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ALCO CHALLENGE, USER MANUAL
by Y. F. BISSADA and J. DERMINE*
(In collaboration with E. Mercier)
INSEAD, FontainebleauVersion 2.5 - Basel III Compatible
*The authors acknowledge the insightful assistance of A. Khalil.INSEAD, Boulevard de Constance, F-77300 Fontainebleau, France
INSEAD, 1 Ayer Rajah Avenue, Singapore 138676(Tel. 33-1-60 72 41 33, Fax 33-1-60 72 40 45)
(E-Mail : [email protected])
ii
The ALCO Challenge created by INSEAD Professors Bissada and Dermine to integrate modern bankmanagement tools has been used by bankers, central bankers and consultants on five continents. It is an educationalcomputer package developed to meet the training needs of bankers -retail, corporate and treasury-, ALM specialistsand strategic planners. The current version is Basel II and III compatible.
In this joint project, the two professors combined their specific skills in research, teaching and developmentof business simulations to design this new and unique package. ALCO Challenge's uniqueness is linked to its :Learning Objectives, Concept, Teaching Methodology and Menu of Financial Instruments.
Learning Objectives for Bankers
The educational objectives of ALCO Challenge are fivefold.
Value creation in financial services. ALCO presents an integrated view of the links between product profitability,risk factors, recent Basel capital and liquidity regulations and stock market value of banks.
Strategic pricing. The competitive environment in which the simulation takes place leads to an in-depth analysisof market prospects, other teams' strategies and competitive positioning of the bank.
Risk Management. Modern risk management techniques will cover both credit, market and liquidity risks.
Negotiation. The pricing of Interest Rate Swaps and the Sale of Loans to other banks help develop the negotiationskills of participants.
Team work. The functioning of an Asset-Liability Committee (ALCO) involves the delegation of tasks, consensusbuilding, decision making, and negotiation with other teams.
Concept : Transparency and Accuracy
ALCO Challenge is not a black box but quite transparent. To help participants understand the outcome oftheir decisions, several control tools have been built in : audit reports on product profitability, a repricing bucket(domestic and forex), a liquidity gap report, a simulation model, and an economic value at risk report.
ALCO Challenge incorporates the latest financial techniques in profitability and risk management. It isentirely accurate, taking properly into account the effects of taxation and Basel II and III regulations.
Teaching Methodology
During the programme, participants will have the opportunity to actually manage a bank with the ALCOChallenge simulation. Grouped into syndicates representing the Asset & Liability Committee (ALCO) of a bank ,participants will have the opportunity to apply modern management tools to create shareholder value and managerisks ; they will face the tensions arising in any ALCO of a bank, the pressure in attempting to outperform theircolleagues, and sleepless nights as they await with anxiety the decision of the Central Bank.
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A computerized simulation represents the backbone of a course on Asset & Liability Management. Themain characteristics are :
USER-FRIENDLY : Although fully computerized, no previous computer experience or knowledge is required bythe participants.
MODULAR : A menu of different modules is available. It can be shortened or expanded to meet the pedagogicalobjectives of a tailor-made course.
FLEXIBLE : ALCO runs fully on PCs, i.e. the package can be used anywhere. It runs in different languages(English, French, Portuguese, Spanish, and Russian) and switches from one language to another instantaneously.ALCO Challenge operates under Windows.
EDUCATIONAL : An unlimited number of sensitivity analyses and tests of hypotheses can be run on the computer,allowing the participants to analyze and understand the effects of all their decisions.
Menu of Financial Instruments
The following financial instruments are available in the simulation. The menu can be shortened to meet thepedagogical objectives.
On-Balance Sheet Off-Balance Sheet
.Deposits .Interest Rate Futures .Loans .Interest Rate Options .Domestic Interbank .Swaps .Forex Interbank .Securitization .Securities .Subordinated Debt .Equity
The control tools incorporated in the simulation include :
.Audit Report for Value Centers (VCs) .Repricing Gap (Domestic and Foreign Currencies) .Liquidity Gap .Economic Value at Risk (duration) .Option simulation .Simulation of Balance Sheets for n-years .Simulation of Income Statements for n-years.
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The Authors
Youssef F. Bissada is Emeritus Professor of Entrepreneurship and Family Business at INSEAD where hehas been teaching and directing programs for 35 years. He is owner - president of Bissada ManagementSimulations, a company specialising in the development of computer-aided educational and strategic planningsoftware packages, as well as president of the academic council of the Euro-Arab Management School. ProfessorBissada works as a consultant for numerous universities, international organisations and corporations in Europe,Asia, Africa and the United States.
Jean Dermine is Professor of Banking and Finance at INSEAD, Fontainebleau. He spent more thantwenty-five years of research and consulting in the field of Asset & Liability Management (ALM). He has directed training programs for bankers and central bankers in Europe, Africa, Japan, South-East Asia, Australasia, NorthAmerica, Latin America and the Middle East. Jean Dermine has been Visiting Professor at the Wharton School ofthe University of Pennsylvania, at the Universities of Lausanne and Louvain, at CESAG in Dakar, at the Göteborgand Stockholm Schools of Economics, at the Luxembourg School of Finance, at the Swiss Finance Institute, anda Visiting Fellow at New York University Salomon Center. He is the founder of the INSEAD Center for InternationalFinancial Services (CIFS).
Jean Dermine and Y.F. Bissada are co-authors of the book “Asset & Liability Management, a Banker’s Guide to Value Creation and Risk Control”, Financial Times-Prentice Hall, London, 2nd edition, 2007 (with translation in Chinese, Portuguese-Braziland Spanish). This book provides a crystal-clear intuitive introduction to ALM.
A more advanced book by Jean Dermine, “Bank Valuation and Value-basedManagement (deposit and loan pricing, performance evaluation and riskmanagement)”, was published in 2015 (2nd edition, McGraw-Hill, NY, with translationin Chinese and Portugese-Brazil) . The first part of the book identifies the drivers ofthe market value of a bank. The second part builds on the bank valuation model todiscuss managerial decisions related to profit and risk control.
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CONTENTS
1. Introduction 1
2. The Environment Description of the Bank Regulatory Environment
22
3. The Role of Management Three Major Tasks Stock Market Valuation Menu
667
4. Pricing Pricing Retail Products Pricing Corporate Products
89
5. Funding
Estimating Volume The Interbank Market
Government Securities
Subordinated Debt
Equity and Dividends The Interest Rate Zoo
101011111112
6. Managing Interest Rate Risk, the Repricing Bucket
13
7. Off-Balance Sheet Management
Financial Futures Interest Rate Options Interest Rate Swaps Off-Balance Sheet and Interest Rate Risk
1414151516
8. Duration Analysis Simple Duration Advanced Duration
1718
9. Loan Sales Sale of Loans on the Open Market Loan Trading Between Banks
1919
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10. Foreign Interbank 21
11.The Simulation Model 22
12. Liquidity Risk The Simulated Balance Sheet The Cash Flow Schedule
2323
Appendix 1 : Decision Variables Appendix 2 : Operating Costs and RegulationsAppendix 3 : References
242628
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Welcome to ALCO Challenge
The purpose of the User Manual is to present the main characteristics of ALCO Challenge. The KISS (Keep It SoSimple) rule has been adopted. A detailed discussion of the tools and techniques will be provided during plenarysessions.
1. INTRODUCTION
Participants in the ALCO Challenge simulation are grouped into teams which represent the Asset &Liability Committee (ALCO) of a bank. Each team competes with the others on retail, corporate and treasury/capitalmarkets. They face economic risks as the pricing policies of other banks, the future level of interest rates, industrialgrowth, inflation and unemployment are uncertain. ALCO Challenge helps to understand and control the sourcesof profitability and risk of various on- and off-balance sheet activities.
At the beginning of each quarter, the team sets the interest rates on loans and deposits and selects an optimalasset-liability mix. Excess funds can be lent on the interbank market, invested in government securities, or used topurchase loans. A shortage of funds can be met by borrowing, selling loans, issuing subordinated debt, or raisingnew equity. Finally, the team takes actions to manage its liquidity, interest rate, and foreign exchange exposure bychoosing an appropriate maturity structure on-balance sheet or by using off-balance sheet tools such as financialfutures, options or swaps.
For efficient management, each member in the ALCO committee assumes one task such as loan and depositpricing, capital monitoring or risk management. The objective of the simulation is to increase long-term shareholder value, that is the market value per share plus any reinvested dividends.
The time sequence is as follows. At the beginning of the quarter, each team receives an economic scenario,a USB-key, and a printed output with the financial results of the previous quarter. After analysis of the results andthe strategies taken by other teams, the ALCO takes decisions to achieve a profitable growth while controlling therisks. Decisions are entered on the USB-key and returned to the administrator on time before the market closes. Aftercomputer processing, the results are returned to the teams.
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2. THE ENVIRONMENT
The banks conduct retail, corporate, and treasury/capital markets activities. They operate in a competitiveenvironment, taking decision at the beginning of each quarter. A description of the various banking activities,regulations, and structure of operating costs follows.
Description of the Banks
All banks start with an identical balance sheet. It consists of reserves with the central bank, consumer loans,corporate loans, interbank assets and fixed assets (building and equipment).The liability side consists of retaildeposits, corporate deposits, interbank deposits, subordinated debt and equity as shown below :
BALANCE SHEET (‘000)
ASSETS LIABILITY & EQUITY
Reserves with Central Bank Retail Deposits : Demand Deposits Consumer Loans Time Deposits Term deposits Corporate Loans Savings Bonds Industry A Fixed Rate Loans Corporate Deposits Industry A Floating Rate Loans Demand Deposits Industry B Floating Rate Loans Time Deposits Interbank (Domestic and Forex) Interbank (Domestic and Forex) Subordinated Debt : Fixed Rate Debt Government Securities Floating Rate Debt Equity : Fixed Assets Paid-in Capital Cumulative Retained Earnings
Assets
Reserves with Central Bank are adjusted automatically by the program. They carry no interest income and are afunction of the volume and mix of deposits. The reserve ratios are given in Appendix 2.
Consumer Loans allocated to each bank are a function of the interest rate set by the bank relative to the interestrates posted by its competitors. Additional factors include GNP growth and unemployment rate. Consumer loansare fixed rate assets with a maturity of 8 quarters.
Corporate Loans can be made to two industries, A and B. They have a maturity of 12 quarters and their terms canbe fixed or floating. The market is competitive as the market share of a bank depends on the relative pricing policies
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of the teams. The loan losses are related to the state of the industry and the level of interest rates relative to inflation.Information on credit risk (expected loss and unexpected loss) is available in the economic scenarios that will bedistributed to each team.
Interbank Assets. The banks have access to an interbank market managed by the computer. They can invest in 3,6 and 12 -month maturities. As explained below, the interbank plays a key role in balancing the balance sheet.Excess funds not allocated by management will be automatically invested in interbank assets. In reverse, a shortageof funds will be met automatically with interbank borrowing.
Government bonds. The risk free-government bond market is managed by the computer. Teams can buy or sellsecurities with maturities ranging from 1 to 12 quarters. They are booked in the accounts at 'face historical value'.A commission of 1 basis point (0.01 %) is paid by the banks upon the sale of securities.
Fixed Assets. The investment in fixed assets is done automatically by the programme. The net fixed assets areproportional to the volume of loans and deposits. The proportional factors are given in Appendix 2.
Liabilities
Retail and Corporate Deposits are offered in a competitive market. Retail demand, time and term deposits, andsaving bonds have as maturity 1,2, 4 and 12 quarters respectively. Corporate demand and time deposits have amaturity of 1 and 2 quarters respectively.
The Interbank Deposit market is managed by the computer. Banks can borrow up to 4 quarters maturity. Anyshortage of funds will be financed on the interbank market.
Fixed and Floating Rate Subordinated Debt of 12 quarter maturity can be issued or repurchased. The spread is75 basis points (bps) over the government security rate. As indicated below, they can be used to meet the Bank forInternational Settlements (BIS) capital adequacy ratio.
Equity Capital can be issued or repurchased at a price close to the current market price. Undistributed net incomewill increase the cumulative retained earnings.
Off-Balance Sheet
The off-balance sheet instruments include :
Financial Futures contracts on 3-month treasury bills with deliveries in 1, 2, or 3 quarters and a notional principalvalue of 10,000.
Financial Futures contracts on 12-quarter government bonds with a coupon of 8% per year, delivery in 1,2, or 3quarters, and a face value of 10,000.
European Call Options on 3-month treasury bills with delivery in 1 quarter and notional value of 10,000.
European Put Options on 3-month treasury bills with delivery in 1 quarter and notional value of 10,000.
Plain Vanilla Swaps of floating rate against fixed rate .
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An Income Statement will be calculated every quarter as follows :
The Income Statement
Interest Income : Consumer Loans Corporate Loans Interbank Assets Government SecuritiesInterest Expense : Retail Deposits Corporate Deposits Interbank Deposits Subordinated DebtOperating expenses : Commissions Salaries Loan Losses DepreciationOff-Balance sheet Income : Futures Options SwapsCapital gains or lossesForeign currency gains or losses Income TaxNet IncomeDividends
Regulatory Environment
Banks must obey three types of regulations. These pertain to reserves held with the Central Bank, capitaladequacy, and liquidity.
Reserve Requirements
The banks are required to maintain a fixed percentage of their deposits in a non-interest bearing account with theCentral Bank. The requirements are 12 % on demand deposits, 8 % on time deposits, 6 % on term deposits, and 2 % on savings bonds. Reserves with the Central Bank are adjusted automatically by the software.
Capital Requirements, Standardized and Internal Ratings-based (IRB) Approaches
The banks must obey the Bank for International Settlements regulations on bank capital (BIS Basel II or IIIratio).This calls for a minimum 8 % capital requirement on risk-adjusted assets.
The risk-weighted assets cover credit risk and operational risk. The risk-weighted assets for credit risk can be fixedwith one of the two methods. Under the standardized approach, the risk-weights are set by the central bank. Underthe internal ratings-based (IRB) approach, the risk-weight is set by the bank itself. The central bank will verify thatthe IRB capital allocation is satisfactory. The risk-weighted assets for operational risk is set according to the BasicIndicator Approach, discussed below.
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Standardized credit risk weight for on-Balance Sheet assets
Risk-weights BIS capital Cash and Reserves 0 % 0% Government Securities 0 % 0% Interbank Lending 20 % 1.6% Consumer Loans 75 % 6 % Corporate Loans 100 % 8 % Fixed Assets 100 % 8 %
Internal ratings-based approach for on-Balance Sheet assets
Under the internal ratings-based approach, the bank will set the BIS capital. The information will be entered in a sub-screen ‘BIS capital ratio’ in the ‘Balance Sheet’ screen.
The off-balance sheet derivative contracts will command zero capital requirement. Futures and options are tradedon organized exchange, while the swaps traded over-the-counter are fully collaterized Derivatives are market-to-market.
Basic Indicator Approach (BIA) for Operational Risk
Operational risk capital = 15% x gross income
Definition of BIS Capital
The capital defined by the BIS includes two parts : Tier 1Capital and Tier 2 Capital.
Tier 1 Capital (Core Capital ) consists of paid-in capital and cumulated retained earnings. Tier 2 Capital (Supplementary Capital) consists of :
a) unrealized gain or loss on securities subject to a 55 % discount b) subordinated debt (fixed or floating bonds) with a maturity over one year.
Tier 2 capital must be less than 100 % of Tier 1, and the subordinated debt portion is limited to 50 % of Tier 1.
ALCO is responsible for the capitalization of the bank. Once the deposits and loans are allocated to eachbank at the beginning of the quarter, the Central Bank will check that the BIS ratio is being met with appropriatecapital. If it is not, the Central Bank will force an equity issue at a price much below the current market price.
Liquidity Requirement
Each bank must meet the liquidity regulation enforced by the Central Bank. According to Basel III ruling,the banks will have to meet a Liquidity Coverage Ratio (LCR). Liquid assets must cover the one quarter-liquiditygap. Assets qualifying for the contingency liquidity buffer include government bonds. If the liquidity constraint isnot met, the Central Bank can force the bank to issue expensive long term bonds to improve its liquidity.
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Operating Costs
All banks in the simulation have an identical cost structure. This consists of variable operating costs, andbuilding and equipment costs. These costs are proportional to the volume of assets and deposits. However, thebuilding and equipment costs can take some time to adjust completely. The proportional factors are given inAppendix 2.
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3. THE ROLE OF MANAGEMENT
There are three major tasks to be achieved each quarter : Pricing deposits and loans ; management of thebalance sheet including the maturity structure of the securities, the level of capital and the sale of loans ; controllingthe risk exposure.
Three Major Tasks
The major issues related to each task are :
Pricing : -price sensitivity -cost allocation -reserve requirement -credit risk
Balance Sheet Management : -capital requirement -liquidity coverage ratio -tax management -loan sale Risk Management : -liquidity exposure -credit risk -interest rate exposure.
Warning ! As a rule of thumb, it is appropriate to take decisions in the following order : .Pricing Deposits and Loans .Balance Sheet Management .Risk Management.
Stock Market Valuation
Banks will be evaluated on the level of the share price plus any reinvested dividends. Additional criteria
of lesser importance will be the cumulative Economic Profit (EP) on the retail and corporate markets, and theaverage accounting rate of return on equity (ROE).
As is the case on any Stock Exchange, nobody has a perfect understanding of the valuation mechanism.However, it should be known that financial analysts in the ALCO Challenge world have detailed information on thebanks' balance sheet, so that they can compute the discounted value of present and future after-tax cash flows.
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The Menu
A menu of sub-screens will appear on the PC screen. The menu is divided into two parts. In the firstcolumn, these are the sub-screens in which decisions have to be entered (such as ‘retail market pricing’ or ‘corporatemarket pricing’), while the second and third columns include various control tools (such as forecasted ‘balancesheet’ and ‘income statement’ or ‘audit reports’ on products profitability).
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4. PRICING
Deposits and loans have to be priced in two market segments : Retail and Corporate.
Retail (Mass Market) Products
The spread on deposits should cover the operating expenses and the cost of the reserve requirements.Lending adds value when the loan rates cover the cost of funds, the operating expenses, and expected losses. The'Audit Report' screen on Retail Banking is a useful guide on costs and profitability.
Pricing Retail Products
The 'Retail Market Pricing' screen is used to price retail deposits and loans. The first two columns refer tothe previous quarter. The first column gives the risk-free government bond rate, while the second column gives theaverage rate set by the market. The last three columns refer to the current quarter and provide the risk-free rate, therate to be chosen by the bank, and the maximum flow of new loans the bank is willing to take during the quarter. Bydefault, the maximum of 999,999 implies that all new loan requests will be accepted.
PREVIOUS PERIOD CURRENT PERIOD
RETAIL MARKET RISK-FREE AVERAGE RISK-FREE RATE MAXIMUM
MASS MARKET
DEMAND DEPOSITS 8 % 3.2 % 8.00 % 3.20 %
TIME DEPOSITS 8 % 4.8 % 8.05 % 4.80 %
SAVINGS BONDS 8 % 7.2 % 8.45 % 7.65 %
CONSUMER LOANS 8 % 9.0 % 8.22 % 9.00 % 999999
PRIVATE BANKING
TERM DEPOSITS 8 % 6 % 8.14 % 6.14 %
The Retail Market Audit Report
An audit report is calculated for each product, as well as for the entire retail market segment. It providesinformation on the profitability of the products. The audit report is automatically updated with the new pricingdecisions. The spread on deposits is calculated on the revenue net of the reserve requirement.
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Corporate Market
Pricing Corporate Products
The 'Corporate Market Pricing' screen includes various information. The first two columns giveinformation about the previous quarter, the risk-free rate and the average loan rate charged by the market. The lastthree columns refer to the current quarter, providing the risk-free rate, the rate to be chosen by the bank, and themaximum flow of new loans the bank is willing to take during the quarter. By default, the maximum of 999,999implies that all new loan requests will be accepted. A full interest rate has to be entered, with one exception: forthe floating rate loans, one must enter the spread (which will be added to the 3-month Treasury Bill rate).
LAST PERIOD CURRENT PERIOD
CORPORATE MARKET RISK-FREE AVERAGE RISK-FREE RATE/SPREAD MAXIMUM
INDUSTRY A
DEMAND DEPOSITS 8 % 4.80 % 8.32 % 4.80 %
FIXED RATE LOANS 8 % 9.00 % 8.52 % 9.52 % 999999
FLOAT. RATE LOANS 1.00 % 1.00 % 999999
INDUSTRY B
TIME DEPOSITS 8 % 6.47 % 8.05 % 6.47 %
FLOAT. RATE LOANS 8 % 1.50 % 1.40 % 999999
The Corporate Market Audit Report
An audit report is available for each product as well as for the Corporate Market segment. It is updatedautomatically with the new rates.
Portfolio Structure
Detailed data on the maturity structure of the loan and deposit portfolios are available in the screen'Portfolio Structure'. The interest rate refers to the contractual rate on a loan, while the maturity is the remaining lifeof a specific tranche of loans made in the past.
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5. FUNDING
Estimating Volume
After pricing deposits and loans, management can estimate (forecast) the volume of deposits and loansexpected by the end of the quarter. These forecasts are entered in the 'Volume Forercast' screen. The simulated end-of-quarter results are automatically computed (balance sheet, income statement, audit reports...). The requiredamount of capital necessary to meet the BIS capital regulations is calculated, and the ALCO can start the fundingprocess.
Excess of cash can be invested on the interbank market or in government bonds. Shortage of cash can bemet with interbank borrowing, issue of subordinated debt, or equity issues.
Warning ! By default, any excess or shortage of funds will be dealt with on the interbank market.
The Interbank Market
The bank can borrow or lend in the interbank market for three maturities : 3, 6 and 12 months. The interestrate is equal to the risk-free rate plus a bid (0.125 %) or ask (0.25 %) spread.
Two procedures can be used. The automatic procedure allocates automatically the excess funds or deficitto the interbank market. The excess (deficit) of funds appear in the 'VOLUME COMPUTED' column. To let the team managethe maturity, a clearing priority can be set by management.
INTERBANK VOLUME DECIDEDASSET DEPOSIT
VOLUME COMPUTEDASSET DEPOSIT
THREE MONTHS 0 80.000 30.000 0
SIX MONTHS 0 0 0 0
ONE YEAR 0 0 0 0
CLEARING PRIORITY 1
Priority 0 or 1 : The funding is done to shorten the maturity of asset. Any excess of funds are invested inthe three month interbank market, while a shortage is met with a twelve month borrowing. This is the default prioritywhich is appropriate if rates are expected to go up.
Priority 2 : The excess or shortage is divided equally over the three maturities.
Priority 3 : The funding is done to lengthen the maturity of asset. Excess funds are invested in a one yearmaturity asset and any shortage of funds is borrowed from the three month interbank market. Such a procedure isappropriate if rates are expected to go down.
Besides the automatic clearing priority, management can take independent interbank borrowing or lendingdecisions.
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Constraint on interbank borrowing
The banks have a limited access to the interbank market. Liquid assets (government bonds) must covershort term funding needs.
Government Securities
Government securities of various maturities are issued every quarter with a fixed coupon equal to the goingmarket rate. Each security has a principal of €1,000. The team can decide to buy a new issue or can sell part of itsportfolio at the going market value. As the bonds are carried in the book at 'acquisition cost', a sale can trigger acapital gain or loss which will be taken to the income statement.
The 'Bond ' screen will allow each team to access the bonds market. It provides information about thenumber of bonds outstanding, the current yield curve, and market price of these securities. Warning ! Note that purchases have to be entered in positive units of 000's (50 if the intention is to book50,000), and sales in negative units of 000's.
Subordinated Debt
The subordinated debt are long term subordinated bonds. In case of bankruptcy, the holders of these bondswill be paid after all deposits have been reimbursed. As a consequence, the risk premium is higher than on interbankdeposits (0.75 % spread over the risk-free rate). Their main attraction is their long term maturity and the fact that,according to BIS regulations, they can be included in the Tier 2 capital when their effective maturity is over one year.
Two types of bonds can be issued in the 'Subordinated Debt' decision screen, fixed and floating rate. Both have aface value of 1,000 and can be repurchased at market value. The fixed rate note can be issued at face value with amaturity going from 1 to 12 quarters. The floating rate notes are issued with only one maturity, 12 quarters.
Warning ! Repurchases have to be entered in negative number of units of 000's, and issues in positivenumber of units of 000's (10 to issue 10,000).
Equity and Dividends
The bank can issue new shares to fund the growth of the bank and to meet the BIS requirement. The issueprice is slightly lower than the going market price. Alternatively, the bank can decide to reduce its equity either bypaying a dividend or by repurchasing shares from the market.
The decision screen 'Equity Decision' includes the number of shares outstanding (5000 at start),the latestmarket price per share (8 at start), and the reinvested dividend per share.
EQUITY
NUMBER OF SHARES OUTSTANDING 5,000
PRICE PER SHARE 10
EQUITY ISSUE (REPURCHASE) -10,000
DIVIDENDS
REINVESTED DIVIDENDS per SHARE
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To manage its capital position, the team can simulate the balance sheet at the end of the quarter. The'Volume Forecast' screen asks the volume of deposits and loans, and a balance sheet is then automatically computed,informing the management about the amount of capital available and the capital required to meet the regulations.
Warning ! Equity and dividends have to be entered in the full amount paid (-10,000 if the intentionis to repurchase an amount of €10,000).
The Interest Rate Zoo
There are three ways to define an interest rate. A 'coupon' rate refers to an interest rate on a security payinga coupon every quarter. Examples are interest rates on government securities or on subordinated bonds. A 'one-quarter forward' rate refers to a one-quarter maturity rate likely to be observed in the future. In ALCO Challenge,these forward rates are used to price financial futures and to simulate alternative interest rate scenarios. Finally, a'zero coupon' rate is the return on a security paying zero coupon and one single payment at maturity. Zero couponrates are used by the computer to evaluate the various securities. The relationship between these three interest rates-coupon, forward and zero coupon- is available in the screen 'Yield Curve'.
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6. MANAGING INTEREST RATE RISK,THE REPRICING BUCKET
Three tools have been provided to evaluate and control the interest rate exposure of the bank : a RepricingBucket (maturity ladder), an economic value at risk (duration-based) report, and a 12-quarter simulationmodel.The first of these tools will be introduced in this section.
A repricing bucket provides information about the time of repricing of all assets and liabilities. It helps toanswer a simple question : if interest rates go up (or down), when will the interest revenue or cost be affected ?
The repricing bucket shows, for every quarter, the difference between the assets to be repriced and theliabilities to be repriced :
REPRICING BUCKET
PERIOD 1 2 3 4+ 8+ 12+
ASSET (000) 489 59 58 218 272 10 0 1106
RESERVES 60 0 0 0 0 0 0 68
CONSUMER LOANS 22 22 21 81 19 0 0 165
CORPORATE LOANS :
IND.A FIXED RATE 13 12 12 47 43 10 0 138
IND.A FLOAT. RATE 102 0 0 0 0 0 0 102
IND.B FLOAT. RATE 102 0 0 0 0 0 0 102
INTERBANK 155 20 20 2.00 0 0 0 195
SECURITIES 5 5 5 70 210 0 0 295
FIXED ASSETS 22 22
FUTURES 0 0 0 0 0 0 0 0
SWAPS 0 0 0 0 0 0 0 0
LIABILITIES (000) 646 189 37 67 89 8 0 1036
RETAIL DEPOSITS :
DEMAND DEPOSITS 151 0 0 0 0 0 0 151
TIME DEPOSITS 77 76 0 0 0 0 0 153
TERM DEPOSITS 27 26 26 25 0 0 0 104
SAVINGS BONDS 10 10 10 38 35 8 0 112
CORPORATE DEPOSITS :
DEMAND DEPOSITS 151 0 0 0 0 0 0 151
TERM DEPOSITS 77 76 0 0 0 0 0 153
INTERBANK 0 0 0 0 0 0 0 0
SUBORDINATED BONDS :
FIXED RATE 1 1 1 4 54 0 0 61
FLOATING RATE 102 0 0 0 0 0 0 102
EQUITY 50 0 0 0 0 0 50
FUTURES 0 0 0 0 0 0 0 0
SWAPS 0 0 0 0 0 0 0 0
ASSET-LIABILITY (GAP) -157 -130 21 151 183 2 0
CUMULATIVE BUCKET -157 -287 -266 -115 68 70 70
A negative gap at the end of the first quarter means that there is an excess of liabilities to be repricedrelative to assets, so that the interest margin would improve if interest rates go down, but would decrease if rates goup. It will be the task of management to evaluate the exposure of the bank, to assess interest rate expectations, andto take a reasonable and educated position (something non-bankers would call a speculative gamble).
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7. OFF-BALANCE SHEET MANAGEMENT
The banks can use three types of off-balance sheet instruments : Interest Rate Financial Futures, InterestRate Options, or Swaps. A decision screen 'Derivatives' allows to enter the decisions. Financial futures and optionscan be bought or sold on a market managed by the computer. Swaps have to be negotiated with another team.
Financial Futures
A Financial Future contract is an obligation to buy or sell a financial instrument at an agreed upon date (thedelivery date), at a predetermined price.
Two types of financial future contract are available in ALCO Challenge : a 3-Month T-Bill contract witha notional value of 10,000 per contract and a 3-Year Bond contract with notional value of 10,000 and quarterlycoupon of 8 %. There are three delivery dates : 3, 6 or 9 months.
Interest Rate Futures can be used to hedge an exposure or to take a position. A 'buy' contract is equivalentto a 'long' position, so that a gain (loss) is incurred when interest rates drop (rise). A 'sell' contract is equivalent toa 'short' position, so that a gain (loss) is incurred when interest rates rise (drop). The accounting for Interest RateFuture follows the practice of marking-to-market, that is the gains and losses are realized immediately.
To take a decision, the team must enter the number of contracts it wants to buy (positive number) or sell(negative number) in the appropriate delivery line. The prices are set by the computer, in line with the current termstructure of interest rates.
FINANCIAL FUTURES : 3-MONTH TREASURY BILL
DELIVERY POSITION PRICE NUMBER OF CONTRACTS (+/-)
THREE MONTHS 0 9016 -1
SIX MONTHS 0 9016 3
NINE MONTHS 0 9016 2
FINANCIAL FUTURES : 3-YEAR, 8 %, Govt BOND
DELIVERY POSITION PRICE NUMBER OF CONTRACTS (+/-)
THREE MONTHS 0 9100 3
SIX MONTHS 0 9150 -2
NINE MONTHS 0 9170 3
At the end of each quarter, the contracts are marked- to- market. The difference between the contract priceat the beginning and at the end of the quarter is taken to the income statement. A bank can close its current positionby taking a reversed position (f.i. selling a contract if it has a long 'buy' position).
Warning ! The team must enter the number of contracts it wants to buy or sell. Each contract refersto a financial asset with a notional value of 10,000.
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Interest Rate Options
A Call option is a right to buy a financial asset at a certain delivery date in the future, at an exercise (orstrike) price fixed today. A Put Option is a right to sell a financial asset at certain delivery date, at an exercise orstrike price fixed today.
The bank can buy or write Call and Put options on a 3-Month Treasury Bill with a notional value of 10,000.This is a European-type option with delivery in one quarter. Buying an option means that you own the right (to buyor sell), while writing the option means that you issue the option and sell it for a price (the premium) to acounterparty.
The 'Option' screen is used to take the decision. The number of contracts and the exercise price have to beentered. The computer computes the premium charged for each option contract.
INTEREST RATE OPTIONS : 3-MONTH T-BILL
PUT NUMBERBUY (+), WRITE (-)
EXERCISE PRICE PREMIUMper CONTRACT
5 9100 12.44
3 9200 31.08
CALL NUMBERBUY (+), WRITE (-)
EXERCISE PRICE PREMIUMper CONTRACT
5 9000 62.93
4 9200 32.55
Warning ! The team must enter the number of contracts it wants to buy or sell. Each option contractrefers to a notional principal of 10,000.
You can visualize your option position by clicking on the graph.
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Interest Rate Swaps
The banks can swap interest rates between each other. They make the agreement whereby one bank agreesto pay a fixed interest rate to the other, while the other agrees to pay the floating rate to the first one. The notionalamount of the contract and its maturity have to be agreed upon. At the end of quarter, the difference between the tworates is paid or received.
The decision screen 'Swaps' is used to enter the decisions. Each bank must enter whether it is paying orreceiving the fixed rate, the maturity, the amount, the fixed rate, and the name of the counterparty. The usual practiceis to negotiate the fixed rate, while setting at zero the margin on the floating rate (that is, one is exchanging a fixedrate against the current Treasury bill rate).
At the clearing, the terms of the swaps entered by the two counterparties will be checked automatically. If they do not match, the swaps will be cancelled.
INTEREST RATE SWAPS
Counterparty A1
Your bank is Paying (receiving) fixed
Notional amount 100,000
Maturity (quarters) 4
Fixed rate 12.5%
Off-Balance Sheet and Interest Rate Risk
The interest rate risk arising out of off-balance sheet positions on financial futures and swaps is taken intoaccount in the repricing bucket, so that the bottom line gives an overall view of interest rate risk, including financialfutures and swaps.
The option position is not included in the repricing bucket and must be monitored separately. The YieldCurve' screen allows to change the forecasts of the forward interest rates and to test the effects of an off-balance sheetposition on the forecasted 'Income Statement' screen.
Warning! The option position is not included in the repricing bucket and must be monitored separately.
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8. ECONOMIC VALUE at RISK (DURATION ANALYSIS)
Duration
Duration gap analysis is a second method to analyse the interest rate exposure of a bank. While repricingbuckets are concerned with the change in future interest margins, duration is concerned with the change in theeconomic value (EV) of the bank. The duration of an asset gives a measure of its price sensitivity for a one percentinterest rate change. The weighted average duration of all assets gives the price sensitivity of the value of all assets.The weighted average duration of liabilities gives the price sensitivity of all liabilities. Finally, the duration gap (thedifference between the duration of assets and liabilities) gives a measure of the sensitivity of the economic value(EV) of a bank for a one percent interest rate change.
In ALCO Challenge, the durations are computed on an after- tax basis. The 'GAP' line gives the duration gapposition on-balance sheet. The 'AFTER FUTURES and SWAPS' line gives the net position on- and off-balance sheet.
DURATION GAP DURATION * LIQUIDATION VALUE **
RESERVES 1.00 66544
CONSUMER LOANS 4.30 145332
CORPORATE LOANS :
IND. A FIXED RATE 6.06 114545
IND. A FLOATING RATE 1.37 95830
IND. B FLOATING RATE 1.37 95830
INTERBANK 1.30 190217
SECURITIES 8.43 234193
FIXED ASSETS 1.00 21284
OTHERS 1.00 12000
TOTAL ASSETS 4.04 963775
RETAIL DEPOSITS :
DEMAND DEPOSITS 1.00 147782
TIME DEPOSITS 1.49 148495
TERM DEPOSITS 2.45 97847
SAVINGS BONDS 4.07 96285
CORPORATE DEPOSITS :
DEMAND DEPOSITS 1.00 148550
TERM DEPOSITS 1.49 147967
INTERBANK 0
SUBORDINATED BONDS : 9.68 46999
FIXED RATE 2.01 95259
FLOATING RATE 2.28 927691
TOTAL LIABILITIES 1.76
GAP 1.76
AFTER FUTURES AND SWAPS
EQUITY at RISK (%) - 2%
* The duration is expressed in quarter.** The liquidation value is the discounted cash flows of the asset.
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YIELD CURVE TWIST
PERIOD ELASTICITY
2 1.0 3 1.0 4 0.9 8 0.7 12 0.5 16 0.4
A useful interpretation of the duration gap is as follows. The estimated percentage change in the economic fair value (EV) of the bank ()EV/EV = Equity at Risk) is given by the following relation :
∆∆
EV
EV
Assets
EVx Du
D
AxDu x
Rx RA d= − −
+1
1
Warning ! !!!! Since the durations are expressed in quarters in the table, one needs to enter quarterly rate change in the above formula. The Equity at Risk shows the percentage change in the economic value of equity for an annual rate change of one percent. !!!! As was the case with the repricing bucket, the option position has to be monitored separately.
Advanced Duration
Theabove measure of duration gives a good measure of interest raterisk when all interest rates in the yield curve move in parallel. If thisis not the case, the duration gap could be a misleading indicator. Toassess the impact of non-parallel shifts in the yield curve, one cancompute an 'advanced' measure of duration. To obtain these morerefined measures of risk, the bank will use the 'Yield Curve Twist'screen located in 'EV Duration'. The information to enter is the ratiosof changes of various long term interest rates to the one-quarter spotrate .The duration gap will be automatically adjusted to take intoaccount the non-parallel shift.
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9. LOAN SALES
ALCO Challenge allows the banks to sell part of their loans in two ways : on the open market (to thecomputer) or to an other bank. The sale of loans does not affect the bank ability to expand its loan portfolio duringthe following quarters.
Sale of Loans on the Open Market
Banks are allowed to sell their corporate floating rate loans on the open market. The price set by thecomputer reflects the profitability of the loans and the market opportunity rates. In the 'Securitization' screen, eachdecision refers to a specific tranche of loans, that is a loan with a specific maturity. Detailed information about theloan portfolio structure is found in the screen 'Portfolio structure'.
The bank enters the following information : the type of loans (Industry A or Industry B),the maturity of thespecific tranche, the face value to sell. The price at which the market is willing to buy back the loans is computedautomatically.
'OPENMARKET' SALE
CONTRACT TYPE MATURITY PRINCIPAL PRICE
1 Industry A 4 5000 4950
2 0 0 0 0
3 0 0 0 0
4 0 0 0 0
5 0 0 0 0
The difference between the market price and the book value is taken immediately to the income statementas a capital gain or loss on loan sale.
Loan Trading Between Banks
Banks can trade consumer loans and fixed rate loans between each other at an agreed upon price .Eachcontract refers to a specific maturity tranche.
The bank selling the loan enters the following information : the type of loan (consumer or industry), thenumber of the counterparty buying the loan, the specific maturity, the negative of the face value of the loan (-6000,if the bank is selling 6000 of face value), the selling price and the contractual interest rate charged on the loan. Theinformation about the loan portfolio structure is available in the 'portfolio structure' screen. The difference betweenthe price and the book value is taken immediately to the income statement as a capital gain or loss on loan sale.
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The bank buying the loan enters the following information : the type of loan (1=consumer or 2=industry),the number of the counterparty selling the loan, the maturity, the face value (6000 if the intention is to buy 6000 offace value), the price, and the contractual interest rate.
LOAN TRANSACTIONS BETWEEN BANKS
CONTRACT TYPE BANK MATURITY PRINCIPAL PRICE INTEREST
1 1 2 4 5000 4900 9.00 %
2 2 2 8 -6000 5900 9.50 %
TYPE 1 : CONSUMER LOANS
TYPE 2 : INDUSTRY A FIXED RATE
Warning ! Make sure to read the above information before entering the data for the sale of loans.
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10. FOREIGN INTERBANK
The 'Foreign Interbank' screen allows the teams to take interbank positions denominated in a foreigncurrency. Interbank assets of one- and two-quarter maturity are available. The decisions have to be entered as theamount of domestic currency to be invested or borrowed. The foreign asset yield curve is available in the screen'Forex ', while the forward rates are given in the economic bulletin.
The accounting rule works as follows. The realized foreign exchange gains/losses on assets or liablitiesare taken directly to the income statement, while an unrealized gain/loss is taken into account in a forex reserves inthe balance sheet. The screen sensitivity analysis allows to test the sensitivity of income to a change in the foreignexchange rate.
The management of multi-currency interest rate risk is dealt with an expanded repricing bucket and aduration gap table. The repricing bucket shows for every quarter the difference between the assets to be repriced andthe liabilities to be repriced :
REPRICING BUCKET
PERIOD 1 2 3 4+ 8+ 12+
ASSET (000) 489 59 58 218 272 10 0 1106
RESERVES 60 0 0 0 0 0 0 68
CONSUMER LOANS 22 22 21 81 19 0 0 165
CORPORATE LOANS :
IND.A FIXED RATE 13 12 12 47 43 10 0 138
--- --- --- --- --- --- --- --- ---
SECURITIES 5 5 5 70 210 0 0 295
FIXED ASSETS 22 22
FUTURES 0 0 0 0 0 0 0 0
LIABILITIES (000) 646 189 37 67 89 8 0 1036
RETAIL DEPOSITS :
DEMAND DEPOSITS 151 0 0 0 0 0 0 151
TIME DEPOSITS 77 76 0 0 0 0 0 153
CORPORATE DEPOSITS :
DEMAND DEPOSITS 151 0 0 0 0 0 0 151
INTERBANK 0 0 0 0 0 0 0 0
SUBORDINATED BONDS :
FIXED RATE 1 1 1 4 54 0 0 61
FLOATING RATE 102 0 0 0 0 0 0 102
EQUITY 50 0 0 0 0 0 50
FUTURES 0 0 0 0 0 0 0 0
SWAPS 0 0 0 0 0 0 0 0
ASSET-LIABILITY (GAP) -157 -130 21 151 183 2 0
CUMULATIVE BUCKET -157 -287 -266 -115 68 70 70
FOREX ASSET 10 15 25
FOREX LIABILITY 15 10 25
FOREX BUCKET -5 5
FOREX CUMUL. BUCKET -5 0
OVERALL BUCKET -162 -125
OVERALL CUMUL. BUCKET -162 -287 -266 -115 68 70 70
Warning ! The decisions have to be entered as the amount of domestic currency to be invested or borrowed.
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11. THE SIMULATION MODEL
The simulation model incorporated in ALCO Challenge allows to control the growth, profitability, andinterest rate risk of the bank over twelve quarters in the future. It works in two steps. In the first, the bank ALCOenters information about the likely growth of accounts over the next twelve quarters, their profitability and the likelyscenarios of one-quarter forward rates in the 'Sensitivity Analysis' screen .In the second step the computer takes theseinputs and forecasts the balance sheet and income statement over the next twelve quarters.
Information about growth of accounts and profitability is entered in the 'Growth of Accounts' screen locatedin 'Sensitivity Analysis'.
FUTURE GROWTH OF ACCOUNTS
GROWTH(% per annum)
INTEREST% of RISK FREE
RETAIL DEPOSITS : DEMAND DEPOSITS 5 50
TIME DEPOSITS 5 70
TERM DEPOSITS 4 80
SAVINGS BONDS 3 80
CORPORATE DEPOSITS : DEMAND DEPOSITS 6 80
TERM DEPOSITS 5 80
GROWTH(% per annum)
SPREADABOVE RISK FREE
CONSUMER LOANS : 6 3
CORPORATE LOANS : INDUSTRY A FIXED 5 1
INDUSTRY A FLOATING 5 1
INDUSTRY B FLOATING 6 1
The growth of accounts is entered in annual terms (p.a.). It refers to the portfolio (not the flow of newbusiness). The pricing of deposits is expressed as a percentage of the risk free interest rate on government securities.The pricing of loans is expressed as an additive spread over the risk-free interest rate.
Warning ! Remember the saying : " Garbage In, Garbage Out !".
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12. LIQUIDITY RISK
The ALCO can manage its liquidity exposure with two tools : The 'Next Quarter Simulated Balance Sheet'and the 'Cash Flow Gap'.
The Simulated (Next Quarter) Balance Sheet
By entering its forecasted volume of loans and deposits in the 'Volume Forecast' screen, the bank cansimulate automatically its next quarter balance sheet and calculate its interbank funding requirement. If this isdeemed excessive, the bank can increase its long term liabilities or control the growth of its loan portfolio.
The Cash BucketThe 'Cash Bucket' screen gives the timing of payments of interest and principal.It can be used to evaluate
the cash needs in the coming quarters. The 'Cash Bucket' is very similar to the 'Repricing Bucket' except that in thelatter it is the repricing date which matters, while in the cash schedule it is the timing of payment of interest orprincipal which is relevant.
CASH BUCKET
PERIOD 1 2 3 4+ 8+ 12+
ASSETS (000) 217 82 81 282 25 31 69 1114
RESERVES 0 0 0 0 0 0 60 60
CONSUMER LOANS 22 22 21 81 19 0 0 165
CORPORATE LOANS :
IND.A FIXED RATE 13 12 12 47 43 10 0 138
IND.A FLOAT. RATE 11 10 10 39 36 9 0 115
IND.B FLOAT. RATE 11 10 10 39 36 9 0 115
INTERBANK 155 20 20 20 0 0 0 195
SECURITIES 5 5 5 70 210 0 0 295
FIXED ASSETS 22 22
FUTURES 0 0 0 0 0 0 0 0
SWAPS 0 0 0 0 0 0 0 0
LIABILITIES (000) 497 191 39 77 195 8 52 1059
RETAIL DEPOSITS :
DEMAND DEPOSITS 151 0 0 0 0 0 0 151
TIME DEPOSITS 77 76 0 0 0 0 0 153
TERM DEPOSITS 27 26 26 25 0 0 0 104
SAVINGS BONDS 10 10 10 38 35 8 0 112
CORPORATE DEPOSITS :
DEMAND DEPOSITS 151 0 0 0 0 0 0 151
TERM DEPOSITS 77 76 0 0 0 0 0 153
INTERBANK 0 0 0 0 0 0 0 0
SUBORDINATED BONDS :
FIXED RATE 1 1 1 4 54 0 0 61
FLOATING RATE 2 2 2 9 106 0 0 122
EQUITY 0 0 0 0 0 50 50
FUTURES 0 0 0 0 0 0 0 0
SWAPS 0 0 0 0 0 0 0 0
ASSET-LIABILITY (GAP) -279 -110 42 20 155 23 18 45
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APPENDIX 1 : DECISION VARIABLES
Interest Decisions
Interest rate on deposits (0 to 99.99 % p.a.) :-Retail demand deposits-Retail time deposits-Retail term deposits-Retail savings bonds-Corporate demand deposits-Corporate time deposits
Interest rate on loans (0 to 99.99 % p.a.) :-Consumer loans-Corporate loans Industry A fixed rate-Corporate loans Industry A floating rate-Corporate loans Industry B floating rate
The default value is the interest rate set in the previous quarter. A maximum can be set on the flow of new loans thatthe bank is willing to finance during one quarter. The default value is 99999.
Interbank
Interbank borrowing or lending-three month-six month-twelve month
Priority for automatic allocation 1 : three-month maturity asset (12-month deposits) 2 : maturity spread over 3,6 and 12 months 3 : twelve month-maturity asset (3-month deposits)
Government Securities
Risk-free government securities purchase or sale (units of 000's).
Capital Decisions
Subordinated Bonds issue or repurchase (units of 000's)Equity issue or Stock Repurchase at market price (full amount)Dividend payment (full amount)
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Loan Sales
Sale to other banks-Consumer loans-Industry A fixed rate loans
Sale to the computer-Industry A floating rate-Industry B floating rate
Off-Balance Sheet
Interest rate future, 3-month Treasury Bill (notional principal of 10,000)-Delivery in three months, purchase or sale-Delivery in six months, purchase or sale-Delivery in twelve months, purchase or sale.
Interest rate future, 3-year government security (notional principal of 10,000)-Delivery in three month, purchase or sale-Delivery in six months, purchase or sale-Delivery in twelve months, purchase or sale.
Option on 3-month T-Bill (notional principal of 10,000)-Call option with delivery in 3 months (buy or write)-Put option with delivery in 3 months (buy or write)
Swaps Fixed Rate against 1-Quarter Treasury Bill rate.
Warning ! Enter the number of financial futures or option contracts.
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APPENDIX 2 : OPERATING COSTS AND REGULATIONS
Assets
SALARIES FIXED ASSETS** CAPITAL(RAA*)
CONSUMER LOANS 0.5 % 1.2 % 75 %
CORPORATE LOANS 0.5 % 1.0 % 100 %
INTERBANK 0.063 % 0.0 % 20 %
FIXED ASSETS 100 %
OFF-BALANCE SHEET
FUTURES 0.5 %
SWAPS < 1 YEAR 0.5 %
EACH ADDITIONAL YEAR 1.0 %
CAPITAL REQUIRED 8 %
CAPITAL AVAILABLE
TIER 1, MINIMUM 4 %
TIER 2, SUBORDINATED BONDS WITH MAT. > 1 AN,MAXIMUM 50 %
TIER 2, UNREALIZED CAPITAL GAIN/LOSS ON SECURITIES 55 %
*RAA = 'RISK-ADJUSTED ASSETS'**Percent of assets ; linear depreciation over 20 quarters.
Liabilities
SALARIES FIXED ASSETS** RESERVES
RETAIL DEPOSITS :
DEMAND DEPOSITS 3.0 % 3.0 % 12 %
TIME DEPOSITS 1.5 % 2.0 % 8 %
TERM DEPOSITS 1.0 % 1.5 % 6 %
SAVINGS BONDS 0.2 % 0.2 % 2 %
CORPORATE DEPOSITS :
DEMAND DEPOSITS 2.4% 2.5 % 12 %
TERM DEPOSITS 0.75 % 1.5 % 8 %
SUBORDINATED BONDS 0.063 % 0.0 % 0 %
**Percent of liabilities ; linear depreciation over 20 quarters.
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Other Costs
Commissions on : Securities 0.01 % Sub. Bonds 0.01 % Futures 0.01 % Options 0.01 %
Accounting Rules
Capital gains or losses
All gains and losses on sale of loans, securities, or repurchases of subordinated bonds are realized immediatelyand taxed at the standard income tax rate.
0ff-balance sheet
Financial futures and swaps are marked-to-market every quarter; gains or losses due to change in valuation arerealized and taxed immediately. Premiums on options are entered as an operating expense. Gains or losses arerealized and taxed immediately.
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APPENDIX 3 : AUTHOR’s ALM PUBLICATIONS
In English
Books
(2007): Asset & Liability Management, the Banker’s Guide to Value Creation and Risk Control, Financial Times/Prentice Hall, 2nd edition, London (with J. Bissada). Available in Spanish (FT-Prentice Hall, Madrid, 2003), Portuguese (Atlas, Sao Paulo, 2005), and Chinese (China Financial Publishing House, Beijing, 2003. 2nd edition 2010).
(2015): Bank Valuation and Value-based Management. Deposit and Loan Pricing, Performance Evaluation and RiskManagement, New York: McGraw-Hill Available In Portuguese-Brazil (Avaliaçao de Bancos - Gestao Baseada NoValor, Atlas, Sao Paulo, 2010) and Chinese (forthcoming).
Articles
J. Dermine (1984) : Pricing Policies of Financial Intermediaries, Springer Verlag, (Studies in Contemporary Economics nE 5), Berlin. Laureate of the 1984 BAC-COB Prize for Economic and Financial Research.
(1985) : "Taxes,Inflation and Banks' Market Values", Journal of Business, Finance and Accounting, 12 (1).
(1985) : "The Measurement of Interest Rate Risk by Financial Intermediaries", Journal of Bank Research, Summer.
(1985) : "Accounting Framework for Banks, a Market Value Approach", SUERF Series, 50 A.
(1986) : "Deposit Rates, Credit Rates and Bank Capital, the Klein-Monti Model Revisited", Journal of Banking and Finance, 10.
(1987) : "Measuring the Market Value of a Bank, a Primer", Finance 8.
(1991) : "Duration and Taxes,an Application of Paul Samuelson's Tax Rate Invariance Theorem", mimeo, INSEAD.
(1991) : "Floating Rate Securities and Duration, a Note", mimeo, INSEAD.
(1991) : "The BIS Proposal for the Measurement of Interest Rate Risk, Some Pitfalls", Journal of International Securities Markets, 1991.
(1992) : "Deposit Rate Ceilings and the Market Value of Banks, the Case of France 1971-1981", Journal of Money, Credit and Banking, (with P.Hillion).
(1993) : "The International Regulation of Interest Rate Risk, Some Pitfalls", in Risk-Based Capital Regulations, Asset Management and Funding Strategies, Stone Ed., Business One Irwin. (1993) : "Danger in Simplicity", Balance Sheet, 1(4).
(1993) : "The Evaluation of Interest Rate Risk, Some Warnings About the Basle Proposal", Finanzmarkt und Portfolio Management, 7.
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(1995) : "Loan Arbitrage-Free Pricing", The Financier, 2(2).
(1996) : "Loan Valuation, a Modern Finance Perspective", mimeo, INSEAD.
(1998) : "Pitfalls in the Application of RAROC, With Reference to Loan Management", The Arbitrageur-The Financier, 1(1).
(1999) : “Unexpected Inflation and Bank Stock Returns, the Case of France 1977-1991", Journal of Banking and Finance, 23 (6) (with F. Lajéri).
(2000) : “DCF vs Real Options : How Best to Value Online Financial Companies ? (with an application to Egg)”, INSEAD Case Series.
(2001) : “Credit Risk and the Deposit Insurance Premium, a Note”, Journal of Economics and Business, 53 (with F. Lajéri).
(2005): ”How to Measure Recoveries and Provisions on Bank Lending: Methodology and Empirical Evidence”, in Recovery Risk, The Next Challenge in Credit Risk Management, eds E. Altman, A. Resti and A. Sironi, Risk Books, (with C. Neto de Carvalho).
(2005). “Le Taux Modèle- ING Direct, a Success Story”, INSEAD Case Series.
(2006) : “Bank Loan Losses-Given-Default, a Case Study”, Journal of Banking & Finance, 30 (4) (with C. Neto de Carvalho).
(2007) : “ALM in Banking”, in Handbook of Asset & Liability Management, Volume 2, eds. S.A. Zenios and W.T.Ziemba, Elsevier Science B.V., 2007.
(2008): “Bank Loan-Loss Provisioning, Central Bank Rules vs. Estimation: The Case of Portugal”, Journal ofFinancial Stability, 4 (1) (with C. Neto de Carvalho).
(2010): “Bank Valuation with an Application to the Implicit Duration of non-Maturing Deposits”, InternationalJournal of Banking, Accounting and Finance, Vol. 2 (1).
(2010): “Basel II, Probability of Bank Run, and Credit Risk Diversification”, mimeo.
(2010): “Lloyds-TSB, a Champion of Shareholder Value 1983 - 2007", INSEAD Case Series.
(2012): ”Fund Transfer Pricing (FTP), Beyond the Global Banking Crisis” in B. Swarup ed. Asset- LiabilityManagement for Financial Institutions: Balancing Financial Stability with Strategic Objectives, Bloomsbury, London.
(2012): “Fund Transfer Pricing, for Deposits and Loans, Foundation and Advanced”, Journal of FinancialPerspectives, Vol. 1 (1), March 2013.
(2013): “Bank Corporate Governance, Beyond the Global Banking Crisis”, (Journal of) Financial Markets, Institutions & Instruments.
(2015): “Basel III Leverage Ratio Requirement and the Probability of Bank Runs”, Journal of Banking and Finance,forthcoming.
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In French
J. Dermine (1983) : "Valeur d'Acquisition ou Valeur de Marché", Revue de la Banque, 1983, 3.
(1985) : "L'Evaluation du Risque d'Intérêt par les Banques", Revue Banque, December.
(1987) : "Les Banques et le Risque d'Intérêt", Analyse Financière. (1991) : "La Réglementation Internationale du Risque d'Intérêt, une Nécessité ?", Revue d'Economie Financière.
(1995) : "Application de la Méthodologie RAROC, Une Mise en Garde", Revue Banque, Juillet.
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