An Introduction to Banking, 2nd Edition

Chapter 7BANK ASSET AND LIABILITY MANAGEMENT I

Asset–liability management (ALM) is a generic term that can mean different things in subtly distinct ways, depending on what type of financial market participant one is. For bankers, the term is used to denote high‐level management of a bank's balance sheet assets and liabilities; in other words, it refers to the process of managing the balance sheet. As such it is a strategy level discipline but at the business line level, it is also a tactical one.

The art of asset and liability management is essentially one of balance sheet risk management and capital management, and although the day‐to‐day activities are run at the desk level, overall direction should be given at the highest level of a banking institution. The risk exposures in a banking environment are multidimensional, and as we have seen they encompass interest‐rate risk, liquidity risk, credit risk, and operational risk.

Traditionally, asset and liability management covered the set of techniques used to manage interest‐rate and liquidity risks; it also dealt with the structure of the bank's balance sheet, which is heavily influenced by funding and regulatory constraints and profitability targets. Interest‐rate risk is one type of market risk. Risks associated with moves in interest rates and levels of liquidity are those that result in adverse fluctuations in earnings levels due to changes in market rates and bank funding costs. By definition, banks' earnings levels are ...