The Reserve Bank of India (RBI) has laid down stringent guidelines for asset-liability management by commercial banks.
The guidelines, issued on September 10, prescribe norms on tolerance levels for asset-liability mismatches, fixing short-term liquidity profiles and measuring them on a continuous basis.
The RBI has asked banks to introduce the asset-liability management guidelines "positively" from April 1, 1999. The guidelines mainly address liquidity and interest rate risk.
According to the RBI, banks will have to take a view on interest rate movements and fix prudential limits on the gap or mismatch. A gap would be measured by calculating gaps over different time intervals at a given date, and would indicate mismatches between rate-sensitive liabilities and rate-sensitive assets.
The RBI has described the scope of asset-liability management as management of liquidity risk, market risk (including interest rate risk) and trading risk; funding and capital planning; profit planning and growth projections.
The RBI circular states that the board of a bank should sanction a higher temporary tolerance level for mismatches if the banks' asset-liability profile deem it necessary. The tolerance level will be restored once the bank restructures its asset-liability profile.
Banks with a large branch network can have a larger tolerance level for mismatches provided they have a high term deposits.
The circular requires banks to measure their liquidity positions regularly and examine options to meet liquidity requirement in the event of a crisis.
"At times, assets commonly considered liquid like government securities and other money market instruments can become illiquid if the market is unidirectional," said the circular.
The circular advocates using maturity profile to measure future cash flows of banks in different times buckets. Given the statutory reserve cycle of 14 days, the time buckets may be distributed as 1-14 days, 15-28 days, 29 days-3 months, 3-6 months, 6-12 months, 1-2 years, 2-5 years and over five years.
To enable banks to monitor their short-term liquidity (during 1-90 days) on a dynamic basis, banks will have to estimate their short-term liquidity profiles on the basis of business projections and other commitments.
According to the RBI, the asset-liability gap report should be generated by grouping rate-sensitive liabilities, assets and off-balance sheet positions into time buckets, based on the residual maturity or next reprising period, whichever is earlier.
The gap report would indicate whether the bank can benefit from moving interest rates.
The RBI feels banks should focus on short-term mismatches, especially 1-14 days and 15-28 days. The asset-liability mismatch should not exceed 20 per cent of the cash outflow during the two buckets, it adds. According to the RBI, the simplest way of avoiding currency risk is to bring down the asset-liabilty mismatch to zero.
Changes in interest rates affects the current earnings and net worth of a bank. The risk from the earnings perspective can be measured through changes in the net interest income or net interest margin. In this regard, the RBI prefers modern techniques of interest rate risk measurement like Duration Gap Analysis, Simulation and Value at Risk.
