CAIIB-RISK%20MANAGEMENT-%20ASSET%20LIABILITY%20MANAGEMENT%20

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CAIIB-RISK MANAGEMENT- ASSET LIABILITY MANAGEMENT
MODULE A

• G.R.RAO, Faculty, IIBF

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BANKING BUSINESS ON 26.09.2008

• figures in crores
• DEMAND DEPOSITS 4,96,673
• TERM DEPOSITS 29,45,465 34,42,138
• LOANS, CC,OD 24,36,890
• BILL FINANCE 1,05,577 25,42,467
• CASH DEPOSIT RATIO 9.91
• CREDT DEPOSIT RATIO 73.86

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BANKING BUSINESS Contd...

• C R R 9
• S L R 25
• TOTAL 34
• HOW BANKS MANAGE
• CREDIT CASH TOTALLING 83.77 OF DEPOSITS
• BORROWING TO DEPOSITS 11.74

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PRESENT DAY PRORITIES

• NET PROFIT WHICH IS OPERATING PROFIT - PROV.
  APPROPRIATIONS
• OPERATING PROFIT
• (OP) INT. INC. OTH. INC.
• NET.INT. INC.(NII) ALSO CALLED SPREAD INT.
  (EARNED SPENT)
• O.P. (INT. EARNED INT.SPENT)
• - OTHER (EXPNS. INC.)

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NII AND NIM

• BANKS WILL BE INTERESTED IN NIM AND WOULD LIKE TO
  SEE IT GROW
• NIM MANAGEMENT IS MAINLY ASSET AND LIABILITY
  MANAGEMENT
• IT MANAGES ASSETS AND LIABILITIES TO IMPROVE NIM
  UNDER A GIVEN RISK FRAME WORK

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ASSET LIABILITY MANAGEMENT

• ENSURE ACCEPTABLE NII / NIM AND LONG TERM
  IMPROVEMENT IN NET WORTH FOR A GIVEN RISK LEVEL
• INCLUDES PLANNING, ACQUIRING AND DEPLOYING FUNDS
  FOR ABOVE PURPOSE
• IT IS ONGOING PROCESS OF FORMULATING,
  MONITORING, REVISING AND FRAMING STRATEGIES
  RELATED TO ASSETS AND LIABILITIES

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ALM Contd

• ENCOMPASSES MANAGEMENT OF
• LIQUIDITY AND INTEREST RISKS
• AVOIDS VOLATILITY, HELPS PRODUCT INNOVATION AND
  COMPLIANCE OF REGULATIONS
• IN REGULATED ENVIRONMENT IT IS
• DAY TO DAY FUND MANAGEMENT FUNCTION ONLY

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ALM Contd..

• FROM BALANCE SHEET ANGLE
• RESERVE MAINTENANCE
• LIABILITY MANAGEMENT
• ASSET MANAGEMENT
• INVESTMENT MANAGEMENT
• CAPITAL MANAGEMENT
• LIQUIDITY MANAGEMENT
• FROM PL ANGLE
• SPREAD MANAGEMENT

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ALM- FUNDS MANAGEMENT

• INCOME ON FUNDS LENT SHOULD BE MAXIMUM
• EXPENSES ON FUNDS BORROWED SHOULD BE REASONABLE
• ENNSURING FUND AVAILABILITY IS LIQUIDTY
  MANAGEMENT
• AT REASONABLE COST IS INT. MGMT

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LIQUIDITY MANAGEMENT

• TO ENSURE SUPPLY OF NEEDED FUNDS FOR
• EXISTING BUSINESS AND NEW BUSINESS
• TAKE CARE OF MIS-MATACHES IN MATURITIES OF ASSETS
  LIABILITIES
• PROJECTS FINANCIAL STRENGTH TO SOCIETY AND
  BANKING SYSTEM WHICH IN TURN ENABLES EASY
  AVAILABILITY OF FUNDS AT REASONABLE COST

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HOW LIQUIDITY GETS AFFECTED

• DUE TO REGULATORY CHANGES
• DUE MARKET CHANGES BOTH EXISTING AND POTENTIAL
• DUE TO CUSTOMERS ACTIONS
• DUE TO CRYSTALLISATION OF CONTINGENT LIABILITIES
• DUE TO NPAs
• BIG FRAUDS

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LIQUIDITY MANAGEMENT

• ESTIMATION OF SIZE AND TIME OF FUND REQUIREMENTS
  CORRECTLY
• PLANNING APPROPRIATELY IN ADVANCE CONSIDERING
  COSTS AT DIFFERENT TIMES
• ACQUIRE FUNDS AT OPTIMUM COSTS

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LIQUIDITY MANAGEMENT

• WHY CASH FLOW ESTIMATES CAN GO WRONG
• DECREASE IN ANTICIPATED REALISATIONS BOTH
  PRINCIPAL INT.
• INCREASE IN NPA LEVELS BEYOND ESTIMATES
• SUDDEN SPURT IN ASSET BEYOND BANKS CONTROL

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LIUQUIDITY MANAGEMENT

• TYPES OF RISKS IN LIQUIDITY MGMT
• FUNDING RISK
• NEED TO PROVIDE FUNDS FOR
  UNEXPECTED OUTGOINGS
• TIME RISK
• NEED FOR COMPENSATING NON REALISED
  SOURCES
• CALL RISK
• CRYSTALLISATION OF CONTINGENCIES

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FOREIGN CURRENCY LIQUIDITY MANAGEMENT- PROCESS

• FINALISE STRATEGY (QUALITY QUANTITY) FOR
  EACH CURRENCY OF EXPOSURE
• STIPULATE LIMITS FOR TOLERANCES REG.
• MISMATCHES IN DIFFERENT TIME BANDS
• LOAN TO DEPOSIT AND LOAN TO CAPITAL
• LIQUID ASSETS TO ST LIAB.
• MEASURE, MONITOR AND MANAGE LIQUIDITY

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LIQUIDITY MANAGEMENT

• IDENTIFICATION OF PRIMARY AND SECONDARY RESOURCES
• DIVERSIFICATIONOF RESOURCES
• CRISIS SCENARIO STUDIES
• CONTINGENCY PLANNING

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DIFFERENT APPROACHES TO LIQUIDITY MANAGEMENT

• STOCK APPROACH FLOW A PPROACH
• IN FLOW APPROACH INFLOWS AND OUTFLOWS ARE
  MEASURED FOR DIFFERENT TIME BUCKETS AND UNDER
  DIFFERENT SCENARIOS LIKE
• NORMAL TIMES, BANK SPECIFIC CRISIS AND SYSTEMIC
  CRISIS AND FUNDING AVENUES IDENTIFIED

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RBI GUIDELINES

• GROUP LIKELY INFLOWS AND OUTFLOWS INTO DIFFERENT
  TIME BUCKETS AND PRESCRIBING MAX MISMATCH IN
  NEAR TERM BUCKETS
• 1 DAY 5
• 2-7 DAYS 10
• 8-14 DAYS 15
• 5-28 DAYS 20
• PERCENTAGES ARE MAX. FOR RESPECTIVE TIME BUCKET

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INTEREST RISK MANAGEMENT

• RISK OF INT. INC. GETTING AFFECTED
• DUE TO EXTERNAL FACTORS ONLY
• MARKET INTEREST RATES AND
• REGULATORY INTEREST RATES
• IMPACT WILL BE ON BOTH ADVANCES AND INVESTMENTS
• LIQUIDTY AND INTEREST RISK ARE NOT EXCLUSIVE
• NOT ALL ASSETS OR LIAB. WILL BE IMPACTED

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INTEREST RISK MANAGEMENT

• GAP OR MISMATCH RISK
• IT IS RISK DUE TO FUNDING OF ASSETS WHICH WILL
  REPRICE IN DIFFERENT PERIOD FROM THAT OF
  LIABILITIES
• BASIS RISK
• DUE TO DIFFERENT IMPACT ON ASSETS AND LIABILITIES
  IN THE SAME TIME BUCKET

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INTEREST RISK Contd

• EMBEDDED OPTION RISK
• INHERENT RIGHT WITH AN ASSET OR LIABILITY FOR
  REPRICING
• YIELD CURVE RISK OR RATE LEVEL RISK
• DUE TO CHANGES INITIATED BY REGULATOR/ MARKET
  FORCES
• VOLATILITY RISK
• SUDDEN VOLATILITIES IN MARKT. MORE IN CASE OF
  BORROWED FUNDS

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MEASUREMENT OF INTEREST RISK

• GAP METHOD AND ANALYSIS
• GROUP RATE SENSITIVE ASSETS AND LIABILITIES INTO
  DIFFERENT BUCKETS
• STUDY THE IMPACT OF INTEREST CHANGES BOTH
  POSITIVE AND NEGATIVE ON THE NIM
• DURATION METHOD
• MODIFIED DURATION METHOD
• SIMULATION APPROACH
• STATIC AND DYNAMIC SIMULATION

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GAP ANALYSIS

• GAP IS VE IF ASSETS gt LIABILITIES
• ? NII GAP ?r ( CHANGE IN INT. RATE)
• NIM NII / EARNING ASSETS(EA)
• GAP ?r ?NIM EA NIM EA ?C
• ?C IS ACCEPTABLE CHANGE IN NIM
• WORKING BACKWARDS YOU CAN ARRIVE AT THE
  ACCEPTABLE GAP FOR AN ACCEPTABLE ?C

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LIMITATIONS IN GAP METHOD

• GAP MAY NOT BE AMENABLE TO CHANGE TO SUIT DESIRED
  ?C
• PRESUMES THAT BOTH ASSETS AND LIAB. WILL BE
  UNIFORMLY IMPACTED
• DOESNOT TAKE INTO ACCOUNT TIME VALUE OF CASH
  FLOWS
• WHEN THERE IS SIGNIFICANT CHANGE EVEN THOSE WHICH
  ARE NOT TO BE REPRICED WILL BE REPRICED

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ADJUSTED DURATION

• IN THIS METHOD ASSETS AND LIABILITIES ARE GROUPED
  DEPENDING UPON THEIR EXTENT OF LIKELY IMPACT AND
  NOT INTO TIME BUCKETS BY ASSIGNING DIFFERENT
  WEIGHTS
• RATE ADJ. GAP ? WAI AI ? WLILI

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MODIFIED DURATION

• MODIFIED DURATION (MD) IS USED TO STUDY THE
  CHANGE IN PRICE OF AN ASSET DUE TO A CHANGE IN
  INTEREST RATE
• MD D/ (1 r) AND
• PC - MD ? r / 100
• PC IS CHANGE IN PRICE AND ? r IS CHANGE IN
  INTEREST RATE IN BASIS POINTS AND THIS IS USEFUL
  ONLY IN CASE OF SMALL CHNGES IN INTEREST RATES

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MANAGEMENT OF FOREX RISK

• TRANSACTION EXPOSURE
• CURRENCY RISK IN SPECIFIC FOREX TRANSACTION
  BETWEEN EXECUTION AND SETTLEMENT
• TRANSLATION EXPOSURE
• CURRECNY RISK INVOLVED AT THE TIME OF REPORTING
  TRANSACTIONS AT THE END OF ACCOUNTING YEAR TO
  H.O.
• OPERATING EXPOSURE

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FOREX RISK MGMT. TOOLS

• FORWARDS
• FUTURES-CURRENCY
• OPTIONS
• SWAPS
• MONEY MARKET INSTRUMENTS
• MONEYMARKETINSTRUMENTS CAN BE USED LIKE A FORWARD
  CONTRACT INMGMT. OF FOREX RISK

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RISK MGMT. IN DEALING ROOM

• OPEN POSITION
• OVERNIGHT AND DAY LIGHT LIMITS
• STOP LOSS LIMITS
• CAP ON SIZE OF TRANSACTION

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TWO PRACTICAL PROBLEMS ON DURATION ANALYSIS

• 1. ASSETS AND LIABILITIES OF FMG FINANCES
  ALONGWITH THEIR DURATION AND INTEREST RATRES ARE
  AS PER GIVEN TABLE. IDENTIFY RISK SENSITIVEGAP
  AND NIM. DURING AFORECASTING PERIOD OF 1YEAR IF
  INTEREST RATES FALL BY 2 WHAT WOULD BE
  IMPLICATION ON NIM
• 2. ABC BANK HAS EARNING ASSETS AMNOUNTING TO Rs
  1980 CRORES AND THEIR NIM IS 4. MANAGEMENTS
  POLICY SAYS THAT A 2.5 DEVIATION FROM NIM IS
  ACCEPTABLE. BANK FORECASTS THAT INTEREST RATES
  WOULD INCREASE BY 0.75 DURING NEXT12 MONTHS.
  WHAT SHOULD BE THE GAP OF THE BANK IF THEY HAVE
  TO BE WITHIN THE GIVEN RANGE OF NIM

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OBJECTIVE QUESTIONS

• 1. THE NEED TO REPLACE NET OUTFLOWS DUE TO
  UNANTICIPATED WITHDRAWAL OF DEPOSITS IS KNOWN AS
  ---------RISK.
• 2. THE NEED TO COMPENSATE FOR NON-RECEIPT OF
  EXPECTED INFLOWS OF FUNDS IS CLASSIFIED AS
  -----RISK.
• 3. CALL RISK ARISES DUE TO CRYSTALLISATION OF
  ------.
• 4. MATURITY LADDERS ENABLES THE BANK TO ESTIMATE
  THE DIFFERENCE BETWEEN-----AND------IN
  PREDETERMINED PERIODS.

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OBJECTIVE QUESTIONS

• Q. THE INSTITUTION IS IN A POSITION TO BENEFIT
  FROM RISING INTEREST RATES WHEN ASSETS ARE
  THAN LIABILITIES.
• A. LESSER.
• B. GREATER
• C. EQUAL
• D. HALF.
• Q. THE LIQUIDITY RISK ARISING OUT OF
  UNANTICIPATED WITHDRAWAL OR NON RENEWAL OF
  DEPOSITS IS CALLED AS
• A. FUNDING RISK.
• B. TIME RISK.
• C. MARKET RISK
• D. OPERATIONAL RISK.

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OBJECTIVE QUESTIONS

• Q.LIQUIDITY RISK ARISING OUT OF CRYSTALLIZATION
  OF LIABILITIES AND CONVERSION OF NON FUND
  BASED LIMITS TO FUND BASED LIMITS IS KNOWN AS
• A. CALL RISK.
• B. TIME RISK.
• C. OPERATIONAL RISK.
• D. MARKET RISK.
• Q. STOCK APPROACH OF MEASURING AND MANAGING
  LIQUIDITY RISK AND FUNDING REQUIREMENTS IS
  BASED ON
• A. LEVEL OF ASSETS AND LIABILITIES AND BALANCE
  SHEET EXPOSURE ON A PARTICULAR DATE.
• B. BASED ON STOCKS PLEDGED TO BANK IN CASH
  CREDIT ACCOUNT
• C. STOCK OF INVESTMENTS OF BANK.
• D. NONE OF ABOVE.

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OBJECTIVE QUESTIONS

• UNDER GAP METHOD THE NET FUNDING
• REQUIREMENT IS CALCULATED BASED ON
• A. RESIDUAL MATURITIES OF ASSETS AND
  LIABILITIES.
• B. ACTUAL MATURITIES OF ASSETS AND LIABILITIES
• C. BOTH THE ABOVE.
• D. NONE OF ABOVE.
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• Q. CASH INFLOWS ARISE FROM MAINLY
• A. MATURING ASSETS.
• B. MATURING LIABILITIES.
• C. MATURING OFF BALANCE SHEET EXPOSURE.
• D. MATURING TIME DEPOSITS.

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OBJECTIVES

• Q. IF THERE IS SIGNIFICANT DEFICIT OBSERVED SAY
  AFTER 30 DAYS PERIOD OPTION AVAILABLE FOR BANK
  IS TO
• A. ACQUIRE AN ASSET MATURING ON THAT DAY.
• B. RENEW OR ROLL OVER A 30 DAY LIABILITY.
• C. ACQUIRE A LIABILITY MATURING AFTER 30
  DAYS.
• D. NONE OF ABOVE.
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• Q. PRESENTLY NUMBER OF SUB DIVISIONS IN 1-14 DAYS
  
• TIME BUCKET FOR STRUCTURAL LIQUIDITY ARE
• A. FOUR.
• B. THREE
• C. FIVE .
• D. NONE OF ABOVE.

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OBJECTIVES

• Q. CAPITAL , RESERVES AND SURPLUS ARE SLOTTED IN
  WHICH TIME BUCKET IN STRUCTURAL LIQUIDITY
  STATEMENT
• A. OVER 5 YEARS.
• B. OVER 3 YEARS.
• C. OVER 1 YEAR.
• D. OVER 6 MONTHS.
• Q. SAVING AND CURRENT DEPOSIT MAY BE TREATED AS
  VOLATILE PORTION UPTO
• A. 10 AND 15 RESPECTIVELY.
• B.20 AND 30 RESPECTIVELY.
• C. 30 AND 40 RESPECTIVELY.
• D. NONE OF ABOVE

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OBJECTIVES

• Q. WHAT IS BASIS RISK
• A. RISK THAT INTEREST RATE OF DIFFERENT ASSETS
  AND LIABILITIES MAY CHANGE IN DIFFERENT
  MAGNITUDES IS CALLED BASIS RISK.
• B. RISK RELATING TO BASIS ON WHICH LOAN IS
  SANCTIONED.
• C. RISK RELATED TO YIELD CURVE.
• D. NONE OF ABOVE.
• Q. ONE OF THE STRATEGIES FOR REDUCING THE ASSET
  OR LIABILITY SENSITIVITY COULD BE
• A. INCREASE FLOATING RATE INSTRUMENTS.
• B. INCREASE FIXED RATE INSTRUMENTS.
• C. NONE OF ABOVE.
• D. ALL THE ABOVE.

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OBJECTIVES

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• Q. HIGHER THE DURATION IMPLIES THAT A GIVEN
  CHANGE IN THE LEVEL OF INTEREST RATES WILL HAVE
• A. LARGER IMPACT ON ECONOMIC VALUE.
• B. SMALLER IMPACT ON ECONOMIC VALUE.
• C. NO IMPACT.
• D. NONE OF ABOVE.
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• Q. DURATION WILL BE HIGHER IFA. LONGER THE
  MATURITY DATE OR SMALLER THE PAYMENTS THAT OCCUR
  BEFORE MATURITY ( COUPON PAYMENTS)
• B. SHORTER THE MATURITY AND HIGHER THE
  PAYMENTS THAT OCCUR BEFORE MATURITY ( COUPON
  PAYMENTS)
• C. NONE OF ABOVE.
• D. ALL THE ABOVE.

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OBJECTIVES

• Q. SHORT TERM DYNAMIC LIQUIDITY STATEMENT
  RELATE TO
• A. MONITORING LIQUIDITY ON DYNAMIC BASIS OVER A
  TIME HORIZON OF 1-90 DAYS.
• B. MONITORING LIQUIDITY ON DYNAMIC BASIS OVER A
  TIME HORIZON OF 7-90 DAYS.
• C. MONITORING LIQUIDITY ON DYNAMIC BASIS OVER A
  TIME HORIZON OF 28-90 DAYS.
• D. NONE OF ABOVE.
•  
• Q. IN STATEMENT OF INTEREST RATE SENSITIVITY
• A. ONLY RUPEE ASSETS AND LIABILITIES AND OFF
  BALANCE SHEET POSITIONS SHOULD BE REPORTED.
• B. ALL ASSETS AND LIABILITIES SHOULD BE
  REFLECTED.
• C. ONLY FOREIGN CURRENCY ASSETS AND LIABILITIES
  SHOULD BE REFLECTED.
• D. NONE OF ABOVE.

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THANQ WISH U ALL SUCCESS IN EXAM