FAQ's in ALM

In this article, I answer 24 of the most frequently asked questions in ALM, aiming to provide a deeper understanding and a practical perspective on managing balance sheet risks effectively.

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1. What is Asset and Liability Management (ALM)?

ALM is a structured process for managing a bank’s balance sheet, focusing on optimising profitability while balancing risks such as interest rate, liquidity, and credit risks. The goal is to ensure that the institution can meet obligations to depositors, borrowers, and shareholders, while adhering to regulatory requirements.

2. Why is ALM essential for financial institutions?

ALM allows banks to manage risk exposures more effectively, preventing potential mismatches that could lead to liquidity or solvency issues. This process supports both regulatory compliance and sustainable profitability by creating a framework for prudent decision-making, even in adverse market conditions.

3. What are the primary risks managed by ALM?

ALM addresses several major risks, including:

- Interest Rate Risk: The impact of interest rate changes on earnings or capital.

- Liquidity Risk: The risk of not meeting short-term obligations.

- Credit Risk: Although mainly managed by credit risk departments, ALM considers the broader impact of credit exposures.

- Market Risk: Broad risks from market changes affecting asset and liability values.

Each risk is managed with specific ALM strategies to prepare for varying economic scenarios.

4. How does ALM relate to liquidity management?

Liquidity management is central to ALM, ensuring that institutions have enough liquid assets to meet short-term obligations. Regulatory changes have made it essential for banks to hold higher levels of high-quality liquid assets (HQLA), enhancing resilience in times of stress.

5. How does interest rate risk affect ALM?

Interest rate risk is one of the key challenges in ALM, arising from mismatches in interest-earning assets and interest-bearing liabilities. ALM teams use tools like gap analysis and interest rate swaps to manage this risk within regulatory guidelines.

6. What role do regulations play in ALM?

Regulations, such as Basel III, heavily influence ALM practices by setting capital and liquidity standards. Compliance ensures that institutions demonstrate financial stability to regulators and stakeholders, supporting both profitability and resilience.

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Here is the list of the remaining FAQs that I have answered on the Global Banking Hub, available for free at the following link:

GlobalBankingHub.com/articles/faqs-in-alm

7. How do banks use stress testing in ALM?

8. What are behavioural assumptions, and why are they relevant in ALM?

9. What are some key metrics used in ALM to assess performance?

10. How does ALM support long-term financial planning?

11. How does technology impact ALM?

12. How can banks balance profitability with regulatory compliance in ALM?

And more...

For a deeper dive into these topics, please visit the Global Banking Hub, where these additional questions are answered in detail.