Chapter 1 – Components of Assets and Liabilities

Components of Liabilities

Capital

Capital represents the owners’ stake in a bank and it serves as a cushion for depositors and creditors to fall back in case of losses.

Reserve

Reserve include reserves such as statutory reserve, capital reserve, share premium reserves etc.

Statutory Reserve: it is created as per provisions of Section 17 of Banking Regulation Act at 20% of the profits before dividend.

Capital Reserve: These are the reserves which are created by the amount other than free for distribution through the profit and loss account. Surplus on revaluation is taken as capital reserves.

Share premium : Premium on issue of share capital is included under this head.

Revenue and other reserves : it include any reserve other than capital reserve_ It includes those which are not classified elsewhere separately.

Balance of profit

It include the balance of profit after appropriations. If there is loss, it is shown as deduction from the balance.

Demand deposits

These include deposits from banks and from others. These also include credit balance in overdraft or cash credit accounts, deposits payable at call, overdue deposits, inoperative accounts, matured time deposits or cash certificates or certificate of deposits etc.

Term deposits

Term deposits include fixed deposits, cumulative and recurring deposits, cash certificates, certificate of deposits, annuity deposits, deposits mobilized under various schemes, ordinary staff deposits, foreign currency nonresident deposit account etc.

Deposits from banks

It include the deposits from banking system in India, cooperative banks, foreign banks.

Borrowing

It include borrowing from RBI including refinance, borrowing from other banks including cooperative banks. Borrowing or refinance obtained from other banks such as EXIM Bank or NABARD is also included underthis. Inter-office transactions are not shown as borrowing.

Other liabilities and provisions

Bills Payable: This includes drafts, telegraphic transfers, travellers cheques, mail transfer payable, payslips, bankers’ cheques and othe miscellaneous items

Inter-Office Adjustments : The credit balance of the net inter-office adjustment

Interest Accrued : The interest accrued but not due on deposits and borrowings

Others: All other liability items like provision for income tax, tax deducted at source, interest tax, provisions etc.

Components of Assets

Cash balances

It include cash in hand (including foreign currency notes), balance with RBI in current or other accounts

Balances with banks

Balances with other banks in currency or other deposit accounts or money at call and short notice. The call loans are repayable at any time while the short notice advances are repayable within 24 hours. The maximum period of notice period is usually of 14 days.

Investments:

Investment include in Govt. securities such as Central and State Govt. treasury bills or

loans, investments in other approved securities, investment in shares of companies and corporations and also in debentures and bonds. Besides the investment include, investment in subsidiaries/joint ventures, in gold, commercial paper etc. In addition, the investments abroad are included.

Advances

Advances are categorized as (a) bills discounted and purchased, (b) cash credit, overdrafts and loans payable on demand and (c) term loans. In additions, these are categorized as (a) secured by tangible assets and (b) those by govt. guarantees and (c) as unsecured.Further these are classified as (a) priority sector, (b) to public sector and (c) banks and others. The gross amount of advances include the refinance and rediscounts.

Fixed assets

These include premises and other fixed assets and are shown at cost on close of previous year, additions and deductions during the year and depreciation till close of the year.

Other assets

These include inter-office adjustments, interest accrued, tax paid in advance, stationery and stamps, non-banking assets acquired in satisfaction of claim etc.

Contingent Liabilities

A bank’s obligations under issuance of letter of credit, guarantees and acceptance on behalf of constituents and bills accepted by the bank on behalf of its customers are reflected under contingent liabilities. Other contingent liabilities include claims against the bank not acknowledged as debts, liability for partly paid-up investments, liability on account of outstanding forward exchange contracts and other items like arrears of cumulative dividends, bill rediscounted, underwriting, commitments, estimated amount of contracts remaining to be executed on capital account and not providedfor,etc.

PROFIT & LOSS ACCOUNT

Profit and loss account of the bank has components of A Income that include interest income and non-interest income & Expenses that include interest expanded, operating expenses and provisions and contingencies.

Income = Interest income + non-interest income.

Expenditure = Interest expenditure + non-interest expenditure.

Income Components

Interest Income

Interest income is the major income component. This comes from :

Loans and advances including bills purchased, discounted and negotiated_
Investments made by the bank in SLR. and non-SLR bonds / loans / securities.
Interest from funds lent to other banks under call money, notice money or term money transactions
Any other type of interest or discount not included above.

Non-interest income

Commission / exchange / brokerage: This include commission of bills collection, issue of remittance instruments like demand drafts, commission on non-fund based credit limits like letter of credit or bank guarantees, commission earned on govt. business. Besides, bank gets brokerage on securities, rent on locker, safe-deposit charges etc.
Profit on sate of investments / assets : Banks undertake lot of trading in securities and eam substantial profits which is included here. In addition, banks also book profit or loss on sale of fixed asset items like fixture & furniture, vehicles etc.
Profit on revaluation of investments: Banks make investments in securities the value of which keeps on fluctuating. Any notional increase or decrease in the value of these investments can result into profit or loss. When it is a loss it is shown as a deduction.
Profit on sale of land, building, exchange transactions.
Income earned by way of dividends on the investment in securities made by the bank
income that include income from recoveries of charges from customers, income from properties of the bank etc.

Expenditure Components

Expenses include interest expenses, operating expenses and provisions and contingencies.

Interest expenses

Interest on deposits : Interest paid by the bank on various types of deposits from public or hanks etc. is part of this item.
Interest on refinance or borrowing : Interest paid to RBI or banks for borrowing is included.
Other interest : Interest paid to refinancing institutions

Operating expenses

Payments and provisions for employees
Rent, taxes and lighting
Printing and stationery
Advertisement and publicity
Depreciation on bank’s property
Directors’ fees, allowances and expenses
Auditors’ fees and expenses (including branch auditors)
Law charges
Postage, telegrams, telephones etc.
Repairs and maintenance
Other expenditure such as licence fee, donations, entertainment expenses, subscriptions, travel expenses

MANAGEMENT OF ASSETS AND LIABILITIES

Due to discriminate policies being followed by banks in the area of interest rates, the matching of maturities of assets and liabilities has become very important. The risk profile of the banks has also seen transition as the interest rate risk, liquidity risk, industry risk, exposure risk etc. have become real.

Profit has become the key parameter of performance of the banks due to which banks are required to move away from asset management (loans and advances and investment) alone to liability management (deposits and borrowings).

ALM is associated with management of the balance sheet with a view to take care of interest rate risk, Liquidity risk, exchange rate risk, credit risk etc.
ALM can also be termed as the act of planning, acquiring and directing the flow of funds within a bank with the objective to generate adequate and regular earnings while taking calculated risk_
Accordingly, the ALM is the management of net interest margin (NINO so that its level is with the risk / return target of the bank. In summary, it can be said that ALM is a coordinated effort for managing balance sheet.

WHY ALM IS SIGNIFICANT

ALM is significant on account of following reasons:

Volatility : Due to opening up of Indian economy, the flow of money from abroad and also the deregulated interest environment causes volatility in the flows of money and the cost at which it flows. The position of money market is changed from time to time that affects the net interest margin of banks.
Product innovation : Banks have introduced a variety of products to meet the competition. These products have different types of feature including relating to interest rates. These products have effect on risk profile of the bank.
Regulatory guidelines : RBI has from time to time, issued regulatory guidelines taking into account the capital adequacy requirement and for meeting these guidelines, banks have to conduct their business within the framework one relating to guidelines on ALM.

Purpose and Objectives OF ALM

Liquidity can be ensured by a bank by taking steps to keep the maturity profile of assets and liabilities, matched. This can be done by placing the residual maturity of assets and liabilities in different maturity buckets.

ALM aims at managing the (a) volume (b) mix (c) maturity profile (d) rate sensitivity and (e) liquidity of assets and liabilities, with a view to achieve the targeted risk / reward ratio. Achievement of this objective requires few important actions on the part of the bank, as under:

Review of the interest rate structure to match it to the interest / product pricing of assets and liabilities.
Review the investment and credit portfolio in the light of possible liquidity and foreign exchange risk
Review the actual performance of the bank against the projected performance and analyse the reasons for effect, if any, on the net interest margin.

There are 3 important parameters that help in stabilizing the ALM within a bank (a) net interest margin (b) net interest income (c) economic equity ratio.

Net Interest income : It is calculated as total interest income less total interest expenses. For stabilizing the net interest income, the banks have to minimize the fluctuation in NII.
Net Interest Margin : Known as ‘spread’ on the earning assets, it is calculated as net interest income divided by average total assets (NII / average total assets). Net interest income comes from the total interest income less total interest expenses. This means, higher the difference, higher the ‘spread’ or NIM. At the same time, higher the NIM, higher is likely to be the risk.
Economic equity ratio : It is calculated as a ratio of shareholders’ funds to total assets. It helps to measure the change in ratio of owned funds to total funds and in understanding the capacity of a bank to sustain