The Principles of Banking

Chapter 7

Asset–Liability Management II

In our second chapter on the subject we look further at the art of ALM as essentially one of risk management and capital management. Although the day-to-day activities are run at the desk level, overall direction is given at the highest level of a banking institution. The risk exposures in a banking environment are multi-dimensional, as we have seen they encompass interest-rate 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. ALM 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 gap report. The increasing use of securitisation and the responsibility of the ALM desk in enhancing the return on assets on the balance sheet are also considered.

Introduction

One of the major areas of decision-making in a bank involves the maturity of assets ...