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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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