Asset liability management amid virus

The Covid-19 pandemic has wrecked havoc throughout this world and Bangladesh has not been spared either. All the sectors including health, communication, and economy have been affected by this deadly pandemic. World including Bangladesh had literally came to a standstill during the early months of the year i.e. March '20- May '20. In Bangladesh, the general holidays started from 26 March, 2020 and lasted up to May 28, 2020. After that, things started opening up on a limited scale and the economy of the country which had come to a halt, started gathering momentum albeit quite slowly. Bangladesh like quite a few other neighbouring countries has announced and started implementing 19 stimulus packages worth Tk. 1.03 trillion (103,117 crore). This amount is around 3.5 per cent of the total GDP of the country. Now the onus of disbursing money under the stimulus package is mostly on the banks. So, as always, banks are in the thick of things. As the economy is not performing at its full potential, banks are under scrutiny as during this current regime of 9.0 per cent interest rate on loans, banks' profit have already been affected . The current portfolios of all financial institutions have already been affected negatively. On top of this, new investment due to stimulus fund disbursement will have to take place which will expose the Financial Institutions to more risks. As a result, they will have to come up with more prudent asset liability management to mitigate all the major risks and survive in the current situation.

For any individual or company, managing its assets and liability is of utmost importance. This assumption holds most true for banks as banks deal with public money. Apart from that, banks initially take capital from the owners, which is also a source of liability. By borrowing money at a lower rate and investing at a higher rate, a bank earns profit as well as makes sure there is liquidity in the economy. But, this is based on an assumption that the borrower will return the money in due time so that the banks will be able to pay off their depositors, whenever the depositor asks for it. This does not work ideally in the real world. That is the reason why banks have to maintain a minimum liquidity all the time and ADR can go up to a certain level which is below 100 per cent. In Bangladesh, banks have to generally maintain ADR at 85 per cent. Bangladesh Bank in an effort to inject liquidity into the economy has allowed the ADR to be as high as 87 per cent. Now, to operate efficiently, banks make liquidity buckets to predict the inflow and outflow. In this way, they are able to maintain efficiency and keep enough liquidity to maintain day to day operations. To address this issue of liquidity in banks, Bangladesh Bank has already taken quite a few steps. Some of the mentionable ones are: Extension of L/C issuance period, Reduction in Repo rate (from 5.25 per cent  to 4.75 per cent), Bank rate has been slashed to 4.0 per cent from 5.0 per cent, decrease in bi-weekly CRR at 4.0 per cent. So, during this pandemic period, the central bank has preempted the liquidity crisis and thereby providing the commercial banks in the country some relief when it comes to the liquidity risk aspect. Having said all these, excess liquidity is also bad for the banks as costs are attached to it. So, keeping an optimum level of asset liability mix is desirable.

Liquidity risk broadly comprises three sub-types:
a) Funding Risk: The need to replace net outflows of funds whether due to withdrawal of retail deposits or non-renewal of wholesale funds.
b) Time Risk: The need to compensate for non-receipt of expected inflows of funds, e.g. when a borrower fails to meet his repayment commitments.
c) Call Risk: The need to find fresh funds when contingent liabilities become due. Call risk also includes the need to be able to undertake new transactions when desirable.

Managing these mentioned risks will ultimately lead to the management of liquidity risks as a whole. Banks need to create bucket according to the duration, projected inflow and outflow to meet the liquidity requirement and cover the risks arising from it.

Next in line is the credit risk. Ultimately, it is the risk all the banks and financial institutions are most concerned about. Credit risk may be defined as any adverse situation because of non-fulfillment of financial obligations on the part of the other party of the contract. In banking industry it has obtained very special significance. It is basically the risk of default. Now, when financing in the current situation, selection of a borrower should be done with utmost care. Disbursement of stimulus packages will be done through the banks and thus banks will need to select and look after the borrowers. To avoid this risk of default, borrower selection is of highest priority. This will go a long way in deciding the ultimate quality of assets the financial institutions will go on to have in their portfolio.       

Extension of credit risk is the capital risk. Capital risk is the risk an investor faces that the investor may lose all or part of the principal amount invested. It is the risk a company faces that it may lose value on its capital. The capital of a company can include equipment, factories and liquid securities. Capital adequacy focuses on the weighted average risk of lending and to that extent, banks are in a position to realign their portfolios between more risky and less risky assets. That is why the Latest BASEL III accord is being implemented in Bangladesh which requires that banks maintain 12.5 per cent capital adequacy ratio. The capital buffer of 2.5 per cent will be really helpful in this current scenario to cover for any uncalled for situation. 

Interest Rate risk is another kind of risk which is very important for the financial institutions to have in mind.  The changes in interest rates affect banks in a larger way. The immediate impact of changes in interest rates is on the banks' earnings by changing its Net Interest Income (NII). A long-term impact of changing interest rates is on the bank's Market Value of Equity (MVE) or Net Worth, as the economic value of the bank's assets, liabilities and off-balance sheet position get affected due to the variation in market interest rates. In Bangladesh, due to our currently prevailing regime of 9.0 per cent interest rate on loans, we can already see the effect of this in the profitability of the banks and financial institutions alike.

Economic Value Perspectives is a long-term effect of interest rate risk. Variations in market interest rates affect the economic value of a bank's assets, liabilities and OBS positions. It will ultimately impact the Market Value of Equity or the value of Net Worth of the bank. Thus the sensitivity of a bank's economic value to fluctuations in interest rates is a particularly important consideration of shareholders, management and supervisors alike.

Now, for banks to maintain profitability proper and prudent Asset Liability management is a must in this current situation. For this banks must take a leaf out of the guidelines of Asset Liability Management and take the steps mentioned below-

- Analyze the current source of funds and prudent management of these funds.

-Matching the assets and liabilities in terms of different types of duration of funds and their quality.

- Formulating proper management strategies for timely identification of gap in interest mismatch for different types of assets and liabilities.

- Monitoring and evaluation of risk dynamics related with assets and liabilities matching their respective cost and returns.

Through proper Asset Liability Management, liquidity, profitability and solvency of banks can be ensured and at the same time banks can manage and reduce risks. The liabilities of a bank have different categories of varying costs, depending upon the tenor and maturity pattern. By managing all these efficiently, the financial institutions will be able to manage their asset liability and in turn sustain in this pandemic period.

Tapash Chandra Paul, PhD, is Chief Financial Officer at Mercantile Bank Limted.
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