This lesson examines the fundamentals of Asset and Liability Management (ALM), a core responsibility of the treasury function for financial stability . The EIF International Certificate programme lists “Asset & Liabilities Management Primer” as a core classroom topic .
5.1 The Purpose of ALM
ALM is the process of managing an organisation’s balance sheet to mitigate risks arising from mismatches between its assets and liabilities, particularly in terms of interest rate sensitivity and maturity. The goal is to ensure stability of earnings and capital over time, and to manage the risk of default .
5.2 Mismatches and their Impact
A mismatch occurs when the interest rate sensitivity or maturity of assets differs from that of liabilities. For example:
-
An organisation that funds long-term fixed-rate loans with short-term variable-rate deposits is exposed to interest rate risk. If interest rates rise, the cost of funding will increase faster than the return on the fixed-rate assets, squeezing margins .
5.3 Managing Interest Rate Risk
Several strategies can be used to manage interest rate risk:
-
Gap Analysis: Measuring the difference between interest-rate-sensitive assets and liabilities over various time buckets .
-
Duration Analysis:Â A more sophisticated measure of the price sensitivity of a portfolio to changes in interest rates.
-
Derivatives: Using instruments like interest rate swaps and futures to hedge exposure .