The final guidelines for ALM systems, which were issued by the Reserve Bank today, will have to be implemented by the banks by April 1. The guidelines address in main, liquidity and interest rate risks, and have been formulated to serve as a benchmark for banks not having a formal ALM system.

The central bank has instructed banks, which already have a sophisticated system in place to fine-tune their management information systems (MIS) to be compatible with the ALM system suggested in the guidelines.

"Other banks should examine their existing MIS and arrange to have an information system to meet the prescriptions of the newALM system. To begin with, banks should ensure coverage of atleast 60 per cent of their liablities and assets. As for the remaining 40 per cent of their asset and liablities, banks may include the positions based on their estimates. It is necessary that banks set targets in the interim for covering 100 per cent of their business by April 1, 2000," an RBI directive to banks said.

Accordingly the MIS would need to ensure that minimum infomation, consistent in quality and coverage, is captured and once the banks gain experience in handling ALM systems, they should be in a position to switch over to more sophisticated techniques like Duration Gap Analysis, simulation and value at risk for interest-rate risk management.

Banks have also been instructed to prepare a statement of structural liquidity designed to measure the maturity profile of cash-flows at quarterly intervals. "It is intended to eventually move over to a monitoring system on a fortnightly basis by April 11, 2000," Reserve Bank said. As a prudentmeasure, banks have been advised to operate within negative gap of 20 per cent of cash outflows during 1-14 days and 15-28 days time periods.

"If a bank, in view of its structural mismatches needs higher limit, it could operate with a higher limit with the approval of it board or management committee giving specific reasons for such higher limit," the RBI circular says. It added that such banks should, however, comply with the prudential limit by April 1,2000.

The Reserve Bank has further instructed banks that a statement of interest-rate sensitivity should be prepared at quarterly intervals and move over to a monthly schedule by April 1,2000. According to the Reserve Bank, the statement would provide useful feedback on interest rate risks faced by banks. However, banks have been warned that their boards should fix a prudent level of earnings at risks (EaR) or a net-interest margin (NIM) to minimise the risk profile.

Banks will now have to capture the impact of embedded operations, exercised bydepositors/borrowers to fine-tune their ALM practices, and evolve internal-transfer pricing mechanism for supplementing the efficacy of ALM techniques.

Insight

The guidelines on asset-liability mismatches are a recognition of the fact that differences in the maturities, currencies, and asset values of banks' and financial institutions' assets and liabilities could have serious impact on both their liquidity as well as their solvency, and repercussions on earnings and net worth. Given the potential for serious mismatches between the assets and liabilities of financial institutions, the guidelines should be extended to FIs as well.

Most Indian banks do not yet have the information systems to put a mismatch monitoring system in place. As SS Tarapore pointed out recently, it is necessary to have information on a residual maturity basis for the system to work. Another essential factor is the development of a term-money market, so that mismatches detected can immediately be corrected. And lastly, acapital charge where the exposure to liquidity and interest rate risks is substantial should be considered as a disincentive to erring banks.