Modeling asset allocation and liability composition for Indian banks

Asset liability management is a multi-dimensional set of activities. Against this backdrop, the purpose of this paper is to build a goal programming model for optimally determining the asset allocation and liability composition for Indian Banks.

The conceptual model framework has been developed and then tested for four banks that typically represent the Indian banking sector. Published balance sheet data were used for the model that span over 1995-2009. The veracity of the model has been tested in terms of its ability to project the optimum asset allocation and liability composition for the year 2010.

The model has been able to generate the optimum asset and liability mix that meets the goals set on the key drivers. The solution provided is realistic and compatible with the actual figures. Sensitivity analysis including current and savings account and interest rate changes has been successfully performed to study impact they cause on profitability.

The model provides an overall approach to asset allocation and liability composition based on past data reflecting the preferences and priorities of the banks with regard to their outlook on setting targets. This may change. The variables like return and risk are stochastic in nature.

The model demonstrated in this paper would be useful to the policy makers in any bank for decision support and planning in view of its ability to incorporate a large number of constraints. Changes in profit could be instantaneously captured through sensitivity analysis.

The goal programming model used here is invariant to the type of bank and year of consideration.