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Asset – Liability Management System in banks

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What is Asset Liability Management??

The process by which an institution manages its balance sheet in order to allow for alternative interest rate and liquidity scenarios

Banks and other financial institutions provide services which expose them to various kinds of risks like credit risk, interest risk, and liquidity risk

Asset-liability management models enable institutions to measure and monitor risk, and provide suitable strategies for their management.

An effective Asset Liability Management Technique aims to manage the volume, mix, maturity, rate sensitivity, quality and liquidity of assets and liabilities as a whole so as to attain a predetermined acceptable risk/reward ratio

It is aimed to stabilize short-term profits, long-term earnings and long-term substance of the bank. The parameters for stabilizing ALM system are:
1. Net Interest Income (NII)
2. Net Interest Margin (NIM)
3. Economic Equity Ratio

3 tools used by banks for ALM

 

ALM Process

Categories of Risk

Credit Risk Market Risk Operational Risk
Transaction Risk /default risk /counterparty risk Commodity risk Process risk
Portfolio risk /Concentration risk Interest Rate risk Infrastructure risk
Settlement risk Forex rate risk Model risk
Equity price risk Human risk
Liquidity risk

Liquidity Risk Management

Bank’s liquidity management is the process of generating funds to meet contractual or relationship obligations at reasonable prices at all times

Liquidity Management is the ability of bank to ensure that its liabilities are met as they become due

Liquidity positions of bank should be measured on an ongoing basis

A standard tool for measuring and managing net funding requirements, is the use of maturity ladder and calculation of cumulative surplus or deficit of funds as selected maturity dates is adopted

Currency Risk

The increased capital flows from different nations following deregulation have contributed to increase in the volume of transactions

Dealing in different currencies brings opportunities as well as risk

To prevent this banks have been setting up overnight limits and undertaking active day time trading

Value at Risk approach to be used to measure the risk associated with forward exposures. Value at Risk estimates probability of portfolio losses based on the statistical analysis of historical price trends and volatilities.

Interest Rate Risk

Interest Rate risk is the exposure of a bank’s financial conditions to adverse movements of interest rates

Though this is normal part of banking business, excessive interest rate risk can pose a significant threat to a bank’s earnings and capital base

Changes in interest rates also affect the underlying value of the bank’s assets, liabilities and off-balance-sheet item

Interest rate risk refers to volatility in Net Interest Income (NII) or variations in Net Interest Margin(NIM)

NIM = (Interest income – Interest expense) / Earning assets

 

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