INTRODUCTION TO BANK MANAGEMENT
In the present time, the financial and credit risk has been increasing rapidly for the banking firms and in order to reduce this inherent risk banks adopts different asset liability management strategies. With the help of asset liability management strategies banking firm ensures their sustainable growth in interest revenue and profits (Bessis, 2011). Moreover, the strategies related to asset liability management protect the value of net worth of banking firm from erosion. The present report is made to discuss and examine the different strategies related to asset liability management which are used by Bank of England in order to ascertain the effectiveness of the strategy in ensuring of its sustainable growth and profitability (Chiu and Li, 2006). The Bank of England adopts underneath Asset-liability management strategies for sustainable growth in profit and reduction in inherent risk.
The fundamental strategies which are used in Bank of England for the effective management of asset and liability is Asset Management Strategy (Bank of England, 2015). The Bank of England gives significant emphasis on the particular strategy as the assets shows its financial strength and position. The Bank gives significant emphasis of this strategy by effective management of assets like Loans, vehicles, buildings, equipment, accounts receivable, inventory, investments and cash surplus. Bank of England undertakes a proper system for the effective management of these assets so that it able to decrease inherent risk and achieve the sustainable growth and profits (Adam, 2008). The asset management manager of Bank of England carefully examines the actual value of assets by considering the depreciation and appreciation aspects on the assets. The evaluation of exact value of assets is essential for the banking firms as it helps the firm and shareholders in knowing the actual worth of assets which the firm is holding. The assets value are examined because the value of assets changes with the passage of time. For example the value of building and equipment lessen down due to depreciation (Adrian and Shin, 2008). Further, when the debtors do not make the payment then it increases the non-performing assets of the firm which increases the liability of the firm. Many of times, it happens that the change in market valuation of assets also increase or decrease the asset value of the firm. This can be seen when the banking firm has made investment in stocks or derivative instruments. The huge change decline in equity market may wipe out the value of investment of Banks (Choudhry, 2011). Thus, from this type of situation Bank of England safeguard itself by doing hedging in the future and option market so that its value of assets do not deplete. The particular approach is used when there is requirement of managing of risk which could arise due to the mismatch between the assets and liabilities. With the help of particular strategy, Bank of England undertake its efforts towards the effective management of interest rate risk and liquidity risk as the Bank of England conceives that these two risk are the biggest risk which could affect its value of assets (Athanasoglou, Brissimis and Delis, 2008). The asset management strategies is usually adopted to bring the balance between assets and liabilities so that the risk related to liquidity rate, interest rate, foreign exchange rate or currency risk can be effectively managed so that value of the assets can be retained.
The Bank of England uses cash flow payment calendar for the sound management of assets. In the particular technique, a well systematic plan is followed about when the cash will flow in the business and when the cash will flow out from the business. With the help of this calendar Bank of England carefully manages its working capital by bringing balance between the assets and liabilities (Kolari, 2007). Here, the bank makes schedule that on which date the loan should be issued so that no mismanagement of cash happens that could affect the asset liability management. The other technique which is used by Bank of England for the effective management of assets is standard immunization. The company believes that the assets must create value for the firm by generating revenue and which will ultimately help in reducing of liability and short term obligation (Rose and Hudgins, 2006). In the particular technique, it is estimated about the money which could be generated by providing to loans. If it would be identified that enough amounts would able to be generated which will help in meeting obligation and will also produce reasonable profit margin then the decision of giving of loan is taken by the Bank of England. Asset liability management can also be done by selling of the excess assets to meet the obligation. The Bank of England sells its Non-performing assets which arise through non-payment of loan by conducting online and offline auctions (Shimpi and et al. eds. 2001).
There is one other strategy which is used in Bank of England for effective management of its assets. The strategy which is used is surplus optimization. The Bank of England invest the surplus amount which it gets each month after reducing short term obligation from the revenue in equity shares, treasury bonds, financial derivative instruments and other debt instruments in order to reap monetary benefits which can be further used to pay the short term obligation or liabilities. Many of times, Bank of England measures its assets performance in order to make more constructive decision related to sound asset management (Van Greuning and Bratanovic, 2009).
In Bank of England there are different practices and strategies are followed for the effective management of liability which ultimately contributes towards adequate management of asset liability management. The liability management is undertaken to reduce the effect of interest risk on the liquid assets i.e. cash (VanBroekhoven, 2002). The liability management strategy is implemented by laying down a structure for management of liquidity risk. In this strategy, a tolerance level or limit of liquidity risk is set so that the management of liability can be done in the effective manner. The particular strategy followed by calculation of number of ratios (Zenios and Ziemba, 2007). The ratios which are calculated or computed in this strategy are ratio of core deposits to total assets, net loan to total deposit ratio, ratio of time deposit to total deposit and ratio of volatile liabilities to total assets, ratio of short term liabilities to liquid assets, ratio of liquid assets to total assets. In addition, the ratios like ratio of short term liabilities to total assets, ratio of prime assets to total assets, ratio of market liabilities to total assets. After determination of these ratios, it is ascertained about liability of the firm and it is assessed whether it is matches with the total assets or not. With the help of this ascertainment, liquidity risk is minimized or eliminated by the Bank of England (Tuckman, 2002). From the secondary information, it was identified that the liquidity risk to bank arises when it gives high number of loans of higher amount which ultimately brings the situation of refinancing. When the bank goes for refinancing then it again creates liquidity risk to it. The past studies give evidence that liquidity risk brings 3 more risk with it which are funding risk, time, and risk and call risk. The funding risk is the risk which arises when unanticipated withdrawals of the deposits are done in high numbers by the customers. The time risk arises when the loan turns into the non-performing asset because the borrower becomes insolvent (Society of Actuaries, 2000). Thus, the cash flow which the Bank expected from the borrower would not be able to receive due to the insolvency of borrower. The third risk which arises due to liquidity risk is call risk (Rose and Hudgins, 2006). The call risk occurs when the banks unable to tap a opportunity when it is available for the business. As per the Basel III norms, banks are required to follow a capital adequacy ratio in order to reduce the Non-performing assets. The particular rules were formed after the happening of 2007-2008 recessions which came because of Subprime mortgage crisis. The Basel III were being adopted by the banks of all the countries in order to reduce the non-performing assets (Bank For International Settlements, 2013). The Basel III norm says banks must need to have a certain capital adequacy ratio in order to demonstrate that it has sound Assets and liability management.
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The liability management is done by the banks by ensuring proper liquidity of funds which can be used to meet the liability (Banking and Capital Markets, 2009). In other words, for the liability managements, Bank of England undertakes a process in which funds are generated to meet the liabilities of payment of funds at reasonable or determined price. The liability management is also done by Bank of England by setting maturity ladder and determining a cumulative surplus or deficit of funds. Bank of England also prepared a statement of structure liquidity for the efficient and effective management of liability (The World Bank, 2010). The management of liability is also effectively done by preparing a statement of structural liability in which all assets and liabilities are required to be reported according to the maturity profile. There are usually 8 maturity buckets namely 1 to 14 days, 15 to 28 days, 29 days and up to 3 months, over 3 months and up to 6 months, over 6 months and up to 1 year, over 1 year and up to 3 years, over 3 years and up to 5 years and over 5 years (The World Bank, 2010). In the statement of structural liquidity all cash inflows and outflows are recorded in the maturity ladder according to the residual maturity or expected timing of cash inflows.
From the secondary information analysis with respect to Bank of England, it has been identified that the bank also undertakes its liability management in the appropriate manner by increasing the liquidity in government securities and bond. The bank buys government bonds in the money market in order to greater liquidity so that liabilities can be met or managed in the best possible manner (Banking and Capital Markets, 2009). The buying of bonds in the money market gives intrinsic as well as extrinsic return to the bank which can be used to meet the liabilities or obligation. The other way through which liability management can be undertaken in the effective manner is setting of benchmarks related to taking of money on credits. The liability of the bank will automatically decrease when it will adopt appropriate policies related to providence of loan (Zenios and Ziemba, 2007). A poor loan providence procedure or rules may create huge negative effect for the bank with respect to management of liability. The liability management can also be done in significant manner in the banks by decreasing the risk of debt portfolio (VanBroekhoven, 2002). The Bank of England did not have many funds in the debts which demonstrating that the bank is undertaking its task related to liability management in sound and effective manner. Furthermore, the liability management can also be done through by retiring or reducing the debt with short remaining life to maturity (Van Greuning and Bratanovic, 2009). This helps the banks in getting cash inflows which will ultimately decrease the liability on the firm. Another way through which liability management can be done is reducing the cost of new funding. The decrease in funding will improve the assets of the firm will decrease the liabilities of ban like Bank of England.
The fund management strategies are also adopted for the sound management of asset and liability of the banks. The assets of banks are vehicles, building, loans provides, investments etc whereas the liabilities includes loan taken from central bank or any other banks etc (Bank For International Settlements, 2013). Here, the fund management means raising of money for the effective carrying out of banking activities. Banks raise money for the operation by issuing equity shares, debentures and deposits. In the management of funds, The Bank of England considers many things obtaining of funds at least cost possible, funding structure and sources, maturity period for which the funds have been raised from the public (Zenios and Ziemba, 2007). In the contemporary time, banks have been facing significant issues and challenges with regard to fund structures due to high volatility in the stock market. However, the implementation of Basel III norms in banks requires banks to follow new capital adequacy ratio and liquidity ratio in order to ensure that they are giving loans in sound manner (Tuckman, 2002). Some critics say Basel III norms would bring more transparency in banking activities while some critics has different views they say Basel III norm is bringing new pressure on the banking firms like Bank of England.
After the year 2007, improvements have been devised in the fund management strategies. Bank of England acquires funds through mainly two type of source: one is asset based funding and other is retail funding (Society of Actuaries, 2000). The asset based funding is acquired through various sources like cash flows, pledging of assets, liquidation of assets or sale of subsidiaries and securitization of assets. It is said that cash flows is the fundamental source of asset side funding. The cash flows in the banks when the investment matures through amortization of loans. The pledging of assets funding comes from providing of collateral securities to the lender. The funding from liquidation of assets comes by selling of the business unit or a line of business (Shimpi and et. al., 2001). Last but not the least the funds from securitization assets comes when the Bank of England transform the loan into CDO which are further sold to the investors who makes investment in the CDO. Through CDO banks receives its full payment of loan and investors receives income from the bank which are received in form of interest payment from the ultimate borrower (Kolari, 2007).
On the other hand the funds which are issued through retail are deposit account, transaction account, saving account, public deposit, current account, fixed deposit, recurring deposit etc. These are the source of funding which regularly inflows money in the bank which ultimately brings balance between the assets and liabilities of the firm. There are also wholesale form of funding from which bank receives or acquire funds (Choudhry, 2011). The wholesale funding which are generally followed or practices by Bank of England are Certificate of Deposits, Deposits from other banks, commercial paper, money market deposits, covered bonds, Asset backed commercial program, promissory note, repurchase agreement, support or grand from central bank. Moreover, Bank of England also raise funds from the sources like equity shares, preference shares, debentures and retained earnings (Athanasoglou, Brissimis and Delis, 2008).
The above report was made on management of bank. In the report three strategies related to Asset Liability management were discussed which are used in the banks like Bank of England for the sustainability growth in revenue and profit. From the report, it was identified that banks must have required following the given strategies in order to receive significant monetary and non-monetary benefits. The project provides the learning that banks use asset management strategies, liability management strategies and fund management strategies in order to minimize the interest risk, currency risk, liquidity risk and exchange rate risk.
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- Athanasoglou, P. P., Brissimis, S. N. and Delis, M. D., 2008. Bank-specific, industry-specific and macroeconomic determinants of bank profitability. Journal of international financial Markets, Institutions and Money.
- Bessis, J., 2011. Risk management in banking. John Wiley & Sons.