Imagine you were put in charge of billions of customer dollars, but you lost them. Congratulations, you are a decision-maker at Silicon Valley Bank. SVB’s inability to manage both interest rate risk and liquidity risk sent them into a painful spiral. The California-based bank was not the first to ever make a major mistake in asset liability risk management, and they are likely not going to be the last. However, they highlight the extreme importance of paying attention to this key area of business preparedness, and organizations the world over have taken heed. Whether you help operate ALM strategies at a bank, an insurance company, or a pension fund, the recent failures of SVB are a clarion call to become versed and fluent in ALM.
Asset-liability management Explained
Simply put, ALM seeks to manage assets to reduce the risk of not meeting a liability. Since the inability to honor a liability threatens the profits and strategic planning initiatives and goals of any organization – and on a smaller scale, any individual who manages their finances – this competency is central to operations. In extreme situations, poor ALM presents an existential threat to the existence of the organization itself.
Using various models for conceptualizing risk can yield different outcomes and scenarios to consider, so it’s important to understand these models and the strengths and weaknesses of each relative to your enterprise.
Pros and Cons of Asset Liability Management
Efficiency and profitability are two of the most important effects of ALM, but you might count the continued trust in your financial stewardship even above those. Without trust, your organization is as good as toast, as recent bank runs have shown. Once your ALM models are robust, the ability to efficiently invest in capital-generating ventures emerges, producing profitability. Additionally, the creation of tools and forecasts that can be used in a company-wide setting allows for better overall strategic planning and decision-making. With the overall balance sheet in view, and data from many different pieces of the ALM puzzle readily available, financial professionals become more well-armed for their fight to advance their company’s goals.
On the other hand, some view ALM as time-consuming due to the need for effective, timely, and streamlined communication between many different departments. They also note a need for investment in technology for more robust projections and analysis. These needs often include an overhaul of older, outdated processes, which might have relied on rudimentary software, to versions that harness machine learning, advanced analytics, and other new developments. While these ultimately create better environments for managing assets and liabilities, their initial implementation can be seen as a hurdle for some.
Strategies for Asset and Liability Management
Deposits and loans make excellent stand-ins for the concepts of assets and liabilities. The interest rates on each must be carefully balanced and monitored in the context of the changing economic landscape to ensure a positive margin when examined as part of a whole.
Liquidity risk, currency risk, and capital market risk each have their own recommended strategies and approaches for managing ALM, and each should be developed to suit your specific organizational needs with tailored processes and systems. Liquidity risk addresses the ability to meet cash-flow obligations, and contingency funding plans specifically address the actions to take during a liquidity crisis. Currency risk, often called exchange rate risk, refers to the fluctuating exchange rates of currencies relative to one another. Capital market risk refers to the danger of investments moving unfavorably.
Even environmental problems can factor into ALM, as Dimitris Papathanasiou, head of global funding concentration and international treasury risk at Credit Suisse, has argued recently. Loans to oil and petrochemical industries could present unique risks in a global environment rapidly being affected by climate change, he suggested.
Tools for the management of ALM are available for purchase, with varying rollout periods. They can also help facilitate the regular reviews and revisions to ALM plans and strategies for tackling crises by identifying plausible events that may stress the bank, company, or asset management group. These regular reviews and revisions should become standard for any operation hoping to maintain a sound foundation for investing.
BankersHub offers in-depth certifications for banking professionals who want to learn more about asset liability management. Our Bank Accounting Specialist certification includes an overview of asset-liability management and interest-rate risk specifically tailored to learners who want to stay abreast of recent changes in regulations, capital requirements, interpretations of GAAP (Generally Accepted Accounting Principles), and more. To become a Certified Treasury Manager, you’ll learn about Enterprise Risk Management, for which asset and liability management has asserted itself as a crucial component not just during the 2008-2009 financial crisis but during the recent failures of Silicon Valley Bank and others.
