basis, banks can examine how liquidity requirements are likely to evolve under
different conditions.

57
7. RECOMMENDATIONS

• A bank should set limits to control its liquidity risk exposure and
vulnerabilities. A bank should regularly review such limits and
corresponding risk escalation procedures. Limits should be relevant to the
business in terms of its location, complexity of activity, nature of products,
currencies and markets served.
• A bank should design a set of indicators to identify the emergence of
increased risk or vulnerabilities in its liquidity risk position or potential
funding needs. Such early warning indicators should identify any negative
trend and cause an assessment and potential response by management in
order to mitigate the bank’s exposure to the emerging risk.
• Market access is critical for effective liquidity risk management, as it
affects both the ability to raise new funds and to liquidate assets. Senior
management should ensure that market access is being actively managed,
monitored and tested by the appropriate staff.

• A bank should actively manage its intraday liquidity positions and risks to
meet payment and settlement obligations on a timely basis under both
normal and stressed conditions and thus contribute to the smooth
functioning of payment and settlement systems.

58
8. CONCLUSION:

• Mismatches can be positive or negative

• Positive Mismatch: M.A.>M.L. and Negative Mismatch M.L.>M.A.

• In case of +ve mismatch, excess liquidity can be deployed in money market

instruments, creating new assets & investment swaps etc.

• For –ve mismatch, it can be financed from market borrowings (Call/Term),

Bills rediscounting, Repo & deployment of foreign currency converted into
rupee.

• To meet the mismatch in any maturity bucket, the bank has to look into
taking deposit and invest it suitably so as to mature in time bucket with
negative mismatch.

59
BIBLIOGRAPHY

1. www.ebscohost.com
2. www.rbi.org.in
3. www.statebankofinda.com
4. Basel Committee report

60