Asset and Liability Management (ALM) is a mechanism to address the risk faced by a bank due to a mismatch between assets and liabilities either due to changes in interest rates. As risk management, it entails managing assets and cash inflows to satisfy various obligations. It is guided by a formal policy on addressing limits on the maximum size of major asset/ liability categories, making a balance sheet mix, controlling the use of derivatives, and frequency and content for board reporting among other matters. It is something all financial institutions must have and must follow up on often because how they asset liability is critical. After 2008, financial institutions need to rethink how they asset liability and here’s why.
RISKING THE RISKS
It is not just one risk, but several of them: currency, control rate, liquidity, and financial. The institutions need to examine what the risks are in depth at micro and macro levels. They also make their assessments on predictions, not on their track record. It is easy to have people give the forecast of profits and losses, but those predictions are usually not accurate and effective. That is why institutions are using performance-management software to make it easier. ALM software can help financial institutions achieve more varied modeling, complete forecasting, and accurate analysis than they could do on their own.
It is all about profit. Everyone knows this. Globalization has become part of financial institutions because of their connections to the world’s financial markets. By opening the floodgates to the tide of companies from everywhere comes the growing risk of a wave that could be too big to handle. It is easier to become unstable these days with the influx of integration with other competitors coming from somewhere where, if their own market faults, it can bring down others from across the globe. ALM needs to cover bases of indirect drops from other places in order to cover their own loses when it occurs.
FULLPROOF OF ALM PLAN
Following the crisis, it is now known that risk management policies by financial institutions were not sound. A philosophy of less regulation with the banks was once again proven wrong, as it was in 1929 on Wall Street, or even 68 years later in Asia, yet financial institutions failed to show they correct their errors. It is bad enough to lose money over a quarter, but to hemorrhage billions so rapidly is detrimental to the institution and damages a whole sector. For good supervision, the maintenance and monitoring of adequate capital in the institution must be maintained and updated often to have the capacity to handle any extra damage or risk they take.
ALM should be a process done by banks to manage and mitigate the risks between assets and liabilities that fail to match up. The economic crisis has altered how financial institutions view and execute ALM. To be really effective in ALM, they need to change how they think about and execute the process. Institutions must evolve and keep pace with the rate of the change in the system starting with ALM because it cannot be swept under the rug. A quick snooze, and they lose – a lot.