Description
Asset-liability management (ALM) doc coves topics of Liquidity risk , Interest rate risk , Credit risk , default risk and operational risk.
Asset-liability management (ALM) is a term whose meaning has evolved. In banking, asset and liability management is the practice of managing risks that arise due to mismatches between the assets and liabilities (debts and assets) of the bank. This can also be seen in insurance. Traditionally, banks and insurance companies used accrual accounting for essentially all their assets and liabilities. They would take on liabilities, such as deposits, life insurance policies or annuities. They would invest the proceeds from these liabilities in assets such as loans, bonds or real estate. Banks face several risks such as the liquidity risk, interest rate risk, credit risk and operational risk. Asset Liability management (ALM) is a strategic management tool to manage interest rate risk and liquidity risk faced by banks, other financial services companies and corporations. Liquidity risk is the risk that a given security or asset cannot be traded quickly enough in the market to prevent a loss (or make the required profit). Interest rate risk is the risk (variability in value) borne by an interest-bearing asset, such as a loan or a bond, due to variability of interest rates. In general, as rates rise, the price of a fixed rate bond will fall, and vice versa. Interest rate risk is commonly measured by the bond's duration. Credit risk is an investor's risk of loss arising from a borrower who does not make payments as promised. Such an event is called a default. Another term for credit risk is default risk. An operational risk is a risk arising from execution of a company's business functions. It is a very broad concept which focuses on the risks arising from the people, systems and processes through which a company operates. It also includes other categories such as fraud risks, legal risks, physical or environmental risks. Banks manage the risks of Asset liability mismatch by matching the assets and liabilities according to the maturity pattern or the matching the duration, by hedging and by securitization. Consider a bank that borrows USD 100MM at 3.00% for a year and lends the same money at 3.20% to a highly-rated borrower for 5 years. The net transaction appears profitable—the bank is earning a 20 basis point spread—but it entails considerable risk. Suppose, at the end of a year, an applicable 4year interest rate is 6.00%. The bank is in serious trouble. It is going to be earning 3.20% on its loan and paying 6.00% on its financing. Example: Asset-Liability Risk Exhibit 1
Asset-liability risk is leveraged by the fact that the values of assets and liabilities each tend to be greater than the value modest fluctuations in values of assets and liabilities result in a 50% reduction in capital.
doc_275684633.docx
Asset-liability management (ALM) doc coves topics of Liquidity risk , Interest rate risk , Credit risk , default risk and operational risk.
Asset-liability management (ALM) is a term whose meaning has evolved. In banking, asset and liability management is the practice of managing risks that arise due to mismatches between the assets and liabilities (debts and assets) of the bank. This can also be seen in insurance. Traditionally, banks and insurance companies used accrual accounting for essentially all their assets and liabilities. They would take on liabilities, such as deposits, life insurance policies or annuities. They would invest the proceeds from these liabilities in assets such as loans, bonds or real estate. Banks face several risks such as the liquidity risk, interest rate risk, credit risk and operational risk. Asset Liability management (ALM) is a strategic management tool to manage interest rate risk and liquidity risk faced by banks, other financial services companies and corporations. Liquidity risk is the risk that a given security or asset cannot be traded quickly enough in the market to prevent a loss (or make the required profit). Interest rate risk is the risk (variability in value) borne by an interest-bearing asset, such as a loan or a bond, due to variability of interest rates. In general, as rates rise, the price of a fixed rate bond will fall, and vice versa. Interest rate risk is commonly measured by the bond's duration. Credit risk is an investor's risk of loss arising from a borrower who does not make payments as promised. Such an event is called a default. Another term for credit risk is default risk. An operational risk is a risk arising from execution of a company's business functions. It is a very broad concept which focuses on the risks arising from the people, systems and processes through which a company operates. It also includes other categories such as fraud risks, legal risks, physical or environmental risks. Banks manage the risks of Asset liability mismatch by matching the assets and liabilities according to the maturity pattern or the matching the duration, by hedging and by securitization. Consider a bank that borrows USD 100MM at 3.00% for a year and lends the same money at 3.20% to a highly-rated borrower for 5 years. The net transaction appears profitable—the bank is earning a 20 basis point spread—but it entails considerable risk. Suppose, at the end of a year, an applicable 4year interest rate is 6.00%. The bank is in serious trouble. It is going to be earning 3.20% on its loan and paying 6.00% on its financing. Example: Asset-Liability Risk Exhibit 1
Asset-liability risk is leveraged by the fact that the values of assets and liabilities each tend to be greater than the value modest fluctuations in values of assets and liabilities result in a 50% reduction in capital.
doc_275684633.docx