Asset and Liability Management (ALM) remains at the core of a bank’s risk management framework and serves as the “secret sauce” of its profitability. Banks typically lend long on a fixed or floating basis and borrow short under similar terms. This creates exposure to various risks, primarily related to the credit quality of loan portfolios, the impact of fluctuating interest rates and yield curves, and liquidity mismatches. Liquidity, in this context, reflects a bank’s ability to meet its obligations by either borrowing or converting assets into cash efficiently.
How does it work?
To navigate these challenges, every bank must implement a robust ALM policy framework that prioritises both profitability and long-term viability. Effective ALM demands strong liquidity risk management paired with interest rate risk (IRR) oversight. These efforts are essential to isolating and managing risks inherent to the non-trading books, distinct from the risks addressed by the dealing room. At its simplest, ALM is a systematic approach that protects against risks stemming from asset and liability mismatches, while supporting hedging policies that align with a bank’s Risk Appetite Statement (RAS). It underpins a bank’s ability to maintain controlled interest and liquidity risk levels.
How does it function in practice?
The Role of ALCO
The Asset-Liability Committee (ALCO) is the central forum for managing balance sheet risk within a bank. Recognised by regulatory authorities, ALCO plays a vital role in fostering balance sheet resilience and optimising Return on Capital. In the context of the UK’s Senior Managers & Certification Regime (SMCR), a strong ALCO infrastructure is indispensable for best-practice governance. ALCO meetings require meticulously prepared reports that focus on strategic decision-making, liquidity monitoring, goal progression, and adherence to policy limits for both assets and liabilities.
Other Influential Factors
Beyond IRR and liquidity management, ALM policies must address additional challenges, including changes in securities pricing, foreign exchange fluctuations, and yield curve volatility. Modern ALM frameworks also account for off-balance-sheet risks and the effectiveness of related hedging strategies. Today’s banks must also have the capacity to simulate earnings and capital impacts under diverse economic scenarios.
What is required?
Modern ALM policies are increasingly shaped by regulatory demands, such as the Basel Committee on Banking Supervision (BCBS) guidance on interest rate risk management. Legacy systems present significant hurdles to compliance, including:
- Lack of automation: Limited end-to-end straight-through processing (STP) and reliance on manual interventions.
- Fragmented IT systems: Dependency on spreadsheet-based processes, increasing operational risks.
- Regulatory challenges: Difficulties in achieving compliance with evolving standards.
- High costs: Rising operational expenses and the need for larger teams.
By upgrading their systems, banks can unlock the benefits of integrated functionalities, such as linking liquidity and interest rate risk management within the non-trading book (IRRBB).
The Shifting Sands
As with trading operations, ALM has undergone transformative regulatory changes. Supervisory bodies demand more granular and transparent reporting that extends beyond traditional metrics like the Liquidity Coverage Ratio (LCR). To keep pace, modern ALM systems must deliver:
- Data integrity ensured through automated quality checks.
- Transparent, audit-ready reporting with granular data capture.
- Compatibility with reporting standards, such as NII, NSFR, EVE, IRRBB
- Intuitive user interfaces that support both operational efficiency and strategic oversight.
The Future
Sustainable finance is poised to redefine ALM in 2025 and beyond. As the European Securities and Markets Authority (ESMA) sharpens its focus on Environmental, Social, and Governance (ESG) factors, banks face heightened expectations for climate risk integration. This includes green bond risk analysis, greenwashing prevention, and climate stress testing. Banks must fully embed climate-related financial risks into their ALM practices, ensuring that they remain at the forefront of sustainable finance.
By embracing cutting-edge technology and comprehensive ALM strategies, banks can navigate the complexities of 2025’s financial landscape with agility and confidence.
