What is ALM and ALCO

Asset Liability Management (ALM) is an integral part of Bank

Management; and so, it is essential to have a structured and

systematic process for manage the Balance Sheet. Banks must have

a committee comprising of the senior management of the bank to

make important decisions related to the Balance Sheet of the Bank. The committee, typically called the Asset Liability Committee

(ALCO), should meet atleast once every month to analysis, review

and formulate strategy to manage the balance sheet.

As the Treasury Department is primarily responsible for Asset

Liability Management, ideally the Treasurer (or the CEO) is the

Chairman of the ALCO committee. The committee consists of the

following key personnel of a bank:

-Chief Executive Officer / Managing Director

-Head of Treasury / Central Accounts Department

-Head of Finance -Head of Corporate Banking

-Head of Consumer Banking

-Head of Credit

-Chief Operating Officer / Head of Operations

The committee calls for a meeting once every month to set and

review strategies on ALM. In every ALCO meeting, the key points

of the discussion should be minuted and the action points should be

highlighted to better position the bank’s balance sheet. In every

ALCO meeting, action points taken in the past ALCO meeting

should be reviewed to ensure implementation. Specific functions of ALCO are:

1.To receive and review reports on liquidity risk, market risk and

capital management as covered in this report.

2.To identify balance sheet management issues like balance sheet

gaps, interest rate gap/profiles etc. that are leading to under-

performance.

3.To review deposit-pricing strategy for the local market.

4.Review liquidity contingency plan for the bank.

The key roles and responsibilities of the ALM Desk:

1)To assume overall responsibilities of Money Market activities.

2)To manage liquidity and interest rate risk of the bank.

3)To comply with the local central bank regulations in respect of

bank’s statutory obligations as well as thorough understanding of

the risk elements

involved with the business.

4)Understanding of the market dynamics i.e competition, potential

target markets etc.

5)Provide inputs to the Treasurer regarding market views and

update the balance sheet movement. 6) Deal within the dealer’s authorized limit.

1.ALCO & Asset Liability Management (ALM)

The bank’s asset liability management is monitored through ALCO.

The information flow in the ALCO can be diagramed as below:

What happens to Bank if ALM is not maintained properly

1.Balance Sheet Risk: Balance sheet risk can be categorized in to

two major types of significant risk, which are liquidity and interest

rate risks. Changes in market liquidity and or interest rates exposes

banks/ business to the risk of loss, which may, in extreme cases,

threaten the survival of institution. As such, it is important that

senior management as well as the directors must understand the

existence of such risk on the balance sheet and they should ensure

that the structure of the institutions’ business and the level of

balance sheet risk it assumes are effectively managed, that appropriate policies and procedures are established to control and

limit these risks, and that resources are available for evaluating and

controlling interest rate risk.

2.Liquidity Risk:The risk that bank or business will be unable to

meet it’s commitment as they fall due leading to bankruptcy or rise

in funding cost. It is the solvency of business and which has special

reference to the degree of readiness in which assets can be

converted into cash without loss. Banks traditionally use the

statutory liquidity reserve and their borrowing capacity in the

volatile interbank money market as the source of liquidity. But a

conscious approach to measure and monitor the liquidity is some what lacking in our market. We can learn and draw immense benefit

by sharing the best practices, tools and techniques of liquidity

management.

3.Interest Rate Risk: Interest rate risk is the exposure of a bank's

financial condition to adverse movements in interest rates.

Accepting this risk is a normal part of banking and can be an

important source of profitability and shareholder value. However,

excessive interest rate risk can pose a significant threat to a bank's

earnings and capital base. Changes in interest rates affect a bank's

earnings by changing its net interest income and the level of other

interest-sensitive income and operating expenses. Changes in interest rates also affect the underlying value of

the bank's assets, liabilities and off-balance sheet instruments

because the present value of future cash flows (and in some cases,

the cash flows themselves) change when interest rates change.

Accordingly, an effective risk management process that maintains

interest rate risk within prudent levels is essential to the safety and

soundness of banks.

4.Capital Adequacy:The need to adopt the best international

practices, given the globolisation of economies and businesses. As

you are aware of “Basel Committee on Banking Supervision” and the emphasis on maintaining the Capital Adequacycommensurate to

exposure or risk on balance sheet. The new “Basel Capital Accord”

stipulates that “ Banks must hold capital commensurate with the

level of interest rate risk they undertake”. As mentioned earlier,

Changes in interest rates expose banks to the risk of loss, which

may, in extreme cases, threaten the survival of the institution. In

addition to adequate systems and controls, capital has an important

role to play in mitigating and supporting this risk. As part of sound

management, banks translate the level of interest rate risk they

undertake, whether as part of their trading or non-trading activities,

into their overall evaluation of capital adequacy, although there is no general agreement on the methodologies to be used in this

process. In cases where banks undertake significant interest rate risk

in the course of their business strategy, a substantial amount of

capital should be allocated specifically to support this risk.