The Purpose of Asset-Liability Management is to Control a Bank’s Sensitivity to Changes in Market Interest Rates and Limit its Losses in its Net Income or Equity
Refers to a strategy where it is assumed that management has control over the allocation of bank assets (loans) but little or no control over funds sources (deposits)
Then: Liability Management Strategy
Strategy that focuses on new sources of funds and managing the mix of deposit and non deposit sources of funds by varying the price or interest rates offered
Now: Funds Management Strategy
The concept of planning and control over both sides of the balance sheet – assets and liabilities
Base (risk free) interest rates are determined by market forces not by individual banks. They are determined by the collective borrowing and lending decisions of thousands of participants in the money and capital markets
Lending interest rates are determined by additional risk factors such as default risk, maturity risk and liquidity risk
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Yield to Maturity (YTM) An interest rate measure
7.
Bank Discount Rate (DR) Another interest rate measure Where: FV equals Face Value
Financial institutions can lose income or value no matter which way interest rates go
Rising rates can lead to losses on security instruments and fixed rate loans as the value of these instruments fall. Rising rates can also cause a loss to income if the bank has more rate sensitive liabilities than assets
Falling interest rates can lead to capital gains but could lead to losses if there are more interest rate sensitive assets than liabilities
If interest revenues are $63 million, interest costs are $42 million, earning assets are 700 million. What is the NIM. If interest costs and interest revenues double while its earning assets increase by 50% what will happen to NIM
Gap management involves the determining the maturity distribution and the repricing schedule for a bank’s assets and liabilities.
When more assets are subject to repricing or will reach maturity in a given period than liabilities or vice versa, the Bank has a gap between assets and liabilities and is exposed to loss from an adverse movement in rates based on the gap’s size and direction and period
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Maturity profile used to identify, measure, manage and control risk 0 +60 -395 455 3 months -60 +30 -250 280 2 months -90 - 40 -105 65 1 month -50 -40 -160 120 1 week -10 -10 -$50 $40 Next day Cumulative gap Gap size liabilities Assets Maturity
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Interest-Sensitive Gap Measurements Dollar Interest-Sensitive Gap Interest-Sensitive Assets – Interest Sensitive Liabilities =
The Total Difference in Dollars Between Those Bank Assets and Liabilities Which Can be Repriced over a Designated Time Period
28.
Aggressive Interest-Sensitive Gap Management Decrease in IS Assets Increase in IS Liabilities Negative IS Gap Falling Market Interest Rates Increase in IS Assets Decrease in IS Liabilities Positive IS Gap Rising Market Interest Rates Aggressive Management’s Likely Action Best Interest-Sensitive Gap Position Expected Change in Interest Rates
If interest rate sensitive assets are $870 and interest sensitive liabilities are $625 during the next month. Is the bank asset sensitive or liability sensitive. What happens to NIM if rate rise? What happens to NIM if rates fall
If the gap for the one year period is + 135 million and rates fall by 2.5% then calculate the expected change in NII. What would happen if rates rise by 1.25%
Loan term 5 years. Annual interest rate payment is 10% (similar to coupon rate on a bond). The face value of the loan is also its current value because the yield to maturity on the loan is also 10%. What is the loan’s duration
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Duration (con’t) 4,169.87/1000=4.17 years Dur. = 3104.61 5 620.92 1000 5 310.4 5 62.09 100 5 273.21 4 68.30 100 4 225.39 3 75.13 100 3 165.29 2 82.64 100 2 90.91 1 90.91 100 1 PV x t Time period PV @10% CF expected CF period
Asset duration is 2.5 years, liability duration is 3 years, total assets = $560 million and total liabilities = $467 million
Duration gap = Da –DL* Liabilities/assets = 2.5 yrs – 3 yrs * (467/560) = 2.5 – 2.5018 = - .018 years
Slight duration gap. If rates rise the value of liabilities will fall by more than the value of assets resulting in a small increase in net worth
Net worth = assets - liabilities
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Duration of an Asset portfolio Where: w i = the dollar amount of the ith asset divided by total assets D Ai = the duration of the ith asset in the portfolio
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Duration of a Liability Portfolio Where: w i = the dollar amount of the ith liability divided by total liabilities D Li = the duration of the ith liability in the portfolio
Asset duration is 3.25 years and liability duration is 1.75 years. The liabilities amount to $485 million while assets total $512 million. Interest rates rise form 7 to 8 per cent. What happens to the net worth.
The change in net worth due to the increase in interest rates is = {-3.25yrsx .01/(1+.07) x $512} – {-1.75 yrs x .01/(1+.07) x $485 mill } = -7.62
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Impact of Changing Interest Rates on a Bank’s Net Worth No Change Interest Rate Fall D. Gap No Change Interest Rate Rise Zero NW Decrease Interest Rate Fall D. Gap NW Increase Interest Rate Rise Negative NW Increase Interest Rate Fall D. Gap NW Decrease Interest Rate Rise Positive
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