Liability Management

4 Key excerpts on "Liability Management"

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  eBook - ePub

  The Money Markets Handbook

  A Practitioner's Guide

  • Moorad Choudhry(Author)
  • 2011(Publication Date)
  • Wiley

    (Publisher)

  CHAPTER 7 Asset and Liability Management

  As part of our discussion on the money markets, we will consider in this chapter a major part of banking activity, and one that is closely related to the main business of banking, which is the subject of asset and Liability Management. The art of asset and Liability Management (ALM) is essentially one of risk management and capital management, and although the day-today activities are run at the desk level, overall direction is given at the highest level of a banking institution. The risk exposure in a banking environment is multi-dimensional, for example they encompass interest-rate risk, foreign-exchange risk, liquidity risk, credit risk and operational risk. Interest-rate risk is one type of market risk. Risks associated with moves in interest rates and levels of liquidity1 are those that result in adverse fluctuations in earnings levels due to changes in market rates and bank funding costs. By definition, banks’ earnings levels are highly sensitive to moves in interest rates and the cost of funds in the wholesale market. Asset and Liability Management covers the set of techniques used to manage interest rate and liquidity risks; it also deals with the structure of the bank’s balance sheet, which is heavily influenced by funding and regulatory constraints and profitability targets.

  In this chapter we review the concept of balance sheet management, the role of the ALM desk, liquidity risk and maturity gap risk. We also review a basic gap report. The increasing use of securitisation

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  eBook - ePub

  Financial Theory: Perspectives From China

  Perspectives from China

  • Xingyun Peng(Author)
  • 2015(Publication Date)
  • WCPC

    (Publisher)

  The basic idea behind the theory of expected income is that the liquidity status of commercial banks is, in the final analysis, based on future income and is positively related to the income. As long as future income is guaranteed, long-term project loans and consumer loans can ensure bank liquidity so long as they are repaid in installments. Conversely, if future income cannot be guaranteed, even short-term loans run the risk of default. Therefore, this theory states that commercial banks should use the future income of borrowers as a standard measurement of their ability to repay loans so as to coordinate profitability with liquidity and safety. The expected income theory also states that the time and amount of borrower income can be expected if a portion of income is used to repay the loans each period, it will not only guarantee loan repayment, but also ensure the amount and time of repayment. If the payment is made in installments, even a long-term loan will often be accompanied with liquidity during the duration of the loan.

  8.2.2Liability Management

  (a) Main Contents of Liability Management

  Liability business is the basis of bank assets. For this reason, Liability Management is much more important to banks than it is to industrial and commercial enterprises. The basic content of bank management of liability business is to find a stable source of financing at a low cost. Drawing deposits, borrowing from the central bank, borrowing from the interbank lending market and issuing financing bonds are the primary means by which banks obtain funding, although the majority of bank liability funds come from deposits. For this reason, the key to bank liability business management is the means by which more deposits can be drawn.

  Capital management is a major element of modern bank Liability Management. There are three primary uses for bank capital: absorbing operating losses including risk losses, ensuring normal bank operations, allowing some time for the bank management to resolve existing issues, and providing a buffer to avoid bankruptcy. Adequate capital will assist in boosting public confidence in the banks and displaying the strength of the bank to its creditors. The more the bank capital, the more confident will depositors become. The capital adequacy ratio calculated on the basis of regulatory capital is an important tool for regulatory authorities to control banks’ risk-taking behaviors and guarantee the stable operation of the market. Therefore, the higher the risk the bank capital is exposed to, the higher is the capital requirement the regulators demand. The capital adequacy requirement may, to some extent, prevent commercial banks from taking excessively risky behaviors in their portfolio choices.

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  eBook - ePub

  Bank Asset and Liability Management

  • (Author)
  • 2018(Publication Date)
  • Wiley

    (Publisher)

  As discussed earlier, a bank's assets and liabilities are contained in its balance sheet. Asset and Liability Management, therefore, is in large part concerned with balance sheet management with the aim of maximising profitability within the constraints of regulations and risks. As the Society of Actuaries defines it, ‘ALM is the ongoing process of formulating, implementing, monitoring and revising strategies related to assets and liabilities to achieve the financial objectives for a given set of risk tolerances and constraints.’

  The importance and functions of ALM can be viewed in terms of the following three-stage approach to balance sheet management as presented in Table 1.2 :

  TABLE 1.2 A three-stage view of asset and Liability Management Source: HKIB.

  Stage I (General)
  Asset management	Liability Management
  Capital management
  Off-balance-sheet activities (OBSAs)	OBSAs
  Stage II (Specific)
  Reserve-position management	Liability Management, LM (‘purchased funds’)
  Liquidity management	Reserve-position LM (Federal Funds)
  Investment/securities management	Generalised or loan-position LM (CDs)
  Loan management	Long-term debt management (notes and debentures)
  Fixed-asset management (‘bricks and mortar’)	Capital management (common equity)
  OBSAs	OBSAs (e.g. interest-rate derivatives, IRDs)
  Stage III (Balance sheet generates the income–expense statement, given interest rates and prices)
  Profit = interest revenue − interest expenses – provision for loan loss + non-interest revenue − non-interest expenses − taxes
  Free cash flow = cash from operations + balance sheet sources − balance sheet uses

  • Stage I reflects a general approach that focuses on coordinated management of a bank's assets, liabilities, capital and off-balance-sheet activities.
  • Stage II

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  eBook - ePub

  Risk Strategies

  Dialling Up Optimum Firm Risk

  • Les Coleman(Author)
  • 2016(Publication Date)
  • Routledge

    (Publisher)

  ALM can be viewed as an integrated financial strategy, linking assets, liabilities and off-balance sheet items to costs and revenues in light of the quality and nature of firm risks. The strategic objective is to minimize financial risks by closing asset-liability mismatches through the business cycle. In particular, ALM optimizes operating risks through ERM and optimizes strategic risks through governance; matches risks in capital structure to other firm risks; and uses risk management products including insurance to balance exposures.

  This is completely consistent with the standard objectives of corporate finance which are to optimize deployment of capital resources so as to maximize value; provide capital to support firm exposures, and liquidity to support operations; and optimize risk and financing costs. It recognizes that a firm’s operations and strategies determine its risks and these can be complemented by matching financial risks. ALM takes account of contingent capital provided through insurance and the residual level of firm risk after financial and operational risk management.

  An advantage of ALM is to specifically link firm risk to corporate finance. Risk management is integral to corporate finance as it affects cash flow uncertainties and capital needs across time; and contributes (especially through insurance) to the level of available capital. A typical example of using ALM to minimize overall risks involves a company with high-commodity price exposure which might prefer to hedge other financial risks whilst minimizing fixed costs including debt.

  Although the management of these risks can be embedded in business units (for example, credit may be a part of the marketing or distribution group), the overall exposures are recognized centrally and coordinated. Let us consider how a firm might utilize ALM to shape portfolio composition, liquidity, counterparties and asset funding.

  The conventional assumption in corporate finance is that investment decisions should be made independently of the method of financing them. Thus an acquisition or new project should be evaluated in terms of the returns it delivers relative to the risks of that investment; and financing should be an independent firm-wide consideration. In practice most firms link the investment and financing decision to optimize risk: acquisitions, for instance, tend to rely more heavily on debt finance than do built investments.

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