Changing Your Perspective on ALM for Better Business Results

Mary Ellen Biery
December 13, 2019
Read Time: min

Getting more from ALM

Financial institution executives and directors historically are tempted to view the asset/liability management process as a regulatory requirement -- a cost center at the bank or credit union that is largely focused on meeting interest rate risk reporting requirements.

However, with stagnant interest rates and the challenges of growing capital and earnings, boards are increasingly having conversations about how to manage profitably and use institutions’ balance sheets more effectively. If those discussions aren’t coming in through the asset/liability management function, financial institutions may be missing out, according to Dave Koch, Managing Director of Abrigo Advisory Services.

“If we’re going to strengthen and improve the institution tomorrow, we need to take a little different tack,” he said during a recent Abrigo webinar, “Running a Dynamic Asset/Liability Management Committee. That approach is a more active performance and strengthening of the ALM process and the asset/liability management committee (ALCO), he said.

An effective ALM process, after all, helps financial institutions decide what loans, investments, deposits, and borrowings to pursue. It also helps determine at what rate to offer these, in order to achieve the desired level of financial performance for the bank or credit union while managing potential risks, Koch said.

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Static vs. dynamic ALM approaches

One important trait of an effective asset/liability management model is whether it uses a dynamic or static approach. What’s the difference?

A static approach examines the balance sheet as it is currently structured over a specific period, usually one to two years. It measures the impact of interest rate changes on earnings at risk and net interest margin, economic value of equity, liquidity sensitivity, and repricing gaps, assuming no shifting of balances between account types or changes in products.

By comparison, an ALM model using a dynamic approach takes into account not only the financial institution’s current balance sheet, but also any projections management has planned for asset/liability mixes in the coming years, said Abrigo Advisor Teri Grams. This allows the impact of rate changes to be evaluated in light of more realistic scenarios for the bank or credit union, since rarely does an institution’s balance remain exactly the same from year to year.

Teri Grams of Abrigo“Every financial institution has different management strategies, depending on where their current capital structure is and what their risk limitations are,” Grams said. “It’s important to be able to measure how those strategies may impact their interest rate risk measurements.”

A dynamic ALM model offers the ability to evaluate the potential impact of a strategy before it is implemented. Financial institution managers can simulate the projected results of a strategy and compare them to financial goals and interest rate policy limits, allowing a test of the risk/return trade-offs before implementation.

As the word implies, a dynamic approach to ALM is providing the bank or credit union a continuous and productive method for evaluating risk and return, rather than the more basic, static approach that might satisfy a regulatory requirement but adds little value to strategic decision-making.

dave-kochKoch said that some ALCOs choose to take a more static, basic approach – running the necessary reports, confirming the institution is inside board-established limits, and signing off. “If that’s our approach, then we’re probably going to be more regulatory in nature,” he said.

A more dynamic, management-oriented approach to ALM and ALCO meetings can yield more decision-useful information to help run the financial institution and set it apart as a high-performing one. In that situation, Koch said, “We’re sitting in our ALCO meetings and we’re constantly looking for ways to improve the performance today. Are we generating enough earnings? Can we do something different? How can we get better today within the boundaries of where we think rates might go – both up and down?” Koch said that the crux of a dynamic approach to the ALCO involves looking at the institution’s numbers and analyzing the costs and benefits of different decision scenarios that are options for the bank or credit union. Such moves would be far more useful for managing the financial institution for improved performance than solely examining what might happen in the unlikely event of a sudden and indefinite extreme spike in interest rates.

Accessing asset/liability management advisory services

Political corruption BSABecause a dynamic ALCO requires more effort, such as rolling forecasts and more regular analysis of the business plan and budget, some financial institutions with time or staffing constraints access outsourced ALM advisory services to help make the transition. ALM management advisors who thoroughly understand the existing and pending regulatory expectations can not only simplify the interest rate risk reporting process, they can also help design cost-effective liquidity strategies under various economic conditions, including stagnant interest-rate environments, to avoid underperformance.

During the above-mentioned Abrigo webinar, 51% of attendees said their financial institutions utilize a static approach to ALM modeling, while 38% said their banks or credit unions use a dynamic approach to ALM modeling. 

“I think it’s important we agree to be a little more uncomfortable to help make more things happen for our institutions,” Koch said. “The magic happens when we put ourselves in positions where new opportunities are out there and we’re willing to take that risk. No risk, no return for ourselves. The ALCO is simply equal to more risk taking that makes sense for your institution, which needs to lead to more profitability for that institution moving forward.”

Utilizing a dynamic approach to the ALM model and ALCO itself is the best process for supporting the financial institution as it seeks and evaluates those opportunities.

About the Author

Mary Ellen Biery

Mary Ellen Biery is a Senior Writer and Content Specialist at Abrigo.

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About Abrigo

Abrigo is a leading technology provider of compliance, credit risk, and lending solutions that community financial institutions use to manage risk and drive growth. Our software automates key processes — from anti-money laundering to fraud detection to lending solutions — empowering our customers by addressing their Enterprise Risk Management needs.

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