Lecture21 - 11/29/2010 MGMT 4370 / MGMT 7760 Risk...

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11/29/2010 1 MGMT 4370 / MGMT 7760 Risk Management Aparna Gupta Lally School of Management and Technology Office: PITTS 2104 Email: guptaa@rpi.edu Phone: x2757 Asset-Liability Management another arm of Risk Management 2 Aparna Gupta, Lally School, RPI Asset-Liability Management ALM is the structured decision-making process for matching the mix of assets and liabilities on a firm’s balance sheet. The objectives are: 1. Stabilize the net interest income •N I I : difference between the amount the bank pays out in interest for funding and the amount it receives from holding assets, such as, loans. 2. Maximize the net worth •N W : long-term economic earnings. 3. Make sure the banks doesn’t assume too much risk from the mismatching of maturities and amounts between assets and liabilities and from funding liquidity risk Funding liquidity risk : the danger that the bank will not be able to raise funds quickly and cheaply enough to fulfill it obligations and remain solvent. 3 Aparna Gupta, Lally School, RPI Asset-Liability Management The wide scope of ALM can include managing – market risk (interest rate, for-ex, commodity, equity price risks), – liquidity risk, – trading risk, – funding and capital planning, and – regulatory constraints, as well as profitability and growth. VaR technique controls market and credit risk in the trading books VaR technique controls market and credit risk in the trading books, ALM uses distinct techniques to control risk in the banking books. – Techniques include – gap analysis, duration gap analysis, long- term VaR . ALM is particularly critical for financial institutions – commercial banks, – savings and loans, – insurance companies and – pension funds. 4 Aparna Gupta, Lally School, RPI Asset-Liability Management For instance, banks engage in collecting deposits and extending loans to retail and corporate clients. This financial intermediation activity can generate two types of imbalances: – Imbalance between the amounts of funds collected and lent. Ib l b t t h ti t i l l i t t t Imbalance between the maturities as well as interest rate sensitivities of the sources of funding and the loans extended to clients. These imbalances drive the net worth (NW) of the bank. – And can cause serious problems of insolvency if not managed. 5 Aparna Gupta, Lally School, RPI Asset-Liability Management For example: In a bank, deposits generally have a shorter maturity than loans – The net worth of many banks benefits from a fall in interest rates.
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This note was uploaded on 01/27/2011 for the course MGMT 4370 taught by Professor Gupta during the Fall '10 term at Rensselaer Polytechnic Institute.

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Lecture21 - 11/29/2010 MGMT 4370 / MGMT 7760 Risk...

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