Asset liability management

Initially pioneered by financial institutions during the 1970s as interest rates became increasingly volatile, asset and liability management (often abbreviated ALM) is the practice of managing risks that arise due to mismatches between the assets and liabilities.

The process is at the crossroads between risk management and strategic planning. It is not just about offering solutions to mitigate or hedge the risks arising from the interaction of assets and liabilities but is focused on a long-term perspective: success in the process of maximising assets to meet complex liabilities may increase profitability.

Thus modern ALM includes the allocation and management of assets, equity, interest rate and credit risk management including risk overlays, and the calibration of firmwide tools within these risk frameworks for optimisation and management in the local regulatory and capital environment.

Often an ALM approach passively matches assets against liabilities (fully hedged) and leaves surplus to be actively managed.

The exact roles and perimeter around ALM can vary significantly from one bank (or other financial institutions) to another depending on the business model adopted and can encompass a broad area of risks.

The traditional ALM programs focus on interest rate risk and liquidity risk because they represent the most prominent risks affecting the organization balance-sheet (as they require coordination between assets and liabilities).

But ALM also now seeks to broaden assignments such as foreign exchange risk and capital management. According to the Balance sheet management benchmark survey conducted in 2009 by the audit and consulting company PricewaterhouseCoopers (PwC), 51% of the 43 leading financial institutions participants look at capital management in their ALM unit.

The scope of the ALM function to a larger extent covers the following processes:

The ALM function scope covers both a prudential component (management of all possible risks and rules and regulation) and an optimization role (management of funding costs, generating results on balance sheet position), within the limits of compliance (implementation and monitoring with internal rules and regulatory set of rules). ALM intervenes in these issues of current business activities but is also consulted to organic development and external acquisition to analyse and validate the funding terms options, conditions of the projects and any risks (i.e., funding issues in local currencies).

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