Asset Liability Management and Risk Management over laps each other on many grounds, they are the two very important concepts of the study of Financial Systems. Asset liability management (ALM) can be defined as the comprehensive and dynamic framework for measuring, monitoring and managing the financial risks associated with changing interest rates, foreign exchange rates and other factors that can affect the organisation’s liquidity.

1. ASSET
LIABILITY
MANAGEMENT
PRACHI GUPTA

2. What is ALM?
• Asset liability management (ALM) can be defined as the comprehensive and
dynamic framework for measuring, monitoring and managing the financial risks
associated with changing interest rates, foreign exchange rates and other factors
that can affect the organisation’s liquidity.
• ALM relates to management of structure of balance sheet (liabilities and assets) in
such a way that the net earning from interest is maximised within the overall risk-
preference (present and future) of the institutions.
• Thus the ALM functions includes the tools adopted to mitigate liquidly risk,
management of interest rate risk / market risk and trading risk management. In
short, ALM is the sum of the financial risk management of any financial institution.

3. RISKS INVOLVED
Three central risks:
• Interest Rate Risk- Risk that arises when the interest income/ market value of the
bank is sensitive to the interest rate fluctuations
• Liquidity Risk- Risk that arises due to the mismatch in the maturity patterns of
the assets and liabilities.
• Foreign currency risk- Risk that arises due to unanticipated fluctuation in
exchange rates

4. • Reserve Bank of India issued its first ALM Guidelines in February 1999, which was
made effective from 1 st April 1999. These guidelines covered, interest rate risk and
liquidity risk measurement/ reporting framework and internal limits.
• Gap statements were required to be prepared by scheduling all assets and liabilities
according to the stated or anticipated re-pricing date or maturity date.
• The Assets and Liabilities at this stage were required to be divided into 8 maturity
buckets (1-14 days; 15-28 days; 29-90 days; 91-180 days; 181-365 days, 1-3 years and 3-
5 years and above 5 years), based on the remaining period to their maturity (also
called residual maturity).

5. • As a measure of liquidity management, banks were required to monitor their
cumulative mismatches across all time buckets in their statement of structural
liquidity by establishing internal limits with the approval of their boards/
management committees.
• As per the guidelines, in the normal course, the mismatches (negative gap) in the
time buckets of 1-14 days and 15-28 days were not to exceed 20 per cent of the
cash outflows in the respective time buckets
• Later on RBI made it mandatory for banks to formALCO (Asset Liability
Committee) as a Committee of the Board of Directors to track, monitor and report
ALM.

6. • ALM information systems
1. Management Information System
2. Information availability, accuracy, adequacy and expediency ·
• ALM organisation
1. Structure and responsibilities
2. Level of top management involvement
• ALM process
1. Risk parameters
2. Risk identification
3. Risk measurement
4. Risk management
5. Risk policies and tolerance levels.

7. Liquidity Risk

8. Statement
of
Structural
Liability
• 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
• Places all cash inflows and outflows in the maturity
ladder as per residual maturity
• Maturing Liability: cash outflow
• Maturing Assets : Cash Inflow
• Classified in to 8 time buckets
• Mismatches in the first two buckets not to exceed 20%
of outflows
• Shows the structure as of a particular date
• Banks can fix higher tolerance level for other maturity
buckets.

9. All Assets & Liabilities to be reported as per
their maturity profile into 8 maturity Buckets:
i. 1 to 14 days
ii. 15 to 28 days
iii. 29 days and up to 3 months
iv. Over 3 months and up to 6 months
v. Over 6 months and up to 1 year
vi. Over 1 year and up to 3 years
vii. Over 3 years and up to 5 years
viii. Over 5 years

10. 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.

11. 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

12. • 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.
1. Gap Method
2. Simulation
3. Duration
4. Value of Risk
Techniques

13. References • http://www.allbankingsolutions.com/Banking-
Tutor/ALM.shtml
• https://www.rbi.org.in/home.aspx
• https://www.investopedia.com/terms/a/asset-
liabilitymanagement.asp
• TechnicalAssistanceConsultant’s Report- ADB
• 10, Chris, M. 2002. Fundamental of Risk Management.