Asset/Liability Asset Liability Modeling

Fine-Tuning ALM Strategies for 2020

Kylee Wooten

January 10, 2020

Read Time: 0 min

Key Takeaways

If you don't feel like your modeling results are relevant, then it might be time to ask different questions.
Shift your ALM model from a static to a dynamic approach to find more value in your results.
Strapped for time to implement these strategies? Consider leveraging valuable resources to help.

If the primary goal of your asset/liability management (ALM) process is centered on meeting interest rate risk reporting requirements, then it’s likely that your institution views ALM as a cost center. Setting up your ALM model to satisfy regulators isn’t particularly difficult; however, getting the most mileage out of your institution’s ALM process can be challenging if you don’t recognize the strategies and benefits ALM can offer. As margins continue to be under pressure, due to Federal Reserve decisions and competitor actions, the need for managing profitability and leveraging balance sheets more effectively is increasingly important. By fine-tuning your ALM strategies, your financial institution can achieve its desired growth and profitability while mitigating risks.

Ask the questions that matter

Do you ever question whether or not your ALM model is reliable? Perhaps you’re not worried about how reliable the results are, but whether or not they’re relevant. “If you ask most financial institution CEOs and CFOs if they believe in the results produced by an interest rate risk forecast, many will tell you no,” said Dave Koch, Managing Director of Advisory Services at Abrigo. A key reason for the lack of conviction? Modeling includes many assumptions and can focus on unrealistic situations, such as a 400 basis point swing in rates. Oftentimes, modeling is used simply to to satisfy a requirement, but it doesn’t measure key areas that banks and credit unions actually care about.

In addition to modeling for the required scenarios, Koch recommends using ALM models to run forecasts on more realistic issues that the financial institution faces, such as possible movements in the market interest rates and the potential effects it may have on margins and capital. “When we spend time modeling the things that we really manage in our daily life, the things that actually cause us to lose sleep, we have a chance to make the ALM process more worthwhile,” Koch said.

To fine-tune your ALM strategy in 2020, consider these three questions:

What is my overall performance on earnings, capital, and growth if rates don’t rise?
Are we making enough return now?
How much risk am I willing to take to improve financial performance?
What can we do to maximize risk and return based on a variety of possible outcomes?

If your institution doesn’t trust your ALM model results or feels that they’re not relevant, then it’s likely that you are not able to provide answers to those questions.

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Find value beyond regulation

Being unable to answer those questions adequate means your institution may need to change its approach to ALM modeling. The majority of financial institutions use a static approach to their ALM model, according to a poll during a recent Abrigo webinar, “Running a Dynamic Asset/Liability Management Committee.” A traditional, static approach to ALM is more regulatory in nature, simply examining the balance sheet in its current state over a specific period. Many financial institutions tend to stick to a static approach due to a lack of time and staff available to dedicate their efforts to ALM.

However, savvy financial institutions have found that by shifting their ALM process from a static approach to a dynamic approach, they are able to make more informed decisions in both strategy and risk. A dynamic approach takes the financial institution’s current balance sheet into account, as well as any projections management has planned for asset/liability mixes in the coming years, said Abrigo Advisor Teri Grams. In a dynamic ALM model, your financial institution has the ability to assess the potential impact different management strategies may have on your institution’s interest rate risk measurements and goals, and test risk and return trade-offs prior to implementation.

A dynamic ALM approach provides more than just interest rate risk reporting; it’s a reflection of future growth and success for a financial institution and can impact an institution’s long-term health. The root of a dynamic approach is that it weighs and analyzes the costs and benefits of different “what-if” scenarios that the bank or credit union might encounter or choose. These considerations are significantly more impactful for managing the institution’s performance than simply examining what might happen in the unlikely event of a sudden and indefinite extreme spike in interest rates, as static approaches tend to focus on.

Leverage the right resources

If you are like the majority of financial institutions, you may be strapped for time and staff to hone these ALM strategies diligently. Whether your bank or credit union leverages a self-run or outsourced ALM model, it could be extremely beneficial to seek out resources to take your model to the next level. Many resources are available to help your team gain a better understanding of how to work with formulas, what-if analysis, stress testing, and building report sets.

For example, if your bank or credit union is interested in additional tips for shifting to a dynamic ALM process to make more informed decisions, watch Abrigo’s free webinar, “Managing a Dynamic Asset/Liability Management Committee.” If your financial institution is seeking more interactive, hands-on experience with ALM modeling and a more in-depth understanding of modeling income at risk and value at risk, join one of Abrigo’s workshops, available to customers.