8/2/2019 Chap-ALM

1/29

Commercial Bank Management

Chapter 06Asset Liability Management

8/2/2019 Chap-ALM

2/29

Asset Liability Management

Today bankers have learned tolook at their asset & liability portfolios asan integrated whole, considering how the

banks total portfolio contributes to itsbroad goals of adequate profitability &acceptable risk.

This type of coordinated &integrated bank decision making is knownas Asset-Liability Management.

8/2/2019 Chap-ALM

3/29

Objective of ALM

To maximize, or at least stabilize, thebanks margin, or spread between

interest revenues & interest expenses To maximize, or at least protect, the

value of the bank, at an acceptable

level of risk.

8/2/2019 Chap-ALM

4/29

Asset Liability Management

Strategies

Asset Management Strategy

Liability Management Strategy

Funds Management Strategy

8/2/2019 Chap-ALM

5/29

ALM Strategy

Asset Management

Strategy:Control of the composition of a

banks assets to provide adequate

liquidity & earnings & meet other

goals.

8/2/2019 Chap-ALM

6/29

Liability Management Strategy:Confronted to soaring interest rates &intense competition for funds, bankers began to

devote greater attention to new sources of fund &monitoring the mix and cost of their deposit &

non-deposit liabilities.

Control over a banks liabilities (usually

through changes in interest rates offered) to

provide the bank with adequate liquidity & meet

other goals.

ALM Strategy

8/2/2019 Chap-ALM

7/29

Funds Management Strategy:

The coordinated

management of both a banksassets & its liabilities to ensure

an adequate level of liquidity& meet other goals.

ALM Strategy

8/2/2019 Chap-ALM

8/29

Objectives of Fund Management

Strategy1. To control over the volume, mix, and return or cost of

both assets and liabilities to achieve the banks goals.

2. To ensure internal consistent between asset and liability

management so that they do not pull against each other;

effective coordination in managing assets and liabilities

will help to maximize the spread between bank revenues

and costs and control risk exposure.

3. Revenue and costs arise from both sides of the banksbalance sheet (i.e., from both assets and liabilities).

Bank policies need to be developed that maximize

returns and minimize costs from supplying services.

8/2/2019 Chap-ALM

9/29

Interest Rate Risk

When interest rate changes in themarket, it leads changes in thebanks

source of revenue- interest income & their

source of expenses- interest cost on

deposits & other bank borrowings.

Moreover change in interest rate leadchanges in the value of abanks assets &

liabilities thus thebanks net worth.

8/2/2019 Chap-ALM

10/29

ALM in Banking

Managing

the banks

response to

changing

interest

rates

Bank InterestRevenues

Bank Interest

Cost

Market ValueOf Bank Assets

Market ValueOf BankLiabilities

Banks Net

Interest

Margin

Banks NetWorth

Banks Value,Profitability &

Risk

8/2/2019 Chap-ALM

11/29

o Price Risk: When the market interest raterise, the market value of most bonds &fixed-rate loans fall.

o Reinvestment Risk: When market interestrate falls, a bank is forced to investincoming funds at the lower rate, lowering

its future expected income.

A big part of ALM is to dealeffectively with these two forms of risk

from changing interest rate.

Interest Rate Risk

8/2/2019 Chap-ALM

12/29

The Measurement of Interest Rates

YTM

Bank Discount Rate

YTM Equivalent Yield

8/2/2019 Chap-ALM

13/29

The Components of Interest Rates

8/2/2019 Chap-ALM

14/29

Interest Sensitive GapManagement:

Gap Management techniques requiremanagement to perform an analysis of

the maturities & repricing opportunities

associated with interest-bearing assets& with deposits & other borrowings.

ALM Techniques

8/2/2019 Chap-ALM

15/29

Interest Sensitive Gap

Management

If management feels its institution is

excessively exposed to interet rate risk, it

will try to match as clearly as possible thevolume of bank assets that can be repriced as

interest rates change with the volume of

liabilities whose rates can also be adjusted tointerest rate risk.

8/2/2019 Chap-ALM

16/29

Amount of Interest Amount of Interest

Rate Sensitive = Rate Sensitive

Assets Liabilities

Interest Sensitive GapManagement

8/2/2019 Chap-ALM

17/29

Repriceable Assets

Short-term securities

issued by governmentsand private borrowers

(about to mature)

Short-term loans made

by the bank to borrowingcustomers (about to

mature)

Variable-rate (floating oradjustable rate) loans and

securities.

Repriceable Liabilities

Borrowings from the

money market (such asfederal funds or RP

borrowings)

Short-term savings

accounts

Money-market deposits

(whose interest rates

often are adjustable everyfew days)

Variable rate (floating or

adjustable rate) deposits

8/2/2019 Chap-ALM

18/29

Nonrepriceable Asset

Cash held in the banks

vault and deposits at the

Central Bank (Legalreserves)

Long-term loans made at

a fixed interest rate to

borrowing customers Long-term securities

carrying fixed (coupon)

rates

Bank buildings andequipment and other

nonearning assets

Nonrepriceable Liabiity

Demand depositaccounts (which pay norate of return or a fixedinterest rate)

Long-term savings andretirement accounts

Equity capital providedby the banks owners

8/2/2019 Chap-ALM

19/29

Assets Amount inMillion Tk.

Vault Cash 20

Short-term

security

15

Long-term

security

30

Variable rate

loan

40

Short-term loan 20Long-term loans 60

Other assets 10

Total 195

Liability & Equity Amount inMillion Tk.

Demand Deposit 5

NOW Accounts 5

Money market

Deposit

20

Short-term savings 40

Long-term savings 60

Federal funds

borrowings

55

Equity 10

Total 195

8/2/2019 Chap-ALM

20/29

Interest-sensitive Gap =

Interest sensitiveAssetsInterest

sensitive Liabilities

Interest Sensitive Gap

Management

8/2/2019 Chap-ALM

21/29

Asset sensitive (positive) gap

Interest-sensitive

Assets > Interest-

sensitive Liabilities

8/2/2019 Chap-ALM

22/29

Interest-sensitive Assets

8/2/2019 Chap-ALM

23/29

Relative IS Gap

)(

IRe

TotalAssetBankSize

apGISsGaplaive

8/2/2019 Chap-ALM

24/29

Interest Sensitivity Ratio

IS

IS

atioRensitivitySInterest

8/2/2019 Chap-ALM

25/29

An Asset-Sensitive

Bank Has:

A Liability-

Sensitive Bank

Has:

Positive Dollar IS

GAP

Negative Dollar IS

GAPPositive Relative IS

GAP

Negative Relatives

IS GAP

Interest Sensitive

Ratio greater than

one

Interest Sensitivity

Ratio less than one

8/2/2019 Chap-ALM

26/29

Important Decision RegardingIS Gap

Management Must Choose the Time PeriodOver Which NIM is to be Managed

Management Must Choose a Target NIM

To Increase NIM Management Must Either:

Develop Correct Interest Rate Forecast

Reallocate Assets and Liabilities to IncreaseSpread

Management Must Choose Dollar Volumeof Interest-Sensitive Assets and Liabilities

8/2/2019 Chap-ALM

27/29

NIM Influenced By

Changes in Interest Rates Up or Down

Changes in the Spread Between Assets

and Liabilities

Changes in the Volume of Interest-

Sensitive Assets and Liabilities Changes in the Mix of Assets and

Liabilities

8/2/2019 Chap-ALM

28/29

Aggressive Interest-SensitiveGap Management

Expected Change

in Interest Rates

Best Interest-

Sensitive Gap

Position

Aggressive

Managements

Likely Action

Rising MarketInterest Rates

Positive IS Gap Increase in ISAssets

Decrease in IS

Liabilities

Falling Market

Interest Rates

Negative IS Gap Decrease in IS

Assets

Increase in IS

Liabilities

8/2/2019 Chap-ALM

29/29

Problems with Interest-SensitiveGap Management

Interest Paid on Liabilities Tend to Move Fasterthan Interest Rates Earned on Assets

Interest Rate Attached to Bank Assets and

Liabilities Do Not Move at the Same Speed asMarket Interest Rates

Point at Which Some Assets and Liabilities are

Repriced is Not Easy to Identify Interest-Sensitive Gap Does Not Consider the

Impact of Changing Interest Rates on EquityPosition