priyanka1987

New member
<h1>INFORMATION ON ASSET LIABILITY MANAGEMENT<h1>


Banks are in the business of managing risk. Of these, liquidity risk management and interest rate risk management are etremely important for and bank. this following document discusses in depth, the importance of liquidity risk magmt and interst rate risk mgmt, various methods of measuring these risk and the challenges faced by indian banks in managing these risks. it explains how these risk can be managed through an ASSET LIABILITY MANAGEMENT SYSTEM


I HOPE THIS WILL HELP YOU GUYS..... LET ME KW IF ITS UESFULL.....


TAKE CARE

REGARDS,

PrIyAnKa


Life is not the amount of breaths u take but the moments that take ur breath away..
 
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priyanka1987

New member
Re: ASSET LIABILITY MANAGEMENT

Asset-Liability Management


Asset-liability management (ALM) is a term whose meaning has evolved. It is used in slightly different ways in different contexts. ALM was pioneered by financial institutions, but corporations now also apply ALM techniques. This article describes ALM as a general concept, starting with more traditional usage.



Traditionally, banks and insurance companies used accrual accounting for essentially all their assets and liabilities. They would take on liabilities, such as deposits, life insurance policies or annuities. They would invest the proceeds from these liabilities in assets such as loans, bonds or real estate. All assets and liabilities were held at book value. Doing so disguised possible risks arising from how the assets and liabilities were structured.

Consider a bank that borrows USD 100MM at 3.00% for a year and lends the same money at 3.20% to a highly-rated borrower for 5 years. For simplicity, assume interest rates are annually compounded and all interest accumulates to the maturity of the respective obligations. The net transaction appears profitable—the bank is earning a 20 basis point spread—but it entails considerable risk. At the end of a year, the bank will have to find new financing for the loan, which will have 4 more years before it matures. If interest rates have risen, the bank may have to pay a higher rate of interest on the new financing than the fixed 3.20 it is earning on its loan.

Suppose, at the end of a year, an applicable 4-year interest rate is 6.00%. The bank is in serious trouble. It is going to be earning 3.20% on its loan and paying 6.00% on its financing. Accrual accounting does not recognize the problem. The book value of the loan (the bank's asset) is:

100MM(1.032) = 103.2MM. [1]

The book value of the financing (the bank's liability) is:
100MM(1.030) = 103.0MM. [2]

Based upon accrual accounting, the bank earned USD 200,000 in the first year.

Market value accounting recognizes the bank's predicament. The respective market values of the bank's asset and liability are:
[3]

100MM(1.030) = 103.0MM. [4]

From a market-value accounting standpoint, the bank has lost USD 10.28MM.

So which result offers a better portrayal of the bank' situation, the accrual accounting profit or the market-value accounting loss? The bank is in trouble, and the market-value loss reflects this. Ultimately, accrual accounting will recognize a similar loss. The bank will have to secure financing for the loan at the new higher rate, so it will accrue the as-yet unrecognized loss over the 4 remaining years of the position.


The problem in this example was caused by a mismatch between assets and liabilities. Prior to the 1970's, such mismatches tended not to be a significant problem. Interest rates in developed countries experienced only modest fluctuations, so losses due to asset-liability mismatches were small or trivial. Many firms intentionally mismatched their balance sheets. Because yield curves were generally upward sloping, banks could earn a spread by borrowing short and lending long.

Things started to change in the 1970s, which ushered in a period of volatile interest rates that continued into the early 1980s. US regulation Q, which had capped the interest rates that banks could pay depositors, was abandoned to stem a migration overseas of the market for USD deposits. Managers of many firms, who were accustomed to thinking in terms of accrual accounting, were slow to recognize the emerging risk. Some firms suffered staggering losses. Because the firms used accrual accounting, the result was not so much bankruptcies as crippled balance sheets. Firms gradually accrued the losses over the subsequent 5 or 10 years.

One example is the US mutual life insurance company the Equitable. During the early 1980s, the USD yield curve was inverted, with short-term interest rates spiking into the high teens. The Equitable sold a number of long-term guaranteed interest contracts (GICs) guaranteeing rates of around 16% for periods up to 10 years. During this period, GICs were routinely for principal of USD 100MM or more. Equitable invested the assets short-term to earn the high interest rates guaranteed on the contracts. Short-term interest rates soon came down. When the Equitable had to reinvest, it couldn't get nearly the interest rates it was paying on the GICs. The firm was crippled. Eventually, it had to demutualize and was acquired by the Axa Group.

Increasingly, 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 might be depleted by narrowing of the difference between assets and liabilities—that the values of assets and liabilities might fail to move in tandem. Asset-liability risk is a leveraged form of risk. The capital of 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.

Exhibit 1 illustrates the evolution over time of a hypothetical company's assets and liabilities. Over the period shown, the assets and liabilities change only slightly, but those slight changes dramatically reduce the company's capital (which, for the purpose of this example, is defined as the difference between assets and liabilities). In Exhibit 1, the capital falls by over 50%, a development that would threaten almost any institution.


Example: Asset-Liability Risk

ex1_asset_liability_management.gif



Asset-liability risk is leveraged by the fact that the values of assets and liabilities each tend to be greater than the value of capital. In this example, modest fluctuations in values of assets and liabilities result in a 50% reduction in capital.



Accrual accounting could disguise the problem by deferring losses into the future, but it could not solve the problem. Firms responded by forming asset-liability management (ALM) departments to assess asset-liability risk. They established ALM committees comprised of senior managers to address the risk.

Techniques for assessing asset-liability risk came to include gap analysis and duration analysis. These facilitated techniques of gap management and duration matching of assets and liabilities. Both approaches worked well if assets and liabilities comprised fixed cash flows. Options, such as those embedded in mortgages or callable debt, posed problems that gap analysis could not address. Duration analysis could address these in theory, but implementing sufficiently sophisticated duration measures was problematic. Accordingly, banks and insurance companies also performed scenario analysis.


With scenario analysis, several interest rate scenarios would be specified for the next 5 or 10 years. These might specify declining rates, rising rate's, a gradual decrease in rates followed by a sudden rise, etc. Scenarios might specify the behavior of the entire yield curve, so there could be scenarios with flattening yield curves, inverted yield curves, etc. Ten or twenty scenarios might be specified in all. Next, assumptions would be made about the performance of assets and liabilities under each scenario. Assumptions might include prepayment rates on mortgages or surrender rates on insurance products. Assumptions might also be made about the firm's performance—the rates at which new business would be acquired for various products. Based upon these assumptions, the performance of the firm's balance sheet could be projected under each scenario. If projected performance was poor under specific scenarios, the ALM committee might adjust assets or liabilities to address the indicated exposure. A shortcoming of scenario analysis is the fact that it is highly dependent on the choice of scenarios. It also requires that many assumptions be made about how specific assets or liabilities will perform under specific scenarios.

In a sense, ALM was a substitute for market-value accounting in a context of accrual accounting. It was a necessary substitute because many of the assets and liabilities of financial institutions could not—and still cannot—be marked to market. This spirit of market-value accounting was not a complete solution. A firm can earn significant mark-to-market profits but go bankrupt due to inadequate cash flow. Some techniques of ALM—such as duration analysis—do not address liquidity issues at all. Others are compatible with cash-flow analysis. With minimal modification, a gap analysis can be used for cash flow analysis. Scenario analysis can easily be used to assess liquidity risk.

Firms recognized a potential for liquidity risks to be overlooked in ALM analyses. They also recognized that many of the tools used by ALM departments could easily be applied to assess liquidity risk. Accordingly, the assessment and management of liquidity risk became a second function of ALM departments and ALM committees. Today, liquidity risk management is generally considered a part of ALM.


ALM has evolved since the early 1980's. Today, financial firms are increasingly using market-value accounting for certain business lines. This is true of universal banks that have trading operations. For trading books, techniques of market risk management—value-at-risk (VaR), market risk limits, etc.—are more appropriate than techniques of ALM. In financial firms, ALM is associated with those assets and liabilities—those business lines—that are accounted for on an accrual basis. This includes bank lending and deposit taking. It includes essentially all traditional insurance activities.

Techniques of ALM have also evolved. The growth of OTC derivatives markets have facilitated a variety of hedging strategies. A significant development has been securitization, which allows firms to directly address asset-liability risk by removing assets or liabilities from their balance sheets. This not only eliminates asset-liability risk; it also frees up the balance sheet for new business.

The scope of ALM activities has widened. Today, ALM departments are addressing (non-trading) foreign exchange risks and other risks. Also, ALM has extended to non-financial firms. Corporations have adopted techniques of ALM to address interest-rate exposures, liquidity risk and foreign exchange risk. They are using related techniques to address commodities risks. For example, airlines' hedging of fuel prices or manufacturers' hedging of steel prices are often presented as ALM.



ReGaRds,

Priyanka
:tea:



Life is not the amount of breaths u take but the moments that take ur breath away..
 

sandmax

New member
Re: ASSET LIABILITY MANAGEMENT

its good..but can we have something covering practical aspect of risk aversion procedures employed in private banks..
 

priyanka1987

New member
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.


Take care

Warm Regards

Priyanka:SugarwareZ-064:
 

ashu9801

Par 100 posts (V.I.P)
Re: ASSET LIABILITY MANAGEMENT

abhishek.. Y would you want the little-of-little work done by somebody else. try covering the information in one document on your own.

priyanka... the information gives a very good understanding.thanks
 

hdss_351741

New member
Re: ASSET LIABILITY MANAGEMENT

HI... CAN YOU PLZ UPLOAD UR PROJECT AGAIN . I URGENTLY NEED THAT. WUD BE THANKFUL TO YOU.
 

vindhya harish

New member
Re: ASSET LIABILITY MANAGEMENT

Hello.. some one help me in writin the statement of problem for my project in ALM.. I'm doing my project in SBM
 

bugsyrawat

New member
Re: ASSET LIABILITY MANAGEMENT

hi priyanka can u please give me a case study on alm in banks
the data which u gave is very nice and informative please if
u can help me in this
 

RCR

New member
Re: ASSET LIABILITY MANAGEMENT

hi everybody i need a 100 marks project on asset liability management.also covering practical part of it.
 

priyanshu007

Par 100 posts (V.I.P)
Re: ASSET LIABILITY MANAGEMENT

can you please re-upload your project it will be really very helpful for me...
if possible pls do as soon as possible...
 

sandy_11109

New member
Re: ASSET LIABILITY MANAGEMENT

can you please re-upload your project it will be really very helpful for me...
if possible pls do as soon as possible...
hey i am doing a project on asset liability management in psb.... if someone can please upload their project ,it would of great help to me.... thanks in advance...
 
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