Commercial Bank Management
Chapter 06
Asset Liability Management
Asset Liability Management
Today bankers have learned to look at their asset & liability portfolios as an integrated whole, considering how the banks total portfolio contributes to its broad goals of adequate profitability & acceptable risk.
This type of coordinated & integrated bank decision making is known as Asset-Liability Management.
Objective of ALM
To maximize, or at least stabilize, the banks 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.
Asset Liability Management Strategies
Asset Management Strategy
Liability Management Strategy Funds Management Strategy
ALM Strategy
Asset Management Strategy:
Control of the composition of a banks assets to provide adequate liquidity & earnings & meet other goals.
ALM Strategy
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
Funds Management Strategy:
The coordinated management of both a banks assets & its liabilities to ensure an adequate level of liquidity & meet other goals.
Objectives of Fund Management Strategy
1. 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 banks balance sheet (i.e., from both assets and liabilities). Bank policies need to be developed that maximize returns and minimize costs from supplying services.
Interest Rate Risk
When interest rate changes in the market, it leads changes in the banks source of revenue- interest income & their source of expenses- interest cost on deposits & other bank borrowings. Moreover change in interest rate lead changes in the value of a banks assets & liabilities thus the banks net worth.
ALM in Banking
Bank Interest Revenues
Managing the banks response to changing interest rates
Bank Interest Cost Market Value Of Bank Assets
Banks Net Interest Margin
Banks Value, Profitability & Risk
Market Value Of Bank Liabilities
Banks Net Worth
Interest Rate Risk
o Price Risk: When the market interest rate rise, the market value of most bonds & fixed-rate loans fall. o Reinvestment Risk: When market interest rate falls, a bank is forced to invest incoming funds at the lower rate, lowering its future expected income. A big part of ALM is to deal effectively with these two forms of risk from changing interest rate.
The Measurement of Interest Rates
YTM
Bank Discount Rate YTM Equivalent Yield
The Components of Interest Rates
ALM Techniques Interest Sensitive Gap Management:
Gap Management techniques require management to perform an analysis of the maturities & repricing opportunities associated with interest-bearing assets & with deposits & other borrowings.
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 the volume of bank assets that can be repriced as interest rates change with the volume of liabilities whose rates can also be adjusted to interest rate risk.
Interest Sensitive Gap Management
Amount of Interest Amount of Interest Rate Sensitive = Rate Sensitive Assets Liabilities
Repriceable Assets Short-term securities issued by governments and private borrowers (about to mature) Short-term loans made by the bank to borrowing customers (about to mature) Variable-rate (floating or adjustable rate) loans and securities.
Repriceable Liabilities Borrowings from the money market (such as federal funds or RP borrowings) Short-term savings accounts Money-market deposits (whose interest rates often are adjustable every few days) Variable rate (floating or adjustable rate) deposits
Nonrepriceable Asset Cash held in the banks vault and deposits at the Central Bank (Legal reserves) Long-term loans made at a fixed interest rate to borrowing customers Long-term securities carrying fixed (coupon) rates Bank buildings and equipment and other nonearning assets
Nonrepriceable Liabiity Demand deposit accounts (which pay no rate of return or a fixed interest rate) Long-term savings and retirement accounts Equity capital provided by the banks owners
Assets Vault Cash Short-term security Long-term security Variable rate loan Short-term loan
Amount in Million Tk.
Liability & Equity
Amount in Million Tk.
20 15 30
Demand Deposit NOW Accounts Money market Deposit Short-term savings Long-term savings
5 5 20 40 60 55 10 195
40
20 Federal funds borrowings Equity Total
Long-term loans 60 Other assets Total 10 195
Interest Sensitive Gap Management
Interest-sensitive Gap = Interest sensitive Assets Interest sensitive Liabilities
Asset sensitive (positive) gap
Interest-sensitive Assets > Interestsensitive Liabilities
Liability sensitive (negative) gap
Interest-sensitive Assets < Interest-sensitive Liabilities
Relative IS Gap
ISG ap Re laiveIsGap BankSize( TotalAsset )
Interest Sensitivity Ratio
ISA Interest SensitivityR atio ISL
An Asset-Sensitive A LiabilityBank Has: Sensitive Bank Has: Positive Dollar IS Negative Dollar IS GAP GAP
Positive Relative IS Negative Relatives GAP IS GAP
Interest Sensitive Ratio greater than one Interest Sensitivity Ratio less than one
Important Decision Regarding IS Gap
Management Must Choose the Time Period Over 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 Increase Spread
Management Must Choose Dollar Volume of Interest-Sensitive Assets and Liabilities
NIM Influenced By
Changes in Interest Rates Up or Down Changes in the Spread Between Assets and Liabilities Changes in the Volume of InterestSensitive Assets and Liabilities Changes in the Mix of Assets and Liabilities
Aggressive Interest-Sensitive Gap Management
Expected Change in Interest Rates Rising Market Interest Rates Best InterestSensitive Gap Position Positive IS Gap Aggressive Managements Likely Action Increase in IS Assets Decrease in IS Liabilities Decrease in IS Assets Increase in IS Liabilities
Falling Market Interest Rates
Negative IS Gap
Problems with Interest-Sensitive Gap Management
Interest Paid on Liabilities Tend to Move Faster than Interest Rates Earned on Assets Interest Rate Attached to Bank Assets and Liabilities Do Not Move at the Same Speed as Market 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 Equity Position