RISK MEASURES IN ASSET & LIABILITY MANAGEMENT

Banks are exposed to several major risks in the course of their business - e.g. credit risk, interest rate risk, Foreign exchange risk, equity / commodity price risk, liquidity risk and operational risks.

The initial focus of the ALM function would be to enforce the risk management

Discipline, i.e, managing business after assessing the risks involved. The objective of good risk management programs should be that these programs will evolve into a strategic tool for bank management.

ALM process:

The scope of ALM function can be described as follows:

· Liquidity risk management

· Management of market risks

(including Interest Rate Risk)

· Funding and capital planning

· Profit planning and growth projection

· Trading risk management

The guidelines given here mainly address Liquidity and Interest Rate risks.

Liquidity Risk Management

 Measuring and managing liquidity needs are vital activities of commercial banks. By assuring a bank's ability to meet its liabilities as they become due, liquidity management can reduce the probability of an adverse situation developing. The importance of liquidity transcends individual institutions, as liquidity shortfall in one institution can have repercussions on the entire system. Bank management should measure not only the liquidity positions of banks on an ongoing basis but also examine how liquidity requirements are likely to evolve under crisis scenarios. Experience shows that assets commonly considered as liquid like Government securities and other money market instruments could also become illiquid when the market and players are unidirectional. Therefore liquidity has to be tracked through maturity or cash flow mismatches. For measuring and managing net funding requirements, the use of a maturity ladder and calculation of cumulative surplus or deficit of funds at selected maturity dates is adopted as a standard tool.

 The Maturity Profile as given could be used for measuring the future cash flows of banks in different time buckets. The time buckets, given the Statutory Reserve cycle of 14 days may be distributed as follow:

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 12 months

vi) Over 1 year and up to 2 years

vii) Over 2 years and up to 5 years

viii) Over 5 years

 Within each time bucket there could be mismatches depending on cash inflows and outflows. While the mismatches up to one year would be relevant since these provide early warning signals of impending liquidity problems, the main focus should be on the short-term mismatches viz., 1-14 days and 15-28 days. Banks, however, are expected to monitor their cumulative mismatches (running total) across all time buckets by establishing internal prudential limits with the approval of the Board / Management Committee. The mismatch during 1-14 days and 15-28 days should not in any case exceed 20% of the cash outflows in each time bucket. If a bank in view of its asset -liability profile needs higher tolerance level, it could operate with higher limit sanctioned by its Board / Management Committee giving reasons on the need for such higher limit.

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