Asset Liability Management: Moving Beyond the Model
In this 2-day workshop, we review lessons learned from the last several business cycles, including what banks missed and why they missed it. Drawing on these lessons, I describe how risk and profitability management are one in the same problem; they cannot be treated as separate and distinct, else the result will be conflicting stories of how the financial institution (FI) makes money.
Following a discussion on the sources of interest rate risk (IRR) and liquidity risk (LR), I describe key metrics and computations used to quantify these risks. I then show how a well-functioning funds transfer pricing (FTP) process immunizes lenders and deposit gatherers against these risks. I provide a detailed description of the mismatch center and how it should contain all IRR- and LR-related earnings and earnings volatility (FYI – this means that mismatch center earnings are highly unlikely to be zero.) This creates a mechanism by which the effectiveness of ALCO can be judged.
David’s understanding of ALM and FTP is exceptional, which is clearly evident in the way he explained the seemingly complex and difficult topics in an easily understandable way. – Head of ALM, European Public Sector Funding Agency
Given that non-maturity deposits (NMDs) make up a material source of funding at most FIs, I describe a dynamic approach to modeling NMDs that incorporates the calculation of their FTP rates. This has the unique benefit of compelling deposit gatherers to consider how product behaviors influence their IRR and LR characteristics; this understanding is embodied in the calculation of the FTP rates and produces significantly more accurate measures of IRR and LR for the financial institution as a result.