Learn · Bank ALM and liquidity
Asset liability management (ALM): gaps, LCR and NSFR in plain words.
ALM is how a bank manages the mismatch between what it owes and what it owns. Deposits are often short and loans are often long, and the two reprice at different times. ALM measures that mismatch, sets limits on it and decides what to do, so the bank can always pay its depositors and its interest margin does not swing too far when rates move. In a bank the work is led by the Asset Liability Committee (ALCO).
Two risks ALM watches
Liquidity risk is the risk that the bank cannot meet an outflow when it falls due, even though it may be solvent. Interest rate risk in the banking book is the risk that a move in rates squeezes the net interest income (NII) or the economic value of the balance sheet. ALM handles both through gap reports, ratios, limits and stress tests.
The structural liquidity gap
Every asset and liability is placed in a time bucket by when it matures or is expected to flow (next day, two to seven days, eight to fourteen days and so on, out to over five years). For each bucket:
Gap = inflows − outflows, and the cumulative gap adds the buckets up from the shortest.
A negative gap in the short buckets means more money must go out than is coming in, and has to be funded. RBI’s liquidity guidelines set tolerance limits for negative mismatches in the shortest buckets, and each bank’s board sets its own limits within them.
The interest rate sensitivity gap
Here assets and liabilities are bucketed by when they reprice, not when they mature. Rate sensitive assets (RSA) minus rate sensitive liabilities (RSL) gives the repricing gap. A positive gap gains when rates rise; a negative gap loses. A first estimate of the effect on a year’s NII is gap × change in rate.
LCR and NSFR, the two Basel III liquidity ratios
The Liquidity Coverage Ratio asks whether the bank can survive a 30-day stress on its own: high-quality liquid assets (HQLA), mainly cash and government securities, divided by the net cash outflows expected over the next 30 calendar days under stress. Expected inflows can offset at most 75% of the outflows. RBI requires the LCR to be at least 100%.
The Net Stable Funding Ratio looks out one year: available stable funding (capital, stable deposits, longer-term borrowing) divided by required stable funding (what the assets need). It too must be at least 100%. LCR guards against a short run; NSFR against funding long assets with short money.
Worked examples for a virtual bank
Two short calculations of the kind an ALCO pack, a JAIIB or CAIIB paper or an interview might ask for (illustrative figures, in crore rupees):
| Calculation | Working | Result |
|---|---|---|
| Repricing gap, up to one year | RSA 1,200 − RSL 1,500 | −300 crore |
| Effect of a 1% rise in rates on the year’s NII | −300 × 1% | about −3 crore |
| Net cash outflows over 30 days | Outflows 3,000 − inflows 800 (within the 75% cap) | 2,200 crore |
| LCR | HQLA 2,400 ÷ 2,200 | about 109%, above the 100% minimum |
The negative gap tells ALCO that the bank’s liabilities reprice faster than its assets, so rising rates hurt. Options include lengthening deposit tenure, pricing more loans on floating rates, or hedging with an interest rate swap. The gap estimate is a first approximation: it assumes everything in the bucket reprices at once and ignores behaviour such as early withdrawal.
Key terms
- ALCO: The Asset Liability Committee of senior management that reviews the gaps and sets the bank’s balance-sheet strategy.
- Residual maturity: The time left until an asset or liability matures, used to bucket it.
- NII and NIM: Net interest income, and the same as a margin over earning assets.
- HQLA: High-quality liquid assets that can be turned into cash quickly with little loss of value.
- Behavioural maturity: When money is expected to flow in practice, such as the stable core of savings deposits, as against its contractual date.
Practise it in TrezCap
Reading is the start. In TrezCap you do the job in FinTreasury Bank, our virtual bank: the platform calculates every figure, you take the decision and see the consequence. Free to try.
The Liquidity Crisis Morning
Depositors are withdrawing: decide how the virtual bank funds the outflow and protects its LCR.
Open in TrezCap →Bank ALM and liquidity simulations
Deposit pricing and NIM, ALCO rate shocks, liquidity stress tests and nostro funding.
See the page →Questions
What is gap analysis in ALM?
Gap analysis places a bank's assets and liabilities in time buckets, by maturity for liquidity or by repricing date for interest rate risk, and measures the difference in each bucket. A negative short-term liquidity gap must be funded; a negative repricing gap loses income when rates rise.
What is the minimum LCR in India?
RBI requires banks to maintain a Liquidity Coverage Ratio of at least 100%, meaning high-quality liquid assets at least equal to the net cash outflows expected over 30 days of stress.
What is the difference between LCR and NSFR?
LCR covers a short, 30-day stress and asks whether liquid assets cover the outflows. NSFR looks one year ahead and asks whether long-term assets are funded by stable sources. Both must be at least 100%.
Who does ALM in a bank?
The Asset Liability Committee (ALCO) of senior management, supported by the ALM desk or cell in treasury and risk, which prepares the gap reports, ratios and stress tests.
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