ALM Process

 The scope of ALM function can be described as follows:

         Liquidity risk management

         Management of market risks

         Trading risk management

         Funding and capital planning

         Profit planning and growth projection

 

The mitigation of a broad range of risks is often involved in ALM frameworks, despite the fact that they vary considerably amongst businesses. Interest rate risk and liquidity risk are two of the most frequent hazards that ALM addresses.Risks connected to fluctuating interest rates and how they impact upcoming cash flows are referred to as interest rate risk. The assets and liabilities that financial institutions normally hold are impacted by shifting interest rates. Deposits (assets) and loans are two of the most typical instances (liabilities). Interest rates have an effect on both, therefore when rates are fluctuating there may be an imbalance between assets and obligations.

 

Risks relating to a financial institution's capacity to meet its current and future cash-flow obligations, commonly known as liquidity, are referred to as liquidity risk. The risk is that it will negatively impact the financial institution's position when it is unable to fulfill its obligations because of a lack of liquidity. Organizations  may  use  ALM  methods  to  boost  liquidity  in  order  to  meet  cash-flow  commitments resulting from their liabilities in order to reduce the risk of liquidity.

 

ALM also reduces risks of other kinds in addition to interest and liquidity hazards. One instance of a risk related  with  changes  in  exchange  rates  is  currency  risk.  A  mismatch  may  occur  when  assets  and obligations are kept in different currencies due to fluctuations in exchange rates.

ALM Organization

 The senior management in the FI must be fully committed to integrating risk management into everyday operations and strategic decision-making in order for the risk management process to be successfully implemented.The Board should be in charge of overall market risk management, select the FI's risk management strategy, and establish upper and lower bounds for liquidity, interest rate, exchange rate, and equity price risks.

The ALCO is a decision-making unit made up of the senior management of the FI, including the CEO, and is in charge of strategic management of interest rate and liquidity issues as well as integrated balance sheet management from a risk-return perspective.While each FI will have to determine the function of its ALCO, its authority, and the decisions that will be made by it, its duties would typically include:

 

     Articulating  the  current  interest  rate  view  and  a  view  on  future  direction  of  interest  rate movements and basing its decisions for future business strategy on this view as well as other parameters considered relevant;

     Monitoring the market risk levels of the FI by ensuring adherence to the various risk-limits set by the Board;

     Choosing a business strategy for the FI that is compatible with its interest rate outlook, financial constraints, and predetermined risk management goals on both the assets and liabilities sides.This in turn would comprise:

Ø   determining the desired maturity profile and mix of the assets and liabilities;

Ø   product pricing for both - assets as well as liabilities side;

Ø   deciding the funding strategy i.e. the source and mix of liabilities or sale of assets; the proportion of fixed vs floating rate funds, wholesale vs retail funds, money market vs capital market funding domestic vs foreign currency funding, etc.

     Reviewing the results of and progress in implementation of the decisions made in the previous meetings

 

Analysis, monitoring, and reporting of the risk profiles to the ALCO should be the responsibility of the ALM Support Groups made up of operating staff. Additionally, the staff should create projections (simulations) that show how various potential changes in market conditions will affect the balance sheet and suggest the necessary steps to stay within FI's internal limitations.

 

The size of each institution, the mix of businesses, and the complexity of the organization will all affect ALCO's membership. The CEO, CMD, DMD, or ED should be in charge of the Committee in order to guarantee Top Management commitment and prompt response to market dynamics. Though the members of the Committee should include the Chiefs of Investment, Credit, Resources Management or Planning, Funds Management / Treasury (forex and domestic), International Business, and Economic Research, the composition of ALCO may vary among FIs depending on their individual setups and business profiles. For the development of MIS and associated computerization, the Head of the Technology Division should also be invited. Even subcommittees and support groups may exist in some FIs.The ALM system should be implemented under the supervision of the Management Committee of the Board or any other Specific Committee that the Board has established, and its operation should be frequently reviewed.