ALM Process

1. A recurring management cycle

1. Set objectives: Board approves risk appetite, policies, responsibilities and limits.
2. Capture and reconcile data: collect asset, liability, derivative, collateral and contingent cash flows by entity and currency; reconcile to finance records.
3. Model behaviour: estimate deposit stability and beta, early withdrawals, prepayments, drawdowns and refinancing assumptions.
4. Measure exposure: cash-flow ladders, cumulative gaps, repricing gaps, earnings scenarios, duration and EVE.
5. Stress and compare: apply rate, withdrawal, funding-market and combined stresses; compare results with limits.
6. Decide and execute: ALCO selects funding, pricing, asset mix and hedging actions, with owners and deadlines.
7. Monitor and challenge: track implementation, escalate breaches, validate models and feed results into the next cycle.

2. Cash-flow gap example

Illustrative undiscounted flows in ₹ crore, excluding opening liquidity buffers. Buckets are chosen for teaching and are not a prescribed regulatory return.

Gap = inflows − outflows. The bank needs ₹50 crore of usable funding or liquidity through day 30 under these assumptions. A positive gap later cannot settle an earlier payment. Adding a ₹60 crore opening usable buffer leaves ₹10 crore at day 30, before haircuts, intraday needs and stress changes.

3. Repricing risk is a different ladder

Suppose rate-sensitive assets of ₹200 crore and rate-sensitive liabilities of ₹300 crore all reprice immediately and remain exposed for one year. Repricing gap = −₹100 crore. With an equal +1% rate change, ΔNII ≈ gap × Δrate × exposure period = −₹1 crore.

If instruments reset halfway through the year, only half-year exposure applies. Unequal betas, basis movements, options and new business require a more detailed simulation. Do not use a liquidity cash-flow gap as though it were a repricing gap.

4. Duration and economic value

For an illustrative portfolio, asset market value A = ₹1,000 crore, liability market value L = ₹920 crore, modified asset duration D_A = 3 and modified liability duration D_L = 1.5. Duration gap = D_A − (L/A)D_L = 1.62 years.

For a small parallel +1% yield shift, ΔEVE ≈ −(D_AA − D_LL)Δy = −₹16.20 crore. This first-order modified-duration approximation omits convexity, options, non-parallel shocks and off-balance-sheet positions. Macaulay duration would require a yield adjustment.

5. What should go into an ALCO pack?

6. Governance and action trade-offs

The Board approves policy and risk appetite. ALCO translates these into balance-sheet decisions. Treasury executes funding and approved hedges; business units price and originate within policy. Independent risk challenges assumptions and monitors limits; finance reconciles data; internal audit reviews controls.

A pay-fixed, receive-floating swap can reduce exposure from fixed-rate assets funded with floating-rate liabilities, subject to benchmark and tenor alignment. It can also create collateral liquidity needs and counterparty exposure. Longer-term borrowing can improve funding resilience but reduce current margin. ALCO evaluates the combined effect.

A contingency funding plan specifies warning indicators, escalation authority, available funding sources, collateral readiness, communications and execution responsibilities. Sources must be operationally tested rather than simply listed.

Check your understanding

7. The three building blocks: information, organisation and process

A minimum data dictionary

Record instrument and customer identifiers, legal entity, currency, principal, coupon and benchmark, spread, next reset date, payment schedule, contractual maturity, optionality, collateral eligibility and encumbrance. Separate observed facts from modelled assumptions.

Reading connection: CAIIB coordinated balance-sheet management discussion; Kallur in the Compilation, PDF pp. 3–11.

8. Contractual and behavioural ladders

Start with contractual cash flows

Allocate each payment to the period when it falls due. Distinguish final principal, instalments, interest, settlements and contingent commitments. Build currency-specific ladders before considering aggregation.

Then model the behavioural differences

Estimate non-maturity deposit run-off, early withdrawals, prepayments and credit-line drawdowns. Maintain separate base and stress assumptions with documented rationale and approval. A normal-condition core deposit estimate is not a guarantee of survival during a run.

Do not confuse two gap conventions

Some texts compare outstanding asset and liability stocks; this series’ earlier liquidity ladder uses inflows minus outflows in each bucket. State the definition and sign convention before interpreting any gap report.

Reading connection: ALM NOTES, Section 7.1.2; Gurnani’s two-page strategic-tool note. Historical bucket lists are not adopted as current reporting rules.

9. Run-off, constant and dynamic balance sheets

Keep comparisons honest

For every scenario state the horizon, balance-sheet treatment, rate path, deposit beta and lag, prepayment behaviour and proposed management actions. Show the exposure before proposed actions as well as the residual risk after them.

Reading connection: ALM NOTES, Section 7.1.2.3, uploaded PDF pp. 17–18; Basel SRP98.

10. Funds transfer pricing: connect risk to business pricing

Why a single average funding rate can mislead

A five-year loan should reflect the cost of funding its tenor and behaviour. Charging every loan the overnight rate can reward growth while hiding term-funding risk. Deposit businesses also deserve recognition for the economic funding value they supply.

A simple internal margin example

For a standalone ₹100 crore fixed-rate loan earning 9%, assume an appropriate matched-tenor FTP charge of 7%. The lending unit earns a ₹2 crore annual margin before credit costs, operating costs and capital charges. For a separate ₹100 crore deposit costing 4%, an illustrative FTP credit of 6% leaves its business unit ₹2 crore before operating costs. These are separate product illustrations, not a complete bank NII reconciliation.

What FTP transfers—and what remains

FTP allocates funding and interest-rate economics internally. It does not create external cash or eliminate risk for the bank. Treasury or ALM manages the resulting structural mismatch. A richer framework can price liquidity tenor, embedded options, reserve effects and contingent funding consistently.

Reading connection: Dermine & Bissada, Stage 5, especially printed pp. 29–32; Kallur, Compilation PDF p. 10. New illustrative rates and balances.

11. Stress testing: from scenarios to survival

Three scenario families

Reverse stress testing

Ask what withdrawal, haircut or funding-closure combination would exhaust usable liquidity or breach a critical limit. This identifies vulnerabilities rather than attaching false precision to one forecast.

A stressed-buffer illustration

The earlier cash-flow ladder needs ₹50 crore through day 30 and begins with ₹60 crore usable cash. An additional ₹20 crore withdrawal leaves a ₹10 crore shortfall. A separate ₹25 crore unencumbered security, not included in that opening cash, would raise ₹20 crore at an assumed 20% haircut if it can actually be pledged. That would restore ₹10 crore headroom. Reusing collateral already counted in the opening buffer would overstate the capacity.

Reading connection: Kallur, Compilation PDF pp. 10–11; Choudhry, 2011, Chapter 8. This is an original cash-funding illustration, not an LCR calculation.

12. Liquidity buffers, collateral and intraday payments

Available is different from owned

Check encumbrance, legal entity, currency, settlement time, haircut and operational ability to sell or pledge. Funding that is trapped in another entity may not be transferable when needed.

Intraday needs

A bank can end the day with enough cash and still fail an earlier payment. Monitor payment peaks, collateral for settlement and reliance on incoming funds. A 30-day metric does not replace intraday analysis.

Currency-specific resilience

A net FX position near zero does not guarantee access to cash in each currency. Currency swaps can align exposures but introduce rollover, basis, counterparty and collateral needs.

Reading connection: RBI Commercial Banks – Asset Liability Management Directions, 2025, Chapters III–VI; Choudhry, 2011, liquidity chapters.

13. Model risk, validation and backtesting

Challenge assumptions that drive the answer

Segment deposits by customer and product; compare projected with realised withdrawals and repricing. Compare prepayment assumptions with actual experience. Test the effect of alternative assumptions and document limitations.

Independent review and governance

Validate calculations, data mappings, behavioural models and scenario implementation. Track model versions, approvals, overrides and remediation. A precise-looking EVE estimate can still be unreliable if deposit duration is poorly supported.

Reading connection: ALM NOTES, Chapter 7; Kallur’s governance discussion. The seven-page Handbook upload is a contents extract, not evidence of reviewed model methodologies.

14. From ALCO report to an accountable action plan

Illustrative meeting sequence

Review prior actions; assess market and balance-sheet developments; examine liquidity, NII and EVE; challenge stress and model assumptions; decide actions; record owners, deadlines and escalation. Meeting frequency depends on the bank and stress conditions; a textbook’s monthly example is not a universal rule.

Reading connection: Choudhry, 2011, Chapter 7, printed pp. 224–229.

15. Historical readings and the current regulatory framework

How to use the uploaded RBI document

The file named RBI_2008-09_ is a historical foreign-exchange risk-management and interbank-dealings circular. It provides background on currency positions and gaps; it is not a current comprehensive ALM master direction. Do not apply its historical product permissions, reporting rules or limits as current requirements.

Use current primary sources for requirements

The RBI’s 2025 Commercial Banks ALM Directions cover liquidity governance, intraday liquidity, LCR, NSFR and interest-rate risk. Basel IRRBB guidance develops earnings and economic-value measurement. Basel standards and local implementation are different layers: check the applicable bank category, amendments and commencement provisions before treating a method or limit as binding.

Reading connection: Historical RBI upload, PDF pp. 1–3; current official RBI and Basel links in Sources.

Continue learning

1. 1. Introduction to Asset Liability Management in Banks
2. 2. Understanding Banks’ Balance Sheet and Income Statement
3. 3. ALM Process

Educational illustrations use fictional data. Prof. V. Ravichandran · The Mountain Path Academy.