General Concepts on ALCO and Liquidity Profiles


In this post I will look at the most common questions asked by those who prepare the Alco and liquidity reports. I will do this by introducing some general concepts in order to understand the Alco reports. I will then move on to the 3 main profiles within the Alco and Liquidity reports and look at the answer to each question under each profile.

What is the difference between Contractual Repayment (Liquidity) and Contractual Repricing (Interest Rate)?

Contractual Repayment is the liquidity risk of assets and liabilities, while Contractual repricing is the interest rate risk of assets and liabilities.For example: Bank A buys a 360 day Floating Rate Note, the issuer resets the asset’s interest rate every 3 months. The contractual repayment is therefore 1 year. However the contractual repricing is 3 months and not 1 year. Generally speaking although the interest repricing on assets and liabilities could be in the same time bucket (e.g. 1-year) as the contractual repayment, the contractual repricing could also be in an earlier time bucket than the contractual repayment (e.g. 3 months).

Note: The actual values of Contractual Repayment (Liquidity) and Contractual Repricing (Interest Rate) for the same balance sheet category are always identical, but may appear in different time buckets.

What is the difference between Zero, Variable and Fixed Contractual Repricing (Interest Rate)?

Only those assets and liabilities that receive or pay no interest should be placed under the Zero contractual repricing (interest rates) bucket. The most common assets and liabilities that come under this category are nostro balances, assets and liabilities like fixed assets, accrued interest and current accounts. Where capital is held locally (and interest is not payable on it to Head Office) please remember that for Interest rate repricing mismatch reports capital should be placed in the zero bucket. For VaR calculations capital should be placed in the repricing tenor that best reflects the next repricing date according to Funds Transfer Policy (FTP).

Those assets and liabilities whose rate of return or cost can be changed at any time during their life are placed under the Variable contractual repricing (interest rate) bucket. Note that the rate can change at any time and for as many times as the bank wishes. The most common assets and liabilities that come under this category are overdrafts and credit cards or savings accounts.

Those assets and liabilities whose rate of return or cost can change only at precise intervals during its life are considered to have a fixed contractual repricing (interest rate) risk.

Note that an asset or liability that has a 5 year contractual maturity and contractual repricing risk of 1 year is still considered fixed (interest rate may change every year, but is fixed for 1 year at a time). Just as an asset or liability that has a 5 year contractual maturity and 5 year contractual repricing risk (interest rate does not change) is considered a 5 year fixed rate contractual repricing risk.

What are the Three Balance Sheet Profiles?

Contractual Profile

The contractual profile places assets and liabilities in time buckets that best reflect the maturity stated on their legal contract. Often this profile is provided automatically by systems for finance.

Forecast Profile

The forecast profile places assets and liabilities in time buckets that best reflect the way they will behave in a practical and real world. This profile takes the contractual repayment (liquidity) profile as a starting point and, through the application of sensible assumptions change the profile to reflect the real world.This profile does not deal with contractual repricing (interest rate) risk.

Stress Profile

The stress profile allows countries to monitor that they have sufficient funds available to survive a certain days liquidity crisis. This period represents the likely period needed to arrange both Group-wide and Central Bank support. This profile takes the contractual repayment (liquidity) profile as a starting point and uses the standard assumptions issued by market risk guideline for stress scenario.

How many assets should I disclose as Reserve Assets?

Under “Reserve Assets” you should only include those assets that are used to meet your regulatory reserve requirement plus any additional assets needed to meet the stress test.

For Example: Country A’s Central Bank has a reserve requirement of 20% of total deposits, and a need to keep a further 10 million of T-bills to meet the 3 day stress test. Assuming total deposits are 100 million, the bank will show 30 million under Reserve assets (20 million to meet regulatory requirements and 10 million for the stress test). The 20 million can be made up of cash, government securities or deposits at the Central Bank.

How do I forecast Reserve assets?

In the contractual profile reserve assets are placed according to time left to maturity. If the country is calculating the forecast and the stress test daily than the country is allowed to show any surplus reserve assets (those not required to meet the statutory reserve requirement and the stress test) at their earliest realisability or in the bucket that shows the bank’s business as usual profile.

Example A: Bank A calculates the forecast and the stress test every day. It has USD 200 million worth of 180 day Government T-Bills but needs only USD 180 million to meet the statutory reserve requirement. In the contractual profile Bank A places USD 200 million in the 6-12 month bucket of the reserve assets section. In the forecast USD 20 million will be shown in the call bucket and is allowable as a cash inflow to meet the business as usual needs.

However if the bank is not calculating the forecast and stress test daily, then the forecast profile should place reserve assets in the 1 to 5 year bucket. This is because of the assumption that the bank will always endeavor to keep those assets to meet the Statutory Reserve Requirement and to pass the stress test.

Example B: Bank A calculates the forecast and stress test once every two weeks. It has USD 100 million worth of 90 day Government T-Bills. In the contractual profile Bank A places USD 100 million in the 3-6 month bucket of the reserve assets section. In the forecast the USD 100 million under reserve assets will be shown in the 1-5 year bucket.Realisability should take account of when the cash is received from the sale of the asset. Therefore if the asset is sold today, but cash from the asset is received in 3 days, then the inflow should be placed in the 2-7 day bucket.

Central Bank dictates the level of reserve assets I keep, can I include them into my stress profile?

Yes, one reason why Central Banks force local banks to keep a percentage of their deposits in very liquid assets is so that the bank always has a minimum level of cash flow to meet an unexpected liquidity crisis. Although this should not be the only source of liquidity it is an important one and thus should be included in the stress profile. You should also include the securities that you have kept in the contractual profile to meet the stress test.

Also remember that as the level of deposits decline, so should the amount of assets required to meet the reserve requirement. Therefore when a stress test is carried out and an acceleration of deposit withdrawal is experienced, the surplus reserve requirement can be used as a cash inflow.

Only include those reserve assets from which cash is available in the specified stress days. Therefore if the bank has a 20-year bond that is not liquid then it should not be included in the specified days stress test.

Note: In some countries reserve assets held to meet the regulatory reserve requirement are not available to the bank even in stress situations.

What assets should be included in Marketable Assets?

Any surplus cash or marketable securities not being used to meet the regulatory reserve requirements or the stress test should be placed under “Marketable Assets”.

How do I forecast Marketable assets?

In the contractual profile marketable assets are placed according to time left to maturity. The forecast profile should place assets disclosed in “Marketable Assets” in the bucket that represents their earliest realisability or in the bucket that shows the banks business as usual profile. Make sure that the profile of inflows shown in the forecast is in line with treasury strategy and the Liquidity Contingency Plan.

Example: Bank A has USD 100 million worth of 2-Year Government Bonds. In the contractual profile Bank A places USD 100 million in the 1-5 year bucket of the marketable assets section. In the forecast the USD 100 million under marketable assets will be placed in the next day bucket (since the asset is very liquid).Realisability should take account of when the cash is received from the sale of the asset.

Note: There may be a cost to selling assets before their maturity and therefore the value shown in the forecast profile may be lower than that shown in the contractual profile.

Can I include all marketable securities into the stress profile?

If the bank does not calculate the forecast and stress test daily then the bank should only include those marketable securities that have not been used to meet the Maximum Cumulative Outflow (MCO) guideline and realistically realisable within the specified days of the stress test. Banks that calculate the forecast and stress test daily can include all “Marketable Securities” realistically realisable within the specified days of the stress test. Note that realisability should take account of when the cash is received from the sale of the asset.

Note: There may be a cost to realising the cash flow from securities before their maturity and therefore the value shown in the stress profile may be lower than that shown in the contractual profile.

What types of assets are included in Interbank, Intragroup and Custodial and Institutional Assets?

Interbank assets should include all assets held by another bank outside the group. This includes Nostro balances. Intragroup is the same except it only includes entities within the bank’s group. Custodial and Institutional should include all balance accounts or operating accounts held at 3rd party financial institutions.

Can I show early realisability of Interbank, Intragroup and Custodial and Institutional assets?

No, the forecast profile of fixed Interbank, Intragroup or Custodial and Institutional placings should place the asset in the same time bucket as the contractual profile does. This is based on the assumption that if a fixed loan is provided then the counter party will not pay it back early.

If I am in a liquidity crisis, can I call back loans made to local banks or banks with in group in other countries before their maturity?

Market Risks stress liquidity guidelines assumes that it is not possible to call in loans made to the Interbank market or Intragroup entities before their maturity. You are however allowed to include any Interbank or Intragroup loan that naturally matures during the specified days of the stress test.

Note: Intra-group deposits will also not be renewed at maturity unless a formal arrangement with the placing branch is in place.

In which time bucket should I place assets that have no precise contractual repayment maturity?

Assets that have no precise contractual repayment maturity or are “on demand” should be placed in the Call bucket. Examples of such assets include Overdrafts and Credit Cards.

In which time bucket should I place assets that have a fixed contractual repayment maturity?

Assets and Liabilities that have a fixed contractual repayment maturity should be placed in the time bucket that represents the time left to maturity(i.e. residual).

Example: Bank A provides a 6 month fixed loan to a customer. The asset should be placed in the 3m to 1 year time bucket when it is issued. In 4 months time, the same asset should be placed in the 1 to 3 month bucket because there are only two months left to the maturity of the asset.

Can I show early realisability of assets that have a contractual fixed maturity?

No, the forecast profile of a fixed loan should place the asset in the same time bucket as the contractual profile does. This is based on the assumption that if a fixed loan is provided to a corporate or personal customer then they will not pay it back early.

How do I forecast assets that have no contractual fixed maturity?

You can forecast assets that have no contractual fixed maturity (nostro, custodial and institutional balances, overdrafts and credit card outstanding) by calculating a Core balance and Volatile balance.

The following 5 steps are the suggested approach for estimating core balance for assets with no contractual fixed maturity. All the statistical measures can be calculated using Excel functions.

  1. Collect historical data: A minimum of 32 data points based on month end balances would be needed.
  2. Calculate the arithmetic mean
  3. Calculate the sample standard deviation
  4.  Obtain the core balance: Core Balance = Mean of Observed Balance – 1 x Standard Deviation. The core balance is then positioned as a medium term cash flow with maturity greater than 1 year (In the 1-5 year bucket).
  5.  Obtain the volatile component of the balance: Volatile Component = Last Observed Balance – Core Balance. The volatile balance is then divided by the number of working days in a month and positioned as a daily cash flow for each working day in the month (the volatile component can be placed in the earlier buckets and in amounts that best suit local patterns).

Note: In an ideal world a country would recalculate the core and volatile balance every month. However, if you cannot re-calculate the core balance each month therefore it is suggested that you calculate the balances for a particular month and turn that into a percent that can be used for the next 5 months.

Example: Bank A has a month end balance for Overdrafts of US $10 million. Their core balance is USD 6 million and their volatile balance is USD 4 million (using the method above). The next month the Bank assumes that 60% (6/10*100) of the month end balance will be core and 40% will be volatile and place the amounts accordingly. After 6 months the Bank recalculates the core balance in order to take account of changes in the behavior of their customers since the last time calculations were carried out. The above methodology is to be used where no alternative proxy is available.

What cash inflows am I allowed to include from Corporate and Personal assets?

As a general rule fixed loans maturing during the specified days of stress test should be included as a cash inflow. However if there are local circumstances that make this unrealistic (e.g. a significant number of the bank’s customers automatically roll over loans provided to them and therefore are not really capable of repaying the loans), the country should identify this and not include those loans into the stress test. No early recall of loans is assumed. At the same time inflows from assets that have no contractual repayment (Liquidity) like Overdrafts and Credit Card balances is prohibited because it is assumed that customers will not pay outstanding amounts back during a liquidity crisis.

What should go into the “other asset” category?

Essentially, no asset that has a customer as the counterparty should appear in the “other asset” column. Generally speaking “other assets” should account for less than 10% of your local balance sheet.

Note: Fixed assets e.g. Buildings etc have no maturity date should be placed in the long-term buckets as per banks accounting policy.

Is it OK for me to disclose bad and doubtful debts in other assets?

There are two types of bad and doubtful debts. Firstly, there are those that are recognized by the bank but no provisions have been made against them locally. In this situation one has to place the portion of the assets that are considered to be bad or doubtful in the longest tenor bucket on a separate line within the same balance sheet sub category.

Example: Bank A has 100 million of Personal overdrafts on their balance sheet. 20% of them are considered to be either bad or doubtful. The bank will show 80 million on one line titled “Overdrafts” in the call bucket and on an another line titled “Unrecognized Bad and Doubtful Debts” 20 million in their longest tenor.

Note: 20 million is not shown in other assets.

The second type of bad and doubtful debts is those that are recognized by the bank and provisions have been made against them locally. In this case (only this case) a separate line will show the amount of bad and doubtful debts in both the other asset side and the other liability side, as well as the interest in suspense in other liabilities.

Example: Bank A has 100 million of corporate overdrafts on their balance sheet. 20% of them are bad or doubtful that have been provided for locally. The bank will show 80 million in the call bucket and 20 million in the longest tenor and on a separate line under other assets. On the liability side two entries will be shown for the bad debt in the longest tenor. One will be the provision for bad and doubtful debts and the other will be interest in suspense shown in other liabilities.

Where banks Special Asset Management has forecasted a maturity profile for bad debts, they should be placed in the forecast and repricing profile according to the repayment and repricing schedule provided by them. They should remain in the 1-5 year bucket for contractual repayment.

How do I forecast Other Assets?

The forecast profile of other assets should place the asset in the same time bucket as the contractual profile does. This is based on the assumption that other assets (e.g. Buildings) are not liquid and therefore we will only see cash flow from the asset when it matures.

The bank has lots of fixed assets; can they be shown as a cash inflow during the stress test?

Usually other assets cannot be considered as cash inflow during the specified day stress test. Take fixed assets for example. The stress test is supposed to show positive cash flow during all specified days so that the bank can open for business on next day after the stress. However if the bank has had to sell it’s fixed assets (buildings, desks etc) to pass the stress test than there is no physical bank to open on day after the specified stress days because it’s buildings have been sold. Also as importantly most other assets are not liquid enough to be sold within specified stress days and therefore cannot be a source of cash inflow during the stress test.

How do I include Repo’s and Reverse Repo’s?

Due to different definitions of what constitutes a ‘Repurchase Agreement’ the treatment for Market Risk purposes is determined by the number of separate transactions involved. When a Repo or Reverse Repo is traded the purchase and sale of the instrument can be classed as one transaction or as two transactions.

  • A ‘One-transaction’ trade will contain a simultaneous Purchase and Sale trade under one contract which covers all trade details,
  • A ‘Two-Transaction’ Trade will involve completing a simultaneous Purchase and Sale trade, with separate documentation for each trade.


‘Repos’ are typically structured so that the asset title will only pass to the Buyer in the event of default of the seller, i.e. default on margin calls or final repayment. Therefore the Bond remains on the Balance Sheet of the ‘seller’ and only the cashflows arising due to the loan or deposit are shown.


Consider a 3 month Reverse Repo on a 5yr Bond (haircuts ignored, bond assumed to be trading at par)

Call 3m 5yr
Cash (100)
Advances under Reverse Repo 100
Impact on Net Mismatch (100) 100 0

Strictly speaking there is a Contingent Asset in the 5 yr. which would only occur in the event of default by the borrower on the principal due in 3m. However this is not noted in accounts, as a comparison this is similar to not showing the value of properties used as security for mortgages in Retail Balance Sheets

Example 2

Consider a 3 month Repo on a 5yr Bond (haircuts ignored, bond assumed to be trading at par)

Call 3m 5yr
Cash 100
Assets pledged as collateral under repo 100*
Liabilities arising under Repo (100)
Impact on Net Mismatch 100 (100) 0

*There is no impact of separately identifying the Assets pledged as collateral, however they should be listed separately so that they are not classed as ‘available’ for the purposes of market risks analysis such as Forecasts and Stress Liquidity.

Two Separate Transactions

This is the case where there are two separate transactions such as a buy/sell-back The Security is transferred to the purchaser’s balance sheet for the duration of the trade, with a contractual maturity reported as the residual maturity. This is consistent with an outright sale of the security.

The Cash Balance is reduced to finance the purchase of the security. The Net Mismatch would show a change in the profile relating to the increase or decrease in Marketable Assets.However, this does not reflect the true Balance Sheet profile in terms of Liquidity and ignores the expected tenor of the trade.

To provide a realistic picture, an entry on the Off Balance Sheet Forwards would show the reversal of the position in 3m, i.e. an adjustment to the cash position and an adjustment to the level of marketable assets. The adjusted mismatch of the Balance Sheet profile will then reflect the tenor of the trade.

Example 3

Consider a 3m Buy/Sell-back on a 5 yr .Bond (haircuts ignored, bond assumed to be trading at par)

Call 3m 5yr
Cash (100)
Marketable Assets subject to Forward Sale 100
Impact on Net Mismatch (100) 100
Off Balance Sheet
Forwards: Forward Sale of Assets under Repo 100 (100)
Impact on Adjusted Net Mismatch (100) 100 0

Placing the forward sale of the Bonds as an Off Balance Sheet Item is consistent with the current treatment of FX forwards.


Number of Transactions Typical Trade Type Treatment
One Classic Repo covered by an ISDA master agreement. Only the resulting loan or deposits is shown
Two Sell/Buy-Back Impact on Cash Balance is recorded. Underlying Security is shown on the Buyers Balance Sheet, the Forward Sale of the Security and resulting flow of cash is shown as an Off Balance Sheet Item

How do I include Repo’s and Reverse Repo’s in my Forecast and Stress?

The forecast of Repo’s and Reverse Repo’s should place the assets and liabilities in the same bucket as the contractual. You should also only show outflows or inflows from Repo’s and Reverse Repo’s if they naturally mature within the specified days of the stress test.

What liabilities should be considered as wholesale deposits?

All funds that meet one or more of the following conditions should be disclosed as wholesale deposits:

  1. The customer’s only Bank relationship is with Treasury.
  2. Pricing is at money market rates.
  3. The size is typical of money market transactions.

 Note: The “typical size” of a money market instrument will differ from country to country.

What types of liabilities are included in Interbank, Intragroup and Custodial and Institutional Liabilities?

Interbank liabilities should include all liabilities placed by another bank outside the group. This includes Vostro balances placed by banks outside the group. Intragroup is the same except it only includes entities within the group. Custodial and Institutional should include all balance accounts or operating accounts from 3rd party financial institutions.

If I am in a liquidity crisis, can I delay repaying wholesale deposits and other deposits obtained from local banks or my banks in other countries?

market risks stress liquidity guidelines assumes there will be no delay in repayment of deposits obtained from either the wholesale market, the Interbank market or Intragroup entities. However you are allowed to exclude any wholesale deposits, Interbank or Intragroup deposits that naturally matures outside the specified days of the stress test.

In which time bucket do I place liabilities that have no precise contractual repayment maturity?

See explanation in Corporate and Personal Assets. Examples of such liabilities include Current Accounts and Savings Accounts.

In which time bucket do I place liabilities that have a fixed contractual repayment maturity?

See explanation provided in Corporate and Personal Assets. Examples of such liabilities include fixed loans or certificate of deposits.

Can I show early repayment of liabilities that have a contractual fixed maturity?

See explanation provided in Corporate and Personal Assets.

How do I forecast liabilities that have no contractual fixed maturity?

See explanation in Corporate and Personal Assets. Examples of such liabilities include Vostro, Custodial and Institutional balances, Current Accounts and Savings Accounts.

What cash outflows do I have to show from Corporate and Personal deposits?

A country should only include those fixed deposits that naturally mature during the specified days of the stress test. For those deposits that have no fixed contractual repayment like current accounts, savings account etc you are to use assumptions of Market Risk and spread the outflows between specified stress days.

Example: 25% of total corporate current accounts will flow out of the bank within specified days.

Assume Bank A has 100 million of corporate current accounts on its balance sheet. It will show an outflow of 25 million between specified days.

Note: Countries are allowed to determine the portion of the 25% outflow that will leave on each individual day with in specified days. This can be based on banking conditions, past experience etc.

What should go into my other liability category?

 See explanation provided in Other Assets.

Is it OK for me to disclose bad and doubtful debts in other liabilities?

See explanation provided in Other Assets.

How do I forecast Other Liabilities?

See explanation in Other Assets.

Can other liabilities be shown as a cash outflow during the stress test?

See explanation in Other Assets.

How do I know when a liability is a commitment?

Generally according to bank’s Legal and Compliance department a liability should be considered a commitment when the bank has an “obligation to lend. That obligation can be conditional but if the conditions are capable of being fulfilled by a third party or we have to act reasonably (say the condition is that the borrower will provide us with a board resolution and all it has wrong with it, is a typographical error) we are Committed. On the other hand, if the documentation states that we have an absolute discretion as to whether or not to fund, then we do NOT have a Commitment.”

Therefore a commitment should be reported as such if the bank “has charged a fee or other wise has a legally binding contract”

Examples of liabilities that are commitments are undrawn Documentary Letters of Credit, unutilized overdraft and credit card limits.

Example: Bank A sets up a customer limit that allows the bank to issue LC’s up to the value of 100 million (essentially a credit limit). When a customer comes to the bank to ask for a LC, the bank still has an opportunity to deny the request for a LC. As a result establishing a limit does not create a commitment that will be shown on the off balance sheet section.

Once Bank A issues a LC on behalf of the customer is the bank committed to paying the exporter. Therefore only LC’s issued but not drawn upon are considered commitments.

Secondly when a LC is drawn and the bank pays funds to the exporter, the LC no longer exists and therefore is not a commitment. The only exposure Bank A has from the transaction is to the importer (especially if the importer has not paid funds to cover the LC amount). In that situation the exposure would be a corporate loan or Bills receivable.

My country deals only in Synthetic forwards, do I still need to show an off balance sheet position?

Yes, because in a synthetic forward the bank hedges the forward contract by taking local currency liabilities and converting them into foreign currency. The bank then deposits the foreign currency at another bank so that it can deliver the currency in the future. Although that creates an on balance sheet hedge you still have to show the position in the off balance sheet section because the bank has a contract to deliver another currency with the customer still outstanding.

I have tried to cover common questions on ALCO and Liquidity profiles in this post. Hope you found this post insightful. Please share your feedback and comments.


Stress Testing In Banks

Sources of Stress on Liquidity

The general sources of stress on liquidity in banks include:

  • Ratings downgrades or other negative news which could cause, among others, reduced market access to unsecured borrowings from interbank money markets;
  • a reduction or cancellation of inter-bank credit lines; a reduction of deposits; and adversely affecting a bank’s capability to securitize its assets;
  • Off-balance sheet banking products, that could give rise to sudden material demands for liquidity including committed lending facilities to customers, committed backstop facilities and committed back-up lines to special purpose vehicles; and
  • Sharp and unanticipated market movements or defaults that could cause demand for additional collateral or margin in connection with derivatives transactions.

While the origins of stresses could be several, the severity of such stress events on a bank is dependent on various factors that include:

  • Customer and market: characteristics of local markets, market participants and depositor base influences the amount and speed of withdrawals in response to a stress;
  • Payment systems & Branch Network: Ease of depositors to withdraw and move funds;
  • Depository Insurance: Existence of depository insurance or guarantee scheme can provide reassurance to depositors and reduce withdrawals;
  • Balance sheet structure including the dependence on volatile funding sources, such as wholesale funds and inter-bank funds;

Management of stresses can vary from country to country thus creating an asymmetric impact of a similar stress occurring simultaneously across the various countries in which the bank operates. Such variance in impact may also be influenced by practices of regulators who may infuse liquidity directly or allow a portion of liquid assets held as reserves with the Central Bank to be repo’d or realized to cover short term liquidity requirements.

Factors or Events That Trigger a Liquidity Stress

Generally banks categorise liquidity crises into those that are triggered by external factors and those triggered by internal factors. An internal factor is one that is specific to the bank, an external factor is an event or cause that results in a disruption to the markets in which the bank operates. These factors can originate at a Country level and at the Group level.
Examples of these factors or events are as below:





  • A significant political and financial disruption in any of the major countries that a bank operates.
  • Default of a large local borrower with exposures to several banks in the country
  • Localised events such as unusual withdrawals at the local branches caused by a rumour.


  • An emerging markets crisis affecting the particular market.
  • A political crisis affecting the markets in which bank operates.
  • A systemic crisis.
  • Two-notch downgrade in credit ratings.
  • The discovery of a major fraud in any part of the bank.
  • Involvement in potentially large litigation claims.
  • A major failure of strategy.

Name Specific Stress Test

It is generally a policy in a bank that each country with a branch or operating subsidiary must perform a name-specific liquidity risk stress test each business day. The name-specific stress calculates accelerated cash flows over an 3 to 10 calendar day period on a cumulative basis. The resulting stress liquidity exposure is reported each business day by each country. The rationale for the 3 to 10 day stress test is that survival is most critical during the first few days of a liquidity crisis and that if bank survives this period it is more likely able to survive a longer period of stress. It also takes into account the time needed for the communication efforts to fully restore calm across various stakeholders of bank and especially customers such that cash flows can return to normal levels and the Bank operates on a business as usual basis.

The following assumptions apply to the name-specific stress framework:

  • The stress scenario is temporary but it is a serious liquidity stress specifically affecting the bank;
  • The stress scenario is unforeseen;
  • The stress scenario may or may not be caused by well-founded concerns by creditors of the bank;
  • The stress scenario is acute and it therefore defines the largest deposit outflow that the bank would wish to, or is likely to be able to, withstand; and
  • The stress scenario is run at entity level, with no presumption of Group or extraordinary Central Bank support.

Deriving Outflow Parameters

Generally, when a bank suffers accelerated deposit withdrawal but survives, the extent of withdrawal is not made public. Where banks do not survive, there is usually some partial information about the extent of withdrawals. By calibrating the stress test to publicly available information, we effectively define the “tipping point” between survival and failure. Three to ten days are taken as the horizon: if withdrawals could not be halted within this time then survival is unlikely, while conversely, it is a sufficiently long test to enable the Group and/or regulators to act to determine survival. The quantification of cash flow acceleration in a name specific stress event is difficult due to the rarity of documented liquidity crisis events specific to a bank.

Daily Outflow Estimation

A key aspect in estimating daily cash flows in a liquidity crisis scenario is customer behaviour. Different customer segments receive and respond to information in different ways. The following are some key assumptions on influences on customer behaviour:

  • Withdrawal of liquidity is based on access to information;
  • Corporate customers access information quicker than retail customers;
  • Bank’s communications and related actions take time to be effective; and
  • Bank’s actions are effective from day 3 onward.

30 Days Market-Wide Stress Test

A bank performs a 30 day market-wide stress test. The stress test is performed in all countries and it is reported to and reviewed by the Country ALCO. There is an exception to this for countries where the local regulator prescribes a local market-wide stress test of similar duration which is reviewed regularly by ALCO.

Combined Stress

A bank should consider stress scenarios that are protracted and combinations of name-specific and market-wide events. To satisfy that requirement, the bank performs a combined stress test, called the Base Stress. The Base Stress is run at Group level only. It considers prolonged liquidity stresses which affect markets across a number of the bank’s main footprint countries and in which the Group itself comes under some sustained, “name-specific” pressure. This pressure may be unwarranted or may be because the Group is inextricably linked with those markets/countries, but a key factor is that there is simultaneous stress on bank’s name across key countries. The Base Stress is used to test, and attest to, the adequacy of the Group’s contingency funding arrangements beyond the marketable securities held to cover the acute 10-day name-specific stress. Unlike the 10-day stress, in which countries must be self-standing, this more prolonged stress enables us to examine the ability to support countries from elsewhere within the Group. The analysis is therefore appropriately managed at a Group, rather than individual country, level.

Reverse Stress Testing

A bank is required to carry out reverse stress testing, i.e. stress tests and scenario analyses that test the Group’s business plan to failure. Business plan failure is specifically defined in the context of reverse stress testing as being “the point at which the market loses confidence in a firm,” resulting in the firm being unable to carry out business activities. This point may be reached well before the firm’s financial resources are exhausted.

The key requirements of Reverse Stress Testing are:

  • The identification of events and circumstances that would cause the bank’s business model to become unviable and lead to the Group’s demise, and an assessment of the likelihood that the events could occur. The scenarios may include liquidity risk scenarios; and
  • To consider scenarios in which the failure of one or more of the bank’s major counterparties, or a significant market disruption arising from the failure of a major market participant, would cause the Group to fail.

Reverse stress testing is coordinated by Group Portfolio Risk with significant input from members of the Stress Testing Committee.

Stress Parameters for Balance Sheet Components

Based on an assessment of customer behaviour and observed periodic movements in major locations of the bank, the following are general stress parameters for balance sheet components.

Interbank Deposits, Commercial Paper and Certificate of Deposits:

External funding sources become less accessible or even inaccessible during a name specific liquidity event. Initially most banks would not provide new funding and be reluctant to rollover maturing deposits. As the liquidity stress scenario develops and facts emerge it is reasonable to expect some rollover of maturing interbank deposits.

Intragroup Funding

Countries need to demonstrate survival without recourse to intragroup funding. This means that new intragroup funding will not be permitted in the stress and that existing intragroup deposits are not rolled-over, i.e. the treatment is contractual not behavioural.There is the underlying assumption of symmetrical treatment – if country A cannot roll intragroup funding then by definition the lending country B will not be assumed to roll the intragroup loan.

Marketable Securities

Eligible marketable securities can be used taking into account settlement practices to make up any shortfall in the cash flows arising from the stress test but there may be restrictions due to local market conditions or local regulatory rules on repo and discount facilities. Such constraints include haircuts or discounts on prevailing market price for repos and for outright sales of marketable securities. The realizable amount for the purpose of stress liquidity is therefore reduced by the amount of applicable haircuts and any other restrictions that apply.

Custodial & Vostro Balances

Custodial and vostro balances are accumulated by FIs in the process of supporting customers’ clearing and custody requirements. Most of these accounts are wholesale in nature. During a liquidity stress scenario the customer’s desire to withdraw funds would be influenced by:

  • Availability of an alternative banking account relationship for clearing and settlement of securities; and
  • Time lags between funds being deposited and the completion of the clearing/settlement cycle.

The total outflow assumed for custodial and vostro balances is generally set conservatively at 75% to 80%, reflecting the relative ease in moving funds when compared to retail and corporate accounts.

Fixed term customer loans

Cash inflows follow the normal contractual repayment schedule. It is conceivable that for some corporate and SME customers, the bank is sole or dominant banker for trade finance.

Overdrafts/Credit Cards

No acceleration of repayments or drawdown is assumed.

Retail Current & Savings Accounts

Current and savings accounts are typically used for salary receipts, bill payments and periodic payment commitments. Customers are expected to keep these accounts operational. The balance per account tends to be small while the number of accounts is large. Typically such accounts have daily withdrawal limits.The liquidity stress scenario therefore assumes that retail current and savings account outflows will be around 20% by and large for the stress test period.

Corporate Current & Savings Accounts

The liquidity stress scenario assumes that corporate current and savings accounts outflows will be around 30% for the stress period. On the first day of stress scenario it will be 10% and the same will taper down gradually over stress period.A higher outflow % is applied to large Transaction Banking (TB) Current And Savings Account deposits defined as “Elephant” deposits.
An Elephant Client is any individual client whose balance has exceeded the country threshold in any single country/currency on any day.

Money Market Deposits Accounts (MMDA)

These accounts are typically used by Broker-Dealer to maintain their clients’ money as fiduciary and hence safety and security of deposits are their main priority. These accounts are non transactional in nature and can be withdrawn usually at short notice. The liquidity stress scenario assumes that MMDA outflows will be 100% spread across equally during stress period.

Fixed Deposits

Usually fixed deposits display a strong propensity to rollover. Many countries have an “auto-rollover” feature where the deposit automatically rolls for another term equal to that of the original tenor unless the customer instructs otherwise. For example, 80% of local currency retail fixed deposits in a country operate with the “auto rollover” feature. In liquidity stress scenario there will be a degree of rollover of retail and corporate fixed deposits due to customer inertia. During a liquidity stress scenario, customers may seek early uplift or withdrawal of fixed deposits prior to the actual maturity date. Contractually, early uplifts are normally permitted at the Bank’s discretion. In order not to exacerbate the stress situation, it may be in the interest of the Bank to allow early uplift. It is assumed that the country liquidity crisis management team will decide on early withdrawal based on the prevailing liquidity conditions.

Other Assets

Other non customer assets (fixed assets and receivables) cannot be considered as a cash inflow.

Commitments and Contingents

Commitments / contingents follow the same behaviour as under normal conditions and will be little affected by a name-specific liquidity stress. Committed funding lines or facilities received by bank are only recognised as an inflow if there is a good probability that the bank will be able to draw upon the line in the event of a stress.


Derivative contracts will normally follow their contractual cash flow. For derivatives that are subject to margin or collateral requirements there may be additional outflows to reflect incremental margin or collateral calls in the event of a ratings downgrade. A country will need to factor these into its stress test if the risk is considered material.

Intraday collateral

Where intraday collateral is required in order to facilitate payments, the cash or securities required to meet normal payments (business as usual) cannot be used to meet stress cash outflows, since there is an ongoing need to hold the collateral (it is effectively encumbered). This amount should be excluded from the stress tests.

Currency Convertibility During Stress

A bank is exposed to cross-currency liquidity risk. This risk arises if assets in one currency unexpectedly cannot be converted into another currency to meet cash outflows. This could arise if markets become very thin and the bank’s trade volumes are larger than the market will bear, or, where official restrictions are introduced. The currencies in which the bank is active have been analysed for convertibility according to the following criteria:

  1. Capital account convertibility. This indicates the extent of freedom (i.e. without permission of any regulatory authority) to convert local financial assets into foreign financial assets, and vice-versa, at market-determined rates of exchange.
  2. Debt serviceability. This considers the volume of refinancing, debt service and short-term debt rollovers in relation to FX reserves, the current account and GDP.
  3. Country credit rating. This uses the Bank’s internal credit ratings methodology.
  4. Central bank independence. This indicates the chance of precipitate action or unexpected market tightness arising from policy decisions.
  5. FX market access, depth and capability. This is an indicator of the likelihood of markets freezing in the event of some stress scenario.

This post will definitely give you a good understanding of stress scenarios and stress test. This again is a niche subject and a very complex concept. Hope you liked it. Looking forward for your feedback and suggestions.

A Bank’s Liquidity Policy – An Example

What is a Bank’s Liquidity Policy?

This policy states a Bank-wide (mentioned as Group) liquidity management structure that must be applied consistently in all centres, and includes clear accountabilities for managing liquidity both at the local and Group level. Generally It is the policy of a bank as a Group to maintain adequate liquidity at all times and hence to be in a position, in the normal course of business to meet all obligations, to repay depositors, to fulfil commitments to lend and to meet any other commitments a bank may have made.  Of critical importance is the need to avoid having to liquidate assets or to raise funds at unfavourable terms resulting in long term damage to the reputation of the Group. Prudent liquidity management is of paramount importance as the ultimate cost of a lack of liquidity is being out of business.

The policy seeks to ensure an adequate liquidity position by:

  • Controlling the Group’s dependence on wholesale deposits
  • Establishing an appropriate stock of marketable assets for use in a liquidity crisis
  • Ensuring that the Group’s balance sheet is not excessively weighted with illiquid assets
  • Monitoring the potential liquidity impact of off-balance sheet activity (e.g. foreign exchange and undrawn loan facilities)

Underpinning the Group liquidity policy is the clear principle that local management is directly responsible for liquidity management in each country.

General Policy Principles

In managing its liquidity, the Group has three sources of funding available: its natural cash flow; its stock of marketable assets; and its capacity to borrow additional funds from the wholesale market.  The analysis distinguishes between liquidity held to deal with normal conditions and additional liquidity held as a reserve for unforeseeable disruptions.  The underlying principles to be applied in the management of liquidity are given below.

Management of Liquidity

The overall Group principle is that the Chairman of the Country ALCO has responsibility for ensuring that Group policy for liquidity management is adhered to on a continual basis.  It is expected that each country will be self-sufficient in its funding operations, in addition to fully complying with local regulatory liquidity requirements.  Where a country is not self-sufficient, the local Treasurer should make appropriate arrangements, through the Regional Treasurer, for committed funding lines to be obtained from elsewhere in the Group. The Treasury operation in each country will be responsible for executing liquidity directives and operating within the liquidity policy.  The local ALCO is the forum for discussing liquidity matters.

Diversified Funding Base

Sound liquidity management requires that the sources of funds available within each local business entity are diversified.  Excessive concentration on either one deposit source or one narrow industry segment results in the operation being dependent on the financial condition of its limited depositors.  As one of its operating principles, each country must ensure that it has a diversified funding base, taking into account all available market opportunities.

Normal Business vs. Stressed Conditions

Liquidity profiles for each country must be prepared under assumptions based on a normal operating environment and also under stressed conditions.  The main difference between the two profiles is in the assumptions relating to the availability of wholesale deposits and the withdrawal of customer deposits.  Under stressed conditions, the sale of assets (potentially at distressed prices) may be necessary to sustain adequate cash flow.  The term “stress condition” is used in relation to a short-term crisis specific to the Group’s operation in a country.  The condition does not cover a general industry crisis in the country, as this type of environment invalidates the assumption made in respect of the ability to liquidate assets in an orderly market.

Contingency Plan

It is the intent of this liquidity policy to establish a process, which will prevent a crisis from ever occurring. It is, however, possible that despite all the prudential liquidity measures being in place, temporary pressures on liquidity may arise from unexpected developments, either internal or from external factors affecting the Group specifically or the financial markets as a whole. Each country must have a contingency plan in place that is subject to annual review by the Country Manager and the local ALCO.

Measurement and Control of Liquidity

The sources of liquidity available to the Group are its cash flow, its liquidity stock and its capacity to borrow additional funds from the wholesale market.  The monitoring system adopted incorporates each of these factors. Guidelines are proposed by the local Treasurer, in consultation with ALCO, and approved by Group Market Risk under delegated authority from GALCO.  The policy distinguishes between liquidity held to deal with normal conditions and additional liquidity held as a reserve for stress conditions.

Normal Business

Measurement of Cash Flow – Maximum Cumulative Outflow Guidelines

Under normal conditions, the day-to-day management of liquidity relies on the effective control of cash flow. Maximum cumulative outflow (MCO) guidelines control the net outflow over the following periods: overnight, one week and one month. The Treasury operation within each country will review its funding capabilities and recommend guidelines to Group Market Risk. These guidelines will be based on the estimated wholesale funding shortfall after calculating the forecast/contractual cash flow of the entity under normal business conditions.

The basis of cash flow measurement is to assume that funds are repaid on their contractual maturity date.  For wholesale funds, this is sufficient. However, it is not realistic to assume that retail business will behave in this manner.  In practice, current accounts and savings deposits are not withdrawn the next day and overdrafts are not repaid on demand.  Retail business can be expected to follow more or less predictable patterns being influenced by seasonal factors and other trends.  In monitoring liquidity, an estimate should be made of the expected change in such assets/liabilities with the resulting need for higher/lower funding from the wholesale market.  Whilst systems constraints will often impede frequent and timely updating of cash flow data relating to retail business, it is nevertheless important to include realistic estimates within the MCO data which Treasury use to manage the bank’s aggregate cash requirements.

The ability to raise cash by selling marketable assets may be factored into the MCO calculation but only to the extent that these assets are not already relied upon in order to meet internal or statutory reserve asset requirements.  The MCO guideline is a ‘business as usual’ measure, which implies that necessary reserve liquidity must be maintained at all times and so cannot be counted towards meeting the MCO requirement.Whilst it may not be possible to include specific figures within MCO controls, countries should also be aware of cash flows from settlement of foreign exchange transactions and of intra-day exposures arising from the operation of the daily clearing systems.

Wholesale Borrowing Guidelines

A further control in the management of liquidity is a set of guidelines placed on each country’s need to raise funds from the wholesale market.  This is the Group’s standard source of marginal funding.  However, it is also the most vulnerable given the large size of individual deposits and the relatively small number of potential counterparties.  To reduce the Group’s dependency on funds from the wholesale market, the local country ALCO should examine the funding products presently offered and consider whether other funding products may diversify/expand the Group’s funding base.

Wholesale borrowing includes intra-group funds. Guidelines will be established for the total level of borrowing as well as for intra-group borrowing.  Separate amounts may be established for local currency and foreign currency markets. The Group’s capacity to borrow from the external wholesale market depends on a number of factors: the size and turnover of the local market; our share of that market; the credit limits imposed by our counterparties, etc.  Given the various factors influencing the Group’s fund-raising from the wholesale market, it is not possible to be absolutely sure of our exact capacity.  In assessing guidelines, countries must demonstrate that the guidelines for wholesale market funding they propose have actually been attained and exceeded on a reasonable number of occasions.  This gives an acceptable degree of certainty that this wholesale borrowing level can be achieved again without causing any adverse market reaction.

Loan/Deposit Ratio

Each country must maintain a prudent loan to deposit ratio for both local currency and consolidated balance sheets unless otherwise agreed by Group Market Risk.  This is the ratio of Corporate and Personal loans to Corporate and Personal deposits


  • Capital may not be included, as part of the deposit base but will be taken into consideration in setting the guideline.
  • Wholesale (Corporate) deposits, defined as money market, price sensitive corporate deposits; repurchase agreements with corporates; and CDs issued, all usually professionally managed and placed direct with Treasury, should not be included in the deposit base for the purpose of calculating this ratio.
  • Only the core element of custodial deposits (as agreed by Group Market Risk) may be included as part of the deposit base.

This ratio identifies the extent to which an operation is able to fund its core assets from a sustainable deposit base.

Other Guidelines

Where appropriate, the reporting of the following statistics will be instituted.  The purpose of these ratios is to track trends that may highlight a change in the Group’s liquidity profile.


Banks’ liquidity is very much vulnerable to undrawn commitments. Undrawn commitments may be unutilised by not drawing an over draft limits of customers or any loan commitments. Customers have the right to ask for these funds at any point of time and the bank is obligated to pay the customers. Allowance should be made for potential drawings on committed lines within MCO and stress test calculations.  In addition, an undrawn commitment guideline may be established which relates the maximum level of undrawn commitments to the unit’s remaining unused wholesale borrowing capacity. These measures are to ensure that we ourselves are able to raise funds in order to meet customers’ demands for drawing on lines that we have granted to them.

Medium Term Funding:

Banks typically make money by running mis-matches, that is, borrowing short and lending long. However short term deposits may go out of the bank upon maturity, whereas a bank cannot call back long-term lendings. Thus a bank has to find the right combination for long-term mismatch. This ratio of liabilities with a contractual maturity of more than one year to assets with a contractual maturity of more than one year. This ratio is intended to highlight the extent to which we as a bank are dependent on being able to roll over short term deposits in order to fund medium term assets.

Swapped Funds:

A limit on the maximum amount (in absolute terms) that can be swapped from foreign currency liabilities in order to fund local currency assets, or, where appropriate, vice versa. The purpose of this measure is to prevent excessive dependence on the continued existence of an orderly foreign exchange market of sufficient depth to meet our funding needs.

Additional Liquidity

Stress Liquidity

The determination of the Group’s cash flow on a combined actuarial/contractual basis and the assessment of the capacity to borrow provide an efficient way of managing day to day liquidity under normal conditions.  The Group must, however, be in a position to ensure that its commitments are met even when some unforeseen event causes conditions to be far from normal.  For this reason, a stock of reserve liquidity must be maintained.  Items qualifying for the reserve liquidity portfolio will be limited to assets that can be refinanced with the local central bank or for which a liquid secondary market exists.  The reserve liquidity must be maintained during all normal conditions and liquidation is restricted to stress conditions.

Group Market Risk has guidelines for standard assumptions that can be adopted for call liabilities in a stress scenario.  These may be updated from time to time. The Group policy is to ensure that each country has sufficient funds available to survive a three to ten days liquidity crisis.  The three to ten day period represents the likely period needed to arrange both Group-wide and central bank support. Countries may, with the approval of Group Market Risk, make use of intragroup support lines in order to meet the stress test requirements.  Where such lines have been agreed, however, the centre providing the support must regard it as a deduction from its own three-day stress liquidity cash flow.

Liquidity Reporting

Treasury is to incorporate the liquidity policy into its daily operations and the local ALCO must review liquidity and compliance with policy as a standing agenda item.  A liquidity profile is to be submitted on a monthly basis to Group Market Risk. Failure to meet statutory and/or Group Liquidity requirements must be reported immediately to Group Market Risk and where appropriate to the local regulatory authorities.

I am sure by now you should have got a flavour of group liquidity policy in a bank. Please share your feedback and suggestions.

Liquidity Guidelines In Banks

What is Liquidity Policy

The banks Liquidity Policy establishes various ratios and guidelines that are to be used in the monitoring and management of liquidity.  A bank generally operates in markets subject to many different local conditions and it is inappropriate to set the levels of these guidelines identically for all countries.  There are various factors and measures taken into account by banks Market Risk Management in establishing appropriate levels.

There are two types of Liquidity measures:

  • Flow Approach: Uses maturity profiling for assessing the compliance of the measure
  • Stock Approach: Uses a predetermined formula to assess the compliance

Please refer the below image on Liquidity Risk Measures. I will briefly explain these measures now except the profiling which is discussed in my earlier post.

Liquidity Risk Measures

“Please note that the limits, cap and percentages in this post are given as an examples only. In real world these will be different for each bank as it depends on the banks geographical operations, business mix and several other factors. Therefore please do not assume that these are the rates, limits and percentages applicable across banking industry.”

Wholesale versus Retail

A distinction is made between countries that have a full retail operation and those that are predominantly wholesale. It is normally desirable for countries to develop a retail deposit base in order to provide a diversified source of funding.  There are, however, some countries where local regulation or market conditions mean that it is not appropriate for a bank to do so.

Local Currency versus Foreign Currency

In general, separate guidelines (at least for wholesale borrowing and loan/deposit ratio) will be set for local currency and foreign currency business. Consolidated guidelines may, however, be set where foreign currency business is immaterial.

Maximum Cumulative Outflows (MCO)

Under normal conditions, the day to day management of liquidity relies on the effective control of cash flow. MCO guidelines control the net outflow (inflow from asset minus outflow from liability) over the following time periods;

  • over night
  • one week and
  • one month.

The basis of cash flow measurement is to assume that funds are repaid on their contractual maturity date. For wholesale funds this is sufficient. However it is not realistic to assume that retail business will behave in this manner. In practice, current accounts and saving deposits will not be withdrawn the next day and over drafts are repaid on demand. This is a kind of liquidity ratio to measure and control a branch’s ability to meet cash obligations as they fall due under normal business conditions. The amounts raised by the unit from the wholesale markets over the previous twelve months should be analysed.  For each of the relevant time periods (overnight, one week, one month), the MCO limit should be set at a level that the unit has demonstrated that it can regularly achieve – for example, 90% of the maximum actually achieved in the previous year.


  • Indicates cash flows from On & Off Balance Sheet items under normal  conditions (Business As Usual).


  • Net Cash inflow/outflow from all On BS and Off BS items under normal conditions.
  • Cashflowsare measured against following time periods.
    • Overnight
    • Up to one week and
    • Up to one month


  • To control cash outflow during a period.

Wholesale Borrowing Guidelines

Wholesale borrowing includes interbank, intragroup and custodial funds and all other funds that meet one or more of the following conditions:

  • The customer’s only Bank relationship is with Treasury.
  • Pricing is at money market rates.
  • The size is typical of money market transactions.

Wholesale borrowing guidelines will be set as an absolute amount bearing in mind the depth of the local market and counterparties’ perceived credit appetite for the bank. The following ratios may be used for guidance as to an approximate level and also for purposes of establishing the appropriate level of approval authority.

Local Currency

Retail Countries: Wholesale borrowing should not exceed 15% of local currency liabilities. Wholesale Countries: Wholesale borrowing should not exceed 25% of local currency liabilities. For wholesale currencies with deep and liquid money markets, guidelines may be set at up to 75% of local currency liabilities

Foreign Currency

Wholesale borrowing should not exceed 50% of foreign currency liabilities. Exceptions may be considered where borrowing is primarily for tenors of three months or more and/or where the transactions causing the excess are matched or cash flow positive (i.e. the asset matures before the liability). Exceptions may also be considered for reserve currency intragroup funding.


  • Indicates the dependence on wholesale markets for funding.


  • This includes inter bank, custodial and Other funds from Corporate institutions.


  • To avoid overdependence on wholesale market and reduce  exposure to undue market and credit risk in those markets.

Loan / Deposit Ratio (LTD ratio)

The loans-to-deposits ratio is an indicator of bank’s ability to support loan growth with deposits. Deposits are the principal way banks, especially community banks, fund their loans and operations. Higher values for this ratio mean there are fewer remaining deposits to fund additional loans, implying lower liquidity.This tool receives the most attention while evaluating the liquidity of a bank. This ratio – a bank’s gross loans divided by total deposits – indicates the percentage of a banks loans funded through deposits. An upswing in the LTD may indicate that the bank has less of a cushion to fund its growth and to protect against a sudden recall of its funding, especially a bank that relies on deposits to fund growth.

This ratio identifies the extent to which an operation is able to fund its core assets from a sustainable base. Each country must maintain a prudent loan to deposit ratio. For countries that are not designated as wholesale, the loan/deposit ratio should be set no higher than its ‘natural’ level, i.e. the point where commercial and other internally generated sources of liabilities (including capital) are sufficient to support the level of commercial assets, after taking into account fixed assets, statutory reserves and other regulatory requirements.

As a simple example, consider the following balance sheet:


Personal & Corporate Loans

Statutory Reserves & Fixed Assets



Personal & Corporate Deposits




Interbank Raisings


In this case, the commercial and internally generated funds that are available for lending are the sum of Personal & Corporate Deposits and Capital less the required Statutory Reserves, which gives a figure of 75.  Expressing this as a percentage of Personal & Corporate Deposits gives (75/80) = 93.75% as the natural loan / deposit ratio. In the example, the country’s actual loan / deposit ratio is (85/80) = 106.25% indicating an excess over the natural ratio, the difference having been made up by interbank raisings.

Ratios that exceed the natural level may be permitted under the following circumstances:

  • On a temporary basis, for less than 6 months, where a clear rectification / exit plan is in place.
  • For local currency, where the transactions causing the excess are matched or cash flow positive (i.e. the asset matures before the liability).
  • For foreign currency, where intragroup funding is provided.
  • Where the country is designated as wholesale.


  • Highlights potential problems that could arise from dependence on volatile source of funds.


  • Ratio of Corporate and personal loans to corporate and personal deposits.


  • To identify the extent to which a bank is able to fund its core retail assets from a sustainable  deposit base.

Commitments Guideline

The level of undrawn commitments (which should be defined in the same way as is required for regulatory reporting) should not exceed a guideline which will be set as an absolute amount and should not exceed 200% of the average unused wholesale borrowing capacity over the previous twelve months.

For example, if a bank unit’s wholesale borrowing guideline is $200 and it has typically raised $170 in wholesale funds, its commitment guideline should not exceed $60. Higher guidelines may be considered where it can be shown that there are natural limitations on customers’ discretion to draw against committed lines.

In setting the guideline consideration may be given by Market Risk Management to a higher guideline by taking into account a unit’s access to additional  funds via realisation of surplus statutory holdings as well as any buffer that may exist between the natural loan deposit ratio and the loan deposit ratio guideline actually set.


  • Indicates the level of commitment to lend relative to the banks available source of funding.


  • The amount of undrawn commitment outstanding at any one time.


  • To be able to meet its commitment to customers and consequent potential drawings.

Medium Term Funding Ratio

The ratio of liabilities with a contractual maturity of more than one year to assets with a contractual maturity of more than one year should not be less than 20%. Exceptions may be made where there is an established consumer banking business that provides a stable retail deposit base or for balance sheets of less than USD 250m equivalent.


  • Indicates structural imbalances of funding long term assets with short term funds.


  • Ratio of Liabilities > 1 year to Assets > 1 year
  • The above can be arrived for both Contractual and Behavioural profile


  • To maintain adequate liquidity at all times.

Swapped Funds Guideline

A limit will be set on the amount of foreign currency liabilities that can be swapped through the foreign exchange market to fund local currency assets (or in some cases, vice-versa). This will be set as an absolute amount bearing in mind the depth of the local market and counterparties’ perceived credit appetite for the bank. For guidance as to an approximate level and also for purposes of establishing the appropriate level of approval authority, the ratio of (local currency assets minus local currency liabilities) to local currency assets should not be greater than +/- 25%.

Swapped Funds therefore includes both:


  • The swapping of foreign currency liabilities into local currency to fund local currency assets (“swapping in”); and
  • The swapping of local currency liabilities into foreign currencies to fund foreign currency assets (“swapping out”).


  • Indicates structural imbalances of funding local currency assets with foreign currency liabilities.


  • The amount that is transferred from foreign currency liabilities to fund local currency assets or vice versa.


  • To limit its dependence on foreign exchange market to a prudent level.

Stress Test

All countries are expected to show positive cash flow under stress assumptions over a three to ten days period.  This should be met on a cumulative basis for each of the three days, e.g. a net outflow on day 2 would be acceptable so long as it is less than the net inflow on day 1. The stress test position should be calculated daily, using estimated figures where necessary.


  • Indicates cash flows from On & Off Balance Sheet items under crisis situations.


  • Cash inflows are affected by asset prices and the ability to liquidate assets in an orderly manner.
  • Cash outflows are affected by acceleration of payments due to the withdrawal of deposits.


  • To ascertain potential impact and establish contingent plans to respond to crisis situations.

These are the general factors considered in liquidity policy of a bank. Please make sure that you read What? How? and Why? section of each factor for better understanding. In the next post I will share an how a bank group applies liquidity policy. Please let me know your feedback and suggestion.

Investment Policy – Goals and Elements

Importance of Investment Portfolio

The interest earned on the investment portfolio is often the second-largest revenue source for banks. In addition to an important revenue source, the investment portfolio serves as a secondary reserve to help banks meet liquidity needs. Further, it is used to meet pledging requirements against governmental deposits. Investments also provide banks with a useful way to diversify their asset base. The investment portfolio is a key revenue source and liquidity management tool for banks.

When loan demand is low, banks invest excess funds in securities to earn a return until demand improves. When that occurs, banks sell the securities they purchased to make loans. Because the investment portfolio plays a critical role in a bank’s success, its management at most banks is governed by policy. The foundation for sound management and administration of the investment portfolio is the investment policy. This policy represents the board of director’s guidance and direction to management regarding the bank’s investments. With boundaries set by policy, management devises the investment strategies to meet the bank’s needs.

Depending upon the bank, the investment policy may be part of the asset and liability management policy or integrated into other polices the bank feels appropriate. It is important to note that bank policies are often integrated with one another to ensure consistent risk management throughout the bank’s operations. For example, it wouldn’t be unusual for the loan policy to do any one of the following (each of these policy items reflect the terms on which loans are available to the bank’s customers, while also addressing the bank’s market risk exposure):

  • Specify a maximum term for which loans are made.
  • State the type of rate (variable or fixed) that will be offered on credit extended.
  • Require a prepayment penalty if a borrower repays a loan early.

Goals of the Investment Policy

Like all other policies of the bank, the investment policy is tailored to the special needs and conditions faced by the bank. Although its primary focus is guiding investment activities, it takes into account the multiple needs of the bank, providing for such matters as asset diversification, earnings and liquidity.

At a minimum, a complete investment policy often includes:

  • A statement of objectives. For example, provide earnings, liquidity, meet pledging requirements)
  • A listing of investments permitted and not permitted for the bank.
  • Diversification guidelines and concentration limits to avoid committing too much of the bank’s capital to a single issuer, industry group or geographical area.
  • Proper reporting of securities activities, making sure investments are appropriately categorized according to generally accepted accounting principles.
  • Maturity and repricing guidelines, setting out the maturity distribution of the bank’s investments, establishing interest rate terms (fixed or adjustable rate) and their appropriate use and setting out circumstances for selling specific maturities.
  • Limitations on quality ratings and the agency issuing the rating. The rating grade will determine which investments the bank can buy.
  • Valuation procedure and frequency—the method used to value securities and the frequency in which it must be done (monthly, quarterly, etc.). At a minimum, it most likely will be quarterly to meet financial reporting requirements to bank supervisors.
  • Officer’s authority and approval process—who has what authority to conduct business for the bank and what prior approvals they must have to exercise that authority.
  • Procedures covering policy exceptions—the process for handling exceptions and who approves policy exceptions. Most often it is the board that approves policy exceptions.
  • New product review – setting out when a review must be done, of what it must consist and documentation required to show the review was done.
  • Selection of securities dealers—listing of broker/dealers with whom the bank will do business, scrutinized for their reputation and financial standing.
  • Reporting requirements—reports and the frequency of those reports to the board on the bank’s security positions including information on such things as issues held, amount of each issue held, purchase price and current market price.
  • Periodic review—when the board should review the investment policy for its consistency with the board current tolerance for risk and evolving market conditions. Also, provides for the periodic independent review of the investment function for adherence to policy. The principal control tools for managing market risk are a bank’s policies.

Elements of an Investment Policy

At any bank, the investment policy is the primary policy tool for controlling the bank’s market risk in its securities portfolio. Like other bank policies, it sets out basic objectives to be accomplished by the policy. These objectives might be to minimize risk, provide a good return, provide ample liquidity and meet pledging requirements. It also covers basic matters relating to the bank’s investment securities, such as: Who is responsible for the various aspects of the securities portfolio?

For example, the board is ultimately responsible for establishing, reviewing and evaluating the investment policy. Management has responsibility for establishing policies, procedures and control systems to implement the board’s policy guidance related to the bank’s investments and for implementing systems to monitor policy adherence.

What …

  • Are acceptable and unacceptable investments?
  • Are unacceptable investment practices?
  • Are the limits on securities holdings from a single issuer?
  • Due diligence should be performed before making investments? (That is, what types of investments require analysis before purchase, what analysis is required, and what documentation is required?)
  • Due diligence should be performed on a broker-dealer with whom the bank does business (reputation, financial condition, etc.)?
  • Reports should be produced on the bank’s securities portfolio and its content?
  • Independent review should be undertaken of the adequacy of the bank’s policies, procedures and control systems that govern the bank’s investment activities?


  • Are investment transactions to be reviewed by the board?
  • Are the fair value of securities to be determined? (Probably at least quarterly to meet Call Report reporting requirements.)
  • Should due diligence be done on the bank’s broker/dealers?
  • Should the board review the investment policy to determine if it reflects the board’s current thinking about appropriate securities investments?

Many banks also have broader interest rate risk policies that address the measurement, management and control of market risk inherent in the entire balance sheet.

In addition to objectives and authorities, the interest rate risk policy typically addresses:

  • The type of risk measurement methodology to use (for instance, the Earnings At Risk (EAR) simulation, the Economic Value of Equity (EVE) simulation, Gap analysis).
  • Risk measurement metrics and explicit market risk limits.
  • Exception procedures and remedies.
  • Permissible hedging strategies and the use of derivatives.
  • Directives regarding broker-dealers.
  • Other aspects as needed.

I have covered the basics of investment policy in a bank with its goals and elements. Hope you got some insights. Please share your views and feedback.

Liquidity Policy – Goals and Elements

Goals of the Liquidity Policy

Policies on liquidity vary from bank to bank based on individual operating environments, customers and needs. Also, policies change over time as a bank’s situation and environment change.

Typically, liquidity policies will:

  • Set out goals or objectives to be accomplished. For example, that liquidity requirements are monitored and that expected and unanticipated funding needs are met on an ongoing basis at the least possible cost.
  • Coordinate decisions made within operating areas that affect a bank’s liquidity position and establish clear responsibility for decisions affecting liquidity.
  • Provide strategies for managing the bank’s liquidity position. Such as management of the bank’s investment portfolio and the potential for investments to provide it liquidity.
  • Set guidelines delineating appropriate levels of liquidity. Examples of some typical guidelines are:
  • A limit on the loan-to-deposit ratio.
  • A limit on the loan-to-capital ratio.
  • A general limit on the relationship between anticipated funding needs and available sources for meeting those needs. For example, the ratio of anticipated needs/primary sources shall not exceed ___ percent.
  • Primary sources for meeting funding needs. These would include core deposits (demand accounts, savings accounts) and noncore deposits (brokered deposits, large CDs) and other funding sources (federal home loan bank advances).
  • Flexible limits on the percentage reliance on a particular liability category. For example, negotiable certificates of deposit should not account for more than ___ percent of total liabilities.
  • Limits on the dependence on individual customers or market segments for funds.
  • Flexible limits on the minimum/maximum average maturity for different categories of liabilities. For example, the average maturity of negotiable certificates of deposit shall not be less than ___months.
  • Desired maturities for loans and investments.
  • Minimum liquidity provision to sustain operations while necessary longer-term adjustments are made.
  • Finally, liquidity policies often provide for handling policy exceptions, periodic evaluation of policy adequacy and policy review and approval, at least annually, by the board of directors or decision making authority in the bank .

Besides board-approved policies that address liquidity, it’s important that directors get reports at monthly board meetings on compliance with these policies. This ensures that you, as a director, are aware of your bank’s liquidity position and its consistency with policy. It’s also important that any review of reports and discussion of issues identified from them be duly recorded in the board’s minutes.

Elements of a Liquidity Policy

In skeletal form, a liquidity policy might include the following:


To fund assets and obligations as they become due in the most cost-effective way without unduly jeopardizing income potential.


Set out a line of responsibility, such as:

  • Who is responsible for daily implementation of the bank’s liquidity policies and procedures?
  • Who monitors the bank’s daily liquidity positions?
  • Who provides and receives reports on the bank’s liquidity positions?
  • Who establishes policies that guide operations?


Outline the rules, including:

  • What internal/external events will be considered for their impact on the bank’s liquidity?
  • What measures are used to judge liquidity and what are the limits on those measures?
  • What are acceptable and unacceptable liquidity sources for the bank?
  • What are appropriate uses of liquidity sources and limits on what those sources can be used to fund?
  • What contingency plans should the bank have in place in the event it loses its normal funding channels?
  • What should be done when there is an exception to the policy?
  • What reports should be generated to keep management and the board apprised of the bank’s liquidity position?


Detail time frames for tasks under the policy to be completed, such as:

  • When should management receive a report on the bank’s liquidity position?
  • When should internal/external events be reviewed for their bearing on the bank’s liquidity?
  • When should the board review the bank’s liquidity position?
  • When should the liquidity policy be reviewed by the board to ensure it reflects the board’s current risk tolerance and position on appropriate funding practices?
  • When should the bank’s liquidity-management strategies, processes, and procedures be subject to internal/external review to ensure that they are appropriate and in keeping with the bank’s current access to funding and liquidity needs?

Well I think this post is good as a reference point to broadly understand the goals and elements of Liquidity policy in a bank. Please share your views and feedback. you are also free to share this posts on social media and for your ease of sharing buttons are placed just below this post. keep sharing.

ALCO Report – Contents

Sources of Information

Transaction Processing (TP) systems

Transaction Processing (TP) systems capture detailed transactions of the bank. The Front Office team uses TP system. To meet the diverse products of the bank and to capture the transactions of each products, numerous TP systems are available. These TP systems are golden source for retrieving information at customer, product, function and geography level. The TP systems also have the maturity details and interest rate repricing details for most of the transactions which are useful for preparation of various balance sheet profiles of liquidity risk management and interest rate risk management.


Profiling is defined as breaking up of the assets and liability balances into various time buckets from the perspective of liquidity and interest risk management. The Data for profiling flows from TP systems since these systems capture the remaining maturity period, interest rates etc of all the balances. Depending on countries, these profiling data are obtained either through running queries directly on the TP system or using systems where report from various systems is pooled.

Example of Profiling (Figures in USDm)


2-7 days 8 d – 1 m 1-3 m 3m – 1 Y 1 – 5 Y Over 5 Y TOTAL





0 0 0 7 16 0 23

Marketable Assets


0 208 5 113 0 0 460

Inter Bank Placings


0 0 0 0 0 0 8

Intragroup Placings


13 467 43 23 35 -18 566

Corporate Assets


0 0 0 0 1 0 1

Personal Assets


0 0 0 0 0 0 8

Other Assets


13 674 48 143 52 -18 1065

Total Assets




0 -23 0 0 0 0 -88

Interbank Deposits


-29 -385 -41 -10 0 0 -466

Intragroup Deposits


0 0 0 0 0 0 -3

Custodial & Inst Balances


0 0 0 0 0 0 -26

Branch Network Corporate


0 0 0 0 0 0 -3

Branch Network Personal


0 0 0 0 0 0 -13

Other Liabilities


0 0 0 0 25 -59 -33

Capital & Reserves


-29 -408 -41 -10 25 -59 -633

Total Liabilities


-16 267 7 134 77 -76 433

Net Mismatch


25 292 299 432 509 433  

Cumulative Net Mismatch


Off Balance sheet


0 -42 -58 -19 -66 0 -214



0 -8 -36 -37 -27 0 -139



223 38 -139 69 -822 0 -722

Fwd FX & Int rate Contracts


222 -11 -233 12 -915 0 -1075

Total Off Balance


205 255 -226 146 -838 -76 -642

Adjusted Net Mismatch


97 353 126 273 -566 -642  

Adjusted Cumm Net Mismatch

Based on the above profiling Graphs are also presented in the ALCO pack.

For instance the graph attached below.

Profiling Graph

While profiling, all the accounts, except for few, in Trial Balance / Balance sheet is categorized into various buckets based on contractual/actuarial pattern. Hence the total of the assets as per the profiles should tie up with the TB / BS. The few exceptions mentioned above relate to accounts like Fixed Assets, accrual accounts etc for which there would be no profiling report generated. The profiling of such accounts is done based on assumptions in line with the banks Market Risk units Guidelines. The TP / systems would generate reports on remaining maturity & on repricing dates. However the Profiles that a bank need for liquidity management  are of three types:

  1. Liquidity Profiles – Contractual
  2. Liquidity Profiles – Actuarial
  3. Repricing Profiles

In order to compile the Liquidity Profiles – Contractual  & Repricing profiles  many banks have system reports. However for the Liquidity Profiles Actuarial the profiling is done based on banks Market Risk unit’s Guidelines.

Depositor Concentration

This is based on the idea of putting all the eggs in one basket. If the bank attracts High Net Worth customer who places huge fixed deposit with the bank, is it good news?

Its good from the point of view of business as the bank is expanding its deposit base. However from the risk perspective it is risky as a single depositor would constitutes a huge proportion of the total deposit. The risk would arise when this depositor decides to withdraw the deposits before the expiry of the contracted terms. The bank in its normal business practice would have deployed the deposits and this sudden demand on repayment would affect the bank.  The bank might be in a position to service this requirement but it would be at a cost. It might have to involve in distress selling of its assets or borrowing at a higher cost. Hence prudence suggests that deposits from customers over and above a threshold fixed by the Market Risk unit should be monitored so as to avoid any liquidity crunch. To facilitate this on a monthly basis the ALCO report highlights such deposits.

Group Market Risk Compliance

The bank as a group sets limits on various ratios, which act as MAT (Management Action Trigger) points. On a monthly basis compliance to these ratios need to be checked and any exceptions need to be highlighted. The Market Risk unit sets limits for Wholesale borrowing, Swap funding, Medium Term Funding ratio, Advance Deposit ratio etc.

Balance Sheet Forecast

A forecast of the Balance sheet is done on a monthly basis for the certain future time periods. The business and banks  central finance team would together forecast the numbers. Compliance with the limits for AD ratio, Wholesale borrowing limit, Swap Funds etc. is also checked. Incase the forecast breaches any of the guidelines then the forecast needs to be revised to ensure compliance with the Market Risk  Guidelines.


Reports are another important tool that banks use to manage their market risk. These reports are generated by models that banks run to assess their market risk. The information taken from these reports is a key input into decisions regarding how best to manage the bank’s potential risk exposure. Most reports pertaining to a bank’s market risk tend to be summaries. Don’t be fooled by this—a tremendous amount of complexity may lie beneath the surface. A lot of assumptions about interest rates, bank strategies, customer behavior, competitor response and a host of other factors are made to generate the simple line graphs and charts that portray the bank’s earnings and capital exposure to interest rate changes. As a result, the validity of what you see in the summaries you review depends upon the soundness of the assumptions made and their correspondence to what actually occurs. In light of the critical importance of assumptions, it is important that you know what they are.

To help you with this, it is helpful to have the key assumptions used in the model accompany the reports you receive. As you look over these assumptions, pay close attention to the treatment of nonmaturity deposits (deposits with no set maturity date), such as demand accounts, savings accounts, current accounts and money market accounts. Because these accounts make up a majority of most banks’ liabilities, the assumed behaviour of account holders to changes in interest rates can have a significant effect on the results you see. Also, pay particular attention to the interest rate changes that are modeled. The central banks suggest modeling a once-and-for-all 200 basis point (2 percentage point) rise and fall in interest rates. This rate bump will help reveal options risk in the portfolio. The central banks also recommend modeling a gradual rise and fall in rates. Besides considerations related to key assumptions, here are some additional matters to think about:

Report Frequency

Depends upon the bank’s potential earnings and capital exposure. At least quarterly if exposure is low to moderate, more frequently if exposure is high (for instance, if the bank would become undercapitalized if forecasted results were to occur).


Metrics chosen to track market risk exposure and the policy limits set for these metrics should appear on the report so that directors can compare where the bank stands with respect to limits.


Exposures that would cause the bank to become undercapitalized should be flagged on reports.

Managed response

Results of any actions taken to manage the bank’s market risk exposure should be highlighted to help bank’s management judge their effectiveness in minimizing the exposure.

Management Response

Once the extent of the bank’s exposure to market risk is known, the board must ask whether it wants to do anything about the exposure, and, if so, what action it should take. The bank’s current position may place it well within limits set by the board, so that no action needs to be taken. On the other hand, the bank may be within prescribed limits, but adverse trends in the bank’s market risk sensitivity might lead the board to take steps to reverse these trends. If the bank’s current position exceeds established limits or models forecast that limits will be breached, action may be required. If something is to be done, what actions should be taken? Should the bank change the mix of assets and liabilities to achieve an acceptable level of risk exposure? Should the bank use derivatives such as options, futures or swaps to reduce its risk? A derivative is a financial instrument whose characteristics and value depend upon the characteristics of an underlier, typically a commodity, bond, equity or currency. Advanced investors sometimes purchase or sell derivatives to manage the risk associated with the underlying security, to protect against fluctuations in value or to profit from periods of inactivity or decline. These techniques can be quite complicated and risky. In some instances, there may be factors that limit the actions a bank can take to manage its risk exposure.

For example, a bank might:

  • Be unable to take certain actions because it doesn’t have ready access to financial markets.
  • Not have sufficient time to implement an action.
  • Not have the expertise to utilize an action.
  • Find an action too costly to use.
  • Find that an action would have an adverse impact on its other risk exposures.

Historical Comparisons

With historical comparisons, you judge your bank’s current performance against that of its immediate past. When making historical comparisons, look for breaks in trends. These breaks may indicate a fundamental change in your bank’s performance. However, you must have several years of information to ascertain performance trends. Also, a break in a trend doesn’t necessarily mean a fundamental performance shift has occurred. It may simply mean your bank is taking advantage of a one-time favorable situation and that operating results will eventually return to their old level. If you have been attending board meetings, you should know whether or not a performance change is permanent or temporary.

Budget Comparisons

Comparing your bank’s current performance with its budget provides another perspective on its performance. The budget represents management’s plan for meeting future goals. When making budget comparisons, look for large deviations between actual and budgeted performance. These deviations can mean that your bank has its resources in the wrong places and may be increasing its risk exposure. For example, assume your bank has budgeted for no loan growth for the next calendar year, but after six months, loans grew by 50 percent. This unanticipated growth might adversely affect the bank’s asset quality. It might overwhelm the loan officers resulting in poor evaluations of loan proposals. It might also impact proper and timely completion of critical administrative tasks, such as lien filings, thereby exposing the bank to added loan losses in the event borrowers don’t pay.

Value At Risk

VARThis is a measure of the potential financial loss could occur to a trading portfolio due to the adverse movement in market factors during the time needed to liquidate or exiting the trading position. Its a technique to estimate the potential loss on a portfolio based on statistical distributions, standard deviation and confidence intervals. A one day 90% USD VAR of 5 Mn would mean that it can be expected to lose more than USD 5 Mn on one out of 10 trading days.

Peer Comparisons

With peer comparisons, your bank’s performance is measured against similar banks. A good report for making peer comparisons is the Uniform Bank Performance Report (UBPR). It is sometimes called the “U-beeper.” The report displays the impact management decisions and economic conditions have on a bank’s performance and balance sheet composition. The report also allows comparisons between banks.

So in summary following are the contents of an ALCO report:

  • Balance Sheets Profiles (Contractual and Actuarial Projections)
  • Liquidity Profile
  • Interest Rate Profiles
  • 3 to 10 Day Stress Test Compliance
  • Depositor Concentration
  • Group Market Risk Compliance Paper
  • Regulatory Compliance
  • Value at Risk Compliance
  • Economic Outlook
  • Competitors Information

Please note that this is a very high level coverage of broadly what an ALCO report contains. Hope you liked this post. Looking forward for your feedback and suggestions.