The Importance of Proper Asset and Liability Management (ALM) in Banks

During my 30-year long experience in banking, mostly focusing on ALM/Treasury, I’ve seen firsthand how crucial effective asset and liability management (ALM) is to the stability and success of financial institutions. The banking turmoil of 2023 was a stark reminder that proper ALM practices are not just beneficial - they're essential. In this blog, I will share my insights on the key components of ALM, including interest rate risk management, liquidity management, and credit-spread risk management, drawing on Bearning 's extensive experience in this field.

Tailored Approaches for Different Bank Sizes and Markets

One size does not fit all in banking, especially when it comes to ALM. Different banks, operating in various markets, require tailored approaches to effectively manage their assets and liabilities. For instance, small and simple banks can often manage with Excel models for mapping non-maturing deposits (NMDs) and balancing their books. NMDs, in particular, are a critical aspect of ALM, as their unpredictable nature can significantly impact a bank's liquidity and interest rate risk profiles. Proper modeling of NMDs helps in creating more accurate and reliable ALM strategies.

In mid-sized banks, a more sophisticated approach involving quantitative planning and scenario analysis is necessary. The ability to run various scenarios prepares banks to respond proactively to market changes, thus safeguarding their financial health.

For larger banks, a holistic and integrated ALM solution is indispensable. These institutions need comprehensive tools that can handle the complexity of their operations and provide a cohesive view of their financial risks.

At Bearning, we offer tailored ALM solutions for banks of all sizes.

(1) Smaller banks looking to model their non-maturing products can utilize our Excel-based ALM_IRLQ model for liquidity and interest rate management. This Excel model is a powerful tool designed to assist banks in calculating Funds Transfer Pricing (FTP) specifically tailored for non-maturing deposits (NMD) and assets (NMA). Learn more about it on Bearning web page.

(2) For mid-sized banks, we provide QuantPlan software, developed by our partner company QuantALM, which facilitates quantitative planning engine for projection of bank's balance sheet, net interest income, transfer and margin contribution, liquidity metrics, FTPs etc. To learn more, you can take advantage of our free Bearning course on quantitative planning with QuantPlan.

(3) For larger banks, we partner with leading software providers like the Finnish company MORS , delivering holistic ALM and Treasury software solutions to meet their comprehensive needs. MORS offers a robust risk management system that integrates Asset Liability Management (ALM) and Treasury Management (TMS) into a single platform. Depending on the bank's priorities and requirements, they have the flexibility to implement either the full solution or specific modules. The platform also includes advanced regulatory reporting and subledger capabilities, ensuring compliance while optimizing financial management and operational efficiency. To learn more about how MORS can transform your bank's treasury and risk management, you can take advantage of our consulting services.

Risks managed by ALM

Interest Rate Risk Management

Interest rate risk (IRR) remains a fundamental challenge for banks, as evidenced by the 2023 crisis that exposed significant vulnerabilities due to rising rates. Effective IRR management is crucial for optimizing Net Interest Income (NII), which directly impacts a bank’s profitability. Even for small and simple banks, key practices include gap analysis to understand the differences between rate-sensitive assets and liabilities, mark-to-market revaluation (or duration analysis) to assess sensitivity to interest rate changes, and the use of hedging instruments like interest rate swaps to manage IRR exposure.

Liquidity Management

Ensuring adequate liquidity is vital for a bank’s stability. The events of 2023 underscored the necessity of robust liquidity management practices. Essential practices include maintaining a liquidity coverage ratio (LCR) with a buffer of high-quality liquid assets, such as eligible bonds, conducting regular stress test scenarios to evaluate the bank's capacity to withstand shocks, and diversifying funding sources to reduce dependency on any single source.

Credit-Spread Risk Management by Bond Portfolio Management

Managing credit-spread risk through bond portfolio management is essential for maintaining a bank’s profitability, which depends on credit-spread volatility in financial markets. Key practices in this area include regular analysis of bond issuers and bond markets, maintaining a well-diversified bond portfolio, and continuously monitoring market conditions to adjust portfolios as necessary.

How Bearning Can Help

While the focus of this blog is to share professional insights into effective ALM, I must mention our company, Bearning, and its approach to supporting banks in implementing these practices.

First, each bank needs ALM experts with adequate know-how in asset and liability management. Bearning stands for Bank Learning, and we provide a variety of online and onsite courses, workshops, and simulations. We challenge bank managers not to underestimate this crucial first step, as it is essential for ALM/Treasury and market risk management. Our tailored training and consulting services ensure that your bank is well-prepared to manage its assets and liabilities effectively.

Second, we provide solutions. These include our own Excel models for replicating portfolios of non-maturing products and modeling FTPs for them, as well as quantitative ALM solutions in collaboration with our business partners. We help banks scale their ALM needs based on the complexity of their balance sheet and recommend the best solutions for their specific requirements.

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