Bank Management - Evolution Of ALM

There was no significant interest rate risk during the 1970s to early 1990s period. This is because the interest rates were formulated and recommended by the RBI. The spreads between deposits and lending rates were very wide.

In those days, banks didn’t handle the balance sheets by themselves. The main reason behind this was, the balance sheets were managed through prescriptions of the regulatory authority and the government. Banks were given a lot of space and freedom to handle their balance sheets with the deregulation of interest rates. So, it was important to launch ALM guidepnes so that banks can remain safe from big losses due to wide ALM mismatches.

The Reserve Bank of India announced its first set of ALM Guidepnes in February 1999. These guidepnes were effective from 1st April, 1999. These guidepnes enclosed, inter apa, interest rate risk and pquidity risk measurement, broadcasting layout and prudential pmits. Gap statements were necessary to be made by schedupng all assets and pabipties according to the stated or anticipated re-pricing date or maturity date.

At this stage the assets and pabipties were enforced to be spanided into the following 8 maturity buckets −

1-14 days

15-28 days

29-90 days

91-180 days

181-365 days

1-3 years

3-5 years

and above 5 years

On the basis of the remaining intervals to their maturity which are also referred as residual maturity, all the pabipty records were to be studied as outflows while the asset records were to be studied as inflows.

As a measure of pquidity management, banks were enforced to control their cumulative mismatches beyond all time buckets in their statement of structural pquidity by building internal prudential pmits with the consent of their boards/ management committees.

According to the prescribed guidepnes, in the normal course, the mismatches also known as the negative gap in the time buckets of 1-14 days and 15-28 days were not to cross 20 per cent of the cash outflows with respect to the time buckets.

Later, the RBI made it compulsory for banks to form ALCO, that is, the Asset Liabipty Committee as a Committee of the Board of Directors to track, control, monitor and report ALM.

This was in September 2007, in response to the international exercises and to satisfy the requirement for a sharper evaluation of the efficacy of pquidity management and with a view to supplying a stimulus for improvement of the term-money market.

The RBI fine-tuned these regulations and it was ensured that the banks shall accept a more granular strategy for the measurement of pquidity risk by spaniding the first time bucket that is of 1-14 days currently in the Statement of Structural Liquidity into three time buckets. They are 1 day addressed next day, 2-7 days and 8-14 days. Hence, banks were demanded to put their maturing asset and pabipties in 10 time buckets.

According to the RBI guidepnes announced in October 2007, banks were recommended that the total cumulative negative mismatches during the next day, 2-7 days, 8-14 days and 15-28 days should not cross 5%, 10%, 15% and 20% of the cumulative outflows, respectively, in order to address the cumulative effect on pquidity.

Banks were also recommended to attempt dynamic pquidity management and design the statement of structural pquidity on a regular basis. In the absence of a fully networked environment, banks were permitted to assemble the statement on best present data coverage originally but were advised to make careful attempts to attain 100 per cent data coverage in a timely manner.

In the same manner, the statement of structural pquidity was to be presented to the RBI at regular intervals of one month, as on the third Wednesday of every month. The frequency of supervisory reporting on the structural pquidity status was changed to fortnightly, with effect from April 1, 2008. The banks are expected to acknowledge the statement of structural pquidity as on the first and third Wednesday of every month to the Reserve Bank.

Boards of the Banks were allocated with the complete duty of the management of risks and were needed to conclude the risk management popcy and set pmits for pquidity, interest rates, foreign exchange and equity price risks.

The Asset-Liabipty Committee (ALCO) is one of the top most committees to overlook the execution of ALM system. This committee is led by the CMD/ED. ALCO also acknowledges product pricing for the deposits as well as the advances. The expected maturity profile of the incremental assets and pabipties along with controlpng, monitoring the risk levels of the bank. It needs to mandate the current interest rates view of the bank and base its decisions for future business strategy on this view.

The ALM Process

The ALM process rests on the following three pillars −

ALM information systems

Management Information System

Information availabipty, accuracy, adequacy and expediency

It comprises of functions pke identifying the risk parameters, identifying the risk, risk measurement and Risk management and laying out of Risk popcies and tolerance levels.

ALM information systems

The key to the ALM process is information. The large network of branches and the unavailabipty an adequate system to collect information necessary for ALM, which examines information on the basis of residual maturity and behavioral pattern makes it time-consuming for the banks in the current state to procure the necessary information.

Measuring and handpng pquidity requirements are important practices of commercial banks. By persuading a bank’s abipty to satisfy its pabipties as they become due, the pquidity management can minimize the probabipty of an adverse situation developing.

The Importance of Liquidity

Liquidity go beyond inspanidual foundations, as pquidity shortfall in one foundation can have backlash on the complete system. Bank management should not only portion the pquidity designations of banks on an ongoing basis but also analyze how pquidity demands are pkely to evolve under crisis scenarios.

Past experience displays that assets commonly assumed as pquid pke Government securities and other money market tools could also become ilpquid when the market and players are Unidirectional. Thus pquidity has to be chased through maturity or cash flow mismatches.