Synetic College Logo
Unit 4 of 4 · MBA Sem 3

Unit 4: Asset-liability and risk management in banks

Management of Financial Services notes · PTU syllabus (MBA 912-18)

3 min read5 topics10 exam questions
On this page
  1. Unit summary
  2. ALM: significance, process and techniques
  3. Credit, operational, market and liquidity risk management
  4. Corporate treasury management
  5. Basel norms
  6. ALM software
  7. Key terms
  8. Quick revision
  9. Important questions

Unit summary

Banks must manage the mismatch between their assets and liabilities and a range of risks. This unit covers ALM — significance, process and techniques (gap, duration, simulation, value at risk) — credit, operational, market and liquidity risk management, corporate treasury management, Basel norms, and ALM software.

After this unit you can

  • Explain the significance and process of ALM
  • Apply gap, duration, simulation and VaR techniques
  • Explain credit, operational, market and liquidity risk management and treasury
  • Explain Basel norms and the use of ALM software

PTU syllabus topics

  • ALM significance
  • process and techniques (gap, duration, simulation, value at risk)
  • credit/operational/market/liquidity risk management
  • corporate treasury management
  • Basel norms
  • ALM software
ClassificationRisks managed by banks
Bank risk

  • Credit risk

    Borrower default

  • Market risk

    Interest rates, FX, equity prices

  • Liquidity risk

    Unable to meet withdrawals

  • Operational risk

    People, process, systems failure

1

Topic 1

ALM: significance, process and techniques

ALM is managing the bank's balance sheet to control liquidity and interest rate risk while achieving profitability.

ProcessALM process
  1. 1

    Board-approved ALM policy

  2. 2

    ALCO (Asset–Liability Committee) meets regularly

  3. 3

    Collect data and prepare statements

    Structural liquidity, interest rate sensitivity

  4. 4

    Measure risks

    Gap, duration, simulation, VaR

  5. 5

    Set limits and take decisions

    Pricing, funding mix, hedging

  6. 6

    Monitor and report

ClassificationALM techniques
ALM techniques

  • Gap analysis

    RSA − RSL by time buckets

  • Duration analysis

    Duration gap — sensitivity of equity value

  • Simulation

    Scenario-based NII and EVE projections

  • Value at risk

    Maximum expected loss at a confidence level

Key formulasALM measures

  • Repricing gap

    RSA − RSL

  • Change in NII

    Gap × Δ interest rate

  • Duration gap

    DA − (L ÷ A) × DL

  • Change in equity value

    −Duration gap × A × Δi ÷ (1 + i)

  • Value at risk (parametric)

    Position value × z × σ × √t

Example

Assets ₹1,000 crore (duration 4), liabilities ₹900 crore (duration 1.5), rates rise 1% from 8%: duration gap = 4 − 0.9 × 1.5 = 2.65; fall in equity ≈ 2.65 × 1,000 × 0.01 ÷ 1.08 ≈ ₹24.5 crore.

2

Topic 2

Credit, operational, market and liquidity risk management

Credit risk

Risk that a borrower fails to repay. Management: credit appraisal (5 Cs), credit rating models, exposure limits (single and group borrower limits — Large Exposures Framework), collateral, covenants, diversification, loan review, provisioning, credit derivatives.

Liquidity risk

Risk of not having enough cash to meet withdrawals and obligations.

  • Basel III ratios: Liquidity Coverage Ratio (LCR) — high-quality liquid assets ≥ net cash outflows over 30 days (100%); Net Stable Funding Ratio (NSFR) — available stable funding ≥ required stable funding (100%).
  • Structural liquidity statements by maturity buckets; contingency funding plans; access to RBI's LAF and MSF.

Operational risk

Risk of loss from failed internal processes, people, systems or external events — fraud, IT failures, cyber-attacks, legal risk.

  • Management: internal controls, segregation of duties, audit, business continuity plans, insurance, KYC, cyber security; capital under Basel (basic indicator, standardised approaches).

Market risk

Risk of losses from movements in market prices — interest rates, equity prices, exchange rates, commodity prices — on the bank's trading book.

  • Measurement: Value at Risk (VaR), stress testing; limits on positions; hedging with derivatives.
FrameworkMajor bank risks

  • Credit risk

    Borrower default — appraisal, limits, collateral

  • Liquidity risk

    Cash shortfall — LCR, NSFR, ALM

  • Operational risk

    Process/people/system failure — controls, BCP

  • Market risk

    Price movements — VaR, limits, hedging

3

Topic 3

Corporate treasury management

  • Bank treasury functions: managing CRR/SLR, money market borrowing and lending, investment portfolio (G-secs, corporate bonds), forex dealing, derivatives, ALM support, transfer pricing of funds.
  • Organisation: front office (dealing), mid-office (risk monitoring, limits), back office (settlement, accounting) — segregation of duties.
4

Topic 4

Basel norms

  • Bank for International Settlements (BIS), Basel, Switzerland (1930) — the "central bank of central banks"; hosts the Basel Committee on Banking Supervision (BCBS).
ComparisonBasel I vs II vs III
Focus
Key provisions

Basel I (1988)

Credit risk

Capital 8% of risk-weighted assets; risk weights 0–100%

Basel II (2004)

Credit, market and operational risk

Three pillars — minimum capital, supervisory review, market discipline

Basel III (2010)

Quality and quantity of capital, liquidity

CET1 4.5%, capital conservation buffer 2.5%, countercyclical buffer, leverage ratio, LCR and NSFR

  • India: RBI requires CRAR of 9%, CET1 5.5%, CCB 2.5% — stricter than Basel minimums; leverage ratio 4% for D-SIBs, 3.5% for others.
5

Topic 5

ALM software

  • Purpose: capture data from core banking, classify assets and liabilities into time buckets, compute gaps, duration, NII and EVE sensitivity, run stress tests and simulations, generate RBI returns (Structural Liquidity Statement, Interest Rate Sensitivity), support LCR/NSFR reporting.
  • Examples: Oracle Financial Services ALM, SAS, Moody's, FIS, and in-house systems integrated with data warehouses.
  • Requirements: accurate data, integration with treasury and risk systems, scenario capability, audit trails, user-friendly dashboards for ALCO.

Key terms

Duration gap
Mismatch between asset and liability durations
Value at Risk
Maximum expected loss at a confidence level over a horizon
ALCO
Asset–Liability Committee
Treasury
Bank function managing liquidity, investments and forex
ALM software
Systems that measure liquidity and interest rate risks

Quick revision

  • ALM: ALCO, liquidity and interest rate risk; gap, duration, simulation, VaR.
  • Risks: credit, operational, market, liquidity; LCR and NSFR.
  • Treasury: front, mid and back office.
  • Basel I–III; India CRAR 9% + CCB 2.5%.
  • ALM software for buckets, gaps, stress tests and RBI returns.

Important exam questions

Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).

Short-answer questions

  1. Q1.What is ALM?
  2. Q2.What is a duration gap?
  3. Q3.What is VaR?
  4. Q4.State two techniques of liquidity risk management.
  5. Q5.What are the functions of a bank treasury?
  6. Q6.What is ALM software used for?

Long-answer questions

  1. Q1.Explain the significance, process and techniques of ALM.
  2. Q2.Explain the management of credit, operational, market and liquidity risks in banks.
  3. Q3.Explain corporate treasury management in banks.
  4. Q4.Explain Basel norms and the role of ALM software.

Stuck on this unit?

Message SBS on WhatsApp for help with Management of Financial Services, or to ask about studying MBA at Synetic.

WhatsApp us