Asset Liability Management: Motivation and Techniques Analysis Report

This report provides an overview of Asset Liability Management (ALM), focusing on its motivation and various techniques. It explores the management of interest rate risk and liquidity risk within financial institutions, emphasizing the significance of gap analysis and the net interest margin in assessing bank profitability. The report delves into the practical application of ALM strategies, including gap analysis and interest margin variance analysis (IMVA), illustrating how banks can mitigate risks and optimize their financial performance. It also examines the sources of liquidity and the impact of maturity mismatches on banks. The report concludes by highlighting the benefits of securitization in reducing risks and improving financial outcomes. The content is contributed by a student and available on Desklib for educational purposes.

Assets liability and
management

TABLE OF CONTENTS
DISCUSSING THE MOTIVATION AND TECHNIQUES OF ALM...........................................3
REFERENCES................................................................................................................................6

DISCUSSING THE MOTIVATION AND TECHNIQUES OF ALM
The aim of asset liability management is to effectively and properly managing the risk in
regard to the change in the interest rates or the mix of the balance sheet assets and liabilities in
addition to the holding of the foreign currencies and usage of derivatives. It is aimed at managing
the liquidity and interest rate risk at the balance sheet level of banks. ALM is the mechanism
used to address the issues faced by banks pertaining to liquidity and interest rate risk. Liquidity is
mainly referred to as the ability of bank in meeting its obligations through borrowing or
converting its assets (Owusu and Alhassan, 2021). In addition to this, the mismatch can be due to
change in interest rates as the banks borrows short term and lend long term. The interest rate risk
(IRR) is the largest problem posed to the bank's net interest income and therefore, on the profits
as the change in the IR is having a significant impact over the bank's interest income.
The net interest margin (NIM) refers to the comparing the net interest income (NII) with
the average earning assets. This is sued for measuring the efficiency of the bank. The bank can
reach its target through the way of implementing number of strategies like spreading the risk
between the loan and deposit rates. For instance, a bank reports $10 bn as interest revenue and
$6.7 bn as the interest expense and if the total earning assets is worth $65 bn, then the NIM
would be NIM= ($10 billion−$6.7 billion)/ $65 billion × 100 = 5.08%, this helps in measuring
the profitability of the bank.
Gap analysis is one of the technique of ALM which is used to determine the IR risk and
liquidity risk. The IRR links the variation in the net interest margin in respect to variation in the
interest rates (Lubinska, 2020). The table below shows a positive gap in 24 hours and therefore,
the earnings will improve if the interest rate increase between today and tomorrow. But in
contrast, on 2nd to 30th, the gap is negative thus, if IR increases in the market then interest
expense will also increase.

Liquidity risk is the inability of the bank to meet its obligations. Sources of liquidity:
ability to sell, discount or pledge assets at a short notice, banks ability to raise more money
through money market. Also, when the maturity of assets and liabilities differs, then bank might
experience shortage of cash leading to liquidity gap or the maturity mismatching (Lubińska,
2018). For example: the below table explains that in 3 months, the bank would be receiving
money NRs 68,677 mn. But, in 3 months, it also has liabilities of NRs 45,431 mn which resulted
into liquidity surplus of NRs. 23,246 mn while in the next 3 month it would have gap of NRs.
8,333 mn. The 271-265 days period, there is shortfall in liquidity and the banks can raise the
funds through external sources.

The interest margin variance analysis (IMVA) is utilized for analysing the interest
income on its earning assets. It involves break out the change in interest margin in 3 components
which are- change in rates, volume and mix. It aims at improving the knowledge of effect of
variable change on banks interest margin. The first step in determining the interest rate risk is to
decide assets and liabilities are rate sensitive within a given interval. This is mainly because debt
instrument matures in that time frame or the re-pricing is done automatically. Through the way
of securitisation, the bank can enjoy various benefits along with eduction in risks like- improving
the risk return trade-off, enhancing the liquidity of the asset, or hedging the IR gaps.

REFERENCES
Books and Journals
Lubińska, B., 2018. Contemporary Challenges in the Asset Liability Management. Prace
Naukowe Uniwersytetu Ekonomicznego we Wrocławiu. (519). pp.135-145.
Lubinska, B., 2020. Asset Liability Management Optimisation: A Practitioner's Guide to Balance
Sheet Management and Remodelling. John Wiley & Sons.
Owusu, F. B. and Alhassan, A. L., 2021. Asset‐Liability Management and bank profitability:
Statistical cost accounting analysis from an emerging market. International Journal of
Finance & Economics. 26(1). pp.1488-1502.