Training Programme on Asset Liability Management An Impact Evaluation Study. Samir R Samantara U D Shirsalkar Niraj K Verma

Training Programme on Asset Liability Management An Impact Evaluation Study Samir R Samantara U D Shirsalkar Niraj K Verma

CONTENTS Particulars Page No. FOREWORD I ACKNOWLEDGEMENTS LIST OF TABLES LIST OF FIGURES LIST OF APPENDIX LIST OF ABBREVIATIONS EXECUTIVE SUMMARY II III IV V VI VII I INTRODUCTION 1 II OBJECTIVE, SAMPLE DESIGN AND METHODOLOGY 4 III RESULTS AND DISCUSSION 8 IV CONCLUSION AND POLICY PRESCRIPTION 23 REFERENCES 25 APPENDIX 26

FOREWORD The development of the banking system is always associated with the contemporary changes in the economy. The Indian banking industry particularly Regional Rural Banks has undergone a metamorphosis in the last two decades due to changes in the political, economic, financial, social, legal and technological environments. The significant advances in technology and deregulation of financial markets across the countries created new opportunities, encouraging banks to enter every business that had been thrown open. The banks are now moving towards universal banking concepts, while adding new channels and a series of innovative product offerings catering to various segments at an attractive price. This makes it imperative for the banks to adopt sophisticated risk management techniques and to establish a link between risk exposures and capital. Effective management of risk has always been the focus area for banks owing to the increasing sophistication in the product range and services and the complex channels that deliver them. The challenge for the banks is to put in place a risk control system that minimizes the volatility in profit and engenders risk consciousness across the rank and file of the organization. Sound risk management will ensure a healthy bottom line for the bank as risk taken by the bank will be commensurate with return and will be within an approved risk management policy. As all transactions of the banks revolve around raising and deploying the funds, Asset-Liability Management (ALM) gains more significance as an initiative towards the risk management practices by the Indian banks. The introduction of ALM in RRBs with a focus on a continuous rearrangement of assets and liabilities of the balance sheet so as to maintain the profit, minimise interest rate risk and provide adequate liquidity is a step in this direction to address the challenge. In order to assess the impact of ALM training programme for RRBs conducted during last 2-3 years, it was felt by BIRD to conduct a study. BIRD conducted a study covering 16 RRBs, 36 officers trained by BIRD in 10 States. The study brings out the fact that implementation of ALM in RRBs in the form of constitution of ALCO, periodicity of ALCO meeting and number of items in the agenda and tools of ALM was in a sub-optimal stage. A few policy pointers on redesigning the ALM training module in the form of suggestions/feedbacks from trainee officers of RRBs included latest ALM tools & techniques (Duration Gap Analysis, Simulation and Value at Risk (VaR), use of software package(cloret,ascrom,alman, FINACLE, etc), sessions by professionals handling ALM desk and capacity building of support staffs. The study has further suggested that there is a need to adopt ALM as a critical exercise of balancing the risk profile due to financial intermediation with the long/short term profits as well as its long-run sustenance. I am sure that the study findings will be useful to bankers, academicians, policy makers and other stake-holders in initiating follow-up actions. Shri K K Gupta Director BIRD, Lucknow 21.10.2014 I

ACKNOWLEDGEMENTS The study team sincerely records its obligation to Shri Sunil Chawla, Joint Director BIRD, Lucknow, for his continuous encouragement and suggestions and guidance in various fora, which helped the study team to enrich the contents of the report. The study team gratefully acknowledges the guidance and the valuable inputs provided by all the Faculty Members of Finance group, BIRD, Lucknow. The study team also makes special mention of the Top management teams of three RRBs Viz, Aryavat Gramin Bank, Baroda Rajasthan Gramin Bank and Bihar Gramin Bank for their useful suggestions and comments. The study team is grateful to team of officers from sixteen Regional Rural Banks, for required inputs (feedbacks through questionnaire) and insights offered in consolidating the report. However, the opinions expressed in the study report, are that of the Study Team and not necessarily reflect those of BIRD. The contents can be reproduced with proper acknowledgement. The write-up is based on information & data procured from various sources and no responsibility is accepted for the accuracy of facts and figures. BIRD or the Study Team assumes no liability, if any, person or entity relies on views, opinions or facts & figures finding place in this Report. Study team: Shri/s Samir R Samantara, U. D.Shirsalkar and N.K.Verma Deputy General Managers/Faculty Members, BIRD, Lucknow II

LIST OF TABLES Table II.1 : Sample Frame RRB Banks and Trainees Table III.1: RRB Trainees/participants having understanding about various type of risk Table III.2: Knowing financial market instruments Table III.3: ALM Concept Table III.4: Usefulness of ALM Training Table III.5: ALM Desk Table III.6: ALM Desk - sharing of inputs Table III.7: ALM training effectiveness for participants Table III.8: ALM Policy Table III.9: ALM Policy Formulation Table III.10: ALM training effectiveness for banks Table III.11: ALM types of tools Table III.12: ALM - Mitigation of liquidity risk Table III.13: ALM training Impact on profitability Table III.14: ALM training Improvement in financial position of banks Table III.15: ALM training Suggestion for improvement Table III.16: Statistical results of step-wise regression model sample RRBs Table III.16: Statistical results of regression model having dummy variables RRBs received ALM training inputs by BIRD III

LIST OF FIGURES Figure III.1: RRB Trainees/participants having understanding about various type of risk Figure III.2: Knowing financial market instruments Figure III.3: ALM Concept Figure III.4: Usefulness of ALM Training Figure III.5: ALM Desk Figure III.6: ALM Desk - sharing of inputs Figure III.7: ALM training effectiveness for participants Figure III.8: ALM Policy Figure III.9: ALM Policy Formulation Figure III.10: ALM training effectiveness for banks Figure III.11: ALM types of tools Figure III.12: ALM - Mitigation of liquidity risk Figure III.13: ALM training Impact on profitability Figure III.14: ALM training Improvement in financial position of banks Figure III.15: ALM training Suggestion for improvement IV

LIST OF APPENDIX Appendix I DETAILS OF THE DATA EXTRACTION AND COVERAGE Appendix II ALM SYSTEM - A FORMALIZED FRAMEWORK FOR MANAGEMENT OF MARKET RISKS Appendix III CORRELATION MATRIX & STEP-WISE REGRESSION RESULTS Appendix IV QUESTIONNAIRE Appendix V KEY FINANCIAL RATIOS OF SAMPLE RRBS (BANK-WISE) V

ABBREVIATIONS ALCO Asset Liability Management Committee ALM Asset Liability Management ANOVA Analysis of Variance ASCROM Asset Classification & Credit Monitoring BIRD Bankers Institute of Rural Development FIMMDA Fixed Income Money Market and Derivatives Association of India NIM Net Interest Margin NSE National Stock Exchange of India Ltd. OTCEI Over-The-Counter Exchange of India RRB Regional Rural Banks SEBI Securities and Exchange Board of India VaR Value at Risk VI

Executive Summary Asset Liability Management Policy aims to lay down the ALM structure, define the role of identified individuals or committees and the top management, measure and manage the asset liability related risks facing the bank by setting down various risk limits and lay down the MIS process to keep the various levels of management including the top management informed to enable them take appropriate decision in a timely manner. The assets and liabilities of the bank have to be managed to maximize profitability and enhance capital thereby increasing shareholders value and also to protect the organization from financial stress arising out of adverse movement in market rates and thereby continue to serve the customers and community more effectively. The major objective of the study was to assess the impact of ALM Programmes conducted by BIRD for Regional Rural Banks. The specific Terms of Reference (ToR) of the study were to critically review the progress of ALM policy formulation with focus on bottlenecks/constraints in the implementation of the ALM and to estimate the effectiveness of liquidity & interest risk management and pricing of loan product. During the study a survey was conducted to find out the training effectiveness. Questionnaire was used to collect data/feedback/input from respondents. Respondents were officials of RRBs. From the study it was found that in all respects the training programs were successful and for majority of the respondents the training program met their needs and expectations. Some suggestions like incorporation of latest ALM tools and techniques in the training modules and designing the training programme keeping in view the jobs assigned or to be assigned merit consideration. Major findings/observation from the study are as under : (i) The respondents were able to understand various types of risks like Liquidity Risk(94%), Interest Rate Risk(91%), Credit Risk(88%) and Operational Risk (77%) after attending the ALM programme. (ii) 83% of the respondents came to know about the financial market instruments and terms like SEBI, OTCEI, NSE, FIMMDA etc., after attending the programme. Remaining officers knew about these terms even before attending the programme. 56% of the respondents had knowledge/experience in ALM before the training indicating strong entry level behavior. (iii) Majority of the respondents had indicated that the course material provided during the training was useful. 22 % of the respondents have not been posted in ALM desk despite receiving training. Further, 8% of the respondents felt that there was no scope for use of knowledge gained during the training in their day-to-day functioning. (iv) Majority of the respondents indicated that their banks have formulated ALM policy approved by Board. Further,78% of the respondents indicated that training programme at BIRD helped in formulation/refinement of the policy in their bank. VII

(v) In percentage terms, officials from RRBs indicated that training programme at BIRD helped in constitution of ALCO(16.7 %), in finalizing agenda items for ALCO(77.8 %), in understanding interest rate movements & expected spreads(86.1 %), mismatches in maturity pattern(75 %), pricing of loan products/ risk mitigating measures for liquidity & interest rate risks(91.7 %), operational issues & difficulties associated in implementation of the ALM(88.9 %), discussions on investment portfolio(83.3%). Further, majority of the respondents agreed that training programme at BIRD helped in areas for further improvement. (vi) Majority of the respondents indicated that training programme at BIRD helped in using some of the ALM tools. To be specific, 83.3 % of the respondents indicated that training programme at BIRD helped in understanding impact of interest rate movement on Net Interest Margin (NIM) and gap statement to measure Interest Rate Risk(77.8 %). (vii) As regards mitigation of liquidity risk, 94.4 % of the respondents mentioned that their banks are putting assets and liabilities in different time buckets, 52.8 % responded affirmatively on preparing Structural Liquidity statement, 61.1 % on preparing Dynamic Liquidity statement and 47.2 % on preparing both Dynamic Liquidity statement and Structural Liquidity statement. Only 5.6 % of the respondents indicated that they are preparing neither Dynamic Liquidity statement nor Structural Liquidity statement. (vii) 78 % of the respondents indicated that the profitability of the bank has improved after implementation of ALM concept in the bank. In terms of percentage contribution in improving financial position of the bank, they have ranked Dynamic Liquidity Ladder (94.4 %), Gap Statement to measure interest rate risk (80.6 %) and Duration concept (25 %). (viii) As regards suggestions to bring about improvement in the training programme on ALM conducted by BIRD, 83.3 % of the respondents indicated that the programme does not need any changes and may continue to be conducted in the present format. However, 11.1% felt that the contents of the programme were inadequate and needed to be up-graded, while remaining respondents could not comment on the issue as they were not presently working on the ALM desk (5.6 %). (ix) Mean Net Interest Margin (NIM) of the two categories (RRB officers who attended ALM training conducted by BIRD and those who did not attend is different. If all other variables are held constant, it may be partially concluded that there is a significant difference in the NIM level of the two categories (sample RRB - 0.96 and other RRBs 0.91). Further, one percentage increase in number of ALM training programme for RRBs may lead to percentage increase in NIM by 13 basis points (0.13). (x) Relevant items in the agenda of ALCO - NAI 1 (0.4329) as a whole influenced significantly the Net Interest Margin compared to other variables, i.e. ALM Policy & Constitution of ALCO (0.1339) and Periodicity of meeting (0.2142) clearly indicating the importance of interest rate sensitivity on NIM variability, structural/dynamic liquid statement, duration analysis as an agenda items in ALCO meeting. 1 NAI Number of Relevant Items in Agenda. VIII

Conclusion and Policy Issues Asset Liability Management is a risk management technique and an on-going process of formulating, implementing, monitoring, and revising strategies related to assets and liabilities in an attempt to achieve financial objectives for a given set of risk tolerances and constraints. Thus a general perspective of ALM as per study team may be laid out as - ALM is a hierarchy (to execute the process), a process (to track, report and monitor risk management), a tool (to analyze relevant data), a technique (to measure risk and suggest alternatives) and a repository (a versatile data warehouse). The study team is of the opinion that since interest rate risk and liquidity risks are significant risks in a bank s balance sheet, they should be regularly monitored and managed. These two aspects should be a key input in business planning process of a bank. Banks should make sure that increased balance sheet size should not result in excessive asset liability mismatch resulting in volatility in earnings. There should be proper limit structures, which should be monitored by Asset Liability Management Committee (ALCO) on a regular basis. The effectiveness of ALM system should be improved with a good Fund Transfer Pricing system by involving all ALCO members in decisions, as ALM sheet item granularity depends on distribution of time buckets of short-duration. Further, the study brings out the fact that implementation of ALM in RRBs in the form of constitution of ALCO, periodicity of ALCO meeting and number of items in the agenda and tools of ALM was in a sub-optimal stage. Based on the feedbacks/suggestion/inputs received on training effectiveness on ALM programme for RRBs, the study team is of the opinion that in all respects the training programs were successful and for majority of the respondents the training program met their needs and expectations. However it was found that there should be more on the job support to encourage employees to practice what they learnt. A few policy pointers on redesigning the ALM training module in the form of suggestions/feedbacks from trainee officers of RRBs included coverage on latest ALM tools & techniques (Duration Gap Analysis, Simulation and Value at Risk (VaR), use of software package(cloret 2,ASCROM,ALMAN 3, FINACLE 4, etc), sessions by professionals handling ALM desk and capacity building of support staff. 2 CLORET menu option will generate GLMAS.txt and PLMAS.txt which will be copied / imported to PC where cloret software is installed. Please take care that GLMAS.TXT is generated for 01 st April of Calendar Year and PLMAS.TXT is generated for 31 st March Calendar Year. 3 Batch job is set for ALMAN Download in CSOLOP. It generates file named XXXXXXFD.DDMMYYYY is generated. Where the XXXXXX is the branch ALPHA and DDMMYYYY is the date of download for which it is created. This file is available in the directory of the user who has done CSOLOP for that day. This file is created in UNIX; therefore we have to bring it to PC to copy on floppy so that the data can be uploaded in ALMAN package. 4 FINACLE Core Banking System. All transactions are accounted in FINACLE on daily basis. ASCROM Advances Monitoring System Data from FINACLE uploaded to ASCROM and Reports generated for Advances Monitoring. CLORET Closing Return System. Data from FINACLE uploaded to CLORET and Final Financials and Schedules generated from CLORET. IX

Introduction Banks Asset Liability Management (ALM) philosophy is aimed at accomplishing its mission of profit maximizing through efficient market risk management by ensuring returns commensurate with the level of risk taken. In an increasingly deregulated market, banks are facing greater exposure to market risks, viz. interest rate risk, foreign exchange risk and liquidity risk. Asset Liability Management System provides a comprehensive and dynamic framework for measuring, monitoring and managing these risks. The objectives of ALM Policy are to formulate guidelines for management of Liquidity Risk and Interest Rate Risk; fixing market risk limits; efficient liquidity risk management for ensuring the bank's ability to meet its liabilities as they become due; interest rate risk management to keep the volatility of the net interest margin within acceptable limits and profit planning and growth projections like Net Interest Margin, Market Value of Equity etc. Thus the areas of consideration of the policy for ALM are Liquidity and funding risk, Interest rate risk, Forex rate risk, pricing risk in relation to Interest Rate fluctuation, Pricing of lending and deposit rates, Allocation of resources, etc. As per NABARD guidelines, the Board of Directors has overall responsibility for deciding the Risk Management Policy of the bank and setting of potential limits. ALM is the function of Asset Liability Management Committee (ALCO) 1, which will operate under the guidance and supervision of the Board and /or Sub-Committee of Board on ALM and Risk Management. The ALCO 2 is responsible for Balance Sheet planning from risk returns perspective, particularly strategic management of interest rate and liquidity risk. ALCO is also responsible for establishing ALM monitoring and management procedures as per risk management guidelines issued by the regulator and adhering to parameters, procedures and policies decided by the Board. As per NABARD guidelines banks were asked to set interim targets so as to cover 100 percent of the business by April 1, 2009. Once the ALM System stabilizes and the 1 Asset Liability Management Committee (ALCO) in general is headed by the Chairman consisting of following Officers: Chief Manager (HRM), Chief Manager (OPR), Senior Manager (ADV), Senior Manager (OPR), Manager (I.T.), Manager (Investment) and Senior Manager(Risk Management) as Convener of ALCO. The quorum for meeting of ALCO shall be five members. The ALCO shall endeavour to meet at least once in a month 2 The ALCO would focus on the following business issues (i) Product pricing (Interest rate) for deposits and advances, (ii) Deciding on desired maturity profile and mix of incremental assets and liabilities. (iii) Articulating interest rate view of the bank and deciding on the future business strategy, (iv) Reviewing and articulating funding policy, including liquidity management.,(v) Monitoring and managing exposures/ mismatches, (vi) Reviewing impact on monetary policies and economic/ political changes on the balance sheet, (vii) Deciding the transfer pricing policy (TPM) or TPM of the bank, (viii) Recommending changes in the liquidity and interest rate sensitivity mismatch limits or any provision of this policy and (ix) Monitoring the structure of Balance Sheet in light of Capital Adequacy requirement. 1

bank gains experience, it should be prepared to switchover to more sophisticated computerized technique like Duration Gap Analysis, Simulation and Value at Risk (VaR) for interest rate risk Management. The details of the data extraction and coverage are given in Appendix- I. Asset Liability Management Policy aims to lay down the ALM structure, define the roles of identified individuals or committees and the top management, measure and manage the asset liability related risks facing the bank by setting down various risk limits and lay down the MIS process to keep the various levels of management including the top management informed to enable them take appropriate decision in a timely manner. The assets and liabilities of the bank shall be managed to maximize profitability and enhance capital thereby increasing shareholders value and also to protect the organization from financial stress arising out of adverse movement in market rates and thereby continue to serve the customers and community more effectively. For attaining the objectives 3, the ALM policy may look into allocation of resources Interest rate risk, Pricing risk, Liquidity risk and Funding risk. The Board of Directors shall have the overall responsibility for deciding the ALM management policy of the bank and setting up of prudential limits. The Board of Directors 4 shall have ultimate responsibility for implementing and ensuring adherence to this policy. If deemed necessary, the function of periodic supervision may be delegated to a Sub- Committee of Board on ALM and Risk Management. If deemed fit, the Board may decide to include in the Sub-Committee persons who are not board members. ALM on a continuing basis is the function of Asset Liability Management Committee (ALCO) 5, 3 Objectives of the ALM Policy : Setting guidelines for management of Liquidity Risk and Interest Rate Risk; Setting risk limits, wherever required; Managing liquidity risk; Managing interest rate risk & Profit planning and projections of business parameters 4 The board may periodically review the fund management activities of the bank. The review shall, inter alias, include the following : a) Study and analysis of the minutes of the ALCO meetings; b) Review of Bank s liquidity position; c) Monitoring of internal and external factors affecting liquidity position; d) Periodic review of Bank s liquidity strategies, policies and procedures; e) Study of Bank s interest rate sensitivity analysis; f) Study of contingency funding plan 5 Liquidity and Market Risk management functions shall be centralized at Head Office level with the Asset Liability Management Committee (ALCO). It may be the top operational unit for managing the balance sheet within the performance/ risk parameters determined by the Risk Management, Internal Audit and Internal Control System Board. Asset Liability Management Committee (ALCO) may be headed by the Chairman/Managing Director (Chairman of ALCO) of the bank. The other members may consist of General Managers and departmental heads. The Chairman/ Managing Director may be the competent person for deciding upon the number of members as well as composition of the ALCO. Depending on the subject being dealt with, other senior functionary/ies may be called to attend the meetings as invitees from time to time. Chairman of ALCO may be empowered to make necessary changes in composition of ALCO. Functional Head of Risk Management department may be the convener of ALCO. The ALCO shall 2

which may operate under the guidance and supervision of the Board. Balance sheet planning may be the primary responsibility of ALCO, with special emphasis on liquidity risk and interest rate risk management. Establishment of process and procedure for management of ALM in line with guidelines from the regulator/ supervisor and monitoring of the same on an ongoing basis may be the responsibility of ALCO 6. ALCO shall draw upon the in-house expertise available in the concerned departments of the bank for effective discharge of its responsibilities. ALCO shall have the overall responsibility of spread management, for achieving the targets set by the Board, in line with the directions given by the Board. Any matter relating to size, composition and price of assets and liabilities may be the functional area of ALCO. Deposit rates, lending rates, concession/ loading (mark down or mark-up) to lending rates, transfer pricing etc., may be first discussed by the ALCO. Only upon approval from ALCO, the matter may be placed before the Board. To focus exclusively on the risks faced by a financial institution in Asset Liability transformation process, the instrument of a systematized ALM process is needed. Asset Liability Management can be defined as a continuous rearrangement of assets and liabilities of the balance sheet so as to maintain the profit, minimise interest rate risk and provide adequate liquidity. ALM system is a formalized framework for management of market risks through measuring, monitoring and managing liquidity and interest risks. The details are given in Appendix II. Need for an evaluation of ALM Programme: The study group has defined the evaluation as an attempt to obtain information on the effects of training on performance and to assess the value of training in the light of that information. Basically, the impact evaluation 7 has been attempted to address the effectiveness of training to improve performance of employees on the jobs/tasks. Review of literature has been attempted through cross references of various study reports/working papers on evaluation of training programmes by reputed research organizations including BIRD. Endeavour to meet at least once in a month. In the absence of Chairman/ Managing Director, the senior most General Manager shall chair the meetings. The quorum for the meetings of the Committee shall be three members. 6 ALCO would, inter alias, focus on the following areas: Desired maturity profile and mix of incremental assets and liabilities; Composition of Capital Funds in the light of the Capital Adequacy regulations; Future interest rate movement and the consequent future business strategy; Liquidity position; Exposures to various sectors, groups, industries etc.; Mismatches in inflow /outflow; Product pricing for deposits and advances; Impact of economic/ political changes on the balance sheet; Transfer pricing policy (TPM) or TPM rates of the Bank; Investment operations of the Bank 7 Evaluation must be continuous, be specific and based on objective method and standards. 3

Objective, Sample Design and Methodology The major objective of the study was to assess the impact of ALM Training 8 Programmes conducted by BIRD on Regional Rural Banks. The specific Terms of Reference (ToR) of the study were (i) To critically review the progress of ALM policy formulation with focus on bottlenecks/constraints in the implementation of the ALM. (ii) To quantitatively estimate the effectiveness of liquidity & interest risk management and pricing of loan product. The study was based on both primary as well as secondary data. The secondary information had been collected from various published and unpublished sources of RRBs, controlling/sponsor banks and other financial institutions. Data/information on ALM information system, ALM decision making processes(alm Committee/ALCO), tools/techniques(traditional Gap Analysis, Maturity Gap analysis, Duration Gap analysis), strategies for liquidity and interest rate risk management through ALM has been used to examine progress made under ALM framework (information systems, organization and processes for effective implementation. To collect data from the trainees, a multi-stage stratified sampling design on the lines given below has been adopted. The survey of the trainees has been carried out in selected RRBs on the basis of total number of trainees covered during 2011-12, 2012-13 and 2013-14. Subsequently, the state, the bank and trainee officers formed three stages of sample selection within the selected region. 8 Definition of Training: It is any attempt to improve current performance by increasing an employee s ability to perform through learning, usually by changing the employee s attitude or increasing his or her skills and knowledge. General objectives of any Training program are: (a) to impart the basic knowledge and skill to the new entrants and enable them to perform their jobs well; (b) to equip the employee to meet the changing requirements of the job and the organization; (c) to teach the employee the new techniques and ways of performing the job or operation and (d) to prepare employees for higher level tasks. Training benefits both the employees and employers. It makes the employee more productive and more useful to an organization; Training enables the employee to develop and rise within the organization; Training makes the employee more loyal to an organization; Training makes an employee to work more efficiently; Training enables to secure promotions easily; Training reduces wastages as the employees use the tools properly. Areas of training: Knowledge: Awareness of the rules & regulations and policies of the company; Social Skills: Teaching the employee how to be a team member and get ahead; Technical Skills: Teaching the employee regarding the technical aspects of his job; Decision making and Problem solving Skills: Emphasis on methods and techniques for making organizational decisions and solving work related problems. 4

Depending upon the number of trainees covered during last three years, a sample of 36 trainee officers has been selected using simple random sampling out of total 67 trainees. Keeping in view the distribution of RRBs(amalgamated), the sample RRBs has been drawn in such a way that the rural banking infrastructure(particularly RRBs) is truly represented. The total number of RRBs selected within the region has been further distributed according to the number of trainees covered, size of the bank in terms of business and coverage, etc. RRBs have been selected on the basis of probability proposal to size method applied independently to each stratum. An independent trainee was the ultimate sampling unit for the selection of sample. From the same state, a sample of 2-3 RRB officials (as a control sample) who had not undergone similar training, had been selected to have a comparative analysis. In this impact evaluation 9 study both pre-post and with-without approaches representing temporal and spatial variation have been adopted. The data has been collected with the help of pre-tested questionnaires 10. The type of data collected with these questionnaires included information on the following variables. 9 Evaluation of Training: Definition: Any attempt to obtain information on the effects of training on performance and to assess the value of training in the light of that information. Objectives of Training Evaluation: To check the effectiveness of training to improve performance of employees on the jobs; To ascertain how far the training is useful to improve career prospects of individual employees in the organization; To identify the deficiencies of the training for the purpose it is intended in order to incorporate additions to the training program; To identify unnecessary aspects in the training program for the purpose of deleting such things from the training program. Principles of Evaluation: Evaluation must be continuous, must be specific, must be based on objective method and standards and Evaluation specialist must be clear about the goods and purpose of evaluation. 10 Techniques of Evaluation: Questionnaires; Tests; Interviews; Cost benefit analysis and Feed back Evaluation methods: Test-retest method: Participants are given a test before they begin the program. After the program is completed the participants retake the test. This test may not be valid but more importantly, Increase in test scores may be due to causes other than the training program. Pre-post performance method: In this method each participant is evaluated prior to training and rated on actual job performance. After instruction (program) is completed the participant is reevaluated. It deals directly with job behavior. Experimental Control group method: Two groups are established i.e. experimental & Control group, comparable as to skills, intelligence and learning abilities and evaluated on actual job performance. Members of control group work on the job but do not undergo training. Experimental group is given the training. At the conclusion of the training the two groups are reevaluated. Four factor comparison method (Kirkpatrick model): This method is proposed by Kirkpatrick& others. According to this method evaluation of following 4 factors are essential to determine the effectiveness of training program. These are Reaction: Employees reaction to the training program by itself is a good indicator. This is subjective evaluation. However it reveals the attitude of the trainees to the training program. Reaction is obtained by opinion surveys and taking majority views. Learning: In this case an attempt is made to assess whether the trainees have learned the skills and knowledge intended to be imparted through the training program. Behavior: here the trainee s behavioral pattern is examined carefully after his training program for the purpose of evaluating whether there are changes in his behavior in the job compared to the period before the training program was imparted. Result: This is a method of evaluating quantifiable indices or attributes of performance which can be directly related as a result of training. For 5

i. Trainee questionnaire Understanding of various risks/financial market instruments, concept of ALM, posting in the concerned desk, programme meeting the needs and expectations, adequate training facilities provided, contents of programme logically organized, exchange of knowledge/skills gained with colleagues, usefulness of training and training materials, ability to handle the job/task, usefulness in day-to-day functioning, use of various types of ALM tools, linkage between ALM and profitability, suggestions in the training programme on ALM, etc. ii. Field level questionnaire- ALM policy formulation, constitution of ALCO, periodicity of meetings, agenda items (interest rate movements & expected spreads, mismatches in maturity pattern, funding policy, liquidity position, net interest margin, investment portfolio, etc.), pricing of loan products, risk mitigating measures in liquidity & risk management, staffing pattern, operational issues and difficulties associated with the implementation of the ALM and areas for further improvement. Feedback received after canvassing trainee questionnaire to all 67 trainees Table II.1 Sample frame of Banks and Trainees No. of RRBs covered No. of RRBs covered for canvassing field level questionnaire States covered during field visit 36 16 03 UP, Bihar and Rajasthan Primary data has been supported by secondary data for the study. Data on the progress, operation aspects under the ALM Programme, etc., were collected from the RRBs covered under the study. Top Management/senior bankers of RRBs was interviewed during field visits to assess the operational advantages and disadvantages of the Programme. Qualitative parameters like ALM policy, constitution of ALCO, periodicity of meeting and number of relevant items in the agenda of ALCO were assigned number/value on a 1 to 5 scale depending upon their performances/progress for sample RRBs. Various techniques of evaluation like questionnaires, interviews & feed-back; evaluation methods like pre-post performance method; experimental control group method and four factor comparison method (reaction, learning, behaviour, and result) have been attempted. Primary data and secondary data (A profile of RRBs-Bank-wise for example Productivity, reduction in rejection rates of finished goods, incidents of accidents, absenteeism, conflicts, etc. 6

year 2013 and 2014) have been tabulated and analyzed using statistical tools such as mean, percentage share, weighted average, pie-chart, correlation matrix, step-wise regression, ANOVA 11 and Dummy variable, etc., to derive inferences. Limitations of the study: 1. Due to organizational restructuring (post-amalgamation) the sample was restricted to 36. More samples would have provided better results. 2. The study is restricted to trained officers of RRBs only as it has no universal application. 3. Details like work-experience in ALM desk were not given by some employees during the survey. 4. The study findings are based on the impressionistic views of some officers instead of their experience of working on the ALM desk. 11 ANOVA Analysis of Variance 7

Results and Discussion Impact of the training (Studying the demand side - testing the water) Trainee Questionnaire 1. After attending the training programme at BIRD, I am able to understand the various types of risks indicated below, associated with banks Type of Risk Able to understand Yes No Credit Risk 32 04 Liquidity Risk 34 02 Interest Rate Risk 33 03 Operational Risk 28 08 % of RRB Trainees/participants having understanding about various type of risk 77.8 % 91.7 % 94.4 % 88.9 % Credit Risk Liquidity Risk Interest Rate Risk Operational Risk The above pie chart shows that: 94 % of the respondents have understanding about liquidity risk. 91 % of the respondents have understanding about interest risk. 88 % of the respondents have understanding about credit risk. 77 % of the respondents have understanding about operational risk. 8

2. I came to know about the financial market instruments and terms like SEBI, OTCEI, NSE, FIMMDA etc., after attending the programme Yes No. I knew these terms even before attending the training programme The above pie chart shows that 83% of the respondents came to know about the financial market instruments and terms like SEBI, OTCEI, NSE, FIMMDA etc., after attending the programme. 3. I came to know on the concept of ALM after attending the programme Yes No. I knew about ALM even before attending the training programme The above pie chart shows that 56 of the respondents had knowledge/experience in ALM before the training indicating strong entry level behavior. 9

4. Whether the course material provided during the training was useful? Yes 36 No Nil. All the respondents had indicated that course material provided during the training was useful. 5. Have you been posted to the ALM desk /Cell after attending the training conducted by BIRD? I was posted to the desk even before I attended the training 07 I have been posted to the desk after attending the training 21 programme I have not been posted although I have undergone the training 08 At present I am working on ALM desk (yes / no) 28 22 % of the respondents have not been posted in ALM desk despite receiving training. 10

6. Whether you shared the inputs received during training with other colleagues working on ALM desk? Yes 36 No Nil All the respondents had indicated that course material provided during the training was useful. 7. To what extent the knowledge gained during the training is useful in your day-to-day functioning? To a great extent 23 To some extent 10 No scope for use 3 8% of the respondents felt that there was no scope for use of knowledge gained during the training in our day-to-day functioning. 8. Whether your bank has formulated ALM policy? Yes 36 No Nil All the respondents indicated that their banks have formulated ALM policy approved by Board. 11

9. If answer to above question is yes, whether the training programme at BIRD helped you to assist in formulation/refinement of the policy in your bank The programme helped me to a great extent in assisting in formulation / refinement of ALM policy in my bank 10 The programme helped to some extent in assisting in formulation / refinement of ALM policy in my bank 18 Policy was formulated in the bank before I attended the programme 6 I did not get an opportunity to assist in formulation / refinement of the policy 2 78% of the respondents indicated that training programme at BIRD helped in formulation/refinement of the policy in their bank. 12

16.7 22.2 13.9 8.3 0.0 IN % AGE 11.1 25.0 16.7 83.3 77.8 86.1 75.0 91.7 88.9 83.3 100.0 Impact Evaluation Study of Training Programme on Asset Liability Management 10. Whether the training programme has helped the bank in any of the following areas? Particulars Programme helped Yes No Constitution of ALCO 6 30 Finalising agenda items for ALCO 28 8 Understanding interest rate movements and expected spreads 31 5 Understanding mismatches in maturity pattern 27 9 Understanding pricing of loan products, risk mitigating measures for 33 3 liquidity and interest rate risks Operational issues and difficulties associated in implementation of the 32 4 ALM Areas for further improvement 36 0 Discussions on investment portfolio 30 6 PROG. HELPED Yes No. 16.7 % of the respondents indicated that training programme at BIRD helped in Constitution of ALCO. 77.8 % of the respondents indicated that training programme at BIRD helped in Finalising agenda items for ALCO. 86.1 % of the respondents indicated that training programme at BIRD helped understanding interest rate movements and expected spreads. 75 % of the respondents indicated that training programme at BIRD helped in Understanding mismatches in maturity pattern 91.7 % of the respondents indicated that training programme at BIRD helped in understanding pricing of loan products, risk mitigating measures for liquidity and interest rate risks. 88.9 % of the respondents indicated that training programme at BIRD helped in Operational issues and difficulties associated in implementation of the ALM. 83.3 % of the respondents indicated that training programme at BIRD helped in Discussions on investment portfolio All the respondents indicated that training programme at BIRD helped in Areas for further improvement. 13

(in %age) Impact Evaluation Study of Training Programme on Asset Liability Management 11. What type of ALM tools have been introduced by your bank after your attending the training programme? Particulars Tool used / introduced Yes No Preparation of Liquidity Gap Statement 33 3 Preparation of Gap Statement to measure interest rate risk 28 8 Duration concept 6 30 Impact of interest rate movement on Net Interest Margin (NIM) 30 6 Only some of these tools have been introduced 36 0 None of these tools are used in the bank for ALM 0 36 ALM Tools 120.0 100.0 80.0 91.7 77.8 83.3 83.3 100.0 100.0 60.0 40.0 20.0 0.0 8.3 Preparation of Liquidity Gap Statement 22.2 Preparation of Gap Statement to measure interest rate risk 16.7 Duration concept 16.7 Impact of interest rate movement on Net Interest Margin (NIM) 0.0 0.0 Only some of None of these these tools havetools are used in been introduced the bank for ALM Yes No 91.7 % of the respondents indicated that training programme at BIRD helped in preparation of Liquidity Gap Statement Constitution of ALCO. 77.8 % of the respondents indicated that training programme at BIRD helped in preparation of Gap Statement to measure interest rate risk. 16.7 % of the respondents indicated that training programme at BIRD helped understanding Duration concept. 83.3 % of the respondents indicated that training programme at BIRD helped in Understanding Impact of interest rate movement on Net Interest Margin (NIM). All the respondents indicated that training programme at BIRD helped in using some of the ALM tools. 14

5.6 5.6 IN %AGE 38.9 47.2 47.2 52.8 52.8 61.1 94.4 94.4 Impact Evaluation Study of Training Programme on Asset Liability Management 12. In order to mitigate liquidity risk, which of the following statements have been introduced in your bank after you are attending the training programme? Particulars Statement introduced Yes No Putting assets and liabilities in different time buckets 34 2 Structural Liquidity statement (1) 19 17 Dynamic Liquidity statement (2) 22 14 Statements at (1) and (2) only are introduced 17 19 None of the above statements introduced 2 34 LIQUIDITY RISK MITIGATION 100.0 90.0 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 P U T T I N G A S S E T S A N D L I A B I L I T I E S I N D I F F E R E N T T I M E B U C K E T S S T R U C T U R A L L I Q U I D I T Y S T A T E M E N T D Y N A M I C L I Q U I D I T Y S T A T E M E N T S T A T E M E N T S A T ( 1 ) A N D ( 2 ) O N L Y A R E I N T R O D U C E D N O N E O F T H E A B O V E S T A T E M E N T S I N T R O D U C E D Yes No 94.4 % of the respondents indicated that in order to mitigate liquidity risk, they are putting assets and liabilities in different time buckets. 52.8 % of the respondents indicated that in order to mitigate liquidity risk, they are preparing Structural Liquidity statement. 61.1 % of the respondents indicated that in order to mitigate liquidity risk, they are preparing Dynamic Liquidity statement. 47.2 % of the respondents indicated that in order to mitigate liquidity risk, they are preparing both Dynamic Liquidity statement and Structural Liquidity statement. Only 5.6 % of the respondents indicated that they are preparing neither Dynamic Liquidity statement nor Structural Liquidity statement. 15

13. In your opinion whether the profitability of the bank has improved after implementation of ALM concept in the bank? Yes 28 No 8 22% profitability of the bank has improved Yes No 78% 78 % of the respondents indicated that the profitability of the bank has improved after implementation of ALM concept in the bank. 16

5.6 5.6 13.9 IN % AGE 19.4 25.0 27.8 86.1 80.6 75.0 72.2 94.4 94.4 Impact Evaluation Study of Training Programme on Asset Liability Management 14. Which of the following areas related to ALM, in your opinion, have contributed in bringing about overall improvement in the financial position of the bank? Particulars Whether resulted in improving financial position of the bank Yes No Preparation of Liquidity Gap Statement 31 5 Preparation of Gap Statement to measure interest rate risk 29 7 Introduction of Duration concept 9 27 Preparation of Structural Liquidity Ladder 26 10 Preparation of Dynamic Liquidity Ladder 34 2 None of the above 2 34 IMPROVING FINANCIAL POSITION OF THE BANK P R E P A R A T I O N O F L I Q U I D I T Y G A P S T A T E M E N T P R E P A R A T I O N O F G A P S T A T E M E N T T O M E A S U R E I N T E R E S T R A T E R I S K I N T R O D U C T I O N O F D U R A T I O N C O N C E P T P R E P A R A T I O N O F S T R U C T U R A L L I Q U I D I T Y L A D D E R P R E P A R A T I O N O F D Y N A M I C L I Q U I D I T Y L A D D E R N O N E O F T H E A B O V E Yes No 86.1 % of the respondents indicated that preparation of Liquidity Gap Statement resulted in improving financial position of the bank 80.6 % of the respondents indicated that preparation of Gap Statement to measure interest rate risk resulted in improving financial position of the bank 25 % of the respondents indicated that Introduction of Duration concept resulted in improving financial position of the bank 72.2 % of the respondents indicated that Preparation of Structural Liquidity Ladder resulted in improving financial position of the bank 94.4 % of the respondents indicated that Preparation of Dynamic Liquidity Ladder Only 5.6 % of the respondents indicated that none of the above areas related to ALM resulted in improving financial position of the bank. 17

83.3 11.1 5.6 Impact Evaluation Study of Training Programme on Asset Liability Management 15. What suggestions would you like to give to bring about improvement in the training programme on ALM conducted by BIRD? Particulars The programme does not need any changes and may continue to be conducted in the present format. 30 The contents of the programme were inadequate and needs to be upgraded 4 Cannot comment as I am not presently working on the ALM desk 2 IMPROVEMENT IN THE TRAINING PROGRAMME 83.3 % of the respondents indicated that the programme does not need any changes and may continue to be conducted in the present format. 11.1 % of the respondents indicated that the contents of the programme were inadequate and needs to be upgraded 5.6 % of the respondents indicated that they cannot comment as they are not presently working on the ALM desk 18

Field level Questionnaire Impact Evaluation Study of Training Programme on Asset Liability Management In order to study the determinants of profitability of RRB, the study team has applied cross - sectional multiple step-wise regression analysis using data for select RRBs. Among the explanatory variables, we have taken ALM policy formulation, constitution of ALCO, periodicity of meetings, agenda item( interest rate movements & expected spreads, mismatches in maturity pattern, funding policy, liquidity position, net interest margin, investment portfolio, pricing of loan products, risk mitigating measures in liquidity, pricing of loan products, risk mitigating measures in liquidity & risk management, staffing pattern). Using dummy variables (ALM training by BIRD and Non-trainees), the intercept term has been allowed to vary across the cost of fund, so as to pick up difference in Net interest margin. In the regression model, the dependent variables Net interest margin is frequently influenced not only by variables that can be readily quantified on some well-defined scale (i.e. cost of funds, Yield on assets, Liquidity risk and interest risk, etc.), but also by variables that are essentially qualitative in nature (i.e. ALM policy formulation, constitution of ALCO, Periodicity of meetings,). Since such qualitative variables usually indicate the presence or absence of an attribute (in the present study it is either officers of RRBs attended ALM training by BIRD or otherwise), one method of quantifying such attribute is by constructing artificial variables that take on values of 1 or 0, 0 indicating the absence of an attribute and 1 indicating the presence (or possession) of that attribute. Variables that assume such as 0 and 1 value are called dummy variables. 19

Analytical Model: In case of ANOVA model, the regression model contains explanatory variable that are exclusively dummy, or qualitative, in nature. For example, we have taken the following model: Y i = α i + β i D i + ξ i Where, Y = Net Interest Margin (NIM), Di = 1 if, officers of RRBs attended ALM training by BIRD = 0, otherwise The results corresponding to above regression are as follows: Ŷ i = 0.91 + 0.0469 D i t = (4.74) (1.689); R 2 = 0.3648 As these results show, the estimated mean NIM (one of the financial Ratios) of RRBs received ALM training inputs by BIRD is 0.9569(α+β) and otherwise 0.91(α). Since βi is statistically significant at 90% level of confidence, the results indicate that the mean NIM of the two categories (RRBs attended ALM training conducted by BIRD or otherwise) is different. If all other variables are held constant, it may be partially concluded that there is a significant difference in the NIM level of the two categories. However, the present model is too simple to answer this question definitely, especially in view of the cross-sectional data used in the analysis. To draw the best-fit regression equation, the study team have adopted the method of stepwise regression. This procedure evaluates each variable in turn on the basis of extent of correlation (Correlation matrix) and accumulates the model by adding variables sequentially. The variable having highest correlation with the dependent variable could be added to the model first, then the second best or so on. Variables are added as long as R 2 is increasing. To avoid the problem of 20

multi-colinearity 12, we dropped many variables from the model and selected only three variables. Details are given in the Appendix - III. Variables Table 1.1 Statistical results of step-wise regression model sample RRBs No. of relevant items in the agenda of ALCO(NAI)) Periodicity of meeting(pm) ALM Policy & Constitution of ALCO(APCO) Co-efficients 0.4329* 0.2142* 0.1339** t value 2.92 2.74 1.98 R 2 =.9724, Ŕ 2 =.9614, F value = 88.19, D stat = 2.34 DL = 0.525 DU = 2.016 D.F. = 1872 * Stands for 10% level of significance. ** Stands for 20% level of significance. The estimated elasticities 13 βi for all the variables with respect to Net Interest Margin for the sample RRBs are presented in Table 1.1. It is observed from the table that No. of relevant items in the agenda of ALCO - NAI (0.4329) as a whole influence significantly to the Net Interest Margin compared to other variables, i.e. ALM Policy & Constitution of ALCO (0.1339) and Periodicity of meeting (0.2142). Table 1.2 Statistical results of regression model having dummy variables RRBs received ALM training inputs by BIRD Varible/s Co-efficient St.dev. t - ratio Constant 0.91 Dummy variable 0.0469** 1.680 2.499 D.F -1874 R 2 = 0.36 Ŕ 2 = 0.29 Dummy variable = RRBs received ALM training by BIRD (RATI) * Stands for 5% level of significance, ** Stands for 10% level of significance. In the above model, there are quantitative and qualitative variables one each. Coefficients of all these variables are statistically significant at the 10% level of significance. For instance, holding all other factors constant, the level of Net Interest Margin is expected to be higher by about 0.13 times in percentage term (13 basis points) of the RRBs received ALM training by BIRD. 12 Multi-colinearity occurs where there is strong relationship among explanatory variables. 13 Increase in percentage term of independent variable tends to increase/decrease in percentage term of dependent variable. 21

Further, average level of NIM of RRBs received ALM training by BIRD (i.e. when the dummy variable is equal to 1) and otherwise (i.e. when the dummy variable takes a value of zero) is NIM i = 0.91 + 0.0469 RATI i ------------------(i) For significance, we have used various statistical tools like t value and R 2. For cross section analysis, we have taken care of the multi- colinearity problem by taking one variable at a time considering the high value in correlation matrix. 22

Conclusion and Policy Prescription Implementation of ALM tools effectively is likely to improve the risk management systems and Net interest Margin of RRBs as the banks aim for adequate capitalization to meet the underlying credit risks and strengthen the overall financial system of the country. However there is some teething problem like lack of a coherent, documented and practical policy is a big hindrance to ALM implementation. Most often, ALCO members may not be aware of implications of risks being measured and impact thereof. Officers in RRBs need to understand risk measurements and risk mitigation procedures. Measurement of risk is a fairly simple phenomenon and does go on regardless. Failures inevitably occur due to lack of understanding, coupled with a feeling that top management knows all that is there in banking. Risk organization in RRBs generally land up reporting to treasury, as they are people who come closest to understanding complex financial instruments. The fact that they are a business unit, in charge of risk taking is overlooked. Risk taking and Risk management are generally two distinct parts of any organization and both must report to Board independently. Openness and transparency are essential to proper risk mitigation. Most organizations react badly to positions going wrong by taking more risks and enter a vicious cycle of risks. Thus, it is required that RRBs follow policy in both letter and spirit. Data may not be available at all times in requisite format. It must be remembered that many data items are assumptions and gaps must be measured in perspective. However, in modern banking, it is mapping of models to zero coupon bonds that are an issue. Once again, arguments are that this should exist within the bank. Based on sophistication required, multiple models may be used to validate this conversion. This is strictly outside ALM framework but integrates into ALM framework. A zero gap is not practical. Returns are expected for taking risks. Banks assume market and credit risk and hence they make returns. ALCO s job is to correctly determine positions and put in place appropriate remedial measures using appropriate risks. It is not to show things as good when they are not. The study team is of the opinion that Interest rate risk and liquidity risks are significant risks in a bank s balance sheet, which should be regularly monitored and managed. These two aspects should be a key input in business planning process of a bank. Banks should make sure that increased balance sheet size should not result in excessive asset liability mismatch resulting in volatility in earnings. There should be proper limit structures, which should be monitored by Asset Liability Management Committee (ALCO) on a regular basis. 23

The effectiveness of ALM system should be improved with a good Fund Transfer Pricing system by involving all ALCO members in decisions as ALM sheet item granularity depends on distribution for non-term products. Further, the study brings out the fact that implementation of ALM in RRBs in the form of constitution of ALCO, periodicity of ALCO meeting and number of items in the agenda and tools of ALM was in a sub-optimal stage. Based on the feedbacks/suggestion/inputs received on training effectiveness on ALM programme for RRBs, the study team is of the opinion that in all respects the training programs were successful and for majority of the respondents the training program met their needs and expectations. However it was found that there should be more on the job support to encourage employees to practice what they learnt. A few policy pointers on redesigning the ALM training module in the form of suggestions/feedbacks from trainee officers of RRBs included latest ALM tools & techniques (Duration Gap Analysis, Simulation and Value at Risk (VaR), use of software package(cloret, ASCROM, ALMAN, FINACLE, etc), sessions by professionals handling ALM desk and capacity building of support staffs. 24

References Reserve Bank of India, (1999). Asset-Liability Management (ALM) System: Circular No. DBOD.No.BP.BC.8/21.04.098/99 dated February 10, 1999. ---------------------------, (2007). Guidelines on Asset-Liability Management (ALM) System Amendments: Circular No DBOD. No BP.BC...38/21.04.098/2007-08 dated October 24, 2007. ---------------------------, (2008). Guidelines on Asset - Liability Management (ALM): Circular No. DBOD.No.BP.BC.68/21.04.098/2007-08 dated April 9, 2008. NABARD, (2007). Guidelines for Introduction of Asset-Liability Management (ALM) in Select Regional Rural Banks : Circular No. Circular No.16/DoS.7/2006.07 Ref. NB.DoS.HO.POL.4420/P.108/2006-07 dated January 9, 2007. --------------, (2008). Introduction of Asset-Liability Management (ALM) in Regional Rural Banks (RRBs) : Circular No. 111 / DOS - 24 /2008 Ref. NB.DoS.HO.POL/1323/P-108/2008-09 dated 30 June 2008 --------------, (2013). Implementation of Asset-Liability Management Systems in Regional Rural Banks : Circular No.25/DoS-03/2013 Ref. NB.DoS.HO.POL./3898/P-108/2012-13 January 30, 2013. --------------, (2014). Profile Data on RRBs from Off-site Surveillance System (OSS): http://nabnet.in/projects/oss/# (Accessed on 02 September 2014). Government of India, (1998). Report of the Committee on Banking Sector Reforms : (Chairman: M Narasimham). Kannan, K (1996). Relevance and importance of asset-liability management in Banks : The Journal of the Indian Institute of Bankers, 67(4). Jalan, B (2000). Agenda for Banking in the New Millennium : Reserve Bank of India Bulletin, March, p(61-64) Jain, J.L. (1996). Strategic planning for asset liability management: The Journal of the Indian Institute of Bankers, 67(4). Jain Manjula et al. Asset-Liability Mangement in the Indian Banks Issues and Implications : (http://www.smsvaranasi.com/insight/assetliability_management_in_the_indian_banks_issues_and_implications.pdf (Accessed on 14 June 2014). 25

APPENDIX-I Consolidated statement of the bank business at weekly, monthly intervals and Balance sheet (annually) which cover 100% of Assets & Liabilities are taken as base figures. Till 100 %conversion of branches in to CBS the above data will obtain in CLORET as well as others format prescribed by the bank. After 100% conversion of the branches in to CBS, the above data will be obtained in prescribed format on daily basis from the Accounts & Audit Department. The changes in the business figures reported in daily/ weekly/monthly statements of the bank is available from the data for which consolidated figures are available, to the date for which structural liquidity statement is to be prepared, are added or subtracted to the base figures to arrive at overall estimated business figures of the bank for the structural liquidity statement. In this process, for the preparation of daily structural liquidity statement, the growth of the non CBS branches gets updated on weekly basis. Residual maturity pattern of Term Deposits is generated from the data submitted by the Regions and processed by ALMAN package at quarterly intervals for every quarter end. The bank will endeavor to generate the report on monthly basis. For preparing the daily structural liquidity statement the balances of Term Deposit are extrapolated in the proportion of latest available data on residual maturity pattern generated from ALMAN package. Till the implementation of ASCROM 14 system, the Residual Maturity of advances will be obtained from the selected branches on the basis of ABC approach. After full implementation of ASCROM system in the bank the residual maturity of advances will be obtained on quarterly basis. For preparing the daily structural liquidity statement the balances of advances (expect CC/OD) are extrapolated in the proportion of the latest available residual maturity pattern of advances from ASCROM package. Residual maturity pattern of investments will be obtained from the investment deptt.on quarterly basis. Liquidity Risk Management. Measuring and managing liquidity risk are among the most vital activities of the bank. By ensuring a bank's ability to meet its liabilities as they become due, liquidity management can reduce the probability of an irreversible adverse situation developing. The analysis of liquidity requires bank managements to measures not only the liquidity position of the bank on an ongoing basis but also to examine how funding requirements are likely to evolve under crises scenarios. The bank will manage the liquidity risk by Traditional Gap Approach. Liquidity Risk Management through "Traditional Gap Approach": 1. For measuring the liquidity risk, Bank shall use maturity ladder and calculation of gaps (surplus /deficit) between inflows and outflows of funds as per NABARD guidelines. 14 ASCROM Asset Classification and Credit Monitoring 26

2. The statement of structural liquidity will be prepared by placing all cash inflow & out flow in the maturity ladder according to the expected timing of Cash Flows in the format prescribed by NABARD for preparation of structural liquidity statement. 3. The guidelines for classification of various components of assets and liabilities into different time buckets for preparation of structural liquidity statement, as provided by NABARD will be followed. For certain other items of assets and liabilities, which are of non-maturity in nature and where NABARD has not provided any norm for classification in to different time buckets the norms prescribed in ALM policy, discussed hereafter, will be followed. 4. For the bucketing of current deposits, saving deposits Cash Credit, overdraft and Bills payable information in the following format will be provided by the bank's data center for CBS branches. For Non-CBS branches weekly data will be provided by the Regions. G/L Code G/L Head Date Op.Balance Dr. Cr. Total Limit* Closing Bal. *Wherever applicable After obtaining above data, outflow will be calculated as under: Liability Heads- Saving, Current deposit and Bills payable: The difference between debit and credit will be calculated for each day (weekly basis till 100% CBS has not done) of one year from the date of calculation, for respective liability heads as above separately. The data points where the amount of debit is more than the amount of credit ie where net outflow of funds has taken place will only be considered. Average of net debit, ie outflow of funds will be calculated for respective heads. Standard deviation of credits and debits for respective heads over a period of past one year will be calculated by applying normal statistical technique. The average of the opening balance under respective heads will be calculated from the data series provided. The outflow,as % to outstanding balance as on the date of calculation, will be calculated by applying the formula as under:- [(Average Dr.+ Standard Deviation of Dr.)-( Average Cr.+ Standard Deviation of Cr.)]*100 Average Op. Balance The difference will be subject to back testing using the usual techniques. Suggestion, if any to improve the calculated will de put up to ALCO for amendments in the policy. Asset Head - Overdraft/ Cash Credit: The difference between credit & debit will be calculated for each day (Till the CBs is not completed,weekly difference may be taken) of one year from the date of calculation for respective Assets Heads as above separately. The Opening and Closing balance will be subjected to Exponential Smoothing 27

Technique with damping factor of 0.99. For this, the balance in the first day will be zero. The balance in the second day will be the balance of 1st day. The balance in the third and the subsequent days will be calculated as under;- Smoothed balance = (0.01*balance of previous day) + (0.99* smoothed balance of previous. day) The smoothed balance for the past one year in respect of opening balance, debits and credits will be calculated. Average net credit ie inflow of funds will be calculated for respective heads. Average of the smoothed opening balance will be calculated from the data series. The inflow % as to outstanding balance as on the date of calculation will be arrived at by applying the formula as under:- {[Average Credit - Average Debit]*100}/Average Op. Bal. The Balances in the heads will be classified into different time buckets as under:- Outflow Current Deposits 1-14 days, 15-28days, 1-3 years, and over 5 years Saving Deposits 1-14 days, 15-28days, 1-3 years, and over 5 years Bills payable 1-14 days Inflow Cash Credit 1-14 days, 15-28days, 1-3 years, and over 5 years Overdraft 1-14 days, 15-28days, 1-3 years, and over 5 years The above equations will give the average inflow/outflow for one day. For inflow/outflow in the 1-14 days will be multiplied by the number of days between the bucket ie.14 days. Similarly for the 15-28 days the one inflow/outflow will be multiplied by the number of days between the buckets i.e. 14 days. The amount placed in these buckets will be volatile. In case of Saving Bank, Current Deposit, Cash Credit & Overdraft last 36 months balances will be arranged date wise and minimum will be calculated which will be the minimum core amount and will be placed in the over 5 years buckets. The remaining balance (excluding volatile and minimum core) will be placed in 1-3 years buckets. As per NABARD guidelines the excess balance over the required CLR/SLR may be shown under 1-14 days time bands, the statutory balance may be distributed amongst various time bands corresponding to the maturity profile of DTL with a time-lag of 28 days. All contingent liabilities will be estimated and placed in gap reported as under: /Un-availed portion of cash credit/overdraft: Potential availment in the unavailed portion of CCIOD accounts (excluding where limit utilization is 100% or more) will be worked out as under:- 1. Quarter wise percentage of utilisation of limits will be worked out for the last 4 quarters based on the sanctioned limit and balance outstanding (Cr. Balance to be ignored) on the last day of the respective quarters. 28

2. Difference between the percentages of utilization from the above worked out. The difference obtained for each consecutive quarter is divided by the unavailed percentage of each preceding quarter. The highest percentage thus obtained is treated as potential percentage availment of the unavailed portion. 3. The unavailed portion is worked out through the latest quarter 's information by taking the difference between the total limits and the outstanding balance (Cr. Balance ignored). 4. The potential availment amount is worked out by multiplying the potential percentage availment ( worked out in point no.2 above) to the unavailed amount ( as obtained in point (3) above) and this is distributed uniformly up to one year buckets in proportion of number of days. Letter of Credit/ Bank Guarantee:- Expected devolvement in LC will be worked out separately as under:- Quarter wise total amount devolved for the previous four quarters would be taken and its average would be worked out. Since devolvement of LIC initially entails cash out flows and subsequently amount gets recovered, the actual devolvement will be limited to one quarter figures on an average. Bank guarantee is normally not expected to devolve on the bank. Therefore devolvement under Bank Guarantee will be bucketed in proportion of number of days up to one year. The average so worked out as above will be the likely devolvement amount and would be distributed uniformly up to 90 days buckets in proportion of number of days to depict outflow of funds, in respect of Letter of Credit. In respect of Bank Guarantee the likely devolvement will be distributed up to one year in the proportion of number of days in each time bucket. All other assets and liabilities where specific maturity dates are available will be bucketed to respective maturity buckets and the assets and liabilities for which specific maturity dates are not available and which do not represent cash payable or cash receivable will be bucketed in Over 5 years bucket. Details of bucketing of all items of assets and liability and off balance sheet for the preparation of structural liquidity statement have been provided in Appendix-I. Structural Liquidity- Prudential limits:- As per NABARD guidelines, RRBs however, are expected to monitor their cumulative mismatches (running total) across all time bands by establishing internal prudential limits with the approval of the Board. The mismatches (negative gap between cash inflow & outflow) during 1-14 and 15-28 days time bands in normal course should not exceed 20% of the cash out flows in each time band. 29

In the light of new ALM guidelines of NABARD, it is proposed to fix prudential gap limits as under:- Sl No. Time Bucket Negative Gap limit% As per NABARD Proposed for guidelines( not exceeded approval for the of cash flow) Bank( not exceeded of cash flow) 01 1-14 days & 14-28 days 20% 20% 02 29days to 3 months * 40% 03 Over 3 months to 6months * 60% 04 Over 6 months to 1 year * 60% 05 Over 1 year to 3 years * 45% 06 Over 3 year to 5 years * 40% 07 Over 5 years * 40% 08 Cumulative mismatch upto1 * 50% year (* NABARD has not stipulated any limit for these buckets.) Dynamic Liquidity: In order to enable the bank to monitor their short term liquidity on a dynamic basis over a time horizon spanning from 1-90 days, bank may estimate their short term liquidity profile on the basis of business projections and other commitments for planning purposes. Negative gap. dynamic liquidity statement (cumu1ative up to 90 days ) after taking into consideration net increase in deposits, advances and investments but excluding unavailed limit in refinance and borrowing facilities, should not exceed 10 percent. Back testing of dynamic liquidity statement should be carried out once in a year and the results obtained should be used as a input for further fine tuning of the statement and utilizing it as decision supporting tool for business development. Contingency Plan: Strategies for managing Short Term liquidity mismatches will be made through the contingency plan by utilization of refinance limits from NABARD, Sp. Bank, NHB, SIDBI & other agencies, CBLO borrowing, Sale of excess SLR investments kept in held for trading or available foe sale categories. Adequacy of the contingency plan to meet Short Term fund requirement should be reviewed by ALCO regularly through structural liquidity gap analysis. Currency Risk:- At present Bank is not doing foreign exchange business. Interest Rate Risk (RII). Interest rate risk is the risk where changes in market interest rates might adversely affect a bank's financial condition. The changes in interest rates affect banks in a larger way. The immediate impact of changes in interest rates is on bank's earning by changing its Net Interest Income (Nil). A Long Term impact of changing interest rates is on bank's Market Value of Equity (MVE) or Net Worth as the economic value of bank's assets, liabilities 30

and off - balance sheet positions gets affected due to variation in market interest rates. The interest rate risk when viewed from these two perspectives is known as "earning perspective" and economic value perspective. There are many analytical tools for measurement and management of Interest Rate Risk. In the context of weak MIS, slow pace of computerization and the absence of total deregulation, the "Traditional Gap Analysis" is considered as a suitable method to measure the Interest Rate Risk in the first place. Traditional Gap Analysis :- Simple Gap model will be used for the measurement of interest rate sensitivity.the exercise will be done for the last reporting Friday of the month and reported to ALCO. The Interest Rate Sensitivity gap is measured as the difference between Rate Sensitive Assets(RSAs) and Rate Sensitive Liabilities (RSLs), including off-balance sheet positions. The reporting format prescribed by NABARD for Interest Rate Sensitivity gap report will be used for this purpose. The statement of Interest Rate Sensitivity is generated by grouping rate sensitive liabilities and rate sensitive assets and off-balance sheet position into time buckets according to residual maturity or next repricing period, whichever is earlier. The benchmark classification of various items of rate sensitive assets and liabilities and off balance sheet items, as provided by NABARD will be followed which is enclosed as Appendix II. ln interest rate sensitivity gap report, all advances that are linked to interest rate (BPLR/Base Rate) are supposed to be placed in the period (bucket) in which interest rate is expected to change. As & when gap report are prepared expected date of revision of interest rate has to be estimated and advances that come under interest rate to be placed in specific bucket. The Gap is the difference between Rate Sensitive Assets (RSA) and Rate Sensitive Liabilities (RSL) for each time band. The positive Gap indicates that it has more RSAs than RSLs where as the negative Gap indicates that it has more RSLs. The Gap report indicate whether the institution is in a position to benefit from rising interest rate by having a positive Gap ( RSA>RSL) OR whether it is in a position to benefit from declining interest rate by a negative Gap ( RSL > RSA) The Gap can, tl1erefore be used as a measure of interest rate sensitivity. Interest Rate Sensitivity- Prudential Limits:- The NABARD has not prescribed any limit on the individual gaps for interest rate sensitivity. However, the guidelines stipulate that each bank should set prudential limits on individual Gaps with the approval of the Board. The prudential limits should have a bearing on the Total Assets, Earning Assets or Equity. In this context the following prudential limits for Interest Rate Sensitivity are suggested:- SI.No. Maturity Bucket Interest Rate Sensitivity(Negative gap) 1 1-28 days 20% of total Rate Sensitive assets 2 29 days to 3 months 20% of total cumulative Rate Sensitive assets 3 Over 3 months to 6 months 20% of total cumulative Rate Sensitive assets 31

4 Over 6 months to 1 year 20% of total cumulative Rate Sensitive assets 5 Over 1 year to 3 years 15% of total cumulative Rate Sensitive assets Over 3 years to 5 years 2.5% of total cumulative Rate Sensitive assets 6 7 Over 5 years 2.5% of total cumulative Rate Sensitive assets In case of need, up to 50% of individual gap limits specified against each maturity bucket between one d ay and up to one year may be allowed to cumulate to immediate preceding or immediate succeedi ng maturity bucket and will be reported to ALCO. Earning at Risk: Impact on Bank 's net interest income (Nil) is worked out for the period of next one year by analyzing the impact due to an adverse change in interest rate on the rate sensitive gap position up to one year time buckets. The EaR will be calculated for last rep01ting Friday of each month and reported to ALCO. EaR will be calculated for the following scenarios: It is assumed that at the change in interest rates is general, uni-directional and is applicable by the same amount and the same time on all rate sensitive assets and liabilities, for working out the decline in Nil. Basis Risk: The change in the rate of interest on different assets and liabilities comes with different magnitudes which are referred to as the basis risk. When the basis risk causes the NIM to expand it is favorable but when it contracts the NIM it is unfavorable to the bank. So factoring in the basis risk, diffe rent rate shocks will be applied to the respective time buckets and the effect will be calculated fior the next full year. The basis will be calculated once in a qua1ter and will be used for the next quarter. The bank also work out Earning at Risk (EaR) i.e.20-30% of the last years Nil or Net Interest Margin ( NIM) based on views on interest rate movement. Implementation: Action plan of ALCO will be implemented by the respective deptt.,alco shall review implementation and apprise progress to ALCO/Sub-Committee of Board on ALM & Risk Management/Board periodically. Bank shall endeavor to maintain the exposures with in the prudential limits prescribed in ALM policy. Review of the Policy and prudential Limits: Bank shall generally review the policy and prudential limits fixed there in every year. Pending such review of the revised policy, the policy in vogue will continue. Reporting and Review:- The following review notes are also to be considered by ALCO with frequency mentioned and suitable corrections I adjustments in the policy decisions where ever required be brought about. 32

SI.No. Particulars Periodicity for review Purpose 1 Structural Liquidity Monthly Liquidity risk management 2 Liquidity Risk Monthly Liquidity risk Indicators management 3 Dynamic Liquidity Monthly Liquidity risk management 4 Interest rate Quarterly Interest Rate Risk Sensitivity analysis Management Reviewing Departments ALCO/to Board on quarterly Basis ALCO/to Board on quarterly Basis ALCO/to Board on quarterly Basis ALCO/to Board on quarterly Basis ALCO will ensure the adherence to the ALM objectives and guidelines. The Deptt. will apprise the position in this regard to ALCO on monthly basis and to Board on quarterly basis. 33

Maturity Profile - Liquidity Heads A.Outflow 1 Capital,Reseves and Surplus 2 Demand Deposit ( Current and Saving Bank Deposit) Classification into Time Band (Bucketing Pattern) Over 5 year band Saving Bank and Current Deposit may be classified into volatile and Core position Saving Bank( I 0%) and Current( 15%) Deposit is generally withdrawable on demand. This portion may be treated as volatile while volatile portion can be placed in the first time band ie, 1-14 days, the core portion may be placed in over 1-3 years time band. (As per NABARD guidelines the above classification of Saving Bank & Current Deposits is only a benchmark.) The Bank may also classify the Saving Bank and Current Deposits on behavioral pattern on following basis:- Behavioral analysis of the bank gives the average out flow for one day. For outflow in 1-14 days bucket the one-day outflow is multiplied by the number of days between the buckets 14. Last 36 months balances is arranged date wise and minimum is calculated which is the minimum core amount and is placed in the over 5 years bucket. The remaining balance (excluding volatile and minimum core) is placed in the 1-3 vears bucket. 3 Term Deposits Respective maturity buckets 4 Certificate of Respective maturity buckets. Deposit, Borrowings & Bonds ( including sub-ordinated Debt) 5 Other Liabilities and Provisions i. Bills Payable 1-14 days time band ii. Branch Adjustments iii. Provisions other than for loan loss and depreciation in investments iv. Other Liabilities The net credit balance may be shown in 1-14 days time band. Respective time bands depending on the purpose Respective time bands. Items not representing cash payable (ie.guarantee fee received in advance, etc.) may be placed in over 5 years time bands. 34

Heads Classification into Time Band B. Inflow 1. Cash l-14 days time bands 2. Balance with RBI/ Public Sector Bank While the excess balance over required for CRR/SLR purpose CRR/SLR may be shown under 1-14 days time bands, the Statutory Balances may be distributed amongst various time bands corresponding to the maturity profile of DTL with a time -lag of 28 days 3. Balances with other Banks (i) Current Account Non- withrawable portion on account of stipulations of minimum balances may be shown under over 1-3 years time band and the remaining balances may be shown under 1-14 days time band. short notice, Term Deposits and other placements 4. Investments(Net of Provision) (i) Approved securities Respective residual maturity time bands excluding the amount required to be reinvested to maintain SLR corresponding to DTL profile in various time bands.. (ii) PSU bonds, CDs and CPs, Units of UTI (close ended) etc. Respective residual maturity time band. Investments classified as NPAs should be shown under over 3-5 years time bands(sub standard) or over 5years time band( Doubtful) (iii ) Equity of all India Fls,Units of UTI(Open ended) Over 5 years time bands. (iv) Securities in the Trading Books 5. Advances (i) Bills Purchased and Discounted (including bills under DUPN) 1-14, 15-28 and 29-90 days time bands corresponding to defeasance periods. Respective residual maturity time bands. (ii) Cash Credit I Overdraft(including TOD) and Demand Loan component of working Capital Behavioural & Seasonal pattern of availments based on outstanding and the core and volatile portion should be identified while the volatile p011ion could be shown in the near -term maturity time bands, the core portion may be shown under over 1-3 year time band. 35

(iii) Term Loans Interim cash flow (Installments) should be shown under respective maturity time bands. 6. NPA(Net of provisions, overdue interest Reserves and claims received from DICGC) (i) Sub- standard Over 3-5 years time bands (ii) Doubtful and loss Over 5 years time bands 7. Fixed Assets Over 5 years time bands 8. Other Assets (branch Adjustment) The net debit balance may be shown in 1-14 days time band. Intangible Assets and assets not representin g cash receivables may be shown in over 5 years time band. 36

Heads Classification into Time Band C. Contingent Liabilities /Lines of Credit committed I available and other Inflows/Outflows I. Unavailed portion of Cash Credit/ Overdraft / demand Loan component of Working Capital limit (Outflow) Behavioural and seasonal pattern of potential availments in the accounts and the amounts so arrived at may be shown under relevant residual maturity time bands with in 12 months Potential availment in the unavailed portion ofcc/od accounts (excluding where limit utilization is 100% or more) is worked out as under:- (1) Quarter wise percentage of utilization of limits is worked out for the last "4" quarters based on the sanctioned limit and balance outstanding (Cr, balance to be ignored) on the last day of the respective quarters. (2) Difference between the percentages of utilization from the above is worked out. The difference obtained for each consecutive quarter is divided by the unavailed percentage of each preceding quarter. The highest percentage thus obtained is treated as potential percentage availment ofthe unavai led portion. (3) The unaveiled portion is worked out throu gh the latest quarter's information by taking the difference between the total limits and the outstanding balance (Cr. Balance ignored). (4) The potential availment amount is worked out by multiplying the potential percentage availment to the unavailed amount (as obtained in point (3) above) and this is distributed uniformly upto one year buckets in proportion of number of days. 2. Contingent Liabilities-Letters of Credit I Guarantees devolvement (Outflow) Expected development in LC will be worked out separately as under:- 1) Quarter wise total amount developed for the previous four quarters is taken and its average is worked out. 2) Since development of LIC initially entails cashout flows and subsequently amounts get recovered, hence actual devolvement will be limited to one quarter figures on an average. Bank guarantee is normally not expected to devolve on the bank. Therefore development under Bank Guarantee will be bucketed in proportion of number of days up to one year. 3) The average so worked out as above will be the likely devolvement amount and would be distributed uniformly up to 90 days buckets in proportion of number of 37 days to

3. Repos/ Bills Rediscounte d (DUPN) (OUTFLO 4. Interest W/ payable /receivable INFLOW) ( outflow/inflow) Accrued Interest which are appearing in the Note: books on the depict outflow of funds, in respect of letter of Credit. In respect of Bank Guarantee the likely devolvement will be distributed up to one year in the proportion of number of days in each time bucket. Respective residual maturity time band' Respective time bands. Liabilities reporting on account day. of event cash flows i.e. short fall in CRR/SLR balances on reporting Fridays, wage settlement, Capital Expenditure, etc. which is known to the bank & other contingent liabilities may be shown under respective maturity bands. All overdue liabilities should be placed in the 1-14 days time band. Interest & Installments from advances and investments, which are overdue for less than one month, may be placed in over 3-6 months; time band. Further interest & installments due (before classification as NPA) may be placed in over 6-12 months time band if earlier receivables remain uncollected. 38

Interest Rate Sensitivity S.No Heads Rate sensitivity and time band Liabilities 1. Capital Non Sensitive 2. Reserves and Non Sensitive surplus 3. Current Non Sensitive DeQosits 4. Saving Bank Sensitive to the extent of interest paying Deposits (core)portion. This should be included in over 3-6 months time band. The non - interest - paying 5. Term Deposits and Certificates of Deposit 6. Borrowings - Fixed 7. Borrowings - Floating 8. Borrowings - Zero Coupon 9. Borrowings - from RBI 10. Refinance from other Agencies portion may be shown in Non - Sensitive band. Sensitive, reprices or resetting of interest rates on maturity. The amounts should be distributed to different time bands on the basis of remaining term to Sensitive, maturity. reprices on maturity. The amount should be distributed to different time bands on the basis of remaining maturity. Sensitive, reprices when interest rate is reset. The amount should be distributed to the appropriate time band that refers to the respective date. Sensitive, repnces on maturity. The amounts should be distributed in the respective maturity Upto time band. 3 months time band. Fixed rate: As per respective maturity. Floating rate: Reprises when interest rate is Reset. 11. Other Liabilities and provisions (I) Bills payable Non Sensitive (ii) Branch Non Sensitive Adjustment (iii) Provisions Non Sensitive (iv) Others Non Sensitive 12. Repos/ Bills Re- Sensitive, re-prices on maturity and amounts discounted(dupn) should be distributed in the respective maturity time band. 39

Interest Rate Sensitivity S.No Heads Rate sensitivity and time band Assets 1. Cash Non Sensitive 2. Balance with RBI Interest earning portion may be shown in over 3-6 months time band. The balance amount is Non- Sensitive. 3. Balances with other Banks (i) Current Non Sensitive (ii) Money Account call & Sensitive, on maturity. The amounts should be Short Notice, distributed to respective maturity time bands. Term Deposits and other Placement 4. Investments (Performing) (i) Fixed Rate I Sensitive on maturity Zero coupon (ii) Floating Rate Sensitive at the next repricing date. 5. Shares of all Non- sensitive India 6. FI/Units Advances of (Performing) UTI (i) Bills Purchased Sensitive on maturity and discounted (including bills (ii) underdupn) Cash Credit Sensitive, may be shown under over 3-6 months time band. I Overdrafts (including TOD)I Loans repayable 7. NPA on demand (Advances and and Investment) (i) Term Sub- standard Loan Over 3-5 years time band. (ii) Doubtful and Over 5 years time band. 8. Loss Fixed Assets Non-sensitive 9. Other Assets:- (i) Inter-office Non Sensitive Ad.iustment (ii) Other Non Sensitive 10. Othea Products(interest rate) (i) Other Should be suitably classified as & when introduced. 40

Appendix - II The ALM system rests on 3 pillars Management Information System Organisation and responsibilities ALM risk control process ALM Information System Management Information System should ensure Information availability, accuracy, adequacy and expediency Successful implementation of the ALM process depends on the Level of representation in the committee Commitment of the members Policy for the ALM process Scope of the ALM function would revolve around the ALM Process Risk parameters Risk identification Risk measurement Risk management Risk policies and tolerance levels. The focus of ALM in a Financial Institution would revolve mainly around Liquidity, Interest Rate Risks and Market risk Liquidity Liquidity is the ability of the bank to meet obligations as and when they fall due If it fails to meet the obligations, Liquidity Risk arises 41

Liquidity positions should be measured and examined as to how the liquidity is likely to evolve under differing assumptions Liquidity needs to be tracked through maturity or cash flow mismatches Interest Rate Risk: The likely adverse effect on financial position of a bank due to changes in market interest rates. The immediate impact is on the Net Interest Income (NII) - Earnings Perspective. Long term impact is on the bank s net worth since the economic value of on and off B/S positions get affected. - Economic Value Perspective Trading Book Price/ Interest rate risk is the prime concern Only GOI securities held under Held for Trading category Marking to market on a fortnightly basis Techniques: PVBP, VaR, Stop Loss Limit Limits: volume,maximum maturity, holding period, duration and defeasance period. VaR limits have also been fixed Stop Loss policy The ALM Policy has been approved in 140th meeting of the Board of Directors held on 12 June 2004. The Asset Liability Management (ALM) policy of RRBs aims at managing liquidity and interest rate risks of funds at acceptable levels. The policy emphasizes the need to formulate, implement, and monitor asset liability strategies to achieve financial objectives within the defined risk tolerance limits and constraints. The major focus of the policy is to optimise returns with financial stability. The major objectives of the ALM policy are 42

a. To manage the assets and liabilities of a bank in order to enhance funds profitability within the existing legal and regulatory framework b. To foster stronger emphasis on risk management and to encourage improvements in risk assessment capabilities to protect the institution from any disastrous financial consequences arising from changes in interest rate. The policy stresses the importance of integrating basic operations and strategic decision making with risk management. c. To strive for effective management and measurement of liquidity so as to meet anticipated and unanticipated operating cash needs, demands for refinance and other withdrawals without incurring sustained negative impact on profitability. d. To outline the measures for trading risk management so as to limit the potential loss that would be incurred in a portfolio of assets/liabilities over a given time period. e. To provide a dynamic framework for measuring, monitoring the foreign exchange risk of liabilities and assets. f. To instill an efficient management information system for adequate, accurate and timely availability of data. ALCO is responsible for recommending to the Board of Directors, prudent asset/liability management policies and procedures that enable the Bank to achieve its goals while operating in full compliance with all rules, and regulations. ALM Policy has stipulated following tolerance limits as regards liquidity mismatch. i) 1 to 14 days and 15 to 28 days negative mismatch should not exceed 10% of the cash outflows in the respective time buckets. ii) 29 days and upto 3 months, over three months and upto 6 months, Over 6 months and upto 1 year negative mismatch should not exceed 15% of the cash outflows in the respective time buckets. For all other time buckets, the negative mismatches should not exceed 25 % of the cash outflows in the respective time buckets. 43

The cumulative negative gap should not exceed 25% of cash outflow. As regards interest rate sensitivity, ALM Policy has stipulated following gap to total asset ratio limits between Rate Sensitive Assets and Rate Sensitive Liabilities - i) All time buckets upto 1 year negative gap should not exceed 1% of total assets. ii) More than 1 year to 3 years negative gap should not exceed 1% of total assets. iii ) For all higher time buckets, no negative gap. iv) Cumulative gap not to exceed 4% of toatal assets. Interest rate sensitivity analysis will also include - i) Impact of repricing of RSA and RSL in time buckets upto1 year on Net Interest Income. ii) Duration analysis. iii)simulation analysis. Limits fixed for the risk to earnings arising from mismatches between the repricing of assets and liabilities. For the Interest ratechange variability in the Net Interest Income +300 basis points Min +20.00% +200 basis points Min +20.00% +150 basis points Min +15.00% +100 basis points Min +12.50% 0 10.00% -100 basis points Max -12.50% -150 basis points Max 15.00% -200 basis points Max 20.00% -300 basis points Max 20.00% 44

Simulation analysis. The focus of simulation is to measure risk to net income by projecting the future composition of the bank s balance sheet and applying different interest rate scenarios. Simulation modeling will be incorporated to run "what if" analyses to determine the effect of different strategies on the bank's risk profile and profitability. simulation can adequately assess short-term (1-2 years) interest rate risk. Duration analysis For capturing and isolating the risks associated with longer term repricing imbalances, duration gap analysis of the balance sheet may be attempted to evaluate longterm fixed-rate positions. Duration is a measure of the percentage change in the economic value of a position that will occur given a small change in the level of the interest rates. Calculating the precise duration for each asset, liability and off-balance sheet items can help assess the effect of changing market rates. This will require information about all the cash flows associated. For minimising the risk of trading stock in Government Securities i) The maximum amount of investments that can be deployed in Government Securities and other Instruments exposed to market risk should not exceed 10 percent of the total assets. ii) The maximum maturity of the securities in the portfolio should not exceed 25 years taking into consideration the active extreme securities in the Yield Curve. iii) The maximum holding period in respect of the Held for Trading (HFT) Category Securities should not exceed 90 days as prescribed by RBI. However, the average holding period of the securities should not be more than 45 days. iv) The duration of the portfolio should not, in any case, exceed 8 years. The structure of the portfolio may be designed by appropriate mix of the short and long duration securities with a view to optimizing the return with risk minimization. v) The stop loss policy as approved by the Board should be operated effectively. vi) The potential price risk to changes in the market risk should be measured using Value at Risk model. with a given confidence level of 99% for a ten days horizon using Monte Carlo simulation method. VaR of portfolio will be kept limited to Rs. 20 crore at present 45

ALM Support Group will be responsible for (i) Collection and compilation of data for ALCO. (ii) Analysis, monitoring and reporting to ALCO (iii) Undertake various analyses and simulations as enshrined in the ALM policy, including preparation of forecast showing the effects of various possible changes in market conditions related to the balance sheet, (iv) Recommend the action needed to adhere to different stipulations of ALM Policy. The Mid-office would be responsible for (i) Independent market risk monitoring, measurement, analysis and reporting for the ALCO, (ii) Tracking the magnitude of market risk periodically, (iii) Control risk related to trading operations and management of interest rate risk in the investment portfolio (iv) Monitoring and reporting of all types of market risk to ALCO (v) Designing an internal Transfer Price Mechanism. (vi) Recommend revision/updation of ALM policy in tune with RBI guidelines. The Reports are prepared at fortnightly intervals. The Reports are to be accurate, complete in all respects and submitted in time. All cash flows emanating over the entire life of all the assets and liabilities are to be classified and included. The cash flows arising from the assets, liabilities and contingencies to be classified into different time-buckets as per their residual maturity/ timing of the cash flow. In case of sensitive cash flow, footnote to be given mentioning the sensitivity. The cash inflows on account of the interest and principal of the loan may be slotted in respective time buckets as per the timing of the cash flows as stipulated in the original/revised repayment schedule. 46

b) Interest payable on bonds / deposits / Borrowings The cash outflows during the entire life of the deposit are to be slotted in respective time buckets as per the residual period to the due date of payment. Interest intervals being used to analyse the interest rate sensitivity are:- Upto 5.0% >5.0% to 5.5% >5.5% to 6.0% >6.0% to 6.5% >6.5% to 7.0% >7.0% to 8.5% >8.5% to 10.5% >10.5% to 12.5% Above 12.5% There was positive gap in all time buckets except in the bucket 7 to 10 years. This gap was fully covered by positive gap in the lower buckets indicating no liquidity risk. Investment in G-Sec and Mutual fund constituted 2.55% of total assets as against the cap of 10% prescribed in ALM policy. Average duration of AFS & HFT portfolio was 5.51 and 6.12 years respectively. VaR of G-Sec AFS and HFT stock at 99% confidence level for 10 days horizon as on 31 March 2014 is Rs. 8.33 crore and Rs. 0.931 crore respectively. Notional profit on the AFS Stock, as per FIMMDA valuation was Rs. 92.53 crore as on 31 March 2014. Provision for depreciation in value of AFS stock is of Rs. 19.60 crore. Price Value of one basis point of the AFS stock of G-Sec as on 31 March 2014 is Rs. 0.19 crore. Impact of 100 bp change is Rs. 18.26 crore.balance is Investment Fluctuation Reserve is Rs. 96.43 crore. G-sec prices recovered during October sharply.10y GOI ranged from 7.62% to 7.53%. In international market oil prices ranged from $59-$62 barrel for around 6 weeks 30% down from record high of $78.40 in July. 47

Appendix - III Correlation Matrix has 3 rows and 3 columns. NAI PM APCO +-------------------------------------------------------------------------------- NAI 1.0000 0.5714 0.1428 PM 0.5714 1.0000 0.3429 APCO 0.1428 0.3429 1.0000 Step-wise regression results Step I ---------------------------------------------------------------------------------+ OLS regression Expl. Variable(s) = NIA Dep. var. = NIM Mean = 0.91, S.D.= 2.2774830E-01 Model size: Observations = 36, Parameters = 2, Deg.Fr.= 34 Residuals: Sum of squares=.4408017005e-03, Std.Dev.=.00577 Fit: R-squared=.674568, Adjusted R-squared =.61478 Model test: F[ 1, 34] = 6.51, Prob value =.00000 Diagnostic: Log-L = 4.6288, Restricted(b=0) Log-L = 2.5691 LogAmemiyaPrCrt.= -.7129, Akaike Info. Crt.= -.4947 +-----------------------------------------------------------------------------------------+ Step II ----------------------------------------------------------------------------------+ OLS regression Expl. Variable(s) = NIA, PM Dep. var. = NIM Mean = 0.91, S.D.= 2.2774830E-01 Model size: Observations = 36, Parameters = 3, Deg.Fr.= 33 Residuals: Sum of squares=.4208017005e-03, Std.Dev.=.00537 Fit: R-squared=.751234, Adjusted R-squared =.72238 Model test: F[ 2, 33] = 6.45, Prob value =.00000 Diagnostic: Log-L = 4.5598, Restricted(b=0) Log-L = 2.3547 LogAmemiyaPrCrt.= -.7845, Akaike Info. Crt.= -.5215 +-----------------------------------------------------------------------------------------+ Step III -------------------------------------------------------------------------------+ OLS regression Expl. Variable(s) = NIA, PM, APCO Dep. var. = NIM Mean = 0.91, S.D.= 2.2774830E-01 Model size: Observations = 36, Parameters = 4, Deg.Fr.= 32 Residuals: Sum of squares=.4108017005e-03, Std.Dev.=.00514 Fit: R-squared=.782376, Adjusted R-squared =.76595 Model test: F[ 3, 32] = 7.62, Prob value =.00000 Diagnostic: Log-L = 5.9871, Restricted(b=0) Log-L = 2.1876 LogAmemiyaPrCrt.= -.8134, Akaike Info. Crt.= -.5673 +-----------------------------------------------------------------------------------------+ 48

Appendix - IV Questionnaire (Please put a tick in appropriate box) 1. After attending the training programme at BIRD, I am able to understand the various types of risks indicated below, associated with banks: Type of Risk Able to understand Yes No Credit Risk Liquidity Risk Interest Rate Risk Operational Risk 2. I came to know about the financial market instruments and terms like SEBI, OTCEI, NSE, FIMMDA etc., after attending the programme Yes No. I knew these terms even before attending the training programme 3. I came to know on the concept of ALM after attending the programme Yes No. I knew about ALM even before attending the training programme 4. Whether the course material provided during the training was useful? Yes No No Scope for use 5. Have you been posted to the ALM desk /Cell after attending the training conducted by BIRD? I was posted to the desk even before I attended the training I have been posted to the desk after attending the training programme I have not been posted although I have undergone the training At present I am working on ALM desk (yes / no) 6. Whether you shared the inputs received during training with other colleagues working on ALM desk? Yes No 49

7. To what extent the knowledge gained during the training is useful in your day-to-day functioning? To a great extent To some esxtent No scope for use 8. Whether your bank has formulated ALM policy? Yes No 9. If answer to above question is yes, whether the training programme at BIRD helped you to assist in formulation/refinement of the policy in your bank The programme helped me to a great extent in assisting in formulation / refinement of ALM policy in my bank The programme helped to some extent in assisting in formulation / refinement of ALM policy in my bank Policy was formulated in the bank before I attended the programme I did not get an opportunity to assist in formulation / refinement of the policy 10. Whether the training programme has helped the bank in any of the following areas? Particulars Programme helped Yes No Constitution of ALCO Finalising agenda items for ALCO Understanding interest rate movements and expected spreads Understanding mismatches in maturity pattern Understanding pricing of loan products, risk mitigating measures for liquidity and interest rate risks Operational issues and difficulties associated in implementation of the ALM Areas for further improvement Discussions on investment portfolio 50

11. What type of ALM tools have been introduced by your bank after your attending the training programme? Particulars Preparation of Liquidity Gap Statement Preparation of Gap Statement to measure interest rate risk Duration concept Impact of interest rate movement on Net Interest Margin (NIM) Only some of these tools have been introduced None of these tools are used in the bank for ALM Tool used / introduced Yes No 12. In order to mitigate liquidity risk, which of the following statements have been introduced in your bank after you are attending the training programme? Particulars Putting assets and liabilities in different time buckets Structural Liquidity statement Dynamic Liquidity statement Statements at (1) and (2) only are introduced None of the above statements introduced Statement introduced Yes No 13. In your opinion whether the profitability of the bank has improved after implementation of ALM concept in the bank? Yes No 14. Which of the following areas related to ALM, in your opinion, have contributed in bringing about overall improvement in the financial position of the bank? Particulars Whether resulted in improving financial position of the bank Yes No Preparation of Liquidity Gap Statement Preparation of Gap Statement to measure interest rate risk Introduction of Duration concept Preparation of Structural Liquidity Ladder Preparation of Dynamic Liquidity Ladder None of the above 51

15. What suggestions would you like to give to bring about improvement in the training programme on ALM conducted by BIRD? Particulars Yes No The programme does not need any changes and may continue to be conducted in the present format. The contents of the programme were inadequate and needs to be upgraded Cannot comment as I am not presently working on the ALM desk 52

Appendix VI- Key Financial Ratios of Sample RRBs (Bank-wise) Net Interest Margin Name of the Bank: Name of the State Sponsor Bank: 31-03- 2012 31-03-2013 31-03-2014 1.Chaitanya Godavari Grameena Bank Andhra Pradesh Andhra Bank 0.99 0.95 1.14 2. Deccan Grameena Bank Andhra Pradesh State Bank of Hyderabad 1.18 1.13 1.23 3. Bihar Gramin Bank, Bihar UCO Bank 0.96 0.92 1.81 4. Uttar Bihar Gramin Bank 5. Chhattisgarh Rajya Gramin Bank Bihar Chhattisgarh Central Bank of India 0.51 State Bank of India 1.10 0.49 0.58 1.06 0.74 6. Baroda Gujarat Gramin Bank Gujarat Bank of Baroda 0.28 0.27 0.47 7. Dena Gujarat Gramin Bank Gujarat Dena Bank 0.67 0.63 0.71 8. Saurashtra Gramin Bank 9. Gurgaon Gramin Bank 10. Narmada Jhabua Gramin Bank, Gujarat Haryana Madhya Pradesh State Bank of India 1.46 Syndicate Bank 1.36 Bank of India 1.37 1.38 0.83 1.28 1.51 1.29 1.72 11. Maharashtra Gramin Bank Maharashtra Bank of Maharashtra 0.73 0.69 0.75 12. Vidharbha konkan Gramin Bank Maharashtra Bank of India 0.74 0.7 0.59 13. Manipur Rural Bank Manipur United Bank of India 0.27 0.25 0.05 53

14. Meghalaya Rural Bank 15. Mizoram Rural Bank 16. Odisha Gramya Bank 17. Utkal Gramya Bank, 18. Puduvai Bharathiar Grama Bank Meghalaya Mizoram Odisha Odisha Tamil Nadu State Bank of India 2.80 State Bank of India 0.60 Indian Overseas Bank 0.39 State Bank of India 0.22 Indian Bank 1.48 2.64 0.93 0.57 1.16 0.37 0.19 0.21 0.42 1.4 1.46 19. Punjab Gramin Bank 20. Sutlej Gramin Bank 21. Baroda Rajasthan kshetriya Gramin Bank Punjab Punjab Rajasthan Punjab National Bank 1.12 Punjab and Sind Bank 0.40 Bank of Baroda 0.45 1.03 0.77 0.37 0.85 0.41 0.84 22. Marudhara Gramin Bank 23. Tripura Gramin Bank 24. Allahabad U P Gramin Bank Rajasthan Tripura Uttar Pradesh State Bank of Bikaner and Jaipur 0.04 United Bank of India 2.02 Allahabad Bank 1.22 0.04 0.83 1.85 1.99 1.12 0.27 25. Gramin Bank Of Aryavart Uttar Pradesh Bank of India 1.25 1.15 1.25 54

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