What is Asset Liability Management (ALM) and what are the risks it addresses?

 Asset and liability management also known as ALM banking or ALM finance by the financial companies in India, manages the size, quantities and totals of balance sheet items. But what are assets and liabilities?

Assets are the items or value that a company or an individual holds which can be liquidated at any point of time. Liabilities on the other hand are something you owe to either your creditors, vendors, suppliers or other stakeholders, and they decrease the value of your company.

Asset and liability management strategies are used by financial companies in India and over the world to solve three major risks – Credit risk, liquidity risk, interest rate risk.

Credit risk – These risks occur when we don’t get paid as much as we expected to. With loans contributing to be the largest source of credit risks for most banks and financial companies in India, cash management, FX, credit derivatives, unfunded loan commitments, letters of credit and lines of credit are some other contributors to disturbing the balance sheet of an institute. They use the ALM model to take a consistent approach to project the impact of credit risks on cashflow and capital under various circumstances to lower their exposure to this risk.

Liquidity risk – Liquidity is the ability of your assets and valuables to convert into cash easily.  For example: Keeping your house as a collateral for an overseas education loan. Asset and liability management helps banks and other institutions to identify, measure and monitor liquidity risks by taking into consideration the future projections and adverse scenarios to warrant themselves against this risk.

Interest rate risk – The most strongly associated risk with ALM is the risk that has resulted because of volatility in the interest rates. Financial institutions quantify their exposure to this risk by running measurement tools and techniques along and create their own ALM model, outsource it or use a hybrid approach to insure themselves against interest rate volatility.