In this sense, liabilities include depositors' money and funds banks borrow from other financial institutions. Banks practice liability management as a sort of insurance against interest rate fluctuations.
Liability management is not new, and at one time was just a theory, but it is now standard practice. Banks began to practice strategies of asset liabilities management in the s by offering negotiable certificates of deposit, or CDs. Banks were then able to sell the CDs into the secondary market in order to raise additional capital. In this sense, liability management goes all the way back to the U. Promising a good rate on return, Hamilton then used the proceeds from selling shares of the debt to finance the new U.
Banks, however, have not always done a good job of liability management.
Asset Liability Management
In the period that led up to the to financial crisis, some banks mismanaged their liabilities because they relied on short-maturity debt borrowed from other banks to fund long-maturity mortgages. In part, this led to the financial crises and the failure — or near failure — of some banks, investment houses, as well as other financial institutions.
Asset liabilities management is the key to success for any bank or financial institution. According to Dr. Harold M. Sollenberger, who is a professor emeritus at Michigan State University:. Asset liabilities theory , a synonym for asset-liability management, ALM banking or ALM finance, is the process that deals with interest rate risk management. Asset liabilities theory, and asset liabilities management which is the implementation of the theory is of extreme importance, because it is one of the two main risks that face financial institutions — the other being credit risks.
Asset liability theory holds that when a bank simultaneously manages its assets and liabilities, it can then measure, monitor, and control the effects of changing interest rates on income, asset values, liquidity, and regulatory capital, thereby protecting the future viability of the bank. Virtually all financial institutions depend on asset liabilities management to stay afloat.
Asset liabilities management is probably the key asset management technique that banks use today. Balance sheet management is very important in a business sense; that is, without proper management of assets and liabilities, a financial institution would cease to exist. Banks, and other financial institutions, have the added burden regarding the fact that their assets and liabilities are essentially moving targets. That is, if banks have to suddenly pay more to borrow money, which as noted generally involves short-term loans, then their liabilities would increase markedly in comparison to their assets, mainly the outstanding loans on which they are collecting interest from borrowers.
But balance sheet management also has an important regulatory definition. Balance sheet management covers "regulatory policy for investment securities, Bank-Owned Life Insurance BOLI , liquidity risk, and interest rate risk for national banks, as well as the assessment of interest rate risk and liquidity risk for the national banking system as a whole, " according to the U.
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Treasury Department, which sets standards and rules for balance sheet management. As the Treasury Department explains, the acceptance and management of financial risk is an integral and unavoidable part of the banking business. To meet the demands of their customers, banks make loans and take deposits with different maturities and interest rates. The Treasury Department sets specific, and somewhat complex, rules dictating how much cash and other assets banks need to hold in reserve in relation to their outstanding loans.
This process, which is balance sheet management, involves such liabilities and asset management techniques as:. The last two items have to do with rules for managing risks associated with securities that banks purchase, as well as derivatives, another financial security product based on an asset or a group of assets that banks trade in. They can profit from derivatives or lose money. All of the above factors involve balance sheet management, rules to help ensure that banks don't take on too much risk in relation to their assets.
In other words, if a bank take deposits from customers in the form of savings accounts and CDs, that bank must be able to pay customers promised interest rates and to honor withdrawals on those savings accounts at any time. About this book This book introduces ALM in the context of banks and insurance companies. Free Access. Summary PDF Request permissions.
- Asset Liability Management Techniques;
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