Summary of Article on “Asset-Liability Management”

Here is the link to the article https://twitter.com/FinsenseG/status/1259705804661256193?s=19

In this article, the concept of ALM is explained.

What is ALM?

Simple, ALM is the management of assets and liabilities. For banks, assets are the loan given to customers and liabilities are the deposit made by the customers or money raised by debt instruments like NCD’s or bonds etc.

What is a mismatch?

When banks have excess of either deposits or liabilities in a single time frame, it is mismatch. Example – A bank has deposits for 5 years but it gives loan for 20 years.  After 5 years when depositors will demand money then bank would not be in a position to pay it back and thus it will default.

Banks have to group all their assets and liabilities (according to time frame) and need to show it in balance sheet.

Some techniques used by banks for management of assets and liabilities –

1. Gap Analysis – Interest rate risk on RSA (Risk Sensitive Assets) and RSL (Risk Sensitive Liabilities) are assessed using this method. RSA and RSL are floating rate loans or deposits or any instrument with premature mature and withdrawal option.
2. Duration Analysis – Duration analysis is done to asses risk of interest rate fluctuation. Higher the maturity of instruments, higher is the chance of change in interest rate.
3. Scenario Analysis – In this method, various scenarios are created to check how ALM can be affected in future. Scenarios can be like rise in interest rate, decline in interest rates etc.

Thus ALM is an important concept when it comes to risk management. Investors gain confidence if ALM is good. It can be checked in annual reports of banks/ NBFC’s.