Asset-Liability Management in Commercial Banks

Asset-Liability Management in
Commercial Banks
• Evolution of the Concept of ALM
• Concept of ALM,
• Objective of ALM
• Functions & process of ALM,
• Utility of ALM
• R BI guide lines
Evolution of the Concept of ALM
• In regulated economy, market risk was near zero in view

of stable interest rates , Fex rates , equity price ,
commodity price etc.
• In open economy , these rates fluctuate on demand &
supply position leading to severe competition between
the Banks to win the customers, ignoring the safety &
interest spread.
• The L P G policy followed by the Indian Govt in 1990 ,
threw open the Indian economy to market forces. This
lead to tough competition in the area of Interest Rates ,
new products , etc. resulting in enhancement of risks .
This kind of change in Economic scenario of the country
was cause for Asset Liability mismatch.
Concept of ALM
• It is essentially to matching Assets &
Liabilities in terms of Interest rate &
maturity to derive maximum yield on the
profile.
Objective of ALM
• The following Objectives:

-To control the volatility of net Interest
Income & net economic value of a bank,
-To control volatility in all target accounts,
-To control liquidity risk ,
-To ensure an acceptable balance
profitability & growth rate
Functions of ALM
• To advise the management about the
market risk profile of the Bank & the
impact of other business decision would
have on future risk profile .
• The ALM supports the management with
the information regarding competitive
pressures ,demand & supply factors in
relevant portfolios.
Process of ALM
• Planning ,Directing & Controlling the flow ,level ,
mix .costs, yield & duration of funds for the
purpose of maximising yield minimum financial
risks.
• Consists of;
-Identification of Risks ,
-Measurement & determination of risks,
-Enhancement of long term profitability for given
level of risks,
-Management of risks
Utility of ALM
• To plan for risks well ahead of the time before

they cause damage to the profitability ,
• To fix prices on the products in very competitive
way with maximum profit & acceptable risks.
• To ensure adequate liquidity in the system &
managing assets &Liabilities effectively
• Role of ALM is vital in case of exposure in Forex
to reduce the exchange risks
• The benefits of ALM overweigh the cost in
managing the ALCO
R BI guide lines
• 20-25% of the demand deposits including savings ,

should be considered as withdrawable on Demand &
shown under 1- 14 days time bucket .
• Banks should study the behavioral patterns of deposit on
the basis of historical trends &classify these in to two
portions ,namely core & volatile deposits.
Volatile deposits should be classified in 1-14 days
bracket , while core be placed in 1- 2years bracket.
• The Term deposits will fit in to respective maturity
bracket,
• N P A ,net of provision , should be shown under 2-5
years, while sub standard assets be shown in 1-2 years
buckets,
• Banks should study the behavioural & seasonal patter of
drawal in credit & classify the outflow as core & volatile.
Core should be shown in 1-2 years bracket , while
volatile should be shown as outflow of inflow.
• Excess balance over required CRR /SLR should be
shown under 1-14 day bracket
• The statutory CRR balance may be distributed under
various time buckets corresponding to the D T L placed
in their bucket with a time lag of 14 days.
• For borrowing on floating rate , the amount should be
distributed to the appropriate bucket referring to the
repricing date.
• Banks are not permitted to have negative gap in their out
flows for the next day.
Negative gap refers to mismatch in interest sensitive
liabilities exceed interest sensitive assets.
• Banks must adopt a more granular approach to
measurement of liquidity risk by splitting the first time
bucket of 1-14 in to three buckets of next day , 2-7 days , 8-
14 days . The net cumulative negative mismatches during
the next day , 2-7 days ,8-14 & 15 -28 days should not
exceed 5%, 10%, 15% & 20 % resp
• Banks are required to report these data to RBI on
Fortnightly basis .
• Banks can finance the gap from call money market , bill
rediscounting ,repos deployment of foreign currency
resources after conversion in to rupees
Maximising Market value of bank
equity
• Asset Management
• Liability Management
• Management of off –balance sheet activities ,
• Interest Rate Margin or spread Management ,
• Credit Risk management ,
• Liquidity Management
• Management of non interest expenses,
• Tax Management,
CAMELS Ratings
• C= Capital adequacy
• A=Asset Quality ,
• M= management Quality ,
• Earnings
• L=Liquidity
• S= sensitivity to Market risk
Profitability Ratios
• ROE= Net Income / Avg Total Equity
• RO A =Net income /Avg Total assets,
• Expenses ratio=Total expenses / Avg
Total assets
• Spread=Avg rate of Interest earned on
Loans & advances – Avg rate of Interest
paid on deposit
• Non interest Income/Avg Total Assets
• Non Interest Expenses /Avg Total assets
Other parameters
• In terms of Productivity ;
Business per employees,
Profit per employee,
Business Per Branch
• In terms of Operating Costs=Operating
expenses /Total Assets
• In terms of Profitability :
Net Profit/ Capital + deposits
• In terms of soundness:
Capital Adequacy
Asset Quality
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Asset-Liability Management in

• In regulated economy, market risk was near zero in view

• The following Objectives:

• To plan for risks well ahead of the time before

• 20-25% of the demand deposits including savings ,

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