29. There are different organizational and governance models that guide the management of bank asset and liability activities. The models reflect fundamentally different risk philosophies that tend to evolve with the growing sophistication and depth of financial markets together with the position and activities undertaken by a bank in the market. The terms ‘ALM unit’ and ‘treasury unit’, can be confusing as they are often used by organizations who assign different responsibilities to them - this will be explained below.
5.1 Key aspects that influence a banks approach
30. The evolution of models is driven by differing philosophies about the role of the treasury or the ALM unit and banks in markets at different stages of development often regard the treasury unit differently.
31. In emerging markets the treasury function is usually simplistic and a support function mainly focused on liquidity management and basic foreign exchange activity. In these banks, it is not uncommon to have a prohibition on involvement in more sophisticated capital markets transactions such as derivatives due to lack of knowledge and suspicion about the instruments. Such markets can suffer from poorly developed capital markets that provide little capacity to offset the risks assumed from the customer franchise. The result is often that these banks are slow to evolve and run risks, without knowing it, which can threaten their very survival. 32. In developing markets the treasury function usually begins to take on more structure, more activities and a broader mandate. At the simpler end of the spectrum it can assume full balance sheet management responsibility, involving itself in more complex analytics and hedging activities. At the more complex end it can assume trading and market making responsibilities for a range of capital market products that are used in hedging but also are provided to customers. This can often be referred to as an ‘integrated treasury function’, with profit making as well as hedge management the central themes.
33. In developed markets the model usually evolves by separating out the trading and market making functions into a more customer centric unit such as a capital markets or institutional banking division, with a subsequent refocusing of the core ALM functions on more detailed analysis, and management of the banks’ assets, liabilities and capital base. Treasury becomes more of a service centre in these banks, providing assistance and support with pricing and analytics to customer facing divisions. The ALM or balance sheet can often be managed aggressively through the use of 11 | P a g e
derivative contracts. Funds transfer pricing mechanisms are used extensively to create economic transparency and to immunize business units to risk.
34. In all models the ALM function reports to either the CEO / CFO with the CFO generally having the day to day responsibility for the ALM core functions. Under all models it is important to establish a clear understanding of activities and risk thresholds in the Treasury function and ensure the risk framework is aligned to the operating structure and market realities. Establishing a governance structure within which the board of the bank is fully informed and cognisant of the risks being run is a critical and mandatory component.
35. It is in the more developed markets that the Chief Risk Officer function has developed and come to represent the single independent point of oversight both internally and externally. 5.2 Focus on some key ALM activities
36. Successful ALM units create a properly aligned risk and return management process. The right mix between skills and risk appetite must be identified, expected outcomes of activities known and appropriate metrics established. The approach adopted needs to be aligned to the realities of the market the bank is operating within and to its desired risk appetite. 5.2.1 Mismatch Management and...