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Asset and Liability Management (FIN215)
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Question 1
(a)
(i)
If I was revising an Asset and Liability program I would ensure that the following happened to so that it was updated to my satisfaction:
1. Revisit Asset and Liability Committee (ALCO).
I would have the ALCO team appropriately resourced with the correct team members. This would include representation from the senior management team, risk, treasury (capital and liquidity divisions) and the product and pricing teams.
2. Revise the ALM framework
After receiving the ALM strategy and policy from the board a review is needed to check that the existing framework (Charter) is in place is sufficient to address the known credit, market, liquidity and interest rate risk. I would then ensure with the business that all known risks are documented with the management of those risks as well. I would ensure that the existing communications between the ALCO and the board are appropriate and meet the needs of the business.
(ii)
Since the GFC there have been material changes into the way banks manage risk via their AML. The following areas must be covered in the AML policy:
i) Liquidity risk: the current and prospective risk arising when the bank is unable to meet its obligations as they come due without adversely affecting the bank's financial conditions. From an ALM perspective, the focus is on the funding liquidity risk of the bank, meaning its ability to meet its current and future cash-flow obligations and collateral needs, both expected and unexpected.
ii) Interest rate risk: The risk of losses resulting from movements in interest rates and their impact on future cash-flows. Generally because a bank may have a disproportionate amount of fixed or variable rates instruments on either side of the balance-sheet. One of the primary causes are mismatches in terms of bank deposits and loans.
iii) Currency risk management: The risk of losses resulting from movements in exchanges rates. To the extent that cash-flow assets and liabilities are denominated in different currencies.
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(b)
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(a)
In the 2013 Westpac annual report is was advised that their treasury team took responsibility for the management of their interest rate “Treasury is primarily focused on the management of the Group’s interest rate risk and funding requirements by managing the mismatch between Group assets and liabilities. Treasury’s earnings are primarily impacted by the hedging decisions taken on behalf of the Group to manage net interest income outcomes and assist net interest income growth.”
Repricing and repayment risk – interest rate repricing may not be the same as the contractual repayment term of the financial instrument. Examples include:
where interest costs fluctuate according to interest rate movements during the life of the loan; resetting of interest rates on an entity’s loans from banks or other lenders; resetting of interest rates on short-term investments such as bank deposits, commercial paper,
bank billsYield Curve Risk: Westpac has the risk of experiencing an adverse shift in market interest rates associated with investing in a fixed income instrument. The risk is associated with either a flattening or steepening of the yield curve, which is a result of changing yields among comparable bonds with different maturities. When market yields change, this will impact the price of a fixed-income instrument. When market interest rates, or yields, increase, the price of a bond will decrease and vice versa.
Basis Risk: The risk that offsetting investments in a hedging strategy will not experience price changes in entirely opposite directions from each other. This imperfect correlation between the two investments creates the potential for excess gains or losses in a hedging strategy, thus adding risk to the position.
Outright interest rate risk: the impact of a change in the overall level of interest rate risk. For example, if an investor holds a fixed interest bond and interest rates generally increase, then the investorwill experience a loss.
Westpac has correctly identified market risk (which includes interest rate risk) has a financial risk. The bank advised in their 2012 Annual report that they adopt the following strategy to achieve stability in the net interest income.
“These activities are overseen by the independent FMTR unit, reviewed by MARCO and conducted within a risk framework and appetite set down by the BRMC.”
For non-traded balance items NII sensitivity is managed in terms of the net interest income-at-risk (NaR) modelled over a three year time horizon using a 99% confidence interval for movements in wholesale market interest rates (Westpac ,2012).
For trade related items on the balance sheet Westpac adopts the follows “a Board-approved market risk framework that incorporates a Board-approved Value at Risk (VaR) limit. VaR is the primary mechanism for measuring and controlling market risk. Market risk is managed using VaR
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and structural risk limits (including volume limits and basis point value limits) in conjunction with scenario analysis and stress testing” (Westpac ,2012).
The bank also uses backtesting, stress testing, a profit and loss framework and risk reporting to manage interest risk.
(b)
Subordinated debt is a class of debt whose holders have a claim on the company's assets only after the senior debt holders' claims have been satisfied. Subordinated debt offers investors a risk/return profile above that of senior debt, but below the risk/return profile of pure equity. As there is a higher level of applicable interest this places more pressure for the corresponding asset to perform if only senior debt was used. Examples include
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A standout amongst the best devices the board and senior administration can give to their staff is a
sound strategy order for the bank's different exercises and danger exposures. Through sound approaches,
the board imparts to bleeding edge and senior faculty its desires concerning danger tolerance, attractive and
undesirable exercises, inner control and review, and danger estimation (Matten, 1996). Regularly, executives
create ALM strategies that combine the board's desires for investment rate and liquidity hazard exposures
and oversight. At the point when inspectors assess ALM approaches, they are looking to see that the
accompanying issues are properly tended to:
The strategy ought to state the bank's goals for ALM and give an overall verbalized methodology for
dealing with the dangers connected with asset report accounts. This would commonly incorporate
the board's perspective in regards to exchange offs in the middle of income and investment rate and
liquidity hazard exposures.
Another basic component of any ALM approach is suitable total danger limits for investment rate and
liquidity hazard exposures. Customarily, group bank ALM strategies would build
development/repricing crevice danger points of confinement to address IRR exposures and one or
two liquidity degree measurements (e.g., credits to-stores or noncore subsidizing reliance
proportions) for liquidity hazard exposures. With the multiplication of callable securities, home loan
upheld securities, Internet and expedited Cds, journalist bank and Federal Home Loan Bank
borrowings, and fiscal subsidiaries, numerous group banks have executed more hearty, forward-
looking danger estimation methods.
The strategy ought to give clear lines of power, obligation, and responsibility with respect to hazard
administration exercises. It ought to incorporate tending to circumstances where the establishment
falls outside of its made danger parameters, characterizing who is in charge of actualizing key and
strategic exercises, building and keeping up danger estimation frameworks, and distinguishing
dangers that may emerge from new items or exercises. In numerous group banks, these obligations
tumble to one or a couple of people. The board ought to be mindful of any focus in obligation or
power and guarantee that satisfactory controls are set up to alleviate any ensuing dangers. A
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successful control may incorporate, for instance, autonomous audits of these exercises by
somebody who comprehends the danger administration exercises and potential issues that could
emerge (Kusy, & Ziemba, 20060.
The strategy ought to additionally obviously outline the sorts of exercises that an organization may
lead. This may incorporate the sorts of monetary instruments or exercises that are allowable for
either the keeping money book or danger relief (that is, supporting) exercises. At the point when
overseeing liquidity hazards, the arrangement ought to show what sorts of financing are adequate
and to what degree these sources ought to be utilized. For instance, some group banks have joined
the utilization of Internet or expedited stores to expand neighborhood store volumes. For such
foundations, the ALM approach ought to examine how Internet or expedited stores may be fittingly
utilized and the degree to which the board considers these stores worthy. While nontraditional
subsidizing may change the bank's innate liquidity danger profile, sound controls over the volume
and sort of innately more dangerous financing sources may help to moderate
Banks need to address these risks in a structured manner by upgrading their risk management and
adopting more comprehensive Asset-Liability Management (ALM) practices than has been done hitherto.
ALM, among other functions, is also concerned with risk management and provides a comprehensive and
dynamic framework for measuring, monitoring and managing liquidity, interest rate, foreign exchange and
equity and commodity price risks of a bank that needs to be closely integrated with the banks' business
strategy. It involves assessment of various types of risks and altering the asset-liability portfolio in a dynamic
way in order to manage risks.
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ALM has to be supported by a management philosophy which clearly specifies the risk policies and
tolerance limits. This framework needs to be built on sound methodology with necessary information system
as back up. Thus, information is the key to the ALM process. It is, however, recognised that varied business
profiles of banks in the public and private sector as well as those of foreign banks do not make the adoption
of a uniform ALM System for all banks feasible. There are various methods prevalent world-wide for
measuring risks. These range from the simple Gap Statement to extremely sophisticated and data intensive
Risk Adjusted Profitability Measurement methods (Giandomenico, 2008).
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Question 4
a) Management of liquidity risk
Liquidity is managed to policies and strategies determined by the Bank’s Asset and Liability
Committee (ALCO) and overseen and approved by the Bank’s Board (Cornett, & Saunders, 2003). These
include:
Maintaining a core of high quality and readily liquefiable securities;
Esuring that there are significant amounts of committed term funding to complement retail
funds;
Ensuring that there are significant and diversified funding lines in place to meet monthly
obligations; and
Monitoring liquidity flows while quickly identifying any anomalies.
The Group’s liquidity management process is monitored by Risk Management and Compliance
within our Institutional and Business Banking Division (IBB) and managed by the Head of Money Markets
and includes:
Monitoring of future cash flows to ensure daily funding requirements can be satisfied;
Managing the concentration and profile of debt maturities.
The daily liquidity position is monitored and regular liquidity stress testing is conducted under a
variety of scenarios covering both normal and more severe market conditions. All liquidity policies and
procedures are subject to review by ALCO and approval by the Board. Risk Management & Compliance
(IBB) monitors adherence to policy limits and is responsible to escalate any exceptions and remedial action
taken per the Group’s policy and to provide a report to ALCO regularly (Goodhart, 2008).
b)
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c) Interest Rate Sensitivity on Net Interest Income
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Various measures are utilized to screen and oversee investment rate danger, including pay
reenactments and premium affectability (hole) breaks down. A salary recreation model is the essential device
used to evaluate the course and extent of progressions in net investment wage coming about because of
progressions in premium rates. Key suspicions in the model incorporate prepayment speeds on home loan
related holdings, money streams and developments of other financing securities, advance and store volumes
and pricing. These presumptions are inalienably unverifiable and, accordingly, the model can't definitely
gauge net investment wage or unequivocally anticipate the effect of higher or lower premium rates on net
premium salary. Genuine results will contrast from reproduced comes about because of timing, extent and
recurrence of premium rate changes and changes in economic situations and administration methodologies,
in addition to different elements. In light of the consequences of the reproduction demonstrate as of
December 31, 2005, we would expect a build in net investment salary of $1.9 million and a diminishing of
$3.9 million if premium rates progressively expand or diminish, separately, from current rates by 200 premise
focuses over a twelve-month period. The reenactment dissection accept rates on center stores slack
changes in advance rates by 3 months.
d) Impact of interest rate on Australian Banks
Australian moneylenders are developing more frightful of how climbing premium rates could
decrease their clients' capacity to reimburse their advances, a complete study of worldwide banks by Pwc
has indicated. The high introduction of Australian banks to home loans – around 50% of their loaning is
made to private lodging – has seen premium rate danger bounce from 30th in 2012 to sixth on an
arrangement of attentiveness toward banks, as indicated by a Pwc biennial study, which takes after a few
investigators and trust chiefs raising the high obligation of Australian families as being an expanding danger
for bank valuations (Maudos, & Solís, 2009).
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The effect of harder regulation since the emergency on development is presently the top stress in
Australia and internationally. The issue of regulation has been brought by the banks up in their
accommodation to the budgetary framework request. The study likewise shows banks are progressively
jumpy about how their notorieties could be harmed by social networking. Australian banks positioned poor
"deals and business practices" and the "pricing of danger" second and third, much higher than their abroad
partners. Contract rivalry in Australia has hotted up in the previous six months, putting weight on giving
models, and the review shows banks are mindful of the dangers of wrong loaning and the potential for value
rivalry to lessen edges.
ANZ Banking Group reports its between time comes about on Thursday, took after by Westpac
Banking Group on Monday one week from now and National Australia Bank on Thursday one week from
now. Regardless of Australia's premium rates (the money rate was left unaltered at 2.5 for every penny on
April 1) as of now being higher than numerous other created nations, rates were just the twelfth greatest
concern universally. Pwc's Australian head of budgetary administrations Hugh Harley said a real explanation
behind the neighborhood banks' affectability about premium rate moves is that Australia's banks get a great
deal a greater amount of their pay from home loans than in most different nations (Maudos, & Solís, 2009).
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Question 5
(a) Entrenched problems of the balance sheet
On the off chance that the development fall in the US was brought about by the high power of family
units, on account of India, it is the high influence of the corporate part which is continuously exacerbated by
the giving way rupee. The issue is that while, over a time of 5 years, the methodology of accounting report
repair for US families is everything except done, that for the Indian corporate division has not by any means
started. Furthermore with India Inc in a bad position, general financing levels in the nation have caved in,
from a high of 38.1% of GDP in Fy08, terrible capital development was down to 35.6% in Fy13—the
breakdown in GDP development is an immediate aftereffect of the speculation starvation. While the
administration is cheerful that speculation levels will get once the Cabinet Committee on Investments (CCI)
clears the build-up of stuck ventures, RBI's most recent Bulletin focuses to venture levels for the
organizations it tracks falling by around 21% in Fy13 versus that in Fy12—and the R2,92,000 crore venture
RBI is talking of in Fy13 is prone to be significantly lower in Fy14. In view of the imaginable plans in this way,
the organizations RBI is following focused around advances made by banks and Ecbs raised—are going to
contribute R1,62,000 crore. As it were, an alternate R1,30,000 crore of ventures need to be made to try and
match the Fy13 number, something RBI says shows up non-achievable (Smith et.al, 2003).
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A State-of-the-Nation report by credit score firm Crisil on Wednesday places this in point of view.
While bringing down GDP estimate for Fy14 from 5.5% only two months prior to 4.8% now, Crisil has raised
its agribusiness GDP projection from 3.5% to 4.5% while bringing modern GDP from 3.5% down to a
negligible 1%—discussion about terminating on one barrel. Much additionally stressing is the thing that Crisil
says over the corporate anxiety of the 2,481 organizations it tracks, organizations that record for a third of
bank credit to the corporate segment. While Crisil's number crunching proposes the forex anxiety is far lower
than envisioned by most, it indicates 36% of the organizations being helpless against two or more burdens
forex, liquidity or interest anxiety. On the off chance that that number doesn't look so irritating, Crisil issues
an admonition: its specimen does exclude extremely focused on huge corporate houses like Essar, GMR,
and GVK among (Cornett, & Saunders, 2003).
(b) Difficulty in developing an asset and liability transfer policy
The relationship between global instalments and the genuine conversion scale is one of the excellent
addresses in global money matters. In the 1920s, Keynes (1929) and Ohlin (1929) discussed this move
issue in the connection of the German war reparations. All the more as of late, the 1980s obligation
emergency, the 1997 Asian emergency and the continually developing outer liabilities of the United States
have headed to a resurgence of enthusiasm on this subject, in perspective of the focal forecast that the
worldwide venture pay streams connected with non-zero net outside stake positions oblige some level of
genuine conversion scale change in the long run (Cowley, & Cummins, J2005). By broadening, as far as the
current arrangement civil argument concerning the conversion standard administration decisions of
developing business economies, the operation of a compelling exchange impact may propose an inclination
for ostensible conversion standard adaptability with a specific end goal to permit the true acclimation to
happen as easily as possible. At long last, the exchange impact assumes a focal part in a lot of people
"new open-economy macroeconomic" shows that highlight the part of the net outside possession position
as a state variable that can create persevering impacts from even transitory stuns (Grubert, & Mutti, 2010).
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(c) Issues of transfer Pricing
Transfer pricing is a standout amongst the most vital issues in worldwide expense. Transfer pricing
happens at whatever point two organizations that are some piece of the same multinational gathering
exchange with one another: when a US-based subidiary of Coca-Cola, for instance, purchases something
from a French-based subsidiary of Coca-Cola. At the point when the gatherings build a cost for the
transaction, this is exchange pricing (Hirshleifer, 2006).
Transfer pricing is not, in itself, illicit or essentially harsh. What is illicit or injurious is exchange
mispricing, otherwise called exchange pricing control or harsh exchange pricing. (Exchange mispricing is a
type of a more general marvel known as exchange mispricing, which incorporates exchange between
inconsequential or clearly offhand gatherings \a case isreinvoicing.)
It is evaluated that something like 60 percent of worldwide exchange happens inside, instead of
between, multinationals: that is, crosswise over national limits yet inside the same corporate gathering.
Recommendations have been made that this figure may be closer to 70 percent. Evaluations shift
concerning the amount charge income is loshet by governments because of exchange mispricing. Worldwide
Financial Integrity in Washington gauges the sum at a few hundred billion dollars yearly. A March 2009
Christian Aid report evaluated $1.1 trillion in two-sided exchange mispricing into the EU and the only us from
non-EU nations from 2005 to 2007. The "Sizes " segment of our site holds a reach of evaluations and
information (Hirshleifer, 2006).
(d)Proposed Policy
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The procurements on the matter which have the standards articulated by the OECD, when all is said
in done, oblige organizations to pick between six separate approaches to evaluate consistence with the a
safe distance rule for assessment purposes. This reference is utilized obviously costs or edges equivalent
transactions around the world. Since correlations normally are not impeccable, you must perform the
quantitative changes in accordance with make from the correlation between operations or organizations. In
the event that it is made that no operations were performed at target costs, the organization must set up its
expense base and pay the extra assessment appropriately, as though the transaction had taken costs or
edges that would be acquired in a practically identical transaction made between autonomous gatherings.
Case in point, if a thing is sold to a wholesaler in an alternate nation, a short of what they charge different
organizations offering the same thing value, the merchant's benefit ought to be computed focused around
the ordinary cost charged by these different organizations, which builds the expense base and accordingly
assess income. That is the reason the organizations working with outside vincualdos, especially multinational
organizations consider that the PT regulations are one of the assessment issues that oblige unique
consideration and wanting to forestall undesirable results, for example, twofold tariff same monetary profit or
a long methodology of discussion confronting duty organizations in expense courts that don't have specific
divisions on the issue and, in this way, can not ensure that the choice is made focused around the best
specialized yet the close estimation criteria that judges bode well, which is not so much clear in the current
complex universal exchange transactions.
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References
Cornett, M. M., & Saunders, A. (2003). Financial institutions management: A risk management approach.
McGraw-Hill/Irwin.
Cornett, M. M., & Saunders, A. (2003). Financial institutions management: A risk management approach.
McGraw-Hill/Irwin.
Cowley, A., & Cummins, J. D. (2005). Securitization of life insurance assets and liabilities. Journal of Risk
and Insurance, 72(2), 193-226.
Giandomenico, R. (2008). Asset Liability Management for Banks.
Goodhart, C. (2008). Liquidity risk management. Banque de France Financial Stability Review, 11, 39-44.
Grubert, H., & Mutti, J. (2010). Taxes, tariffs and transfer pricing in multinational corporate decision
making. The Review of Economics and Statistics, 285-293.
Hirshleifer, J. (2006). On the economics of transfer pricing. The Journal of Business, 29(3), 172-184.
Kusy, M. I., & Ziemba, W. T. (2006). A bank asset and liability management model. Operations
Research, 34(3), 356-376.
Matten, C. (2006). Managing bank capital: capital allocation and performance measurement. Chichester:
Wiley.
Maudos, J., & Solís, L. (2009). The determinants of net interest income in the Mexican banking system: An
integrated model. Journal of Banking & Finance,33(10), 1920-1931.
Smith, R., Staikouras, C., & Wood, G. (2003). Non-interest income and total income stability (p. 37). Bank of
England.
Sunday to Fri, 6 am to 2 pm AU time, Jack: [email protected], Jack: 1800 730 851Jack:
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