The Asset Liability Management (ALM) process helps a company manage its assets and liabilities in such a way as to avoid loss due to defaulting in the repayment of liability. It allows management to monitor assets and cash flows to provide the best advantage to the company and increases the chances of the company securing future loans.
Asset Liability Management not only helps businesses with risks related to currency and liquidity but also helps maximize profit on assets, creating a surplus. Therefore, it is also called surplus management. Asset Liability Management makes its decisions by reviewing past and recent performance through financial statements using indicators to make a financial decision accordingly and in the business’s or the bank’s best interest. The funding strategy is also concerned with countering liquidity issues and increasing the rate of return.
Uses of Asset Liability Management
Gap Management: A change in the interest rate causes a gap between the assets and liability. This gap ends up creating Sensitive Rate Assets and Rate Sensitive Liabilities. You can reduce such gaps by making time bands, checking, and matching assets and liabilities after completing each time band, optimizing the earnings of the current economic cycle.
Meeting the Liquidity Needs: The primary purpose of Asset Liability Management is to make the assets available whenever needed. This method maximizes profit by allocating the assets to the department that needs it the most and where its utilization will be the most cost-effective.
Alteration: The method of alteration by the asset management tool helps the business reduce the risk imposed on the company through the balance sheet. It does not eliminate the risk but allows the company to manage and reduce it.
Banks
A banking institution deals with a massive number of transactions regularly. Such an enormous number of transactions increases its chances of having risks on the balance sheet. Therefore, banks try to find a balance to prevent themselves from risk in case of a sudden change in the interest rates. A bank must fix the interest rate on its funding; otherwise, banks will incur a significant loss if the interest rates increase higher than the charged rates. Moreover, banks are exposed to the risks related to foreign exchange rate fluctuation and currency depreciation. Therefore, banks make use of Assets Liability Management to manage such risks because they cannot be prevented but can only managed. ALM helps banks manage liquidity, risk analysis, future projection, and capital planning while mitigating risks.
Business Use
Asset Liability Management tools help the company find the best funding structure using an analysis of the company’s dynamics. Every company has a core product in which it uses some material, causing the material to be its essential material. A management tool like ALM helps the company forecast the fluctuation in the prices of the core material and make decisions accordingly. Moreover, it helps businesses make decisions by reviewing past and recent performance through financial statements, performance indicators, and consideration of company goals and interests.
Seven factors revolve around the asset liability management cycle and are necessary for smooth operational activities. They are data collection, cash flow evaluation, portfolio architecture, result monitoring, decision making, risk/revenue evaluation, and strategy development. Asset liability management refers to capital development and transformation, including gap financing, cash flow, and interest rate analysis.
Asset Liability Management and Market Environment
ALM and other modules offer a certain way to help you manage the environment market:
- Instruments costs and dividends
- Indexes, yield curves, and credit spread curves
- Foreign exchange trading rates
- Stock indexes
- Interactive broker rates
- Implied volatility
- Bond baskets for future
- Table of life for insurance instruments
- Eligibility for providers
- Multiple market application
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