CAIIB-BFM-CHAP 19- TREASURY AND ASSET LIABILITY MANAGEMENT

CHAP 19- TREASURY AND ASSET LIABILITY MANAGEMENT

 

 

·         If current interest rates are higher than the contracted rates on mortgage advances, the mismatch in interest rates leads to negative spread , or reduction in net interest income (Nil).

·         If current interest rates are higher than the contracted rates on mortgage advances, the mismatch in interest rates leads to negative spread , or reduction in net interest income (Nil).

·         The difference between sources and uses of funds in specific time bands is known as liquidity gap which may be positive or negative. The liquidity gap arises out of mismatch of assets and liabilities of the bank.

·         Market risk comprises of liquidity and interest rate risks

·         Liquidity risk is reflected as maturity mismatch - which is the gap in cash inflow and outflow. The risk is not being able to find enough cash, or cash at acceptable rate of interest, to fund the gap.

·         Interest rate risk arises when interest earnings are not adequate to set off interest payments due in a given period, even if the book value of the asset equals that of the liability, owing to a change in market rates of interest.

·         Liquidity and interest rate sensitivity gaps arise out of mismatch of bank's assets and liabilities, and are measured in specific time bands.

·         Net interest income (NII) of the bank is the difference between interest earnings and interest payments in a given accounting period. Hence interest rate risk may be defined as the risk of erosion of NII, on account of interest rate movements in the market.

·         The risk of erosion of NII is on account of deposit rates being floating (repriced every 6 months), while the loan interest is fixed (repriced only after 5 years when the ftmds are available for fresh lending, on repayment of the loan), or vice versa. The interest rate mismatch is therefore also known as repricing risk.

·         ALM uses broad time bands, hence even after using appropriate hedges, the market risk may not be completely mitigated - the residual risk is called basis risk.

·         Treasury is mostly concerned with market risk.

·         Derivatives, such as swaps and options are extensively used in managing the mismatches in bank's balance sheet.

·         Treasury is also responsible for transfer pricing, whereby market risk is removed from the banking assets and liabilities and cost of funds and return on assets is arrived at on a rational basis.

·         The process is called securitisation, whereby credit receivables of the bank can be converted into units or bonds (often called pass-through certificates - PTCs) that can be traded in the market. For instance, the mortgage loans of a bank can be securitised and issued in the form of PTCs through a special purpose vehicle (SPV) - which amounts to sale of bank's loan assets.

·         Transfer pricing refers to fixing the cost of resources and return on assets of the bank in a rational manner.

·         Run on the Bank is a situation where depositors of a bank lose confidence in the bank and withdraw their balances immediately.

·         Risk Appetite is the capacity and willingness to absorb losses on account of market risk.

·         SPV: Special Purpose Vehicle formed exclusively to handle securities paper, on behalf of the sponsoring bank - also known as fire-proof company, as it exists independent of parent company.

·         Credit default Spread (CDS) is the annual fee the credit protection buyer must pay the protection seller over the length of the contract, expressed as a percentage of the notional amount.

·         Credit derivatives segregate the credit risk from the assets through instruments known as credit default swaps and transfer the risk from the owner to another person who is in a position to absorb the credit risk for a fee.

A transaction where financial securities are issued against the cash flow generated from a pool of assets is called “ SECURITIZATION”

CAIIB-BFM-CHAP 20-COMPONENTS OF ASSETS & LIABILITIES IN BANK’S BALANCE SHEET

CHAP 20-COMPONENTS OF ASSETS & LIABILITIES IN BANK’S BALANCE SHEET

 

·         At macro-level. Asset Liability Management involves the formulation of critical business policies, efficient allocation of capital and designing of products with appropriate pricing strategies.

·         At micro-level the Asset Liability Management aims at achieving profitability through price matching while ensuring liquidity by means of maturity matching.

·         ALM is therefore, the management of the Net Interest Margin (NIM) to ensure that its level and riskiness are compatible with risk/return objectives of the bank.

·         The strategy of actively managing the composition and mix of assets and liabilities portfolios is called balance sheet restructuring.

·         The impact of volatility on the short-term profit is measured by Net Interest Income. Net Interest Income = Interest Income - Interest Expenses.

·         Minimizing fluctuations in  NII stabilizes the  short term profits of the banks.

·         Net Interest Margin is defined as net interest income divided by average total assets. Net Interest Margin (NIM) = Net Interest Income/Average total Assets.

·          Net Interest Margin can be viewed as the 'Spread' on earning assets. The higher the spread the more will be the NIM

·         The ratio of the shareholders funds to the total assets(Economic Equity Ratio) measures the shifts in the ratio of owned funds to total funds. This fact assesses the sustenance capacity of the bank.

·         Price Matching basically aims to maintain spreads by ensuring that deployment of liabilities will be at a rate higher than the costs.

·         Liquidity is ensured by grouping the assets/liabilities based on their maturing profiles. The gap is then assessed to identify future financing requirements

CAIIB-BFM-Chap 23- Supervisory Review

Chap 23- Supervisory Review

 

·         Pillar I: Minimum Capital Requirements - which prescribes a risk-sensitive calculation of capital requirements that, for the first time, explicitly includes operational risk in addition to market and credit risk.

·         Pillar 2: Supervisory Review Process (SRP) - which envisages the establishment of suitable risk management systems in banks and their review by the supervisory authority.

·         Pillar 3: Market Discipline - which seeks to achieve increased transparency through expanded disclosure requirements for banks.

CAIIB-BFM-Chap 22 -Capital Adequacy - The Basel-II Overview

Chap 22 -Capital Adequacy - The Basel-II Overview

·         The Basel Committee provided the framework for capital adequacy in 1988, which is known as the Basel-I accord. The Basel-I accord provided global standards for minimum capital requirements for banks.

·         The Revised Framework consists of three-mutually reinforcing pillars, viz., minimum capital requirements, supervisory review of capital adequacy, and market discipline.

·         The Framework offers three distinct options for computing capital requirement for credit risk and three other options for computing capital requirement for operational risk.

·         The options available for computing capital for credit risk are Standardised Approach, Foundation Internal Rating Based Approach and Advanced Internal Rating Based Approach.

·         The options available for computing Market risk is standardized approach (based on maturity ladder and duration baSed) and advanced approach, i.e., internal models such as VAR

·         The options available for computing capital for operational risk are Basic Indicator Approach, Standardised Approach and Advanced Measurement Approach.

·         The revised capital adequacy norms shall be applicable uniformly to all Commercial Banks (except Local Area Banks and Regional Rural Banks).

·         A Consolidated bank is defined as a group of entities where a licensed bank is the controlling entity.

·         All commercial banks in India shall adopt Standardised Approach (SA) for credit risk and Basic Indicator Approach (BIA) for operational risk.

·         Banks shall continue to apply the Standardised Duration Approach (SDA) for computing capital requirement for market risks.

·         The term capital would include Tier-I or core capital, Tier-II or supplemental capital, and Tier-Ill capital

·         Core capital consists of paid up capital, free reserves and unallocated surpluses, less specified deductions.

·         Supplementary capital comprises subordinated debt of more than five years' maturity, loan loss reserves, revaluation reserves, investment fluctuation reserves, and limited life preference shares.

·         Tier-II capital is restricted to 100% of Tier-I capital as before and long-term subordinated debt may not exceed 50% of Tier-I capital.

·         Tier-Ill capital will be limited to 250% of a bank's Tier-1 capital that is required to support market risk. This means that a minimum of about 28.5% of market risk needs to be supported by Tier-I capital. Any capital requirement arising in respect of credit and counter-party risk needs to be met by Tier-I and Tier-II capital.

·         Capital adequacy ratio(C)  = Regulatory capital(R)/Total risk weighted assets(T).

·         Regulatory Capital ‘R’=C*T  and Total Risk weighted Assets ‘T’= R/C

·         Total Risk weighted assets =(Risk weighted assets for credit risk) +(12.5*Capital requirement for market risk)+(12.5*Capital requirement for operational risk)