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Asset liability management (ALM) in banksBankingSamiq MuradovSunday, October06, 20191
Asset liability managementAsset Liability Management (ALM) can be defined as a mechanism to address the risk faced by a bank due to a mismatch between assets and liabilities either due to liquidity or changes in interest rates. Liquidity is an institution’s ability to meet its liabilities either by borrowing or converting assets. Apart from liquidity, a bank may also have a mismatch due to changes in interest rates as banks typically tend to borrow short term (fixed or floating) and lend long term (fixed or floating).A comprehensive ALM policy framework focuses on bank profitability and long term viability by targeting the net interest margin (NIM) ratio and Net Economic Value (NEV), subject to balance sheet constraints. Significant among these constraints are maintaining credit quality, meeting liquidity needs and obtaining sufficient capital.Sunday, October06, 20192
Asset liability managementAn insightful view of ALM is that it simply combines portfolio management techniques (that is, asset, liability and spread management) into a coordinated process. Thus, the central theme of ALM is the coordinated – and not piecemeal – management of a bank’s entire balance sheet.Although ALM is not a relatively new planning tool, it has evolved from the simple idea of maturity-matching of assets and liabilities across various time horizons into a framework that includes sophisticated concepts such as duration matching, variable-rate pricing, and the use of static and dynamic simulation. Sunday, October06, 20193
Asset liability managementThe function of ALM is not just protection from risk. The safety achieved through ALM also opens up opportunities for enhancing net worth. Interest rate risk (IRR) largely poses a problem to a bank’s net interest income and hence profitability. Changes in interest rates can significantly alter a bank’s net interest income (NII), depending on the extent of mismatch between the asset and liability interest rate reset times. Changes in interest rates also affect the market value of a bank’s equity. Methods of managing IRR first require a bank to specify goals for either the book value or the market value of NII. In the former case, the focus will be on the current value of NII and in the latter, the focus will be on the market value of equity. In either case, though, the bank has to measure the risk exposure and formulate strategies to minimize or mitigate risk.