Asset Liability Management Optimisation

CHAPTER 2Methods of Measurement and Management of the Interest Rate Risk and Liquidity Risk

Chapter 1 described the concept of asset and liability management (ALM) in a financial institution. The ALM role and the importance of achieving trade-off between profitability of the ALM unit and its exposure to financial risks, which such a position creates, has been discussed based on the analysis of the strict interrelation between interest rates risk and liquidity risk. Moreover, the chapter introduced the process of transferring interest and liquidity risk from business units to ALM, known as the funds transfer pricing (FTP) process, and founds the basis of the balance sheet management. The FTP process is further developed in Chapter 2, along with a detailed description of the interest rate risk in the banking book (IRRBB) and liquidity measurement techniques and key metrics. Building on the concepts of IRRBB and liquidity risk already discussed, this chapter will expand upon the main risks managed by ALM. Consequently, it provides an overview of the main measurement techniques adopted by banks in order to measure the IRRBB and liquidity risk and focuses on the key metrics which provide senior management with knowledge of the extent of the exposure to those risks. It concludes with an analysis of the FTP process components of the FTP rate and balance sheet shaping tools used under the FTP practice. Additionally, this chapter touches on the concept of behaviouralisation and proposes ...