A STUDY OF THE IMPACT OF ASSET-LIABILITY

MANAGEMENT ON THE PROFITABILITY OF BANKS IN INDIA

Mihir Dash, Professor
Department of Quantitative Methods
School of Business, Alliance University, India
Introduction
Asset-liability management is concerned with the strategic management of assets
and liabilities aimed to optimize bank profitability, while ensuring liquidity, and pro-
tecting the bank against interest rate risk, exchange rate risk, liquidity risk, credit risk,
and contingency risk.
There is a considerable literature examining asset-liability management in banks.
Vaidyanathan (1999) examined strategies of asset-liability management both from
assets and liabilities side, particularly in the Indian context. Beck et al. (2000) present-
ed a more realistic approach to measure portfolio duration and duration gap, which
would enhance banks’ strategic planning process. Vaidya and Shahi (2001) discussed
how liquidity risk and interest rate risk can be managed through an asset-liability man-
agement system (ALM). Seethapathi (2002) also focuses on ALM using gap analysis.
Al Subiri (2010) examined the impact of ALM on bank profitability.
Dash and Pathak (2011) proposed a linear model for asset-liability assessment.
They found public sector banks having best asset-liability management positions. In
their turn, Dash et al. (2011) found that public sector banks had a strong short-term
liquidity position, but with lower profitability, while private sector banks had a com-
fortable short-term liquidity position, balancing profitability. They suggested that there
is great scope for improvement in profitability and liquidity for Indian banks.
Most of the literature emphasizes the strategic aspects of asset-liability manage-
ment, and very few studies have considered the impact of asset-liability management
on the performance of banks. The present study tries to address the gap in the litera-
ture.

Methodology
The objective of the present study is to examine the impact of asset-liability
management on the profitability of the banks. The scope of the study covers both pub-
lic sector and private sector banks in India. A sample of thirty-five banks was consid-
ered for the study. The study period is the financial year 2005-06, with the financial
position of the sample banks considered on March 31st, 2006. The data for the study is
in the form of balance sheets of the sample banks and was collected from the Capital-
ine database. The sample banks are listed in Table 1.
The average profits of the public sector banks were Rs. 673.07 crore, with a
standard deviation of Rs. 868.36 crore, while that of private sector banks were Rs.
410.88 crore, with a standard deviation of Rs. 752.41 crore. The Mann-Whitney test
indicated that public sector banks had significantly higher profits than private sector
banks (z = -2.452, p = 0.007).
The study applied maturity gap analysis to measure the liquidity position of the
sample banks, and to assess the match between assets and liabilities, with the following
maturity brackets: 1-14 days, 15-28 days, 1-3 months, 3-6 months, 6-12 months, 1-3
years, 3-5 years, and 5+ years. This was done by placing all cash inflows (maturing

Electronic copy available at: http://ssrn.com/abstract=2403644

 assets) and cash outflows (maturing liabilities) in the maturity bracket according to the
expected timing of cash flows. The assets and liabilities were allocated into different
maturity brackets in accordance with RBI’s guidelines (ALM System, 1999). Within
each maturity bucket, the mismatch between cash inflows and outflows was calculated.
Table 1. Sample Banks and Their Profit (in Rs. Crore) for 2005-06
Public Sector Banks Profit Private Sector Banks Profit
Allahabad Bank 706.13 City Union Bank 56.37
231
Andhra Bank 486.00 HDFC Bank 870.78
Bank of Baroda 826.85 ICICI Bank 2540.07
Bank of India 701.21 Karnataka Bank 176.03
Bank of Maharashtra 51.00 Karur Vysya Bank 135.35
Canara Bank 1343.37 Kotak Mahindra Bank 118.23
Central Bank 257.42 Lakshmi Vilas Bank 22.47
Corporation Bank 444.52 South Indian Bank 50.90
IDBI Bank 561.00 UTI Bank 485.08
Indian Bank 504.99 Vysya Bank 9.06
Indian Overseas Bank 783.35 Yes Bank 55.32
Oriental Bank of Commerce 557.00
Punjab National Bank 1439.31
State Bank of India 4407.00
State Bank of Hyderabad 427.04
State Bank of Mysore 216.72
State Bank of Travancore 258.68
State Bank of Indore 139.11
State Bank of Patiala 303.16
Syndicate Bank 536.50
UCO bank 196.65
Union Bank of India 675.00
United Bank of India 204.82
Vijaya Bank 126.86

Regression analysis was used to examine the impact of these mismatches on the
profitability of the banks. The model is given by:  i    1 M 1i  ...   k M ki   i ,
where the independent variables M1,… Mk represent the maturity mismatches, and the
dependent variable π represents profit. The constant term α represents the profit level
expected from interest rate spread alone. As the maturity mismatches must sum to zero,
there is expected to be a high degree of multicollinearity among the independent varia-
bles. To deal with this multicollinearity, factor analysis was performed. Thus, it ex-
cluded from consideration three factors: the first represented the maturity mismatch for
1-90 days (i.e. aggregating 1-14 days, 15-28 days, and 1-3 months), the second repre-
sented the maturity mismatch for 3-12 months (aggregating 3-6 months and 6-12
months), and the third represented the maturity mismatch 1+ years (i.e. 1-3 years, 3-5
years, and 5+ years). The same procedure was used for cumulative maturity mismatch-
es; three maturity mismatches were derived. These factors were used in the regressions.

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 Findings
The descriptive statistics of the maturity mismatches and the sensitivity mis-
matches of public sector and private sector banks are given in Table 2.

Table 2. Descriptive Statistics of the Maturity Mismatches of Public and

Private Sector Banks
public private
sector sector overall z stat p-value
232
Mismatch 1: 1- Mean -2269.02 -2989.69 -2495.51 -0.32 0.7491
14 days Std. Dev. 9688.98 7311.81 8907.53
Mismatch 2: 15- Mean -847.25 -488.41 -734.47 -2.91 0.0036
28 days Std. Dev. 734.33 840.50 775.32
Mismatch 3: 1-3 Mean -881.05 -525.80 -769.40 -2.52 0.0116
months Std. Dev. 700.93 1053.95 828.89
Mismatch 4: 3-6 Mean -650.30 -406.21 -573.59 -1.88 0.0597
months Std. Dev. 1055.69 732.37 961.71
Mismatch 5: 6- Mean 472.56 73.17 347.04 -1.63 0.1021
12 months Std. Dev. 1552.28 411.77 1309.68
Mismatch 6: 1-3 Mean -17275.86 -5138.93 -13461.39 -3.13 0.0018
years Std. Dev. 18682.23 7395.70 16878.16
Mismatch 7: 3-5 Mean 10658.25 5554.55 9054.23 -2.77 0.0056
years Std. Dev. 13187.90 9780.25 12311.15
Mismatch 8: 5+ Mean 16670.24 8550.07 14118.18 -2.59 0.0095
years Std. Dev. 22027.80 14738.17 20168.15

Most of the sample banks were found to have negative mismatches for shorter
maturities, and all banks were found to have positive mismatch for the 3-5 years and
5+ years maturity brackets. Thus, there was found to be a high exposure to short-term
risks. The Mann-Whitney test indicated that the negative maturity mismatches were
significantly worse for the public sector banks in the 15-28 days, 1-3 months, and 3-6
months maturity brackets.
The results of the regressions of profit on the maturity mismatches (model I) and
on cumulative maturity mismatches (model II) are presented in Table 3.
Model I was significant, explaining 78.8% of the variation in profit of the sample
banks. The constant term was significant, indicating a significant interest rate spread. A
negative maturity mismatch for the 1-90 day bracket was found to have a significant
positive impact on profit, while a negative maturity mismatch for the 3-12 months
bracket was found to have a significant negative impact on profit.
Model II was also significant, explaining 78.8% of the variation in profit of the
sample banks. The constant term was significant, indicating a significant interest rate
spread. As in the previous model, a negative cumulative maturity mismatch for the 1-
90 day bracket was found to have a significant positive impact on profit, while a nega-
tive cumulative maturity mismatch for the 3-12 months bracket was found to have a
significant negative impact on profit.

Electronic copy available at: http://ssrn.com/abstract=2403644

 Table 3. Regression Results
Model I: regression of profit on maturity mismatches
Coeff. Std. Error Beta t stat p-value
[Constant] 352.932 79.552 4.436 0.000
Mismatch: 1-90 days -0.064 0.009 -0.741 -6.983 0.000
Mismatch: 3-12 months 0.081 0.041 0.207 1.949 0.030
2
R 78.8%
233 F stat 59.394 0.000
Model II: regression of profit on cumulative maturity mismatches
Coeff. Std. Error Beta t stat p-value
[Constant] 352.932 79.552 4.436 0.000
Cumulative Mismatch: 1-
-0.145 0.036 -1.673 -3.999 0.000
90 days
Cumulative Mismatch: 3-
0.081 0.041 0.816 1.949 0.030
12 months
R2 78.8%
F stat 59.394 0.000

Conclusions
The results of the study indicate that most of the banks are exposed to short term
risk, with negative maturity mismatches in the 1-90 days bracket, and more so for pub-
lic sector banks. However, the regression results indicate that there is an incentive to
maintain negative maturity mismatch in the short-term, as this improves profitability.
Thus, there is a risk-return trade-off for short-term maturity mismatch.
There were several limitations inherent in the study. The sample size was rela-
tively small. Also, the maturity analysis was based on assumptions suggested by RBI,
not necessarily reflecting the actual maturity patterns of the sample banks’ assets and
liabilities. Another difficulty is the limited study period, as the data represents the
banks’ financial status as on 31st March, 2006. The results of the study may not gener-
alize to other periods, particularly after the banking crisis following the Global Finan-
cial Crisis of 2007-08. There is a great scope for further study, extending the study to
include the longitudinal perspective, and perhaps to consider the impact of maturity
mismatches on other performance parameters, e.g. risk, non-performing assets, effi-
ciency, and value. The impact of interest rate sensitivity on bank performance could
also be investigated.
References
Al Subiri, F.N. (2010), “Impact of Bank Asset and Liability Management on Profitabil-
ity: Empirical Investigation,” Journal of Applied Research in Finance, Vol. 2,
No. 4, pp. 101-109.
ALM System (1999), Guidelines for Asset Liability Management (ALM) System in
Financial Institutions (FIs), Reserve Bank of India, Circular Ref DBS. FID No.
C-11, December 31, available at: http://rbidocs.rbi.org.in/rdocs/notification/
PDFs/10962.pdf.
Beck, K.L., Goldreyer, E.F., and d’Antonio, L.J. (2000), “Duration Gap in the context
of a Bank’s strategic planning process,” Journal of Financial and Strategic De-
 cisions, Vol. 13, No. 2, pp. 57-71.
Dash, M. and Pathak, R. (2011), “A Linear Programming Model for Assessing Asset-
Liability Management in Banks,” IUP Journal of Financial Risk Management,
Vol. 8, No. 1, pp. 50-67.
Dash, M., Venkatesh, K. A., and Bhargav B.D. (2011), “An Analysis of Asset-Liability
Management in Indian Banks,” SSRN Working Paper Series, available at SSRN:
http://ssrn.com/abstract=1760786.
Seethapathi, K. (2002), Risk Management in Banks, ICFAI Press, Hyderabad. 234
Vaidyanathan, R. (1999), “Asset-liability management: Issues and trends in Indian
context,” ASCI Journal of Management, Vol. 29, No. 1, pp. 39-48.

A STUDY OF THE IMPACT OF ASSET-LIABILITY MANAGEMENT

ON THE PROFITABILITY OF BANKS IN INDIA
Mihir Dash
Alliance University, India
Abstract
Asset-liability management in banks is the strategic management of assets and
liabilities aimed to optimize profitability, while ensuring liquidity, and protecting
against different risks. The study examines the impact of asset-liability management on
the banks’ profitability for a sample of thirty-five public and private sector Indian
banks. The results of the study indicate that most of the banks are exposed to short
term risk, with negative maturity mismatches in the 1-90 days bracket, and more so for
public sector banks. However, the regression results indicate that there is an incentive
to maintain negative maturity mismatch in the short-term, as this improves profitabil-
ity.
Keywords: asset-liability management, profitability, liquidity, risk, maturity gap
analysis