Asset Liability Management

Definition of ALM (Asset Liability management ) and ALCO (Asset Liability Committee).

ALM:

Asset 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.

ALCO:

Asset Liability Management (ALM) is an integral part of Bank Management; and so, it is essential to have a structured and systematic process for manage the Balance Sheet. Committee comprising of the senior management of the bank to make important decisions related to the Balance Sheet of the Bank (asset-Liability). The committee typically called the Asset Liability Committee (ALCO).

As per central bank guideline, the committee consists of the following key personnel of a bank:

- Chief Executive Officer / Managing Director

- Head of Treasury / Central Accounts Department

- Head of Finance

- Head of Corporate Banking

- Head of Consumer Banking

- Head of Credit

- Chief Operating Officer / Head of Operations

The committee calls for a meeting once every month to set and review strategies.

The key roles and responsibilities of the ALM Desk.

1) To assume overall responsibilities of Money Market activities.

2) To manage liquidity and interest rate risk of the bank.

3) To comply with the local central bank regulations in respect of bank’s statutory obligations as well as thorough understanding of the risk elements involved with the business.

4) Understanding of the market dynamics i.e competition, potential target markets etc.

5) Provide inputs to the Treasurer regarding market views and update the balance sheet movement.

6) Deal within the dealer’s authorized limit.

Description of "absence of good/effective ALM of a bank may lead it to different crisis jeopardizing image and foundation of the bank?"

In banking, asset liability management is the practice of managing the risks that arise due to mismatches between the assets and liabilities (debts and assets) of the bank. Banks face several risks such as liquidity risk, interest rate risk, credit and operational risk. Asset/Liability management (ALM) is a strategic management tool to manage Asset, Liability, spread of interest rate and liquidity risk faced by banks & Financial Institutions.

In absence of good/effective ALM of a bank may lead it to following crisis:

Liquidity risk:

the current and prospective risk arising when the bank is unable to meet its obligations as they come due without adversely affecting the bank's financial conditions.

Interest rate risk:

The risk of losses resulting from movements in interest rates and their impact on future cash-flows. One of the primary causes are mismatches in terms of bank deposits and loans.

Currency risk management:

The risk of losses resulting from movements in exchanges rates. To the extent that cash-flow assets and liabilities are denominated in different currencies.

Funding and capital management:

As all the mechanism to ensure the maintenance of adequate capital on a continuous basis. (Usually a prospective time-horizon of 2 years).

Profit planning and growth:
Profit planning is required to make a sufficient growth for the organization itself.

In addition, ALM deals with aspects related to credit risk as this function is also to manage the impact of the entire credit portfolio (including cash, investments, and loans) on the balance sheet. The credit risk, specifically in the loan portfolio, is handled by a separate risk management function and represents one of the main data contributors to the ALM team.

Ending words :

So, it can be said undoubtedly that absence of good/effective ALM of a bank may lead it to different crisis jeopardizing image and foundation of the bank.