89852038-ALM-Liquidity-Risk.ppt

ALM
 Asset Liability Management is the act of planning,
acquiring and directing the flow of funds through
an organisation. ALM aims at liquidity and
profitability taking reasonable and measured
business risk.
 Example : A financial institution may have
enough assets to payoff liabilities. But what if
50% of the liabilities are maturing within one
year but only 10% of assets are maturing within
same period. There is temporary insolvency due
to severe liquidity crisis.


ALM & Liquidity Risk
Asset Liability Management (ALM) is one of the
most important risk management functions in
bank.
ALM is concerned with strategic balance sheet
management involving risks caused by changes
in interest rate, exchange rate, credit risk and
the liquidity position of a bank.
Balance sheet items?
The ultimate objective of ALM process is to
generate adequate/ stable earnings and to
steadily build an organization’s equity overtime,
while taking reasonable and measured business
risks.
Significance of ALM: Minimise liquidity and
market risk.

ALM
 The primary management goal is the control of interest
income and expenses and the resulting net interest margin
on an ongoing basis.
 Parameters for stabilising ALM of banks are:
 Net interest income (NII). The impact of volatility on short
term profit is measured by NII.In order to stabilise short
term profit banks have to minimise fluctuation in the NII.
 Net Interest Margin :NII / Average total assets
 This can be viewed as the spread on earning assets.
 Economic Equity Ratio. The ratio of share holder’s fund to
the total assets. This assesses the sustenance capacity of
the bank.

ALM Contd.
 Objective of ALM: It aims at profitability through
price matching while ensuring liquidity by means
of maturity matching. ALM is the management of
the NIM.
 Asset Liability Management Committee (ALCO) of
the Bank.
 Price Matching : Rising interest rate with positive
gap ( assets> liability ) & declining interest rate
with a negative gap (Liability > assets ).
 Liquidity is ensured by grouping the assets and
liabilities based on their maturity profiles.

ALCO
 AlCO is a decision making unit responsible for
balance sheet planning from risk- return
perspective including the strategic management
of interest rate and liquidity risk.

 ALCO functions include inter alia product pricing
for both deposits and advances, desired maturity
profile and mix of the incremental assets and
liabilities etc.

Liquidity Management
 Bank’s liquidity position depends upon an
analysis of the following factors:
 Historical funding requirements
 Current liquidity position
 Anticipated future funding needs
 Sources of funds
 Options for reducing funding needs
 Present and anticipated assets quality
 Present and future earning capacity
 Present and planned capital position

Contd.
 Measuring and managing Liquidity risk :
 Necessary steps are
 1. Developing a structure for managing liquidity
risk
 2. Setting tolerance level and limit for liquidity
risk
 3. Measuring and managing liquidity risk
 Board should monitor the performance and
liquidity risk profile of the bank periodically
reviewing the relevant information on inflow and
outflow of cash.
 ALCO to formulate liquidity management
structure and execute effectively the liquidity
strategy, policies and procedures.

Contd.
 Setting tolerance level and limit for liquidity risk :
 Limit could be set on the following
 The cumulative cash flow mismatches over
particular periods say next day, next week, next
month, next year should be calculated
 8 time buckets as prescribed by the RBI. 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 outflow in each time bucket.

Contd.
 Measuring and managing Liquidity Risk :
 (i) Stock approach (ii ) Flow approach
 Under stock approach various ratios are
calculated to assess the liquidity position of a
bank.
 Under flow approach the three major dimensions
are:
 (a) Measuring and managing net funding
requirements
 (b) Managing market access, and
 © Contingency planning

Stock Approach
 Ratio of core deposit to total assets
 Net loans to total deposit ratio.
 Ratio of time deposit to total deposit.
 Ratio of volatile liabilities( Market borrowings)to total assets
 Ratio of short time liabilities to liquid assets
 Ratio of liquid assets to total assets
 Ratio of short term liabilities to total assets
 Ratio of prime asset to total assets

Flow Approach
 It is called gap method of measuring and managing
liquidity being practiced by Indian banks.
 It requires the preparation of structural liquidity gap report.
In this method net funding requirement is calculated on the
basis of residual maturities of assets and liabilities.
 Difference of outflow and inflow of cash in the future time
buckets is calculated.
 Incase the gap is negative the bank has to manage the
short fall. The analysis of net funding requirements involves
the construction of a maturity ladder.
 RBI has prescribed 8 time buckets for liquidity management
 by banks.

89852038-ALM-Liquidity-Risk.ppt

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