Asset Liability Management or ALM is a mechanism designed to address the risk faced by banks due to a mismatch between assets and liabilities, which arise either because of liquidity or because of changes in interest rates. As such, asset liability management techniques involve ALM finance and ALM banking. Banks use asset liability management techniques as part of an overall asset liability management system
A sound ALM system for the bank should include:
1. Interest rate movement and outlook,
2. Pricing of assets and liabilities,
3. Review of investment portfolio and credit risk management,
4. Review of investment of foreign exchange operations,
5. Management of liquidity Risk,
6. Management of NIM and of balance sheet ratios, and
7. Formulation of budgets and operational planning.
Tools of ALM
There are different tools for Asset and Liability Management.
Some of which are:
1. Gap Analysis,
2. Duration Analysis,
3. Value-at-risk method, and
4. Risk management.
1. Gap Analysis:
Basically Assets and Liabilities both are rate sensitive in different degree. It is therefore necessary to identify the rate sensitivity among different groups of assets and liabilities and match identical groups of assets with liabilities. In the ALM process, Gap is generally used for quantifying the rate sensitive groups only (as compared to rate insensitive groups of liabilities like current deposits, float funds etc.)
In other words, GAP is the “excess” of interest sensitive assets over interest sensitive liabilities or vice – versa> If Risk sensitive liabilities and Risk sensitive Assets are equal when difference of two (GAP RSA-RSL) becomes NIL, Net Interest Margin (NIM) is free from any effect of interest rates movements.
2. Duration Method:
Under this method, impact of changes in interest rate on the market value of assets and liabilities is considered. Duration analysis is carried out with respect to cash flows and average maturity.
3. Value-at-risk (VAR) method:
This method is variant of the practice of ‘Market-to Market’ approved securities based on Yield- to Maturity.
4. Risk Management:
Under this process, the risk profiles of assets and liabilities are evaluated to ensure that they are within the acceptable levels of risk. The availability of hedging mechanisms (e.g. derivative instruments) would facilitate risk management.
The Reserve Bank of India issues specific guidelines to be followed by banks for managing their respective. Asset and Liability Management. Although the principles of managing assets and liability based on Basel committee have been given above some important points of the guidelines issued by RBI (these are reviewed periodically to suit the changing atmosphere of the monetary and economic policies of the government)
Factors Influencing ALM
For asset-liability management (ALM) system the broad guidelines of RBI specify three important factors to be looked into by each bank:
1) ALM information system,
2) ALM Organisation, and
3) ALM process.
Under the Information system banks are required to ensure development of information procuring system for measuring, monitoring, controlling and reporting the risks.
The method is used to analyze the behavior of assets and liability products to assess in which way the assets and liability would behave in the business of banking. The ALM Organisation guidelines insist that each bank at the top management level and Board of Directors should on the ongoing basis review the situation to ensure appropriate policies and procedures are adopted and implemented to timely arrest the prospective risks.
The ALM process is meant to create parameters for managing the risks like, identification of risk, measurement of risk, management of risk, planning to mitigate the risk etc..