A FINAL PROJECT REPORT

ON

“Asset Liability Management in YES

Bank”
In the partial fulfillment of the Degree of

bechelor of business administration under the University of

Rastrasant Tukdoji Maharaj Univercity

By

IRFAN KHAN
Under the Guidance of

Prof. Sagar Jadhav

SHANKARLAL AGRAWAL COLLEGE OF

MANAEGEMNT STUDIES

2018-19
 Certificate

This is to certify that the dissertation submitted in partial fulfillment for the
award of Bechular of Business administration Studies of Rashtrasant Tukdoji
Maharaj Univercity of Management Studies, is a result of the bonafide research
work carried out by Ms. Sagar Jadhav under my supervision and guidance. No
part of this report has been submitted for award of any other degree, diploma,
fellowship or other similar titles or prizes. The work has also not been published
in any journals/Magazines.

Place: Gondia

Faculty guide : Prof. Sagar Jadhav

 Student’s Declaration

I hereby declare that this report, submitted in partial fulfillment of the

requirement for the award for the becholer of business administration, to
Sankarlal Agrawal College Of Management Studies, is my original work and
not used anywhere for award of any degree or diploma or fellowship or for
similar titles or prizes.

I further certify that without any objection or condition I grant the rights to
Sankarlal Agrawal College Of Management Studies, to publish any part of the
project if they deem fit in journals/Magazines and newspapers etc without my
permission.

Place : Gondia

Ms. Sagar Jadhav

 ACKNOWLEDGEMENT

First, I would like to thank the Rastrasant Tukdoji Maharaj Univercity for
giving me the opportunity to make the project on subject “Asset Liability
Management in YES Bank” and explore my knowledge.

I would like to thank my college Sankarlal Agrawal College Of Management

Studies for giving a great opportunity to do work on this project.

I would like to thank Prof. Sagar Jadhav for his valuable advice and support;
in spite of her busy schedule, she was always there to give feedback and
guidelines whenever needed.

Thank you, Sir for mentoring and kind support for the accomplishment of the
project.

Hereby, I want to take the opportunity to thank all sources, people, guides who
helped me to get the required data.

I also express my gratitude to all those who have not been mentioned in this
report work but helped me in completing this report.

Place : Gondia

Ms. Sagar Jadhav

TABLE OF CONTENTS

1. Executive Summary

2. Introduction
3. ALM in the Indian Banking Industry
4. Generic Bank Risk Management Framework
5. Bank within a Bank
6. Company Profile
7. ALM System in Banks – RBI Guidelines
8. ALM Core Functions - Managing Interest Rate Risk, Structural Gaps & Liquidity
9. Literature Review
10. Benefits Of Asset Liability Management
11. Components of Financial Statement
12. Risk Managed in ALM
13. Asset Liability Committee – ALCO
14. Process of ALCO
15. Organisation Structure of ALCO
16. Elements of Asset Liability Management
17. Risk Measurement Techniques
18. Operations and Performance of Commercial Banks
19. Asset Liability Mismatches (ALM) in the Indian Banking Sector:
The Extent and Persistence
20. Off-Balance Sheet Operations of Scheduled Commercial Banks
21. Objective of the study
22. Asset Liability Mismatches in the Indian Banking Sector
23. Net Interest Margin of the Indian Banking Sector: Efficiency versus Profitability
24. Computation of performance measures
25. Comparison of Banks Using Ratio Analysis
Public Sector Banks
26. Private Sector Banks
27. Findings of the study
28. Recommendations
29. Conclusion
30. References
31. Annexures
EXECUTIVE SUMMARY
Executive Summary

ALM as a concept is gradually gaining importance in the Indian scenario.

The Asset Liability Management (ALM) process in a bank is multidimensional
in nature. It is the art of ensuring that the maturity profiles of assets match that
of liabilities and combines the techniques of asset management, liability
management and spread management into a cohesive process leading to an
integrated management of the total balance sheet. The process of ALM will
differ from bank to bank and the success of the technique depends upon how
effectively banks are able to forecast and manage the risks they carry and are
exposed to. Efficient liquidity and interest rate management are the two
important activities of the banks and financial institutions in maximizing their
income while controlling the risk exposure.

The deregulated interest rate environment has brought pressure on the

management of banks to maintain a good balance among spreads, profitability
and long-term viability. Over the last few years, there has been an intense
competition and banks have been required to take up strategic planning as an
exercise for asset-liability management in order to survive and grow in the ever
increasingly competitive and risky environment.

The Reserve Bank of India (RBI) has implemented the Basel II norms for the
regulation of Indian banks, providing a framework for banks to develop ALM
policies. The present study analyses asset-liability management in banks
operating in India using the asset-liability guidelines provided by the Reserve
Bank of India. The primary objective of the study was to compare the maturity
gaps in public, private and foreign banks in the Indian banking industry & How
Asset Liability Management can be used as an important tool for managing
liquidity risk and interest rate risk?
ALM is based on three pillars and they are ALM Information System, ALM
Organization and ALM Process. ALM brings to bear a holistic and futuristic
perspective to the balance sheet management. Banks provide services that
exposes them to various risks like credit risk, liquidity risk, interest rate risk to
name a few. It is therefore appropriate for banks to focus on ALM when they
face different types of risks.

There are different techniques used by banks for Asset Liability Management
and they are GAP analysis Model, Duration Gap analysis Model, Simulation
Model and Value at Risk.
INTRODUCTION
Introduction

Asset Liability Management (ALM) plays a critical role in weaving together the
different business lines in a financial institution. Managing liquidity and the
balance sheet are crucial to the existence of a financial institution and
sustenance of its operations. It is also essential for seamless growth of the
balance sheet in a profitable way.

Asset Liability Management (ALM) defines management of all assets and

liabilities (both off and on balance sheet items) of a bank. It requires assessment
of various types of risks and altering the asset liability portfolio to manage risk.
Till the early 1990s, the RBI did the real banking business and commercial
banks were mere executors of what RBI decided. But now, Bureau of Indian
Standards (BIS) is standardizing the practices of banks across the globe and
India is part of this process. The concept of asset liability management is of
recent origin in India. It has been introduced in Indian Banking industry with
effect from. 1st April, 1999. Asset liability management is concerned with risk
management and provides a comprehensive and dynamic framework for
measuring, monitoring and managing liquidity, interest rate, foreign exchange
and equity and commodity price risks of a bank that needs to be closely
integrated with the banks’ business strategy.

In recent times, even large multinational financial institutions were in a deep

liquidity crisis and in dire need of external intervention for survival. The
practical importance of ALM and Liquidity Management had been somewhat
underestimated. Even managements of large institutions, regulators, and
observers saw how well-reputed firms and trusted institutions folded up and
were not able to find a way out of the deep liquidity crisis. This resulted in
regulators attaching high importance to new measures needed to ensure a sound
liquidity management system. Consequently, regulators have enhanced and in
some geographies, thoroughly revamped, regulatory oversight on ALM and
liquidity management.

ALM has gained significance in the financial services sector in recent years due
to the dramatic changes that have occurred in the post-liberalization period.
There has been a vast shift in the borrowers’ profile, the industry profile and the
exposure limits for the same, interest rate structure for deposits and advances,
and so on. This has been accompanied by increased volatility of markets,
diversification of bank product profiles, and intensified competition between
banks on a global scale, all adding to the risk exposure of banks.

Thus, banks increasingly need to match the maturities of the assets and
liabilities, balancing the objectives of profitability, liquidity, and risk. To this
end, the Bank of International Settlements (BIS) has suggested a framework for
the banks to tackle the market risks that may arise due to rate fluctuations and
excessive credit risk. The Reserve Bank of India (RBI) has implemented the
Basel II norms for the regulation of Indian banks, providing a framework for
banks to develop ALM policies.

An effective ALM technique aims to manage the volume, mix, maturity, rate
sensitivity, quality and liquidity of the assets and liabilities as a whole so as to
attain a predetermined acceptable risk/reward ratio. The purpose of ALM is to
enhance the asset quality, quantify the risks associated with the assets and
liabilities and further manage them, in order to stabilize the short-term profits,
the long-term earnings and the long-run sustenance of the bank.

Banks are always aiming at maximizing profitability at the same time trying to
ensure sufficient liquidity to repose confidence in the minds of the depositors on
their ability in servicing the deposits by making timely payment of
interest/returning them on due dates and meeting all other liability commitments
as agreed upon. To achieve these objectives, it is essential that banks have to
monitor, maintain and manage their assets and liabilities portfolios in a
systematic manner taking into account the various risks involved in these areas.
This concept has gained importance in Indian conditions in the wake of the
ongoing financial sector reforms, particularly reforms relating to interest rate
deregulation. The technique of managing both assets and liabilities together has
come into being as a strategic response of banks to inflationary pressure,
volatility in interest rates and severe recessionary trends which marked the
global economy in the seventies and eighties and also till date.

Components of Financial Statement

Balance Sheet

Liabilities Assets

Capital Cash & Bank Balances

Reserves & Surplus Investments
Deposits Advances
Borrowings Fixed Assets
Other Liabilities & Provisions Other Assets
Contingent Liabilities
Liabilities

1. Capital: Capital represents owner’s contribution/stake in the bank. It serves

as a cushion for depositors and creditors. It is considered to be a long term
sources for the bank.
2. Reserves & Surplus: It includes Statutory Reserves, Capital Reserves,
Investment Fluctuation Reserve, Revenue and Other Reserves, Balance in
Profit and Loss Account
3. Deposits: This is the main source of bank’s funds. The deposits are classified
as deposits payable on ‘demand’ and ‘time’. This includes Demand Deposits,
Savings Bank Deposits and Term Deposits
4. Borrowings: Borrowings include Refinance / Borrowings from RBI, Inter-
bank & other institutions
a) Borrowings in India i.e. Reserve Bank of India, Other Banks and Other
Institutions & Agencies
b) Borrowings outside India

5. Other Liabilities & Provisions: It can be grouped as Bills Payable, Interest

Accrued, Unsecured redeemable bonds, and other provisions

Assets

1. Cash & Bank Balances: This includes cash in hand including foreign notes,
balances with Reserve Bank of India in current and other accounts
2. Investments: This includes investments in India i.e. Government Securities,
Other approved Securities, Shares, Debentures and Bonds, Subsidiaries and
Sponsored Institutions, Others and investments abroad.
3. Advances: Bills Purchased and Discounted, Cash Credits, Overdrafts &
Loans repayable on demand, Term Loans, Secured by tangible assets, Covered
by Bank/ Government Guarantees.
4. Fixed Assets: This includes premises, land, furniture & fixtures, etc.
5. Other Assets: This includes Interest accrued, Tax paid in advance/tax
deducted at source, Stationery and Stamps, Non-banking assets acquired in
satisfaction of claims, Deferred Tax Asset (Net) and others.

Asset Repayment Inflows into Banks

Cash 1 - 14 Days Bucket
Excess balance over required CRR
Bank Balance SLR shown under 1 - 14 Days
Bucket
Investments Respective Maturity Buckets
Advances Respective Maturity Buckets
other Assets Respective Maturity Buckets

Asset Repayment Outflows from the Banks

Capital Over 5 Years Bucket
Reserves & Surplus Over 5 Years Bucket
Respective Maturity
Deposits
Buckets
Respective Maturity
Borrowings
Buckets
Other Liabilities and Respective Maturity
Provisions Buckets
Respective Maturity
Contingent Liabilities
Buckets

Contingent Liabilities

Bank’s obligations under Letter of Credits, Guarantees, and Acceptances on

behalf of constituents and Bills accepted by the bank are reflected under this
heads.
Profit and Loss Account

Profit and Loss Account includes:

Income

1. Interest Earned: This includes Interest/Discount on Advances / Bills, Income

on Investments, Interest on balances with Reserve Bank of India and other
inter-bank funds
2. Other Income: This includes Commission, Exchange and Brokerage, Profit
on sale of Investments, Profit/ (Loss) on Revaluation of Investments, Profit
on sale of land, buildings and other assets, Profit on exchange transactions,
Miscellaneous Income.

Expenses

1. Interest Expense: This includes Interest on Deposits, Interest on Reserve

Bank of India / Inter-Bank borrowings and others.
2. Operating Expense: This includes Payments to and Provisions for
employees, Rent, Taxes and Lighting, Printing and Stationery,
Advertisement and Publicity, etc.
 ALM in the Indian Banking Industry

In its normal course, banks are exposed to credit and market risks in view of the
asset-liability transformation. There has been a wide range of changes at a fast
pace in the Indian financial markets due to its liberalisation over the last few
years and growing integration of domestic markets with external markets.
Therefore, the risks associated with bank’s operations have become complex
and large, thus requiring strategic management. Banks are now operating in a
fairly deregulated environment and are required to determine on their own,
interest rates on deposits and advance, in both domestic and foreign currencies
on a dynamic basis.

The interest rates on bank’s investments in government and other securities are
now market related. Also, intense competition for business involving both the
assets and liabilities together with increasing volatility in the domestic interest
rates as well as foreign exchange rates, has brought pressure on the management
of banks to maintain a good balance among spreads, profitability and long-term
viability.
Handling these pressures requires structured and comprehensive measures and
not just ad hoc action.

The Management of banks has to base their business decisions on a dynamic

and integrated risk management system and process, driven by corporate
strategy. Banks are exposed to several major risks in the course of their business
including credit risk, interest rate risk, foreign exchange risk, equity/commodity
price risk, liquidity risk and operational risks. Banks need to address these risks
in a structured manner by upgrading their risk management and adopting a more
comprehensive Asset-Liability Management (ALM) practices than has been
done before by other procedures.

ALM, among other functions, is also concerned with risk management and
provides a comprehensive and dynamic framework for measuring, monitoring
and managing liquidity, interest rate, foreign exchange and equity and
commodity price risks of a bank that needs to be closely integrated with the
bank’s business strategy. It involves assessment of various types of risks and
altering the asset-liability portfolio in a dynamic way in order to manage risks.
For this very reason, in the year 1998, the Reserve Bank of India (RBI)
forwarded guidelines for implementing ALM systems in banks. Based on the
feedback received from various banks, the final guidelines were revised by the
RBI, and implemented from the year 1999.

The objective of ALM is to manage risk and not eliminate it. Risks and rewards
go hand in hand. One cannot expect to make huge profits without taking a huge
amount of risk. The objectives do not limit the scope of the ALM functionality
to mere risk assessment, but expanded the process to the taking on of risks that
might conceivably result in an increase in economic value of the balance sheet.

Apart from managing the risks ALM should enhance the net worth of the
institution through opportunistic positioning of the balance sheet. The more
leveraged an institution, the more critical is the ALM function with enterprise.

The objectives of Asset-Liability Management are as follows:

▪ To protect and enhance the net worth of the institution.

▪ Formulation of critical business policies and efficient allocation of Capital.
▪ To increase the Net Interest Income (NII)
▪ It is a quantification of the various risks in the balance sheet and optimizing
of profit by ensuring acceptable balance between profitability, growth and
risks.
▪ ALM should provide liquidity management within the institution and choose
a model that yields a stable net interest income consistently while ensuring
liquidity.
▪ To actively and judiciously leverage the balance sheet to stream line the
management of regulatory capital.
▪ Funding of banks operation through capital planning.
▪ Product pricing and introduction of new products.
▪ To control volatility of market value of capital from market risk.
▪ Working out estimates of return and risk that might result from pursuing
alternative programs.
 Generic Bank Risk Management Framework

A broad scope of what managing a balance sheet typically involves in a commercial

bank.
 Bank within a Bank

Inflows and outflows pass through Group Treasury implying that ALM acts as the
Bank within bank.

The various lines of business and the financial products offered within a financial
institution invariably have a common touch point within the bank, as the Group
Treasury and ALM are responsible for managing the cash flows within the institution.
Viewed from an economic perspective, financial institutions are essential
intermediaries that create and absorb liquidity in the financial system. The financial
resources undergo a maturity transformation as they pass in and out of the bank. The
maturity transformation is influenced by the market demand and supply, the policies
and appetite of the financial institution and the market segments that the bank deals
with. The process of financial and maturity transformation inevitably results in the
financial institution undertaking significant maturity mismatch risk, interest rate risk
and foreign exchange risk apart from credit risk. The core functions of ALM and
Liquidity Risk Management enable financial institutions to manage and mitigate the
risks within accepted levels. Notably, financial institutions are increasingly inclined to
carry out this process profitably and seek to use optimal allocated capital.
COMPANY PROFILE
Yes Bank was incorporated as a Public Limited Company on
November 21, 2003. Subsequently, on December 11, 2003, RBI was
informed of the participation of three private equity investors namely
{Citicorp International Finance Corporation, ChrysCapital II, LLC and
AIF Capital Inc.), to achieve the financial closure of the Bank. RBI by
their letter dated February 26, 2004 provided their no-objection to the
participation of the three private equity investors namely Citicorp
International Finance Corporation, ChrysCapital II, LLC and AIF
Capital Inc. in the equity of the Bank at 10%, 7,5% and 7.5%,
respectively, and also advised the Bank to infuse a sum of Rs. 2000
million as the paid up capital. Additionally, the RBI advised the Bank
to submit an application for final approval after completion of all
formalities for incorporation as a banking company and setting out the
capital structure of the Bank as approved by RBI.

RBI by their letter dated December 29,2003 decided to further

extending `In Principle' approval for a period up to February 29, 2004
to allow the Bank to complete all financial arrangements.

Yes Bank obtained its certificate of Commencement of Business on

January 21, 2004. Subsequently, in March 2004, the Bank achieved
the mobilization of the initial minimum paid up capital of Rs. 2,000
million. Further, the Promoters by their letter dated March 29, 2004
made a final application for a banking licence under Section 22 (1) of
the Banking Regulation Act, 1949 providing complete details of the
capital structure, the composition of Board of Directors, the proposed
human resources, information technology, premises and legal-policies
and the business and financial plan of the Bank.

RBI by their letter dated May 24, 2004, under Section 22 (1) of the
Banking Regulation Act, 1949, granted us the licence to commence
banking operations in India on certain terms and conditions including
a term that 49.0% of our pre-Issue share capital held by the
Promoters (domestic and foreign) was to be locked-in for five years
from the licensing of the Bank, being May 24,2004. In our case, this
49.0% has been met by locking-in Equity Shares representing 29.0%
of the share capital held by Mr. Rana Kapoor and Mr. Ashok Kapur
and Equity Shares representing 20.0% of the share capital held by
Rabobank International Holding. See Note 2 in the section titled
"Capital Structure-Promoter Contribution and Lock-In" on page 13 of
this Red Herring Prospectus. Further, the terms of the banking license
granted to us by RBI require that the promoter holding in excess of
49%, shall be diluted after one year of the Bank's operation. It is also
stipulated that the paid up capital (which currently stands at 2,000
million) must be raised to Rs. 3,000 million within three years of
commencement of business.
ALM System in banks – RBI Guidelines

Over the last few years the Indian financial markets have witnessed wide
ranging changes at fast pace. Intense competition for business involving both
the assets and liabilities, together with increasing volatility in the domestic
interest rates as well as foreign exchange rates, has brought pressure on the
management of banks to maintain a good balance among spreads, profitability
and long-term viability. These pressures call for structured and comprehensive
measures and not just ad hoc action. The Management of banks has to base their
business decisions on a dynamic and integrated risk management system and
process, driven by corporate strategy. Banks are exposed to several major risks
in the course of their business - credit risk, interest rate risk, foreign exchange
risk, equity / commodity price risk, liquidity risk and operational risks.

This note lays down broad guidelines in respect of interest rate and liquidity
risks management systems in banks which form part of the Asset-Liability
Management (ALM) function. The initial focus of the ALM function would be
to enforce the risk management discipline viz. managing business after
assessing the risks involved. The objective of good risk management
programmes should be that these programmes will evolve into a strategic tool
for bank management.
The ALM process rests on three pillars:
1. ALM information systems
▪ Management Information System
▪ Information availability, accuracy, adequacy and expediency
2. ALM organization
▪ Structure and responsibilities
▪ Level of top management involvement
3. ALM process
 ▪ Risk parameters
▪ Risk identification
▪ Risk measurement
▪ Risk management
▪ Risk policies and tolerance levels.
Risk Managed in ALM

When we use the term “Risk”, we all mean financial risk or uncertainty of
financial loss. If we consider risk in terms of probability of occurrence
frequently, we measure risk on a scale, with certainty of occurrence at one end
and certainty of non-occurrence at the other end.

Risk is the greatest where the probability of occurrence or non-occurrence is

equal. As per the Reserve Bank of India guidelines issued in Oct. 1999, there
are three major types of risks encountered by the banks and these are Credit
Risk, Market Risk & Operational Risk. Asset Liability Management essentially
consists of managing the above referred to risks in an effective and efficient
manner.

The ALM function normally derives its charter from the Asset Liability
Committee (ALCO) framework, which sets out the scope of the ALM function,
the risk types that come under its purview and the acceptable levels of risk
appetite. Though the primary focus of ALM is managing balance sheet risks, the
ALM function increasingly tends to focus on balancing profitability while
managing risks, and in the process pro-actively seeks to guard the bottom line
and even maximize profitability.
The different types of risk encompassed in ALM and Liquidity Risk Management.

A). Market Risk

Market Risk may be defined as the possibility of loss to bank caused by the
changes in the market variables. It is the risk that the value of on-/off-balance
sheet positions will be adversely affected by movements in equity and interest
rate markets, currency exchange rates and commodity prices. Market risk is the
risk to the bank’s earnings and capital due to changes in the market level of
interest rates or prices of securities, foreign exchange and equities, as well as
the volatilities, of those prices. Market Risk Management provides a
comprehensive and dynamic frame work for measuring, monitoring and
managing liquidity, interest rate, foreign exchange and equity as well as
commodity price risk of a bank that needs to be closely integrated with the
bank’s business strategy.

Scenario analysis and stress testing is yet another tool used to assess areas of
potential problems in a given portfolio. Identification of future changes in
economic conditions like – economic/industry overturns, market risk events,
liquidity conditions etc that could have unfavourable effect on bank’s portfolio
is a condition precedent for carrying out stress testing. As the underlying
assumption keep changing from time to time, output of the test should be
reviewed periodically as market risk management system should be responsive
and sensitive to the happenings in the market.

1. Interest Rate Risk

Financial institutions borrow and lend for different terms and maturity tenors.
Apart from equity and retained earnings, the average maturity of borrowings
and liabilities tend to be on the short to medium term buckets. On the asset side,
the maturity tends to be across a broad range from overnight to as long as a
home mortgage could run. A financial institution is normally required to
participate in lending short, medium and long-terms depending on the nature of
financial products on offer and what segment of the market the bank operates
within.
 Types of Interest Rate Risk

Re-pricing Risk: The assets and liabilities could re-price at different dates and
might be of a different tenor. For example, a loan on the asset side could re-
price at three-monthly intervals whereas the deposit could be at a fixed interest
rate or a variable rate, but re-pricing half-yearly. Even if the loan and deposit re-
price similarly, the re-pricing dates do not synchronize.

Basis Risk: The assets could be based on LIBOR rates whereas the liabilities
could be based on Treasury rates or a Swap market rate.

Yield Curve Risk: The yield curve has the potential to change at different
points for differing terms. In other words, the changes are not always parallel
but it could be a twist around a particular tenor and thereby affect different
tenors differently.

Option Risk: The borrowers sometimes (or many times) have the ability to
prepay their borrowings based on contractual terms and conditions. Loan
contracts might have caps, floors, teaser rates, prepayment options and so on.
Exercise of options impacts the financial institutions by giving rise to premature
release of funds that have to be deployed in unfavourable market conditions and
loss of profit on account of foreclosure of loans that earned a good spread.

2. Credit Risk

Credit Risk is the potential that a bank borrower/counter party fails to meet the
obligations on agreed terms. There is always scope for the borrower to default
from his commitments for one or the other reason resulting in crystallisation of
credit risk to the bank. These losses could take the form outright default or
alternatively, losses from changes in portfolio value arising from actual or
perceived deterioration in credit quality that is short of default. Credit risk is
inherent to the business of lending funds to the operations linked closely to
market risk variables. The objective of credit risk management is to minimize
the risk and maximize bank’s risk adjusted rate of return by assuming and
maintaining credit exposure within the acceptable parameters.

Credit risk consists of primarily two components, viz Quantity of risk, which is
nothing but the outstanding loan balance as on the date of default and the
quality of risk, viz, the severity of loss defined by both Probability of default as
reduced by the recoveries that could be made in the event of default. Thus credit
risk is a combined outcome of Default Risk and Exposure Risk. The element of
Credit Risk is Portfolio risk comprising Concentration Risk as well as Intrinsic
Risk and Transaction Risk comprising migration/down gradation risk as well as
Default Risk. At the transaction level, credit ratings are useful measures of
evaluating credit risk that is prevalent across the entire organization where
treasury and credit functions are handled. Portfolio analysis help in identifying
concentration of credit risk, default/migration statistics, recovery data, etc.
In general, Default is not an abrupt process to happen suddenly and past
experience dictates that, more often than not, borrower’s credit worthiness and
asset quality declines gradually, which is otherwise known as migration. Default
is an extreme event of credit migration. Off balance sheet exposures such as
foreign exchange forward can tracks, swaps options etc are classified in to three
broad categories such as full Risk, Medium Risk and Low risk and then
translated into risk Neighed assets through a conversion factor and summed up.
The management of credit risk includes a) measurement through credit rating/
scoring,
b) Quantification through estimate of expected loan losses, c) Pricing on a
scientific basis and d) Controlling through effective Loan Review Mechanism
and Asset Liability Management .

A. Tools of Credit Risk Management.

The instruments and tools, through which credit risk management is carried out,
are detailed below:

a) Exposure Ceilings: Prudential Limit is linked to Capital Funds – say 15%

for individual borrower entity, 40% for a group with additional 10% for
infrastructure projects undertaken by the group, Threshold limit is fixed at a
level lower than Prudential Exposure; Substantial Exposure, which is the sum
total of the exposures beyond threshold limit should not exceed 600% to 800%
of the Capital Funds of the bank (i.e. six to eight times).

b) Review/Renewal: Multi-tier Credit Approving Authority, constitution wise

delegation of powers, Higher delegated powers for better-rated customers;
discriminatory time schedule for review/renewal, Hurdle rates and Bench marks
for fresh exposures and periodicity for renewal based on risk rating, etc are
formulated.

c) Risk Rating Model: Set up comprehensive risk scoring system on a six to

nine point scale. Clearly define rating thresholds and review the ratings
periodically preferably at half yearly intervals. Rating migration is to be mapped
to estimate the expected loss.

d) Risk based scientific pricing: Link loan pricing to expected loss. High-risk
category borrowers are to be priced high. Build historical data on default losses.
Allocate capital to absorb the unexpected loss. Adopt the RAROC framework.

e) Asset Liability Management : The need for credit Asset Liability

Management emanates from the necessity to optimize the benefits associated
with diversification and to reduce the potential adverse impact of concentration
of exposures to a particular borrower, sector or industry. Stipulate quantitative
ceiling on aggregate exposure on specific rating categories, distribution of
borrowers in various industry, business group and conduct rapid portfolio
reviews. The existing framework of tracking the non-performing loans around
the balance sheet date does not signal the quality of the entire loan book. There
should be a proper & regular on-going system for identification of credit
weaknesses well in advance. Initiate steps to preserve the desired portfolio
quality and integrate portfolio reviews with credit decision-making process.

f) Loan Review Mechanism: This should be done independent of credit

operations. It is also referred as Credit Audit covering review of sanction
process, compliance status, review of risk rating, and pick up of warning signals
and recommendation of corrective action with the objective of improving credit
quality. It should target all loans above certain cut-off limit ensuring that at least
30% to 40% of the portfolio is subjected to LRM in a year so as to ensure that
all major credit risks embedded in the balance sheet have been tracked. This is
done to bring about qualitative improvement in credit administration. Identify
loans with credit weakness. Determine adequacy of loan loss provisions. Ensure
adherence to lending policies and procedures. The focus of the credit audit
needs to be broadened from account level to overall portfolio level. Regular,
proper & prompt reporting to Top Management should be ensured.

B. Risk Rating Model

Credit Audit is conducted on site, i.e. at the branch that has appraised the
advance and where the main operative limits are made available. However, it is
not required to risk borrowers’ factory/office premises. As observed by RBI,
Credit Risk is the major component of risk management system and this should
receive special attention of the Top Management of the bank. The process of
credit risk management needs analysis of uncertainty and analysis of the risks
inherent in a credit proposal.

3. Liquidity Risk

Bank Deposits generally have a much shorter contractual maturity than loans
and liquidity management needs to provide a cushion to cover anticipated
deposit withdrawals. Liquidity is the ability to efficiently accommodate deposit
as also reduction in liabilities and to fund the loan growth and possible funding
of the off-balance sheet claims. The cash flows are placed in different time
buckets based on future likely behaviour of assets, liabilities and off-balance
sheet items. Liquidity risk consists of Funding Risk, Time Risk & Call Risk.

Funding Risk: It is the need to replace net out flows due to unanticipated
withdrawal/nonrenewal of deposit
Time risk: It is the need to compensate for non receipt of expected inflows of
funds, i.e. performing assets turning into nonperforming assets.
Call risk: It happens on account of crystalisation of contingent liabilities and
inability to undertake profitable business opportunities when desired.

The Asset Liability Management (ALM) is a part of the overall risk

management system in the banks. It implies examination of all the assets and
liabilities simultaneously on a continuous basis with a view to ensuring a proper
balance between funds mobilization and their deployment with respect to their
a) maturity profiles, b) cost, c) yield, d) risk exposure, etc. It includes product
pricing for deposits as well as advances, and the desired maturity profile of
assets and liabilities.

4. Forex Risk

Foreign exchange risk is the risk that a bank may suffer loss as a result of
adverse exchange rate movement during a period in which it has an open
position, either spot or forward or both in same foreign currency. Even in case
where spot or forward positions in individual currencies are balanced the
maturity pattern of forward transactions may produce mismatches. There is also
a settlement risk arising out of default of the counter party and out of time lag in
settlement of one currency in one center and the settlement of another currency
in another time zone. Banks are also exposed to interest rate risk, which arises
from the maturity mismatch of foreign currency position. The Value at Risk
(VaR) indicates the risk that the bank is exposed due to uncovered position of
mismatch and these gap positions are to be valued on daily basis at the prevalent
forward market rates announced by FEDAI for the remaining maturities.
Currency Risk is the possibility that exchange rate changes will alter the
expected amount of principal and return of the lending or investment. At times,
banks may try to cope with this specific risk on the lending side by shifting the
risk associated with exchange rate fluctuations to the borrowers. However the
risk does not get extinguished, but only gets converted in to credit risk.

5. Country Risk

This is the risk that arises due to cross border transactions that are growing
dramatically in the recent years owing to economic liberalization and
globalization. It is the possibility that a country will be unable to service or
repay debts to foreign lenders in time. It comprises of Transfer Risk arising on
account of possibility of losses due to restrictions on external remittances;
Sovereign Risk associated with lending to government of a sovereign nation or
taking government guarantees; Political Risk when political environment or
legislative process of country leads to government taking over the assets of the
financial entity (like nationalization, etc) and preventing discharge of liabilities
in a manner that had been agreed to earlier; Cross border risk arising on account
of the borrower being a resident of a country other than the country where the
cross border asset is booked; Currency Risk, a possibility that exchange rate
change, will alter the expected amount of principal and return on the lending or
investment. In the process there can be a situation in which seller (exporter)
may deliver the goods, but may not be paid or the buyer (importer) might have
paid the money in advance but was not delivered the goods for one or the other
reasons.

B). Operational Risk

Operational Risk is the risk of loss resulting from inadequate or failed internal
processes, people and systems or external factors. In order to control this, the
Bank primarily relies on its Internal Audit system. Furthermore, to monitor
operational risk on an ongoing basis, the Bank has set up an Operational Risk
Management Committee under the supervision of Sub-Committee of Board on
ALM and Risk Management. The Bank collects and analyses loss and near miss
data on operational risk based on different parameters on a half yearly basis and
takes corrective actions, wherever necessary.

C).Regulatory Risk

When owned funds alone are managed by an entity, it is natural that very few
regulators operate and supervise them. However, as banks accept deposit from
public obviously better governance is expected of them. This entails multiplicity
of regulatory controls. Many Banks, having already gone for public issue, have
a greater responsibility and accountability. As banks deal with public funds and
money, they are subject to various regulations.
The very many regulators include Reserve Bank of India (RBI), Securities
Exchange Board of India (SEBI), Department of Company Affairs (DCA), etc.
Moreover, banks should ensure compliance of the applicable provisions of The
Banking Regulation Act, The Companies Act, etc. Thus all the banks run the
risk of multiple regulatory- risk which inhibits free growth of business as focus
on compliance of too many regulations leave little energy and time for
developing new business. Banks should learn the art of playing their business
activities within the regulatory controls.
D).Environmental Risk

As the years roll by and technological advancement takes place, expectation of

the customers change and enlarge. With the economic liberalization and
globalization, more national and international players are operating the financial
markets, particularly in the banking field.
This provides the platform for environmental change and exposes the bank to
the environmental risk. Thus, unless the banks improve their delivery channels,
reach customers, innovate their products that are service oriented, they are
exposed to the environmental risk resulting in loss in business share with
consequential profit.

ALM Core Functions - Managing Interest Rate Risk, Structural Gaps

& Liquidity
The ALM core function consists of managing maturity gaps and mismatches
while managing interest rate risk within the overall mandate prescribed by
ALCO. The key responsibilities and some typical actions initiated by the ALM
team are dealt with in the following paragraphs:

1. Managing Structural Gaps

In a financial institution with a mature ALM function, this is arguably the most
critically and continuously monitored aspect, since the ALM Managers seek to
manage the structural gaps in the Balance Sheet. While liquidity management
focuses typically on short-term time ladders, the structural gap management
shifts the focus on time ladders more than a year. This aspect of ALM stresses
the importance of balancing maturities as well as cash flows on either side of
balance sheet. It strategizes dynamically on balancing the gaps, issuing timely
guidelines to adjust focus on ‘right’ product types and tenors, and actively
involve ALCO in this process.

a. Static Gap: The ALM function takes into consideration assets maturing in
short, medium and long time ladders and seeks to balance it vis-à-vis liabilities
maturing across short, medium and long term ladders. The gaps reports
typically point to funding gaps and excess funds at different points in time. The
challenge with the ALM function is that the gaps are dynamically evolving and
need continuous monitoring as the balance sheet changes every day.
b. Duration: Duration is considered as a measure of interest rate sensitivity.
However, for our immediate purpose, let us set aside interest rate sensitivity.
Macaulay’s duration is traditionally accepted as a good measure of ‘length’ of
portfolio or a measure of centre of gravity of discounted cash-flows over life of
an asset (or liability). It’s common practice to measure duration of portfolio for
different product types as well as on an overall portfolio level. It’s useful to
simulate how duration of portfolio will be affected by future events.
c. Dynamic Gap: It is normal practice to rely on dynamic gap reports to
simulate future gap positions for assumed business volumes and exercise of
options (e.g., prepayments). In addition to proposed new volumes, prepayment
transactions and assumed deposit roll-overs, the ALM manager would like to
include a proposed hedge transaction.
Let us assume that an international bank ABC averagely accumulates home
loans to the tune of $50 MN in a month and the loans are predominantly linked
to variable Swap Offer Rates (SOR). The bank likes to hedge its risk by
entering into a swap transaction in order that it is less prone to vulnerable
interest rates.
The bank will enter into a $50 MN swap with another financial institution, so by
design it receives SOR linked cash-flows and pays fixed as part of the swap
transaction. In this case, our international bank ABC would like to visualize
what its forecast gap positions and interest rate sensitive positions will look like
assuming that it would enter into a swap transaction say, one month from now,
by using a good ALM solution.

d. Long-Term Assets / Long-Term Liabilities Ratio: ALM practitioners

prefer to focus on the ratio of assets and liabilities exceeding one year and often
want to set acceptable limits around this. Where there are operative limits, the
ALCO meetings will usually monitor the ratio, and the institution constantly
endeavours to stay within a comfortable level around this limit. This along with
liquidity gaps help to bring in any imbalances and help maintain a structurally
sound balance sheet.

2. Managing Interest Rate Sensitivity

A financial institution typically relies on certain measures to evaluate and
manage interest rate sensitivities.
We deal with them below:
a. Interest Rate Sensitivity Gap Reports: The ALM function seeks to monitor
interest rate sensitivity by generating so-called interest rate sensitive gap
reports, which provide a cash flow laddering based on re-pricing profile and
frequency of interest rate sensitive assets and liabilities.

b. Duration Measures: Modified duration seeks to measure net present value

of a loan portfolio (or simply bond price) under different interest rate
conditions. For example, one seeks to analyze by how much percentage the
bond price will be affected by a basis point up and down move in interest rates.
The resulting outputs help us determine the modified duration or simply interest
rate sensitivity of the net present value or bond price.

c. DV01 or PVBP: This one is arguably the most popular measure among ALM
practitioners. DV01 seeks to calculate the dollar value by which the market
value is affected by a basis point expected movement in the interest rates. It’s
common to find leading banks setting internal limits around this measure to
manage interest rate risk in the balance sheet.

d. Net Interest Income (NII) Sensitivity: Financial institutions attach much

importance to assessing the impact of interest rate changes, new business,
change in product-mix and roll-over of deposits on net interest income. Income
statements that allow for comparison of net interest income under different
scenarios are immensely helpful in understanding the impact of mild market
movements and shocks on the income statement as well as balance sheet.

3. Managing Liquidity
Typically, the ALM function seeks to generate daily gaps on short-term ladders
and ensures that cumulative gaps operate within pre-set limits. Of course,
managing liquidity gaps alone is not adequate. A well managed liquidity
function will include liquidity contingency plan, liquid asset buffers and setting
liquidity policies and limits in tune with level of risk that the management
believes is acceptable and manageable.

4. ALCO Reporting
In most banks, ALCO meets at pre-determined intervals and the agenda is
usually pre-determined. In order that ALCO meetings are effective, the ALCO
pack (comprehensive in many cases) is distributed in advance and reviewed in
the meeting. The reports include some of what is listed above and certain other
reports. The ALCO function is critical to ALM function and serves as the
reviewing and approving authority for several key decisions including balance
sheet structure, gap analysis, capital adequacy ratios and above all pro-active
management of Balance Sheet.

5. Funds Transfer Pricing (FTP)

A healthy FTP mechanism is part of a healthy ALM solution FTP helps to
ensure the demarcation between market risk and credit risk by passing on the
appropriate cost of funds to respective owners of risk. In recent years, focus has
been placed on not just the base FTP, but also on including FTP add-ons like
liquidity premium and similar adjustments. Financial institutions appear to be
reviewing their FTP practices including the basis for liquidity premium both as
a result of process improvement and increasing regulatory interest.
 Asset Liability Committee – ALCO

The Asset-Liability Committee (ALCO) consisting of the bank's senior

management including CEO should be responsible for ensuring adherence to the
limits set by the Board as well as for deciding the business strategy of the bank
(on the assets and liabilities sides) in line with the bank's budget and decided
risk management objectives.

The ALM desk consisting of operating staff should be responsible for

analyzing, monitoring and reporting the risk profiles to the ALCO. The staff
should also prepare forecasts (simulations) showing the effects of various
possible changes in market conditions related to the balance sheet and
recommend the action needed to adhere to bank's internal limits.

The ALCO is a decision making unit responsible for balance sheet planning
from risk-return perspective including the strategic management of interest rate
and liquidity risks. Each bank will have to decide on the role of its ALCO, its
responsibility as also the decisions to be taken by it. The business and risk
management strategy of the bank should ensure that the bank operates within
the limits/parameters set by the Board. The business issues that an ALCO would
consider, inter alia, will include product pricing for both deposits and advances,
desired maturity profile of the incremental assets and liabilities, etc. In addition
to monitoring the risk levels of the bank, the ALCO should review the results of
and progress in implementation of the decisions made in the previous meetings.
The ALCO would also articulate the current interest rate view of the bank and
base its decisions for future business strategy on this view. In respect of the
funding policy, for instance, its responsibility would be to decide on source and
mix of liabilities or sale of assets. Towards this end, it will have to develop a
view on future direction of interest rate movements and decide on a funding mix
between fixed v/s floating rate funds, wholesale v/s retail deposits, money
market vs capital market funding, domestic v/s foreign currency funding, etc.
Individual banks will have to decide the frequency for holding their ALCO
meetings.

Top Management, the CEO/CMD or ED should head the Committee. The

Chiefs of Investment, Credit, Funds Management/Treasury (forex and
domestic), International banking and Economic Research can be members of
the Committee. In addition the Head of the Information Technology Division
should also be an invitee for building up of MIS and related computerization.
Some banks may even have sub-committees.

The size (number of members) of ALCO would depend on the size of each
institution, business mix and organizational complexity.

Committee composition

Permanent members:
▪ Chairman
▪ Managing Director/CEO
▪ Financial Director
▪ Risk Manager
▪ Treasury Manager
▪ ALCO officer
▪ Divisional Managers

By invitation:

▪ Economist
▪ Risk Consultants

Purposes and Tasks of ALCO:

▪ Formation of an optimal structure of the Bank’s balance sheet

to provide the maximum profitability, limiting the possible risk level;
▪ Control over the capital adequacy and risk diversification;
▪ Execution of the uniform interest policy;
▪ Determination of the Bank’s liquidity management policy;
▪ Control over the state of the current liquidity ratio and resources of the
Bank;
▪ Formation of the Bank’s capital markets policy;
▪ Control over dynamics of size and yield of trading transactions
(purchase/sale of currency, state and corporate securities, shares,
derivatives for such instruments) as well as extent of diversification
thereof;
▪ Control over dynamics of the basic performance indicators (ROE,
ROA, etc.) as prescribed in the Bank's policy.

Process of ALCO
 Organization Structure of ALCO

Elements of Asset Liability Management

There are nine elements related to ALM and they are as follows:

1. Strategic framework: The Board of Directors are responsible for setting the
limits for risk at global as well as domestic levels. They have to decide how
much risk they are willing to take in quantifiable terms. Also it is necessary
to determine who is in chare of controlling risk in the organization and their
responsibilities.
2. Organizational framework: All elements of the organization like the ALM
Committee, sub–committees, etc., should have clearly defined roles and
responsibilities. ALM activities should be supported by the top management
with proper resource allocation and personnel committee.
3. Operational framework: There should be a proper direction for risk
management with detailed guidelines on all aspects of ALM. The policy
statement should be well articulated providing a clear direction for ALM
function.
4. Analytical framework: Analytical methods in ALM require consistency,
which includes periodic review of the models used to measure risk to avoid
miscalculation and verifying their accuracy. Various analytical components
like Gap, Duration, Stimulation and Value-at-Risk should be used to obtain
appropriate insights.
5. Technology framework: An integrated technological framework is required
to ensure all potential risks are captured and measured on a timely basis. It
would be worthwhile to ensure that automatic information feeds into the
ALM systems and he latest software is utilized to enable management
perform extensive analysis, planning and measurement of all facets of the
ALM function.
6. Information reporting framework: The information – reporting
framework decides who receives information, how timely, how often and in
how much detail and whether the amount and type of information received is
appropriate and necessary for the recipient’s task.
7. Performance reporting framework: The performance of the traders and
business units can easily be measured using valid risk measurement
measures. The performance measurement considers approaches and ways to
adjust performance measurement for the risks taken. The profitability of an
institution comes from three sources: Asset, Liabilities and their efficient
management.
8. Regulatory compliance framework: The objective of regulatory
compliance element is to ensure that there is compliance with the
requirements, expectations and guidelines for risk – based capital and
liquidity ratios.
9. Control framework: The control framework covers the control over all
processes and systems. The emphasis should be on setting up a system of
checks and balances to ensure the integrity of data, analysis and reporting.
This can be ensured through regular internal / external reviews of the function.
 Risk Measurement Techniques
There are various techniques for measuring exposure of banks to interest rate
risks:

Gap analysis model

Measures the direction and extent of asset-liability mismatch through either
funding or maturity gap. It is computed for assets and liabilities of differing
maturities and is calculated for a set time horizon. This model looks at the
repricing gap that exists between the interest revenue earned 9n the bank's assets
and the interest paid on its liabilities over a particular period of time (Saunders,
1997). It highlights the net interest income exposure of the bank, to changes in
interest rates in different maturity buckets.

Repricing gaps are calculated for assets and liabilities of differing maturities. A
positive gap indicates that assets get repriced before liabilities, whereas, a
negative gap indicates that liabilities get repriced before assets. The bank looks
at the rate sensitivity (the time the bank manager will have to wait in order to
change the posted rates on any asset or liability) of each asset and liability on
the balance sheet. The general formula that is used is as follows:

NIIi= R i (GAPi)
While NII is the net interest income, R refers to the interest rates impacting
assets and liabilities in the relevant maturity bucket and GAP refers to the
differences between the book value of the rate sensitive assets and the rate
sensitive liabilities. Thus when there is a change in the interest rate, one can
easily identify the impact of the change on the net interest income of the bank.

Interest rate changes have a market value effect. The basic weakness with this
model is that this method takes into account only the book value of assets and
liabilities and hence ignores their market value. This method therefore is only a
partial measure of the true interest rate exposure of a bank.

Duration model
Duration is an important measure of the interest rate sensitivity of assets and
liabilities as it takes into account the time of arrival of cash flows and the
maturity of assets and liabilities. It is the weighted average time to maturity of
all the preset values of cash flows. Duration basic -ally refers to the average life
of the asset or the liability.

DP p = D (d R /1+R)
The above equation describes the percentage fall in price of the bond for a given
increase in the required interest rates or yields. The larger the value of the
duration, the more sensitive is the price of that asset or liability to changes in
interest rates. As per the above equation, the bank will be immunized from
interest rate risk if the duration gap between assets and the liabilities is zero.
The duration model has one important benefit. It uses the market value of assets
and liabilities.

Value at Risk
Refers to the maximum expected loss that a bank can suffer over a target
horizon, given a certain confidence interval. It enables the calculation of market
risk of a portfolio for which no historical data exists. It enables one to calculate
the net worth of the organization at any particular point of time so that it is
possible to focus on long-term risk implications of decisions that have already
been taken or that are going to be taken. It is used extensively for measuring the
market risk of a portfolio of assets and/or liabilities.
Simulation
Simulation models help to introduce a dynamic element in the analysis of
interest rate risk. Gap analysis and duration analysis as stand-alone too1 for
asset-liability management suffer from their inability to move beyond the static
analysis of current interest rate risk exposures. Basically simulation models
utilize computer power to provide what if scenarios, for example: What if:

▪ The absolute level of interest rates shift.

▪ There are nonparallel yield curve changes.
▪ Marketing plans are under-or-over achieved.
▪ Margins achieved in the past are not sustained/ improved.
▪ Bad debt and prepayment levels change in different interest rate
scenarios.
▪ There are changes in the funding mix e.g.: an increasing reliance on short
term funds for balance sheet growth.

This dynamic capability adds value to the traditional methods and improves the
information available to management in terms of:
▪ Accurate evaluation of current exposure of asset and liability portfolios to
interest rate risk.
▪ Changes in multiple target variables such as net interest income, capital
adequacy, & liquidity.
▪ Future gaps.

It is possible that the simulation model due to the nature of massive paper
outputs may prevent us from seeing wood for the tree. In such a situation, it is
extremely important to combine technical expertise with an understanding of
issues in the organization. There are certain requirements for a simulation model
to succeed. These pertain to accuracy of data and reliability of the assumptions
made. In other words, one should be in a position to look at alternatives
pertaining to prices, growth rates, reinvestments, etc., under various interest rate
scenarios. This could be difficult and sometimes contentious.

It is also to be noted that managers may not want to document their assumptions
and data is not easily available for differential impacts of interest rates on
several variables. Hence, simulation models need to be used with caution
particularly in the Indian situation. Last but not the least the use of simulation
models calls for commitment of substantial amount of time and resources. If we
cannot afford the cost or, more importantly the time involved in simulation
modeling, it makes sense to stick to simpler types of analysis.
Operations and Performance of Commercial Banks

The Indian banking sector performed better in 2017-18 over the previous year
despite the challenging operational environment. The banking business of
Scheduled Commercial Banks (SCBs) recorded higher growth in 2017-18 as
compared with their performance during the last few years. Credit grew at 22.9
per cent and deposits grew at 18.3 per cent in 2017-18 over the previous year.
Accordingly, the outstanding credit-deposit ratio of SCBs increased to 76.5 per
cent in 2017-18 as compared with 73.6 per cent in the previous year. Despite the
growing pressures on margins owing to higher interest rate environment, the
return on assets (RoA) of SCBs improved to 1.10 per cent in 2017-18 from 1.05
per cent in 2017-18. The capital to risk weighted assets ratio under both Basel I
and II frameworks at 13.0 per cent and 14.2 per cent, respectively in 2017-18
remained well above the required minimum of 9 per cent. The gross NPAs to
gross advances ratio declined to 2.25 per cent in 2017-18 from 2.39 per cent in
2017-18, displaying improvement in asset quality of the banking sector. Though
there was improvement in the penetration of banking services in 2017-18 over
the previous year, the extent of financial exclusion continued to be staggering.
The number of complaints received at the Banking Ombudsman offices
witnessed decline in 2017-18 over the previous year.

Performance of banks was conditioned by the dynamics of growth-inflation

trade-off

The Indian banking sector, which is the edifice of the Indian financial sector,
though weathered the worst consequences of the global financial turmoil to a
large extent, had to traverse through a challenging macroeconomic environment
during the post crisis period. Followed by the financial turmoil, the global
financial sector was generally turbulent mainly because of the European
sovereign debt crisis, and sluggish growth recovery in the Euro zone as also in
the US.

Banks operated in a challenging operational environment

During 2017-18, higher interest rate environment not only caused concerns
about slowdown in credit growth, but also increased the possibility of
deterioration in asset quality on the back of the possible weakening of the
repayment capacities of borrowers in general. The tight interest rate
environment also affected the profit prospects of commercial banks due to the
possibility of lower margins in 2017-18. During the year, the large credit intake
by some of the crucial sectors such as NBFCs and infrastructure, also raised
concerns about financial soundness through the potential build up of sectoral
credit booms. Large borrowings by the telecommunication companies to
participate in the auction of 3G spectrum, reduction in Government spending as
also the large currency holdings by the public due to high inflation made the
liquidity conditions more stringent in 2017-18.
Consolidated balance sheet of SCBs registered higher growth

The consolidated balance sheet of SCBs recorded higher growth in 2017-18 as

compared with the previous year. This is in contrast to the trend observed
during the last two years and signals a revival from the peripheral effects of
global financial turmoil. The higher growth in the consolidated balance sheet of
SCBs was contributed by all the bank groups except old private sector banks
(OPRBs), which recorded marginal deceleration in growth. The highest growth
was recorded by new private sector banks (NPRBs) followed by public sector
banks (PSBs). Yet, as at end-March 2018, almost three fourths of the total assets
of the banking sector belonged to PSBs followed by NPRBs (15 per cent). Old
private sector banks had the lowest share (around four per cent) followed by
foreign banks (FBs) (around seven per cent).

Liability side of the balance sheet was driven by capital, borrowings and,
other liabilities

On the liability side of the balance sheet, the growth was driven mainly by
borrowings, capital, and other liabilities and provisions. The recapitalization of
public sector banks by the Central Government, and the mobilization of funds
from the stock market through public issues by PSBs were the main factors
behind the growth of capital of SCBs in 2017-18. An interesting development
about the consolidated balance sheet of SCBs in 2017-18 was the deceleration
in the growth of savings bank deposits and demand deposits with a
corresponding acceleration in the growth of term deposits. This could be due to
the prevailing higher interest rate environment, making term deposits more
attractive as compared with demand and savings deposits.
 Asset side of the balance sheet was driven by loans and advances

On the asset side of the balance sheet, the growth was primarily driven by loans
and advances. There was a revival in credit growth across all the bank groups
except old private sector banks in 2017-18 as compared with the previous year
despite the tight interest rate environment. Credit growth in 2017-18 of new
private sector banks and foreign banks was particularly noteworthy when
compared with their performance during the last year. Notably, the growth of
investments of the banking sector witnessed deceleration in 2017-18 in
comparison with the previous year. The only exception to this general trend was
the new private sector banks, which recorded higher growth in investments in
2017-18 as compared with the previous year.

Major Assets of Scheduled Commercial Banks

1. Bank Credit: Growth of loans and advances witnessed acceleration

It is interesting to note that despite the widespread concerns with regard to

slowdown in credit off-take in the context of tight monetary policy, on a y-o-y
basis, the loans and advances of the banking sector recorded higher growth in
2010-11 as compared with the previous year. While the economic recovery
from the recent financial turmoil increased the demand for credit; from the
supply side, higher growth in deposits as well as growth in capital facilitated
higher credit growth. In contrast to the previous year’s trend, term loans grew at
a higher rate in 2010-11 as compared with the previous year. In 2010-11, new
private sector banks recorded significantly higher growth in term loans as
compared with the previous year, on the back of corresponding high growth in
term deposits mobilization.
 2. Investments: Growth of investments decelerated

Due to the accommodation of higher credit growth, there was an overall

deceleration in the growth of investments in securities in 2010-11 as compared
with the previous year. In 2010-11, almost three fourths of the total investments
of the banking sector were in Government securities held in India, mainly to
meet the SLR requirements prescribed by the Reserve Bank and to raise funds
from the short term money market. However, investments of the banking sector
in Government securities held in India recorded lower growth in 2010-11 as
compared with the previous year in tune with the reduction in SLR requirements
from 25 per cent to 24 per cent with effect from December 18, 2010.

3. Non-SLR investments declined

The non-SLR investments of SCBs witnessed a decline in March 2011 as

compared with those during the corresponding period of the previous year. This
was primarily due to a decline in the investments in commercial paper in 2010-
11 over those during the previous year. Investments in commercial paper are
short-term investments of the banking sector to reap economic gain out of short-
term surplus funds. The decline in such investments reflected tight liquidity
conditions during 2010-11. On the other hand, banks’ investments in shares
witnessed increase in 2010-11 over the previous year. Alongside, banks’
investments in bonds/ debentures also witnessed a marginal increase during
2010-11 as compared with the previous year.

International Liabilities and Assets of Scheduled Commercial Banks

International liabilities registered moderated growth

In 2010-11, international liabilities of the banking sector grew at a lower rate as

compared with the growth in international assets. Yet, the international
liabilities of the banking sector continued to be almost double of the
international assets of the banking sector in 2010-11 as in the recent past. The
growth in international liabilities was mainly led by growth in equities of banks
held by non-residents, Non-Resident Ordinary (NRO) deposits and foreign
currency borrowings.

International assets recorded higher growth

The growth in international assets was mainly led by foreign currency loans to
residents, outstanding export bills drawn on non-residents by residents and
Nostro balances.

Consolidated International Claims

Consolidated international claims recorded higher growth

The consolidated international claims of the banking sector registered higher

growth in 2010-11 as compared with the previous year. The sector-wise
composition of international claims showed that it was mainly claims on banks,
which led the growth in total international claims of banks.
Financial Performance of Scheduled Commercial Banks

Profitability: Consolidated net profits recorded higher growth

Despite widespread concerns with regard to profitability on account of higher

interest expenses on the one hand and, higher nonperforming assets and the
consequent higher provisioning requirements, and lower interest income on the
other, the financial performance of SCBs improved in 2017-18 as compared
with the previous year.

The consolidated net profits of the banking sector recorded higher growth in
2017-18, in contrast to the deceleration experienced in 2017-18, primarily
because of higher growth in interest income. The implementation of the Base
rate system with effect from July 1, 2017, which prohibited sub-prime lending
to the corporate sectors might have contributed to the higher interest income in
2017-18 apart from robust credit growth.

Off-balance sheet exposures (OBS) raise concern as its exact impact on the
soundness of the banking sector is uncertain. In the event of a default, the off-
balance sheet exposures can seriously damage the soundness of the banking
sector as demonstrated by the recent global financial turmoil. During the last ten
years, the OBS of the banking sector witnessed substantial growth, especially
that of new private sector banks and foreign banks.
 Comparison of Banks Using Ratio Analysis

Public Sector Banks

State Bank of India, Punjab National Bank & Bank of Baroda

Profitability Ratios
SBI PNB BOB
Interest Spread 4.12 4.67 4.6
Adjusted Cash Margin(%) 9.6 15.39 18.16
Net Profit Margin 8.55 14.56 17.18
Return on Long Term Fund(%) 96.72 108.49 89.23
Return on Net Worth(%) 12.71 22.12 20.2
Adjusted Return on Net Worth(%) 12.74 22.11 20.2
Return on Assets Excluding Revaluations 1,023.40 632.48 536.16
Return on Assets Including Revaluations 1,023.40 678.91 536.16

Management Efficiency Ratios

SBI PNB BOB
Interest Income / Total Funds 8.39 8.87 7.5
Net Interest Income / Total Funds 4.1 4.35 3.39
Non Interest Income / Total Funds 0.09 0.19 0.25
Interest Expended / Total Funds 4.29 4.52 4.11
Operating Expense / Total Funds 2.67 2.41 1.7
Profit Before Provisions / Total Funds 1.43 2.05 1.86
Net Profit / Total Funds 0.65 1.32 1.33
Loans Turnover 0.14 0.14 0.12
Total Income / Capital Employed (%) 8.48 9.06 7.75
Interest Expended / Capital Employed (%) 4.29 4.52 4.11
Total Assets Turnover Ratios 0.08 0.09 0.08
Asset Turnover Ratio 7.24 6.04 5.25
 Balance Sheet Ratios
SBI PNB BOB
Capital Adequacy Ratio 11.98 12.42 14.52
Advances / Loans Funds(%) 77.19 78.98 78.56
Debt Coverage Ratios
Credit Deposit Ratio 79.9 76.25 73.87
Investment Deposit Ratio 33.45 30.75 24.24
Cash Deposit Ratio 8.96 7.49 6.11
Total Debt to Owners Fund 14.37 15.62 14.55
Financial Charges Coverage Ratio 0.35 0.47 0.47
Financial Charges Coverage Ratio Post Tax 1.19 1.31 1.34
Leverage Ratios
Current Ratio 0.04 0.03 0.02
Quick Ratio 8.5 22.24 26.38
Private Sector Banks

Profitability Ratios
HDFC ICICI AXIS
Interest Spread -- -- 3.73
Adjusted Cash Margin(%) 18.28 11.47 18.71
Net Profit Margin 16.12 9.94 17.2
Return on Long Term Fund(%) 60.12 50.09 72.29
Return on Net Worth(%) 15.6 11.01 17.83
Adjusted Return on Net Worth(%) 15.7 11.37 17.87
Return on Assets Excluding Revaluations 549.97 480.15 462.77
Return on Assets Including Revaluations 549.97 480.15 462.77

Management Efficiency Ratios

HDFC ICICI AXIS
Interest Income / Total Funds 9.89 7.36 9.14
Net Interest Income / Total Funds 6.12 3.57 5.08
Non Interest Income / Total Funds -- 4.65 0.17
Interest Expended / Total Funds 3.76 3.79 4.06
Operating Expense / Total Funds 3.08 6.39 2.57
Profit Before Provisions / Total Funds 2.84 1.68 2.54
Net Profit / Total Funds 1.6 1.24 1.6
Loans Turnover 0.17 0.16 0.16
Total Income / Capital Employed(%) 9.89 12 9.3
Interest Expended / Capital Employed(%) 3.76 3.79 4.06
Total Assets Turnover Ratios 0.1 0.07 0.09
Asset Turnover Ratio 4.65 3.58 5.65
 Balance Sheet Ratios
HDFC ICICI AXIS
Capital Adequacy Ratio 16.22 -- 12.65
Advances / Loans Funds(%) 79.74 65.63 76.16
Debt Coverage Ratios
Credit Deposit Ratio 76.41 91.58 74.65
Investment Deposit Ratio 34.29 79.09 38.71
Cash Deposit Ratio 10.81 9.8 7.07
Total Debt to Owners Fund 8.14 4.69 9.96
Financial Charges Coverage Ratio 1.81 1.48 0.66
Financial Charges Coverage Ratio Post Tax 1.48 1.35 1.43
Leverage Ratios
Current Ratio 0.06 0.1 0.02
Quick Ratio 6.79 3.26 19.6
OBJECTIVE OF THE STUDY
Objective of the study

▪ To study the importance of ALM and its applications in the Indian

banking industry.
▪ To study the importance of ratio analysis and explore its uses in accessing
the ALM (Assets and Liabilities Management) in the Indian banking
industry.
▪ To study the management of assets and liabilities with reference to the
interest rate sensitivity in banks.
▪ To analyze the liquidity, solvency and profitability of the public and
private sector banks taken into consideration
▪ To analyse the Profit after Tax (PAT) and the Non-Performing Assets
(NPA) performance for the selected banks
▪ To study with comparison between public and private banks.
RESEARCH METHODOLOGY
 Research Methodology

▪ Type of research: The research methodology is descriptive in nature as it

involves fact-finding enquiries and reporting of what has happened or
what is happening.
▪ Data: Secondary data has being used for the analysis.
▪ Source of the secondary data: The source for the data is mainly the
CMIE (Centre for Monitoring Indian Economy) Database. Other sources
include RBI publications, Books, websites and, Newspaper articles.
▪ Statistical Tools: The statistical tools used for the study and the analysis;
include graphs, tables and ratios.
 Literature Review

This is an analytical research study. The bank under study is State Bank of
India, Bank of Baroda, Punjab National Bank, ICICI, HDFC, and Axis bank.
The banks were selected as they have undergone a lot of policy changes after a
lot of strategic moves. As a researcher wanted to know how this banks are
maintaining and managing their assets and liabilities portfolios especially in the
wake of various financial reforms, particularly relating to interest rate
deregulation. The secondary data was collected from the annual reports of all
Banks, circulars and reading material on ALM. Period of the study is year 2018-
2019 respectively.

Benefits of Asset Liability Management

It is a tool that enables bank managements to take business decisions in a more

informed framework with an eye on the risks that bank is exposed to. It is an
integrated approach to financial management, requiring simultaneous decisions
about the types of amounts of financial assets and liabilities - both mix and
volume - with the complexities of the financial markets in which the institution
operates.
FINDINGS OF THE STUDY
Findings of the study

1. PNB is better than other banks in regards to Profitability ratios.

2. For Management Efficiency Ratios: all banks are working hard and have
more or less same ratios.
3. SBI is good at managing its assets & liability (current ratio)
4. Axis bank is high on Profits ratios, Asset Turnover Ratio, and
Management Efficiency Ratios.
5. ICICI bank has high current ratio in comparison to other banks 0.1, where
as HDFC is better at all other balance sheet ratios, because In ICICI
Bank, interest rate risk is measured through the use of re-pricing gap
analysis and duration analysis. ICICI Bank also uses interest rate
derivatives to manage asset and liability positions. The bank is an active
participant in the interest rate swap market and is one of the largest
counterparties in India.
6. Public sector banks are doing better than private banks with all respects.
RECOMMENDATIONS
Recommendations

The two types of banks balance sheet risks include interest rate risk and
liquidity risks.
• So their regular monitoring and managing is the need of the hour.
• Banks should use the information about these risks as key input in their
strategic business planning process.
• While increasing the size of the balance sheet, the degree of asset liability
mismatch should be kept in control. Because, the excessive mismatch
would result in volatility in earnings.
• Banks can also use sensitivity analysis for risk management purpose. It is
found that the all bank are exposed to interest rate risk.
CONCLUSION
Conclusion

ALM was developed in the 1980s to help financial institutions control a sharp
increase in interest rate risk. Subsequently, it evolved into a set of techniques
that enable financial institutions to manage a much broader set of risks. ALM is
likely to play a growing role in financial institutions going forward.

In the future, the management of interest rate risk will be more important to the
performance of financial institutions. The removal of regulatory barriers,
combined with a trend toward consolidation, has created larger and more
complex institutions in need of more sophisticated risk management tools.
Regulators and rating agencies are focusing increasingly on the risk
management practices of the institutions they monitor. Finally, impressive
technological progress in the capture, transfer, and processing of data has made
sophisticated risk management techniques available to financial institutions.

The more bank managers will take advantage of these new developments to
improve the transparency and flexibility of their business. In large part because
they have adopted more systematic ALM, banks in developed markets offer
more diverse and complex products than their emerging-market counterparts.
An extension of that logic suggests that, even within developed markets, ALM
could be an important determinant of bank product strategy
BIBLIOGRAPHY
BIBLIOGRAPHY
1. RBI Guidelines on Asset Liability Management Practices in banks,
http://www.rbi.org
2. Basel committee on banking supervision (2001). Principles for the
management and supervision of interest rates risk, bank for international
Settlements.
3. http://www.thehindu.com/business/Industry/article2755287.ece
4. http://www.adb.org/documents/reports/consultant/42096-reg/42096-reg-
tacr.pdf
5. http://business-standard.com/india/news/rbi-again-warns-banksasset-
liability-mismatch/423227/
6. Sinkey, J.F. (1992). Commercial bank financial management (4th ed).
New York:
Maxwell Macmillan International Edition.
7. Annual Report of Bank for the years, (2010 - 2011).
8. http://www.moneycontrol.com/competition/statebankindia/comparison/S
BI
9. http://www.sify.com/finance/stockpricequote/State_Bank_of_India-
SBI/balancesheet.html
10.http://www.rbi.org.in/scripts/PublicationsView.aspx?id=12976
 QUESTIONNAIRE

Survey on investor’s views about Asset Liability

Management

Name:
Age:
Occupation:

Are you aware of services offered by portfolio manager?

Yes No

If yes, what types of services you are aware of ?

Management of Mutual fund investment

Management of Equities

Management of Money market investment

Advisory or consultancy services

Others

(If other please specify)

Would you want to hire a Asset Liability Management at present or

in future?

Yes No

If yes, for what type of services?

Investments in Mutual Funds Investments in Equities

Investments in Money market Investments in other[s]

(If other please specify)
Advisory or consultancy service
If No, why?
_____________________________________________________
_______________________________________________
What is the Percentage of commission that you are ready to pay to
Asset Liability Management for services provided by him in ?

Equities Money market investment

Mutual fund investment Advisory or consultancy

services

Other investment
(If other please specify)

Do you think there will be growth in Asset Liability Management in

future?

If Yes why?

If No, why?

What type of services would you want from Asset Liability

Management in future?

_____________________________________________________
_______________________________________________

Suggestions if any:
_____________________________________________________
_____________________________________________________
____________________________________________

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