MBA 2018-2020

Managing Interest Rate and Liquidity Risks

Submitted to: Mr. Aneesh Day
Submitted on: 18th December 2018

Submitted by:
Ashray Sawhney, D-14
Awanish Kumar, D-15
Badri Narayan Goswami, D-16
Bipul Kumar, D-17
Deepak Kumar, D-18
Deepika Rana, D-19

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 INDEX

Page
Name Topic
No.
Badri Narayan
Goswami Introduction to the Major Risks Faced by
Banks 3-8
D-16

Bipul Kumar Asset liability Management

D-17 9-14

Ashray Sawhney
Interest Rate Risk Management
D-14 15-19

Deepika Rana Managing Interest Rates Risk with Interest

20-25
D-19 Rate Derivatives

Deepak Kumar Liquidity Risk Management and Basel III 26-37

Applicability to Banks in India

Awanish Kumar 38-42

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 Introduction to the Major Risks Faced by Banks

Over the decades, the financial services industry has undergone significant transformation due to
internal and external factors, including business model transformation, adoption of advanced
technologies, changing regulatory environments, etc. Modern banking sector is a highly complex
ecosystem, where stakeholders of different backgrounds — internet, tech companies, startups —
play an increasingly influential role.

In an increasingly complex environment of the financial services industry, new complexities

arise, requiring an adjustment in risk management systems and procedures. For financial
institutions, expanding the array of risks that come with new types of players, new technologies,
ever-growing complexities of national and international regulations, as well as changing
consumer behavior, require significant resource investments to address financial and other risks
naturally occurring as a result of those changes. More than ever, chief risk and compliance
officers play a critical role in monitoring and managing these risks to ensure a safe
transformation of banking, and ensure continuity of their businesses.

In its simplest sense, risk could be defined as the uncertainty of an event to occur in the future. In
the banking context, it’s the exposure to the uncertainty of an outcome, where exposure could be
defined as the position/stake a bank takes in the market.

If history was any indication, banks have borne billions in losses due to imprudent risk-taking. It
is hence vital to understand the different types of risks faced by every bank in 2018 and beyond.

Banking risks can be broadly classified under 11 categories:

1. Business/Strategic risk
2. Compliance risk
3. Credit risk
4. Cybersecurity Risk
5. Liquidity risk
6. Market risk
7. Moral hazard
8. Open Banking Risk
9. Operational risk
10. Reputational risk
11. Systemic risk

1. Business/Strategic risk
Business risk is the risk arising from a bank’s business strategy in the long term. When a bank
fails to adapt to the changing environment as quickly as their competitors, it faces the risk of
losing market share, getting acquired, or shutting shop.Technology is changing the banking
landscape at an incredibly rapid pace. Banks need to rethink the outdated framework of the core
banking systems, rethink the design of their end to end tech stack and build upon efficient and
quicker bank end systems to turn around and meet the demand of the largely impatient digital
consumer.
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We already see progressive banks like BBVA, DBS, make strides in technological innovation to
meet changing consumer demands — whether through strategic partnerships, acquisitions, or in-
house developments. Moreover, the non-financial tech players like Google, Amazon, Alibaba,
Tencent are either aggressively acquiring or investing in the in-house development of new age
technologies to offer certain financial services to their vast user bases.

2. Compliance Risk
In February this year, U.S. Bancorp agreed to pay $613 million in penalties to state and federal
authorities for violations of the Bank Secrecy Act and a faulty AML program. This was a result
of the banks’ failure to adopt and implement an effective compliance program with adequate
internal controls, testing, and training.

Source: Cost of Bank Misconduct, MEDICI Research

According to the Bank of International Settlements(BIS), in the banking context, compliance risk
is defined as the risk of legal or regulatory sanctions, material financial loss, or loss to reputation

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a bank may suffer as a result of its failure to comply with laws, regulations, rules, related self-
regulatory organization standards, and codes of conduct applicable to its banking activities.

It is imperative for banks to establish an infrastructure to organize and analyze data and
efficiently manage legal documentation. The senior management of a bank plays the crucial role
in formulating, communicating and managing compliance policies across all business units of the
bank to minimize compliance risk.

In the recent years, banks have begun to implement tech solutions(“RegTech”) across various
cases - data management, digital identity, e-KYC/AML/CFT, fraud monitoring and control,
governance, internal integrity, regulatory reporting, risk management, etc. Startups like Trulioo,
Signzy, Onfido have been working with banks to enable digital identities and provide seamless
customer onboarding by using effective tools that collect and assess large volumes of data and
perform related tasks.

3. Credit risk

Credit risk is the one that most would be familiar with as economies continue to recover from the
more recent occurrence in the history of financial services: the subprime crisis. Both global and
national banks suffered heavy losses due to incorrect evaluation and monitoring of potential
default rates on mortgage payments by subprime borrowers. This fiasco resulted in billions of
dollars in damages and millions to be jobless overnight.

The Basel Committee on Banking Supervision defines credit risk as the potential that a bank
borrower, or counterparty, will fail to meet its payment obligations regarding the terms agreed
with the bank. It includes both uncertainty involved in repayment of the bank’s dues, and
repayment of dues on time.

It could occur because of the following reasons:

 Inadequate income of borrowers

 Inadequate underwriting frameworks
 Business failure of the borrowers
 The unwillingness of the borrowers to repay

4. Cybersecurity Risk

In May 2018, two of Canada’s largest banks, Bank of Montreal, and the Canadian Imperial Bank
of Commerce’s Simplii Financial confirmed hackers stole the personal and financial data of
more than 90,000 customers. While the banks took online security measures after the hackers
contacted them, it was surprising to see that these processes were not put in place before.

Cybersecurity risk is the most prevalent IT risk in the financial services industry. It refers to the
risk undertaken by a financial institution to keep electronic information private and safe from
damage, misuse or theft.

Cybersecurity risk is as much of a people risk as it is technology risk. The risk arises from a
range of external and internal factors at banks such as:
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 1. Lack of user privilege segregation
2. Missing transaction business controls
3. Poor password policies;
4. Inadequate logical access controls
5. Shortcomings in personnel vetting

The key to mitigating the cybersecurity risk is to ensure that the controls are applied across all
business units and divisions to ensure that no permissions to access are granted
unintentionally/without prior knowledge.

5. Liquidity risk

Northern Rock, a small bank in Northern Ireland, had a small depositors’ base and hence
financed a significant portion of its loans by securitization. In 2007–08, during the subprime
crisis, the bank was unable to sell the loans to other banks that it had originated in the form of
new loans resulting in investors withdrawing their money from the bank. This resulted in a
liquidity crunch, which led to the bailout by the government and an eventual government
takeover. This is a classic example of how imprudent management of liquidity risk can ruin a
bank.

Liquidity management can be defined as the risk of a bank not being able to finance its day to
day operations. Failure to manage this risk could lead to severe consequences for the bank’s
reputation as well as the bond pricing and ratings of the bank in the money market.

6. Market risk

According to The Basel Committee on Banking Supervision, market risk can be defined as the
risk of losses in on- or off-balance sheet positions that arise from movement in market prices.\
The four components of market risk are:

 Interest risk: potential losses due to a change in interest rates. Requires Banking
Asset/Liability management.
 Equity risk: potential losses due to change in stock prices as banks accept equity against
disbursing loans.
 Commodity risk: potential losses due to change in commodity (agricultural, industrial,
energy) prices. Massive fluctuations occur in these prices due to continuous variations in
demand and supply. Banks may hold them as part of their investments, and hence face
losses.
 Foreign Exchange risk: potential loss due to change in the value of the bank’s assets or
liabilities resulting from exchange rate fluctuations as banks transact with their
customers/other stakeholders in multiple currencies.

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7. Moral hazard
The probability for a bank to take on unprecedented levels of risk without evaluating the
economic soundness of the decision of risk-taking for all parties involved can be regarded as a
moral hazard. The decision is often based on the fact that a third party/another institution will
underwrite the risk.

Moral hazard occurs when the bank decides the magnitude of the risk to be undertaken with the
knowledge that a counterparty bears the cost of the risk taken.

Once again, the subprime crisis proves to be a classic example of this. Banks risked depositors’
money to facilitate transactions of very risky instruments, knowing they would not face the
consequences directly. Top management of all banks can be prone to moral hazard.

8. Open Banking risks

An open banking ecosystem functions as a single platform for a number participants like
regulators and government agencies, data providers, third-party providers, customers, to engage
in an open infrastructure with an end motive to enhance the customer experience.

While this will push banks to aim at being fully digital, and make customer data more accessible
for the ecosystem to build superior products on, it could also create an environment that would
enable more fraud.

Aggregated customer data such as transactions maintained in the third-party provider’s(FinTech

startup’s) infrastructure and servers, can cause significant risk to the bank’s cybersecurity. Banks
need to move quick in complying with PSD2 and GDPR directives laid down by independent
government agencies, and the financial regulatory bodies to avoid exposing themselves to a
myriad of systemic risks which could lead to financial as well as reputational damages.

9. Operational risk
Barings, one of the oldest British Banks in 1995, collapsed due to mismanagement of operational
risk. One of its traders successfully hid his trading losses for more than two years due to
inefficient and inadequate internal controls. He authorized his own trades without any approvals.
The supervisors only noticed once the losses became huge and couldn’t be hidden any longer. It
was, however, too late.

The Basel Committee on Banking Supervision defines operational risk as the risk of loss
resulting from inadequate or failed internal processes, people, and systems or external events.

All banks(full service/others) face operational risks in their day to day BAUs across all their
departments including treasury, credit, investment, information technology.

There are three main causes of this risk:

 Human Intervention & Error

 Failure of the IT/internal software & systems
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  Failure of Internal Processes to transmit data & information accurately

10. Reputational risk

Punjab National Bank, the second largest public sector bank in India, was defrauded for more
than ~$1.647 billion by the largest diamond and jewelry businesses in the country, making it the
largest fraud to be detected.

The fraud, incidentally, is 49X the net profit posted by PNB for the quarter ending December 31,
2017, and more than twice the amount that PNB got under bank recapitalization plan. This scam
has caused immense mistrust in the bank’s internal controls and checks causing massive damage
not only to its market capitalization but more importantly its reputation in the country.

Reputational risk implies the public’s loss of confidence in a bank due to a negative perception
or image that could be created with/without any evidence of wrongdoing by the bank.
Reputational value is often measured in terms of brand value. Advertisements play a significant
role in forming & maintaining the public perception, which is the key reason for banks spend
millions in content marketing dollars.

Reputational risk could stem from:

1. The inability of the bank to honor government/regulatory commitments

2. Nonobservance of the code of conduct under corporate governance
3. Mismanagement/Manipulation of customer records
4. Ineffective customer service/after sales services

11. Systemic risk

This risk includes a possibility of bringing down the entire financial system to a standstill, what
was possibly seen during the dot-com bubble in 1995, or the housing market crash of 2008. This
is caused due to a domino effect where the failure of one bank could ripple down the failure of
its counterparties/other stakeholders, which could, in turn, threaten the entire financial services
industry.

The Volatility Index(or VIX) is a good measure of systemic risk. Systemic risk, in itself, would
not lead to direct losses. However, in a scenario where VIX is at high levels, there is a high
probability of market risks(and other risks) to reach very high levels which would eventually
lead to losses.

Conclusion
Banks can exercise a large degree of control over certain risks by enabling and investing in
efficient internal and external controls, systems and processes. They can also manage some types
of risk by ensuring meticulous, tech-driven audits and compliance. Some risks such as systemic
risk, which the banks have little or no control over, can only be mitigated if banks have a strong
capital base, to ensure a sound infrastructure. For further clarification we will be discussing more
about Interest rate and Liquid risk.
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 Asset liability Management

Asset liability management (ALM) can be defined as the comprehensive and dynamic framework for
measuring, monitoring and managing the financial risks associated with changing interest rates, foreign
exchange rates and other factors that can affect the organisation’s liquidity .ALM relates to management
of structure of balance sheet (liabilities and assets) in such a way that the net earning from interest is
maximised within the overall risk-preference (present and future) of the institutions. Thus the ALM
functions includes the tools adopted to mitigating liquidly risk, management of interest rate risk / market
risk and trading risk management. In short, ALM is the sum of the financial risk management of any
financial institution.

In other words, ALM is all about managing three central risks:

Interest Rate Risk

Liquidity Risk

Foreign currency risk

For banks with forex operations, it also includes managing

Currency risk

Through ALM banks try to match the assets and liabilities in terms of Maturities and Interest Rates
Sensitivities so as to minimize the interest rate risk and liquidity risk.

Interest Rate Risk

Asset/liability management is also used in banking, given that a bank must pay interest on deposits, and
also charges a rate of interest on loans. To manage these two variables, bankers track the net interest
margin, or the difference between the interest paid on deposits and interest earned on loans. Assume, for
example, that a bank earns an average rate of 6% on three-year loans and pays a 4% rate on three-year
certificates of deposit. The interest rate margin the bank generates is 6% - 4% = 2%. Since banks are
subject to interest rate risk, or the risk that interest rates increase, clients demand higher interest rates on
their deposits to keep assets at the bank.

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

Currency Risk

Floating exchange rate arrangement has brought in its wake pronounced volatility adding a new
dimension to the risk profile of banks' balance sheets. The increased capital flows across free
economies following deregulation have contributed to increase in the volume of transactions.
Large cross border flows together with the volatility has rendered the banks' balance sheet.
vulnerable to exchange rate movements.

Dealing in different currencies brings opportunities as also risks. If the liabilities in one currency
exceed the level of assets in the same currency, then the currency mismatch can add value or
erode value depending upon the currency movements. The simplest way to avoid currency risk is
to ensure that mismatches, if any, are reduced to zero or near zero. Banks undertake operations in
foreign exchange like accepting deposits, making loans and advances and quoting prices for
foreign exchange transactions. Irrespective of the strategies adopted, it may not be possible to
eliminate currency mismatches altogether. Besides, some of the institutions may take proprietary
trading positions as a conscious business strategy.

Managing Currency Risk is one more dimension of Asset- Liability Management. Mismatched
currency position besides exposing the balance sheet to movements in exchange rate also
exposes it to country risk and settlement risk. Ever since the RBI (Exchange Control
Department) introduced the concept of end of the day near square position in 1978, banks have
been setting up overnight limits and selectively undertaking active day time trading. Following
the introduction of "Guidelines for Internal Control over Foreign Exchange Business" in 1981,
maturity mismatches (gaps) are also subject to control. Following the recommendations of
Expert Group on Foreign Exchange Markets in India (Sodhani Committee) the calculation of
exchange position has been redefined and banks have been given the discretion to set up
overnight limits linked to maintenance of additional Tier I capital to the extent of 5 per cent of
open position limit.

Presently, the banks are also free to set gap limits with RBI's approval but are required to
adopt Value at Risk (VaR) approach to measure the risk associated with forward exposures. Thus
the open position limits together with the gap limits form the risk management approach to forex
operations. For monitoring such risks banks should follow the instructions contained in Circular
A.D (M. A. Series) No.52 dated December 27, 1997 issued by the Exchange Control
Department.

The Asset Coverage Ratio

An important ratio used in managing assets and liabilities is the asset coverage ratio which
computes the value of assets available to pay a firm’s debts. The ratio is calculated as:
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Asset Coverage Ratio = [(BV Total Assets - Intangible Assets) – (Current Liabilities - ST Debt
Obligations)] / Total Debt Outstanding

where BV is short for book value, and ST is short term.

Tangible assets, such as equipment and machinery, are stated at their book value, which is the
cost of the asset less accumulated depreciation. Intangible assets such as patents, are subtracted
from the formula, because these assets are more difficult to value and sell. Debts payable in less
than 12 months are considered short-term debt, and those liabilities are also subtracted from the
formula. The coverage ratio computes the assets available to pay debt obligations, although the
liquidation value of some assets, such as real estate, may be difficult to calculate. There is no rule
of thumb for what a good or poor ratio is, since calculations vary by industry.

Overview of what are asset liability mismatches :

The Assets and Liabilities of the bank’s B/Sheet are nothing but future cash inflows & outflows. Under
Asset Liability Management i.e. ALM, these inflows & outflows are grouped into different time
buckets. Then each bucket of assets is matched with the corresponding bucket of liability.
The differences in each bucket are known as mismatches. banks can even make money as a result of such
mismatches sometimes. Alam Greenspan, ex-Chairman of US Federal Reserve has once observed “risk
taking is necessary condition for wealth creation”. However, it is a risky proposition to keep large
mismatches as it can lead to massive losses in a volatile market. Therefore, in practice, the idea is to
limit the mismatches rather than aim at zero mismatches.

Evolution of ALM in Indian Banking System:

In view of the regulated environment in India in 1970s to early 1990s, there was no interest rate risk as
the interest rate were regulated and prescribed by RBI. Spreads between deposits and lending rates were
very wide. At that time banks Balance Sheets were not being managed by banks themselves as they were
being managed through prescriptions of the regulatory authority and the government. With the
deregulation of interest rates, banks were given a large amount of freedom to manage their Balance
sheets. Thus, it became necessary to introduce ALM guidelines so that banks can be prevented from big
losses on account of wide ALM mismatches.

Reserve Bank of India issued its first ALM Guidelines in February 1999, which was made effective from
1 st April 1999. These guidelines covered, inter alia, interest rate risk and liquidity risk measurement/
reporting framework and prudential limits. Gap statements were required to be prepared by scheduling all
assets and liabilities according to the stated or anticipated re-pricing date or maturity date. The Assets
and Liabilities at this stage were required to be divided into 8 maturity buckets (1-14 days; 15-28 days;
29-90 days; 91-180 days; 181-365 days, 1-3 years and 3-5 years and above 5 years), based on the
remaining period to their maturity (also called residual maturity).. All the liability figures were to be
considered as outflows while the asset figures were considered as inflows.

As a measure of liquidity management, banks were required to monitor their cumulative mismatches
across all time buckets in their statement of structural liquidity by establishing internal prudential limits
with the approval of their boards/ management committees. As per the guidelines, in the normal course,
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the mismatches (negative gap) in the time buckets of 1-14 days and 15-28 days were not to exceed 20 per
cent of the cash outflows in the respective time buckets

Later on RBI made it mandatory for banks to form ALCO (Asset Liability Committee) as a Committee
of the Board of Directors to track, monitor and report ALM.

It was in September, 2007, in response to the international practices and to meet the need for a sharper
assessment of the efficacy of liquidity management and with a view to providing a stimulus for
development of the term-money market, RBI fine tuned these guidelines and it was provided that the
banks may adopt a more granular approach to measurement of liquidity risk by splitting the first time
bucket (1-14 days at present) in the Statement of Structural Liquidity into three time buckets viz., 1 day
(called next day) , 2-7 days and 8-14 days. Thus, banks were asked to put their maturing asset and
liabilities in 10 time buckets.

Thus as per October 2007 RBI guidelines, banks were advised that the net cumulative negative
mismatches during the next day, 2-7 days, 8-14 days and 15-28 days should not exceed 5%, 10%, 15%
and 20% of the cumulative outflows, respectively, in order to recognize the cumulative impact on
liquidity. Banks were also advised to undertake dynamic liquidity management and prepare the statement
of structural liquidity on a daily basis. In the absence of a fully networked environment, banks were
allowed to compile the statement on best available data coverage initially but were advised to make
conscious efforts to attain 100 per cent data coverage in a timely manner. Similarly, the statement of
structural liquidity was to be reported to the Reserve Bank, once a month, as on the third Wednesday of
every month. The frequency of supervisory reporting of the structural liquidity position was increased to
fortnightly, with effect from April 1, 2008. Banks are now required to submit the statement of structural
liquidity as on the first and third Wednesday of every month to the Reserve Bank.

Board’s of the Banks were entrusted with the overall responsibility for the management of risks and
required to decide the risk management policy and set limits for liquidity, interest rate, foreign exchange
and equity price risks.

Asset-Liability Committee (ALCO), the top most committee to oversee the implementation of ALM
system is to be headed by CMD /ED. ALCO considers product pricing for both deposits and advances,
the desired maturity profile of the incremental assets and liabilities in addition to monitoring the risk
levels of the bank. It will have to articulate current interest rates view of the bank and base its decisions
for future business strategy on this view.

Progress in Adoption of Techniques of ALM by Indian Banks : ALM process involve

in identification , measurement and management of risk Parameter. In its original guidelines RBI asked
the banks to use traditional techniques like Gap analysis for monitoring interest rates and liquidity risk. At
that RBI desired that Indian Banks slowly move towards sophisticated techniques like duration , simulation
and Value at risk in future. Now with the passage of time, more and more banks are moving towards these
advanced techniques.

Asset- Liability Management Techniques :

ALM is bank specific control mechanism, but it is possible that several banks may employ similar ALM
techniques or each bank may use unique system.
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Gap Analysis : Gap Analysis is a technique of Asset – Liability management . It is used to assess
interest rate risk or liquidity risk. It measures at a given point of time the gaps between Rate Sensitive
Liabilities (RSL) and Rate Sensitive Assets (RSA) (including off balance sheet position) by grouping them
into time buckets according to residual maturity or next re-pricing period , whichever is earlier. An asset or
liability is treated as rate sensitive if;

i) Within time bucket under consideration is a cash flow.

ii.) The interest rate resets/reprices contractually during time buckets

iii.) Administered rates are changed and

iv.) It is contractually pre-payable or withdrawal allowed before contracted maturities.

Thus ; GAP=RSA-RSL

GAP Ratio=RSAs/RSL

• Mismatches can be positive or negative

• Positive Mismatch: M.A.>M.L. and vice-versa for Negative Mismatch
• In case of +ve mismatch, excess liquidity can be deployed in money market instruments,
creating new assets & investment swaps etc.
• For –ve mismatch, it can be financed from market borrowings(call/Term),Bills rediscounting,
repos & deployment of foreign currency converted into rupee.

Gap analysis was widely used by financial institutions during late 1990s and early years of present century
in India. The table below gives you idea who does a positive or negative gap would impact on NII in case
there is upward or downward movement of interest rates:

Gap Interest rate Change Impact on NII

Positive Increases Positive

Positive Decreases Negative

Negative Increases Negative

Negative Decreases Positive

Duration Gap Analysis :

This is an alternative method for measuring interest-rate risk. This technique examines the sensitivity of
the market value of the financial institution’s net worth to changes in interest rates. Duration analysis is
based on Macaulay’s concept of duration, which measures the average lifetime of a security’s stream of
payments.
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 We know that Duration is an important measure of the interest rate sensitivity of assets and liabilities as it
takes into account the time of arrival of cash flows and the maturity of assets and liabilities. It is the weighted
average time to maturity of all the preset values of cash flows. Duration basically refers to the average life
of the asset or the liability. DP /p =D ( dR /1+R) The above equation describes the percentage fall in price
of the bond for a given increase in the required interest rates or yields.

The larger the value of the duration, the more sensitive is the price of that asset or liability to changes in
interest rates. Thus, as per this theory, the bank will be immunized from interest rate risk if the duration
gap between assets and the liabilities is zero. The duration model has one important benefit. It uses the
market value of assets and liabilities.

Duration analysis summarises with a single number exposure to parallel shifts in the term structure of
interest rates.

It can be noticed that both gap and duration approaches worked well if assets and liabilities comprised
fixed cash flows. However options such as those embedded in mortgages or callable debt posed problems
that gap analysis could not address. Duration analysis could address these in theory, but implementing
sufficiently sophisticated duration measures was problematic.

Scenario Analysis :

Under the scenario analysis of ALM several interest rate scenarios are created during next 5 to 10 years .
Such scenarios might specify declining interest rates , rising interests rates, a gradual decrease in rates
followed by sudden rise etc. Different scenarios may specify the behavior of the entire yield curve, so
there could be scenarios with flattening yield curve, inverted yield curves etc. Ten to twenty scenarios
might be specified to have a holistic view of the scnario analysis. Next assumptions would be made
about the performances of assets and liabilities under each scenario. Assumptions might include
prepayment rates on mortgages and surrender rates on insurance products. Assumptions may also be
made about the firms performance . Based upon these assumptions the performance of the firm’s balance
sheet could be projected under each scenario. If projected performance was poor under specific scenario
the ALCO might adjust assets or liabilities to address the indicated exposure . A short coming of scenario
analysis is the fact that it is highly dependent on the choice of scenario. It also requires that many
assumptions be made about how specific assets or liabilities will perform under specific scenario.

Value at Risk

VaR or Value ar Risk refers to the maximum expected loss that a bank can suffer over a target horizon,
given a certain confidence interval. It enables the calculation of market risk of a portfolio for which no
historical data exists. It enables one to calculate the net worth of the organization at any particular point of
time so that it is possible to focus on long term risk implications of decisions that have already been taken
or that are going to be taken. It is used extensively for measuring the market risk of a portfolio of assets
and/or liabilities.

Conclusion:
We can conclude to say that ALM is an important tool for monitoring, measuring and managing the
interest rate risk, liquidity risk and foreign currency risk of a bank. With the deregulation of interest
regime in India , the banking industry has been exposed to interest rate risk / market risk . Hence to
manage such risk, ALM needs to be used so that the management is able to assess the risks and cover
some of these by taking appropriate decisions.
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INTEREST RATE RISK MANAGEMENT
Interest rate risk management is the banks financial condition which is exposed to the adverse
movements in the interest rates. If it is accepted and managed as a normal part of the business of
banking, it can be used the enhance the shareholder value and the profitability. However, when
the interest rate risk is high, it could lead to substantial volatility in the earning and affect the
value of the bank’s off-balance sheet instruments, liabilities or even the assets. Hence, a risk
management process which is effective, whose aim is the sound financial health of the bank,
would have to keep the interest rate under check. There are two most common perspective for
assessing the banks interest rate exposure:
a) Earnings Perspective: This focuses on the short-term earnings
b) Economic Value Perspective: This looks at the long-term economic viability of the bank
The ‘Earnings Perspective’ assesses the impact of the changes in the interest rates on the ‘Net
Interest Income’ (NII), which is the difference in the total interest paid on borrowings and
deposits and the total interest earned from the investments and loans given, of the bank. This is
known as a traditional method of risk assessment because a low or reduced net interest income
could affect the market confidence and even threaten the financial stability of the bank.
However, banks today have been able to generate income which is non-interest from fee-based
activities like transaction processing, managing securitization pools, off-balance sheet
transactions, loan servicing etc, most of which depend on the way the credit markets perform.
Hence, a major chunk of this fee-based income can be interest sensitive, and the banks would
have to analyse the impact of the interest rate variations on the net income.

The value or the expected value is the present value of the expected net cash flow in the future,
which is discounted in the market rates. The expected net cash flow is the difference between the
expected cash flow on the assets and the expected cash flow on the liabilities, plus the net cash
flow arising from the off-balance sheet activities. Variations in the market interest rates impacts
the economic value of the off-balance sheet positions, banking assets and the liabilities. The
sensitivity of the bank’s economic to the fluctuations in the market interest rate is of great
importance to the stake holders (the management, directors, supervisors and the investors),
because if the economic value of the bank fluctuates, the net worth of the bank fluctuates
accordingly. Thus, it is evident that the economic value perspective is long term and more
comprehensive than the earnings perspective and realistically it cannot impact the interest rate
movement on the bank’s overall positions, and hence the financial health is in the long run.
But the banks financial performance is not always impacted by the future interest rates. The
interest rates in the past also effects the banks future performance. For example, a fixed rate,
long term loan contract may have to be refinanced at a higher rate of interest during the tenure of
the loan. The securities market may not contain the embedded gains or losses due to the
movement in the interest rate of the past, which could impact the bank’s earning over time in the
banks earnings. Hence, the impact of such gains and losses due to the fluctuations in the interest
rate would have to be assessed realistically.
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Some of the common sources of interest rate risk are as follows:
a) Repricing Risk: This is the primary and the most frequently discussed form of the
interest rate risk which arises when the average cost of the liabilities or the average yield
on the banks assets are more sensitive to the changes in the market interest rates. This
difference in the sensitivity could arise from the possible mismatches in the liability and
the assets characteristics of the bank:
i) The fixed rate asset and the fixed rate liability could have different
maturity dates.
ii) Floating rate assets and liabilities could have different repricing periods,
with different base rates. For example, the liabilities could reprice in a
three-year period, whereas the assets could reprise in a one-year period.
iii) Floating rate assets and liabilities could have base rates which are of
different maturities, such as assets that reprice annually based in a long-
term rate and liability that reprices on a short-term base.
iv) In countries with deregulated interest rates, the bank may change the
interest rates at will, and the rate setting policies of the banks follow
determine the effective repricing behaviour of such an instrument. The
difference in the pricing could depend on a number of factors in addition
to the market interest rate, like the expected behaviour of the customers to
the bank in competition and the extent of competition in the market.
v) In some countries, the banks give the option to repay the bank loan at a
very low (or no) cost or to withdraw their deposits whenever they want
with no penalties. The decisions of the customers of repaying the loan
would influence the average pricing of the assets and liabilities to the
changes in the market rates. For example, a bank which funds a long-term
fixed-rate loan with a short-term deposit would face a decline in both the
future income arising from the position and its underlying value if the
interest rate increase. This decline arises because the cash flow on the
loans are fixed over its lifetime, while the interest which is paid on the
funding are variable and increases after the short-term deposit matures.

b) Yield Curve Risk: The yield of the bank’s liabilities and assets adjust to the changes in
the market rates. Even if they change to the same extent, a bank may still be under the
yield curve risk. A yield curve risk is the possibility that changes in the shape of the yield
curve could have differential effect on the assets and liabilities of the bank. For example,
if the assets and liabilities of the bank reprised annually, it would want to balance a
medium-term base rate for its assets with a mixture of short-term and long-term base
rates for its liabilities. This leads to an increased curvature of the yield curve which
would boost the medium-term yields relative to the short and the long-term yields, and
thus it would affect the rate of the banks assets to the relative average cost of its liabilities
and reduce the short-term earnings volatility.
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 The reprising mismatches could expose the bank to changes in the shape and slope of the
bank’s yield curve. The yield curve risk arises when the unanticipated shifts to the yield
curve has adverse effects on the bank’s income and the underlying economic value.

c) Basis Risk: If the banking instruments have base rates which are different, the banks are
exposed to what is known as the basis risk. For example, the yields on the floating rates
of the bank could be tied to the yields of the government security, while those with the
floating rate liabilities could be base on the interbank rate such as the Libor. There is a
possible outcome that the two base rates can diverge unexpectedly owing to the differing
credit risk or liquidity characteristics, which might increase the private yields relative to
the yields of the government securities. In such a case, the cost of the bank’s liabilities
will increase relative to the yield on the assets, thus lowering the bank’s earnings.

d) Optionality: This is an increasing important source of interest rate risk which arises from
the options embedded in many banks off-balance sheet portfolios, liabilities and assets.
Stated simply, the option provides the holder the right, but not obligation, to sell, buy or
in some manner alter the cash flow of an instrument or financial contract. Options may be
over the counter or exchange-traded options or may be embedded within the otherwise
standard instruments. While the banks are exchange-traded and OTC options in both
trading and non-trading accounts, instruments with embedded options are generally more
important than non-trading activities. For example, bonds and securities may include
options. Call options are exercised by the by issuers to redeem bonds before they mature.
Such kind of options exposes the banks to interest rate risk.
Other example of this kind instruments with embedded options would be the loans that
give the borrowers the right to prepay the balances, or transaction deposit instruments
that give the depositors the right to withdraw their funds any time, without any penalties.
If this is not manged adequately, the payoff’s asymmetrical characteristics of instruments
with optionality feature can pose risk which are significant to those who sell them, since
both explicit and embedded options are held, and are generally exercised to the advantage
of the holder and to the disadvantage to the seller. Also, an increasing array of options
can involve significant leverage which can magnify the influences, which can be both
negative and positive, of option positions on the financial condition of the firm.

e) Other sources of Risk: Banks may also have an interest risk because of the interest rate
risk through the interest sensitivity of their non-interest income. For example, interest
rates which are lower, could lead to prepayments (with interest of refinancing the loans),
that would deplete the pool of loans serviced by the bank, which reduce its fee income,
which would lead to a ‘prepayment’ risk. In a scenario, where the interest rates are
declining, the cash inflows from the prepayments could be used to invest at a lower
interest rates, thus leading to a volatility in the earning. The substantial interest rate
exposures embedded in the off-balance sheet positions of large banks are significant and
are held as a hedge for their on-balance sheet interest rate exposures or as a result of their
trading activities in the derivative markets.
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Banks will have a mix of the above interest rate risk, with some offsetting or reinforcing one
another. It is the complexity of the resulting combination of factors which makes interest rate
risk difficult to manage. The management of the interest risk depends on predicting how the
interest rates would behave in the future. If the interest rates can be accurately forecasted, the
risk of interest rate fluctuations can be mitigated to a great extent.

INTEREST RATE RISK IN THE BANKING BOOK

IRRBB refers to the current or prospective risk to a bank’s capital and to its earnings, arising
from the impact of adverse movements in interest rates on its banking book.
When there is a change in the interest rate, the timing of the future as well as the current cash
flows change. This in turn effects the underlying value of the banks liabilities, assets and off-
balance sheet items and hence effects its economic value (EVE). Changes in the interest rate also
has its effects on the banks earning by changing the interest rate sensitive expense and income
which affects the Net Interest Income (NII). Excessive IRRBB poses a threat to the bank’s
current capital base and the future earnings of the bank if it is not managed properly.
The Basel document identifies three sub-types of interest rate risk which potentially change the
price/value or earnings/costs of interest rate sensitive assets, liabilities or off-balance sheet item
way which can affect the bank’s financial statement adversely. The types of risks are as
following:
a) Gap Risk: This arises from the term structure in the banks book instruments and describes
the risk arising from the timing of instruments rate changes. The extent of the gap risk
depends on whether the changes to the term structure of the interest rate occur
consistently across the yield curve (parallel risk) or differentially by period (non-parallel
risk)
b) Basis Risk: It is the impact of relative changes in the interest rate for financial
instruments that have tenors which are similar but the pricing are different based on the
interest rate indices.
c) Option Risk: This arises from option derivative positions or from optional elements
embedded in banks assets, liabilities and/or off-balance sheet items, where the bank or its
customers can alter the level and timing of their cash flows. Option risk can further be
classified into automatic option risk and behavioural option risk.
Apart from the above risks related to the interest rate risk, Credit Spread Risk in the Banking
Book (CSRBB) needs to be measured and monitored. Components of interest rates:

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IRRBB and CSRBB
The main driver of IRRBB is a change in market interest rate, both current and expected by
changes to the shape, slope and level of a range of different yield curve that incorporated some or
all of the components of the interest rates.
Whenever the level or the shape of the yield curve for a given interest rates basis changes, the
relationship between interest rates if different maturities of the same index or market, and
relative to the other yield curves for different instruments, is affected. This may result in changes
to a bank’s income or underlying economic value.
CSRBB is driven by changes in the market perception about the credit quality of groups or
different credit-risky instruments, either because of the changes to expected default levels or
because of changes to market liquidity. Changes to the underlying credit quality perceptions can
amplify the risks already arising from the yield curve risk. CSRBB is therefore defined as any
kind of asset/liability spread risk of credit-risky instruments which is not explained by the
IRRBB, nor by the expected credit/jump-to-default risk.

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MANAGING INTEREST RATES RISK WITH INTEREST RATE
DERIVATIVES

INTEREST RATE DERIVATIVES

A derivative security is a security that derives its value from an underlying asset. The underlying
asset could be anything ranging from a company’s stock, a bond, metals, commodities and several
other asset classes. If the underlying is an interest rate then the derivative security becomes an
interest rate derivative. The underlying interest rates depend on the contract which is being agreed
to by the counter parties and can range from LIBOR, domestic interbank offered rates, Fed Funds
Rate etc.
Types of interest rate derivatives and the way they function:
A) Vanilla
B) Quasi Vanilla
C) Exotic derivatives
In context to the degree of complexity, there are three types of interest rate derivatives,
each of which can be distinguished based on the extent of liquidity, tradability and complexity.
Where the vanilla type is the most basic and standard type of interest rate derivative with maximum
liquidity, Quasi vanilla is the next level after vanilla type and is fairly liquid. The exotic derivatives
are the most illiquid, more complex compared to the commonly traded vanilla derivatives.

I. SWAPS
This is an important and interesting area under fixed income derivatives. It is an example of a
structured transaction to hedge risks in a fixed income investment.
A swap essentially is a contract between counter parties to exchange a series of intermediate cash
flows arising throughout the tenor/life of the swap. Almost every swap contract comes under an
interest rate swap. Most of them are basically variants of interest rate swaps.

INTEREST RATE SWAPS

An IRS is a swap contract to exchange a series of intermediate cash flows based on interest rates
on a notional amount throughout the tenor of the swap.
In general, they come in the form of exchanging cash flows arising from a fixed interest rate for
cash flows arising from a floating interest rate over the tenor of the swap. This type of swap is also
known as a fixed for floating swap where on leg of the swap pays/receives a fixed rate and the
other leg, a floating rate. It is also called a plain vanilla IRS.

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Here’s a simple example to illustrate a fixed for floating swap. We all know that a bank takes
deposits and makes loans. Let’s assume that for the deposits Bank A takes, they pay a fixed rate
of interest say 5%. For the loans they make let’s assume they charge a floating rate of interest
which is the LIBOR (say 3%) plus a spread (3%) over it to account for the riskiness of the
borrower. The spread is fixed but the LIBOR keeps changing. If for example LIBOR falls to 1%
or below by year end, banks will be paying a constant 5% on deposits but charging lesser on their
loans. In order to safeguard against this risk of making a lower interest margin ultimately due to
rates falling they enter into an IRS with another Bank B. Bank A currently pays fixed and receives
floating on its deposits and loans respectively. They will enter into an IRS with Bank B to pay
floating and receive fixed for a certain time period, say 3 years.
Effectively, the structure of the transaction will look like this:

The Swap Rate here is only indicative – a no arbitrage rate has been calculated. By paying floating
on the swap, Bank A’s exposure to interest rates falling are benefited. If rates go up above 5%,
Bank A still benefits since it pays a lower rate on its deposits and the higher rate will anyway be
passed on through the loans it makes which finance the swap’s floating leg. Here Bank B act as a
counter party to Bank A, simply because they would be having the opposite exposure where they
pay floating on their deposits and receive fixed on their loans. As mentioned earlier, the swap
payments/cash flows are based on a notional amount.
Counter parties agree to do a swap since they have either have opposite views or exposures to the
underlying.

CURRENCY SWAP
These are also called Cross Currency Swaps or Cross Currency Interest Rate Swaps. A good way
to refer to it is “Xccy IRS.” As you would guess, this is a variant of an IRS, the difference being
two different currencies involved.
A typical transaction would be Bank A (Japanese bank) borrowing say $10m (Notional amount)
@ 5% p.a. and lending ¥100m (Notional amount) @ 3% p.a. to Bank B (US bank) for 5 years as
part of a Xccy swap. Bank A pays B $500,000 to Bank B while Bank B pays ¥3m to Bank A as
swap payments every year throughout the life of the swap.

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A fixed for fixed Xccy IRS is simple. A fixed for floating Xccy IRS works similar to that of an
equivalent IRS with the exception of two currency legs like the above example where Bank A may
borrow $10m at LIBOR + 2% instead of 5%. A fixed for floating IRS though, will have the
intermediate cash flows netted against each other depending on a gain or loss. If Bank A’s interest
payment at the end of the year is $300,000 and Bank B’s is $500,000 after converting to USD,
then Bank B will pay the difference of $200,000 to A. Similar would be the case when A has to
pay B the difference.
A floating for floating Xccy IRS (Basis Swap) and normal IRS are also part of the structuring
game. Though it is easy we can end this discussion here rather than get deeper and deeper.

DIFFERENCE BETWEEN A XCCY SWAP AND AN IRS

A Xccy swap and an IRS differ apart from the currency legs. The Notional amounts on which the
interest payments/cash flows are made are exchanged in the beginning and end in an Xccy swap.
The same doesn’t hold for an IRS. In the earlier example the notional principal of $10m and ¥100m
are exchanged in the beginning and end. Therefore, a Xccy swap eliminates currency risk or
exchange rate risk of the notional principal amounts.

OTHER TYPES OF SWAPS

There are other types of swap derived from interest rate like an Equity swap or a Total Return
Swap (TRS) where the swap rate is paid on one leg and the other leg pays equity/equity index
related payments like the dividends and capital gains differences; Overnight Indexed Swap (OIS)
which is a fixed for floating swap where the floating rate is based on a geometric average of
floating rates on an overnight index say LIBOR or Fed Funds.

USES OF SWAPS
Just like any other derivative contract, swaps are used as a tool to hedge risk. They can also be
used as a tool to speculate on interest rates where a counter party may not be having an original
exposure. Thirdly, they can be used to make arbitrage gains if the swap rates are slightly mispriced
– here the mispricing difference gets quickly noticed whereby multiple entities would like to make
a riskless profit ultimately making this demand and supply lead to an equilibrium rate which cannot
be arbitraged away.

II. INTEREST RATE OPTIONS

SWAPTION
This is an option on swap – a double derivative. It isn’t difficult though. An option gives the buyer
of the option, the right but not the obligation to buy or sell the underlying at a predetermined strike
price on a future date (at expiration in the case of European Options; before or at expiration in the
case of American Options).
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In the case of a Swaption, the strike price is replaced by a strike rate, an interest rate based on
which the buyer can choose to exercise the option and the underlying is a swap.
Example: ABC buys a 3-year Swaption where they pay fixed and receive floating (they buy a
payer Swaption) at a strike rate of 2% exercisable at the end of one year. At expiration, if the
reference rate is greater than 2%, ABC will exercise the option following which the swap takes
effect for 3 years. If the reference rate is less than 2% the option will not be exercised.

CAPS AND FLOORS

A Cap caps one’s risk and a Floor floors one’s risk. Caps and Floors are options on interest rates
i.e. the underlying is an interest rate and the strike rate is the rate at which the buyer exercises the
option. They are generally issued with Floating Rate Bonds/Notes (FRNs).
Caps consist of a series of ‘Caplets’ and Floors of ‘Floorlets’. Caplets and Floorlets are essentially
caps and floors but with short time frames. A one-year Cap may consist of a series of four Caplets
which have a tenor/expiration of 3 months each.
Generally, a Cap transaction goes like this: ABC Corporation issues a floating rate bond at
LIBOR+2% where LIBOR may be at 3%. The risk for ABC is if interest rates or LIBOR rise
quickly say in a year, where they have to pay higher rates. So, along with the bond they buy a Cap
from a bank at a strike of 3.5% so that if LIBOR goes above 3.5%, ABC exercises the Cap.
Exercising it makes ABC pay only 3.5% and they make the profit which is the difference between
LIBOR or the reference rate and 3.5% over that time period. The profit helps repay the increase
in LIBOR and thus ABC is effectively capped in his payments. In the worst-case scenario ABC
ends up paying only 5.5%. If ‘minus (-)’ indicates outflows and ‘plus (+)’ inflows, here is how it
would look for ABC Corp if the payments were agreed on an annual basis:
FRN payments: ‒ (LIBOR + 2%)
Cap related payment: +LIBOR – 3.5%
Combining both would give: – 3.5% – 2% = –5.5% thus limiting the borrower’s exposure to
interest rate changes.

A floor similarly would be combined with an FRN but by lenders. So, the lender of ABC Corp’s
bond would buy a floor to limit their exposure to interest rate changes. There are variants of caps
and floors one of them being ‘interest rate collars’ which are a combination of buying a cap and
selling a floor but let’s not get into that.

III. FORWARD RATE AGREEMENTS (FRAS)

These are forward contracts on interest rates between counterparties. FRAs are contracts to borrow
or lend money at a predetermined rate on a notional principal at future point in time.
ABC may enter into a FRA to borrow @ 5% on a notional amount for 3 months, starting after 6
months (a 6X9 FRA – a FRA expiring after 6 months to borrow money for 3 months). This helps
ABC in the event of 3-month interest rates going up at the end of 6 months from today.
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ABC could also enter into a FRA to lend @ 5% on a notional amount for 3 months, starting after
6 months (a 6X9 FRA – a FRA expiring after 6 months to borrow money for 3 months). This helps
ABC in the event of 3-month interest rates going down at the end of 6 months from today.

IV. INTEREST RATE FUTURES (IRF)

An interest rate futures contract is a futures contract, based on an underlying financial instrument
that pays interest. It is used to hedge against adverse changes in interest rates. Such a contract is
conceptually similar to a forward contract, except that it is traded on an exchange, which means
that it is for a standard amount and duration. The standard size of a futures contract is $1 million,
so multiple contracts may need to be purchased to create a hedge for a specific loan or investment
amount. The pricing for futures contracts starts at a baseline figure of 100, and declines based on
the implied interest rate in a contract.
For example, if a futures contract has an implied interest rate of 5.00%, the price of that contract
will be 95.00. The calculation of the profit or loss on a futures contract is derived as follows:
Notional contract amount × Contract duration/360 Days × (Ending price – Beginning price)
Most trading in interest rate futures is in Eurodollars (U.S. dollars held outside of the United
States), and are traded on the Chicago Mercantile Exchange.
Hedging is not perfect, since the notional amount of a contract may vary from the actual amount
of funding that a company wants to hedge, resulting in a modest amount of either over- or under-
hedging. For example, hedging a $15.4 million position will require the purchase of either 15 or
16 $1 million contracts. There may also be differences between the time period required for a
hedge and the actual hedge period as stated in a futures contract. For example, if there is a seven-
month exposure to be hedged, a treasurer could acquire two consecutive three-month contracts,
and elect to have the seventh month be unhedged.
When the buyer purchases a futures contract, a minimum amount must initially be posted in a
margin account to ensure performance under the contract terms. It may be necessary to fund the
margin account with additional cash (a margin call) if the market value of the contract declines
over time (margin accounts are revised daily, based on the market closing price). If the buyer
cannot provide additional funding in the event of a contract decline, the futures exchange closes
out the contract prior to its normal termination date. Conversely, if the market value of the contract
increases, the net gain is credited to the buyer’s margin account. On the last day of the contract,
the exchange marks the contract to market and settles the accounts of the buyer and seller. Thus,
transfers between buyers and sellers over the life of a contract are essentially a zero-sum game,
where one party directly benefits at the expense of the other.
It is also possible to enter into a bond futures contract, which can be used to hedge interest rate
risk. For example, a business that has borrowed funds can hedge against rising interest rates by
selling a bond futures contract. Then, if interest rates do in fact rise, the resulting gain on the
contract will offset the higher interest rate that the borrower is paying. Conversely, if interest rates
subsequently fall, the borrower will experience a loss on the contract, which will offset the lower

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interest rate now being paid. Thus, the net effect of the contract is that the borrower locks in the
beginning interest rate through the period of the contract.
When a purchased futures contract expires, it is customary to settle it by selling a futures contract
that has the same delivery date. Conversely, if the original contract was sold to a counterparty,
then the seller can settle the contract by buying a futures contract that has the same delivery date.

ADVANTAGES OF INTEREST RATE DERIVATIVES

Interest rate derivatives are opted for adjustments of portfolios
They are more liquid compared to the underlying instrument
They help in lowering the cost of funding
Speculative positions can be taken in context to future movement in interest rates
They can provide yield irrespective of the market conditions
Market participants use interest rate derivatives either to hedge the risk or take future
positions
It helps in mitigating the risk from unpredictable interest rate swings (risk diversification
instrument)

DISADVANTAGES OF INTEREST RATE DERIVATIVES

Risk of loss is unlimited
Prices are generally not available publicly
Complex structure of the derivative can make it difficult to gauge the risk and calculate the
yield

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LIQUIDITY RISK MANAGEMENT AND BASEL III:

BASEL III LIQUIDITY METRICS:

Strong capital requirements are a necessary condition for banking sector stability but by
themselves are not sufficient. A strong liquidity base reinforced through robust supervisory
standards is of equal importance. Prior to 2010, there were no internationally harmonised
standards in this area. To complement the other elements of its liquidity framework (Principles
for Sound Liquidity Risk Management and Supervision and Additional Monitoring Metrics), the
Basel Committee developed two minimum liquidity standards:
The Liquidity Coverage Ratio (LCR): to promote short‐term funding resilience
The Net Stable Funding Ratio (NSFR): to provide a sustainable maturity structure of assets
and liabilities.
In Europe, a minimum LCR was introduced in October 2015. Implementation of the NSFR,
however, is not due until 2018, to give global regulators sufficient time to conduct parallel run
exercises to enable proper calibration of the ratio.

Liquidity coverage ratio:

The LCR focuses on the short term and is designed to ensure that a financial institution has
sufficient unencumbered high‐quality liquid resources to survive a severe liquidity stress
scenario lasting for 1 month. The ratio is calculated as:

Stock of high‐quality liquid assets/Total net cash outflows over the next 30 days (in a stress
situation) ≥ 100%

The highest quality liquid assets (for example, cash or government bonds) are included in the
calculation at their market value. Assets of a slightly lower quality, such as covered bonds and
securitisation paper, may also be counted if their ratings are above minimum thresholds, but will
be subject to a haircut.

Run‐off factors are applied to liabilities and off‐balance‐sheet commitments based on their
likelihood of withdrawal/drawdown in a stress.

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Liquidity stress scenario
The assumptions are provided by the regulatory authorities based upon a combined market and
idiosyncratic stress, which incorporates many of the shocks experienced during the financial
crisis. They should be viewed as a minimum supervisory requirement for banks. Banks are
expected to conduct their own stress tests to assess the level of liquidity they should hold beyond
this minimum, and construct their own scenarios that could cause difficulties for their specific
business activities.

Liquid assets

Liquid assets eligible for inclusion in the calculation were initially split into two categories
(Level 1 and Level 2), but this was subsequently increased to three (Level 1, Level 2A, and
Level 2B) to capture a broader range of securities:

Level 1: up to 100% of the total, comprising cash, deposits at the central bank
government/government guaranteed bonds, and covered bonds rated ECAI 1 (External Credit
Assessment Institutions – EU rating system) that meet certain conditions (subject to a 7% haircut
and a 70% cap in the liquidity buffer);
Level 2A: up to 40% of the total with a minimum haircut of 15%, comprising government bonds
with 20% risk weight, EU covered bonds rated ECAI 2, and non‐EU covered/corporate bonds
rated ECAI 2;
Level 2B: up to 15% of the total with a haircut of 25–50%, comprising RMBS, auto, SME, and
consumer loan securitisations, corporate bonds rated ECAI 3, shares that are part of a major
stock index, and other high‐quality covered bonds.

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The Net Stable Funding Ratio 18020441081

In contrast to the LCR, the NSFR is a measure of structural liquidity and focuses on the longer‐
term horizon by placing a formal limit on the amount of maturity transformation that banks are
able to undertake. The required ratio is calculated as:

Available amount of stable funding/Required amount of stable funding ≥100%

All assets (required amount of stable funding) and liabilities (available amount of stable funding)
are weighted according to their likelihood of still being on the balance sheet 12 months into the
future.

The implications of the Basel liquidity metrics for banks' funding and lending strategies
The new rules combined with banks' own desire to reduce liquidity risk have resulted in material
changes in balance sheet structures. The adjustment process began in 2008, so is now well
advanced. Initially, LCR/NSFR presented a compliance issue, but satisfying the ratios on an
ongoing basis is increasingly becoming an efficiency issue.

Some of the main impacts have included:

Customer loan/deposit ratios moving more into balance;

A reduction in inter‐bank loan/deposit market and repo activity (except in government
securities);
A focus on retail/SME deposits, including the introduction/relaunch of deposit products, such
as 35‐day notice accounts;
Simplification of balance sheet structures to reduce trapped liquidity in branches and/or
subsidiaries;
Higher liquid asset holdings and disposal of traded securities that do not count towards the
LCR;
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 Tighter control of undrawn commitments, particularly liquidity facilities, where the treatment
is asymmetric;
Increased consideration of the currency denomination of activities;
The generation of liquidity from long‐term assets.

For efficient balance sheet optimisation, a bank should consider how the above impacts its
business model and specific business lines, and seek to concentrate on those areas that provide
efficiency in both return and regulatory compliance.

OPTIMUM LIABILITIES STRATEGY AND MANAGING THE HIGH‐QUALITY

LIQUID ASSETS (HQLA) PORTFOLIO

Liabilities strategy

As part of an integrated liquidity risk management framework, a bank should articulate an

optimum liabilities strategy. This sits at the heart of the balance sheet planning process. The
liabilities strategy of an organisation needs to take into consideration the diversification of the
liability base to ensure that it is not concentrated in any particular aspect such as tenor, client,
industry sector, or product type.

Under the strategic asset‐liability management (ALM) umbrella, there are a few core
components that are directly relevant to the liabilities strategy:

 A single, integrated balance sheet approach that ties in asset origination with liabilities
raising;
 Thus, asset type must be relevant and appropriate to funding type and source…;
 …and the funding type and source must be appropriate to the asset type.

In order to apply these three key principles, it is important to undertake a comprehensive review
of the bank's balance sheet liabilities as a first step towards determining both the optimum
liability profile and then the overall liabilities strategy.

This exercise is more involved in the larger and more complex businesses, but critical
nonetheless.

The strategy setting is not a static or one‐off process. The objective is to arrive at a balance sheet
liability mix and structure by design, and one which is optimum from a strategic ALM
perspective, rather than one that is a result simply of history and business line BAU activity – in
other words, a passive inherited liability shape.

The liability structure of many EU and MENA banks have changed since 2007–2008 and have
focused on moving away from wholesale funds, both short term (supply) and long term
(demand), and move towards more non‐interest-bearing liabilities (NIBLs) and equity. This has
largely been driven by the introduction of the ILAS regime and subsequent LCR stress testing
regulatory metrics. Both of these stress tests penalise the use of wholesale funding and hence
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banks have diversified and focused on retail and NIBLs balances. For one high street UK bank,
NIBLs rose from 28% of liabilities and equity in 2007 to 41% in 2012.

The liability structure: what is the optimum mix?

In compiling the optimum liability mix targets, there are some important considerations that need
to be applied in the planning process. These revolve around:

 Regulation;
 Liquidity value (to what extent is a type of customer deposit or type beneficial towards
the final LCR or NSFR metric?);
 Funding diversification/concentration;
 Impact to net interest income (NII) and net interest margin (NIM);
 NII sensitivity;
 How to build the customer franchise

From a liquidity value perspective, a bank should seek to maximise funding from customer
relationship balances and minimise its reliance on wholesale inter‐bank funding.

Peer group analysis

In the UK, the Bank of England (BoE) publishes monthly data showing effective interest‐rate
paid on (sterling) deposit balances of UK household and UK non‐FI corporate sectors, split by
deposit type. It is a measure of back‐book deposit costs (in the UK), not front book (i.e. marginal
cost of new funds).

Through this peer review, one can compare the current bank levels to peer levels to establish
whether your bank is paying above the sector‐wide average and to establish a better
understanding of what your bank is paying for its deposits and assess if this can be improved.

We observe that for UK banks, 2‐year fixed‐rate bonds have reduced by ∼200bp since 2010,
from an average of 3.25% to 1.46%. For instant access liability products, this has reduced by
∼90bp from 1.44% to 0.54%.

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Product volume sensitivity to interest‐rate movements

Some liability products are sensitive to movements in interest rates and are referred to as NII‐
sensitive products. A high-volume sensitivity may not be a good thing as this could lead to
certain challenges, notably cannibalisation from other product types and “hot money”.

Cannibalisation from other deposit products offered by the bank can lead to a dramatically
different impact on NII than originally anticipated, especially if large volumes of deposits switch
to the new/repriced product from high margin accounts. Placing restrictions on who can apply
for certain products can attract the attention of the regulators.

“Hot money” from interest‐rate seekers (stand‐alone customers): if a new/repriced account

attracts deposits from customers who are only interested in the rate being paid, then you may
finish up with expensive funding that has no liquidity value. For this reason, many banks have
withdrawn from offering offshore instant access Internet‐based accounts.

The same can also be said of products that have been offered at below par rate. Deposit products
often have tiered rates and/or customer relationship managers are given the discretion to pay a
higher rate to protect/attract business. Average product margins can mask underlying trends.

Output of the liability review

The result of the liabilities mix review should be a medium‐term (for example, 3‐ to 5‐year)
strategy that specifies a precise target for:

 The liabilities mix: how much do we wish of each funding type, and why;
 What the drivers are;
 What, if any, funding types are of less value and should be reduced or withdrawn from;
 Plan for implementation.

This liabilities strategy review would be presented for ALCO approval and subsequent
implementation. This plan could include a series of initiatives that would be tracked at ALCO on
a regular basis to ensure that the balance sheet is tracking in the right direction and is being
measured by some key performance indicators.
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Tracking progress through ALCO

The liabilities strategic review output should articulate the high‐level deposits strategy. For
example, this could be a simple statement such as “The 2016 strategy is to retain current
balances and enhance the value of those retained balances for NIM” or “The medium‐term
strategy is to grow the deposit book by £2 billion”.

The ALCO review should have a level of product emphasis aligned to the specific initiatives that
the plan has identified such as focus on instant access savings or term deposits.

There should be a regular competitive analysis, as previously described, to ensure that pricing is
still relevant in the market and that process against key performance indicators is tracked
monthly and any variations clearly understood.

THE LIQUID ASSET BUFFER

We consider now the liquid asset buffer (LAB), which can be a sizeable item on the asset side of
the balance sheet. The size of the LAB is determined purely by the quality of the liabilities mix
on the balance sheet, as it is required to offset the potential outflow of liabilities in a time of
stress, for example, a financial crisis.

All firms are required to hold buffers of liquid assets and it forms a key part of the PRA
requirement for liquidity, and this is now enshrined in global regulation by Basel III (the High-
Quality Liquid Assets (HQLA) portfolio). These assets must be uncorrelated to the institution –
so it cannot be the bank's own debt issued – nor can they be repo funded (i.e. unencumbered) and
should preferably be funded by long‐term (>90 days) liabilities.

Liquid assets are those that can be easily converted to cash at any time (including times of
stress), with little or no loss of value. They have certain characteristics that need to be fulfilled in
order to qualify as liquid assets. These characteristics can be divided into fundamental and
market components.

The fundamental characteristics of LAB asserts are described as:

 Low Credit and Market Risk:

o Low degree of subordination, low duration, low volatility, low inflation risk, and
denominated in a convertible currency;
 Ease and Certainty of Valuation:
o Pricing formula must be easy to calculate with no strong assumptions and inputs
must be publicly available;
 Low Correlation with Risky Assets:
o Should not be subject to wrong way risk;
 Listed on a Developed and Recognised Exchange Market:
o Increases transparency;
 The market characteristics are described as:
 Active and sizeable market:
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 o Outright sale and repo markets at all times. Historical evidence of market breadth
and market depth;
 Presence of Committed Market‐makers:
o Quotes are always available for buying and selling the asset Low Market
Concentration;
o Diverse group of buyers and sellers in the assets' market;
 Flight to Quality:
o Historic evidence of these types of asset being traded in a systemic crisis.

Under the Basel III LCR calculation, the liquidity value of differing types of liquid assets is
predetermined within the confines of the stress test.

Hedging the liquid asset buffer

Part of the LAB will be comprised of longer-term securities and so ALCO must agree an
interest‐rate risk (and credit risk) hedging approach, particularly for those assets that are fixed
rate.

Interest‐rate risk hedges may be transacted using interest‐rate swaps, short sterling futures (fixed‐
rate instruments up to 3 years), or LIFFE gilt futures (fixed‐rate instruments of over 3 years)

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Liquid asset buffer policy

Given the importance of the LAB, it is important to ensure that investment criteria are
established in line with the Board risk appetite of the firm. An integral part of the Board‐
approved liquidity risk management policy is that all banks must maintain a portfolio of high‐
quality genuinely liquid assets to act as a funding reserve against liabilities outflow in times of
stress.

The amount of liquid assets should cover the outflows projected from the bank's liquidity stress
tests, provide collateral for payment systems, and satisfy minimum regulatory requirements.

The Liquid asset buffer policy sets out the parameters in respect of the ownership, size, maturity,
and composition of the liquidity portfolio.

LIQUIDITY REPORTING, STRESS TESTING, ILAAP, AND ASSET

ENCUMBRANCE POLICY

We continue our detailed look into the liquidity risk management process. We consider first the
regulatory aspect and the process of the “individual liquidity adequacy assessment process”
(ILAAP). We also review intra‐day liquidity risk and the importance of understanding the
liquidity risk aspects of having encumbered assets on the balance sheet.

Liquidity reporting

Liquidity reporting is necessary because:

 It obliges banks to monitor their liquidity risk on a daily or intra‐day basis;

 The data required by the regulator would normally be required by firms for their own
purposes in undertaking prudent liquidity risk management (regulatory guidance);
 It enables the regulator to identify and challenge outliers;
 Supervisors can apply their own stress testing scenario analysis to data provided by a
firm;
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  It enables the regulator to form firm, specific, sector, and industry‐wide views on
liquidity risk during good and bad times, and provide feedback to firms on their liquidity
positioning within their peer group.

In the UK, in 2009–2010, in the wake of the financial crisis, the Financial Services Authority
(FSA, now Prudential Regulation Authority) introduced a series of new liquidity reports. The
most well-known of these reports are the FSA 047 (Daily Flows) and the FSA 048 (Enhanced
Mismatch Report), which show, respectively, contractual liquidity flows out to 3 months (for the
analysis of survival periods and potential liquidity squeezes), and liquidity mismatch positions
across the whole maturity spectrum.

LIQUIDITY STRESS TESTING

The liquidity stress testing process involves the modelling of assumptions on how assets and
liabilities of a bank (inventory) will behave in various stress scenarios, to produce an output
for review and action by senior management.

Inventory

The inventory is the composition and maturity profile of the balance sheet (including off‐
balance‐sheet exposures) on a given date – a basic building block for all modelling activity.

Stress scenarios

The calculation of the LCR is based upon a stress scenario set by the regulatory authorities. In
contrast, the scenarios used for liquidity stress testing should be generated by banks and include
a range of idiosyncratic, market, and macroeconomic stresses. These should be severe, but
plausible and focus upon key vulnerabilities. Examples could include: a sustained period of
systems failure, a vulnerability to previously liquid markets becoming illiquid (for example,
commercial paper or securitisation), and heavy reliance on a particular sector for funding that
becomes no longer available (local authorities in a credit downgrade scenario).

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INDIVIDUAL LIQUIDITY ADEQUACY ASSESSMENT PROCESS

A bank should undertake a regular review of whether its liquidity resources are sufficient to
cover the major sources of risk to the firm's ability to meet its liabilities as and when they fall
due. This “Individual Liquidity Adequacy Assessment Process” (ILAAP) should incorporate:

 A clearly articulated risk appetite defining the duration and type of stress the firm aims to
survive;
 A range of stress scenarios focusing upon key vulnerabilities of the firm;
 The results of stress tests; and
 Those measures set out in the Contingency Funding Plan that it would implement.

The ILAAP should also be:

 Recorded in a document approved by the Board;

 Proportionate to the nature, scale, and complexity of a bank's activities; and
 Updated annually or more frequently if the business model of the firm changes.

INTRA‐DAY LIQUIDITY RISK

A bank should actively manage its intraday liquidity positions and risks to meet payment and
settlement obligations on a timely basis under both normal and stressed conditions and thus
contribute to the smooth running of payment and settlement systems.”

Intra‐day liquidity is defined as funds that can be accessed during the business day to enable
firms to make payments in real time. Intra‐day liquidity risk is the risk that a bank fails to
manage its intra‐day liquidity effectively, which could leave it unable to meet a payment
obligation at the time expected, thereby affecting its own liquidity position and that of other
parties.

Intra‐day sources of liquidity include:

 Reserve balances and collateral pledged at central banks;

 Unencumbered liquid assets that can be freely transferred to the central bank;
 Secured or unsecured committed or uncommitted credit lines available intra‐day;
 Balances with other banks that can be used for settlement on the same day;
 Payments received from other payment system participants and ancillary systems.

Intra‐day liquidity needs arise from:

 Payments needing to be made to other system participants and ancillary systems;

 Contingent payments (for example, as an emergency liquidity provider) relating to a
payment system's failure to settle procedures;
 Contingent intra‐day liquidity liabilities to customers;
 Payments arising from the provision of correspondent banking services.

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The Basel Committee and the EU recommend that a bank's usage of and requirement for intra‐
day liquidity are monitored in both normal and stressed conditions via eight metrics:
DEEPAK KUMAR D-18
1. Daily Maximum Liquidity Requirement;
2. 18020441081
Available Intra‐day Liquidity at the Start of the Business Day;
3. Total Payments;
4. Time Specific and Other Critical Obligations;
5. Value of Payments Made on Behalf of Correspondent Bank Customers;
6. Intra‐day Credit Lines Extended to Customers;
7. Timing of Intra‐day Payments;
8. Intra‐day Throughput.

The total liquidity requirement

Liquid assets required to manage a bank's intra‐day obligations cannot also be available to
support the LCR buffer. So, a bank's total liquidity requirement must include an allowance for all
of the items identified in figure.

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 APPLICABILTY TO BANKS IN INDIA

Interest Rate Derivatives in India

Indian participation in the derivative markets has accelerated only since the late 1990s. After the
introduction of the currency forwards in the 1980s, the Indian banking system saw no new
instrument till 1997 when long term foreign currency swaps began trading in the OTC markets.

Thereafter, the rise of the derivatives in India has been swift – Interest rate swaps and FRAs were
introduced as OTC products in July 1999, followed by several exchange-traded derivatives such
as equity index futures (2000), equity index options (June 2001), stock options and stock futures
later in the same year, and interest rate futures in June 2003.

In India, the different derivatives instruments are regulated by various regulators, such as Reserve
Bank of India (RBI), Securities and Exchange Board of India (SEBI), and Forwards Markets
Commission (FMC). Broadly, RBI is empowered to regulate the interest rate derivatives, foreign
currency derivatives and credit derivatives.

There are two distinct groups of derivative contracts:

 Over-the-counter (OTC) derivatives: Contracts are traded directly between two eligible
parties, with or without the use of an intermediary and without going through an exchange.
RBI is the primary regulator for OTC derivatives.

 Exchange-traded derivatives: Derivative products that are traded on an exchange.

Typically, participants in this market are broadly classified into two functional categories, namely,
market-makers and users.
 User: A user participates in the derivatives market to manage an underlying risk.

 Market-maker: A market-maker provides bid and offer price to users and market-
makers. A market-maker need not have an underlying risk.

At least one party to a derivative transaction is required to be a market-maker. (It is to be

noted that the definition is purely functional. For example, a market making entity,
undertaking a derivative transaction to manage an underlying risk, would be acting in the role
of a user.)
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 In India, all commercial banks (excluding Regional Rural Banks) and primary dealers can act
as market makers. They all are governed by the regulations in force. The users are typically
business entities with identified underlying risk exposures.

At present, the following types of derivative instruments are permitted, subject to conditions
and regulations in force:
 Rupee interest rate derivatives: Interest Rate Swap (IRS), Forward Rate Agreement
(FRA), and Interest Rate Futures (IRF). IRS and FRA are OTC products, while
Interest rate futures are exchange traded.

 Foreign Currency derivatives: Foreign Currency Forward, Currency Swap and

Currency Option – (Separate guidelines regarding Foreign Currency derivatives are
issued by the regulator).

 Credit derivatives: Credit Default Swaps (CDS) on single name corporate bonds.

OTC Derivatives in India conventionally, OTC derivative contracts are classified based on the
underlying into (a) foreign exchange contracts, (b) interest rate contracts, (c) credit linked
contracts, (d) equity linked contracts, and (e) commodity linked contracts. The equity linked
contracts and commodity contracts have been relatively insignificant and are absent in the
domestic Indian OTC markets.

The structure of the OTC derivatives market (excluding equity and commodity linked derivatives)
is broadly depicted in the chart below. (Instruments in bold face indicate that these are traded in
the Indian market at present).

The Indian OTC derivatives markets is dominated by Forex derivatives, followed by interest rates.
In the OTC Forex derivatives, FX Swaps have been the most widely used instruments, followed
by the currency options and cross currency swaps.

In the Indian markets, four OTC interest rate products are traded viz., Overnight Index Swap based
on overnight MIBOR (Mumbai Inter Bank Offered Rate – a polled rate derived from the overnight
unsecured inter-bank market), contracts based on MIFOR (Mumbai Inter-Bank Forward Offered
Rate – a (LIBOR) and USD-INR forward premium), contracts based on INBMK (Indian
Benchmark Rate – a benchmark rate published by Reuters that represents yield for government
securities for a designated maturity), and contracts based on MIOSIS (Mumbai Interbank
Overnight Index Swap – a polled rate derived from the MIBOR rates of designated maturity).

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 OTC Derivatives

Interest Rate Forex Credit

 Repos based on  Forward  Repos based on

government  Swap corporate debts
securities  Option  Credit default swap
 Interest rate swap  Credit linked notes
 Forward rate  Total return notes
agreement  Credit default option
 Interest rate
option
 Hybrid
instruments like
swaption, bais
swap, etc.

A typical characteristic of the Indian interest rate market is that unlike in the overseas inter-bank
funds markets, there is very little activity in tenors beyond overnight and such as there is no
credible interest rate in segments other than overnight. Absence of a liquid 3-month or 6-month
funds market has been a hindrance for trading in Forward Rate Agreements (FRA), as also in
swaps based on these benchmarks. This is reflected in trading volumes of the product. It is also
evident that MIBOR swaps dominate the market.

All scheduled commercial banks (SCBs) excluding Regional Rural Banks, primary dealers (PDs)
and all-India financial institutions have been allowed to use IRS and FRA for their own balance
sheet management as also for the purpose of market making. The non-financial corporations have
been allowed to use IRS and FRA to hedge their balance sheet exposures, with a caveat that at
least one of the parties in any IRS/FRA transaction should be a RBI regulated entity.

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The OTC derivative market is characterized by large exposures between a limited number of
market players. When the market is characterized by the existence of a few market makers, most
of the activity takes place between these players and disruptions at any major dealer would soon
transmit to other financial institutions and spread contagion to the entire market. The risk in the
OTC derivative market also emanates from the opacity in the market that constrains the market
participants from assessing the quantum of risk held with the counterparty. Further, with increase
in volumes and complexities of the OTC derivatives, the non-standardized infrastructure for
clearing and settlement also becomes a major impediment in containing risk, especially in the wake
of the financial crisis of 2007-08. At the G 20 Toronto summit declaration of June 2010, Central
banks and Market regulators agreed to initiate measures to enhance the post trading infrastructure
in the OTC derivative markets.

Establishing Central counterparties (CCP) and Trade Repositories (TR) were two of the important
commitments made at the above Summit.

A CCP is a financial institution that interposes as an intermediary between security (including

derivatives) market participants. This reduces the amount of counterparty risk that market
participants are exposed to. A sale is contracted between the seller of a security and the central
counter party and the buyer on the other. This means that no market participant has a direct
exposure to another and if one party defaults, the central counterparty absorbs the loss. Settlement
through a central counterparty has been progressively used on most major stock and security
exchanges. However, a CCP based system can lead to concentration of risk with the CCP, which
issue needed to be addressed.

On the other hand, the objective of TRs is simply to maintain an authoritative electronic database
of all open OTC derivative transactions. It collects data derived from centrally or bilaterally
clearable transactions as inputted/verified by both parties to a trade. An important attribute of a
TR is its ability to interconnect with multiple market participants in support of risk reduction,
operational efficiency and cost saving benefits to individual participants and to the market as a
whole. The typical drawback of the OTC market is that the information concerning any contract
is usually available only to the contracting parties. While expanding the scope of availability of
information, it became pertinent to distinguish between information available to regulators, to
market participants and to public at large. Post trade processing services is another important
function of TR.

The reporting arrangement in interest rate derivatives in India follows a two-tier system. Since at
least one party to an OTC interest rate derivatives transaction is a RBI regulated entity, there has
been an elaborate prudential reporting requirement in so far as the risk implication of the derivative
positions for the entity is concerned.

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ALM Framework for Indian Banks

From 1 April 1999, banks in India were expected to implement an effective ALM system, the
guidelines for which were contained in RBI circular dated 10 February 1999. The salient features
of this system are as follows:

1. Banks were expected to form an ALCO headed by the bank’s chief executive.
2. The ALM process rested on three pillars – ALM information system, ALM organization
and the ALM process.
3. The ALM information system emphasized the need for accurate and timely information to
asses risks of individual banks.
4. The prerequisite for an effective ALM organization is strong commitment from the bank’s
senior and top management. The ALCO of the bank would be responsible for ensuring
proper asset liability management as set by the bank’s Board of Directors.
5. Through the scope of the ALM process would encompass management of liquidity risk,
market risk, trading risk, funding and capital planning and profit planning, the RBI
guidelines primarily address liquidity and interest rate risks.

Liquidity Risk Management in Indian Banks

The global financial crisis of 2007 has highlighted, like never before, the role of prudent
management as the cornerstone of financial stability. On November 7, 2012, RBI released
guidelines for liquidity risk management, based on the documents Principles for Sound Liquidity
Risk Management and Supervision as well as Basel III: International Framework for Liquidity
Risk Measurement, Standards and Monitoring published by the Basel Committee on Banking
Supervision (BCBS) in September 2008 and December 2010 respectively.

Banks had to implement the guidelines immediately. However, these guidelines have been further
refined based on the January 2013 document of the Basel Committee titled ‘Basel III: The Liquidity
Coverage Ratio and Liquidity Risk Monitoring Tools’.

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REFERENCES
https://www.bis.org/bcbs/publ/d368.pdf
http://pubdocs.worldbank.org/en/161391507314945324/note-interest-rate-risk-
management-201708.pdf
https://www.boi.org.il/en/BankingSupervision/SupervisorsDirectives/ProperConductOfB
ankingBusinessRegulations/333_et.pdf
https://home.kpmg.com/de/en/home/insights/2017/01/management-interest-rate-
risks.html
https://www.nseindia.com/education/resources/download/ncfm_irdbm_sm.pdf
https://www.edupristine.com/blog/interest-rate-derivatives-in-detail
https://learning.oreilly.com/library/view/an-introduction-to/9781119115892/c10.xhtml
https://learning.oreilly.com/library/view/measuring-and-managing/9781119990246/
http://bankingandnonbanking.com/wp-content/uploads/2016/07/Asset-Liability-
Management.pdf
http://shodhganga.inflibnet.ac.in/bitstream/10603/152924/14/11_chapter%202.pdf
https://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/3204.pdf
RBI, 2011, Report of the working Group on Reporting of OTC interest rate and forex
derivatives, paragraph 3.8, page 16 and RBI circular dated December 29, 2016, enclosing
the Interest Rate Options (Reserve Bank) Directions, 2016, accessed at www.rbi.org.in.

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