Re: ASSET LIABILITY MANAGEMENT
Asset-liability management in banks
Ever since the the initiation of the process of deregulation of the Indian banking system and gradual freeing of interest rates to market forces, and consequent injection of a dose of competition among the banks, introduction of asset-liability management (ALM) in the public sector banks (PSBs) has been suggested by several experts. But, initiatives in this respect on the part of most bank managements have been absent. This seems to have led the Reserve Bank of India to announce in its monetary and credit policy of October 1997 that it would issue ALM guidelines to banks. While the guidelines are awaited, an informal check with several PSBs shows that none of these banks has moved decisively to date to introduce ALM.
One reason for this neglect appears to be a wrong notion among bankers that their banks already practice ALM. As per this understanding, ALM is a system of matching cash inflows and outflows, and thus of liquidity management. Hence, if a bank meets its cash reserve ratio and statutory liquidityratio stipulations regularly without undue and frequent resort to purchased funds, it can be said to have a satisfactory system of managing liquidity risks, and, hence, of ALM.
The actual concept of ALM is however much wider, and of greater importance to banks' performance. Historically, ALM has evolved from the early practice of managing liquidity on the bank's asset side, to a later shift to the liability side, termed liability management, to a still later realisation of using both the assets as well as liabilities sides of the balance sheet to achieve optimum resources management. But that was till the 1970s. In the 1980s, volatility of interest rates in USA and Europe caused the focus to broaden to include the issue of interest rate risk. ALM began to extend beyond the bank treasury to cover the loan and deposit functions. The induction of credit risk into the issue of determining adequacy of bank capital further enlarged the scope of ALM in later 1980s. In the current decade, earning a proper returnof bank equity and hence maximisation of its market value has meant that ALM covers the management of the entire balance sheet of a bank. This implies that the bank managements are now expected to target required profit levels and ensure minimisation of risks to acceptable levels to retain the interest of investors in their banks. This also implies that costing and pricing policies have become of paramount importance in banks.
In the regulated banking environment in India prior to the 1990s, the equation of ALM to liquidity management by bankers could be understood. There was no interest rate risk as the interest rates were regulated and prescribed by the RBI. Spreads between the deposit and lending rates were very wide (these still are considerable); also, these spreads were more or less uniform among the commercial banks and were changed only by RBI. If a bank suffered significant losses in managing its banking assets, the same were absorbed by the comfortably wide spreads. Clearly, the bank balance sheetwas not being managed by banks themselves; it was being `managed' through prescriptions of the regulatory authority and the government. This situation has now changed. The banks have been given a large amount of freedom to manage their balance sheets. But the knowledge, new systems and organisational changes that are called for to manage it, particularly the new banking risks, are still lagging. The turmoil in domestic and international markets during the last few months and impending changes in the country's financial system are a grim warning to our bank managements to gear up their balance sheet management in a single heave. To begin with, as the RBI's monetary and credit policy of October 1997 recommends, an adequate system of ALM to incorporate comprehensive risk management should be introduced in the PSBs. It is suggested that the PSBs should introduce ALM which would focus on liquidity management , interest rate risk management and spread management. Broadly, there are 3 requirements to implement ALMin these banks, in the stated order: (a) developing a better understanding of ALM concepts, (b) introducing an ALM information system, and, (c) setting up ALM decision-making processes (ALM Committee/ALCO). The above requirements are already met by the new private sector banks, for example. These banks have their balance sheets available at the close of every day. Repeated changes in interest rates by them during the last 3 months to manage interest rate risk and their maturity mismatches are based on data provided by their MIS. In contrast, loan and deposit pricing by PSBs is based partly on hunches, partly on estimates of internal macro data, and partly on their competitors' rates. Hence, PSBs would first and foremost need to focus son putting in place an ALM which would provide the necessary framework to define, measure, monitor, modify and manage interest rate risk. This is the need of the hour.
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