(ALM): Policy-Organizational Structure and Procedural Guideline!
Core Risk Management in Bank:
- Asset Liability Management
- Credit Risk Management
- Foreign Exchange Risk Management
- Internal Control and Compliance
- Anti-Money Laundering
- IT Security
Different Aspects of Balance Sheet (ALM) of a Bank:
Different Aspects of Balance Sheet (ALM) in a Bank.
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
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.
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.
Purpose of ALM:
The purpose of asset-liability management is to formulate strategies and take actions that shape a bank’s balance sheet as a whole in a way that contributes to its desired goals. Usually, the principal goals of asset-liability management are:
(a) to maximize, or at least stabilize, the bank’s margin, or spread between interest revenues and interest expenses
(b) to maximize, or at least protect, the value (stock price) of the bank, at an acceptable level of risk.
ALM and ALCO
Banks must have a committee comprising of the senior management of the bank to make important decisions related to the Balance Sheet of the Bank.
The committee, typically called the Asset Liability Committee (ALCO), should meet at least once every month to analysis, review and formulate strategy to manage the balance sheet.
ALCO: Policy Statement:
Board or Management Committee of the Bank should set out the policy statement in at least for the followings and an annual review should be done taking into consideration of changes in the balance sheet and market dynamics.
+Basel-III Liquidity Ratios
+Advance to Deposit Ratio (ADR)
+Wholesale Borrowing Guidelines (WBG)
+Structural Liquidity Profiles
+Interest Rate Risk Limit
+Swapped Funds Limit
+Contingency Funding Plan
+Local Regulatory Compliance
Basel-III Liquidity Ratios:
+The ratios represent the way forward in ALM through liquidity measurement and management. These ratios along with the liquidity gap should be central to liquidity measurement and management.
+LCR or Liquidity Coverage Ratio is a new liquidity standard introduced by the BCBS. This standard is built on the methodologies of traditional liquidity coverage ratio used by banks to assess exposure to contingent liquidity events.
+NSFR or Net Stable Funding Ratio is another new standard introduced by the BCBS. The NSFR aims to limit over-reliance on short-term wholesale funding during times of abundant market liquidity and encourage better assessment of liquidity risk across all on- and off-balance sheet items.
Advance to Deposit Ratio:
+The ratio is determined by putting Advance in numerator and Liabilities (excluding capital) in denominator. The ratio should be fixed in such a manner so that there will be no unnecessary liquidity pressure on the bank in any point of time.
+Considering the regulatory liquidity requirements (CRR and SLR), the maximum value of the ratio shall be derived using the formula [100%-CRR*-SLR*].
+Depending upon the capital base, liquidity condition, NPL status etc. and above all the maintenance of LCR & NSFR, the board may decide adding highest 4.5% and 2% (for conventional banks and Shariah based banks respectively) with the result of the above formula to fix a suitable AD ratio.
Wholesale Borrowing Guidelines:
+The aim of wholesale borrowing (WB) guidelines is to set a limit for borrowed fund. The limit should be set in absolute amount based on bank’s eligible capital (Tier-1 plus Tier-2) capital and considering liquidity needs due to maturity mismatch, borrowing capacity of the bank and historic market liquidity.
+The WB Limit should be capped at 80% (for Non PD banks) and 100% (for PD banks) of bank’s eligible capital on fortnightly average basis with maximum two deviations (not more than 90% and 110% of the eligible capital for Non PD and PD banks respectively) in a particular fortnight. The eligible capital determined under Basel III for any quarter will be applicable as eligible capital until it is determined for the next quarter.
+Total Commitments include undrawn portions of continuous loan including interest thereon and undrawn portions of term loans, outstanding irrevocable letters of credit and similar instruments, letters of guarantee, acceptances and similar instruments. Counter guarantee provided by foreign banks, FC held against Back to Back LC and Margin on LC or guarantee shall be deducted from the total commitment amount.
+The commitment limit should be fixed considering i) Total commitments to total Assets, ii) Total commitments to Total Eligible Capital and iii) Total commitments to total High Quality Liquid Assets (HQLA). The highest acceptable limits of these ratios are less than 50%, less than 500% and less than 250% respectively. The commitment limit should be the lowest amount of the three ratios mentioned above.
Structural Liquidity Profile
+The structural liquidity profile of a bank provides information regarding maturity transformation of assets and liabilities in a simple manner. The negative liquidity GAP (if exist), may be taken as a preliminary signal for the need of maturity adjustment of assets and liabilities in different time buckets. The Maximum Cumulative Outflow ratio may be considered as an important benchmark in this regard.
+MCO upto one month bucket should not be greater than the sum of daily minimum CRR plus SLR. For example, the MCO should be 19% (6% CRR+ 13% SLR) for conventional banks. The Shariah based banks, due to higher ADR and Short nature of their investment are also allowed MCO at the same level. MCO in the other maturity buckets should be prudently fixed by the BODs depending on bank’s business strategy.
Interest Rate Risk Limit:
+The BODs should set a limit on the interest rate risk in the banking book. The limit should be set according to the risk appetite of the bank.
+The BODs should also set the management action plan to reduce interest rate risk if the situation warrants. Both NII (Net Interest Income) and MVE (Market Value of Equity) limits and action plan should be set so that management can act promptly.
Swapped Funds Limit:
+Swapped fund is the difference between assets and liabilities including capital denominated in the same currency.
+Assets and liabilities will not always be in the same currencies. A bank might be exposed to the risk that it may not meet by its currency-wise obligations as they fall due. Swapped funds position results from reliance on foreign exchange markets and therefore needs to be controlled.
+Swapped funds limits are established on the maximum amount that may be swapped out of foreign currency into local currency and swapped out of local currency into foreign currency.
Contingency Funding Plan:
+A contingency funding plan needs to be approved by the BODs (ALCO in case of foreign banks).
+A contingency funding plan needs to be prepared keeping in mind that enough liquidity is available to meet the funding requirements in a liquidity crisis situation.
+There should be a firm policy on compliance with Bangladesh Bank requirements relevant to ALM, such as CRR and SLR, CRAR, Single Borrower Exposure Limit, etc.
Organizational Structure of ALM:
+The Asset Liability Committee (ALCO) is responsible for balance sheet (asset liability) risk management. Managing the asset liability is the most important responsibility of a bank as it runs the risks for not only the bank, but also the thousands of depositors who put money into it.
+The responsibility of Asset liability Management is on the Treasury Department of the bank. Specifically, the Asset liability Management (ALM) desk of the Treasury Department manages the balance sheet. The results of balance sheet analysis along with recommendation is placed in the ALCO meeting by the Treasurer where important decisions are made to minimize risk and maximize returns. Typically, the organizational structure looks like the following:
Responsibilities of ALCO:
+Ensure that bank’s measurement and reporting systems accurately convey the degrees of liquidity and market risk
+Monitor the structure and composition of bank’s assets and liabilities and identify balance sheet management issues that are leading to under performance.
+Decide on the major aspects of balance sheet structure, such as maturity and currency mix of assets and liabilities, mix of wholesale versus retail funding, deposit mix, etc.
+Decide on how to respond to significant, actual and expected increases and decreases in required funding.
+Review maturity profile and mix of assets and liabilities
+Articulate interest rate view of the bank and decide on balance sheet strategy
+Approve and periodically review the transfer pricing policy of the bank
+Evaluate market risk involved in launching of new products
+Review deposit-pricing strategy, and
+Review contingency funding plan for the bank
Organizational Structure of ALM:
CEO / MANAGING DIRECTOR
Head of Retail Banking / General Banking
Head of Treasury
Head of Corporate Banking
Head of Finance/ CFO / CAD / FAD
Head of SME/ ID/ Commercial Customers
Head of RMD
Head of Asset Liability Mgt (ALM) (under Treasury Division)
Money Market Dealers (under Treasury Division)
Key Responsibilities of ALM Desk:
+To oversee the growth and sustainability of assets and the liabilities.
+To manage and oversee the overall activities of Money Market.
+To manage liquidity and market risk of the bank.
+To understand the market dynamics i.e. competition, potential target markets etc. for expansion of the business.
+To Provide inputs regarding market views and to suggest proper balance sheet movement (expand or shrink) to cope with the changing situation in the market or in the economy.
+To keep records of ALCO meetings, to monitor the implementation status of the action taken in ALCO meetings etc.
ALCO Process: Key Agenda:
+Review of actions taken in previous ALCO and the status of implementation
+Review of monthly changes in various key parameters
+Overall fund position including loanable funds, maintenance of CRR and SLR, LCR and NSFR position, Structural Liquidity Profile, etc.
+Asset position: Concentration, Quality
+Liability position: deposit mix, market situation, concentration, cost of fund
+Foreign Exchange related asset and liability position: forward agreement, net foreign exchange liability, OBU position, SWAP position, Sight L/C.
+Economic and Market Status and Outlook
+Liquidity Risk related to the Balance Sheet
+Review of the price / interest rate structure: interest rate risk in banking book, interest rate risk in trading book, equity price risk
+Off-balance sheet position: Unused portion of lines of credit (undrawn commitments), Acceptances, Guarantees, Maturity profile of other L/Cs
+Capital Market Investment position: Solo and Consolidated basis.
+Investment in associates
+Stress Test, VaR (Value at Risk) analysis, Gap Analysis and others with proper interpretation.
+Actions to be taken by whom and by when
Contents of the ALCO Paper:
+Confirmation of Minutes of last meeting
+Review of the action items of the previous meetings
+Review of Economy and Markets
+Review of Balance Sheet and Liquidity Limits
+Review of the Status of Regulatory Compliance
+Top 10 Depositors List
+Top 10 Borrowers List
+Details of Loans and Deposits Movement
+Loans and Deposit Projections
+Trend of Lending Rates and Deposit Rates