Asset Liability Management
Management of Assets and Liabilities by Banks
Paul George 0921420
Meaning of ALM
ALM is an attempt to match Assets and Liabilities, in terms of Maturities and Interest Rate Sensitivities, to minimize Interest Rate Risk and Liquidity Risk.
• ALM can be termed as a risk management technique designed to earn an adequate return while maintaining a comfortable surplus of assets beyond liabilities.
• It takes into consideration interest rates, earning power, and degree of willingness to take on debt and hence is also known as Surplus Management
ALM and NIM
• ALM is all about efficient management of balance sheet dynamics with regard to its size, constituents and quality.
• It is the process of managing the Net Interest Margin (NIM) within the overall risk bearing ability of a bank
• ALM process depends on the understanding of the balance sheet; the availability, accuracy, adequacy and expediency of the data and the MIS system
DEFINITION OF ALM
• ALM is defined as, “the process of decision – making to control risks of existence, stability and growth of a system through the dynamic balances of its assets and liabilities.”
• The text book definition of ALM is “a risk management technique designed to earn an adequate return while maintaining a comfortable surplus of assets beyond liabilities. It takes into consideration interest rates, earning power and degree of willingness to take on debt. It is also called surplus- management”.
PURPOSE AND OBJECTIVES OF ALM
➢ Review the interest rate structure and compare the same to the interest/product pricing of both assets and liabilities.
➢ Examine the loan and investment portfolios in the light of the foreign exchange risk and liquidity risk that might arise.
➢ Examine the credit risk and contingency risk that may originate either due to rate fluctuations or otherwise and assess the quality of assets
➢ Review,the actual performance against the projections made and analyse the reasons for any effect on spreads.
➢ Aim is to stabilise the short-term profits,long-term earnings and long-term substance of the bank.The parameters that are selected for the purpose of stabilising asset liability management of banks are:
-Net Interest Income(NII)
-Net Interest Margin(NIM)
-Economic Equity Ratio
• Net Interest Income-
Interest Income-Interest Expenses.
• Net Interest Margin-
Net Interest Income/Average Total Assets
• Economic Equity Ratio-
The ratio of the shareholders funds to the total assets measures the shifts in the ratio of owned funds to total funds. The fact assesses the sustenance capacity of the bank.
RISKS INVOLVED IN ALM
• Various Risks involved in Asset-Liability Management are:
– Interest Rate Risk
– Foreign Exchange Risk
– Liquidity Risk
– Credit Risk
– Contingency Risk
MANAGEMENT OF LIQUIDITY RISK
Liquidity Risk: It is the risk of having insufficient liquid assets to meet the liabilities at a given time.
➢ Stock Approach
Stock Approach is based on the level of assets and liabilities as well as off balance sheet exposures on a particular date.
• liquid assets to short term liabilities ratio
• loan to deposits ratio
➢ Flow Approach
• Measuring and managing net funding requirements.
• Managing Market Access
• Contingency Planning
MANAGEMENT OF INTEREST RATE RISK
Interest Rate Risk: It is the risk of having a negative impact on a bank’s future earnings and on the market value of its equity due to changes in interest rates.