asset liability management canara bank

8/21/2019 Asset Liability Management Canara Bank

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CHAPTER -I

INTRODUCTION

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INTRODUCTION

ASSET LIABILITY MANAGEMENT

Banks should introduce the proposed ASSET LIABILITY MANAGAENT

(ALM) syste positi!ely "y April 1st 1###$ The introduction o% such procedure is

necessary to the isatches in the assets and lia"ilities o% the "anks& 'hich are

increasinly seen in the past$ Banks are eposed to se!eral a*or risks in the course o%

their "usiness$ Su o% the are credit risk & interest risk & %orein echane risk & price

risk & li+uidity risk and operational risk$ It is the risk 'ith respect to interest rate and

li+uidity that are souht to "e heded and anaed "y Asset ,Lia"ility Manaeent$

The -BI and ALM propose to di!ide assets into di%%erent tie "uckets dependin

on the aturity and cateory o% the assets$ The tie "uckets are supposed to "e used %or

identi%yin cuulati!e isatches and esta"lishin internal prudential liits 'ith in the

"anks the isatches that eists a%ter such and eercises should "e reported to the -BI

periodically$

The rational %or accessin risk on a continuin "asis is also to ensure that each

"ank has enouh at all ties to co!er the risks they incur& includin those arisin %ro

interest rate risk$ Till no'& "ank ha!e only %ocused on aintainin a prudent capital to

risk.'eihted assets ratio(/A-)& B0T LENING risk is not only risk$ Banks ha!e to

ensure that their capital co!ers all risks includin interest rate and li+uidity risks$

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OBJECTIVES OF THE STUDY:

To kno' the concept o% ALM in /ANA-A BAN3$

To study ALM Mechanis in Indian Bankin Sector$

To analy4e and understand the ALM procedure in /ANA-A BAN3

To study traditional ap analysis in anain li+uidity risk 5 interest rate risk$

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NEED FOR THE STUDY

Assets lia"ilities and anaeent (ALM) is a relati!ely ne' process the 'orld

o!er$ Its iportance 'as %irst reali4ed in the 1#78s in the 0SA& 'hen a nu"er o% sa!ins

and loan institutions& ha!in hue asset.ina"ility isatch on their "alance sheet& turned

insol!ent$

9ith ro'in copetition 'orld 'ide& pro%it arins o% %inancial interediaries

are reducin$ This coupled 'ith reater !olatility in the international interest rates& has

eant lo'er incoe %or these earnin& they ha!e adopted :aressi!e strateies& 'hich

ha!e increased their risk pro%ile su"stantially$ This led to the "ankruptcy o% soe hanks$

Thus& these institutions ha!e to "rin their le!el in anaea"le proportions& 'hile

not se!erely reducin their incoes$ -estructurin their "alance sheet can only do this$

Thus& the acti!ity o% asset lia"ility anaeent has recei!ed treendous iportance$

-isk in odern parlance is enerally thouht to "e ;the daner o% loss;$ It is enerally

associated 'ith the do'nside and not the upside o% a transaction$ In %inance theory&

ho'e!er& risk is de%ined as dispersion o% unepected outcoes due to o!eents in

%inancial !aria"les$ -isk is easured "y the standard de!iation o% unepected outcoes

or sia$ Also called !olatility$


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SCOPE OF THE STUDY:

The scope o% the study is con%ined to Li+uidity risk and Interest rate risk$

ALM in relation o% "anks co!ers a 'ide aut o% "oth sources and application

o% %unds$

Gro'in copetition %or the access to the sources and the need %or arrestin the

erosion o% net 'orth are the ain challenes in anain the lia"ilities$

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RESEARCH METHODOLOGY:

PRIMARY SOURCE:

Gathered in%oration "y interactin 'ith eployees o% /ANA-A

BAN3 in ALM departent 5 re%erred to Bank Li"rary "ooks related to ALM$

SECONDARY SOURCE:

-e%erred to ALM related articles %or !arious aa4ines and *ournals

like Bank >uest&

1/?AI analyst& I/?AI -eader etc$

ALM related aterial that is "ein pro!ided "y /ANA-A BAN3$

@arious 9e" sites pertainin to ALM$

ALM is the anaeent o% structure o% Balance sheet in such a 'ay that the

net earnins %ro interest in particular are aii4ed 'ith o!erall risk pre%erence

o% the institutions;


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LIMITATIONS OF THE STUDY:

In%oration relatin to the internal aspects reardin !arious ites is not pro!ided$

ere is no practical eposure in calculations$

Most o% the in%oration is %ro the Secondary ata$

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CHAPTER -II

REVIEW OF LITERATURE

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ASSET-LIABILITY MANAGEMENT:

-isk Manaeent and Asset Lia"ility Manaeent (ALM) are the "u44'ords

no' in the 'orld o% %inancial institutions and "anks especially in India %or the last =

years$ In case the readins all around tend to i!e a %eelin as i% the entire %inancial

syste is su"*ected to interest rate risk only no'& do not "e carried a'ay$ The

%rae'ork o% ALM "roadly co!ers the area o% interest rate risk& and credit risk$ The

le!el o% a'areness a"out the nature and ipact o% risks is at a !ery lo' le!el %or

historical reasons$ -BI has %orally issued uidelines to all "anks reardin interest

rate sensiti!ity and li+uidity aspect o% ALM$ Arua"ly& it is in their o'n interest "anks

should look at ALM& "ut it is perhaps appropriate %or --I to i!e instructions in this

reard since "ank ha!e "een used to carry out -BI instructions %or alost 68 years

'ith little proacti!e policies$ 9hile it is preature to state that "anks 'ill no' "e a"le

to anae risks& this is de%initely a step in the riht direction$

The dereulation o% doestic interest rates& !olatility in the doestic de"t and

%orein echane arkets and introduction o% ne' %inancial instruents has posed a

+uestion o% e%%icient li+uidity and interest rate risk anaeent 'ith in "anks$ Banks

a"ility to contain and anae these risks o"!iously has an ipact on the "otto line$

In a "ank& ho'e!er& there are endless speci%ic entries on the lia"ility side and also on

the assets side$ The areation there%ore& then presents a coplete picture o% "anks

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isatches$ -BI has circulated a dra%t o% asset.lia"ility uidelines& 'hich& as the

prea"le says is intended to ake "ank ali!e to the risks they carry$ Asset.Lia"ility

Manaeent (ALM) is the art o% ensurin that the aturity pro%iles o% assets atch

that o% the lia"ilities$ A lia"ility (deposit) once raised is typically %unded in to the

creation o% an asset$ The lia"ility has to "e s+uared o%%D the depositor& %or eaple has

placed the deposit %or = years$ But the asset ay ha!e a di%%erent aturity pro%ile$ It

ay ha!e one in to lon estation road pro*ect& 'herein the loan 'ill "e repaid a%ter

18 years$

In a "ank& ho'e!er& there are endless speci%ic entries on the asset as 'ell as

lia"ility side$ The areation there%ore& then& presents a coplete picture o% the

"atiks isatches$ There%ore& the ALM syste is not only a anaeent in%oration

syste& "ut also an ad!ance 'arnin syste o% the "anks sensiti!ity to ad!erse

chanes in the en!ironent$

WHAT IS ASSET LIABILITY MANAGAENT?

ALM is the anaeent o% structure o% "alance in such a 'ay that the net

earnin %ro interest in particular are aii4ed 'ith o!er all risk.pre%erence

o% the institutions$

It need to "e noted that ALM is an interated approach to

%inancial anaeent re+uirin siultaneous decision a"out the type o%

aount o% %inancial assets and lia"ilities& "oth i and !alue 'ith the

copleities o% the %inancial arkets in 'hich the institution operates$

Assue that the structure o% the eistin assets and lia"ilities is such that at the

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areate& the aturity o% the assets is loner than the aturity o% the

lia"ilities$ This 'ould epose to "ank to interest rate risk as the interest rate

can increase and decrease$ Thus the interest incoe can su%%er in the

process $This has to "e set riht either "y reducin the aturity o% assets or

increasin the aturity o% the lia"ilities$

Ad*usted "ank:s lia"ilities to eet loan deands& li+uidity needs and the sa%ety

re+uireents 'ith a %ocus on pro%it and lon ter operatin !ia"ility$

iscretionary %unds anaeent 'here the %ocal point is to increase or

decrease interest sensiti!ity %unds at the initiati!e o% the "ank$

irectin and controllin the %lo'& the eans& the cost and the yield o% the

consolidated %unds o% the "ank 'ith the eye on pro%it and lon.ter lia"ility$

Manaeent o% total "alance sheet lia"ilities 'ith reards to its si4e and

+uality$ Manain the net interest arin 'ith in the o!erall risk "earin

capacity o% the "ank$ It there%ore& in!ol!es +uanti%ication o% risk and conscious

decision.akin 'ith reard to asset lia"ility structure so as to aii4e

interest earnin 'ithin the %rae'ork o% percei!ed risk$

ALM helps "ankers in success%ully atchin the assets and lia"ilities in ters

o% rate and aturity 'ith a !ie' to o"tain optiu yield to sur!i!e in the dereulated

and copetiti!e en!ironent$

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WHY ASSET LIABILITY MANAGAENT

In pre.%inancial re%ors era& "anks 'ere su"*ected to control easures "y -BI in

all acti!ities undertaken "y the 'hich includesD

-eulated deposit interest rates$

Miniu lendin rates$

Adinistered prie lendin rates linked to "orro' accounts$

Generally %ied rates transactions& and Nu"ers o% instruents a!aila"le to

the user 'ere also liited$ All the a"o!e le%t the "ank 'ith 'idespread and

helped to aintain there "otto.lines at respecta"le le!els$

The re%ors process "rouhtD

?aced dereulation$

Ne' player$

Ne' instruents$

Ne' products at copetiti!e rates$

Nu"er o% risks such as credit risk& interest risk& disinterediation risk&

li+uidity risk& %orein echane risk and arket risk$

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In the liht o% the a"o!e de!elopent and to aintain and ipro!e the "otto.lines&

there has to "e soe syste in place 'hich should help to achie!e the orani4ational

o"*ecti!es$

Asset lia"ility anaeent is one such e%%ecti!e and iportant tool$ Thus& ALM is a

risk anaeent tool throuh 'hich arket risk associated 'ith the "usiness are

identi%ied& easured and onitored to aintainFoptii4e pro%its "y re.alininFre

.structurin asset and lia"ilities$

Iportant prere+uisites success%ul AI$M is a!aila"ility o% ade+uate& accurate and

epediency o% data$ Bankin is an acti!ity 'here "ank accept deposits %or the purpose o%

lendin$ It is also called interediation$

Banks do interediation 'ith an intention to earn pro%its$

9hile doin so& "anks are eposed to certain type o% risks$

OBJECTIVES OF ASSET LIABILITY MANAGAENT

Banks "ein %inancial interediaries deri!e their lon ter pro%ita"ility "y

e%%ecti!ely and e%%iciently acceptin in!estent %ro the pu"lic and trans%orin the to

a relati!ely sa%e port%olio o% credit "y !irtue o% their "etter access to arket in%oration

and epertise in apprisin credit propositions o% entrepreneurs$ By o%%erin custoers the

product.eposits& /redits& In!estents that are in hihest deand& the interediaries

earn hiher pro%its$ 9hile earnin pro%its& interediaries

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are also kno'n to pro!ide li+uidity deanded "y the arket and to an etent& also

pro!ide certain aount o% insulation %ro credit risk$ o'e!er& 'hile pro!idin these

ser!ices& interediaries are su"*ected to interest rate risk since the !alue o% the short.ter

lia"ilities and the lon.ter assets chane di%%erentially in response to interest rate

o!es$ And "ein hihly le!eraed& they are eposed to sini%icant interest rate risk and

losses could at tie& "e catastrophic i% not anaed properly$

ere coes :Asset Lia"ility Manaeent; as a tool pro!idin a deree o%

protection to "ank %ro interediation risk& there"y akin risk accepta"le$ It helps "ank

in.Maii4ation o% incoe throuh.

Spread Manaeent

Li+uidity Manaeent

/apital Manaeent

Gap Manaeent

By assessin the ipact and choosin optial co"ination at

@arious Asset Mies$

@arious %und co"inations$

riceF@olue relations and

Interest rate !ariations$

And anain risk eposure !i4$

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/redit -isk$

Interest -ate -isk$

Li+uidity -isk&

Market -isk$

/apital -isk$

ASSET LIABILITY MANAGAENT:

It is "asically a tool %or li+uidity and interest rate risk anaeent$ Bulk o% the

"ank:s pro%it coes %ro net interest incoe and hence the paraount need to easure&

control and anae interest rate eposure$ It is no eaeration to state that any

%inancial institutions %ailed isera"ly "y isanain the interest rate risk e$$ ousin

%inance copanies o% 0SA$ These institutes used to collect short.ter deposits cheaply

and lend on lon ter %ied interest rate %or housin$ 9ith dereulation o% interest rates&

the short.ter deposit rates ha!e one up leadin to poor spread and ultiate collapse$

ALM has thus "ecoe an a"solute necessity$

re.-e+uisites %or success%ul ALM

1$ Easy access to "ank:s lia"ilities %or potential in!estors$

2$ Interest rates on "ank:s assets and lia"ilities to "e copetiti!ely deterined$

6$ ?a!ora"le reulatory %actor$

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HOW TO PRACTISE ASSET LIABILITY MGMT:

Success%ul ipleentation o% ALM in!ol!es .

1$ /hoosin a suita"le lenth o% plannin hori4on. one& t'o& three onths ahead$

1$ 9orkin out estiates o% return and risk that iht result %ro pursuin

alternati!e proraers& and

2$ ?inally& choosin a odel that yields a sta"le reardless o% the le!el or

o!eent consistently$ The task o% eneration o% desired net interest re!enues

reardless o% the le!el or o!eent o% interest rates is achie!ed priarily

Estiation o% core sources o% %unds& core deposit& /s and call

"orro'ins$

rudential anaeent o% %unds in respect o% si4e and pattern$

Minii4in undesira"le aturity isatchH and

-educin the ap "et'een rate sensiti!e assets and rate sensiti!e

Lia"ilities 'ithin a risk takin capacity$

WHAT IS RISK?

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The risk is nothin "ut a possi"le loss or daae oin to occur$ It has to "e

anaed and cannot "e eliinated to earn aiu pro%its$ There are three types o%

iportant risks in!ol!ed in the "ankin acti!ity$

/redit risk$

Market risk$

peration risk$

and lon.ter hori4ons$ Based on this& they are to assess their !ulnera"ility to ad!erse

chanes& and$ there%ore& protect the in ad!ance$

Interestinly& in the international arket& the reulator dose not onitors the ALM

%unction o% the "anks under its chares$ It is internally oti!ated and not reulated$

Manain risk is the inherent %unction o% a "ank& hut "anks ha!e inored house$ Althouh

soe %ront line "anks ha!e ALM syste in place& there are se!eral "anks that do not ha!e

sophistication o% akin isatches in assets and lia"ilities$

The -BI is tryin to assist these "anks "y pro!idin the 'ith an educati!e

uideline o% anain assets and lia"ility$ Li+uidity risk is the risk o% a "ank suddenly

%indin itsel% strapped %or cash$ This arises i% the aturity pro%iles o% assets and lia"ilities

do not atch$ The o"*ecti!e o% ALM is to ensure that the "ank is li+uid enouh to eet

all its lia"ilities$

The -BI is tryin to ensure that the short.ter lia"ility should not "e used to eet

lon.ter assets$ The -BI 'anted to discourae "anks %ro "orro'in short and

in!estin lon$ Soe "anks 'ere "orro'in %ro the call oney arket and in!estin in

#8.days coercial papers$

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"!iously& i!en that the total "asket o% assets and lia"ilities is ade up o% di!erse

interest."earin securities any chane in the interest rate scenario ipact "anks

di%%erentially$ Accordin to a study paper prepared "y the Basle /oittee

on "ank super!ision& althouh this risk is a noral part o% "ankin& ecessi!e interest rate

risk can pose a sini%icant threat to a "ank:s earnins and capital "ase$ /hanes in interest

rates also a%%ect the underlyin !alue o% the "ank:s assets& lia"ilities and o%% "alance sheet

instruents "ecause the present !alue o% %uture cash %lo's chanes 'hen the interest rate

structure chanes$ Thus& an e%%ecti!e risk anaeent processes re+uire that "ank

aintain their interest rate risk 'ith in prudent le!els& said the "anks analysts$

HOW THE BANK MANAGES INTEREST RATE RISK THROUGH

ASSET LIABILITY MANAGAENT

Asset Lia"ility Manaeent (ALM) in "anks is kno'n as the process o% ad*ustin

the lia"ilities to eet the desired loan deands& li+uidity needs and sa%ety re+uireents$

A coprehensi!e ALM policy %rae'ork %ocuses on "ank pro%ita"ility and lon.

ter !ia"ility "y taretin a net interest arin (NIM) ratio su"*ect to soe "alance sheet

constrains$ Sini%icant aon these constraints are aintainin credit +uality& eetin

li+uidity needs and o"tainin su%%icient capital$ Minii4in the "urden also ets

interated to eet the o!erall "ank o"*ecti!es$ A success%ul ALM re+uires a

coprehensi!e dereulation o% interest rates coupled 'ith a arket.dri!en asset.lia"ility

allocation and a %a!ora"le reulatory attitude$ The latter& prere+uisite has coe in& "ut

then coin in to operation o% an acti!e and 'ell.de!eloped secondary arket %or the

"ank lia"ilities and assets is still %ar %ro coplete$

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DIMENSION OF RISK MANAGEMENTS

n the yriad "alance.sheet risks that "ank %ace today credit and interest rate risks

ostly accounts %or their "usiness risks$ These and other risks epose a "ank:s "usiness to

certain potential losses$ These losses are o% three types !i4$& epected& unepected and

stress loss$ The epected loss is al'ays insura"le "y the yriad hedes and there%ore&

%ors part o% "anks cost o% operation$ There is the unepected loss under ad!erse

conditions& 'hich cannot "e predicted$ It is unepected loss that is de%ined as !alue at risk

(@A-)$ Then there is also a third type o% loss the "ank ay "e prepared to %ace under

etree conditions 'hich occurs rarely "ut possi"ly$ It is called as stress loss$

VALUE AT RISK

@alue at risk technically is de%ined as the ;loss aount& accuulated o!er a certain

period that is not eceedin in ore than a certain percentae o% all tie;$ @A- (##J& 1

'eek) is e+ual to the loss aount& accuulated o!er one 'eek& 'hich is not eceedin in

ore than one 'eek& and 'hich is not eceedin ore than 1J o% all lie$ ?or easurin

@A- one relics on a odel o% rando chanes in the price o% underlyin instruents.

interest rate chanes& chanes in %orein echane rates etc$ and a odel %or coputin

sensiti!ity o% deri!ati!es price relati!e to the price o% underlyin instruent$ In all these&

one has to ree"er that a @A- easures is erely a "enchark %or relati!e *udents&

such as the risk o% one port%olio relates to another& etc$& e!en i% accurate& coparison such

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as these are speci%ic to a tie hori4on and the con%idence le!el 'ith 'hich @A- is

chosen$

EARNING AT RISK

Earnin at risk (Ea-) odels capture the period o% pro%it or loss in ters o% the

reali4ed pro%it or loss as per the cost ethod used currently$ It consists o% three

coponents !i4$& %unds pro%it or loss K redeption pro%it or loss K sales ain or loss$

EXPANDED VaR

It easures Ear and ad*usts it %or o!eent in arket !aluation as part o% the period

pro%it or loss$ It is e+ual to Ea- K chane in !aluation ain or loss$

CAPITAL AT RISK

/apital at risk (/a-) easures risk as transportation %ro @a-$ it is a surroate o%

@a- !ie'ed %ro the anle o% sol!ency o% the "ank$ It is e+ui!alent to the unepected

losses since epected losses are taken care o% "y 'ay o% pro!isions$ So lon as the

epected plus unepected losses stay 'ith in the liits o% con%idence then the "ank is said

to stay sol!ent$

INTEREST RATE RISK MANAGEMENT THE CRUX OF ALM

Market risk easures coodity& currency and interest rate risk as 'ell$ /oodity

risk is alost non.eistent today %or any Indian "ank:s and currency risk is controlled

throuh reulatory prescription there reains the interest rate risk (I--) that larely

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poses a pro"le to "ank:s interest incoe and hence pro%ita"ility$ It arises "ecause "ank:s

assets and lia"ilities enerally ha!e their interest rates reset at di%%erent ties$ /hanes in

interest rates can sini%icantly alter a "ank:s net interest incoes (Nil) dependin on the

etent or isatch "et'een the ties 'hen asset and lia"ility interest rates are reset$

/hanes in interest rates do also a%%ect the arket !alue o% "ank:s e+uity$ A ethod

o% anain I-- %irst re+uires a "ank to speci%y oals %or either the "ook !alue or the

arket !alue o% Nil$ In the %orer case& the %ocus 'ill "e on the current !alue o% Nil and

in the latter caseH the %ocus is on the arket !alue o% e+uity$ In either case the "ank as to

easure the risk eposure and %orulate strateies to inii4e or irate the risk$ The

"ank oals and strateies in doin so norally re%lect the anaeent:s policy

concurrence$

The Gaps o% interest rate sensiti!e ay "e identi%yin in the %ollo'in tie "ucketsD

1$ 1.C days

2$ 7.1< days

6$ 1=.2# days


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All relati!ely non.sensiti!ity assets and lia"ility ites like intani"les& %ied assets&

capital etc$ are taken out and the rest are put in to tie "uckets accordin to their

reainin aturity as opposed to oriinal aturity$

Ta"leD Maturity pro%ile (-s in /rores)

T'"e 01+e$ L'a0'.'$'es Asse$s6 onths 28$88 6=8$88

onths 88$88 =88$88

# onths =88$88


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address the issue pertainin to credit risk$ E!ery year the coittee 'ill lay do'n the

nors %or lendin policy& 'hich contains se!eral easures like prudential nors&

sartorial deployent o% %unds& assessent o% risk associated 'ith the loan proposal "y

'ay o% custoer credit ratin etc$ %or entire loan aount 'ith the liit o% o!er -s 2 laces

ha!e "een co!ered under credit audit& 'hich helps to ipro!e its +uality o% pre.sanction

appraisal and post.sanction onitorin$

MARKET RISK

I% the incoe that is Nil or NIM is a%%ected due to chane in the interest rateFprice in

the arket& such risk are called arket risks$

KINDS OF MARKET RISKS

Interest -ate -isk

/urrency or ?ore -isk

E+uityF/oodity rice -isk$

INTEREST RATE RISK

The phased dereulation o% interest rate and operational %lei"ility i!en to "ank in

pricin ost o% the assets and lia"ilities has "een eposed "ank to interest rate risk$

Interest rate risk is the risk 'here chanes in arket interest rates iht ad!ersely a%%ect

a "ank:s %inancial condition$ /hanes in the interest rates iht ad!ersely a%%ect "oth the

current earnins (earnin prospecti!e) and also the net 'orth o% the "ank (econoic !alue

perspecti!e)$ The risk %ro earnin prospecti!e is easured as chane in the net interest

incoe (Nil) or net interest arin (NIM)$

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CURRENCY OR FOREX RISKS

This risk arises out o% lia"ilities in one currency eceedin the le!el o% assets in

the sae currency$ resently& "anks re.%ree to set ap liits 'ith -BIs appro!al "ut are

re+uired to adopt !alue at risk approach to easure the risk associated 'ith %or'ard

eposures$ Thus the open position liits toether 'ith ap liits %ro the risk

anaeent approach to %ore operations$

E2UITY PRICE3COMMODITY PRICE RISK

E+uity priceFcoodity price risk arises o'in lo chanes in the prices

o% sharesFcoodities& 'here the in!estors or indi!idual has in!ested$

EMBEDDED OPTION RISK

enalty %or preature payent o% "oth deposits$

Miniu lock in period etc$

Buyin coitent chares on nonFunder utili4ation o% liits$

ASSET-LIABILITY COMMITTEE ,ALCO)

The prie %unction o% AL/ o% the "ank consistin o% the "ank:s senior anaeent

includin /E should "e to ensure adherence to Dthe liits set "y the "oard as 'ell as %or

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decidin the "usiness stratey o% the "ank in line 'ith "ank:s "udet and laid do'n risk

anaeent o"*ecti!es$

The /EF/M should head the coittee$ The chie%s o% in!estent& credit %unds

ManaeentFtreasury& international "ankin and Econoic -esearch can "e e"er o%

the coittee$

AL/ re!ie's the status o% li+uidity and interest rate risk is.a.sis tolerance

liits$

AL/ articulates and decides pricin o% products includin L-

AL/ eainesFrecoends %undin options %or lon estation in%rastructure

pro*ects$

Tie "ucketsD In order to ascertain the risk associated 'ith the "ank:s port%olio the

-BI ad!ice all the "ank:s to distri"ute all the aturin assets and lia"ilities in to

Tie "uckets ranin %ro 1.C days& C.1< days& and 1


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9hich do not et a%%ected due to chane in the interest rate or price e$$ NA:s& cash on

hand etc&

MANAGEMENT-DEPTH AND 2UALITY

In e!aluatin anaeent& the intention is to assess the depth& +uality& and operatin

style to; the orani4ation$ In particular& it is iportant to aue the le!el o% risk that

anaeent is 'illin to assue& its understandin o% issues that are a%%ectin its

acti!ities& and the "alance it strikes "et'een "usiness de!elopent and risk anaeent$

"!iously& a %ull assessent o% these issues can only "e achie!ed o!er a lenthy period o%

lie a%ter ha!in had the opportunity o% contract 'ith all le!el o% the orani4ation$

The -BI epects "ank to take a !ie' on %uture interest rate o!eents$ That is&

pro*ect %or thesel!es ha!e interest rates& 'ill o!e in the %uture.o!er "oth short BS

position in to a certain nu"er o% pre.deterined tie "ands accordin to their aturity$

These schedules can "e used to enerate siple indicators o% the interest rate risk

sensiti!ity o% "oth earnins and econoic !alue to chanin interest rates$ This ap

analysis i$e$ the si4e o% the ap %or a i!en tie "and i!es an indication o% the "anks re.

pricin risk eposure$ The interest rate sensiti!e assets inus interest rate sensiti!e

lia"ilities in each tie "and can "e ultiplied "y an assued chane in interest rate to

yield an approiation o% chane in net interest incoe that is likely to result %ro such

interest rate o!eents$

Matheatically& rate sensiti!e aps (-SG) is de%ined as ratio o% rate sensiti!e assets

(-SA) to rate sensiti!e lia"ility (-SL) occurrin durin a particular aturity period$ A

2


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neati!e or lia"ility sensiti!e ap occurs 'hen lia"ilities eceeds assets in a i!en tie

"and$ It eans as increase in arket interest rates could cause a decline in net interest

incoe$ /on!ersely& a positi!e or asset sensiti!e ap iplies that "anks net interest

incoe could decline as a result o% a decrease in the le!el o% interest rates$

GAO-SAs.-SLs

9hen interest rates chane the "ank:s nil chanes "ased on the %ollo'in

InterrelationshipsD

/hanes in NII-SAs chanes in a!erae interest rate on -SAs O (elta rl).-SLs chane

in a!erae interest rate paid on -SLs O (elta r2)

(1) elta NIIO-SAs elta -SLs elta r2

(2) ?or siplicity& assue %or a 'hile that elta rl.elta r2 O elta r$ that is "oth the

A!erae interest paid on lia"ilities chane to the sae etent& thouh not al'ays true

in reality$ The (2) "ecoes

elta NI1O (-SAs.-SLs) elta r

elta NII3PA elta r

(6) It is e!ident that not only chanes in the arket interest rates& "ut also chanes in the

relationship "et'een the "ank asset and lia"ility costs and in the coposition o% the

!olues o% outstandin and increental assets and lia"ility a%%ect NIL the actual

chane in the direction and aount anticipated "y the$ The Gap relationship suests

that a "ank that either can or does not choose to speculation on %uture interest rates can

only reduce I-- "y taretin a 4ero Gap$

2C


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MORE ADORABLE BUT LESS APPLICABLE DURATION GAP

All those "ank assets and lia"ilities that are Interest insensiti!e %ro cash.o'

standpoint also eperiences lare %luctuation in !alue due to o!eents in interest rates$

E!en i% the Gap is 4ero& the "ank ay still "e su"*ect to su"stantial I--$ o'e!er& 'ith

the duration GA (GA) approach& it is possi"le to o%%set the undesira"le e%%ects o%

%undin GA "y a care%ully orchestrated position in non.rate sensiti!e assets and

lia"ilities$ GA reconi4es that I-- arise 'hen tiin o% cash in%lo's and out%lo's

di%%ers e!en i% the assets and lia"ilities are cateori4ed as rate intensi!e as per the

con!entional GA techni+ue$ Interest rate risk is easured in GA "y a coparison o%

the 'eihted duration o% lia"ilities$ The %undin GA techni+ue atches cash %lo' "y

structurin the short.ter aturity "uckets$ n the other hand& the GA hedes aainst

I-- "y structurin the port%olios o% assets and lia"ilities to chane e+ually in !alue

'hene!er interest rates chane$ The tiin and anitude o% areate cash %lo' on

assets and lia"ilities are atched in such a 'ay that the arket !alue o% e+uity reains

unchaned in a per%ect hede$ uration is de%ined as a!erae li%e o% %inancial instruent$

It e+uals the a!erae tie necessary to reco!er the initial cost$ It also pro!ides an

approiate easure o% arket !alue interest elastically$ The GA is coputed as the

di%%erence "et'een the coposite duration o% "ank assets and a arked do'n coposite

duration o% its lia"ilities$

GA O A.3L (C)

3O Jo% assets %unded "y lia"ility$

Thus& a "ank can iuni4e the arket !alue o% its e+uity "y settin GAO8$

27


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o'e!er& in reality i% a "ank 'ants to per%ectly hede !alue& it has to set its asset duration

slihtly less than its lia"ility duration to aintain positi!e e+uity$ ?or GA to e+ual

4ero (AFL) should e+ual 'hich is& less than one$ ne can approiately

estiate the epected chane in the arket !alue o% a "ank %or i!en chane in the

interest rates$ /hane in Market @alue o% E+uityFTotal Assets O GA Approiate

chane in interest rate (7)

?ro this it is clear that i% GA is close to 4ero then the arket !alue o% "ank

e+uity 'ill not chane and accordinly "ecoe iuni4ed %or any chanes in the interest

rates$

The GA easure has se!eral erits$ It is ore scienti%ic& ore realistic "ut

ore sophisticated and cople in approach$ A "asic precondition %or the use o% this tool

as a hede echanis is that all the assets and lia"ilities o% "anks ha!e to position as

arked to arket$ There%ore& at the present *unction& the GA tool eists ore %or

adorin its scienti%ic erits than %or its applica"ility in its iuni4ation o% a "ank:s

"alance sheet$

Basic uration %orula (Macaulay)

O (/(IKY) K /Q2F(lKY)2K(/K)NF(1KY)NFrice

9here / O eriodic /oupon$

Y O Yield (YTM)

O rincipal Aount

N O total nu"er o% years$

CAN FUNDING GAP IMMUNI4 E2UITY?

2#


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@ery siple assuption is re+uired to ha"ilitate the con!entional ap %ro "ank

e+uity iuni4ation$ ne is that the "ank adopts a constant di!idend rate policy and the

other is that alost all the net incoe o% the "ank is Nil$ No' the stron assuption is

that i% the "anks ha!e ore or less the sae Nil %or at least ore than one year& then the

e+uity o% a "ank can "e 'ritten as the present !alue o% its %uture di!idend payents$

/.(dQNII)Fr (#)

9here c O capital (e+uity) o% the "ank$ By siple calculus and su"stitution one can arri!e

at /hane in / . (d Q GA . c)F (chane in rFr)

elta c . (d Q GA . c)F (elta rFr) (18)

No' %or elta / . 8 'hich is e+ui!alent to iuni4in arket !alue o% e+uity %ro

%luctuation& 'hat is re+uired as a stratey is to aintain$

GA O (/F) (11)

The iplications o% (11) are se!eral$ I% it re+uires %or the "ank to aintain a positi!e ap

%or iuni4ation e+uity& siultaneously the "ank cannot keep its Nil and NIM

unchaned$ But in an en!ironent o% decline interests rates& the "ank ha!e to scari%ies

soe Nil and hence NIM %or the sake o% iuni4in its e+uity$ Lookin at it %ro

another anle& %or GA to "e 4ero& the "ank e+uity has to %luctuate 'hene!er interest rates

chanes as per the %ollo'in relationship$

/hane in / O . (chane in rFr) Q /

elta / (GA . 8) O . (elta rFr) Q / (12)

It is o"!ious %ro (12)& 'hen GA O 8& decline in interest rates causes ;/; to

increase and !ice.a.!ersa$

68


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SIMULATION TECHNI2UE

Siulation techni+ue siply in!ol!es a detailed "reak do'n o% !arious cateories o%

"alance sheet position and assins speci%ic interest rate %or each position and then

'orkin out the cash inFout %lo's$ Such siulation strateies could "e either static or

dynaic$ In static stiulation& cash %lo's arisin %ro the "anks current "alance sheet

position are as it is assessed "ased on one or ore assued interest rate scenarios$ By

discountin the resultin cash %lo's& o!er the entire epected lines o% the "anks holdin&

an estiate o% the chane in the econoic !alue o% the "ank can "e 'orked out$

In a dynaic siulation approach& the siulation "uilds in ore detailed

assuptions a"out the %uture course o% interest rates and the epected chane in a "anks

"usiness acti!ity o!er that tie$ Such siulation studies a%%ord dynaic interaction o%

payent strea 'ith interest rates and capture the e%%ect o% i"edded or eplicit option

61


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CHAPTER-III

COMPANY PROFILE

62


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ABOUT THE BANK

/anara Bank 'as %ounded "y RS5!' A""e"0a. S00a Ra% Pa'6& a reat

!isionary and philanthropist& in Puly 1#8& at a sall port in Manalore& 3arnataka$ The

Bank has underone !arious phases in its ro'th path o!er hundred years o% its eistence$

The ro'th o% /anara Bank 'as phenoenal& especially a%ter nationali4ation in the year1##& attainin the status o% a national le!el player in ters o% eoraphical reach and

clientele seents$ Eihties 'as characteri4ed "y "usiness di!ersi%ication %or the Bank$

In Pune 288& the Bank copleted a century o% operation in the Indian "ankin industry$

The e!ent%ul *ourney o% the Bank 'as stre'n 'ith any eora"le ilestones$ Today&

/anara Bank occupies a preier position in the coity o% Indian "anks& eerin as the

larest nationali4ed "ank in India in ters o% areate "usiness !olue %or 288.8C$

9ith an un"roken record o% pro%its since its inception& /anara Bank has se!eral %irsts to

its credit$

!er the years& the Bank has "een scalin up its arket position to eere as a

a*or :?inancial /onloerate: 'ith as any as nine su"sidiariesFsponsored

institutionsF*oint !entures in India and a"road$ As at ece"er 288C& the Bank has %urther

epanded its doestic presence& 'ith 2


34/69

array o% alternati!e deli!ery channels that include o!er 1#88 ATMs. co!erin 78 centers&

11=C "ranches pro!idin Internet and Mo"ile Bankin (IMB) ser!ices and 1766 "ranches

o%%erin :Any'here Bankin: ser!ices$ 0nder ad!anced payent and settleent syste&

1#6 "ranches o% the Bank o%%erRea. T'"e G!%ss Se$$.e"e#$ ,RTGS/ and Na$'%#a.

E.e1$!%#'1 )s T!a#s&e! ,NEFT/7

/anara Bank has ade a distincti!e ark in !arious corporate social

responsi"ilities& naely& ser!in national priorities& prootin rural de!elopent&

enhancin rural sel%.eployent throuh se!eral trainin institutes& spearheadin

%inancial inclusion o"*ecti!e etc$ rootin an inclusi!e ro'th stratey& 'hich %ors the

"asic plank o% national policy aenda today& is in %act deeply rooted in the Bank:s

%oundin principles$ ;A ood "ank is not only the %inancial heart o% the counity& "ut

also one 'ith an o"liation o% helpin in e!ery possi"le anner to ipro!e the econoic

conditions o% the coon people;$ These insiht%ul 'ords o% our %ounder continue to

resonate e!en today in ser!in the society 'ith a purpose$

The ro'th story o% /anara Bank in its %irst century 'as due& aon others& to the

continued patronae o% its !alued custoers& stakeholders& coitted sta%% and uncanny

leadership a"ility deonstrated "y its leaders at the hel o% a%%airs$ 9e stronly "elie!e

that the net century is oin to "e e+ually re'ardin and e!ent%ul not only in ser!ice o%

the nation "ut also in helpin the Bank eere as a ;Glo"al Bank 'ith Best ractices;$

This *usti%ia"le "elie% is %ounded on stron %undaentals& custoer centricity& enlihtened

leadership and a %aily like 'ork culture$

S'8#'&'1a#$ M'.es$%#es

1st Puly 1#8

/anara indu eranent ?und Ltd$ %orally reistered 'ith a capital o% 2888

shares o% -s$=8F. each& 'ith < eployees$

1#18 /anara indu eranent ?und renaed as /anara Bank Liited

1## 1< a*or "anks in the country& includin /anara Bank& nationali4ed on Puly 1#

1#C 1888th "ranch inauurated

1#76

!erseas "ranch at London inauurated

/an card (the Banks credit card) launched

1#7< Merer 'ith the Laksi /oercial Bank Liited

1#7= /oissionin o% Indo on 3on International ?inance Liited

1#7C /an"ank Mutual ?und 5 /an %in oes& launched

1#7# /an"ank @enture /apital ?und started

1#7#.#8 /an"ank ?actors Liited& the %actorin su"sidiary launched

6


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1##2.#6

Becae the %irst Bank to articulate and adopt the directi!e principles o% RGood

Bankin$

1##=.#

Becae the %irst Bank to "e con%erred 'ith IS #882 certi%ication %or one o% its

"ranches in Banalore

2881.82

pened a :Mahila Bankin Branch:& %irst o% its kind at Banalore& %or caterin

eclusi!ely to the %inancial re+uireents o% 'oen clientele$2882.86 Maiden I o% the Bank

2886.8< Launched Internet 5 Mo"ile Bankin Ser!ices

288


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BALANCE SHEET

6


37/69

6C


38/69

CHAPTER 9IV

DATA ANALYSIS AND

INTERPRETATION

DATA ANALYSIS

O$&.%s CANARA BANKS$a$e"e#$ %& S$!1$!a. L'(')'$* ;


39/69

1 to 1< :days1= to 27

days:2#days and

upto

6onths

!er6

onthsand upto

onths

$!er $

onths andupto 1 year

yer$1

Year and6 years

!er 6years and

upto5 years

!er =

years Total

1 /apital 1C2= 1C$2=

2 -eser!es 7 Surplus 1 C


40/69

IN?L9S

1to 1 0 > 0

N% 15a#8e

7= 7>

N% 15a#8e > 0 -

N% 15a#8e -> 0

-> 0 N% 15a#8e -7>-> 0 -> 0 -7= I


64/69

The ipact o% chanes on N'. 'as rather hih at -s$ 1C8$8 crores in a scenario

'here the lendin rate chanes 188 "p in either direction 'ithout a correspondin chane in

deposit rates$ n a closer eaination& it 'as o"ser!ed that the incidence o% the ipact 'as

hih due to concentration o% "alances in /ash /redit account and Ter Loans 'hich et re.

priced in the "ucket o% ;2# days and up to 6 onths; o% the aturity ladder and continues till

the rest o% the year$

-BI ha!e suested that thouh Interest -ate -isk eposure ay "e calculated usin

the ap ethod initially& a radual shi%t to duration ap analysis o% assets and lia"ilities ay

"e carried out at a later stae$ 9e ha!e coenced duration analysis o% the %ied incoe

securities at onthly inter!als and duration ap analysis %or entire "alance sheet ites at hal%.

yearly$


65/69

CHAPTER 9V

FINDINGS SUGGESTIONS

CONCLUSION

=


66/69

FINDINGS

ALM techni+ue is aied to tackle the arket risk$ Its o"*ecti!e is to

sta"ili4eF ipro!e the NIL Althouh ipleentation o% A$L$M as a risk anaeent

tool is done usin ap analysis it is essential that "anks strenthen their Manaeent

In%oration Syste (MIS) and coputer processin capa"ilities %or accurate

easureent o% interest rate risk in their "ankin "ooks& 'hich ipact& in the short.

ter& their net interest incoe (Nil) or net interest arin (NIM) and in the lon.ter&

the econoic !alue o% the "ank.'hich in!ol!es up radation o% eistin syste and

application so%t'are to attain "etter and ipro!ised le!els

It is also essential that a "ank reains alert to the e!ents that a%%ect its

operatin en!ironent and react accordinly in order to a!oid any undesira"le risks$

ALM in this contet presents a disciplined decision akin %rae'ork %or "anks

'hile at the sae tie uardin the risk le!els$


67/69

SUGGESTIONS

The Bank should ha!e a stron and reular relationship 'ith "oth

depositors and "orro'ers and trade.o%% relationship 'ith soe

custoers accordin to their iportance to the Bank %or li+uidity to

sur!i!e 'hen crisis increases$

The Bank should ha!e a stron and reular relationship 'ith

lenders and lare lia"ility holders durin the periods o% relati!e cal&

the Bank 'ill "e in a "etter position to secure sources o% %unds durin

eerencies$

C


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CONCLUSION

It should reduce the outstandin in -eports a"out 28 /r$ ay "e used to

create Short.Ter 5 Mediu.Ter Assets on %loatin rate& especially loans and

ad!ances$

In the current scenario& to copete 'ith pri!ate "anks& %orein "anks and

non."ankin %inancial institutions& /ANA-A BAN3 re+uires e%%icient huan and

technoloical in%rastructure 'hich 'ill %urther lead to sooth interation o% the risk

anaeent process 'ith the "ank:s "usiness strateies$ $

7


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BIBILOGRAPHY

rasanna /handra& ?inancial Manaeent Theory and ractice& 2887$

thEdition& Tata McGra' ill$

I$M$ andey D ?inancial Manaeent& @ikas u"lishers$

E$?$ Briha& and M$/ Ehrhardt$$& 288& ?inancial Manaeent Theory and

ractice& 18thEdition& Thoson South.9estern$

M$Y$3han and $3& Pain$ Manaeent Accountin& 288#& I@ edition& Tata Mc

Gra' ill& Ne' elhi$

We0s'$es :

'''$oole$co

'''$/anara Bank$co

'''$'ickipedia$co
http://www.google.com/http://www.hdfcbank.com/http://www.wickipedia.com/http://www.google.com/http://www.hdfcbank.com/http://www.wickipedia.com/

asset liability management canara bank

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