Asset Liability Management:
Moving Beyond the Model
Risk in a depository institution's balance sheet is not innate or static; risk results from how the balance sheet is managed and how it evolves through the business cycle.
Asset/Liability Management (ALM) is the practice of managing the risks to earnings and equity value that arise from mismatches between the repricing and liquidity cash flow characteristics of the assets and liabilities on a bank balance sheet. Interest rates are finally moving up in many countries and banks, credit unions, their regulators, analysts and investors are finding that it has been quite some time since any of them have given much thought to interest rate risk (IRR). It has also been several years since new rules for quantifying and reporting liquidity risk (LR) went into effect, but it is only now that much of the excess liquidity that has made balance sheet funding a relatively easy and inexpensive task in recent years is going away; deposit costs are beginning to rise, potentially much faster than many institutions had anticipated.
Compounding these challenges, ALM analysts and their managers have come into the space having not ever worked in a rising rate environment. In addition to mastering the fundamentals of IRR and LR and developing a feel for how changes in rates and the price of liquidity flow through the earnings statement and balance sheet, it is important to recognize that well-designed and well-managed quantitative models are but a small part of an effective ALM framework; a deliberate integration is required with closely-related functions within the firm, including finance (margin attribution and management), product management (marketing and design features), performance management (compensation schema) as well as strategic balance sheet management (rate of targeted loan growth), because risk in a depository institution's balance sheet is not innate or static, risk results from how the balance sheet is managed and evolves through the business cycle.
Delegates to the workshop are provided a comprehensive overview of the theory and practice of ALM. Anecdotes from Dr. Green’s work with financial institutions around the globe for over two decades infuse the discussion. He offers a compelling explanation of the forces that have driven the evolution of ALM and what remains to be done to enhance the understanding of earnings and balance sheet dynamics. A central premise of the workshop is that risk and profitability management cannot be treated as separate and distinct exercises.
- IRR and LR are intrinsic to the business of banking; these risks are ever-present and in addition to being a key source of earnings and economic value volatility, these risks also explain the actual level of earnings and economic value
- IRR and LR cannot be quantified through a single metric, so multiple measures are required in order to construct a mosaic of the exposures; the relative strengths and weakness of re-pricing and liquidity GAP reports, earnings simulation reports and duration of equity measures (economic value of equity sensitivity) are described
- The measurement and management of IRR and LR is materially enhanced through the use of FTP; a well-functioning FTP process ties the identification, quantification and management of risk to the measurement and management of profitability at a very granular level
- The relevance of ALM modeling changes dramatically when it is integrated into other aspects of balance sheet management such as budgeting/forecasting, margin management, strategic planning and mergers and acquisitions; logical extensions are discussed at length
- The assessment of IRR and LR is highly-levered to the assumptions around the behavior of NMDs; an approach to NMD modeling is described which simultaneously estimates re-pricing cash flows, liquidity cash flows and FTP rates, linking the treatment of NMDs in risk and profitability management contexts
- Behavioral models must be calibrated to a specified level of robustness; many risk limits span a wide range of rate and liquidity scenarios, so the underlying behavioral assumptions must be consistent with the economic environment being contemplated
- Regulatory expectations regarding the quantification and disclosure of IRR and LR exposures continue to expand; these will inevitably compel more accurate reporting of mismatch center earnings
Why You Should Attend
This course provides a comprehensive take on the exciting challenges and possibilities of ALM. Despite its traditional name, the function is probably better labeled 'balance sheet management'. Regardless of how it is called, all the right pre-conditions (detailed transaction/position data for every line item on the balance sheet, vast simulation capabilities, limitless reporting and analytical possibilities) exist for contemplating outcomes in any pro forma scenario, yet, at most depository institutions, the function fails to produce the value insights and feedback for which it is capable. One key reason is that risk (ALM) and profitability management are often located in separate and distinct functional areas of the organization - ALM is usually a part of Treasury, and profitability management is in Finance. While ALM is intrinsically forward-looking and acknowledges a world of uncertainty, the perspective of Finance tends to be more focused on explaining the very near past and the very near future, and, in the case of the latter, the explanation is usually focused only on a single scenario - the budget.
While each of these functions is critical to the success of the organization, if each produces stories that are not aligned, management is challenged, first, to recognize the mis-alignment and then, second, to reconcile the stories . The truth is that risk management cannot be meaningfully separated from profitability management; these two exercises must be considered as one (see interview with Dr. Green). The alignment of risk and profitability management is accomplished through the development, management and operation of a well-functioning Funds Transfer Pricing (“FTP") process. In practice, FTP remains very much in its infancy; IRR- and LR-related earnings are all but ignored in the earnings management process, erroneously attributed to lending and deposit gathering activities (see Roulette Wheels, Interest Rate Risk and the Mismatch Center). At many organizations, and even within much of the regulatory community, FTP is viewed solely as a profitability management exercise of carving up the earnings pie. For many, though, the change in the rate environment has begun to reveal that current earnings attribution processes are inadequate, producing only noise at a time when clarity is desperately needed.
In the workshop, Dr. Green speaks to data challenges and important ETL considerations, simulation and behavioral model design, as well as implementation and governance considerations relating to model calibration. There are also discussions on recommended approaches to integrating ALM models in other aspects of risk and balance sheet management, including budgeting/forecasting, strategic balance sheet management, mergers and acquisitions and balance sheet stress testing.
Dr. Green also discusses behavioral modeling of NMDs, a necessity for every single depository institution. In addition to a comprehensive set of IRR and LR analytics, the NMD Model that he has developed has its own FTP rate calculator that is specifically designed to ensure the consistent treatment of NMDs in a wide variety of risk and profitability exercises.
Who Should Attend
This course is intended to benefit all members of a depository institution’s ALCO committee, ALM managers and their analysts, FTP managers and their analysts, liquidity managers and their analysts, budgeting/forecasting managers, auditors, product managers, product profitability managers, performance management personnel, as well marketing directors. Regulators, central bankers and academics will also benefit from the extensive discussions and applications of theoretical and conceptual modeling frameworks to real-world problems.
A detailed questionnaire will be sent to each delegate to identify their specific training needs and elicit questions and topics they would like to see covered. The completed forms will be reviewed by Dr. Green; he will make every effort to ensure that the course speaks to these requests.
What Past Delegates Have Said About David's Asset/Liability Management Workshop
"Very informative and educational. Caters to all levels." - Wells Fargo
"Excellent, even better than I expected it would be! David put the ALM Model into a comprehensive perspective." - Barclays Bank
"The course is informative, educational and insightful. I enjoyed it very much." - Federal Reserve Bank of Chicago
For courses in the US and Canada, contact:
Office: +1.305.358.6138 ext 4222 or 4206 (Miami)
For courses in Central and South America, contact:
Office: +1.305.358.6138 ext 4240 (Miami)
For courses in Europe, contact:
Office: +44.203.002.3354 (London)