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SUMMER INTERNSHIP & RESEARCH PROJECT 2010 ON LIQUIDITY RISK MANAGEMENT

SMALL AND MEDIUM ENTERPRISES DEPARTMENT BANGALORE

SUBMITTED BY: - NEETHU BAHULEYAN ENROLLMENT NO: - 09MMA4109 UNDER THE SUPERVISION AND GUIDEANCE OF: - Prof. BRR ACADEMIC YEAR: - 2009-2011

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DECLARATION

I Neethu Bahuleyan hereby declare that the Summer Internship report submitted in partial fulfillment of the requirement of Post Graduate Diploma in Business management to MIME Leaders in Management & Entrepreneurship under the guidance and supervision of Dr. BRR, MIME is my original work and not submitted for the award of any other degree, diploma, fellowship or other similar titles or prizes.

DATE: PLACE: Bangalore SIGN:

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ACKNOWLEDGEMENT

It is my proud privilege to release the feelings of my gratitude to several persons who helped me directly or indirectly to conduct this project work. I express my heart full indebtness and owe a deep sense of gratitude to my faculty guide Dr. BRR, Professor, MIME Leaders in management and Entrepreneurship, Bangalore, for his invaluable guidance in this endeavor. I sincerely thank them for his suggestions and help to prepare this report. I am extremely thankful to the Dean and faculties of the Institute for their coordination and cooperation and thankful for organizing summer internship training for students. I express deep sense of gratitude to my company guide Mr. Ramakrishna, Deputy General Manager of SBI, for offering suggestions and help in successfully completing my project. They have been a constant source of inspiration and motivation.

Thanking you

Date:

NEETHU BAHULEYAN

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INDEX Sr No. Particulars Page No. 1. 2. ABSTRACT INTRODUCTION TO THE STUDY 2.1 Introduction 2.2 Framework for measuring and managing liquidity 2.3 Measuring and managing net funding requirements: 3. OBJECTIVES AND METHODOLOGY 3.1 Objectives 3.2 Methodology 3.3 Literature review 3.4 Explanation of concepts 4. INDUSTRY PROFILE 4.1 Introduction 4.2 Post Independence 4.2 Nationalization 4.3 Liberalization 4.5 Current Situation 4.6 Regional Banks 4.7 Recent Developments 4.8 Government Regulations 5. COMPANY PROFILE 5.1 History

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5.2 Key area of operations 5.3 Management 5.4 SWOT Analysis 5.5 Competitors and other players 5.6 Awards 5.7 Products 6. ANALYSIS 6.1 Statement of interest rate sensitivity 6.2 Maturity gap method 6.3 Observations of the study 7. 8. RECOMMENDATIONS CONCLUSIONS

1. ABSTRACT:

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Today in the banking sector every bank nationalized or private are striving to reach the pinnacle. Though in the national scenario the Govt./Nationalized banks are leading bank in the metropolitan context the private banks are leading both in business as well as service. STATE BANK OF INDIA has built its leadership by making itself as Indias largest commercial bank having largest retail lender with great brand image, high market capitalization and also to find place in the fortune global 500 list. The Broad objective of the project is to identify the liquidity risks faced by the banks and Classification of assets and liabilities into different time buckets as per RBI guidelines issued for liquidity management in banks. Analysis of liquidity risk through Cash Flow Approach Method This study is basically divided into eight major parts. The first part of the report includes the introduction to the study. The second part deals with the banking Industry. The third part includes the Introduction of State bank of India. The fourth part is analysis then recommendations and conclusions.

2. INTRODUCTION TO THE STUDY

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2.1INTODUCTION TO LIQUIDITY RISK MANAGEMENT: Banks are in the business of maturity transformation. They lend for longer time periods, as borrowers normally prefer a longer time frame. But their liabilities are typically short term in nature, as lenders normally prefer a shorter time frame (liquidity preference). This results in long-term interest rates typically exceeding short-term rates. Hence, the incentive for banks for performing the function of financial intermediation is the difference between interest receipt and interest cost which is called the interest spread. It is implicit, therefore, that banks will have a mismatched balance sheet, with liabilities greater than assets in short term, and with assets greater than liabilities in the medium and long term. These mismatches, which represent liquidity risk, are with respect to various time horizons. Hence, the concern of a bank is to maintain adequate liquidity Liquidity risk is the potential inability to meet the bank's liabilities as they become due. It arises when banks are unable to generate cash to cope with a decline in deposits or increase in assets. It originates from the mismatches in the maturity pattern of assets and liabilities. Measuring and managing liquidity needs are vital for effective operation of commercial banks. By assuring a bank's ability to meet its liabilities as they become due, liquidity management can reduce the probability of an adverse situation developing. Analysis of liquidity risk involves the measurement of, not only the liquidity position of the bank on an ongoing basis but also examining how funding requirements are likely to be affected under crisis scenarios. Net funding requirements are determined by analyzing the bank's future cash flows based on assumptions of the future behavior of assets and liabilities that are classified into specified time buckets and then calculating the cumulative net flows over the time frame for liquidity assessment.

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Future cash flows are to be analyzed under "what if" scenarios so as to assess any significant positive/ negative liquidity swings that could occur on a dayto-day basis and under bank specific and general market crisis scenarios. Factors to be taken into consideration while determining liquidity of the bank's future stock of assets and liabilities include: their potential marketability, the extent to which maturing assets /liability will be renewed, the acquisition of new assets/liability and the normal growth in asset/liability accounts. Factors affecting the liquidity of assets and liabilities of the bank cannot always be forecast with precision. Hence, they need to be reviewed frequently to determine their continuing validity, especially given the rapidity of change in financial markets. The liquidity risk in banks manifest in different dimensions:

Funding Risk need to replace net outflows due to unanticipated withdrawal/non- renewal of deposits (wholesale and retail); Time Risk need to compensate for non-receipt of expected inflows of funds, i.e., performing assets turning into non-performing assets; and Call Risk due to crystallization of contingent liabilities and inability to undertake profitable business opportunities when desirable.

2.2 FRAMEWORK FOR MEASURING AND MANAGING LIQUIDITY

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Measuring and managing liquidity needs are vital for effective operation of commercial banks. By assuring a bank's ability to meet its liabilities as they become due, liquidity management can reduce the probability of an adverse situation developing. The importance of liquidity transcends individual institutions, as liquidity shortfall in one institution can have repercussions on the entire system. Bank managements should measure not only the liquidity positions of banks on an ongoing basis, but also examine how liquidity requirements are likely to evolve under different assumptions. Experience shows that assets like government securities and other money market instruments, which are generally treated as liquid could also become illiquid when the market and players are unidirectional. Therefore, liquidity has to be tracked through maturity or cash flow mismatches. The framework for assessing and managing bank liquidity has three dimensions:1. 2. 3.

Measuring and managing net funding requirements Managing market access and Contingency planning.

2.3 MEASURING AND MANAGING NET FUNDING REQUIREMENTS:9

The first step towards liquidity management is to put in place an effective liquidity management policy, which, inter alia, should spell out the funding strategies, liquidity planning under alternative scenarios, prudential limits, liquidity reporting/reviewing, etc. Liquidity measurement is quite a difficult task and can be measured through stock or cash flow approaches. The key ratios, adopted across the banking system are: loans to total assets, loans to core deposits, large liabilities (minus) temporary investments to earning assets (minus) temporary investments, purchased funds to total assets, loan losses/net loans, etc.

While liquidity ratios are the ideal indicators of liquidity of banks operating in developed financial markets, the ratios do not reveal the intrinsic liquidity profile of Indian banks which are operating generally in an illiquid market. Experiences show that assets like government securities, other money market instruments, etc., commonly considered as liquid have limited liquidity as the market and players are unidirectional. Thus, analysis of liquidity involves tracking of cash flow mismatches.

For measuring and managing net funding requirements, the use of a maturity ladder and calculation of cumulative surplus or deficit of funds at selected maturity dates is adopted as a standard tool. The maturity profile could be used for measuring the future cash flows of banks in different time buckets. The time buckets, given the Statutory Reserve Cycle of 14 days, which are generally treated as liquid may be distributed as under:

1. 2.

1 to 14 days 15 to 28 days

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3. 4. 5. 6. 7. 8.

29 days and up to 3 months 3 months and up to 6 months 6 months and up to 1 year 1 year and up to 3 years 3 years and up to 5 years Above 5 years. illiquid due to lack of depth in the secondary market and are, therefore, required to be shown under the respective maturity buckets, corresponding to the residual maturity. However, some of the banks may be maintaining securities in the `Trading Book', which are kept distinct from other investments made for complying with the Statutory Reserve Requirements and for retaining relationship with customers. Securities held in the `Trading Book' are subject to certain preconditions like: Clearly defined composition and volume; Maximum maturity/duration of the portfolio is restricted; The holding period not to exceed 90 days; Cut-loss limit prescribed; Defeasance periods (product-wise) , i.e., time taken to liquidate the position on the basis of liquidity in the secondary market are prescribed; Marking to market on a daily/weekly basis and the revaluation gain/loss charged to the profit and loss account, etc.

The investments in SLR securities and other investments are assumed as

1. 2. 3. 4. 5.

6.

Banks which maintain such `Trading Books' and comply with the above standards are permitted to show the trading securities under 1-14 days, 15-28 days and 29-90 days buckets on the basis of the defeasance periods. The Board/ALCO of the banks should approve the volume, composition, holding/defeasance period, cut loss, etc., of the `Trading Book' and copy of the policy note thereon should be forwarded to the Department of Banking Supervision, RBI.11

Within each time bucket, there could be mismatches depending on cash inflows and outflows. While the mismatches up to one year would be relevant since these provide early warning signals of impending liquidity problems, the main focus should be on the short-term mismatches, viz., 1-14 days and 15-28 days. Banks, however, are expected to monitor their cumulative mismatches (running total) across all time buckets by establishing internal prudential limits with the approval of the Board/Management Committee. The mismatches (negative gap) during 1-14 days and 15-28 days in normal course may not exceed 20% of the cash outflows in each time bucket. If a bank, in view of its current asset-liability profile and the consequential structural mismatches, needs higher tolerance level, it could operate with higher limit sanctioned by its Board /Management Committee, giving specific reasons on the need for such higher limit.

The Statement of Structural Liquidity (Annexure I) may be prepared by placing all cash inflows and outflows in the maturity ladder according to the expected timing of cash flows. A maturing liability will be a cash outflow while a maturing asset will be a cash inflow. It would also be necessary to take into account the rupee inflows and outflows on account of Forex operations. While determining the likely cash inflows/ outflows, banks have to make a number of assumptions according to their asset-liability profiles. For instance, Indian banks with a large branch network can (on the stability of their deposit base as most deposits are rolled-over) afford to have larger tolerance levels in mismatches in the long-term, if their term deposit base is quite high. While determining the tolerance levels, the banks may take into account all relevant factors based on their asset-liability base, nature of12

business, future strategy, etc. The RBI is interested in ensuring that the tolerance levels are determined keeping all necessary factors in view and further refined with experience gained in Liquidity Management.

"In order to enable banks to monitor their short-term liquidity on a dynamic basis over a time horizon spanning from 1-90 days, they may estimate their short-term liquidity profiles on the basis of business projections and other commitments for planning purposes."

3. OBJECTIVES AND METHODOLOGY OF THE STUDY:

Though Basel Capital Accord and subsequent RBI guidelines have given a structure for Liquidity Management and Asset Liability Management (ALM) in banks, the13

Indian banking system has not enforced the guidelines in total. The banks have formed Asset-Liability Committees (ALCO) as per the guidelines; but these committees rarely meet to take decisions. Taking this as a base, this research is done to find out the status of Liquidity Management in State Bank of India with the help of "Cash Flow Approach" methodology for controlling liquidity risk. To achieve the main purpose, the following objectives are set forth: 3.1OBJECTIVES

To identify the liquidity risks faced by the banks. Classification of assets and liabilities into different time buckets as per RBI guidelines issued for liquidity management in banks. Analysis of liquidity risk through Cash Flow Approach Method.

3.2METHIDOLOGY: The study covers SBI's data for evaluation. The relevant data have been collected from the published annual report of the bank for the period from March 2010. In order to have effective liquidity management, bank need to undertake periodic funds flow projections, taking into account movements in non-treasury assets and liabilities [fresh deposits, maturing deposits (and maturing) and new term loans]. This enables forward planning for Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) maintenance.

3.3CASH RESERVE RATIO: A scheduled bank is under the obligation to keep a cash reserve called the Statutory Cash Reserve, with the Reserve Bank of India (RBI) under Section 42 of the

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Reserve Bank of India Act, 1934. Every scheduled bank is required to maintain with the Reserve Bank an average daily balance equal to least 3% of its net demand and time liabilities. Average daily balances mean the average of balances held at the close of business on each day of the fortnight. The Reserve Bank is empowered to increase the rate of Statutory Cash Reserve from 3% to 20% of the Net Demand and Time Liabilities (NDTL). The rate of CRR in March 2010 was 5.75%. Liabilities of a Scheduled bank exclude:

Its paid-up capital and reserves Loans taken from the RBI or IDBI or NABARD The aggregate of the liabilities of a scheduled commercial bank to the State Bank or its subsidiary bank, any nationalized bank or a banking company or a cooperative bank or any financial institution notified by the Central Government in this behalf shall be reduced by the aggregate of the liabilities of all such banks and institutions to the concerned scheduled bank.

Thus, the entire amount of interbank liability for the purpose of Section 42 is excluded and the net liability of a scheduled bank to the entire banking system, (i.e., after deducting the balance maintained by it with all other banks from its gross liabilities to them) will be deemed to be its liabilities to the system. The objective of maintaining a minimum balance with RBI is basically to ensure the liquidity and solvency of the scheduled banks. Every reporting fortnight starts on a Saturday, or, if it is a holiday, the next working day and ends on the following second Friday (Thursday or the previous working day if Friday is a holiday). Branches send their data to their Head Office. Preliminary NDTL returns are due to the RBI in seven days of the close of a reporting fortnight, while final returns must reach in 21 days.

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The NDTL statement in Form A is prescribed by the RBI. There is a fixed format in which branches send data to the CRR/SLR cell responsible for the RBI returns.

3.4STATUTORY LIQUIDITY RATIO: Section 24(2A) of Banking Regulation Act, 1949, requires every banking company to maintain in India in Cash, Gold or Unencumbered Approved16

Securities or in the form of net balance in current accounts maintained in India by the bank with a nationalized bank, equivalent to an amount which shall not at the close of the business on any day be less than 25% or such other percentage not exceeding 40% as the RBI may from time to time, by notification in the Gazette of India, specify, of the total of its demand and time liabilities in India as on the last Friday of the second preceding fortnight, which is known as SLR. At present, all Scheduled Commercial Banks are required to maintain a uniform SLR of 25% of the total of their demand and time liabilities in India as on the last Friday of the second preceding fortnight which is stipulated under Section 24 of the RBI Act, 1949. RBI can enhance the stipulation of SLR (not exceeding 40%) and advise the banks to keep a large portion of the funds mobilized by them in liquid assets, particularly government and other approved securities. As a result, funds available for credit would get reduced.

All banks have to maintain a certain portion of their deposits as SLR and have to invest that amount in these Government securities. Government securities are sovereign securities. These are issued by the RBI on behalf of the Government of India, in lieu of the Central Government's market borrowing program.

3.5 THE TERM GOVERNMENT SECURITIES INCLUDE:1.

Government Dated Securities, i.e., Central Government Securities17

2. 3.

State Government Securities Treasury Bills. market borrowing of the Central Government is raised through the issue of dated securities and 364 days Treasury Bills, either by auction or by floatation of fixed coupon loans.

The Central Government borrows funds to finance its fiscal deficit. The

In addition to the above, Treasury Bills of 91 days are issued for managing the temporary cash mismatches of the government. These do not form part of the borrowing program of the Central Government.

Based on the required CRR and SLR per day, the treasury department of the bank ensures that sufficient balance is maintained in the Reserve Bank (at its different branches). The fund manager calculates on a daily basis the RBI balances based on opening RBI balances and taking into account various inflows and outflows during the day. The fund manager takes the summary of inflows and outflows and the net effect is added to/subtracted from the opening RBI balances. By this method, an RBI balance of all the 14 days is arrived at. For instance, on the opening day of the fortnight, if there is an anticipated surplus, banks can generally lend it at an average, subject to subsequent inflows/outflows. Conversely, for a shortfall, the bank may borrow the required amount in call/repo/Collateralized Borrowings and Lending Obligations (CBLO) markets on a daily basis.

Successful functioning of the funds department depends mostly on the prompt collection of information from branches/other departments regarding the inflow and outflow of funds. The information should also be collected accurately and collated properly/correctly. Improper maintenance of liquidity18

and CRR position by the fund manager may lead to either a default or an excess which does not earn any interest for the bank.

3.6 MANAGING MARKET ACCESS: Apart from the above cash flows, banks should also track the impact of prepayments of loans, premature closure of deposits and exercise of options built in certain instruments which offer put/call options after specified times. Thus, cash outflows can be ranked by the date on which liabilities fall due, the earliest date a liability holder could exercise an early repayment option or the earliest date on which contingencies could be crystallized. The difference between cash inflows and outflows in each time period, the excess or deficit of funds becomes a starting point for a measure of a bank's future liquidity surplus or deficit, at a series of points of time. Banks should also consider putting in place certain prudential limits, as detailed below, to avoid liquidity crisis:

Cap on interbank borrowings, especially call borrowings Purchased funds vis--vis liquid assets Core deposits vis--vis Core Assets, i.e., CRR, SLR and Loans Duration of liabilities and investment portfolio Maximum Cumulative Outflows across all time bands Commitment Ratio track the total commitments given to corporate/banks and other financial institutions to limit the off-balance sheet exposure; and Swapped Funds Ratio, i.e., extent of Indian Rupees raised out of foreign currency sources.

Banks should also evolve a system for monitoring high-value deposits (other than interbank deposits), say Rs. 1Cr, or more to track the volatile liabilities. Further, the cash flows arising out of contingent liabilities in normal situation and the scope for19

an increase in cash flows during periods of stress should also be estimated. It is quite possible that market crisis can trigger substantial increase in the amount of draw downs from cash credit/overdraft accounts, contingent liabilities like letters of credit, etc. The liquidity profile of the banks could be analyzed on a static basis, wherein the assets and liabilities and off-balance sheet items are pegged on a particular day and the behavioral pattern and the sensitivity of these items to changes in market interest rates and environment are duly accounted for. Banks can also estimate the liquidity profile on a dynamic way by giving due importance to:

Seasonal pattern of deposits/loans;Potential liquidity needs for meeting new loan demands, unavailed credit limits, potential deposit losses, investment obligations, statutory obligations, etc.

3.7CONTINGENCY PLANNING:

All banks are required to produce a Contingency Funding Plan (CFP). These plans are to be approved by ALCO, submitted annually as part of the Liquidity and Capital Plan, and reviewed quarterly. The preparation and the implementation of the plan may be entrusted to the treasury.

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CFP are liquidity stress tests designed to quantify the likely impact of an event on the balance sheet and the net potential cumulative gap over a 3month period. The plan also evaluates the ability of the bank to withstand a prolonged adverse liquidity environment. At least two scenarios require testing: Scenario A, a local liquidity crisis, and Scenario B, where there is a nationwide problem or a downgrade in the credit rating if the bank is publicly rated.

The bank's CFP should reflect the funding needs of any bank managed mutual fund whose own CFP indicates a need for funding from the bank.

Reports of CFPs should be prepared at least quarterly and reported to ALCO.

If a CFP results in a funding gap within a 3-month time frame, the ALCO must establish an action plan to address this situation. The Risk Management Committee should approve the action plan.

At a minimum, CFPs under each scenario must consider the impact of accelerated run off of large funds providers.

The plans must consider the impact of a progressive, tiered deterioration, as well as sudden, drastic events.

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Balance sheet actions and incremental sources of funding should be dimensioned with sources, time frame and incremental marginal cost and included in the CFPs for each scenario.

Assumptions underlying the CFPs, consistent with each scenario, must be reviewed and approved by ALCO.

The Chief Executive/Chairman must be advised as soon as a decision has been made to activate or implement a CFP. The Chief Executive or the Risk Management Committee may call for implementation of a CFP.

The ALCO will implement the CFP, amending it with the approval of the Risk Management Committee, where necessary, to meet changing conditions; daily reports are to be submitted to the Treasury Head, comparing actual cash flows with the assumptions of the CFP.

3.8FOREIGN CURRENCY LIQUIDITY MANAGEMENT: For banks with an international presence, the treatment of assets and liabilities in multiple currencies adds a layer of complexity to liquidity management for two reasons. First, banks are often less well-known to liability holders in foreign currency markets. Therefore, in the event of market concerns, especially if they relate to a bank's domestic operating environment, these liability holders may not be able to distinguish rumor

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from fact as well or as quickly as domestic currency customers. Second, in the event of a disturbance, a bank may not always be able to mobilize domestic liquidity and the necessary foreign exchange transactions in sufficient time to meet foreign currency funding requirements. These issues are particularly important for banks with positions in currencies for which the foreign exchange market is not highly liquid in all conditions. Banks should, therefore, have a measurement, monitoring and control system for liquidity positions in the major currency markets in which they are active. In addition to assessing their aggregate foreign currency liquidity needs and the acceptable mismatch in combination with their domestic currency commitments, banks should also undertake separate analysis of their strategies for each currency individually. When dealing in foreign currencies, a bank is exposed to the risk that a sudden change in foreign exchange rates or market liquidity, or both, could sharply widen the liquidity mismatches. These shifts in market sentiment might result, either from domestically generated factors or from contagion effects of developments in other countries. In either event, a bank may find that the size of its foreign currency funding gap has increased. Moreover, foreign currency assets may be impaired, especially where borrowers have not hedged foreign currency risk adequately. The Asian crisis of the late 1990s demonstrated the importance for banks to closely manage their foreign currency liquidity position on a day-to-day basis.

The particular issues to be addressed in managing foreign currency liquidity will depend on the nature of the bank's business. For some banks, the use of foreign currency deposits and short-term credit lines to fund domestic currency assets will be the main area of vulnerability, while for others; it may be the funding of foreign currency assets with domestic currency. As23

with overall liquidity risk management, foreign currency liquidity should be analyzed under various scenarios, including stressful conditions.

3.3 LITERATURE REVIEW1. The article explains that in the year 2003 the Mortgage Backed Securities

Clearing Corporation (MBSCC) and the Government Securities Clearing Corporation (GSCC) merged into the Fixed Income Clearing Corporation (FICC) under the Depository Trust Clearing Corporation (DTCC) umbrella. FICC continually searches for cost-effective ways to provide increased liquidity, risk management and other dynamic processes that help firms24

operate more efficiently as well as expand the population of firms that can take advantage of these benefits. This paper will outline the motivations, customer needs, regulatory interests and market dynamics behind these initiatives, the benefits they will bring to the industry and the progress they have made so far. In addition, the author has addressed some of the challenges that currently face the industry and how FICC, along with its members and partners, is fashioning solutions for those as well. 2. Developed countries and is becoming increasingly relevant for corporate firms in India. This paper examines the practices and policies of foreign exchange risk and interest rate risk management followed by the corporate firms in India. The study reveals that Indian firms are aware of the risk management techniques and many of them are using the same to manage various risks. However, all the risks are not managed and the type of ownership control significantly influences the usage of the techniques to manage exchange rate risk and interest rate risk. 'Exposures are not large enough' is the most widespread and prominent reason for not managing risks. Risks inherent in derivatives are a significant reason in making the firms using risk management techniques. The prominent barriers hindering the routine use of derivatives are monitoring and evaluating the risk of derivatives, pricing, valuing and accounting in conjunction with credit and liquidity risk. About two-fifths of the firms are risk averse but do not hedge their full exposure. A majority of the firms follow cost-center approach towards risk management. Ownership has been observed to be a significant determinant of firms' strategy towards risk management. While a majority of foreign controlled firms and private sector business group firms can be characterized as partial hedgers, the majority of the public sector firms belong to the category of negligible hedgers. In sum, the adoption of risk management techniques is still in infancy. It is desirable that decision makers25

and managers review their risk management practices afresh and devise anticipatory and proactive policies in order to have competitive advantages internationally.

3. Financial and insurance theories explain that large widely-held corporations manage corporate risks if doing so is cost-effective to reduce frictional costs such as taxes, agency costs and financial distress costs. A large number of previous empirical studies, most in the U.S., have tested the hypotheses underlying corporate risk management with financial derivative instruments. In order to quantify corporate hedge demand, most previous studies have used the ratio of principal notional amount of derivatives to company size, although they recognize that company size is not an appropriate proxy for financial risk. This paper analyzes the interest-rate-risk hedge demand by Australian companies, measured through the ratio of principal notional amount of interest rate derivatives to interest-rate-risk bearing liabilities. Modern panel data methods are used, with two panel data sets from 1998 to 2003 (1102 and 465 observations, respectively). Detailed information about interest-rate-risk exposures was available after manual data collection from financial annual reports, which was only possible due to specific reporting requirements in Australian accounting standards. Regarding the analysis of the extent of hedge, their measurement of interest-rate-risk exposures generates some significant results different from those found in previous studies. For example, this study shows that total leverage is not significantly important to interest-rate-risk hedge demand and that, instead, this demand is related to the specific risk exposure in the interest bearing part of the firm's liabilities. This study finds significant relations of interest-rate-risk hedge to company size, floating-interest-rate debt ratio, annual log returns, and company industry type (utilities and non-banking financial institutions).26

4. The article deals with the development of an efficient asset/liability management (ALM) process at the bank. ALM is one of the most important functions for creating an optimal risk/reward trade-off in community banking. The successful implementation of the ALM process is the differentiating factor with regard to profitability among community banks. Frequently, ALM is narrowly considered as market risk or interest rate risk management. The committee responsible for managing the balance sheet is called the Asset/Liability Management Committee (ALCO). The role of ALCO is to manage assets, liabilities and capital along with managing balance sheet risk. 5. The article explains how building connections between stress-testing and contingency planning work in the liquidity risk management at financial institutions. Three lines of defense employed by institutions to address liquidity risk are key risk indicators, contingency planning and scenariobased stress testing. Uses of scenario-based stress testing are tactical risk management decisions, identification of potential weaknesses and vulnerabilities, contingency planning process, and setting limits and comparing forecasted risk exposures to the risk limits 6. The article focuses on the challenges faced by banks on their compliance with the rules that concern liquidity risk management which were established by regulators such as the Basel Committee on Banking Supervision, Committee of European Banking Supervisors and the Great Britain Financial Services Authority (FSA). It states that the primary challenge that confronts some banks is the need to understand the requirements of the regulators despite the inconsistency of the rules that each of them imposed. It adds that the requirements to use the stress tests and calculate the liquidity buffer in27

the measurement of liquidity risk offer a challenge among banks. Moreover, despite the rules provided by regulators in liquidity risk management, many banks still failed to meet the requirement. 7. The article discusses the significance of liquidity risk management as a regulation for credit control firms in Great Britain. The author noted how Chief Executive Hector Sants of the Financial Services Authority (FSA) stressed the importance of liquidity risk like a capital for managing of firms. The author presented issues surrounding FSA's guidance for liquidity policies such as the systems and controls requirements and contingency funding plan.

4. INDUSTRY PROFILE 4.1 INTRODUCTION

Banks in India as modern senses emerged only till 18th century. During the time of the American Civil War, the supply of cotton to Lancashire stopped from Americas. At that time some banks were opened, which functioned as entities to finance industry, including speculative trades in cotton. Most of the banks opened in India during that period could not survive and failed because of the high risk which came

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with large exposure to speculative trades in cotton. In India in the year 1786, The General Bank of India was the first bank to come into existence in India and then in the year 1870 which is almost after a century The Bank of Hindustan became the 2ndbank

in India.

In India at least 94 banks failed during the years 1913 to 1918. This was really a turbulent time for the world as a whole and the banking sector in India specially. This was the period which witnessed the First World War (1914-1918). Since then through the end of the Second World War (1939-1945), and two years thereafter until India achieved independence, were very challenging period for Indian banking. The years of the First World War were turbulent, and it took toll on many banks which simply collapsed despite the Indian economy gaining indirect boost due to war-related economic activities. There were at least 106 numbers of banks which downed shutters during that period. Following is a table giving year wise closed banks detail during the period:

Years

Number of Banks that failed

Authorised capital (Rs Lakhs)

Paid-up Capital (Rs. Lakhs)

1913

12

274

35

29

1914

42

710

109

1915

11

56

5

1916

13

231

4

1917

9

76

25

1918

7

209

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4.2POST-INDEPENDENCE: The partition of India bought about a social unrest throughout India in 1947. Riot and chaos ruled. The most adversely impacted provinces were the Punjab and West Bengal. So did the economies of both these provinces. As a result, the banking activities had remained paralyzed for months. Till then the banking sector was wide open and there were almost no regulation. Most of the promoters were private players. With Independence, things started changing. Rather the independence marked the end of a regime of the Laissez-faire for the Indian banking. The new government initiated a process of playing an active role in the economy of the

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nation. The Industrial Policy Resolution adopted by the government in 1948 was the first step towards it. The resolution opted for a mixed economy. This resulted into greater control and involvement of the state in different segments of the economy, more so, in the sensitive sectors including banking and finance. The important banking regulatory steps were as follows: In 1948, India's central banking authority the Reserve Bank of India got nationalized, and it became an institution owned by the Government of India. With the enactment of the Banking Regulation Act in 1949, the Reserve Bank of India (RBI) got empowered "to regulate, control, and inspect the banks in India." The Banking Regulation Act also provided that no new bank or branch of an existing bank may be opened without a license from the RBI, and no two banks could have common directors. Interestingly, despite these provisions, control and regulations, almost all banks in India except the State Bank of India, continued to be owned and operated by private persons. However, the situation changed dramatically with the nationalization of major banks in India on 19th July, 1969. 4.3NATIONALISATION: From Independence, it took some years for the banking sector to mature. By 1960s, the Indian banking industry did occupy an important position to facilitate the development of the Indian economy. Moreover, it did employ a quantum volume which could affect national economy. It resulted in a debate about the possibility to nationalize the banking industry. At that point, during the annual conference of the All India Congress Meeting, in a paper entitled "Stray thoughts on Bank Nationalization", Indira Gandhi, the-then Prime Minister of India expressed the intention of the GOI favouring nationalisation. The paper was received with positive

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enthusiasm. Thereafter, in a swift and sudden move, the GOI issued an ordinance and nationalised the 14 largest commercial banks with effect from the midnight of July 19, 1969. The decision was even termed as a "masterstroke of political sagacity" by non other than a leader of the stature of Jaypraksh Narayan. Then, within the next fortnight of issuing the ordinance, the Parliament passed the Banking Companies (Acquisition and Transfer of Undertaking) Bill. The bill finally received the presidential approval on 9th August, 1969. In 1980, there came the second phase of nationalisation of 6 more commercial banks. The reason forwarded for this was to have more control of credit delivery by the government. By the time, GOI effectively got hold of 91% control of the total banking business of India. Till 1990s, all nationalised banks grew at a pace of around 4%, similar to the average growth rate of the Indian economy.

4.4LIBERALIZATION:

Since the launch of the economic liberalisation and global programme in 1991, India has considerably relaxed banking regulations and opened the financial sector for foreign investment. India is also committed to further open the banking sector for foreign investment in pursuance to its commitment to the World Trade Organsation(WTO)

Licenses were issued to a small number of private banks, such as Global Trust Bank (the first of such new generation banks to be set up)which later amalgamated with Oriental Bank of Commerce, UTI Bank(now re-named as32

Axis Bank), ICICI Bank and HDFC Bank. These banks also came to be known as New Generation tech-savvy banks because of their improved service condition and their extensive use of IT in the operations.

This move instigated competition, resulting increased efficiency and performance and did a lot of good to the banking sector. The rapid growth in the economy of India, again as a result of liberalisation, also did help transform the sector to this new look. The new situation shifted many goal posts. Till then, the widely used method of 4-6-4 (Borrow at 4%; Lend at 6%; Go home at 4) of functioning by the banks become redundant. Technology, competition, change in customer behaviour, macro-economic conditions, government policies, resultant of all together ushered a new modern, efficient and innovating banking environment in India. People started receiving more from the banks and also constantly started demanding more. Retail banking boom can be attributed to this phenomenon. With the second phase of economic reforms, the next stage for the Indian banking has been setup with the proposed relaxation in the norms for Foreign Direct Investment, where all Foreign Investors in banks may be given voting rights which could exceed the present cap of 10%. Its notable that FDI permissible limit, at present, has gone up to 49% with some restrictions.

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4.5CURRENT SITUATION: Today, the banking sector in India is fairly mature in terms of supply, product range and reach. As far as private sector and foreign banks are concerned, the reach in rural India still remains a challenge. In terms of quality of assets and capital adequacy, Indian banks are considered to have clean, strong and transparent balance sheets relative to other banks in comparable economies in its region. The Reserve Bank of India is an autonomous body, with minimal pressure from the government. The stated policy of the Bank on the Indian Rupee is to manage volatility but without any fixed exchange rate. Till now, there is hardy any deviation seen from this stated goal which is again very encouraging.

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With passing time, Indian economy is further expected to grow and be strong for quite some time-especially in its services sector. The demand for banking services, especially retail banking, mortgages and investment services are expected to grow stronger. Therefore, it is not hard to forecast few M&As, takeovers, and asset sales in the sector. Consolidation is going to be another order of the day. The significant change in the policy and attitude that is currently being seen is encouraging for the banking sector growth. In March 2006, the Reserve Bank of India allowed Warburg Pincus, a private foreign investor, to increase its stake in Kotak Mahindra Bank to 10%. Notably, this is the first time that a foreign individual investor has been allowed to hold more than 5% in a private sector bank since 2000. Earlier, The RBI in 2005 announced that any stake exceeding 5% by foreign individual investors in the private sector banks would need to be vetted by them. Currently, India has 88 scheduled commercial banks (SCBs) - 28 public sector banks (that is with the Government of India holding a stake), 29 private banks (these do not have government stake; they may be publicly listed and traded on stock exchanges) and 31 foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs. According to a report by ICRA Limited, a rating agency, the public sector banks hold over 75 percent of total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5% respectively.

Despite the current global slowdown, despite the fear of US economic recession, despite the volatility of Indian stock markets, every informed observer is more or less optimistic about the 8% to 10% growth per annum

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for the Indian economy till the next few years. Therefore, it can safely be said that the banking industry in India will only surge ahead in coming years. We can also expect to see many other sea changes in terms of their operations, funding and structures. As they say, this is just the beginning!

India has a strong and vibrant banking sector comprising state-owned banks, private sector banks, foreign banks, financial institutions and regional banks including cooperative banks, rural banks and local area banks. In addition there are non-banking financial companies (NBFCs), housing finance companies, Nidhi companies and chit fund companies.

As monetary authority of the country, the Reserve Bank of India (RBI) regulates the banking industry and lays down guidelines for day-to-day functioning of banks within the overall framework of the Banking Regulation Act, 1949, Foreign Exchange Management Act, 1999 and Foreign Direct Investment (FDI) policy of the government state owned banks.

The Indian banking sector is dominated by 28 state-owned banks which operate through a network of about 50,000 branches and 13,000 ATMs. The State Bank of India (SBI) in the largest bank in the country and along with its seven associate banks has an asset base of about Rs. 7,000 billion (approximately US$150 billion).

The other public sector banks are Punjab National Bank, Bank Of Baroda, Canara Bank, Bank Of India, IDBI Bank.

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The public sector banks have overseas operations with Bank of Baroda topping the list with 51 branches, subsidiaries, joint ventures and representative offices outside India, followed by SBI (45 overseas branches/offices) and Bank of India (26 overseas branches/offices). Indian banks, including private sector banks, have 171 branches and offices abroad.

SBI is present in 29 countries, Bank of Baroda in 20 countries and Bank of India in 14 countries.

Private sector banks India has 29 private sector banks including nine new banks which were granted licenses after the government liberalised the banking sector. Some of the well known private sector banks are ICICI Bank, HDFC Bank and IndusInd Bank and the latest Yes Bank has recently entered the private sector bank. In terms of reach the private sector banks with an asset of over Rs 5,700 billion (about US$124 billion) operate through a network of 6,500 branches and over 7,500 ATMS.

Foreign banks As many as 29 foreign banks originating from 19 countries are operating in India through a network of 258 branches and about 900 ATMs. With total assets of more than Rs 2,000 billion (about 44 billion US dollars) they are present in 40 centers across 19 Indian states and Union Territories. Some of the leading international banks that are doing brisk business in India include Standard Chartered Bank.

Foreign banks operating in India: 1. ABN-AMRO Bank N.V. (24 branches)

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2. Abu Dhabi Commercial Bank Ltd. (2 branches) 3. Arab Bangladesh Bank Ltd. (1 branch) 4. American Express Bank (7 branches) 5. Antwerp Diamond Bank N.V. (1 branch) 6. Bank International Indonesia (1 branch) 7. Bank of America (5 branches) 8. Bank of Bahrain & Kuwait (2 branches) 9. Bank of Nova Scotia (5 branches) 10. Bank of Tokyo-Mitsubhai UFJ Ltd. (3 branches) 11. BNP Paribas (8 branches) 12. Bank of Ceylon (1 branch) 13. Barclays Bank Plc. (1 branch) 14. Calyon Bank (5 branches) 15. Citi Bank N.A. (39 branches) 16. Shinhan Bank (1 branch)38

17. Chinatrust Commercial Bank (1 branch) 18. Deutsche Bank (8 branches) 19. DBS Bank (2 branches) 20. HSBC Ltd. (45 branches) 21. JP Morgan Chase Bank N.A. (1 branch) 22. Krung Thai Bank Public Co. Ltd. (1 branch) 23. Mizuho Corporate Bank Ltd. (2 branches) 24. Mashreq Bank PSC (2 branches) 25. Oman International Bank SAOG (2 branches) 26. Standard Chartered Bank (81 branches) 27. Sonali Bank (2 branches) 28. Societe General (2 branches) 29. State Bank of Mauritius (3 branches) The Netherlands-based ING Group has taken over the management of the Indian private sector Vysya Bank Ltd. in October 2002 and is operating as ING Vysya Bank Ltd.

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4.6REGIONAL BANKS: Rural areas in India are served through a network of Regional Rural Banks, urban cooperative banks, rural cooperative credit institutions and local area banks. Many of these banks are not doing well financially and the government is currently engaged in restructuring and consolidating them. Local area banks were of recent origin as on March 31, 2006 four such banks were operating in the country. Financial institutions in India have seven major state-owned financial institutions which include Industrial Development Bank of India, Industrial Financial Corporation of India, tourism Finance Corporation of India, Exim Bank, Small Industries Development Bank of India, National Bank for Agriculture and Rural Development and National Housing Bank. These institutions provide term loans and arrange refinance. These are also specialized institutions like the power Finance40

Corporation, Indian Railway Finance Corporation, Infrastructure Development Finance Company and state-level financial corporations. India also has a vibrant NBFC sector comprising 13,000 NBFCs that are registered with the RBI and fund activities like equipment leasing, hire purchase etc. Out of the total about 450 NBFCs are allowed by the RBI to collect funds from the public. Large NBFCs have an asset base of about Rs 3,000 billion

4.7 RECENT DEVELOPMENTS:

State Bank of India has acquired 76% stake in Giro Commercial Bank, a Kenya bank. Bank of Baroda is planning to acquire a bank in Africa to consolidate its presence in the continent.

Canara Bank is helping Chinese banks recover their huge non-performing assets.

ICICI banks is in the process of taking over Sangli Bank, a private sector bank in Maharashtra. The RBI has recently allowed the commonwealth Bank of Australia, Banche Popolari uniote S.c.r.l (based in Italy), Vneshtorgbank (Russia trade bank), Prmsvyazbank (Russian commercial bank), Banca Popolare Di VIcenza

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(Italian bank), Monte Dei Paschi Di Siena (Italian bank) and Zurcher Kantonalbank (Swiss bank) to set up representative office in India.

4.8GOVERNMENT REGULATIONS: Even though banking companies are registered under the companies Act, 1956 they are regulated by the RBI which grants license to companies for operating a bank , operating branches and ff sit ATMs, fixes statutory liquidity ratio (SLR) and cash reserve ratio , and lays down other conditions for day-to-day operations. The RBI permission is also needed for board level appointments in banks. With regard to interest rates, individual banks are free to fix rates with the expectation of savings bank rate which is decided by the RBI. The individual banks are free to fix lending rates.

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5. COMPANY PROFILE

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State Bank of India (SBI), Mumbai Main Branch

5.1HISTORY The state Bank of India was established in 1955, its predecessor, the Imperial Bank of India, was established in 1921, as a result of the amalgamation of the three banks including Bank of Bengal, Bank of Bombay and Bank of Madras. Since 1973, the bank has been involved in a non-profit activity called commodity service banking. All the branches and administrative offices throughout the country sponsor and participate in a large number of welfare activities and social causes. State Bank of India opened its first offshore banking unit (OBU) in 2003. The bank entered into an agreement with western unions Kouni Travels to offer inward remittance facilities in 2005. During2006, the bank faced huge disruptions in its services on account of a week long strike by over 200,000 employees, demanding upward revision of their pension benefits. Later the same year, the bank announced that it

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would securitize 25-30% of its loan assets over the next few years as an alternative source of funds. The bank also announced that it would increase its overseas presence and would set up 60 new overseas offices in two years. SBI entered into wealth management and financial planning services to clients who have INR0.5million or more in their accounts. SBI announced plan to roll out banking services in 50,000 unbanked villages by March 2010. In2009, the bank announced that got a full banking license from the regulator, the Dubai Financial Services Authority.

5.2KEY AREAS OF OPERATIONS The business operations of SBI can be broadly classified into the key income generating areas such as National Banking, International Banking, Corporate Banking, & Treasury operations.

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5.3MANAGEMENT The bank has 14 directors on the Board and is responsible for the management of the Banks business. The board in addition to monitoring corporate performance also carries out functions such as approving the business plan, reviewing and

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approving the annual budgets and borrowing limits and fixing exposure limits. Mr. O. P. Bhatt is the Chairman of the bank. The five-year term of Mr. Bhatt will expire in March 2011. Prior to this appointment, Mr. Bhatt was Managing Director at State Bank of Travancore. Mr. Bhatt has more than 30 years of experience in the Indian banking industry and is seen as futuristic leader in his approach towards technology and customer service. Mr. Bhatt has had the best of foreign exposure in SBI. We believe that the appointment of Mr. Bhatt would be a key to SBIs future growth momentum. Mr. T S Bhattacharya is the Managing Director of the bank and known for his vast experience in the banking industry. Recently, the senior management of the bank has been broadened considerably. The positions of CFO and the head of treasury have been segregated, and new heads for rural banking and for corporate development and new business banking have been appointed. The managements thrust on growth of the bank in terms of network and size would also ensure encouraging prospects in time to come.

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5.4SWOT ANALYSIS

State Bank of India (SBI) is the leading commercial bank in India, offering services such as retail banking, commercial banking, international banking and treasury operations. Low cost CASA and reduced reliance on bulk deposits help the bank reduce the cost of funds and thus improve profitability, but increasing competition and tepid global interbank market could affect the banks market share and financial performance.

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STRENGTHS

WEAKNESS Compared to foreign banks in India, SBIs overseas presence is minuscule

The largest public sector bank in India and also one of the worlds top 100 banks in the world

Low cost CASA and reduced reliance on bulk deposits Prudent lending practices helping

Susceptible to political interventions

control NPAs OPPORTUNITIES

THREATS Opening of banking sector in2009 will cause intense competition Teid global interbank lending could derail overseas expansion.

New licenses and approvals likely to expand revenue and profits Investments in information technology will decrease transaction costs of SBI

Growth in general insurance industry will help SBI to increase the market share

SBS merger further hastens SBI and its

associate banks merger and helping defend its leadership position

5.5COMPETITORS AND OTHER PLAYERS:

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TOP PERFORMING PUBLIC SECTOR BANKS

Andhra Bank Allahabad Bank

Punjab National Bank Dena Bank Vijaya Bank TOP PERFORMING PRIVATE SECTOR BANKS HDFC ICICI Bank AXIS Bank Kotak Mahindara Bank Centurion Bank of Punjab TOP PERFORMING FOREIGN BANKS Citi Bank Standard Chartered HSBC Bank ABN AMRO Bank American express

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5.6 AWARDS

5.7DIFFERENT PRODUCTS OF SBI51

DEPOSIT Savings

LOANS Home

CARDS Consumer

DIFFERENT CREDIT CARDS SBI international

MATURITY GAP ANALYSIS FOR LIQUIDITY RISK (SHORT TERM) THROUGH CASH FLOW APPROACH (MARCH 200010)

Account 1 to 14 Days Life PlusDeposits

15 to 28 Days

Loansdays to 29 3 LoanMonths Property

Senior Citizens 31,596.91 14,592.93Against 37,853.31 Savings5,531.82 10,490.96

Over 3 Cards Over 6 Months Credit Cardup to Months 6 Months to 1 Year 56,627.41 86,114.19

Over 1card Over 3 Over 5 Year up to Gold Cards Years SBI Years up 3 Years to 5 Years 1,81,909.6 1,02,864.7 1,78,420.51 1 7 9,173.88 3,052.88 30537.79

BorrowingsAccount 2,985.88 FCL 4,319.68

8,523.60

4,384.83

Fixed Deposits9,152.31

Personal Loans14,704.28

Travel Card14,831.34

SBI Gold Master17,878.41

1,677.01 Cards 6,550.34 Security deposits Car Loan Debit Card Partnership Cards Total Cash Recurring Deposits Loan Against 80,454.11 38902.47 29,277.06 63,048.55 105,330.36 208,961.90 employee Commercial Card SBI 112,467.99 210,635.31 outflow(a) Loans & Advances 30,886.76 8,026.04 Tax- Saver Fixed

15,303.10

Securities Cards 33,299.25 Loan Corporate Card 2,40,706.9 26,620.89 19,452.19 42,276.20 Two Wheeler0 32,238.61 60,331.76

84,900.05

Deposits InvestmentsSalary Account 7,505.92 4,494.75 Preapproved Loan 21,733.42 7,848.99Prepaid Card 6,777.18FCA 4,319.68 9,152.31 14,704.28 Advantage Woman Retail Asset

1,24,504.50

15,303.10 14,831.34 Purchase Card 17,878.41

6,550.34

1,677.01

Total Cash(b) Gap(b-a)

Savings account 77,918.80 117,740.48 91,696.97 75,344.24 290,823.92 Rural savings 38,851.45 Farmer Finance Distribution Card account 39,016.33 9,574.39 Business 54,691.93 Peoples Saving Account Account11,242.86 -29,986.12 Business Card 81,862.02 130,966.13 100,980.0 182,842.03 Merchant Services 9,64,432.0 8 13.58 9,64,432.0 8 10.47 9,64,432.0 8 18.95

157,984.84

211,081.56

45,516.85

446.25

Installment Loans228,358.88 228,805.13

CumulativeFreedom Savings 55,456.95 65,031.34Flexi Cash 119,723.27 Gap Total Assets Gap to Total Assets (%) 9,64,432.0 8 5.750 9,64,432.0 8 6.743 9,64,432.0 8 12.41

9,64,432.0 8 23.68

9,64,432.08

23.72

6. ANALYSES

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6.1STATEMENT OF INTEREST RATE SENSITIVITY Generated by grouping RSA, RSL & OFF-Balance sheet items in to various (8) time buckets. RSA: A) Money at call B) Advances C) Investment RSL: A) Deposits B) Borrowings 6.2MATURITY GAP METHOD Three options: A) RSA>RSL= Positive Gap B) RSL>RSA= Negative Gap C) RSL=RSA= Zero Gap

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6.3OBSERVATIONS OF THESTUDY From the year ending March 31, 2000, banks are required to disclose the maturity patterns of loans and advances, investments in securities, deposits and borrowings, and foreign currency assets and liabilities. The data of the year ending March 31, 2010 has been used to conduct a Cash Flow Approach (short-term maturity gap) analysis of assets and liabilities for different maturity buckets.

The analysis of net funding requirements involves the construction of a maturity ladder and the calculation of cumulative net excess or deficit of funds at selected maturity dates. This is called "Cash Flow Approach" to liquidity management. A maturity ladder of an 8 time bucket is used to compare SBI's future cash inflows to its future cash outflows. Evaluating whether a bank is sufficiently liquid depends in large measure on the behavior of cash flows under different scenarios, such as normal conditions (going concern scenario) or a bank specific crisis (the bank's liabilities cannot be rolled over or replaced and will have to pay higher at maturity) or general market crisis (liquidity affects all the banks or one or two markets). For evaluation of Cash Flow Approach, 1-14 days bucket, 15-28 days time bucket and 29-90 days time buckets have been taken as the relevant time frames for active liquidity management as it does not generally extend to more than a few weeks. Since the SLR/CRR maintenance period is 14 days,

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meaningful information is arrived at by a short time horizon which is stacked by many short periods (ranging up to 3 months by every week). In the year 2010, there was a positive gap in short-term liquidity, i.e., up to 6 months. Its short-term cash outflow was less than cash inflow which means that SBI maintained a sound liquidity position, as shown in the table.

Other than in the bucket of 6 months to 1 year liquidity position shows positive cumulative gap throughout its time. So its short-term liquidity was maintained and during this period, SBI had a sound liquidity position.

There was a negative gap between 6 months to 1 year (Rs. 29,986.12). But at the end, i.e., in the 5 years ad above it had a positive cumulative gap which shows that its medium-term liquidity risk could be maintained.

Percentage of negative gap to cash out flow was 5.75 % in 1-14 days time bucket, 6.74%in 15-28 days time bucket, 12.41% 29 to 3 months, 13.58% 3months to 6 months, 10.47% 6 months to 1 year, 18.95% 1 year to 3 years, 23.68%3 years to 5 years, 23.72% 5 years. Here RSA > RSL so its a positive gap.

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6.4LIQUIDITY MANAGEMENT IN BANKS: THE CASH FLOW APPROACH: Liquidity has been defined as the ability of an institution to replace liability run off and fund asset growth promptly and at a reasonable price. Maintenance of superfluous liquidity will, however, impact profitability adversely. It can also be defined as the comprehensive ability of a bank to meet liabilities exactly when they fall due or when depositors want their money back. This is a heart of the banking operations and distinguishes a bank from other entities.

Measuring and managing the liquidity needs are vital for effective operation of commercial banks. By assuring a bank's ability to meet its liabilities as they become due, liquidity management can reduce the probability of an adverse situation developing. By measuring the liquidity positions of banks on an ongoing basis, banks can examine how liquidity requirements are likely to evolve under different conditions.

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7. RECOMMENDATIONS A bank should set limits to control its liquidity risk exposure and vulnerabilities. A bank should regularly review such limits and corresponding risk escalation procedures. Limits should be relevant to the business in terms of its location, complexity of activity, nature of products, currencies and markets served. A bank should design a set of indicators to identify the emergence of increased risk or vulnerabilities in its liquidity risk position or potential funding needs. Such early warning indicators should identify any negative trend and cause an assessment and potential response by management in order to mitigate the banks exposure to the emerging risk. Market access is critical for effective liquidity risk management, as it affects both the ability to raise new funds and to liquidate assets. Senior management should ensure that market access is being actively managed, monitored and tested by the appropriate staff. A bank should actively manage its intraday liquidity positions and risks to meet payment and settlement obligations on a timely basis under both normal and stressed conditions and thus contribute to the smooth functioning of payment and settlement systems.

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8. CONCLUSION:

Mismatches can be positive or negative Positive Mismatch: M.A.>M.L. and Negative Mismatch M.L.>M.A. In case of +ve mismatch, excess liquidity can be deployed in money market instruments, creating new assets & investment swaps etc. For ve mismatch, it can be financed from market borrowings (Call/Term), Bills rediscounting, Repo & deployment of foreign currency converted into rupee.

To meet the mismatch in any maturity bucket, the bank has to look into taking deposit and invest it suitably so as to mature in time bucket with negative mismatch.

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BIBLIOGRAPHY1. www.ebscohost.com 2. www.rbi.org.in 3. www.statebankofinda.com

4. Basel Committee report

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