Asset-Liability and Liquidity Management

Introduction

A bank at its core is a financial intermediary institution that collects funds from those individuals or entities who do not have immediate use for them and lends to those who can use the capital to generate economic benefits. Depositors with excess cash can benefit from the interest earned on their deposits while borrowers can benefit from the borrowed funds for their personal needs, such as purchasing real properties, or business needs, such as investing in their small business ventures. As the facilitators of such fund transfers, banks earn the difference between the interest paid to the depositors and the interest earned from the borrowers. A bank with an asset-driven business model seeks to originate assets through lending activities and simultaneously pursue funding methods to fund those assets, whereas a bank with a liability-driven business model primarily focuses on collecting deposits and then attempts to lend or invest the proceeds from the deposits. While traditionally deposits are the main source of funds in the banking industry, nowadays banks use a variety of methods to raise funds, including the issuance of short-term and long-term notes, securitization, and collateralized borrowings. Use of funds is also evolved from traditional lending in the form of loans to individuals and businesses, in investment in securities, and even in speculation using derivatives. The net revenue a bank makes is the difference between the costs associated with its sources ...