what is alm and alco.pdf
TRANSCRIPT
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.