Introduction to Asset/Liability Management (ALM)
Asset/liability management refers to using assets and cash flows to lower the firm’s risk of loss due to not paying a liability on time. Well-managed assets and liabilities can help you grow your business profits. This process is used to determine the risk on bank loan portfolios and pension plans. It also includes the economic value of equity.
Understanding Asset And Liability Management
- Asset and liability management is a process used by companies to help address any risks resulting from a mismatch of liabilities and assets. These discrepancies can occur due to changes to the economic landscape, such as different interest rates or liquidity requirements.
- A complete ALM framework basically focusses on long-term stability and profitability. They do so by managing credit quality, liquidity requirements, and creating enough operating capital. Unlike other risk management practices, ALM is a collaborative process that uses frameworks to have a look at an organisation’s complete balance sheet. It helps to ensure that assets are invested most optimally and liabilities are moderated over the long term.
Examples Of ALM Risk Mitigation
Although ALM frameworks differ significantly among organisations, they involve the mitigation of a broad range of risks. Some of the most basic risks addressed by ALM are interest rate risk and liquidity risk.
- Interest Rate Risk - Risks associated with changes to interest rates and how unstable interest rates affect future cash flows.
Two examples are deposits and loans. As interest rates impact both, changing rates can cause mismatching of assets and liabilities.
Liquidity Risk - This is a financial institution’s ability to liquidate assets. An inability to do so will negatively affect its financial position.
Other Types of Risk -Currency risk and capital market risk are also mitigated via ALM.
