Chapter - 1

INTRODUCTION

The composition of assets and liabilities largely decide the solvency, liquidity

and profitability of a corporate entity, more so that of a financial institution. The

components of the liabilities determine the cost of funds. The mix of the assets

influences the return on investment. Therefore the asset liability management assumes

great importance; also, it is absolutely necessary to prevent the Asset - liability

mismatch, both in term of maturity (tenure) and relative costs (minimum or interest

differential) particularly in the control of increasing pressure on margins. In the case

of state financial corporation, the instrumentality of Business Plan and Resources

Forecast (BPRF), and effective treasury management techniques can be, gainfully

utilized to make correction in the existing imbalances in the resource mix and the

avoidable misalignments between the profile or liabilities and the portfolio of assets.

While BPRF is introduced at the instance of IDBI & SIDBI.

The Asset - Liability management broadly deals with both sides of the balance

sheet. It is primarily concerned with the market risk that arises from a financial

institutions structural position. These are interest rate and liquidity risks. The interest

rate risk arises from the possibility of change in profits caused by fluctuations in

interest rank. The delay in recoveries, a principle cause of liquidity risk, leads to

possibility.

Opportunities and damage due to honoring payment commitments. Both these

risks are obviously the result of mismatch between the Financial Institutions / Banks

as Assets and Liabilities. In case of banks of Financial Institutions, the ALM positions

are relatively liquid. Usually the banking institutions hold the assets and liabilities

until they mature. This practice of course is changing of late. It is increasingly

becoming to bundle banking products such as loans into marketable securities and

then sell them or trade them with other banks as well as other traditional and new

players in the financial markets.

1

This is especially true of asset-based securities i.e., mortgage loans,

securitization is a new phenomenon in the Indian context. But it has a vast scope. It

can make or mm the future of a financial institution. The stability, profitability,

growth and image of Financial Institutions largely depend upon the ability and skill

with which it can conduct its ALM.

Asset - liability management practices which effect from April 1, 1999. While

guidelines on management of credit risk, market risk and operational risk will be

issued later on. The RBI has issued guidelines for the introduction of Asset - liability

management (ALM) as a part of the risk management and control system in banks.

They are intended to form the basis for initiating collection, compilations and analysis

of dates required tu support the ALM System.

Over the last few years, the Indian Financial System markets have witnessed vide

ranging changes at a 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 measures. The bank management has to base their

business decision on a dynamic and integrated risk management system and process,

driven by corporate strategy. The banks are exposed to several major risks in the

course of the business credit risk, interest rate risk, foreign exchange risk, and

equity/commodity price risk. Liquidity and Operational risks. It is against this

background that the RBI guidelines relating to AL:!v1 focus on interest rate and

liquidity risk-management system in banks, which form part: of the ALM function.

The initial thrust of the ALM function would be to enforce the risk management

discipline that is, managing offer assessing the risk involved. The objective of good

risk Management programs should be that their programs evolve into a strategy tool

for bank management.

2

In the normal course, Financial Institutions are exposed to credit and market risks

in view of the asset liability transformation. With liberalization in Indian Financial

markets, over the last four years and growing integration of domestic markets and the

entry of MNC's for meeting the credit needs of not only the corporate but also the

retail segments, the risks associated with Financial Institutions operations have

become complex and large, requiring

strategic management. Financial Institutions are now operating in a fairly deregulate

1. environment and are required to determine interest rates on deposits, they can also

offer deposits prescribe by the R 131: they can also offer advances on dynamic basis.

The interest rates on investments of 1:1 –in government and other securities are also

now market related. Intense competition for business involving both assets and

liabilities has brought pressure on the management of Financial Institutions to

maintain a good balance among spreads, profitability and long-term liability.

Imprudent liquidity management can put Financial Institutions earnings and

reputation at great risk. The management of Financial Institutions have to base their

business decisions on a dynamic and integrated risk management system and process

driven by' corporate strategy, Financial Institutions are exposed to several major risks

in the course of their business; credit risk, interest rate risk, equity/commodity price

risk, liquidity risk and operational risk. It is, therefore, important that Financial

Institutions introduce effective risk measure management systems that address the

issues relating to interest rate and liquidity risks.

3

NEED FOR THE STUDY:

In the event of highly volatile interest rates and liquidity crisis, Financial

Institutions/banks face the problem of real valuation of their assets and liabilities. This

Mismatch of assets and liabilities may produced an effect on calculation of real worth

of the business. There are some methods adopted by banks/financial institutions in

order to cover the problems of liquidity mismatch and interest rate risk. The present

study focused such measures taken by APSFC for its Asset - Liability management.

OBJECTIVES OF THE STUDY:

To study the ALM procedure in APSFC

To study and evaluate the performance of APSFC in managing liquidity risk and interest rate risk management.

To study the various schemes and activities of APSFC

4

METHODOLOGY OF THE STUDY:

Description of the method:

To fulfill the above objectives mainly secondary data is used by collecting the records of APSFC and other published data like journals, books, internet etc…

The financial statement of different information of APSFC are collected and used for analysis to examine how the APSFC is managing it’s assets and liabilities

The primary information also collected through discussion with officers and managers of APSFC to get first hand information about risk, return, solvency and liquidity, leverage positions etc.

Under this asset liability management in APSFC the required data collected from

secondary source.

Secondary source:

Asset liabilities management related articles from various magazines

Journals and Banking books

The other main sources of secondary data

Annual reports of APSFC

Brochures of APSFC

RBI guidelines for ALM management

Indian Financial System By 'M. Y.KHAN'

Asset Liabilities management by different authors

Websites pertaining to asset liability management

5

SCOPE OF THE STUDY:

ALM in relation of SFCs covers a wide gamut of both sources and

applications of funds. The drying up of some of the conventional sources, the choice

of the basket, rising cost of funds available and the associated stringent conditions,

growing competition for the access to the sources and the need for arresting the

erosion of net worth are the main challenges in managing the liabilities. On the assets

side, the key issues are the resource allocations, the assets portfolio-mix, the yields,

the recoveries, NPA management, write off policies and above all the market and

credit risk management.

LIMITATIONS OFTHE STUDY:

In spite of utmost care taken for the smooth conduct of study while preparing this

project; this report suffers from certain setbacks.

1. This is the study conducted with in short period, so it may not be covering all

the aspects in detail.

2. The study has made an attempt for evaluating the performance of APSFC in

managing liquidity risk management and interest rate risk management.

3. Due to limitations of the sources the data collection could not be adequate.

6

CHAPTER -2

COMPANY PROFILE

INTRODUCTION

ROLE OF APSFC

FUNCTIONS OF APSFC

OBJECTIVES OF APSFC

LOCATION

CAPITAL STRUCTURE

MANAGEMENT OF APSFC

UNITS ELIGIBLE FOR FINANCIAL ASSISTANCE

ELIGIBILITY FOR FINANCIAL ASSISTANCE

LIMITS FOR FINANCIAL ASSISTANCE IN APSFC

LOAN SANCTION POWER

SOURCES OF FINANCIAL ASSISTANCE TO APSFC

DETAILS OF SCHEMES

MILESTONES OF APSFC

QUALITY POLICY

PERFORMANCE REVIEW OF APSFC

GOLDEN JUBLEE YEAR OF APSFC 2005-2006

INSURANCE POLICIES AT APSFC

FUTURE PLANS OF APSFC

OPERATIONAL ZONES

LENDING POLICY FOR FINANCIAL YEAR 2007-08

7

ANDHRA PRADESH STATE FINANCIAL CORPORATION

INTRODUCTION

Andhra Pradesh State Corporation (APSFC) is term lending institution established

in 1956 for promoting small and medium scale industries in Andhra Pradesh under the

provisions of the State Financial Corporation Act, 1951. The corporation has many

entrepreneur friendly schemes to provide term loans, working capital term loans and

special and seed capital assistance to suit the needs of the various categories of

entrepreneurs. The corporation has 50 years of expertise in industrial financing

engaged in the business of financing tiny, small and medium scale sector units and

thriving for balanced regional development of the state.

Andhra Pradesh State Financial Corporation aims to be the leading financial

institutions in the state by providing adequate and timely financial assistance to its

customers for industrialization. APSFC shall also ensure customer satisfaction

through professional management and team work by implementing quality

management system that meets the requirement of ISO 9002:1994.

APSFC extends financial assistance for setting up of industrial and service

enterprises with in the state of the Andhra Pradesh. APSFC is actively considering

venturing into joint financing to assist the medium and large scale enterprises for both

new and existing units by means of tie up with SIDBI and other financial institutions.

In order to provide medium and long term credit to industrial under taking, which

fall outside the normal activities of commercial banks, a Central Industrial Finance

Corporation was set up under the Industrial Finance Corporation Act 1948. The State

Government also considered that the State Corporations should be established under

the special statute in order to make it possible to incorporate in the constitution. The

State Government has requested the Government of India to enact the necessary

enabling legislation, which is sort to be affected by the State Financial Corporations

Act, 1951.

APSFC came into existence on 1st November, 1956 after the amalgamation of

erstwhile Andhra Pradesh State Financial Corporation and Hyderabad State Financial

Corporation with the main objective of extending financial assistance.

8

ROLE OF APSFC

APSFC has playing significant role in taking the state to its right place on the

industrial map of the country.

APSFC has been playing an important role in the development of finance

intermediary and has more made significant contribution to the

industrialization of the state by extending financial assistance to enterprises.

APSFC plays a bigger role in development of small scale entrepreneurs.

Corporation also extends working capital term loan for existing good working

units.

APSFC by providing rehabilitation schemes in order to motivate them.

It provides various friendly entrepreneur schemes in order to motivate them.

Traditionally the corporation’s main role was to lead lend money for

establishing a unit or a factory.

FUNCTIONS OF APSFC

Granting loans and advances to the Entrepreneurs.

Formulating various schemes and policies for financial assistance.

Participating in the equity capital of the Small-scale Industrial Units coming

up in backward areas.

Underwriting of the issue of stock, shares, bonds or debentures of industrial

concerns.

Providing for discounting of Bills of Exchange.

Acting as an agent of behalf of Central and State Government.

Generating non fund based income.

9

OBJECTIVES OF APSFC

Extending term loan to tiny, small and medium scale industries besides

services industries like Hospital, Hotels, Construction and Marketing

Assistance to SSI products, Tourism related activities etc.

Being Development bank, encouraged first generation Entrepreneurs.

Providing Quality Service through professional management and teamwork.

Contributes for Balanced Regional Development of the State.

LOCATION

The corporation with its head office at 5-9-149, Chiragali Lane, Abids, Hyderabad

opened one branch in 1956 at Vijayawada. During 1972-73 the corporation opened

two branches at Vishakapatnam and Tirupati. In 1975-76 the corporation opened six

one man offices in six districts of Andhra Pradesh and one extra branch each in Ranga

Reddy and Medak districts.

CAPITAL STRUCTURE

APSFC started with paid-up equity capital of Rs. 1.50 crores in 1956 which now

stands at Rs. 92.22 crores against an authorized capital of Rs. 500 crores. The

Government of Andhra Pradesh holds 68.40% and IDBI 31.31% equity while the

remaining share of 0.29% is held by LIC and individual shareholders.

MANAGEMENT OF APSFC

All the activity’s that are undertaken by APSFC are decided by the Board of Directors

in the meeting. SIDBI plays an important role in decision making. The Board of

Directors consists of Chairman and Directors nominated by state government and

Director nominated by SIDBI and Director by RBI. Managing Director is appointed

by government of Andhra Pradesh in consultation with SIDBI.

10

DEPARTMENTS

The departments wing in Projects Department looks in to matter of loan

enquires and verifies the project. The appraisals officers in the projects

department will appraise the project with reference to the economic viability

and technical feasibility.

The legal Department looks in to the matters related to scrutiny of title and

documentations etc.

The Internal Audit Departments are under the direct control of managing

director, conducts the regular and concurrent audit.

The Human Resource Departments look after the recruitment, leaves, staff

loans and disciplinary actions of employees.

The Finance and Accounts Department deals with accounting matters, sources

and uses of funds.

The Documentation Department provides information to corporation and the

entrepreneur about eh market, new products and provides the source of

institutional assistance and availability of raw materials etc.

The monitoring and Recovering Department deals with policy matters relating

to recovery, loss assets recovery and revival of sick industries.

Net Working Department deals with arranging training programmes

improving non fund based income.

UNITS ELIGIBLE FOR FINANCIAL ASSISTANCE

Industrial concerns under any form of ownership, whether it be a proprietary or

partnership concern, joint Hindu family, registered cooperative society, private or

public limited company engaged in or proposed to engage in one or more of following

activates are eligible for financial assistance.

Manufacture, preservation or processing of goods;

Mining or development of mines;

Hotel/Motel/Restaurants;

11

Transport of passengers or goods by road or by water or by air or by rope-way

or by lift;

Generation or distribution of electricity of any other form of energy;

Maintenance, repair, testing or servicing of machinery of any description or

vehicles or vessels or motorboats or trailers or tractors;

Assembling, repairing or packing or any article with the aid of machinery or

power;

Setting up or development of industrial area or industrial estate;

Fishing or providing shore facilities for Fishing or maintenance

thereof;Providing weigh bridge facilities;

Providing engineering, technical, financial, management, marketing or other

services or facilities for industry;

Service industry such as altering, ornamenting, polishing, finishing, oiling, washing,

cleaning or otherwise treating or adapting any article or substance with a view to its use,

sale, transport, delivery or disposal;

Providing medical, health or other allied services;

Providing services relating to information technology, telecommunication or

electronics including satellite lnkage and audio or visual cable

communication;

Research and development of any concept, technology, design, process or

product;

Setting up or development of tourism realte3d facilities including amusement

parks centre, convention centre, restaurants, travel and transport (including

those at airports) tourist service agencies and guidance and counseling services

to tourists;

Development, maintenance and construction of roads;

12

Bore well rigs/road laying equipments – earth excavator;

Business enterprises set up by qualified professionals in management,

accountancy, medicine, architecture, engineering etc;

Floriculture;

Tissue culture, fish culture, poultry farming, breeding and hatcheries

Commercial complex, facilities and community centers (including marriage halls) as a

part of the hotel business.

Financial assistance to SSI units to undertake various activities necessary to increase

their sales turnover in domestic and export market.

To finance Corporate entities to enable them provide support services and/or

infrastructure facilities to Small Scale Sector to improve its marketing

capabilities.

The Corporation extends the financial assistance for working capital term

loans to existing units operating on profitable lines.

The corporation extends financial assistance towards WORKING CAPITAL

requirements for New Units only under Single Window Scheme.

ELIGIBILITY FOR FINANCIAL ASSISTANCE

Financial Assistance shall be considered with a maximum DER of 3:1 for

projects Costing less than Rs. 10.00 lakhs and maximum of 2:1 for projects

Costing above Rs. 10.00 Lakhs.

The loan eligibility under various schemes can be considered up to the limits

specified below subject to the DER norms.

For loans above Rs. 500.00 Lakhs, the minimum promoter’s contribution shall

be 33% and the overall DER shall not exceed 1.50:1

13

PURPOSE OF ASSISTANCE

Term loans for acquiring fixed assets.

Working capital term loans to existing units.

Seed capital to smaller projects.

What the Organization looks while financing:

Back ground of the entrepreneur.

Capability of the entrepreneur to invest his margins.

Capability of the entrepreneur to offer Collateral Security for the erm loans as

well as Working Capital.

Technical feasibility of the project.

Market potential for products and services.

Financial viability.

Risk perception.

LOAN SANCTION:

For loan sanction following documents are necessary:

Land document/lease.

Building plans along with estimates.

List of plant & machinery along with comparative quotations.

Detailed economics of working

Details of collateral security property proposed to be offered and copy of the

document.

Detailed of bio-data/back ground of promoters.

14

Licenses/approvals viz SSI registration, APCCD, AP Transco.

Details of market/demand for the proposed products.

Promoter’s Contributions:

The minimum Promoter’s Contribution in the scheme shall not be less than

22.5% in SSI unit.

The Promoter’s Contribution in case of SES, GES and SSES cases shall be as

applicable under the perspective schemes.

Application Checklist:

Promoters Background.

Particulars of the Industrial Concern.

Particulars of the Project Capacity, Process Technical Arrangements,

Measurement and Location of Land and Building, Plant & Machinery, Raw

materials, Effluents, Labor housing and Schedule of implementation.

Cost of Project.

Means of Financing.

Marketing and selling arrangements.

Profitability & cash flow.

Economic consideration.

Government consents.

15

LIMITS FOR FINANCIAL ASSITANCE IN APSFC:

Few limits for financial assistance in APSFC are as given below:

Proprietary & Partnership Joint Hindu families have a maximum limit per

project of 500 Lakh rupees.

Limited companies, Co-operative societies have a maximum limit per project

of 500 lakh rupees.

LOAN SANCTION POWER

Term Loans (Non Traditional Lines of Activities)

Branch office – loans up to Rs. 15.00 lakhs.

Zonal office – loans above Rs. 15.00 lakhs and up to Rs. 30.00 lakhs.

Head office – loans above Rs. 30.00 lakhs and up to Rs. 240.00 lakhs.

Term Loans (Traditional Line of Activities)

Branch office – loans up to Rs. 20.00 lakhs.

Zonal office – loans above Rs. 20.00 lakhs and up to Rs. 40.00 lakhs.

Head office – loans above Rs. 40.00 lakhs and up to Rs. 240.00 lakhs.

Working Capital Term Loans

Units which are assisted by the corporation:

Branch office – loans above Rs. 5.00 lakhs and up to Rs. 10.00 lakhs.

Zonal office – loans above Rs. 10.00 lakhs and up to Rs. 20.00 lakhs.

Head office – loans above Rs. 20.00 lakhs and up to Rs.240.00 lakhs.

16

SOURCES OF FINANCIAL ASSISTANCE TO APSFC

APSFC is actively considering venturing into joint financing to assist the medium and

large scale enterprises for both new and existing units by means of tie up with SIDBI

and other financial institutions. Corporation is coming out with strategic alliance with

SIDBI for extended joint finance for the loans over 5.00 crores for SSI, SME

infrastructure units, service sector units, tourism, pharmacy, construction of roads and

bridges under BOT scheme.

Share Capital comprises of:

Government of Andhra Pradesh------------------------------------------------------67.52 %

SIDBI-------------------------------------------------------------------------------------32.18 %

Others-------------------------------------------------------------------------------------00.30 %

DETAILS OF SCHEMES

APSFC currently operates 33 innovate schemes to cater to various industrial and

market segments. It has special schemes for women entrepreneurs and self help

groups under DWACRA program and for first generation entrepreneurs.

The corporation has supported the Government’s Industrial Investment Policies by

introducing specific schemes for the educated unemployed under ‘Crash Program’

and ‘Self Employment’ schemes for young entrepreneurs. It operates many schemes

for modernization and up gradation of technology besides being the Government

agency for disbursement of subsidies.

It is now preparing a scheme for the benefit of the ‘Export Oriented Units’ in line with

the commitment of the Government to increase earnings through exports.

17

General Schemes:

General loans.

Assistance to good entrepreneurs.

Super entrepreneur’s scheme.

Equipment refinance scheme.

Modernization scheme.

Scheme for Hotels/Motels/Restaurants.

Scheme for tourism related facilities.

Assistance to Hospitals/Nursing Homes.

Assistance for acquiring Electro-Medical Equipment.

Assistance for Diesel Generator Sets.

Transport loans scheme.

Scheme for acquiring road laying equipment and heavy earth moving

equipment.

Scheme for acquiring bore well drilling ring.

Civil contractor’s scheme.

Assistance for setting up industrial estates.

Scheme for qualified professionals.

Single window scheme.

Scheme for acquisition of ISO 9000 series certificates by SSI units.

Marketing assistance scheme for SSI products.

18

Special Schemes:

Mahila Udhyam Nidhi Scheme.

National Equity Fund Scheme & SEMFEX Scheme.

Scheme for assistance to self help groups of women under Development of

Women and Children in Rural Areas (DWACRA).

Other Schemes:

Composite loan.

Scheme for SC/ST entrepreneurs.

Scheme for physically handicapped persons.

Merchant Banking(WCTL).

Concerns engaged in Industrial Activity (between Rs. 50.00 & Rs. 100.00

lakhs).

Concerns engaged in Industrial Activity (above Rs. 100.00 lakhs).

Trading concerns engaged in Industrial Activity by obtaining the industrial

units on lease (above Rs. 100.00 lakhs).

Civil contractors engaged in development/maintenance/construction of works

(up to Rs. 50.00 lakhs).

Civil contractors engaged in development/maintenance/construction of works

(between Rs. 50.00 lakhs and Rs. 100.00 lakhs).

Civil contractors engaged in development/maintenance/construction of works

(above Rs. 100.00 lakhs).

Short term loan to practicing doctors and existing nursing homes.

Existing commercial complex buildings (up to Rs. 50.00 lakhs).

Existing commercial complex buildings (between Rs. 50.00 and Rs. 100.00

lakhs).

19

MILESTONES

Andhra Pradesh state Financial Corporation has so far stationed 6,098 crores

for 86,384 units in Andhra Pradesh.

Created total investment of around 14,219 crores.

Established unblemished repayment track record since inception.

Has consistent record of earning operating profit throughout its history.

It has disbursed 4,150 crores to 66,516 units – 70% to Small Scale Industry

sector.

Recovered an amount of Rs. 4,895 crores including interest since inception.

Generated direct and indirect employment to about 8.57 lakh persons.

Channeled a significant share of assistance of around 70% to tiny and small

scale industries.

It has industrialized backward areas by extending 50% of its assistance to

industries coming up in notified backward rates.

It is enjoying 60% of the market share in term lending business in Andhra

Pradesh.

Quality Policy

APSFC aims to be the leading term lending financial institution in the state by

providing adequate and timely financial assistance to its customers for

industrialization specifically in small and medium scale sector including

service enterprise.

APSFC shall ensure customer satisfaction through professional management

and teamwork with commitment to implement the requirements of ISO

9001:2000.

APSFC shall also review and improve continually the suitability and

effectiveness of quality management system and its quality objects.

20

PERFORMANCE REVIEW FOR THE LAST 5 YEARS

(Rs. In Lakhs)

Year ended 31st

March2006 2007 2008 2009 2010

Sanctions 41985.70 43058.46 46469.60 58596.93 70475.23

Disbursements 30130.03 28324.87 34887.45 42172.45 52313.69

Recoveries 40849.62 45021.74 45139.40 48214.04 51595.25

Cumulative Sanctions

Number 65274 66288 67243 68246 69323

Amount 333681.10 360409.45 391421.62 436273.10 491638.25

Operative Income

15264.41 14309.21 13004.80 13851.53 15861.16

Operational Costs

14895.22 13707.77 12313.84 13067.90 15045.91

Operating Profit 369.19 601.44 690.96 783.63 815.25

O/S Amount 139865.48 127149.40 120955.88 122839.27 133450.01

No. of Accounts 2157 20802 19623 17878 15796

No. of Employees

546 534 523 519 514

21

FUTURE PLANS OF APSFC

The corporation has prepared a road map with detailed action plan of the next five

years with the following:

To improve its assets base to at least Rs.1500 crores.

To wipe out the entire accumulated losses.

To create minimum equity base of over Rs.200 crores.

To achieve capital adequacy over 10%.

To bring down NPAs to a single digit.

To make a beginning in this direction:

The corporate has declared the current financial year as a ‘No NPA YEAR’.

The strategic plan has been prepared on the premise that the corporation will

build fresh loan portfolio of Rs.700 crores during 2010-11.

The corporation is explore the possibilities offer more number of products and

expecting to serve better the needs of its clientele by emerging as a ‘Financial

Supermarket’.

22

OPERATION ZONES OF APSFCThe following re-organization of operation departments is ordered with immediate

effect:

OPD Branches

1 Hyderabad, Nalgonda and Warangal

2 Nizamabad, Karimnagar and Adilabad

3Ranga Reddy[east], Ranga Reddy[west],

R.C.Puram, Sanga Reddy

4 Mahboobnagar and Tirupati

5 Ananthapur, Kurnool, Nellore and Kadapa

6 Vijayawada, Guntur, Khammam and Ongole

7 Eluru, Rajamundry, Vizag

8 Srikakulam and Vijayanagaram

LENDING POLICY FOR THE FINANCIAL YEAR 2010-11

The lending policy for the financial year 2008-09 is as under

1. Lines of activities listed under encouraged and not to be encouraged

categories:

The lines of activities are classified into two categories i.e.,

ENCOURAGED and NOT TO BE ENCOURAGED categories, for the

financial year 2010-11.

Loans below 10 lakhs shall not be encouraged irrespective of line

activity/scheme. Permission from concerned HOD (operations) shall be

obtained to sanction loan between Rs.5 Lakhs shall not be considered for

sanction.

For ST/SC entrepreneurs only the minimum loan amount is relaxed to Rs.5

Lakhs.

2. Lines of activities not listed under any of the two categories:

For the lines of activities not listed in any of the two categories of the

23

lending policy, prior approval shall been taken from the Head Office,

expecting those lines of activities for which financial assistance was

considered in the respective branch jurisdiction during the last 2 years and

where there are no sick units.

For loan enquiries which require approval of Head Office, the Branches

shall forward the enquiries to the projects Appraisal Department Head

Office for processing the enquiries and to place the same before the

projects screening committee for a decision.

3. Applicability of lending policy:

The lending policy is applicable to first generation entrepreneurs and

for new projects. The lending policy is also applicable to the existing

promoters going in for expansion/modernization and/or diversification

of their activities into other lines of activities.

The units being set up by existing promoters as backward/forward

integration, expansion/modernization, in the lines of activities listed

into not to be encouraged category/the lines of Activities not listed in

the lending policy, the Branch Managers may issue the loan applicable

depending on the merits of the case and the same shall be forwarded to

Projects Appraisal Department, H.O.D to put up to decide on the terms

of financial assistance.

4. Collateral security norms:

A minimum collateral security as mentioned against each line of

activity shall be instead for all lines of activities listed under

ENCOURAGED category.

All the industrial units listed under encouraged category being setup in

lease hold premises.

The collateral security shall be minimum of 50% of total loan being

24

considered or the requirement of CS for the line of activity as per

lending policy, whichever is higher.

For projects in APIIC/ALEAP etc., Industrial estates / IDAS the

collateral securities shall be insisted on the total expect loan

component on land and Buildings provided the marketability of the

land and buildings in such estates is to be satisfaction of corporation.

A GOLD LETTER DAY FOR APSFC

Andhra Pradesh State was formed on 1st November, 1956. The Andhra Pradesh

legislative assembly and the Andhra Pradesh high court were also constituted on the

same day, the Andhra Pradesh State Financial Corporation come into existence with

the amalgamation of the rest while Andhra State financial corporation and Hyderabad

state financial corporation with the mandate to promote and develop small and

mediul11 industries. 1st November, 1956 is thus a gold letter day for Andhra Pradesh

State Financial Corporation.

25

CHAPTER -3

ASSETS LIABILITY MANAGEMENT (ALM)

Asset - liability management practices which effect from April 1, 1999. While

guidelines on management of credit risk, market risk and operational risk will be

issued later on. The RBI has issued guidelines for the introduction of Asset - liability

management (ALM) as a part of the risk management and control system in banks.

They are intended to form the basis for initiating collection, compilations and analysis

of dates required tu support the ALM System.

Over the last few years, the Indian Financial System markets have witnessed vide

ranging changes at a 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 measures. The bank management has to base their

business decision on a dynamic and integrated risk management system and process,

driven by corporate strategy. The banks are exposed to several major risks in the

course of the business credit risk, interest rate risk, foreign exchange risk, and

equity/commodity price risk. Liquidity and Operational risks. It is against this

background that the RBI guidelines relating to AL:!v1 focus on interest rate and

liquidity risk-management system in banks, which form part: of the ALM function.

The initial thrust of the ALM function would be to enforce the risk management

discipline that is, managing offer assessing the risk involved. The objective of good

risk Management programs should be that their programs evolve into a strategy tool

for bank management. In the normal course, Financial Institutions are exposed to

credit and market risks in view of the asset liability transformation.

26

With liberalization in Indian Financial markets, over the last four years and

growing integration of domestic markets and the entry of MNC's for meeting the

credit needs of not only the corporate but also the retail segments, the risks associated

with Financial Institutions operations have become complex and large, requiring

strategic management. Financial Institutions are now operating in a fairly deregulate

1. environment and are required to determine interest rates on deposits, they can also

offer deposits prescribe by the R 131: they can also offer advances on dynamic basis.

The interest rates on investments of 1:1 –in government and other securities are also

now market related. Intense competition for business involving both assets and

liabilities has brought pressure on the management of Financial Institutions to

maintain a good balance among spreads, profitability and long-term liability.

Imprudent liquidity management can put Financial Institutions earnings and

reputation at great risk. The management of Financial Institutions have to base their

business decisions on a dynamic and integrated risk management system and process

driven by' corporate strategy, Financial Institutions are exposed to several major risks

in the course of their business; credit risk, interest rate risk, equity/commodity price

risk, liquidity risk and operational risk. It is, therefore, important that Financial

Institutions introduce effective risk measure management systems that address the

issues relating to interest rate and liquidity risks.

Financial institutions need to address these risks in a structural manner by upgrading their

risk management and adopting more comprehensive asset-liability management (ALM)

practices than has been done hitherto. ALM, among other functions, is also concerned with

risk management and provides a comprehensive and dynamic framework for measuring,

monitoring and managing liquidity and interest rates and equity and commodity price risks of

27

major operators in the financial system, which needs to be closely integrated with the

Financial Institutions business strategy. It involves assessment of various types of risks and

altering the asset-liability portfolio in a dynamic order to manage risks. The RBI guidelines

relate to interest rate and liquidity risks management system in Financial Institutions, which

form parts of the Asset -liability management (ALM) function. The initial focus of the ALM

function would be to enforce the risk management discipline that is managing business after

assessing the risks involved. The objective of good risk management systems should

be that these systems would evolve into a strategic tool for financial institution management.

The ALM Process rests in these pillars

1. ALM Information System

A. Management Information Systems

B. Information availability, accuracy. adequacy and expediency

2. ALM Organization

A. Structure and Responsibilities

B. Level of top Management involvement

3. ALM Process

A. Risk Parameters

B. Risk identification

C. Risk Measurement

D. Risk Management

E. Risk policies and tolerance levels.

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ALM INFORMATION SYSTEM

ALM has to support by a management philosophy that clearly specifies the risk

policies and tolerance limits. This framework needs to be built on sound technology

with the necessary information system as backup. Thus information is the key to the

ALM process. It however, recognized that varied business profiles of Financial

Institutions in the public and private sectors do not make the adoption on a uniform

ALM system for all Financial Institutions feasible.

These are various method prevalent worldwide for measuring risks. These range

from the simple gap statement to extremely sophisticated and dam intensive risk

adjusted profitability measurement methods. However, though the central element for

die entire ALM exercise, is- the availability of adequate and accurate information

with expedience and the systems existing some of the major Financial Institutions do

not generate information in the manner required for ALM. Collecting accurate data in

a timely manner would be the biggest challenge before the NBFC's particularly those

lacking full-scale computerization. However, the introduction of a base information

system of risk management, risk measurement and monitoring has to be addressed

urgently.

Financial Institutions have heterogeneous organization structures, capital base,

asset size, management profiles, business activities and geographical spread. Some of

them have a large number of branches and agents/brokers, where as some have

unitary offices. Considering the large number of branches and the lack of adequate

support system to collect information requires for the ALM. Which analysis

information on the basis of residual maturity and reprising pattern of liabilities and

assets, it would take time for Financial Institutions in the present state, to get the

requisite information. With respect to investment portfolio and funds management, in

view of the centralized nature of the functions, it would refined overtime as the

Financial Institutions management gains experience of conduction business within an

ALM framework the spread of computerization will also help Financial Institutions in

accessing data.

29

The business issues than ALCO would consider, inter, should include product

pricing for both deposits and advances, desired maturity profile and mix of the

incremental assets and liabilities, prevailing interest rates offered by other peer

NBFCs for similar services/products and so on. In addition to monitoring the risk

levels, the ALCO should review the result of and progress in implementation of the

decision made in the previous meeting. The ALCO should also articulate the current

interest rate view of the Frs and base its decision for future business strategy on this

view. With respect to the funding policy, for instance, its responsibility would be to

decide on the source and mix of liabilities or sale of assets. Towards this end, it

should develop a view regarding the future direction of interest rate movements and

decide on funding mixes between fixes vs. floating rate funds, wholesale vs. retail

deposits, money markets vs. capital markets, funding domestic vs. foreign currency

funding, and so on. Individual Financial Institutions should decide the frequency of

holding their ALCO meetings.

COMPOSITION OF ALCO

The size (number of members) of ALCO would depend on the size of the each

institution, business mix and organizational complexity. To ensure commitment of the

Top management and timely response to market: dynamics the

CEO/CMD/President/Director should head the committee. The chief of investment,

credit resources management/planning funds management/treasury. International

Business and Economics research can be members of the committee. In addition, the

head of the technology division should also be an invitee building up of MIS and

related computerization. Large FI may even have sub-committee and support groups.

COMMITTEE OF DIRECTORS

The management committee or any other specific committee constituted by the

board of directors should oversee the implementation of the system and review its

function periodically.

30

The scope of the ALM functions can be described as follows:

1. Liquidity risk management

2. Management of market risks

3. Funding and capital planning

4. Profit planning and growth projection and

5. Forecasting and analyzing 'what if scenario' and preparation of contingency

plans.

DEFINITION OF RISK

Risk is the potential loss of an asset due to different factors.

IDENTIFICATION OF RISK

ALM in a commercial bank of Financial Institutions is to decide what should be

the risk measurement parameters that the management would need to focus on. The

appropriateness of risk management parameters depends upon the degree of volatility

in the operating environment, availability of supporting data and expertise within

bank/Financial Institutions and the expected market and business developments.

Generally, these are two major parameters, which banks/Financial Institutions all over

the world employ to measure their balance sheet risks viz., risk to the net interest

income and market value portfolio equity.

While the former seeks to measure the risk to the immediate profits that emanate

from cash flow mismatches occurring in the accounting years, the latter measures the

risk arising out of the maturity mismatches in its assets and liabilities over the future

years. These two parameters together attend to the short term and long-term balance

sheet risk.

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MEASURING THE RISK

Due to difficulty in measuring interest rate risk and also the complexes the present

in the understanding of the concept measurement of interest rate risk assumes greater

importance in the ALM function. It has observed that banks risk exposure depends

upon the volatility of interest rates and asset prices in the financial market, the

Financial Institutions maturity/gaps, the duration to measure and interest rate

elasticity of its assets and liabilities and the liability of the management to measure

and control the exposure. In the management of Financial Institutions assets and

liabilities, interest risk management lays the foundation for a good ALM.

RISK ANALYSIS

Interest rate risk can be analyzed in the following four methods.

1. Gap Analysis

2. Duration Analysis

3. Value at risk

4. Simulation

Gap analysis is the most important basic technique used in analyzing interest rate

risk. It measures the difference between financial institution assets and liabilities and

off balance sheet position which will be re priced or will mature within a

predetermine period. (Gap is the difference between rate sensitive assets minus rate

sensitive liabilities)

32

COMPONENTS OF RISK MANAGEMENT

Risk management may be defined as the process of identifying and controlling risk. It is

also described at times as the responsibility of the management to identify measure, monitor

and control various items of risk associated with Financial Institutions position and transaction.

The process of risk management has three clearly identifiable steps, viz., risk identification, risk

measurement and risk control.

CONTROL RISK

After identification and assessment of risk factor, the next step involved is risk

control, the major alternatives available in risk control are

1. Avoid the exposure

2. Reduce the impact by deducing frequency of severity

3. Avoid concentration in risky area

4. Transfer the risk to another party

5. Employ risk management instruments to cover the risks

RISK IN FINANCIAL INSTITUTIONS

Risks in financial institutions are many and a broadly classifies into three

categories

They are as follows:

1. Balance sheet risks

2. Transaction risks

3. Operating and liquidity risk

33

I. BALANCE SHEET RISK

The balance sheet generally arise out of the mismatch between currency, maturity

and interest rate structure of assets and liabilities resulting in

1. Interest rate mismatch risk

2. Liquidity risk

3. Foreign exchange risk

1. INTEREST RATE MISMATCH RISK

It is the impact of the change in interest rate on the net interest income of the bank

and value of the assets and liabilities. For example,

(a) When fixed deposits are accepted on the fixed rate basis and the amount is lent

on floating rate basis, any download revision of interest rate on advances will

result in the reduction of income stream for the bank Financial Institutions.

But interest rate on deposits can be changed only when they fall due or pre

closed by the depositor.

(b) A bonds (investments asset of the bank) price falls down as interest rate rise.

2. LIQUIDITY RISK

Liquidity is the potential inability to meet the banks/Financial Institutions as they

become due. It rises when Financial Institutions are unable to generate cash to cope

with the declines in deposits or increase in loans. It originates the mismatches in the

maturity of assets and liabilities as well as uncertainty of future cash flows.

3.FOREIGN EXCHANGE RISK

The risk that a long (over bought) or short (over sold) position in the foreign

currency might have to be closed out at a. loss duet to an adverse movement in

exchange rates.

34

II. TRANSACTIONS RISKS

The transaction risk essentially involves two types of risks. They are

1. Credit risk

2. Price Risk

l. MARKET RISK

Market risk may be defined as the possibility of the loss to financial institution

caused by changes in market variables. The financial institution defines market risk as

the risk that the value on and off balance sheet position will be adversely affected by

movements in the equity and interest rate of markets, currency, exchange rate and

Commodity prices.

2. ISSUER-RISK

The financial strength and standing of the institute/sovereign that has issued the

instrument can affect price as well as reliability. The risk involved with the

instruments issued by corporate bodies would be an ideal example.

3. INSTRUMENT RISK

The nature of instrument creates risks for the investor. With many hybrid

instruments in the market and with fluctuations in market conditions, the prices of

various instruments ma react differently form one another.

35

MANAGEMENT OF LIQUIDITY RISK AND INTEREST RATE

RISK

LIQUIDITY RISK

Measuring and managing liquidity needs are vital for the effective operations of

financial institution. By ensuring a Financial Institutions ability to meet its liabilities

as then become due liquidity management can reduce the probability of an adverse

situation developing. The institution of liquidity transcends individual institutions, as

liquidity shortfall in one institution can have repercussion on the entire system. The

Financial Institutions management should measure not only the liquidity position of

Financial Institutions 011 an ongoing basis but also examine how liquidity

requirements are likely to evolve under different assumptions. Experience show that

assets commonly considered as liquid, like government securities and other money

market instrument, could also become liquid when the market and players are

unidirectional. Therefore, liquidity has to tracked through, the use of the maturity or

cash flow mismatches. For measuring and managing net funding requirements, the

use 01' maturity ladder and calculation of cumulative surplus or deficit of funds at

selected maturity dates are adopted as a standard tool.

The time buckets are distributed as under:

Less than one month

Over 1 month to 3 months

Over 3 months to 6 months

Over 6 months to 12 months

Less than or equal to 1 year

More than 1 year and up to 3 years

More than 3 years and up to 5 years

36

More than 5 years and up to 7 years

More than 7 years and up to 10 years

More than 10 years

Financial Institution holding public deposits are required to invest up to a

prescribed percentage (15 % as on date) of their public deposits in approval securities,

in terms of the liquid asset requirements of sections 45-IB of the RBI Act, 1934.

Financial Institutions ,Fi' required to invest up to 80 percent of their deposit in the

manner prescribed in the RB 1 directors issued under the act, as detailed in an earlier

section. There is no such requirement for Financial Institutions that are not holding

public deposit~. Thus various Financial Institutions including SFCs would be holding

in their investment portfolio, securities that could be broadly classifiable as

'mandatory securities' (under obligation of law) and' non-mandate securities'. In case

of Financial Institutions not holding public deposits, all the investment and in GISC.

Financial Institutions holding public deposits, the surplus securities would fall in

the category of non mandatory securities.

Financial Institutions holding public deposits may place mandatory securities in

any time – bucket suitable to them. The listed non-mandatory securities may be

placed in any of the less than one month, over 1 month to 3 months, "Over 3 months

to 6 months" and "over () months to 12 months" buckets, depending upon the

defeasance period proposed b Financial Institutions.

Unlisted non-mandatory securities (e.g., equity shares, securities without a fixed term of

maturity and so on) may be placed in the "more than 10 years" buckets, where as unlisted non-

mandatory securities having a fixed term of maturity may be placed in the relevant time

bucket, as per residual maturity. The mandatory securities and listed securities may be marked

to market for the purpose of the ALM System. Unlisted securities may be valued as per RBIs

prudential norms directions. The statements of structural liquidity may be prepared by placing

all cash inflows and outflows in the maturity ladder according to the expected timing of cash

flows. A maturity liability is cash outflows while a maturity asset is a cash inflow while

determining the likely cash inflows/outflows.

37

Liquidity Problems may be created due to any of the following reasons:

a) Funding Risk:

Failure to replace net outflow of funds weather due to withdrawal of retail

deposits on non-renewal of wholesale deposits.

b) Time Risk: Non-receipt of expected inflow of funds e.g. Where borrowers fails to

meet their commitments besides irregularly in advances which present delay in

fulfilling commitments by borrowers the growth of non-performing assets also leads

to immediate liquidity problem. Non-performing assets cut into profitability as well.

ALM process if it fails to take NPA problems cannot succeed.

c) Call Risk:

It represents sudden demand for money owing to contingent become due. If

contingent liabilities start developing the may create huge drain on liquidity.

d) Opportunity Risk:

A Financial Institution can only grow if its customers are also prospering (succeeding)

request for funds from important and valuable clients can only be profitably serviced

if adequate liquidity is available.

Approaches to control Liquidity

1. Maintenance of adequate liquidity remains sinquonon for banks are other

financial institutions.

2. Once maturity of assets exceeds those of liabilities there is inevitable liquidity

risk.

3. Minimum criteria to remain liquid is the ability both to meet commitments

when due and to undertake new transactions when desirable.

4. Confidence to rise, mobilize or, roll over the deposits from existing clients.

This confidence may be found to be misplaced when liquidity prevails as

38

existing clients at that stage may be in the grip of liquidity crisis.

5. To avail of Export Refinance Facility (ERF) and Collateralized Lending

Facility (CLF) and the Additional Collateralized Lending Facility (ACLF).

6. Financial Institutions should make a No. of assumptions according to their

Asset –liability profiles,while determining the tolerance levels.Financial

Institutions may take into accounts all relevant factors based on their asset-

liability base, nature of business future strategy & so on. The tolerance levels

should be determines keeping all necessary factors in view and further refined

with experience gained in liquidity mgmt

Currency Risk:

Floating exchange rate arrangement has brought in its wake pronounced volatility,

adding a new dimension to the risk profile of Financial Institutions balance sheets

having foreign assets and liabilities. The increased capital flows across free

economics, following deregulation, have contributed to increase in the volume of

transactions large cross border flows together with volatility has rendered Financial

Institutions balance sheet unable to exchange rates.

Interest Rate Risk:

Deregulation of interest rates and the operational flexibility, given to financial institution in

pricing most of the assets and liabilities imply the need for the financial system to hedge the

interest rate risk, defined as the risk where changes in market interest rates might adversely affects

on Financial Institutions financial condition. The change in interest rates affects Financial

Institutions in a larger way. The immediate impact of changes in interest rates is on Financial

Institutions earnings (i.e., reported profits), by changing its net interest income (NIT). A long term

impact of changing interest rates is in Financial Institutions market the of Equity (MVE) or net

worth, as the economic value of Financial Institutions assets, liabilities and off balance sheet

positions yet affected due to various variations in market interest rates. The interest rare risk when

viewed form thee tow perspectives is known as the "earning perspective" and "economic value

perspective" respectively. The risk from the earnings perspective can be measured as changes in

the net interest income (NIT) or net interest margin (NIM). These are many analytical techniques

for measurement and management or interest rate risk, to begin with the traditional gap analysis is

considered as a suitable method to measure the interest rate risk. It is the intention of the RBI to

39

move over to modem techniques.

Financial Institutions should make a number if assumptions according to their asset liability

profiles. While determining the tolerance levels, Financial Institutions may take into account all

factors based on their asset liability base nature of business, future strategy and so on The

tolerance levels should be determined keeping all necessary factors in view and further refined

with experience gained in liquidity management.

In order to enable Financial Institutions to monitor their short-term

liquidity on a dynamic basic over tine horizon spanning from less than one month,

over 1 to 3 months Financial Institutions should estimate their Short term liquidity

profiles on the basis of business projects and other commitments for planning

purpose.

Interest rate risk gaps in time buckets:

Over 1 month to 3 months

Over 3 months to 6 months

Over 6 months to 12 months

Less than or equal to 1 year

More than 1 year and up to 3 years

More than 3 years and up to 5 years

More than 5 years and up to 7 years

More than 7 years and up to 10 years

More than 10 years

The gaps or mismatch risk can be measured by calculation gaps over

different time interval, as on a given data. Gap analysis measures mismatch between

interest rate sensitive liabilities and rate sensitive assets (including off-balance sheet

position).

40

Asset and Liabilities is normally classified as interest sensitive if:

1. With in the time interval under considerations, there is a cash flow.

2. The interest rate resets/reprises contractually during the interval.

3. Dependent on the RBI changes in interest rate/bank rates.

4. It is contractually pre payable or withdrawn before the state maturities.

5. Grouping rate sensitive assets and liabilities and of the-balance sheet positions

into time bucket according to residual maturity or next pricing period should

regenerate the gap report.

6. The gap is the difference between the rate sensitive assets (RSA) and rate

sensitive liabilities (RSL) for each time bucket. The positive gap indicates that

is has more RS than RSL where as the negative gap indicates that I has more

RSL than RSA.

7. The gap reports indicate the whether the institution is in a position 'LO benefit

rising interest rates by having a position gap (rs3>rsl) or weather it is in

position to benefit from declining interest rates by negative gap (rsl>rsa). The

gap a therefore be used as a measure of interest rate sensitive.

Sources of Interest Rate Risk:

As financial intermediaries, financial institutions encounter interest rate risk in

several ways. These can be described as follows:

a) Re-Pricing Risk: This risk arises from holding assets and liabilities with different

principal amounts, maturity or re-pricing dates, there by creating exposure to

unexpected changes in the interest rates.

41

b) Yield Curve Risk: Re-pricing mismatches can also expose a bank to changes in

the slope and shape of the yield curve. Yield curve risk arises when unanticipated

shifts of the yield curve adverse effects on a banks income or underlying economic

value. For instance, the underlying economic value of a long position in 10 years

government bonds hedged by a short position in 5 years government notes could

declare sharply if the yield curve steepens, even if the position is hedged against

parallel movements in the yield curve.

c) Basis Risk: Another important source of interest rate risk (commonly referred as

basis risk) arises from imperfect correlation in the adjustment of the rates and paid on

different instruments with otherwise similar re-pricing characteristics. When interest

rates change, thee differences can give risk to unexpected changes in the cash flows

arid earnings spread between assets and liabilities.

d) Option Risk: An additional and increasingly important source of interest rate risk

arises from the option embedded in many Financial Institutions assets and liabilities.

Formally, an option provides the holder that right, but not the obligation, to buy or sell

in some manner after the cash flow of an instrument of financial contract.

42

GENERAL

The classification of various assets and liabilities into different time - bucket for

preparation of gap reports (liquidity and interest rate sensitive) Financial Institutions

that are better equipped to reasonably estimated the behavioral pattern of various

components of assets and liabilities, on the basis of the past data/empirical studies

could classify them in the appropriate time-buckets, subject to approval from the

ALCO board of directors. A copy of the note approved by the ALCO may be sent to

the registered office of the company is located. These notes may contain 'what if

scenario' analysis wider various assumed conditions and the contingency plans to face

various adverse developments.

The present framework does not capture the impact of premature closures of

deposits and prepayments of loans and advances on the liquidity and interest rate risk

profile on Financial Institutions. The magnitude of premature withdrawal of deposits

at times of volatility in market interest rate is quite substantial. Financial Institution

should therefore evolve a suitable mechanism supported by empirical studies and

behavioral analysis to estimate the further behavioral of assets, liabilities and off-

balance sheet items to changes in market variable and estimate the probabilities of the

options. A scientifically evolved internal transfer pricing model of assigning values on

the basis of current markets rates to funds provided and funds used is an important

component for effective implementation of the ALM system. The transfer price

mechanism can enhance the management of margin, that is lending or credit spread.

The funding or liability spread and mismatch spread. It also helps centralizing

interest rate risk at one place. Which facilities effective control and management of

interest rate risk. A well defined transfer pricing system also provides a nominal

framework for pricing of assets and liabilities.

43

There are four different types of analysis:

1. Gap Analysis"

2. Duration Analysis

3. Trend Analysis

4. Ratio Analysis

l. GAP ANALYSIS:

Maturity/pre-pricing schedules can be used to generate simple indicators of the

interest rate risk sensitivity of both earnings and economic value to changing interest

rates. When this approach is used to asses the interest rate risk of current earnings. It

is typically referred to as gap analysis. Gap analysis was one of the first methods

developed to measure Financial Institutions interest rate risk exposure and continues

to be widely used by Financial Institutions. To evaluate earnings, interest rate

sensitive liabilities in each time band are sub traced from the corresponding interest

rate sensitive asset to produce are pricing gap for that time band. This gap can be

multiplied by as assume change in interest rate to yield an approximation of the

change in the interest rate income that would result from such as interest rate

movement. The size of the interest rate movement used in the analysis can be used on

a variety of factors, including historical experience. Simulation of potential future

interest rate movements and the judgment of bank management. A negative or

liability sensitive gap occurs when liabilities exceeds assets (including off-balance

sheet positions) in a given time band.

This means that an increase in market interest rates could cause a decline in net

interest income. Conversely, a positive or assets-sensitive. Gap implies that the

Financial Institutions net interest rate income could decline as a result of decrease in

the levels of the interest rates.

44

LIMITATIONS OF GAP ANALYSIS:

Although gap analysis is a very commonly used approach to assessing interest rate

risk exposure, it has a number of shortcomings. First, gap analysis does not take it

account of variation in the characteristics of different position with a time band. In

particulars all positions with in a given time band are assumed to mature or reprise

simultaneously a simplification that is likely to have greater impact on the precision

of the estimates as the degree of aggregation with in a time band increases, moreover

gap analysis ignore differences in spreads between interest rates that could arise as the

level of the market interest rates changes. In addition, it does not take into account

any changes in the timing of payments that might occur as a result of changes in the

interest rate environment. Thus, it fails to account for differences in the sensitivity of

income that may arise form option-related positions, for these reasons gap analysis

provides only a rough approximation to the actual change in net interest income

would result from the chosen change in the pattern of interest rates. Finally gap

analysis fail to capture variability in non interest revenues and expenses, potentiality

important sources of risk of the current income.

2. CURRENT ANALYSIS

A maturity/re-pricing schedule can also used to evaluate the effects of changing

interest rates on Financial Institutions economic value by applying sensitivity weights

to each time band. Typically, such weights are based on estimates of the duration of

the assets and liabilities that fall into each time and duration give a small change in

the level of interest rates. Duration may also be defined as the weighted average of the

time until expected cash flows from a security will be receive, relative to the current

price of the security. The weights are the present values of each cash flow divided by

the current price. In its simples form, duration measures changes in economic value

resulting from a percentage change of interest rates under the simplifying

assumptions that changes in value are proportional to changes in the levelof interest

rates and that the timing of payments is fixed. Modified duration is standard duration

divided by 1+r, where the level of market interest rate is is elasticity. As such, it

ref1ects the percentage change in the economic value of the instrument for a given

percentage change in the economic value of the instrument for a given percentage

change in 1+r. as with simple duration, it assumes a linear relationship between

45

percentages changes in value and percentage changes in interest rates / in other words,

modified duration = Macaulay duration/Cl +r), where Macaulay duration = cft(t)/(l+r)

/cft/(l+r) to the power t

left = rupee value of cash flow at time t

T = number of periods of time until the cash flow payment

Y = periodic yield to maturity of the security generating cash flow and

K = the number of cash flows.

3. TREND ANALYSIS

This is a statistical tool with his we can find out the position of anything in

financial institution, I did the trend analysis of "cumulative mismatch of last one year

as percentage to working funds", by this, it is possible to know that how that

fluctuation in funds take place in the one year mismatches.

4. RATIO ANALYSIS

The liquidity ratios are very useful in the liquidity risk management analysis.

Because with the ratios we can analyze "the liquidity positions for the company by

taking the past data and we can interpreter the findings. Here in financial institution,

we should also given by the RBI on the bank, by observing the limits and of findings

we can analyze as Financial Institutions is with in the limits or not. The ratios, which

are used in financial institutions, are

Current assets/current liabilities

Total loans/ total assets

Total assets/ total liabilities

Total advances/total liabilities

46

Quick ratio:

The ratios, which helps to find out liquidity position of all financial institution.

Liquidity and Interest rate analysis:

This is the only tool, which is used in the ALM process to manage the liquidity

risk, by doing the gap analysis, Financial Institutions ,can avoid risks and can earn

more profits, and this is used to analyze the gaps in between the inflows and outflows

of the statement for every fortnight. By doing the gap, analysis the Financial

Institutions can know about in which bucket the risk. This gap raised due to the

changes in the values of the assets and liabilities and changes in their interest rates.

For measuring and managing net funding requirements the use of maturity ladder and

calculation of cumulative surplus / deficit of funds at selected maturity data is

suggested for adoption by FI. The maturity profile is used to measure the future cash

flows of banks different buckets.

Value At Risk (VAR).

VOR is defined as an estimate of potential loss in position or asset/liability or

portfolio of assets liabilities over a given holding period at a given level of certainty

or unexpected happening the probability of suffering a loss.

BUCKETING:

The time columns used in the below statement, are called as the time buckets.

These buckets are mainly divided in to three types short - term, medium - term and

long term. Allocating the items of inflows and outflows in this column is called as

bucketing.

Over 1 month to 3 months

Over 3 months to 6 months

Over 6 months to 12 months

47

Less than or equal to 1 year

More than 1 year and up to 3 years

More than 3 years and up to 5 years

More than 5 years and up to 7 years

More than 7 years and up to 10 years

More than 10 years

To analyze the statement a person should have to get grip on the various items or

liquidity statement. Various items are covered in the statement under the inflow and

out flows.

Methods to bucket:

The nature of the each item is different with others. So few models are used to

find out under which bucket it will come like residual maturity, behaviouralization.

Residual Maturity:

This is the type where the item due date is taken as a base to bucket. Based on

maturity date and the starting date of the item time period is calculated. Statements

preparation data should also be considered.

48

CHAPTER -4

DATA ANALYSIS AND INTERPRETATION

As per RBI guide lines the banks, NBFC’s are required to have ALM and conduct

asset liability management committee meetings regularly APSFC though not require

to maintain ALM, has constituted a asset liability managers committee with the

managing directors as chairman and other senior officers as members of the ALCO

meets every month and reviews cash budgets, interest rate changes, funds position and

statement of structural liquidity of various out flows and inflows and statements of

interest sensitivity as at a particular month and as per RBI guidelines.

The cash budget comprises of various sources of funds to APSFC by way of

refinancing from SIDBI, short term loans from banks, fixed deposits, its also gives the

uses of funds by way of disbursement of loans repayment of principal of amounts to

SIDBI, commercial banks and fixed deposits, payment of interest, administrative and

personal expenses. It reveals the gap in funds requirement and various sources to fill

the gap.

The structural liquidity statements and interest sensitivity statements are proposed as

per formats prescribed by RBI.

49

DATA INTERPRETATION / DATA ANALYSISTHE CASH BUDGET PRESENTED TO ALCO MEETING OF APSFC AS ON 30/10/2010 AS UNDER

SI.NO PARTICULARS UPTO         TOTAL    30.10.2010 Nov-2010 Dec-2010 Jan-2011 Feb-2011  (A) APPLICATION OF FUNDS:            [1] DISBURSEMENTS 33241.37 7000.00 8000.00 8500.00 8258.63 65000.00[2] REPAYMENTS            i SIDBI Refinance 4214.66     1404.89   5619.55ii SIDBI Prepayment 552.90     447.10   1000.00iii SLR Bonds 864.00 748.00 1100.00   200.00 2912.00iv APIIC     2500.00   2500.00 5000.00v CBI 1000.08         1000.08vi BOI 625.00         625.00vii Other Commercial Banks           0.00viii HUDCO           0.00ix Public Deposits 2939.64 100.00 100.00 50.00 50.00 3239.64

Total(2) 10196.28 848.00 3700.00 1901.99 2750.00 19396.27[3] REVENUE PAYMENTS:            i SIDBI – Interest 4524.07 0.00     1800.00 6324.07ii Interest on SLR Bonds 976.41 249.77 199.65 198.33 137.02 1761.18iii Interest on Non-SLR Bonds     247.50     247.50iv Interest on FDs 121.43     228.40   349.83v Interest on CBI loan 267.63 26.61 26.61 24.89 26.61 372.35vi Interest on BOI loan 285.41 33.44 33.44 31.28 33.44 417.01vii Interest on Commercial Bank Loans 52.72         52.72viii Interest on HUDCO loan 46.71     100.00   146.71ix Interest on APIIC loan 175.48 87.50     87.50 350.48x Interest Others / SOB/IDBI 74.09 25.00 25.00 20.00 25.00 169.09xi Administrative / Establishment expenses 2025.17 250.00 250.00 250.00 250.00 3025.17xii Income tax paid 140.14 65.12     75.00 280.26xiii Capital expenditure 45.28 20.00 100.00 100.00 100.00 365.28

Total(3) 8734.54 757.44 882.20 952.90 2534.57 13861.65[4] OTHER PAYMENTS:            i Staff loan disbursements   15.00 10.00 10.00 10.00 45.00ii Subsidy releases 3533.03 1000.00 1000.00 1000.00 200.00 6733.03iii Inc / Dec in current assets liabilities 4227.82         4227.82total(4)   7760.85 1015.00 1010.00 1010.00 210.00 11005.85

GRAND TOTAL(1+2+3+4) 59933.04 9620.44 13592.20 12364.89 13753.20 109263.77               (B) SOURCES AND USES OF FUNDS:                           [1] INCREASE IN SHARE CAPITAL           0.00               [2] BORROWINGS:            i SIDBI 3427.57   0.00 0.00 6572.43 10000.00ii SIDBI MTL           0.00iii Non-SLR Bonds 5000.00   10000.00     15000.00iv APIIC           0.00v Commercial Bank 200.00         200.00vi HUDCO 1000.00 2000.00   2000.00   5000.00vii Public Deposits 4219.21 50.00 50.00 50.00 50.00 4419.21

Total(2) 13846.78 2050.00 10050.00 2050.00 6622.43 34619.21[3] RECEIPTS AGAINST:            i Recovery of principal (Realized) 22132.75 4000.00 3600.00 5385.68 4881.57 40000.00ii Staff Loan Recoveries 6.50 6.50 6.50 6.50 6.50 32.50iii Subsidies 6159.37   1000.00     7159.37

Total(3) 28298.62 4006.50 4606.50 5392.18 4888.07 47191.87[4] REVENUE RECEIPTS:            i Recover of interest (Realized) 10515.39 500.00 1000.00 3000.00 1484.61 16500.00ii Other Income 777.32 100.00 100.00 100.00 122.68 1200.00

Total(4) 11292.71 600.00 1100.00 3100.00 1607.29 17700.00

[5] INC / DEC IN CURRENT ASSETS / LIABILITIES 0.00         0.00GRAND TOTAL(1+2+3+4+5) 53438.11 6656.50 15756.50 10542.18 13117.79 99511.08

              0.00  Opening Bank / OD Balance+FDs 10138.26 3643.33 879.39 2843.69 1020.98 10138.26  Closing Bank / OD Balance+FDs 3643.33 679.39 2843.69 1020.98 385.57 385.57

1) The corporation has disbursed an amount of Rs.332.41 crores up to November,

2010 and the disbursement are project at Rs.317.59 crores up to 31.03.2011 to

50

achieve the disbursement of Rs.650.00 crores for the current financial year.

2) The corporation’s total borrowings during the year up to November, 2010

were Rs.138.46 crores which includes refinance of Rs.34.27 crores from

SIDBI, term loan of Rs.10.00 crores from HUDCO, fixed deposits of Rs.42.19

crores by way of raising Non-SLR Bonds.

3) The corporation has repaid Rs.47.67 crores towards refinance to SIDBI,

Rs.8.64 crores towards SLR bond, Rs.10.00 crores to Central Bank of India

and Rs.6.25 crores to Bank of India aggregating to Rs.72.57 crores up to

November, 2010. The corporation has also repaid the matured public deposits

of Rs.29.40 crores.

4) Total principal repayment commitment for the next 4 months would be

Rs.92.00 crores.

5) The corporation has incurred Rs.65.22 crores towards interest payment on

borrowings and Rs.20.25 crores towards administrative/ establishment

expenses. The future commitments towards interest, administrative and other

expenditure up to 31.03.2011 are estimated at Rs.51.27 crores.

6) The principal recovery up to November, 2010 was Rs.221.32 crores and

interest collected was Rs.105.15 crores (realizations). The principal and

interest recovery (realization) in the remaining part upto 31.03.2011 are

estimated at Rs.178.68 crores and Rs.59.85 crores (realization) respectively.

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7) In order to meet the commitments up to 31.03.2011, it is proposed to avail

refinance of Rs.65.72 crores from SIDBI and avail Rs.40.00 crores being the

balance un-availed portion of HUDCO’s term loan. If the SBH term loan

sanction is given with lower interest rate, we may avail the same instead of

HUDCO loan. It was also proposed to raise Non-SLR Bonds of Rs.100 crores

in the month of January, 2011.

8) After reckoning all the commitments, disbursements, expenditure and

recoveries. There is no gap in resources and the liquidity position of the

corporation is comfortable.

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LIQUIDITY STATEMENTS AND INTEREST RATE SENSITIVITY AS ON 30-11-2010 ARE AS UNDER

(Rs. In Crores)

53

Out Flow1-28 Days

29 Days and upto 3 Months

Over 3 Months

and upto 6 Months

Over 6 Months

and upto 1 Year

Over 1 Year

and upto 3 Years

Over 3 Years

and upto 5 Years

Over 5 Years Total

1 Capitali Equity 92.22 92.22ii Loan Pending conversion 50.00 13.34 63.34

2 Reserves & Surplus 21.73 21.73i Current Deposits 0.00ii Savings Bank Deposits 0.00iii Term Deposits 0.19 0.32 29.11 14.31 15.30 0.00 0.00 59.23iv Certificates of Deposits 0.00

3 Borrowings 0.00i Call and short notice 0.00ii Inter-Bank(Term) 0.00iii Refinances 0.00 14.05 34.19 67.20 336.44 322.28 157.37 931.53iv Others(specify) 0.00

SLR Bonds 9.98 14.98 3.84 12.78 60.36 102.14 23.00 227.08Bank term loan 0.60 1.16 3.45 14.48 52.67 19.22 0.00 91.58

HUDCO 0.00 0.27 0.28 0.55 3.81 3.62 8.48 17.01Non-SLR Bonds 0.00 1.46 0.00 2.27 9.10 59.95 0.00 72.78

4 Other Liabilities & Provisions 0.00i Bills Payable 0.00ii Inter-Office adjustment 0.00

LIQUIDITY STATEMENTS AND INTEREST RATE SENSITIVITY AS ON 30-11-2010 ARE AS UNDER

(Rs. In Crores)

Out Flow 1-28 Days

29 Days and upto 3 Months

Over 3 Months and upto 6 Months

Over 6 Months and upto 1 Year

Over 1 Year and upto 3 Years

Over 3 Years and upto 5 Years

Over 5 Years

iii Provisions              iv Others 0.05 0.11 11.46 8.99 72.40 43.45 12.32

5 Line of Credit Commodited to              i Institutions              ii Customers              

6 Unavailed portion of term loans              7 Letter of Credit/Guarantee              8 Repos              9 Bills Rediscounted(DUPN)              

10Swaps (Buy / Sell) maturing forwards              

11 Interest Payable              12 Others(specify) 10.82 32.35 82.33 120.58 600.08 550.66 328.46

A.   TOTAL OUTFLOWS                               

B.  CUMULATIVE OUTFLOWS 10.82 43.17 125.50 246.08 846.16 1396.82 1725.28

                 

In Flow 1-28 Days

29 Days and upto 3 Months

Over 3 Months and upto 6 Months

Over 6 Months and upto 1 Year

1 Cash        2 Balances        3 Balances with Other Banks        

  i Current Accounts + FDs 8.61      

  ii Money at Call and Short        

  iii Notice, Term Deposits & Other placements        

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4 Investments 40.00      5 Advances(Performing)         

  i Bills Purchased and Discounted        

  ii Cash Credits, ODs and Loans repayment on demand          iii Term Loans 33.34 75.40 80.00 172.73

6 NPA(Advances and Investments)        7 Fixed Assets        8 Other Assets 0.55 0.80 6.29 0.60

  i Inter-Office Adjustments          ii Leased Assets        

iii Others        

THE LIQUIDITY STATEMENTS AND INTEREST RATE SENSITIVITY AS ON 30-11-2010 ARE AS UNDER

(Rs. In Crores)

THE LIQUIDITY STATEMENTS AND INTEREST RATE SENSITIVITY AS ON 30-11-2010 ARE AS UNDER

(Rs. In Crores)

In Flow 1-28 Days

29 Days and upto 3 Months

Over 3 Months and upto 6 Months

Over 6 Months and upto 1 Year

9 Reverse Repos        10 Swaps(Sell/Buy)maturing forwards        11 Bills rediscounted (DUPN)        12 Interest receivable 5.33 35.00 35.00 51.3513 Committed Lines of Credit        14 Export Refinance from RBI        15 Others (specify)        

             C TOTAL INFLOWS 87.83 111.20 121.28 224.68             D MISMATCH(C-A) 77.02 78.85 38.95 104.09E MISMATCH AS % TO OUTFLOWS (D AS % to A) 712.24 243.76 47.31 86.32F CUMULATIVE MISMATCH 77.02 155.87 194.82 298.92G CUMULATIVE OUTFLOWS (F as A% to B)  712.24 361.13 155.25 121.47           

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STATEMENT OF INTEREST RATE SENSITIVITY AS ON 30-11-2010 PRESENTED TO ALCO (Rs. In Crores)

Items / Time Buckets1-28 Days

29 Days and upto 3 Months

Over 3 Months and upto 6 Months

Over 6 Months and upto 1 Year

Over 1 Year and upto 3 Years

Over 3 Years and upto 5 Years

Over 5 Years to 7 Years

A- LIABILITIES                  

1 Capital              

a) i Equity              

  ii Loan pending conversion         50.00    

b) Non-perpetual preference              

2 Reserves & Surplus              

3 Gifts, grants, donations              

4 Notes, bonds, debentures              

5 Term Borrowings              

  i SIDBI 0.00 14.05 34.19 68.20 336.44 322.28 141.08

  ii SLR 9.98 14.98 3.84 12.78 60.36 102.14

  iii Commercial Banks 0.60 1.16 3.45 14.48 52.67 19.22

  iv HUDCO 0.00 0.27 0.28 0.55 3.81 3.62

  v Fixed Deposits 0.19 0.38 29.11 14.31 15.30 0.00

  vi Non-SLR Bonds 0.00 1.46 0.00 2.27 9.10 59.95

  vii Term money borrowings              

  viii From RBI Vot. & Others              

6 Current liabilities & provisions 0.05 0.11 11.46 8.99 72.40 43.45  

7 Others              

                   

A TOTAL LIABILITIES (A) 10.82 32.41 82.33 121.58 600.08 550.66 167.26

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STATEMENT OF INTEREST RATE SENSITIVITY AS ON 30-11-2010 PRESENTED TO ALCO

(Rs. In Crores)

Items / Time Buckets1-28 Days

29 Days and upto 3 Months

Over 3 Months and upto 6 Months

Over 6 Months and upto 1 Year

Over 1 Year & upto 3 Years

Over 3 Years and upto 5 Years

Over 5 Years to 7 Years

B-ASSETS              1 Cash                i Branch current accounts              2 Investments under various categories              3 Advances (Performing)                i Standard 33.34 75.40 100.42 172.73 613.59 104.16 8.67  ii Sub-standard           126.27    iii Doubtful             97.95  iv Loss             116.82  v Interest on Standard 5.33 35.00 35.00 51.53 126.23 39.98 10.604 Assets on lease              5 Fixed Assets              6 Others Assets 0.00 0.80 6.29 0.60 2.40 2.40 2.407 Contingent items              8 Others              C TOTAL ASSETS (B) 38.67 111.20 141.71 224.86 742.22 272.81 236.44                 D IR GAP(C-A) 28.41 78.85 59.38 104.09 142.15 -227.85 69.17  Other products              i FRA's              ii IR Swaps              iii Options              iv Futures              v Others              E TOTAL OTHER PRODUCTS (D) 0.00 0.00 0.00 0.00 0.00 0.00 0.00F NET GAP (C-D) (E) 28.41 78.85 59.38 104.90 142.15 -277.85 69.71G CUMULATIVE GAP 28.41 107.26 166.64 270.73 412.88 135.03 204.20H E as % of A 263.00 244.00 72.00 86.00 24.00 -50.00 41.00  Impact of 1% interest change on 0.28 1.07 1.67 2.71 4.13 1.35 2.01  Profit annualised              

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ANALYSIS AND INTERPRETATION

I. Liquidity Statement:

1. The future cash flows were shown in the time buckets as per guidelines issued by

the RBI .

2. While capital, reserves and surpluses were shown in the over 5 years buckets,

repayments towards refinance, SLR Bonds, Non-SLR Bonds, bank term loans and

public deposits were shown under respective maturity buckets.

3. Similarly, principal recovery from standard assets has been classified into

respective maturity buckets and the collection from SSD assets were shown in 3 to 5

years & DBT under over 5 years buckets.

4. There is a mismatch in the over 3 years and up to 5 years time bucket and over 5

years time bucket which works out to Rs.303 crores. However, there will be a positive

cumulative mismatch and the cumulative surplus works out to Rs.137 crores.

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II. Interest Rate Sensitivity Statement

In the interest rates sensitivity statement all the assets and liabilities are classified

into the respective time buckets. The cumulative gap in the various time buckets and

the impact of 1% change in the interest rate on the cumulative mismatch amount

works out as under:

Time Bucket Cumulative Gap Impact of 1% interest

change

1 to 28 days 28.41 0.28

29 days to 3 months 107.26 1.07

3 to 6 months 166.64 1.67

6 months to 1 year 270.73 2.71

1 to 3 years 412.88 4.13

3 to 5 years 135.03 1.35

5 to 7 years 204.20 2.04

7 to 10 years 194.87 1.95

Over 10 years 188.21 1.88

Non-sensitive 137.21 1.37

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CHAPTER -5

FINDINGS & SUGGESTIONS

1. ALM is a strategic approach or managing of managing the balance sheet dynamics

in such a way that the net earnings are maximized and it ensure the level and risk

less with the risk return objectives of banks/FIs.

2. The composition of assets and liabilities largely decides the solvency, liquidity

and profitability of a corporate entity, the components of liabilities determines the

cost of funds and it broadly with both sides of balance sheet.

3. The reduction of liquidity risk by lengthen the maturity of liabilities less

profitability because long term funds to be more expansive than short term funds.

4. It also implies fewer earnings opportunities from negative gapping.

5. The appropriate balance between liquidity and profitability is determined by Top

Managers.

6. It is found that in APSFC is strictly practicing ALM concept.

7. To deal with the market risk ALM works.

8. ALM is the process, which is used to manage liquidity risk and interest rate risk.

9. The changes in the interest rate always has a effect in the risk management.

10. Interest rate risk can influence more the business than the liquidity risk in market.

11. Dealing with liquidity risk is earlier than dealing with the interest rate risk.

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CONCLUSIONS

1. It shall be mandatory for all state financial institutions to introduce ALM concept

for better management of risk.

2. The methods of date acquisition for managing the liquidity risk management and

interest rate risk management should improve.

3. The banks & financial institutions should utilize the readily available software

package for ALM and for easy and speedy preparation of data for ALM meetings.

61