Value and Capital Management: A Handbook for the Finance and Risk Functions of Financial Institutions

Chapter 17The Practical Aspects of Asset/Liability Management

This chapter focuses on making the “rules of the game” for asset/liability management practical. It builds on the previous chapters on balance sheet management organization and the economics of ALM.

Rules of the Game: ALM Operations

Both banks and insurers take an open mismatch position, either by choice or by product design. These mismatch positions contribute significantly to the earnings and risk of the firm, but generally not to a premium on their valuation multiple. The “rules of the game” for managing the mismatch result are straightforward.

1. The group needs to put in place the organizational prerequisites to manage asset/liability mismatch risk.
   1. A management organization, including a governance body (the ALCO) and line management (the ALM unit, ALM process manager and selected business units) with explicit limits and delegated authorities.
   2. A risk and performance measurement framework focusing on both accounting earnings as well as market-consistent or fair values of the mismatch portfolio.
   3. A clear separation of product contribution from the mismatch result using Funds transfer Pricing (FTPs) and New Business RAPM, to provide the right incentives to product managers and the ALM function.
2. A value-oriented asset/liability management strategy.
   1. Effective asset/liability management begins with product design. There is no investment or hedging strategy which can circumvent the potential drag of a poorly designed ...