Core Risk Management in Bank
Asset Liability Management (ALM):
Conceptual Discussion
1. Asset Liability Management
2. Credit Risk Management
3. Foreign Exchange Risk Management
4. Internal Control and Compliance
Md. Nehal Ahmed 5. Anti-Money Laundering
Associate Professor, BIBM 6. IT Security
Different Aspects of Balance Sheet Different Aspects of Balance Sheet
(ALM) of a Bank (ALM) in a Bank
ASPECTS OBJECTIVES
1. Outside Liability Minimization of cost & stability
(volatility) of fund
BALANCE SHEET 2. Inside Liability Regulatory requirement :
10% of RWA
ASSET LIABILITY
3. Non-earning Asset Regulatory requirement
NON- CASH & DEPOSIT OUTSIDE
EARNING LIQUID BORROWING LIABILITY
ASSET RESERVE 4. Earning Asset Maximization of return &
minimization of risk
LOANS/ CAPITAL
EARNING ADVANCES/ INSIDE 5. Matching Strategy Matching between asset & liability:
ASSET INVESTMENT LIABILITY Maturity risk, Interest/Profit rate risk
BOTTOM - LINE : PROFIT 6. Pricing of Earning Asset Based on liability cost :
COF, COA, COC & risk premium
7. Profitability mgt./ Based on above all.
Bottom Line banking
1
Asset-Liability Management Asset-Liability Management
The Purpose of Asset-Liability Management is to Control a The purpose of asset-liability management is to formulate
Bank’s Sensitivity to Changes in Market Interest Rates and strategies and take actions that shape a bank’s balance
Limit its Losses in its Net Income or Equity sheet as a whole in a way that contributes to its desired
goals. Usually, the principal goals of asset-liability
management are:
Managers of financial firms focused on asset-liability risk.
The problem was not that the value of assets might fall or
that the value of liabilities might rise. It was that capital (a) to maximize, or at least stabilize, the bank’s margin,
might be depleted by narrowing of the difference between or spread between interest revenues and interest
expenses
assets and liabilities.
(b) to maximize, or at least protect, the value (stock
Asset-liability risk is a leveraged form of risk. The capital of
price) of the bank, at an acceptable level of risk.
most financial institutions is small relative to the firm's
assets or liabilities; so small percentage changes in assets
or liabilities can translate into large percentage changes in
capital.
Asset-Liability Management Asset-Liability Committee (ALCO)
Banks must have a committee comprising of the senior Specific functions of ALCO are:
management of the bank to make important decisions 1. To receive and review reports on liquidity risk,
related to the Balance Sheet of the Bank. market risk and capital management as covered in
this report.
The committee, typically called the Asset Liability
Committee (ALCO), should meet at least once every month 2. To identify balance sheet management issues like
to analysis, review and formulate strategy to manage the balance sheet gaps, interest rate gap/profiles etc.
balance sheet. that are leading to under-performance.
3. To review deposit-pricing strategy for the local
market.
4. Review liquidity contingency plan for the bank.
2
ALCO: Policy Statement ALCO: Policy Statement
Board or Management Committee of the Bank should set out Loan Deposit Ratio (LD)
the policy statement in at least for the followings and an
annual review should be done taking into consideration of Loan deposit ratio, typically calculated as the ratio of loans
changes in the balance sheet and market dynamics. against deposits, is the most common way to see a bank’s
liquidity position. In an ideal scenario, loan deposit ratio
1) Loan Deposit Ratio (LD) should not exceed 80%-85%. However, a bank may decide
2) Wholesale Borrowing Guidelines (WBG) to lend out its capital or raise funds from the inter-bank with
3) Commitments a view that market interest rates would be low.
4) Medium Term Funding Ratio (MTF)
5) Maximum Cumulative Outflow But excessive lending (a high Loan Deposit Ratio) may
6) Liquidity Contingency Plan expose a bank in serious liquidity and interest rate risk as
7) Local Regulatory Compliance the market liquidity may tighten any time.
ALCO: Policy Statement ALCO: Policy Statement
Wholesale Borrowing Guidelines (WBG) Commitments
The guideline should be set in absolute amount of borrowing The commitments Guideline limits should not exceed 200%
depending on bank’s borrowing capacity, historic market of the unused wholesale borrowing capacity of the last
liquidity. The limit should be capped at the bank’s highest twelve months. The limit can be increased if there are
level of past borrowings. However, this limit can be natural limitations on customer discretion to draw against
committed lines or a bank’s access to additional funds via
increased based on the match-funding basis.
realization of surplus statutory holdings.
3
ALCO: Policy Statement ALCO: Policy Statement
Medium Term Funding Ratio (MTF) Maximum Cumulative Outflow
Banks typically make money by running mismatches, that is, Under normal conditions, the day-to-day management of
by borrowing short term and lending long term. However, liquidity relies on the effective control of cash flow.
short term deposits may go out of the bank upon maturity, Maximum cumulative outflow (MCO) guidelines control the
whereas a bank cannot call back long term lending. Medium net outflow (inflow from asset maturity minus outflow from
term funding ratio is calculated as the ratio of liabilities with liability maturity) over the following periods: overnight, one
a contractual maturity of more than one year to assets with week and one month.
a contractual maturity of more than one year.
MCO up to I month bucket should not exceed 20% of the
The MTF of a bank should not be less than 30%. The ideal balance sheet.
scenario should be 45%. Given, the overall scenario of
current market, it will be suitable to move towards the MTF
limit of 45% as we progress.
ALCO: Policy Statement ALCO: Policy Statement
Liquidity Contingency Plan Local Regulatory Compliance
A liquidity contingency plan needs to be approved by the There should be a firm policy on compliance to the
board. A contingency plan needs to be prepared keeping in Bangladesh Bank in respect of CRR, SLR, Capital adequacy
mind that enough liquidity is available to meet the fund etc.
requirements in liquidity crisis situation. An annual review of
the contingency planning should be made.
4
Organizational Structure of ALM Organizational Structure of ALM
CEO / MANAGING DIRECTOR
The Asset Liability Committee (ALCO) is responsible for
balance sheet (asset liability) risk management. Managing
the asset liability is the most important responsibility of a
bank as it runs the risks for not only the bank, but also the
thousands of depositors who put money into it.
Head of Head of Treasury Head of Head of Finance Head of Credit Head of Operations
Consumer Corporate
Banking Banking
The responsibility of Asset liability Management is on the
Treasury Department of the bank. Specifically, the Asset
liability Management (ALM) desk of the Treasury
Head of Asset Liability
Department manages the balance sheet. The results of Mgt (ALM)
Treasury: Responsible for ALM
balance sheet analysis along with recommendation is
placed in the ALCO meeting by the Treasurer where
important decisions are made to minimize risk and Money Market Dealers
maximize returns. Typically, the organizational structure
looks like the following:
The key responsibilities of ALM Desk ALCO Paper
1) To assume overall responsibilities of Money Market Commentary
activities.
Interest rate trend of the market
2) To manage liquidity and interest rate risk of the bank.
Balance sheet
3) To comply with the local central bank regulations in
respect of bank’s statutory obligations as well as Indicators
thorough understanding of the risk elements
involved with the business. Maturity profile
4) Understanding of the market dynamics i.e competition, Liquidity test
potential target markets etc.
Interest rate profile
5) Provide inputs to the treasurer regarding market views
and update the balance sheet movement. Compliance
6) Deal within the dealer’s authorized limit.
5
ALCO Process Risk Exposure in Banking
ALCO & Asset Liability Management (ALM) Foreign Exchange Risk
Market Risk
The bank’s asset liability management is monitored through ALCO. Interest Rate Risk
The information flow in the ALCO can be diagramed as below:
Corporate Banking Feedback & Recommendation ST Transaction Risk
Feedback & Recommendation
RA
TE
Credit Risk
GY
Finance Feedback & Recommendation Portfolio Concentration
&
Key Balance Sheet Features Bank Risk
Depo-Adv AC
Trend & Outlook TIO
N
Risks
Funding Liquidity Risk
POI Liquidity Risk
Treasury Analysis & ALCO B/S Status & NT
Recommendation Meeting Recommended CEO S Trading Liquidity Risk
Actions
Depo-Adv
Trend & Outlook Other Balance Sheet Features
Operational Risk
Other Depts. Feedback & Recommendation
Consumer Banking Feedback & Recommendation
Legal and Regulatory Risk
Market Risk Management Interest Rate Risk Management
Market risk is the risk that the bank suffers losses due to In Money Market transactions, interest rate risk arises from
Gapping Strategy
adverse movements in market interest rates and
exchange rates. Risk exposures exists whenever there Gapping is a strategy to take advantage of expected
changes in interest rates. A gap is the difference between
is a maturity date mismatch between assets and the tenors in our assets and the tenors in our liabilities.
liabilities, or between principal and interest cash flows.
NEGATIVE POSITIVE
We can split interest-rate risk into two elements: GAP GAP
FUNDING Long-term asset funded Short-term asset funded
with a short-term liability with a long-term liability
Interest rate risk INTEREST RATE Future short-term rates Future short-term rates
EXPECTATION will be less than or equal will be greater than or
Foreign exchange risk to current market rates equal to current market
rates
RISKS Price and liquidity Price
6
Interest Rate Risk Management Interest Rate Risk Management
In money market transactions, price risk arises when the
maturities of investments do not match the maturities of Maturity gap analysis measures the gap between the
borrowings absolute values of the assets and liabilities that are
To address interest rate risk, an interest rate profile is prepared,
sensitive to movements in interest rates. Therefore the
where consolidated yield for assets and liabilities for different analysis measures the relative interest-rate sensitivities of
maturity buckets are shown for better understanding of interest the assets and liabilities.
profile.
Maturity Gap Schedule Widely used technique is Rate Sensitive Gap =
Asset/Liability Total < 1mth < 3mths 4-6 mths > 6mths
Cash B/S 100 100 Rate Sensitive Assets – Rate Sensitive Liabilities
Banks 300 100 200
Loans 600 50 100 150 300 Another widely used technique is Sensitivity Analysis:
Other 100 100
Demand deposits (400) (400) Calculation the changes in Net Interest Impact by
Term deposits (500) (100) (200) (200) multiplying the changes in interest rate with the Gap.
Bonds issued (100) (100)
Other (100) (100) NII = i X Gap
Maturity Gap (250) 0 (50) 300
Cumulative Gap (250) (250) (300) 0
Interest Rate Risk Management Interest Rate Risk Management
Interest Impact on ABC Bank Ltd.
RSA RSL GAP
Movement NII Interest Rate Risk based on Rate Sensitive Assets & Liabilities as on
Synchronized
1% +2 December, 2012
1000 800 +200 (1% increase in the Market Interest Rate)
1% -2
-2 Over 3 month Over 6 month
1% Over 9 month
Particular 1-90 Days to up to 6 to up to 9
800 1000 -200 to up to 1 year
month month
1% +2
Rate Sensitive Assets (RSA) 6700 2400 1400 1000
Rate Sensitive Liabilities (RSL) 8700 1100 750 800
GAP (2000) 1300 650 200
RSA RSL Cumulative GAP (2000) (700) 1950 850
Non--Synchronized
Non
GAP Impact on NII
(Repricing @1%) (Repricing @2%) Adjusted Interes Rate Change 1.00% 1.00% 1.00% 1.00%
Quarterly Earning Impact (Cum. Gap * IRC) (4.93) (3.45) 14.42 8.50
Accumulated Earning Impact to Date (4.93) (8.38) 10.97 22.92
Earning Impact/ Avg. Quarterly Opening
-3.52% -5.99% 7.84% 16.37%
1000 1000 Nil Profit
** Avg Quarterly Profit 140 crore
7
Foreign Exchange Risk Management Foreign Exchange Risk Management
Policy and Measurement : Foreign Exchange Position
A common approach to measuring and monitoring
Over
exchange rate risk is to limit the size of open
Bought
positions (whether positive or negative) in each Exchange
Rate + USD 40.00 ml
currency as of the close of each business day. + USD .…………
+ USD 3.00 ml
+ USD 2.00 ml
Limit set by BB: + USD 1.00 ml
Square Square
Open Position Limit as stipulated by the central bank Position Position
from time to time based on capital fund(Suppose
- USD 1.00 ml
open position limit is USD 40.00 million set for ‘X’- - USD 2.00 ml
Bank). - USD 3.00 ml
- USD ………….
- USD 40.00 ml Exchange
Over Rate
sold
Foreign Exchange Risk Management Liquidity Risk Management
In banking, liquidity is the ability to meet its financial
Forex Risk Management under Cross Currency Dealing obligation when they become due. ‘Liquidity Risk’ is the
risk that the bank will be unable to meet its financial
Individual Dealers’ limit obligations or commitment as they fall due leading to
Intra-day limit bankruptcy or rise in funding cost.
Dealing Limits Overnight limit
Stop Loss limit Funding liquidity risk is the risk that funds will not
Counter party forex dealing limit be available to meet financial commitments when
they are contractually due or that funds will not be
Revaluation of outstanding Position
available to take advantage of attractive business
Mandatory Leave opportunities.
Position of Reconciliation
Additional Measures Nostro account Reconciliation Trading liquidity risk is the risk that the bank will
After Hour and Off-premises Dealing not be able to instantly liquidate price risk positions
VAR calculation on regular basis without changing market prices, attracting the
Internal Audit on Treasury Functions attention of other market participants, or
compromising on counterparty quality.
8
Liquidity Risk Management Liquidity Risk Management
Policy of Liquidity Risk Management in Banks Policy of Liquidity Risk Management in Banks
The Bank prepares a Statement of Structural Liquidity The Commitments Guidelines Limit (Undrawn portion)
by placing all cash flows in the maturity ladder according to should not exceed 200% of the bank’s Wholesale Borrowing
the expected timing of the cash flows, based on the Guidelines (WBG).
projected behavior of assets, liabilities and off-balance
sheet items. Maximum cumulative Outflow (MCO) up to 1 month
bucket should not exceed 20% of the Balance sheet.
Moreover, it needs to prepare a statement of Short Term
Dynamic Liquidity to monitor the Bank’s short term As per BB policy medium term deposit to medium term loan
liquidity position on a dynamic basis in a time horizon i.e Medium Term Funding (MTF) ratio would be
spanning 1 to 90 days. For 1-14 –day bucket, together with minimum 45%.
the 15-28 Day bucket, the negative gap shall not exceed
the Bank’s total Capital. Maintain ‘liquidity buffer’ of instant liquid assets
(government treasury bills/bonds).
Advance Deposit (AD) Ratio should not exceed 81.00% .
Establish liquidity contingency plan.
THANK YOU
