Asset and Liability Management
As part of our discussion on the money markets, we will consider in this chapter a major part of banking activity, and one that is closely related to the main business of banking, which is the subject of asset and liability management. The art of asset and liability management (ALM) is essentially one of risk management and capital management, and although the day-today activities are run at the desk level, overall direction is given at the highest level of a banking institution. The risk exposure in a banking environment is multi-dimensional, for example they encompass interest-rate risk, foreign-exchange risk, liquidity risk, credit risk and operational risk. Interest-rate risk is one type of market risk. Risks associated with moves in interest rates and levels of liquidity1 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 highly sensitive to moves in interest rates and the cost of funds in the wholesale market. Asset and liability management covers the set of techniques used to manage interest rate and liquidity risks; it also deals with the structure of the bank’s balance sheet, which is heavily influenced by funding and regulatory constraints and profitability targets.
In this chapter we review the concept of balance sheet management, the role of the ALM desk, liquidity risk and maturity gap risk. We also review a basic ...