This study discusses issues in asset-liability management and elaborates on various categories

of risk that require to be managed. It examines strategies for asset-liability management from

the asset side as well as the liability side, particularly in the Indian context. Banks are always

aiming at maximizing profitability at the same time trying to ensure sufficient liquidity to

repose confidence in the minds of the depositors on their ability in servicing the deposits by

making timely payment of interest/returning them on due dates and meeting all other liability

commitments as agreed upon. To achieve these objectives, it is essential that banks have to

monitor, maintain and manage their assets and liabilities portfolios in a systematic manner

taking into account the various risks involved in these areas. This concept has gained

importance in Indian conditions in the wake of the ongoing financial sector reforms,

particularly reforms relating to interest rate deregulation. The technique of managing both

assets and liabilities together has come into being as a strategic response of banks to

inflationary pressure, volatility in interest rates and severe recessionary trends which marked

the global economy in the seventies and eighties.

The last decade has seen many positive developments in the Indian banking sector. The

policy makers, which comprise the Reserve Bank of India (RBI), Ministry of Finance and

related government and financial sector regulatory entities, have made several notable efforts

to improve regulation in the sector. The sector now compares favourably with banking

sectors in the region on metrics like growth, profitability and non-performing assets (NPAs).

A few banks have established an outstanding track record of innovation, growth and value

creation. This is reflected in their market valuation. However, improved regulations,

innovation, growth and value creation in the sector remain limited to a small part of it. The

cost of banking intermediation in India is higher and bank penetration is far lower than in

other markets. India’s banking industry must strengthen itself significantly if it has to support

the modern and vibrant economy which India aspires to be. While the onus for this change
lies mainly with bank managements, an enabling policy and regulatory framework will also

be critical to their success. The failure to respond to changing market realities has stunted the

development of the financial sector in many developing countries. A weak banking structure

has been unable to fuel continued growth, which has harmed the long-term health of their

economies. In this “white paper”, we emphasise the need to act both decisively addressed,

could seriously weaken the health of the sector. Further, the inability of bank managements

(with some notable exceptions) to improve capital allocation, increase the productivity of

their service platforms and improve the performance ethic in their organisations could

seriously affect future performance.

India’s Financial System: One of the major economic developments of this decade has been

the recent takeoff of India, with growth rates averaging in excess of 8% for the last four

years, a stock market that has risen over three-fold in as many years with a rising inflow of

foreign investment. In 2006, total equity issuance reached $19.2bn in India, up 22 per cent.

Merger and acquisition volume was a record $27.8bn, up 38 per cent, driven by a 371 percent

increase in outbound acquisitions exceeding for the first time inbound deal volumes. Debt

issuance reached an all-time high of $13.7bn, up 28 per cent from a year earlier. Indian

companies were also among the world's most active issuers of depositary receipts in the first

half of 2006, accounting for one in three new issues globally, according to the Bank of New

York. The questions and challenges that India faces in the first decade of the new millennium

are therefore fundamentally different from those that it has wrestled with for decades after

independence. Liberalization and globalization have breathed new life into the foreign

exchange markets while simultaneously besetting them with new challenges. Commodity

trading, particularly trade in commodity futures, have practically started from scratch to attain

scale and attention. The banking industry has moved from an era of rigid controls and

government interference to a more market-governed system. New private banks have made
their presence felt in a very strong way and several foreign banks have entered the country.

Over the years, microfinance has emerged as an important element of the Indian financial

system increasing its outreach and providing much-needed financial services to millions of

poor Indian households.