Asset-Liability Management

Topics: Balance sheet, Subprime mortgage crisis, Asset Pages: 10 (2924 words) Published: August 5, 2009
Asset-Liability Management

“Asset-Liability Management (ALM) can be defined as the ongoing process of formulating, implementing, monitoring and revising strategies related to assets and liabilities to achieve an organization's financial objectives, given the organization's risk tolerances and other constraints”[1]. ALM also is known as balance sheet management. In banking activity the gap between assets and liabilities can bring some consequences where the following risks are arose. And as a whole it influences badly on the bank’s functioning. Solving that problem is the primary goal of ALM. The good balance sheet management means that the return on loans and securities as the highest as possible, risks are minimized and liquid assets are in adequate amount (See Appendix 1 and 2). For these reasons bank staff when managing assets and debts should follow four main strategies which include liquidity, asset, liability and capital adequacy management[2] (See Appendix 3). Traditionally, ALM has focused primarily on the interest rates risk[3] which is arose when the maturity of assets and debts and their volume are not the same. For example, commercial bank is viewed as ‘short-funded’ when the maturity of its assets is longer than the liability maturity. On the contrary, bank can be called ‘long-funded’ when the maturity of debt is bigger. Both situations are risky and maybe not much profitable because in both cases bank has to refinance or reinvest funds at a rate that can be unfavorable. However, today in addition to interest rate risk, the control of a much broader range of risks such as equity, liquidity, currency, credit, operational risks etc. is engaged by balance sheet management. Also there are some methods commercial banks use to manage the risks: by matching the assets and liabilities according to the maturity pattern or the matching the duration, by hedging and by securitization.

Asset securitization

‘Asset securitization is a process of packaging illiquid individual loans and other debt instruments into liquid securities with credit enhancement to further their sale in the capital market’[4]. There are different types of asset which can be securitized: mortgages, auto loans, credit card receivables, high-yield bonds and loans and equipment lease and so on. Even future royalties from record sales can be a type of securitized asset. However, the mainstream examples of ABS are mortgage-backed securities (MBS) and secured credit card receivables.

The process of asset securitization

The process of securitization you can find in Appendix 4. First of all, the borrower comes to a bank and asks for a loan. Then, the bank or the originator provides that loan. After that, homogeneous assets are put together in different tranches and passed to an organization which is created by the bank and calls a special purpose vehicle (SPV). It issues securities backed by these assets (ABS) and spreads them among a wild range of institutional investors such as banks, insurance companies and pension funds. The key aim of creation of SPV is to demarcate originator’s risks of bankruptcy from the securities which are issued by the SPV. That’s why this vehicle also calls a bankruptcy-remote entity[5]. So, investors in ABS issued by SPV do not have to worry about bank’s solvency position and its credit rating because the securities are not affected by the parent company rating. As a consequence, rating agency evaluates ABS by analyzing a securitization program but not look at a bank’s rating. Asset-backed securities have several levels of credit enhancement. It is necessary for reducing losses which can be arose from the underlying assets credit risks. Usually credit enhancement depends on the issuer rating. So, SPV can archive a high credit rating through overcollateralization, excess spread, letter of credit or an insurance. Another member of the process involved in the ABS creation is an underwriter. It...
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