Asset Liability Management

Transcription

1 Asset Liability Management

2 Risks in Banking Interest rate risk : Risk that arises when the interest income/ market value of the bank is sensitive to the interest rate fluctuations. Credit Risk : Risk that arises due to the possibility of a default/delay in the repayment obligation by the borrowers of funds.

3 Risks in Banking Liquidity risk : Risk that arises due to the mismatch in the maturity patterns of the assets and liabilities. Treasury management risk : Risk to the banks due to changes in cash flows in its deposit and credit structure that requires an obligation to maintain liquidity.

4 Risks in Banking Operational risk: Risk arising out of fluctuations in day to day operations of the banks. Market risk: Risk of events reducing the return expectation of bank capital owners.

5 Risks in Banking Foreign Exchange/Currency Risk: Risk that arises due to unanticipated fluctuation in exchange rates. Contingency risk: Risk that arises due to the presence of offbalance sheet items such as guarantees, letters of credit, underwriting commitments etc.

6 Interest Rate Risk Management Interest rate risk management deals with the possibility that future events could change the return expectation of banks. Risk management provides strategies, techniques, tools and approaches to handle interest rate change implications for banks.

7 Interest Rate Risk Management Tasks Evaluate the quantum of loss likely to occur due to interest rate change. Organize the structure of banking operations to react to interest rate changes. Balance the risk control mechanism of a bank to manage risk and maintain expected returns. Managing risks by foreseeing the interest rate changes and make informed banking decisions to utilize the opportunities and minimize the threats.

8 Interest Rate Risk Management Goal Maximize bank profits. Creating opportunity out of interest rate risk. Minimize risk and protect the bank assets. Reduce losses arising out of interest rate commitments by banks.

9 Asset-Liability Management (ALM) Asset-liability management considers the effect of bank profits on the overall bank strategy. The nature of capital of banks being small when compared to its asset structure, any change in asset structure is likely to prove detrimental to the bank s profitability. Banks need to examine the effect of changes in capital to changes in the asset structure simultaneously to enhance overall profits.

10 Sample Bank Balance Sheet Liabilities Assets Capital Reserves Borrowings Advances Short term Investments deposits Long term Fixed Assets 7000 deposits Total Total What if advances value is reduced by 2%?

11 What if Advances Value is Reduced by 2%? Approximately 58.8% Reduction in Capital!!! Liabilities Assets Capital 8240 Reserves Borrowings Advances Short term deposits Long term deposits Investments Fixed Assets 7000 Total Total

12 Risks Handled by ALM Core risk Changes in interest rates Changes in exchange rates Changes in liquidity position of the bank Additional risk Credit risk Contingency risk

13 ALM Risk Management Models Asset Models Liability Models Randomness Models Multi-dimensional Models CALM (Computer Aided Asset/ Liability Management) Stochastic Programming Model

14 Asset Models Analyze risk in terms of bank assets - Advances - Loan syndication - Investments Analyze returns of bank assets - Credit default - Portfolio loss Model determination - Long term / Short term

15 Liability Models Deposit maturity structure Borrowings management Bond risk management / Immunization of bond portfolios Swap structures for management of interest rate risk Management of liability driven investments

16 Randomness Models Random parameters - Asset price - Interest rates - Credit default - Deposit flow - Inflation rate - Market price

17 Multi-Dimensional Models

18 CALM Stochastic Programming Models Dynamic asset liability management Computer aided applications by banks Optimization decision model based on constraints Uncertainty in terms of asset and liability flows Change in asset and liability classes

19 Multi-Stage Stochastic Programming First Stage Decision Observation n th Observation Second Stage Decision n th Stage Decision

20 Managing Interest Rate Risk Manage the volume Manage the mix Manage the maturity Manage the rate sensitivity Manage the quality Manage the liquidity of the assets and liabilities Achievement of a predetermined acceptable risk/reward ratio

21 Parameters for ALM Net Interest Margin (NIM) : Impact of volatility on the short-term profits is measured by NIM. To stabilize the short-term profits the banks aim at minimizing fluctuations in the NIM. Net Interest Margin Net Interest Income TotalAssests

22 Parameters for ALM Market Value of Equity (MVE) : The market value of equity represents the long-term profits of the bank. The banks aim at minimizing adverse movement in their market value due to interest rate fluctuations. In the case of unlisted banks, the difference between the market value of assets and liabilities represent the target that is to be achieved by the banks.

23 Parameters for ALM Economic Equity Ratio : This ratio measures the shifts in the ratio of owned funds to total funds. Evaluates the sustenance capacity of a bank. Economic Equity Ratio = Shareholder 's Funds TotalAssests

24 Managing Bank Risk - A Note by Reserve Bank of India Traditional methods - Operational limits on credit lines - Loan provisioning - Portfolio diversification - Collateralization

25 RBI Note on Managing Bank Risk - Innovative methods Loan securitization Capital adequacy guidelines Derivatives - Swap products - Option products (spread options, sovereign risk options) - Forward Rate Agreements

26 Prerequisites for Risk Management A well-developed Repo market Forward trading in securities Revolving Underwriting facilities Introduction of asset-liability based derivatives (Strips and Asset Backed Securities) - Benchmark securities - Fungibility, auction system, settlement procedures and market infrastructure A strong money market