Asset Liability Management Canara Bank

CHAPTER -I INTRODUCTION

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INTRODUCTION ASSET LIABILITY MANAGEMENT Banks should introduce the proposed ASSET LIABILITY MANAGAENT (ALM) system positively by April 1 st 1999. The introduction of such procedure is necessary to the mismatches in the assets and liabilities of the banks, which are increasingly seen in the past. Banks are exposed to several major risks in the course of their business. Sum of them are credit risk , interest risk , foreign exchange risk , price risk , liquidity risk and operational risk. It is the risk with respect to interest rate and liquidity that are sought to be hedged and managed by Asset –Liability Management.

The RBI and ALM propose to divide assets into different time buckets depending on the maturity and category of the assets. The time buckets are supposed to be used for identifying cumulative mismatches and establishing internal prudential limits with in the banks the mismatches that exists after such and exercises should be reported to the RBI periodically.

The rational for accessing risk on a continuing basis is also to ensure that each bank has enough at all times to cover the risks they incur, including those arising from interest rate risk. Till now, bank have only focused on maintaining a prudent capital to risk-weighted assets ratio(CAR), BUT LENDING risk is not only risk. Banks have to ensure that their capital covers all risks including interest rate and liquidity risks.

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OBJECTIVES OF THE STUDY:  To know the concept of ALM in CANARA BANK.  To study ALM Mechanism in Indian Banking Sector.  To analyze and understand the ALM procedure in CANARA BANK  To study traditional gap analysis in managing liquidity risk & interest rate risk.

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NEED FOR THE STUDY Assets liabilities and management (ALM) is a relatively new process the world over. Its importance was first realized in the 1980s in the USA, when a number of savings and loan institutions, having huge asset-inability mismatch on their balance sheet, turned insolvent. With growing competition world wide, profit margins of financial intermediaries are reducing. This coupled with greater volatility in the international interest rates, has meant lower income for these earning, they have adopted 'aggressive strategies, which have increased their risk profile substantially. This led to the bankruptcy of some hanks.

Thus, these institutions have to bring their level in manageable proportions, while not severely reducing their incomes. Restructuring their balance sheet can only do this. Thus, the activity of asset liability management has received tremendous importance. Risk in modern parlance is generally thought to be "the danger of loss". It is generally associated with the downside and not the upside of a transaction. In finance theory, however, risk is defined as dispersion of unexpected outcomes due to movements in financial variables. Risk is measured by the standard deviation of unexpected outcomes or sigma. Also called volatility.

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SCOPE OF THE STUDY:  The scope of the study is confined to Liquidity risk and Interest rate risk.  ALM in relation of banks covers a wide gamut of both sources and application of funds.  Growing competition for the access to the sources and the need for arresting the erosion of net worth are the main challenges in managing the liabilities.

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RESEARCH METHODOLOGY: PRIMARY SOURCE: 

Gathered information by interacting with employees of CANARA BANK in ALM department & referred to Bank Library books related to ALM.

SECONDARY SOURCE:

 Referred to ALM related articles form various magazines and journals like Bank Quest,  1CFAI analyst, ICFAI Reader etc.  ALM related material that is being provided by CANARA BANK.  Various Web sites pertaining to ALM.

ALM is the management of structure of Balance sheet in such a way that the net earnings from interest in particular are maximized with overall risk preference of the institutions"

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LIMITATIONS OF THE STUDY:  Information relating to the internal aspects regarding various items is not provided.  Here is no practical exposure in calculations.  Most of the information is from the Secondary Data.

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CHAPTER -II REVIEW OF LITERATURE

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ASSET-LIABILITY MANAGEMENT:

Risk Management and Asset Liability Management (ALM) are the buzzwords now in the world of financial institutions and banks especially in India for the last 5 years. In case the readings all around tend to give a feeling as if the entire financial system is subjected to interest rate risk only now, do not be carried away. The framework of ALM broadly covers the area of interest rate risk, and credit risk. The level of awareness about the nature and impact of risks is at a very low level for historical reasons. RBI has formally issued guidelines to all banks regarding interest rate sensitivity and liquidity aspect of ALM. Arguably, it is in their own interest banks should look at ALM, but it is perhaps appropriate for RRI to give instructions in this regard since bank have been used to carry out RBI instructions for almost 30 years with little proactive policies. While it is premature to state that banks will now be able to manage risks, this is definitely a step in the right direction.

The deregulation of domestic interest rates, volatility in the domestic debt and foreign exchange markets and introduction of new financial instruments has posed a question of efficient liquidity and interest rate risk management with in banks. Banks ability to contain and manage these risks obviously has an impact on the bottom line. In a bank, however, there are endless specific entries on the liability side and also on the assets side. The aggregation therefore, then presents a complete picture of banks 9

mismatches. RBI has circulated a draft of asset-liability guidelines, which, as the preamble says is intended to make bank alive to the risks they carry. Asset-Liability Management (ALM) is the art of ensuring that the maturity profiles of assets match that of the liabilities. A liability (deposit) once raised is typically funded in to the creation of an asset. The liability has to be squared off: the depositor, for example has placed the deposit for 5 years. But the asset may have a different maturity profile. It may have gone in to long gestation road project, wherein the loan will be repaid after 10 years. In a bank, however, there are endless specific entries on the asset as well as liability side. The aggregation therefore, then, presents a complete picture of the batiks mismatches. Therefore, the ALM system is not only a management information system, but also an advance warning system of the banks sensitivity to adverse changes in the environment.

WHAT IS ASSET LIABILITY MANAGAENT?

• ALM is the management of structure of balance in such a way that the net earning from interest in particular are maximized with over all risk-preference of the institutions. • It

need

to

be

noted

that

ALM

is

an

integrated

approach

to

financial management requiring simultaneous decision about the type of amount of financial assets and liabilities, both mix and value with the complexities of the financial markets in which the institution operates. • Assume that the structure of the existing assets and liabilities is such that at the 10

aggregate, the maturity of the assets is longer than the maturity of the liabilities. This would expose to bank to interest rate risk as the interest rate can increase and decrease. Thus the interest income can suffer in the process .This has to be set right either by reducing the maturity of assets or increasing the maturity of the liabilities.

 Adjusted bank's liabilities to meet loan demands, liquidity needs and the safety requirements with a focus on profit and long term operating viability.

 Discretionary funds management where the focal point is to increase or decrease interest sensitivity funds at the initiative of the bank.

 Directing and controlling the flow, the means, the cost and the yield of the consolidated funds of the bank with the eye on profit and long-term liability. Management of total balance sheet liabilities with regards to its size and quality.

Managing the net interest margin with in the overall risk bearing

capacity of the bank. It therefore, involves quantification of risk and conscious decision-making with regard to asset liability structure so as to maximize interest earning within the framework of perceived risk.

ALM helps bankers in successfully matching the assets and liabilities in terms of rate and maturity with a view to obtain optimum yield to survive in the deregulated and competitive environment. 11

WHY ASSET LIABILITY MANAGAENT

In pre-financial reforms era, banks were subjected to control measures by RBI in all activities undertaken by them which includes:

 Regulated deposit interest rates.  Minimum lending rates.  Administered prime lending rates linked to borrow accounts.  Generally fixed rates transactions, and Numbers of instruments available to the user were also limited. All the above left the bank with widespread and helped to maintain there bottom-lines at respectable levels.

The reforms process brought:

 Faced deregulation.  New player.  New instruments.  New products at competitive rates.

Number of risks such as credit risk, interest risk, disintermediation risk, liquidity risk, foreign exchange risk and market risk.

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In the light of the above development and to maintain and improve the bottom-lines, there has to be some system in place which should help to achieve the organizational objectives.

Asset liability management is one such effective and important tool. Thus, ALM is a risk management tool through which market risk associated with the business are identified, measured and monitored to maintain/optimize profits by re-aligning/re -structuring asset and liabilities.

Important prerequisites successful AI.M is availability of adequate, accurate and expediency of data. Banking is an activity where bank accept deposits for the purpose of lending. It is also called intermediation.

 Banks do intermediation with an intention to earn profits.  While doing so, banks are exposed to certain type of risks.

OBJECTIVES OF ASSET LIABILITY MANAGAENT Banks being financial intermediaries derive their long term profitability by effectively and efficiently accepting investment from the public and transforming them to a relatively safe portfolio of credit by virtue of their better access to market information and expertise in apprising credit propositions of entrepreneurs. By offering customers the product-Deposits, Credits, Investments that are in highest demand, the intermediaries earn higher profits. While earning profits, intermediaries

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are also known to provide liquidity demanded by the market and to an extent, also provide certain amount of insulation from credit risk. However, while providing these services, intermediaries are subjected to interest rate risk since the value of the short-term liabilities and the long-term assets change differentially in response to interest rate moves. And being highly leveraged, they are exposed to significant interest rate risk and losses could at time, be catastrophic if not managed properly.

Here comes 'Asset Liability Management" as a tool providing a degree of protection to bank from intermediation risk, thereby making risk acceptable. It helps bank in-Maximization of income through-

 Spread Management  Liquidity Management  Capital Management  Gap Management

By assessing the impact and choosing optimal combination at

 Various Asset Mixes.  Various fund combinations.  Price/Volume relations and  Interest rate variations.

And managing risk exposure viz.

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 Credit Risk.  Interest Rate Risk.  Liquidity Risk,  Market Risk.  Capital Risk.

ASSET LIABILITY MANAGAENT: It is basically a tool for liquidity and interest rate risk management. Bulk of the bank's profit comes from net interest income and hence the paramount need to measure, control and manage interest rate exposure. It is no exaggeration to state that many financial institutions failed miserably by mismanaging the interest rate risk e.g. Housing finance companies of USA. These institutes used to collect short-term deposits cheaply and lend on long term fixed interest rate for housing. With deregulation of interest rates, the short-term deposit rates have gone up leading to poor spread and ultimate collapse. ALM has thus become an absolute necessity.

Pre-Requisites for successful ALM 1. Easy access to bank's liabilities for potential investors. 2. Interest rates on bank's assets and liabilities to be competitively determined. 3. Favorable regulatory factor.

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HOW TO PRACTISE ASSET LIABILITY MGMT:

Successful implementation of ALM involves 1. Choosing a suitable length of planning horizon- one, two, three months ahead. 1. Working out estimates of return and risk that might result from pursuing alternative programmers, and 2. Finally, choosing a model that yields a stable regardless of the level or movement consistently. The task of generation of desired net interest revenues regardless of the level or movement of interest rates is achieved primarily 

Estimation of core sources of funds, core deposit, CDs and call borrowings.

 Prudential management of funds in respect of size and pattern.  Minimizing undesirable maturity mismatch; and  Reducing the gap between rate sensitive assets and rate sensitive  Liabilities within a risk taking capacity.

WHAT IS RISK?

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The risk is nothing but a possible loss or damage going to occur. It has to be managed and cannot be eliminated to earn maximum profits. There are three types of important risks involved in the banking activity. • Credit risk. • Market risk. • Operation risk.

and long-term horizons. Based on this, they are to assess their vulnerability to adverse changes, and. therefore, protect them in advance. Interestingly, in the international market, the regulator dose not monitors the ALM function of the banks under its charges. It is internally motivated and not regulated. Managing risk is the inherent function of a bank, hut banks have ignored house. Although some front line banks have ALM system in place, there are several banks that do not have sophistication of making mismatches in assets and liabilities.

The RBI is trying to assist these banks by providing them with an educative guideline of managing assets and liability. Liquidity risk is the risk of a bank suddenly finding itself strapped for cash. This arises if the maturity profiles of assets and liabilities do not match. The objective of ALM is to ensure that the bank is liquid enough to meet all its liabilities. The RBI is trying to ensure that the short-term liability should not be used to meet long-term assets. The RBI wanted to discourage banks from borrowing short and investing long. Some banks were borrowing from the call money market and investing in 90-days commercial papers. 17

Obviously, given that the total basket of assets and liabilities is made up of diverse interest-bearing securities any change in the interest rate scenario impact banks differentially. According to a study paper prepared by the Basle Committee on bank supervision, although this risk is a normal part of banking, excessive interest rate risk can pose a significant threat to a bank's earnings and capital base. Changes in interest rates also affect the underlying value of the bank's assets, liabilities and off balance sheet instruments because the present value of future cash flows changes when the interest rate structure changes.

Thus, an effective risk management processes require that bank

maintain their interest rate risk with in prudent levels, said the banks analysts.

HOW THE BANK MANAGES INTEREST RATE RISK THROUGH ASSET LIABILITY MANAGAENT Asset Liability Management (ALM) in banks is known as the process of adjusting the liabilities to meet the desired loan demands, liquidity needs and safety requirements.

A comprehensive ALM policy framework focuses on bank profitability and longterm viability by targeting a net interest margin (NIM) ratio subject to some balance sheet constrains. Significant among these constraints are maintaining credit quality, meeting liquidity needs and obtaining sufficient capital. Minimizing the burden also gets integrated to meet the overall bank objectives. A successful ALM requires a comprehensive deregulation of interest rates coupled with a market-driven asset-liability allocation and a favorable regulatory attitude. The latter, prerequisite has come in, but then coming in to operation of an active and well-developed secondary market for the bank liabilities and assets is still far from complete. 18

DIMENSION OF RISK MANAGEMENTS

On the myriad balance-sheet risks that bank face today credit and interest rate risks mostly accounts for their business risks. These and other risks expose a bank's business to certain potential losses. These losses are of three types viz., expected, unexpected and stress loss. The expected loss is always insurable by the myriad hedges and therefore, forms part of banks cost of operation. There is the unexpected loss under adverse conditions, which cannot be predicted. It is unexpected loss that is defined as value at risk (VAR). Then there is also a third type of loss the bank may be prepared to face under extreme conditions which occurs rarely but possibly. It is called as stress loss.

VALUE AT RISK

Value at risk technically is defined as the "loss amount, accumulated over a certain period that is not exceeding in more than a certain percentage of all time". VAR (99%, 1 week) is equal to the loss amount, accumulated over one week, which is not exceeding in more than one week, and which is not exceeding more than 1% of all lime. For measuring VAR one relics on a model of random changes in the price of underlying instrumentsinterest rate changes, changes in foreign exchange rates etc. and a model for computing sensitivity of derivatives price relative to the price of underlying instrument. In all these, one has to remember that a VAR measures is merely a benchmark for relative judgments, such as the risk of one portfolio relates to another, etc., even if accurate, comparison such

19

as these are specific to a time horizon and the confidence level with which VAR is chosen.

EARNING AT RISK

Earning at risk (EaR) models capture the period of profit or loss in terms of the realized profit or loss as per the cost method used currently. It consists of three components viz., funds profit or loss + redemption profit or loss + sales gain or loss.

EXPANDED VaR It measures Ear and adjusts it for movement in market valuation as part of the period profit or loss. It is equal to EaR + change in valuation gain or loss.

CAPITAL AT RISK Capital at risk (CaR) measures risk as transportation from VaR. it is a surrogate of VaR viewed from the angle of solvency of the bank. It is equivalent to the unexpected losses since expected losses are taken care of by way of provisions. So long as the expected plus unexpected losses stay with in the limits of confidence then the bank is said to stay solvent.

INTEREST RATE RISK MANAGEMENT THE CRUX OF ALM Market risk measures commodity, currency and interest rate risk as well. Commodity risk is almost non-existent today for many Indian bank's and currency risk is controlled through regulatory prescription there remains the interest rate risk (IRR) that largely 20

poses a problem to bank's interest income and hence profitability. It arises because bank's assets and liabilities generally have their interest rates reset at different times. Changes in interest rates can significantly alter a bank's net interest incomes (Nil) depending on the extent or mismatch between the times when asset and liability interest rates are reset. Changes in interest rates do also affect the market value of bank's equity. A method of managing IRR first requires a bank to specify goals for either the book value or the market value of Nil. In the former case, the focus will be on the current value of Nil and in the latter case; the focus is on the market value of equity. In either case the bank as to measure the risk exposure and formulate strategies to minimize or migrate the risk. The bank goals and strategies in doing so normally reflect the management's policy concurrence. The Gaps of interest rate sensitive may be identifying in the following time buckets: 1. 1-7 days 2. 8-14 days 3. 15-29 days 4. 1 month to 3 months 5. Over 3 months to 6 months 6. Over 6 months to 12 months 7. Over 1 year to 3 years 8. Over 3 years to 5 years 9. Above 5 years 10.

Non-sensitive.

Measurement of Liquidity Risk (maturity profile)

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All relatively non-sensitivity assets and liability items like intangibles, fixed assets, capital etc. are taken out and the rest are put in to time buckets according to their remaining maturity as opposed to original maturity. Table: Maturity profile (Rs in Crores)

Time bucket

Liabilities

Assets

3 months 6 months 9 months 1 year

260.00 600.00 500.00 1000.00

350.00 500.00 450.00 1200.00

This information affords comparison of assets and liabilities within each maturity range. The identified mismatch indicates the future needs for funds and help in planning future borrowings.

Liquidity always changes with reference to time. Therefore, a statement of potential funds lows during say the next month and the next month after that can provide the potential change in the liquidity position of a bank. It helps bank in deciphering which pattern of cash flow is dangerous, which is not and thus plan remedial action.

Measurement of Interest Rate Risks (GAP Analysis) The simplest technique for measuring banks interest rate risk exposure begin with a maturity/re-pricing schedule that distributes interest sensitive asset liability and

VARIOUS TYPE OF RISK INVOLVED IN THE BANKING SECTOR CREDIT RISK To address, the credit risk in the bank there is a committee called credit policy committee (CPC). Which is headed by GM with other top executives as members? They 22

address the issue pertaining to credit risk. Every year the committee will lay down the norms for lending policy, which contains several measures like prudential norms, sartorial deployment of funds, assessment of risk associated with the loan proposal by way of customer credit rating etc. for entire loan amount with the limit of over Rs 2 laces have been covered under credit audit, which helps to improve its quality of pre-sanction appraisal and post-sanction monitoring.

MARKET RISK If the income that is Nil or NIM is affected due to change in the interest rate/price in the market, such risk are called market risks.

KINDS OF MARKET RISKS • Interest Rate Risk • Currency or Forex Risk • Equity/Commodity Price Risk.

INTEREST RATE RISK The phased deregulation of interest rate and operational flexibility given to bank in pricing most of the assets and liabilities has been exposed bank to interest rate risk. Interest rate risk is the risk where changes in market interest rates might adversely affect a bank's financial condition. Changes in the interest rates might adversely affect both the current earnings (earning prospective) and also the net worth of the bank (economic value perspective). The risk from earning prospective is measured as change in the net interest income (Nil) or net interest margin (NIM). 23

CURRENCY OR FOREX RISKS This risk arises out of liabilities in one currency exceeding the level of assets in the same currency. Presently, banks re-free to set gap limits with RBI’s approval but are required to adopt value at risk approach to measure the risk associated with forward exposures. Thus the open position limits together with gap limits from the risk management approach to forex operations.

EQUITY PRICE/COMMODITY PRICE RISK

Equity price/commodity price risk arises owing lo changes in the prices of shares/commodities, where the investors or individual has invested.

EMBEDDED OPTION RISK

• Penalty for premature payment of both deposits. • Minimum lock in period etc. • Buying commitment charges on non/under utilization of limits.

ASSET-LIABILITY COMMITTEE (ALCO) The prime function of ALCO of the bank consisting of the bank's senior management including CEO should be to ensure adherence to : the limits set by the board as well as for

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deciding the business strategy of the bank in line with bank's budget and laid down risk management objectives. The CEO/CMD should head the committee. The chiefs of investment, credit funds Management/treasury, international banking and Economic Research can be member of the committee. 

ALCO reviews the status of liquidity and interest rate risk \is-a-sis tolerance limits.



ALCO articulates and decides pricing of products including PLR



ALCO examines/recommends funding options for long gestation infrastructure projects. Time buckets: In order to ascertain the risk associated with the bank's portfolio the

RBI advice all the bank's to distribute all the maturing assets and liabilities in to Time buckets ranging from 1-7 days, 7-14 days, and 14-29 days. 29- days to 3 months. 3 to 6 months, 6-12 months, 1-3 years, 3-5 years, and above 5 years and ascertain the risk in each time bucket and take steps to over come the risk Rate sensitive Assets and Liabilities: Any Asset/Liability gets reprised and get changed their value with a chance in interest/price i9n the market during the period of study they are called rate sensitive Asset and Liabilities.

NTI: Net Interest Income means difference between interest income and interest expenditure. NIM; Net Interest Margin means Nil divided by Earning Assets of the Bank Earning Assets: Any Asset, which is affected due to changes in market value, they are called Earning Assets. NON-BARN ING Assets are nothing but those Assets,

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Which do not get affected due to change in the interest rate or price e.g. NPA's, cash on hand etc,

MANAGEMENT-DEPTH AND QUALITY In evaluating management, the intention is to assess the depth, quality, and operating style to" the organization. In particular, it is important to gauge the level of risk that management is willing to assume, its understanding of issues that are affecting its activities, and the balance it strikes between business development and risk management. Obviously, a full assessment of these issues can only be achieved over a lengthy period of lime after having had the opportunity of contract with all level of the organization.

The RBI expects bank to take a view on future interest rate movements. That is, project for themselves have interest rates, will move in the future-over both short OBS position in to a certain number of pre-determined time bands according to their maturity. These schedules can be used to generate simple indicators of the interest rate risk sensitivity of both earnings and economic value to changing interest rates. This gap analysis i.e. the size of the gap for a given time band gives an indication of the banks repricing risk exposure. The interest rate sensitive assets minus interest rate sensitive liabilities in each time band can be multiplied by an assumed change in interest rate to yield an approximation of change in net interest income that is likely to result from such interest rate movements.

Mathematically, rate sensitive gaps (RSG) is defined as ratio of rate sensitive assets (RSA) to rate sensitive liability (RSL) occurring during a particular maturity period. A 26

negative or liability sensitive gap occurs when liabilities exceeds assets in a given time band. It means as increase in market interest rates could cause a decline in net interest income. Conversely, a positive or asset sensitive gap implies that banks net interest income could decline as a result of a decrease in the level of interest rates.

GAP=RSAs-RSLs When interest rates change the bank's nil changes based on the following Interrelationships:

Changes in NIIRSAs changes in average interest rate on RSAs = (Delta rl)-RSLs change in average interest rate paid on RSLs = (Delta r2) (1) Delta NII=RSAs Delta RSLs Delta r2 (2) For simplicity, assume for a while that Delta rl-Delta r2 = Delta r. that is both the Average interest paid on liabilities change to the same extent, though not always true in reality. The (2) becomes Delta NI1= (RSAs-RSLs) Delta r Delta NIIKJAP Delta r (3) It is evident that not only changes in the market interest rates, but also changes in the relationship between the bank asset and liability costs and in the composition of the volumes of outstanding and incremental assets and liability affect NIL the actual change in the direction and amount anticipated by them. The Gap relationship suggests that a bank that either can or does not choose to speculation on future interest rates can only reduce IRR by targeting a zero Gap.

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MORE ADORABLE BUT LESS APPLICABLE DURATION GAP

All those bank assets and liabilities that are Interest insensitive from cash-How standpoint also experiences large fluctuation in value due to movements in interest rates. Even if the Gap is zero, the bank may still be subject to substantial IRR. However, with the duration GAP (DGAP) approach, it is possible to offset the undesirable effects of funding GAP by a carefully orchestrated position in non-rate sensitive assets and liabilities. DGAP recognizes that IRR arise when timing of cash inflows and outflows differs even if the assets and liabilities are categorized as rate intensive as per the conventional GAP technique. Interest rate risk is measured in DGAP by a comparison of the weighted duration of liabilities. The funding GAP technique matches cash flow by structuring the short-term maturity buckets. On the other hand, the DGAP hedges against IRR by structuring the portfolios of assets and liabilities to change equally in value whenever interest rates change. The timing and magnitude of aggregate cash flow on assets and liabilities are matched in such a way that the market value of equity remains unchanged in a perfect hedge. Duration is defined as average life of financial instrument. It equals the average time necessary to recover the initial cost. It also provides an approximate measure of market value interest elastically. The DGAP is computed as the difference between the composite duration of bank assets and a marked down composite duration of its liabilities. DGAP = DA-KDL (7) K= %of assets funded by liability.

Thus, a bank can immunize the market value of its equity by setting DGAP=0. 28

However, in reality if a bank wants to perfectly hedge value, it has to set its asset duration slightly less than its liability duration to maintain positive equity. For DGAP to equal zero

(DA/DL) should equal which

is,

less

than

one.

One

can approximately

estimate the expected change in the market value of a bank for given change in the interest rates. Change in Market Value of Equity/Total Assets = DGAP Approximate change in interest rate (8)

From this it is clear that if DGAP is close to zero then the market value of bank equity will not change and accordingly become immunized for any changes in the interest rates.

The DGAP measure has several merits. It is more scientific, more realistic but more sophisticated and complex in approach. A basic precondition for the use of this tool as a hedge mechanism is that all the assets and liabilities of banks have to position as marked to market. Therefore, at the present junction, the DGAP tool exists more for adoring its scientific merits than for its applicability in its immunization of a bank's balance sheet. Basic Duration formula (Macaulay) D= (C(I+Y) + C*2/(l+Y)2 +(C+P)N/(1+Y)N/Price Where C = Periodic Coupon. Y = Yield (YTM) P = Principal Amount N = total number of years.

CAN FUNDING GAP IMMUNIZ EQUITY? 29

Very simple assumption is required to habilitate the conventional gap from bank equity immunization. One is that the bank adopts a constant dividend rate policy and the other is that almost all the net income of the bank is Nil. Now the strong assumption is that if the banks have more or less the same Nil for at least more than one year, then the equity of a bank can be written as the present value of its future dividend payments. C-(d*NII)/r

(9)

Where c = capital (equity) of the bank. By simple calculus and substitution one can arrive at Change in C - (d * GAP - c)/ (change in r/r) Delta c - (d * GAP - c)/ (Delta r/r)

(10)

Now for Delta C - 0 which is equivalent to immunizing market value of equity from fluctuation, what is required as a strategy is to maintain. GAP = (C/D)

(11)

The implications of (11) are several. If it requires for the bank to maintain a positive gap for immunization equity, simultaneously the bank cannot keep its Nil and NIM unchanged. But in an environment of decline interests rates, the bank have to scarifies some Nil and hence NIM for the sake of immunizing its equity. Looking at it from another angle, for GAP to be zero, the bank equity has to fluctuate whenever interest rates changes as per the following relationship. Change in C = - (change in r/r) * C Delta C (GAP - 0) = - (Delta r/r) * C

(12)

It is obvious from (12), when GAP = 0, decline in interest rates causes "C" to increase and vice-a-versa.

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SIMULATION TECHNIQUE

Simulation technique simply involves a detailed break down of various categories of balance sheet position and assigns specific interest rate for each position and then working out the cash in/out flows. Such simulation strategies could be either static or dynamic. In static stimulation, cash flows arising from the banks current balance sheet position are as it is assessed based on one or more assumed interest rate scenarios. By discounting the resulting cash flows, over the entire expected lines of the banks holding, an estimate of the change in the economic value of the bank can be worked out.

In a dynamic simulation approach, the simulation builds in more detailed assumptions about the future course of interest rates and the expected change in a banks business activity over that time. Such simulation studies afford dynamic interaction of payment stream with interest rates and capture the effect of imbedded or explicit option

31

CHAPTER-III COMPANY PROFILE

32

ABOUT THE BANK Canara Bank was founded by “Shri Ammembal Subba Rao Pai”, a great visionary and philanthropist, in July 1906, at a small port in Mangalore, Karnataka. The Bank has undergone various phases in its growth path over hundred years of its existence. The growth of Canara Bank was phenomenal, especially after nationalization in the year 1969, attaining the status of a national level player in terms of geographical reach and clientele segments. Eighties was characterized by business diversification for the Bank. In June 2006, the Bank completed a century of operation in the Indian banking industry. The eventful journey of the Bank was strewn with many memorable milestones. Today, Canara Bank occupies a premier position in the comity of Indian banks, emerging as the largest nationalized bank in India in terms of aggregate business volume for 2006-07. With an unbroken record of profits since its inception, Canara Bank has several firsts to its credit. Over the years, the Bank has been scaling up its market position to emerge as a major 'Financial Conglomerate' with as many as nine subsidiaries/sponsored institutions/joint ventures in India and abroad. As at December 2007, the Bank has further expanded its domestic presence, with 2641 branches spread across all geographical segments. In view of the centrality of customer convenience, the Bank provides a wide 33

array of alternative delivery channels that include over 1900 ATMs- covering 680 centers, 1157 branches providing Internet and Mobile Banking (IMB) services and 1833 branches offering 'Anywhere Banking' services. Under advanced payment and settlement system, 1693 branches of the Bank offer Real Time Gross Settlement (RTGS) and National Electronic funds Transfer (NEFT). Canara Bank has made a distinctive mark in various corporate social responsibilities, namely, serving national priorities, promoting rural development, enhancing rural self-employment through several training institutes, spearheading financial inclusion objective etc. Promoting an inclusive growth strategy, which forms the basic plank of national policy agenda today, is in fact deeply rooted in the Bank's founding principles. "A good bank is not only the financial heart of the community, but also one with an obligation of helping in every possible manner to improve the economic conditions of the common people". These insightful words of our founder continue to resonate

even

today

in

serving

the

society

with

a

purpose.

The growth story of Canara Bank in its first century was due, among others, to the continued patronage of its valued customers, stakeholders, committed staff and uncanny leadership ability demonstrated by its leaders at the helm of affairs. We strongly believe that the next century is going to be equally rewarding and eventful not only in service of the nation but also in helping the Bank emerge as a "Global Bank with Best Practices". This justifiable belief is founded on strong fundamentals, customer centricity, enlightened leadership and a family like work culture.

Significant Milestones Canara Hindu Permanent Fund Ltd. formally registered with a capital of 2000 1st July 1906 shares of Rs.50/- each, with 4 employees. 1910 Canara Hindu Permanent Fund renamed as Canara Bank Limited 1969 1976 1983 1984 1985 1987 1989 1989-90

14 major banks in the country, including Canara Bank, nationalized on July 19 1000th branch inaugurated Overseas branch at London inaugurated Can card (the Bank’s credit card) launched Merger with the Laksmi Commercial Bank Limited Commissioning of Indo Hong Kong International Finance Limited Canbank Mutual Fund & Can fin Homes, launched Canbank Venture Capital Fund started Canbank Factors Limited, the factoring subsidiary launched 34

1992-93 1995-96 2001-02 2002-03 2003-04 2004-05 2005-06

2006-07

Became the first Bank to articulate and adopt the directive principles of “Good Banking”. Became the first Bank to be conferred with ISO 9002 certification for one of its branches in Bangalore Opened a 'Mahila Banking Branch', first of its kind at Bangalore, for catering exclusively to the financial requirements of women clientele. Maiden IPO of the Bank Launched Internet & Mobile Banking Services 100% Branch computerization Entered 100th Year in Banking Service Launched Core Banking Solution in select branches Number One Position in Aggregate Business among Nationalized Banks Notched up the highest ever net profit since its inception Retained Number One Position in Aggregate Business among Nationalized Banks Singed MoUs for Commissioning Two JVs in Insurance and Asset Management with international majors.

As at march 2007 the total business of the bank was over Rs.2, 40,000 crores

ORGANISATION STRUCTURE

35

BALANCE SHEET

36

37

CHAPTER –IV DATA ANALYSIS AND INTERPRETATION

DATA ANALYSIS Outflows

CANARA BANK Statement of Structural Liquidity 31st March 2013-14 Rs. in crores

38

Over 3

15 to 28 1 to 14 'days days'

1 2 3

4

7

8 '

Over 3 Over years and years upto5 years

5

Total

Capital

1725

17.25

Reserves 8 Surplus

1 748 40

1746 AC

Deposits Current Deposits i. Savings Bank Deposits iji.~Term Deposits iv. Certificate Of Deoosils Borrowings i. From SBI/ other bank ii. Inter-Bank (Term) iii. Refinances IV, ATM Withdraw! A/C

5

29days and .Over 6 . Oyer.1 months months and Year and upto and upto upto 1 year 3 years 3months 6months

Other Liabilities and Provisions i Biils Payable ii . Inter-Office Adjustments iii. Provisions iv. Others > Lines of Credit Committed to j Institutions 11. Customers Unavailed portion of CC/ODffJUWCUL InygcatJon/Devolvements in LC/BG Repos

478.21 760.86 45465

20.45 0.00 0.30 46.25

43925

1334.20

1262.47

45OS6

1753.42

3935 06

1-102.15

19611 03

1308.68

5-134.73

1892 78

4415.41

2257.05

586.30

8511.31

1 3390 96

0.00

00.00

000

0.00

000

20.45 0.00

0.00

235

1 15

1 40

054

0.25

0.08

6.47

0.00

000

000

000

000

0.00

0.00

4625

1202 86

232.15

1485.01

0.00 0.00

59.22

118 10

4684

9351

000

187.50

0.O0 507.17

5.16

0.00

000

000

12500

18604

45 63

430 O0

18685

124.56

1401

324

2330

4.92

5.68

0.95

0.03

0.01

53 15

508.92

14.01

1029.5C

57356

1069.23

O.OC

0.00

000

321 4 2.1

810

449

16.90

21.81

39.25

64.4 2

2299

17 13

197 10

Misc. items Total Outflows

2904.07

653.05

2532.02

2549.32

6096.09

6 4 09 .3 7

3249.69

372.63 13962.04

372.53 38518.57

Cumulallva Outflows

290407

3557.12

614914

8 7 98. 46

14894. 55

2130 3.93

24553. 83

33515.57

-

2.00 68.17

260 O0

260.00 498.27

809 64

Bills Rediscourited (DUPN) 11

12

Swaps (Buy'Se Ill/maturing forwards interest Provisions

13

Demand Deposit Int Provision A/c Term Deposit Int Provision A/c Others (Specifv)

36.97

36.97

Table.1

CANARA BANK 31st March 2014 Statement of Structural liquidity

39

Rs. in Crores

29 and upto 3 Over6 Over 3 months year 1to 14 15 to months INFLOWS and days 28 days and upto upto 1 6 months Year

1 2

Cash Balances with other RBI

3

4

5

6

7

Over3 year and upto 5

Over 3 Over 5 years years and upto 5 years

72.85

72. 85 0.00

O.O0

26690

207.99

416.26 238.60 0.06

90 04

48.08 1317.66 100.97

Balances with Other Banks i. Current Account 100.31 ii. Money al call and short notice. iii.Term deposit and other Investments (including those under Repos but excluding Advances (Performing) i Bills including bills under (DUPIN) ii. Cash Credits Overdrafts and Loans iii Term Loans

77500

200.00 35500

3577

75.82

52534

26913

4434

308.5 1

1330.00

500.46

30656

31. 58 0 18

636.27

1726 99

2278. 38

53 50

064

025

1 73

84

1452872 676.45

286523 1779.4 150.03 5434.99 6

141449 347.20 245.50 425.64

432.24 1524 24

1359.7 2451.5 8404.87 5 1

NPAs [Advances & In vestments] Advance

2053

7479

Investments

0.75

29.93

fixed Assess 40

95.32

30. 6 2 172.26 172.26

8

Other Assets i. Inter adjustments ii Others

9

office 404. 56 82.00 000

Reverse Repos; 10 Swaps (sell/buy) 534.00 14.34

11 Bills Rediscounted (DUPN) 12 Interest Receivable 13 Lines of Credit Committed to Institutions Custom BIS

0.00

12.84

28.32

10624

1153.98 735.18

5173

2.25

133239 0.00

o.oo

o.oo

000

443.76 30.91

404.65 706.82

0.00 0.00

3770.42

0.00 0.00

51.73

14 Others (Specify) Unvaried Export 29.47 Refinance Devolvement / Invocations Overdue installments Accrued Interest 6707 on Investments Unavailed Portion of Misc. items TOTAL INFLOWS

29.47

76 SO

133.7

40.59

4.92

43.06

131.24

67.65

402

435.99

373.70

5.65

0.95

004

52.18 174.29

0.00

0.00 0.00

351 .31 809.69

0.00

4445.1 1452.3 3054.67 2519.45 3109.2 6577.6 5973.6 11384. 38515.5 6 0 5 8 7 19 7

Cumulative Inflows 4445.1 5397.4 6 6

89 11471.57 14579. 21157.5 27131. 38515. 52. 82 0 38 57 T

Table.2

41

CANARA BANK Statement of structural liquidity 31st March 2014

Summary Of Liquidity Statement

1 to 14 15 to 28 days days

29days Over 3 Over 6 Over 1 year Over3 and and upto 3 months and months and and upto 3 years upto 5 years Over months upto 6 upto 1 year years

( LIABILITIES ) ( ASSETS)}

D. Cumulative Outflows E Cumulative Mows F Cumulative Mismatch

5 Total

year

months

A. TOTAL OUTFLOWS B. TOTAL INFLOWS C. MISMATCH (B- A)

Rs. in Crores

2904.07 653.05 4445. 1 6 1541.09 799.25

2592.02 2649.32 3054.67 2519.45 462.64 -129.88

609609 6409.37 3108.25 -2987.84 168.31

3249.60 38515.57 5973.87 11384.1 38515.57 2724.27 38515.57 0.00 .... 0.00

2904.07 4445.16 1541.09

6149.14 8798.46 14894.55 21303.93 24553.53 385 15. 0.00 8952.13 11471.57 14579.82 21157.50 27131.38 38515.5 0.00 2673.11 -314.73 -146.42 2577.85 0.00 0.00

PRUDENTIAL LIMITS : Individual Bucket

G Cum-mismatch as % to cum-inflows Of Respective 34.67 Bucket

39.68

31.31

23.30

H As per RBI stipulation-in First Two buckets the 53.07 Negative Gap as % to Outflows of respective Bucket (A) should not be > 20%

122.39

17.85

-4.90

-2.16 -0.69 -49.00 2.63

PRUDENTIAL LIMITS : Cumulative Mismatch

I Cumulative Mismatch upto 1 year as a % of Working Funds it should not be more than ( -2)% -0.90

ADDITIONAL INFORMATION 1

:

SPECIAL

RATE

DEPOSITS

5555.45 5555.45

2

TOTAL WORKING FUNDS IN CRORES

The totals of constituent Items may not tally due lo rounding off

INCRORES

34922.2 9

1

Chief Manager (ALM ) 42

9.50 O.O0 83.83 -18.48

0.00

CANARA BANK ANALYSIS OF ALM STATEMENTS STATUTORY LIQUIDITY RISK STATEMENT:

Maturity pattern of Assets and Liabilities as on 31s1 March 2014.

Short Term (upto 6 months) Medium Term (6 months to 5 years) Long Term (Above 5 years) Total

8798,46 15755.06 13962.04 38515.57

Rs in Crores 11471.57 15659,80 11384.19 38515,57

+2673.11 - 95.26 - 2577.85

1. Liquidity Risk:

Liquidity Risk is being identified, measured and controlled through. The Traditional Gap Analysis at fortnightly intervals The Ratio Analysis at monthly intervals The Contingency Funding plan at quarterly intervals

The Traditional Can Analysis as on 31 -03-2014: The gap is the difference between outflows and inflows. To identify, measure and control liquidity risk of the Bank. RBI have stipulated the Following benchmark for the first two lime buckets:

43

Mismatch (Negative Gap) may not exceed 20% of cash outflows in each of the

Our Position: As on 31st Bucket March 2014 2"d Bucket

(31-03-2014 to 14-04-2014) 53.07

As on 18 February 2014

1st Bucket

(15-04-2014 to 28-04-2014)12239

(18-02-2014to

2nd Bucket (04-03-2014to

03-03-2014) 32.78 7-03-2014) 66.74

INTERPRETATION: From the above, we can observe that the gaps are within the prudential limits prescribed by RBI in the first two time buckets Remarks:

1.

The positive gap (32.78%) in the first bucket as on 18-02-2014 has increased to 53.07% as on 31-03-2014, due to more inflows in Term Loans.

2.

The positive gap (66.74%) in the second bucket as on 18-02-2014 has increased to 122.39% as on 31-03-2014 mainly due to increase in inflows on account of Term Money and other Investments maturing in this bucket.

44

RBI, have not prescribed any other benchmarks for mismatches other than the first two time buckets. They have, however, left it to the individual banks to establish prudential gap limits for other buckets based on their risk appetite and risk return profile. Accordingly, the Bank's Board at their meeting held on 16-01-2014 has approved the following prudential limits.

BUCKET

1-14 Days

15-28 Days

Inflows

4445.16 1452.30

Outflows Mismatch Cumulative Inflows Cumulative Outflows Cumulative Mismatches CumMismatches as % to Cuminflows

29(14.07 1541.09

29 days to 3 to 6 6 to 12 3 Months Months Months 2519.45 3054.67 3108.25

1year to 3 Years 6577.68

2649.32 653.05 799.25

2592.02 462.64

-129.88

6096.09 2987.84

14579.72 21157.50

4445.16 5897.46

8952.13

11471. 7

2904.07 3557.12

6149.14

8798.4 6 14894.55

1541.09 2340.34

2802.99

34.67% (22.97)

31.31% (16.23)

39.68% (26.75)

2673. 1 1 23.30% (19.55)

-314.73 -2.16% (2.41)

6409.37 168.31

3 to 5 Years

Over 5 Years

5973.87

11384.19

3249.60

13962.04

2724.27 i 27131.38

-2577.85 i 38515.57

21303.93 24553.53 38515.57 -146.42 -0.69% (0,12)

2577.85 0 I 9.50% 0% (0) (5.71)

Table.3

I.

The Cumulative Mismatch (Cumulative Negative Gap) should not be more than 25%

of Cumulative Inflows of the respective time buckets up to 1-year time bucket and should not be more than 35% of cumulative inflows of respective time buckets from above I -year time bucket.

45

Our Position: -Figures in brackets pertain to Februar2014: (i). From the above, it can be observed that the mismatches were within the prudential norms across all the time buckets. (ii). The core portion of Current Account, Savings Bank, Cash Credit, Agricultural Cash Credit, Demand Loan, Jewellery Loan, Overdraft and Working Capital demand Loans has been classified into various time buckets over more than one-year time based on the behavioral study carried out by us. (iii). Cumulative mismatch (Negative Gap) in '6 months to 1 year' time Bucket should not be more than (-) 2% of the working funds: Our position:

As on. 31-03-2014 -0.90%

As on..18-02-2014 +1.13%



The cumulative mismatch in "6 months to 1 year" time bucket: Rs. -314.73 cr.



Total Assets/Working funds of the Bank: Rs. 34922.29 cr. The cumulative mismatch (Negative Gap) in the '6 months to one year' time bucket

was well within the stipulated norm.

46

RATIO ANALYSIS RBI has not prescribed any threshold limits for liquidity measurement through ratio analysis but our ALM policy has prescribed various threshold limits for liquidity measurement .through ratio analysis. The detailed analysis of various ratios and their movement over the last month is furnished in Armexure -II. The ratio analysis indicates that, the following ratios were below/above the benchmark:

Below as on 18-02-2014 as on 31-03-2014 1. Liquid Assets /Total Assets (15-20%)

12.62%

11.26%

2. Liquid Assets / Deposits (20-25%)

16.09%

13.29%

3. Loans / Core Deposits (55-60%)

61.78%

67.23%

4. Special Rate Deposits / Total Deposits (